# **UNITED STATESSECURITIES 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 31,2004**

 

**OR**

 

**Commission File Number:  0-11518**

 

**PPT VISION, INC.**

(Name of Small Business Issuer in its Charter)

 
| **MINNESOTA**                                                                           | ** ** | **41-1413345**                        |
|-----------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization)                         |       | (I.R.S. Employer  Identification No.) |
|                                                                                    |       |                                  |
| **12988 Valley View Road  Eden Prairie, MN  55344**                           |
| (Address of principal executive offices, including  zip code)                           |
|                                                                                    |       |                                  |
| Registrant’s telephone number, including area  code:  **(952) 996-9500** |
|                                                                                    |       |                                  |
| Securities registered pursuant to Section 12(b)  of the Act:  **None**   |
|                                                                                    |       |                                  |
| Securities registered pursuant to Section 12(g)  of the Act:                       |
| **(1) Common Stock $.10 par value (2)  Preferred Stock Purchase Rights**                |

 

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 such shorterperiod that the registrant was required to file such reports) and (2) has beensubject 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-KSB or anyamendment to this Form 10-KSB.  ý

 

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 21, 2005 was approximately $4.7 million.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

Portionof the Company’s Proxy Statement for its Annual Meeting of Shareholders will befiled within 120 days of October 31, 2004 and are incorporated byreference into Part III of this Form 10-KSB.

 

 

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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 the Company’s expectations, beliefs,intentions and strategies regarding the future. Forward-looking statementsinclude, without limitation, statements regarding the extent and timing offuture revenues and expenses and customer demand. All forward-lookingstatements included in this document are based on information available to theCompany as of the date hereof, and the Company assumes no obligation to updateany 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 capital spendingby 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 calls for a total focus of ourresources on our core 2D machine vision business.  Accordingly, in the quarter we initiated andcompleted the sale of our 3D business unit, together with all the relatedpatents, 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 anddescription of business in this Form 10-KSB have been revised to reflect onlyour continuing operations and all references to our now discontinued 3Dbusiness have been eliminated.

 

**Item 1. DESCRIPTION OF BUSINESS**

 

**CORPORATE PROFILE**

 

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 (OEM’s) 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 (“AIA”) estimates thatthe North American market for machine vision systems in 2003 was approximately$1.245 billion, which was essentially the same as in 2002.  On a global basis, AIA estimated that theworldwide market for machine vision in 2002 was approximately $6.5 billionrepresenting an increase of 13.5% from 2002. The AIA expects the machine visionmarket to grow at approximately 8.8% per year over the next 5 years. Itprojects that the North American market revenues will reach $1.9 billion by2008.  Demand for machine vision systemscomes from end-user manufacturers who apply these systems as an integral partof their manufacturing process, original equipment manufacturers (“OEMs”) whoincorporate machine vision systems into their products, system integrators andmachine builders.

 

The growth of the end-user machine vision market isbeing driven by global competitive trends, which 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. To accomplish these objectives, manufacturers areincreasingly 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 comprehensivediagnostic and 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  corecompetencies, including image acquisition, image processing, applicationdevelopment software, and application expertise, the Company believes it willbe able to meet its objective and successfully implement 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 growingthe number of our selling partners.  Selling partners include distributors, systemintegrators, machine builders, OEM’s 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, the Company’s sales results continueto grow right with it.  Thus, the Companyis focusing 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 Builder software environment.  The Company has successfully deployed severalniche applications in the medical device, electronic component,

 

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packaging, and automotivemarkets, and will continuously target emerging, high value-add nicheapplications.

 

**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. PPT VISION also pioneered theuse of an icon-based visual programming system operating in the Microsoft® WindowsTM environment.Users are able to program the Company’s systems by creating a flowchart oficons linked together rather than having to write a computer program in aprogramming language such as C++ or using a complex menu-based system. Thisresults in lower cost and less time for implementation.

 

**IMPACTTM  T-series Intelligent Camera Family**

 

In fiscal 2004, PPTintroduced the IMPACT T-series intelligent camera family, the industry’s firstintelligent camera with all the features of a full scale-vision system.  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.  With it’s broad family ofproduct offerings, including high-resolution cameras, color cameras, micro-headmodels, and high performance software. IMPACT T-series family is designed to offer the full-scale vision systemfeatures which were not previously available on the market.

 

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 into a sealed industrial unit which 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 seven offerings in the T-seriesfamily, offering manufacturers the most cost-effective solution for a broadrange of machine vision applications.  Anarray of T-series cameras can be installed in a TCPIP network configuration formultiple camera installations.

 

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**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.

 

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

 

Togetherwith the T-series, the IMPACT product family offers the most complete range ofcost-effective options for manufacturers requiring a broad range of machinevision 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 products.  Thesoftware contains the latest innovations in image processing technology plus abroad range of tools for deploying complete solutions in the factoryenvironment.

 

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 areavailable to all users.

 

InspectionBuilder software virtually eliminates the need to use 3rd partypackages for application deployment. This is a unique concept in machine vision applications and has givenmanufacturers a significant advantage in reducing installation time, thusgreatly improving productivity.  Infiscal 2004 several major enhancements were made to Inspection Buildersoftware, including Ethernet IP, a widely utilized fieldbus standard, andActivex controls, for greater dissemination of data across manufacturingenterprises.  In addition, over 20 newimage processing algorithms were added to Inspection Builder software in fiscal2004

 

**Passport DSLTM and Scout DSLTM (DigitalSerial Link)**

 

The Company introduced its completely digital machinevision systems, the patented Passport DSL and Scout DSL systems, in fiscal1998. These products offer an integrated network of cameras, lighting, imageprocessors and hubs that together form a complete machine vision system.

 

The Passport DSL and Scout DSL systems are completelydigital, which results in much greater accuracy and repeatability thantraditional analog systems. These DSL systems feature PPT’s Vision ProgramManagerTM (VPM) software, a powerful, graphical programming interfacethat requires no programming expertise and operates in the Microsoft® WindowsTMenvironment. The Passport DSL and Scout DSL both incorporate a fullyintegrated Pentium-based PC that can be easily added onto a factory network,allowing for a full range of control and monitoring capabilities and an easyway to import or export process information and images. The DSL systems supporta network of up to 16 asynchronously functioning cameras that capturenon-interlaced video images at rates up to 4,000 full frames per minute. Tocomplement the DSL product family, the Company has also developed the DSL5000,DSL5600, DSL6000 and DSL7500 digital cameras.

 

The Company has been working to enhance the price/performancecapabilities of its core 2D product line. In this regard, the Company hasrecently made several enhancements to expand the

 

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applicationsfor the Passport and Scout products. These include enhancements to the Company’sproprietary VPM Software as well as the introduction of new high-resolution,remote head and low-cost digital cameras.

 

**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 andplastics. As of October 31, 2004, the Company had sold more than 5,500machine vision systems to over 350 customers since inception.

 

In the past year, twocustomers each accounted for over 10% of net revenues.  The largest of these customers, Tokyo Weld,Co, Ltd. accounted for 22.9%.  In addition, Simac Masic BVPDC accounted for 10.2% of net revenues. During fiscal 2003, three customers each accounted for over 10% of netrevenues.  The largest of thesecustomers, Tokyo Weld Co., Ltd accounted for 13.8% of net revenues.  In addition, Chrysler Corporation accountedfor 12.8% of net revenues and Simac Masic B.V. accounted for 12.5% of net revenues.  The loss of, or significant curtailment ofpurchases by, any of the Company’s principal customers could have a materialadverse effect on the Company’s results of operations. See Risk Factors – “Weare 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 markets itsproducts through appearances at industry trade shows, advertising in industrytrade journals, articles published in industry and technical journals, its ownwebsite and through direct-selling in specific vertical markets. In addition,the Company’s strong customer relationships serve as valuable references.

 

The Company focuses on delivering a high level ofvalue-added applications engineering support to its end-user customers throughits own in-house applications engineering resources. The Company also providesextensive training opportunities for its customers, either at the Company’sfacilities or on-site at the customer’s facilities.

 

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,** | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|
| United States                   |       | 41         | %          | 49         | %          |
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Europe & Canada             |       | 20         | %          | 22         | %          |
|                            |       |       |       |       |       |
| Asia-Pacific                    |       | 38         | %          | 28         | %          |
|                            |       |       |       |       |       |
| South America                   |       | 1          | %          | 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. The

 

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Companybelieves that maintaining as short a time as practical for delivery is acompetitive 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 three core competencies: image acquisition, imaging processing,and application development software. The Company believes that the integration of these core competencies isessential to achieving long term success in the machine vision market. TheCompany’s three core competencies can 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 applications along with mechanicalfixturing for mounting camera and lighting components, networking andprogrammable controllers for process control, and reject mechanisms forejection 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 completemachine vision systems. The Company’s current research and development effortsare directed to increasing performance in image acquisition, image processingand application development software, which could produce systems with greaterspeed and accuracy while also providing customers with more expanded softwaretools.  Key software products underdevelopment will enable support for different hardware and user interfaces, aswell as increasing the development speed of application specific softwaretools. The Company also intends to expand its offerings of application-specificsoftware and hardware products for the industries it identifies as being poisedto exhibit significant growth in demand for machine vision solutions, whichincludes electronics and semiconductors.

 

Research and development expenditures were $1.6million, and $2.2 million in the fiscal years ended October 31, 2004, and2003, respectively.  We expect thesecosts to decrease slightly in fiscal 2005.

 

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**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 same general market. There can be no assurances thatthe Company would be able to compete with similar products produced by acompetitor.

 

**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.

 

A number of users of machine-vision technology havereceived notice of alleged patent infringement from, or have been sued by, theLemelson Medical, Education and Research Foundation Limited Partnership (“LemelsonFoundation”) alleging that their use of machine-vision technology in theirproduction processes infringes certain patents issued to Jerome H. Lemelson.Certain of these users have

 

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notifiedthe Company that, in the event it is subsequently determined that their use ofthe Company’s products in their production processes infringes any of Mr.Lemelson’s patents, they may seek indemnification from the Company for damagesor expenses resulting from this matter. The Company believes that it hasdefenses to such indemnification claims. To date, the Company has received noactual claims for indemnification. The Company cannot predict the outcomes fromthe claims of alleged infringement made by the Lemelson Foundation or theeffect of such outcomes on the operating results of the Company.

 

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 hasfiled for federal registration of additional trademarks and intends to continueto do so in the future. Although no assurance can be given as to the strengthor scope 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 15, 2005, the Company had 58 full-timeemployees, including 18 employees in research and development, 21 in sales,marketing and application engineering, 13 in manufacturing and 6 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 be madein the Company’s other reports filed under the Securities Exchange Act of 1934,in its press releases and in other documents. In addition, from time to timethe Company, through its management, may make oral forward-looking statements.

 

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:

 

**RISK FACTORS**

 

**We have incurred losses in each ofthe last three years.**  The Company has incurred net losses and negative cash flowsfrom operating activities in each of the past three years and has anaccumulated deficit of $31.5 million at October 31, 2004. In 2004, our netloss was $1.9 million.  In 2003, our net loss was $4.1 million. In 2002,our net loss was $6.9 million.  Inaddition, the Company expects to incur losses and negative cash flows for atleast the next several fiscal quarters. The Company believes that the amount of the losses will be substantiallysmaller than in recent fiscal years.

 

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 31,2004, we had a cash balance of approximately $2.6 million, working capital of$4.4 million 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

 

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beavailable on acceptable terms or at all, and the failure to obtain additionalcapital as needed may have an adverse effect on the Company’s ability tocontinue to take advantage of future opportunities or respond to competitivepressures or unanticipated requirements, which could adversely affect itsbusiness, 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, we cannot guarantee that this system willsuccessfully compete in this market.

 

**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 2004, two customers each accounted for over 10% of ournet revenues. The largest of these customers, Tokyo Weld, Co, Ltd.accounted for 22.9% ofnet revenues.  In addition, Simac MasicBV PDC accounted for 10.2% of net revenues. During fiscal 2003, three customers each accounted for over 10% of netrevenues.  The largest of thesecustomers, Tokyo Weld Co., Ltd accounted for 13.8% of net revenues whileChrysler Corporation accounted for 12.8% of net revenues and Simac Masic B.V.accounted for 12.5% of net revenues.  Wedo not have in effect long-term agreements with these customers under whichthey agree to continue purchasing significant quantities of our products.

 

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 thefourth quarter of fiscal 2004.  While wewere able to effectively replace these sales with sales to other customers inthe fourth quarter of fiscal 2004, thereby broadening our overall customerbase, we may not be able to achieve the level of revenues in the first severalquarters of fiscal 2005 that we achieved in the first several quarters offiscal 2004.

 

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

 

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characterizedby the existence of a large number of patents and frequent litigation forfinancial gain based on patents with broad, and often questionable,applications. As the number of our products increases, the markets in which ourproducts are sold expand and the functionality of those products grows andoverlaps with products offered by competitors. We have been sued for patentinfringement in the past and may be subject to patent infringement claims inthe future. In addition to being expensive and time consuming for us,protracted litigation to defend or to prosecute intellectual property couldresult in some customers deferring or limiting their purchase of our productuntil resolution of the litigation. Although we do not believe that any of ourproducts or proprietary rights infringe upon the valid rights of third parties,we cannot guarantee that infringement claims will not be asserted against us inthe future or that any such claims will not require us to enter into royaltyarrangements or result in costly 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. The failureby one or more of these subcontractors to deliver quality components in atimely 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 ending October 31, 2004, and 2003,sales of our products to customers outside of the United States accounted forapproximately 59%, and 51%, 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 not have a material adverse effect on our futureinternational 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 netoperating loss if we fail to generate sufficient taxable income.**The utilization of  net operating loss carryforward is dependentupon our ability to generate sufficient taxable income during the carryforwardperiod. In fiscal 2004, there was no tax provision due to the net loss for theperiod. At October 31, 2004, we had available federal and state netoperating loss and tax credit

 

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carryforwardsfor income tax purposes of approximately $28.8 million, $8.5 million and $1.3million respectively. These carryforwards expire in the years ending October 31,2005 through October 31, 2024.

 

**Failure to meet the Nasdaq SmallCap MarketRequirements*.* **On November 2, 2004the Company was informed by Nasdaq that the bid price of the Company’s commonstock had closed below the minimum $1.00 per share requirement for continuedinclusion under Marketplace Rule 4310(c)(4) (the “Rule”).  The Company hasbeen provided 180 calendar days, or until May 2, 2005, to regain compliance.  If, at anytime before May 2, 2005, the bidprice of the Company’s common stock closes at $1.00 per share or more for aminimum of 10 consecutive business days, Nasdaq will provide writtennotification that the Company complies with the Rule.  Nasdaq may grant anadditional 180-day grace period if, at the end of the initial grace period, theCompany meets the Nasdaq SmallCap Market initial listing criteria as set forthin Marketplace Rule 4310(c), except for the bid price requirement.  If the Company is unable to achievecompliance with the minimum bid requirements, and its stock is desisted fromthe Nasdaq system, the liquidity for the Company’s stock may be impaired.

 

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

 

Theexecutive officers of the Company are as follows:

 
| **NAME**              | ** ** | **AGE** | ** ** | **POSITION**                   | ** ** |
|-----------------------|------------|---------|------------|--------------------------------|------------|
| Joseph C. Christenson |       | 46      |       | President,  Director           |       |
| David L. Friske       |       | 60      |       | Vice President,  Manufacturing |       |
| Timothy C. Clayton    |       | 50      |       | Chief Financial  Officer       |       |

 

**Joseph C. Christenson**has been President of the Company since January 1989and a director since December 1987. Prior to being elected President ofthe Company, Mr. Christenson served in a series of positions of increasingresponsibility since joining the Company in 1985. Mr. Christenson has a Mastersin Business Administration from the University of Michigan and a Bachelor ofArts 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.

 

**Timothy C. Clayton**was elected Chief Financial Officer ofthe Company in November 2002. Mr. Clayton serves as a consultant to theCompany and is a principal of the firm Emerging Capital, a financial consultingand merger and acquisition advisory firm that he founded in September 2000.From November 1997 until May, 2000, Mr. Clayton was Executive VicePresident, Chief Financial Officer and Treasurer of Building One Services Corp.Prior to Building One Services, Mr. Clayton was a partner with PriceWaterhouse, LLP.

 

Mr. Christenson and Mr. Friske serve as full timeemployees of the Company.  Mr. Claytondevotes such time as is necessary to fulfill his duties as Chief FinancialOfficer.

 

**Item 2. DESCRIPTION OF PROPERTY**

 

The Company entered into a ten-year lease in May 1999for approximately 59,000 square feet of office and manufacturing space in EdenPrairie, Minnesota. The lease commenced on June 1, 1999 at an initialmonthly rate of approximately $51,000. During fiscal 2004 the monthly rateincreased to $54,700.  The lease includesa provision that enables the landlord to require us to take an additional21,000 square feet of space in July, 2005. The monthly rent on this space would be approximately $19,000.  This space is currently occupied by anothercompany and negotiations are underway to extend the term of its lease on thatspace.  There can be no assurances,however, that these negotiations will be successful and that we will not berequired to assume the responsibility for this additional space.  Our lease also includes a terminationprovision that enables us to terminate our lease effective May of 2006.  The termination fee is $500,000.  It is the Company’s intention to exercisethis termination provision unless we can successfully negotiate a

 

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restructuringof our existing lease agreement.  We haveinitiated discussions with our landlord in this regard.  The Company also leases space for itsregional sales and support offices in Michigan.

 

**Item 3. LEGAL PROCEEDINGS**

 

None

 

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

 

None

 

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**PART II**

 

**Item 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERSAND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES**

 

**PRICE RANGE OF COMMON STOCK**

 

The Company’s Common Stock trades on the Nasdaq SmallCap Market under the symbol “PPTV”. The following table sets forth the high andlow closing sale prices of the Company’s Common Stock as reported by Nasdaq forthe years listed below:

 
| ** **                                  | ** ** | **HIGH** | ** ** | **LOW** | ** ** |
|---------------------------------------------|------------|----------|------------|---------|------------|
| **FISCAL YEAR ENDED OCTOBER 31, 2004** |       |     |       |    |       |
| First Quarter                               |       | $        | 1.90       |    | $          | 1.05 |   |
| Second Quarter                              |       | 1.97     |       | 1.22    |       |
| Third Quarter                               |       | 1.46     |       | 1.07    |       |
| Fourth Quarter                              |       | 1.29     |       | 0.60    |       |
|                                        |       |     |       |    |       |
|                                        |       |     |       |    |       |
| **FISCAL YEAR ENDED OCTOBER 31, 2003** |       |     |       |    |       |
| First Quarter                               |       | $        | 0.85       |    | $          | 0.45 |   |
| Second Quarter                              |       | 0.77     |       | 0.43    |       |
| Third Quarter                               |       | 0.80     |       | 0.51    |       |
| Fourth Quarter                              |       | 1.58     |       | 0.62    |       |

 

**HOLDERS**

 

On January 9, 2005, 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 cashdividends on its Common Stock. The Company currently intends to retain anyearnings for use in its operations and expansion of its business and thereforedoes not anticipate paying any cash dividends in the foreseeable future.

 

**ISSUER PURCHASES**

 

The Company did not repurchase any equity securitiesduring the quarter ended October 31, 2004.

 

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

 

During the fourth quarter of fiscal 2004, the Companyimplemented a revised operating strategy which calls for a total focus of ourresources on our core 2D machine vision business.  Accordingly, in the fourth quarter weinitiated and completed the sale of our 3D business unit, together with all therelated 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 a historicalbasis as a separate line in our income statements and balance sheets entitled “DiscontinuedOperations”.  Our continuing operationsrepresent our 2D business only.  Allreferences to financial information in this Management’s Discussion andAnalysis or Plan of Operations

 

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havebeen revised to reflect only our continuing operations and all references toour now discontinued 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 basis for makingjudgments about the carrying values of assets and liabilities. Actual resultscould 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,specifically the allowance for doubtful accounts and 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 alsorecognizes revenue on products sold to distributors upon shipment becausecontracts with distributors do not include post-shipment obligations or anyright of return provisions and pricing is fixed at the time of sale. Revenuerelated to application engineering, product development and customer trainingservices is recognized 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 ourcustomers were to deteriorate, or if actual product demand or market conditionsare less favorable than anticipated by management, additional reserves may berequired.

 

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

 

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impairmentto be recognized is measured by the amount by which the carrying amount of theassets exceeds 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 valuewas expensed as a cost associated with this sale.

 

**RESULTS OF OPERATIONS**

 

**Comparison of Year Ended October 31, 2004 to Year Ended October 31,2003**

 

**NetRevenues**increased 15.6% to $8.7 million in fiscal 2004 from$7.5 million in fiscal 2003. Unit sales of the Company’s machine vision systemsincreased to 989 in fiscal 2004 from 492 in fiscal 2003. Net revenues increaseddue to an upturn in the level of purchases of capital equipment in the manufacturingsector of the global economy and specifically in the electrical connectorsegment of the economy and due to an increased acceptance of the Company’s newIMPACT 2D vision system.  The mostsignificant increase was in sales to a large OEM customer who sells productinto the electrical connector market. Sales to this customer increased by 92% over sales to this customer infiscal 2003 and represented approximately 23% of our total sales for fiscal2004.  In late fiscal 2004, we wereinformed by this customer that it would most likely not purchase any additionalproducts from us and we did not receive any orders or ship any product to themin the fourth quarter of fiscal 2004. This customer had purchased our older analog products which we were inthe process of phasing out.  While wewere able to effectively replace these sales with sales to other customers inthe fourth quarter of fiscal 2004, thereby broadening our overall customerbase, we may not be able to achieve the level of revenues in  fiscal 2005 that we achieved in fiscal 2004.

 

The Company sold almost 700 IMPACT units in fiscal2004 as compared with 200 IMPACT units in fiscal 2003. The significant growthin our IMPACT sales indicates strong acceptance of these products in the marketand we expect that sales of our IMPACT units will grow and replace the sales ofour other machine vision systems.  Averageselling prices in fiscal 2004 were 40% lower on a per unit basis when comparedto fiscal 2003, due to the fact that a significant portion of our sales infiscal 2004 were related to our new IMPACT C-series product which has a loweraverage selling price than our other systems. This trend reflects an overall trend in the machine vision industry formore powerful yet lower priced machine vision systems.  We expect the trend of lower average sellingprice to continue in the next fiscal year.

 

**Gross Profit**improved 10.7% to $4.5 million in fiscal2004 from $4.1 million in fiscal 2003. Gross profit as a percentage of netrevenues for fiscal 2004 decreased to 52.1% compared to 54.4% in fiscal 2003.The increase in gross profit dollars reflects the overall higher revenue levelsachieved by the Company in fiscal 2004. The slight decrease in the gross profit margin is primarily as a resultof the increase in the level of sales in fiscal 2004 to a large OEM customerwho receives favorable pricing related to volume purchases.

 

**Sales and Marketing Expenses**decreased 3.6% to $2.8 million in fiscal2004, compared to $2.9 million in fiscal 2003. This decrease is the result ofcost-control measures implemented during last fiscal year.  As a percentage of net revenues, fiscal 2004selling and marketing expenses decreased to 32.3%, compared with 38.7% infiscal 2003. The percentage decrease reflects both the increase in revenues aswell as the cost reductions.

 

**General and Administrative Expenses**decreased 29.5% to $1.1 million in fiscal 2004,compared to $1.6 million in fiscal 2003. As a percentage of net revenues,general and administrative expenses decreased to 13.2% for fiscal 2004,compared to 21.6% for fiscal 2003.  Thisdecrease is primarily the result of lower salaries and related costs as theresult of workforce reductions that were implemented in the second and thirdquarter of fiscal 2003.  In addition,expenses were lower in fiscal 2004 for severance, bad debts, travel, depreciationand patent amortization.

 

**Research and Development Expenses**decreased 24.8% to $1.6 million in fiscal2004, from $2.2 million in fiscal 2003. Research and development expenses as apercentage of net revenues for fiscal 2004 decreased to 18.8%, compared to28.9% for fiscal 2003. The decrease in research and development

 

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spendingreflects the Company’s work force reduction actions taken last year as well ascontinuing efforts to control operating costs while still supporting anaggressive new product development activities for the IMPACT product family.

 

**Income Taxes:**There was no tax provision or benefit forfiscal 2004 or 2003 due to the net losses in the periods.

 

**Loss from Discontinued Operations** of$817,000 in fiscal 2004 is made up of a gain from the results of thediscontinued operations for the year of $234,000 and a loss from the sale ofthe 3D business unit of $1,051,000.  Infiscal 2003, the loss from discontinued operations of $1,513,000 was onlyrelated to the operating results of that unit. The improvement in the operating results of the 3D business unit infiscal 2004 is due an increase in engineering services revenues in fiscal 2004which resulted in a $789,000 improvement in the gross profit of that unit.  In addition, in fiscal 2003 we stoppedmanufacturing one of our 3D products which enabled us to reduce our 3D relatedoperating costs (including the shut down related costs) by approximately$958,000.  The loss from the sale of the3D business unit reflects difference between the sales price of $1.0 millionand the asset values of that unit of approximately $2.0 million.  We also incurred $38,000 of costs associatedwith the sale of the business.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

As of October 31, 2004, the Company had cash of$2.6 million as compared with $2.1 million as of the end of last fiscal year.Due to its continuing losses, the Company has been using its existing cash andcash equivalents 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 2003 and fiscal 2002, the Companycompleted a Shareholder Rights Offering which in the aggregate resulted in theissuance of approximately 5.6 million shares of Common Stock and raised netproceeds of approximately $5.4 million.

 

The Company believes that cash generated fromoperations together with the cash provided by the sale of the 3D business unitand the Shareholder Rights Offering will be sufficient to provide the cashnecessary to meet its operating, working capital and capital resourceobligations through the second quarter of fiscal 2006. The Company believesthat it may need to obtain additional financing thereafter to fund the workingcapital needs of its operating plan which anticipates revenue growth.

 

Because we have working capital of $4.4 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,  orcustomer-sponsored research and development projects.

 

The Company financed its operations during fiscal 2004through existing cash and cash equivalents and in part from the proceeds of thesale of the 3D business unit. Net cash used in operating activities duringfiscal 2004 was $372,000, a significant decrease from $1.6 million used inoperations in fiscal 2003.  Accountsreceivable decreased $88,000 primarily due to strong collections. Inventoriesincreased $113,000 during fiscal 2004 due to growth in the sales of the IMPACTvisions system.  Accounts payable andaccrued expenses increased by $256,000 due to an increase in deferred rent andas the result of a slow down in payments to vendors.

 

Net cash provided by investing activities was $646,000in fiscal 2004, primarily related to the proceeds from the sale of the 3D businessunit, offset by fixed asset additions of $112,000. During fiscal 2003, fixedasset additions totaled $111,000.  Weexpect fixed asset additions in fiscal 2005 to be approximately the same as infiscal 2004.

 

Net cash provided by financing activities was $115,000for fiscal 2004, primarily from the sale of stock to employees through ourEmployee Stock Purchase Plan.  In fiscal2003 the Company generated $1.2 million of cash primarily from the exercise ofwarrants that were issued in connection with our Shareholder Rights Offering.

 

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The Company incurred a net loss of $1,872,000 forfiscal 2004, and has an accumulated deficit of $31.5 million as of October 31,2004. 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 such arrangements.

 

The Company entered into a ten-year lease in May 1999for approximately 59,000 square feet of office and manufacturing space in EdenPrairie, Minnesota. The lease commenced on June 1, 1999 at an initialmonthly rate of approximately $51,000. During fiscal 2004 the monthly rateincreased to $54,700.  The lease includesa provision that enables the landlord to require us to take an additional 21,000square feet of space in July, 2005.  Themonthly rent on this space would be approximately $19,000.  This space is currently occupied by anothercompany and negotiations are underway to extend the term of their lease on thatspace.  There can be no assurances,however, that these negotiations will be successful and that we will not berequired to assume the responsibility for this additional space.  Our lease also includes a terminationprovision that enables us to terminate our lease effective May of 2006.  The termination fee is $500,000.  It is the Company’s intention to exercisethis termination provision unless we can successfully negotiate a restructuringof our existing lease agreement.  We haveinitiated discussions with our landlord in this regard.

 

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

 
| 2005  |   | $       | 783,000   |   |
|-------|--------|---------|-----------|--------|
| 2006  |   | 847,000 |      |
| 2007  |   | 837,000 |      |
| 2008  |   | 837,000 |      |
| 2009  |   | 488,000 |      |
| Total |   | $       | 3,792,000 |   |
|       |        |         |           |        |  |

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

 

In December 2002,the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation -Transition and Disclosure.”  SFAS No. 148is an amendment 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 amendments are effective for financialstatements for fiscal years ending after December 15, 2002 and for theinterim periods beginning after December 15, 2002.  The Company adopted the annual disclosureprovisions of SFAS No. 148.  The Companychose not to adopt the voluntary change to the fair value based method ofaccounting for stock-based employee compensation, pursuant to SFAS No. 148,which, if adopted, could have a material effect on the Company’s financialstatements.

 

In December 2003, FASBissued FASB Interpretation No. 46R, “Consolidation of Variable InterestEntities” (FIN 46R).  FIN 46R states that companies that have exposure tothe economic risks and potential rewards from another entity’s assets andactivities have a controlling financial interest in a variable interest 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 allvariable interest entities by the end of the first reporting period endingafter March 15, 2004, for enterprises that are not small

 

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business issuers or December 15, 2004 forenterprises that are small business issuers. The Company does not expect the adoption of FIN 46R to have a materialeffect on its financial statements.

 

In November 2004, FASBissued SFAS No. 151 “Inventory Costs” amends the guidance in ARB No. 43,Chapter 4 “Inventory Pricing,”  toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs, and wasted material (spoilage). Paragraph 5 pf ARB 43, Chapter4, previously stated that under some circumstances, items such as idle facilityexpense, excessive spoilage, double freight, and rehandling 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 inventorycosts incurred during fiscal years beginning after June 15, 2005. Earlierapplication is permitted for inventory costs incurred during fiscal yearsbeginning after the date SFAS No. 151 was issued. SFAS No. 151 shall be appliedprospectively.  The Company does notexpect the adoption of SFAS No. 151 to have a material effect on its financialstatements.

 

In December 2004, FASBissued SFAS No. 153 “Exchanges of Nonmonetary Assets” 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. 153 amends APB No. 29to eliminate the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetaryassets that do not have commercial substance. A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange.  SFAS No. 153 shall be effective fornonmonetary asset exchanges occurring in fiscal periods beginning after June 15,2005. Earlier application is permitted for nonmonetary asset exchangesoccurring in fiscal periods beginning after the date SFAS No. 153 was issued.SFAS No. 153 shall be applied prospectively. The Company does not expect the adoption of SFAS No. 153 to have amaterial effect on its financial statements.

 

In December 2004, FASBissued SFAS No. 123 (revised 2004), “Share-Based Payment”, that focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions. This statement replaces SFAS No. 123, “Accounting for Stock-BasedCompensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issuedto Employees.”  Beginning with ourquarterly period that begins February 1, 2006, we will be required toexpense the fair value of employee stock options and similar awards.  As a public company, we are allowed to selectfrom two alternative transition methods, each having different reportingimplications.  The impact of SFAS No.123R has not been determined at this time.

 

**EFFECTS OF INFLATION**

 

The Company believes that the effect of inflation hasnot been material during each of the years ended October 31, 2004, and2003.

 

**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 31,2004 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, 2004, 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.

 

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**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.  At October 31, 2004, the Company had noforeign 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**

 

In a Form 8-K dated July 1, 2003 the Companyannounced that it had changed its independent accountants**.**

 

**Item 8A. CONTROLS AND PROCEDURES**

 

**(a)****                                 ****Evaluation of Disclosure Controls andProcedures.**

 

The Company’s Chief Executive Officer, JosephChristenson, and Chief Financial Officer, Timothy Clayton, have reviewed theCompany’s disclosure controls and procedures as of the end of the periodcovered by this report. Based upon this review, these officers believe that theCompany’s disclosure controls and procedures are effective in ensuring thatmaterial information related to the Company is made known to them by otherswithin the Company.

 

**(b)****          ****Changes in InternalControls Over Financial Reporting.**

 

There have been no significant changes in internalcontrol over financial reporting that occurred during the fiscal period coveredby this report that have materially affected, or are reasonably likely tomaterially affect, the registrant’s internal control over financial reporting.

 

**Item 8B.OTHER INFORMATION**

 

None

 

20

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**PART III**

 

**Item 9. DIRECTORS AND EXECUTIVE OFFICERS, OF THE REGISTRANT**

 

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 “2005Proxy Statement”), a definitive copy of which will be filed within 120 days of October 31,2004 and is incorporated herein by reference. Information concerning executive officers is set forth in the Section entitled“Executive Officers of the Company” in the 2005 Proxy Statement and isincorporated herein by reference.

 

Information concerning compliance with Section 16(a)is contained in the section entitled “Compliance with Section 16(a)of the Securities Exchange Act of 1934,” and is incorporated herein byreference.  Information concerning the Company’sCode of Ethics is included in the Section entitled “Other InformationRegarding the Board of Directors,” 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 2005 Proxy Statement and is incorporated herein by reference.

 

**Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDERS MATTERS**

 

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 2005 Proxy Statement and is incorporated herein byreference.

 

Information required under this Item with respect tostock ownership under equity compensation plans is contained in the section entitled“Equity Compensation Plan Information” in the Company’s 2005 Proxy Statementand is incorporated herein by reference.

 

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

 

Information required under this item is contained inthe section entitled “Certain Transactions” in the Company’s 2005 ProxyStatement and is incorporated herein by reference.

 

**Item 13. EXHIBITS**

 

**(a) Documents filed as Part of thisReport**

 

(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 31,2004 and 2003

Balance Sheets as of October 31, 2004 and 2003

Statements of Cash Flows for the Years ended October 31,2004 and 2003

Statements of Shareholders’ Equity for the Years endedOctober 31, 2004 and 2003

Notes to Financial Statements

 

21

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(2)LISTING OF EXHIBITS

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                          |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Restated Articles of Incorporation of PPT Vision,  Inc. (incorporated by reference to Exhibit 3.1 of 2002 Form 10-KSB)                                                                                                                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.2             |       | By-Laws  of PPT Vision (incorporated by reference to Exhibit 3.2 of 1996 Form 10-K)                                                                                                                                                                                                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 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  10.5 of 2002 Form 10-KSB)                                                                                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 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)                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.6            |       | 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)                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 21              |       | The  Company has no subsidiaries                                                                                                                                                                                                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 23.1            |       | Consent  of Virchow, Krause & Company, LLP                                                                                                                                                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.1            |       | Certification  of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act and Rules 13a-14  and 15d-14 of the Exchange Act.                                                                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.2            |       | Certification  of 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 and CFO Pursuant to Section 906  of the Sarbanes-Oxley Act and 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                                    |

 

----

*Indicatescompensatory plan

 

22

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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 2005 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 31, 2005 | ** **           | **By:** | **/s/Joseph C. Christenson** |   |
|                          |                 |   | Joseph  C. Christenson |
|                          |                 |   (Principal  Executive 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 signany or 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 31, 2005 | **/s/ Joseph C. Christenson**       |   |
|------------------------------|-------------------------------------|--------|
|                         | Joseph C. Christenson               |   |
|                         | President, Director                 |   |
|                         | (Principal Executive Officer)       |   |
|                         |                                |   |
| Date:  January 31, 2005 | **/s/ Timothy C. Clayton**          |   |
|                         | Timothy C. Clayton                  |   |
|                         | Chief Financial Officer             |   |
|                         | (Principal Accounting Officer)      |   |
|                         |                                |   |
| Date:  January 31, 2005 | **/s/ Robert W. Heller, Director**  |   |
|                         | Robert W. Heller, Director          |   |
|                         |                                |   |
| Date:  January 31, 2005 | **/s/ David C. Malmberg, Director** |   |
|                         | David C. Malmberg, Director         |   |
|                         |                                |   |
| Date:  January 31, 2005 | **/s/ Peter R. Peterson, Director** |   |
|                         | Peter R. Peterson, Director         |   |
|                         |                                |   |
| Date:  January 31, 2005 | **/s/ Benno G. Sand, Director**     |   |
|                         | Benno G. Sand, Director             |   |

 

23

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

Shareholders, AuditCommittee and Board of Directors

PPT VISION, Inc.

Eden Prairie, Minnesota

 

We have audited theaccompanying balance sheets of PPT VISION, Inc. as of October 31, 2004 and2003 and the related statements of operations, shareholders’ equity and cashflows for the years then ended.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of PPT VISION, Inc. as of October 31,2004 and 2003 and the results of its operations and its cash flows for theyears then ended in conformity with U.S. generally accepted accountingprinciples.

 
| /s/ Virchow,  Krause & Company, LLP |   |
|-----------------------------------------|--------|
|                                    |
| Minneapolis,  Minnesota                 |
| November 23,  2004                 |

 

24

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**STATEMENTS OF OPERATIONS**

 
| **YEAR ENDED OCTOBER 31,**           | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|
| Net revenues                         |       | $          | 8,671,000  |       | $          | 7,501,000 |   |
| Cost of sales                        |       | 4,154,000  |       | 3,419,000  |       |
| Gross profit                         |       | 4,517,000  |       | 4,082,000  |       |
| Expenses:                            |       |       |       |       |       |
| Sales and marketing                  |       | 2,797,000  |       | 2,902,000  |       |
| Research and development             |       | 1,631,000  |       | 2,168,000  |       |
| General and administrative           |       | 1,144,000  |       | 1,622,000  |       |
|                                 |       |       |       |       |       |
| Total expenses                       |       | 5,572,000  |       | 6,692,000  |       |
| Loss from continuing operations      |       | (1,055,000 | )          | (2,610,000 | )          |
| Loss from discontinued operations    |       | (817,000   | )          | (1,513,000 | )          |
| Net loss                             |       | $          | (1,872,000 | )          | $          | (4,123,000 | ) |
| Basic and diluted loss per share:    |       |       |       |       |       |
| Loss from continuing operations      |       | $          | (0.09      | )          | $          | (0.25 | ) |
| Loss from discontinued operations    |       | $          | (0.07      | )          | $          | (0.15 | ) |
| Net loss                             |       | (0.16      | )          | (0.40      | )          |
| Weighted average shares outstanding: |       |       |       |       |       |
| Basic and diluted                    |       | 11,877,570 |       | 10,253,975 |       |

 

Theaccompanying notes are an integral part of the financial statements.

 

25

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**BALANCE SHEETS**

 
| **OCTOBER 31,**                                                                                                                   | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| ASSETS                                                                                                                            |       |        |       |        |       |
| Current assets                                                                                                                    |       |        |       |        |       |
| Cash and cash equivalents                                                                                                         |       | $           | 2,617,000  |        | $          | 2,086,000 |   |
| Accounts receivable, net                                                                                                          |       | 1,912,000   |       | 2,000,000   |       |
| Inventories                                                                                                                       |       | 977,000     |       | 864,000     |       |
| Other current assets                                                                                                              |       | 243,000     |       | 319,000     |       |
| Assets of discontinued operations                                                                                                 |       | 200,000     |       | —      |       |
| Total current assets                                                                                                              |       | 5,949,000   |       | 5,269,000   |       |
| Property and equipment, net                                                                                                       |       | 323,000     |       | 582,000     |       |
| Intangible assets, net                                                                                                            |       | 109,000     |       | 152,000     |       |
| Assets of discontinued operations                                                                                                 |       | —      |       | 2,391,000   |       |
| Other assets, net                                                                                                                 |       | 53,000      |       | 53,000      |       |
| Total assets                                                                                                                      |       | $           | 6,434,000  |        | $          | 8,447,000 |   |
|                                                                                                                              |       |        |       |        |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                         |       |        |       |        |       |
| Current liabilities                                                                                                               |       |        |       |        |       |
| Accounts payable                                                                                                                  |       | $           | 944,000    |        | $          | 699,000 |   |
| Accrued expenses                                                                                                                  |       | 513,000     |       | 502,000     |       |
| Deferred revenue                                                                                                                  |       | 54,000      |       | 96,000      |       |
| Liabilities of discontinued operations                                                                                            |       | —      |       | 470,000     |       |
| Total current liabilities                                                                                                         |       | 1,511,000   |       | 1,767,000   |       |
|                                                                                                                              |       |        |       |        |       |
| Commitments and contingencies                                                                                                     |       |        |       |        |       |
| Shareholders’ equity                                                                                                         |       |        |       |        |       |
| Preferred stock $.10 par value; authorized 10,000,000 shares, none  issued and outstanding                                        |       |        |       |        |       |
| Common stock $.10 par value; authorized 20,000,000 shares; issued and  outstanding 11,982,362 and 11,802,801 shares, respectively |       | 1,198,000   |       | 1,180,000   |       |
| Capital in excess of par value                                                                                                    |       | 35,177,000  |       | 35,080,000  |       |
| Accumulated deficit                                                                                                               |       | (31,452,000 | )          | (29,580,000 | )          |
| Total shareholders’ equity                                                                                                   |       | 4,923,000   |       | 6,680,000   |       |
| Total liabilities and shareholders’ equity                                                                                   |       | $           | 6,434,000  |        | $          | 8,447,000 |   |

 

Theaccompanying notes are an integral part of the financial statements

 

26

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**STATEMENTS OF CASH FLOWS**

 
| **YEAR ENDED OCTOBER 31,**                                                            | ** ** | **2004**  | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------|------------|------------|------------|
| Net loss                                                                              |       | $         | (1,872,000 | )          | $          | (4,123,000 | ) |
| Adjustment to reconcile net loss to net cash used in operating  activities:           |       |      |       |       |       |
| Depreciation and amortization                                                         |       | 418,000   |       | 829,000    |       |
| Stock based compensation                                                              |       | —    |       | 8,000      |       |
| Loss (income) from discontinued operations                                            |       | (234,000  | )          | 1,513,000  |       |
| Loss on sale of discontinued operations                                               |       | 1,051,000 |       | —     |       |
| Change in operating assets and liabilities:                                           |       |      |       |       |       |
| Accounts receivable, net                                                              |       | 88,000    |       | (279,000   | )          |
| Inventories                                                                           |       | (113,000  | )          | 449,000    |       |
| Other assets                                                                          |       | 76,000    |       | (25,000    | )          |
| Accounts payable                                                                      |       | 245,000   |       | 23,000     |       |
| Accrued expenses                                                                      |       | 11,000    |       | (91,000    | )          |
| Deferred revenue                                                                      |       | (42,000   | )          | 72,000     |       |
| Total adjustments                                                                     |       | 1,500,000 |       | 2,499,000  |       |
| Net cash used in operating activities                                                 |       | (372,000  | )          | (1,624,000 | )          |
| Cash flows from investing activities:                                                 |       |      |       |       |       |
| Purchase of property and equipment                                                    |       | (112,000  | )          | (111,000   | )          |
| Net investment in other long-term assets                                              |       | (4,000    | )          | (15,000    | )          |
| Proceeds from sale of discontinued operations, net of expenses of  $38,000            |       | 762,000   |       | —     |       |
| Net cash provided by (used in) investing activities                                   |       | 646,000   |       | (126,000   | )          |
| Cash flows from financing activities:                                                 |       |      |       |       |       |
| Proceeds from issuance of common stock, net of offering costs                         |       | 115,000   |       | 1,151,000  |       |
| Net cash provided by financing activities                                             |       | 115,000   |       | 1,151,000  |       |
| Net cash provided by (used in) discontinued operations                                |       | 142,000   |       | (247,000   | )          |
| Net increase (decrease) in cash and cash equivalents                                  |       | 531,000   |       | (846,000   | )          |
| Cash and cash equivalents at beginning of year                                        |       | 2,086,000 |       | 2,932,000  |       |
| Cash and cash equivalents at end of year                                              |       | $         | 2,617,000  |       | $          | 2,086,000 |   |
|                                                                                  |       |      |       |       |       |
| 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.

 

27

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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, 2002                                                      |       | 10,067,950         |       | $                 | 1,007,000  |                                 | $          | 34,094,000                 |       | $                                   | (25,457,000 | ) | $ | 9,644,000 |   |
| Stock based compensation                                              |       |               |       |              |       | 8,000                                |       |                       |       | 8,000                               |        |
| Stock issued through the employee stock purchase plan                 |       | 46,141             |       | 4,000             |       | 25,000                               |       |                       |       | 29,000                              |        |
| Stock issued through the exercise of warrants, net of cost of $60,000 |       | 1,688,710          |       | 169,000           |       | 953,000                              |       |                       |       | 1,122,000                           |        |
| Net loss                                                              |       |               |       |              |       |                                 |       | (4,123,000                 | )          | (4,123,000                          | )           |
| October, 31, 2003                                                     |       | 11,802,801         |       | 1,180,000         |       | 35,080,000                           |       | (29,580,000                | )          | 6,680,000                           |        |
|                                                                  |       |               |       |              |       |                                 |       |                       |       |                                |        |
| Stock issued through the employee stock purchase plan                 |       | 170,671            |       | 17,000            |       | 92,000                               |       |                       |       | 109,000                             |        |
| Stock options exercised                                               |       | 8,890              |       | 1,000             |       | 5,000                                |       |                       |       | 6,000                               |        |
| Net loss                                                              |       |               |       |              |       |                                 |       | (1,872,000                 | )          | (1,872,000                          | )           |
| October 31, 2004                                                      |       | 11,982,362         |       | $                 | 1,198,000  |                                 | $          | 35,177,000                 |       | $                                   | (31,452,000 | ) | $ | 4,923,000 |   |

 

The accompanying notes arean integral part of the financial statements.

 

28

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**NOTES TOFINANCIAL STATEMENTS**

**OCTOBER 31,2004 and 2003**

 

**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 (OEM’s) primarily in theelectronic and semiconductor component, automotive, medical device, andpackaged goods industries.

 

**DISCONTINUED OPERATIONS**

 

During the fourth quarter of fiscal 2004, theCompany implemented a revised operating strategy which calls for a total focusof our resources on our core 2D machine vision business.  Accordingly, in the fourth quarter weinitiated and completed the sale of our 3D business unit, together with all therelated 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 financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

**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 theservices are performed.

 

**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.

 

**ACCOUNTS RECEIVABLE**

 

The Company reviews customers’ credit historybefore extending unsecured credit and establishes an allowance for doubtfulaccounts based upon factors surrounding the credit risk of specific customersand

 

29

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otherinformation. Invoices are due net 30 days. Accounts receivable over 60 days are considered past due.  The Company does not accrue interest on pastdue accounts receivable. The Company writes off accounts receivable when they aredeemed uncollectible. Accounts receivable are shown net of an allowance fordoubtful accounts of $81,000 and $163,000 at October 31, 2004 and 2003,respectively.

 

**INVENTORIES**

 

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

 

**PROPERTY AND EQUIPMENT**

 

Property and equipment consist of furniture,fixtures and 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.

 

**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 the carryingamount of an asset may not be recoverable. Recoverability of assets to be heldand used is measured by a comparison of the carrying amount of an asset toundiscounted future net cash flows expected to be generated by the assets. Ifthese assets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets.

 

**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 areexpensed as incurred.

 

**INCOME TAXES**

 

The Company accounts for income taxes usingthe asset and liability approach, which requires the recognition of deferredtax assets and liabilities for tax consequences of temporarydifferences between the financial statement income tax reporting bases ofassets and liabilities based on currently enacted rates and laws. Thesetemporary differences include depreciation, allowance for doubtful accounts,inventory valuation adjustments, accrued expenses and net operating losses.Deferred taxes are reduced by a valuation allowance to the extent thatrealization of the related deferred tax asset is not assured.

 

**ADVERTISING EXPENSE**

 

Advertising expense isexpensed as incurred.  Advertisingexpense was $40,000 and $50,000 for the years ended October 31, 2004 and 2003,respectively.

 

30

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**STOCK-BASED COMPENSATION**

 

The Company uses the intrinsic value methodprescribed by Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations in accounting for employeestock options.  Under the intrinsic valuemethod, compensation expense is recorded only to the extent that the marketprice of the common stock exceeds the exercise price of the stock option on thedate of grant.

 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation - Transition and Disclosure.”  SFAS No. 148is an amendment 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 withrespect to stock options.  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,** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Net loss                           |       | Reported   |       | $        | (1,872,000 | )        | $          | (4,123,000 | ) |
|                               |       | Pro forma  |       | $        | (2,061,000 | )        | $          | (4,387,000 | ) |
| Basic and diluted loss per share   |       | Reported   |       | $        | (0.16      | )        | $          | (0.40 | ) |
|                               |       | Pro forma  |       | $        | (0.17      | )        | $          | (0.43 | ) |

 
| Stock based compensation - as reported |   | — |    | $      | 8,000 |    |
|----------------------------------------|--------|--------|---------|--------|-------|---------|
| Stock based compensation - pro forma   |   | $      | 189,000 |   | $     | 264,000 |   |
|                                        |        |        |         |        |       |         |  |  |

 

The pro forma amounts may not be representative of theeffects on reported net loss for future years. The per share, weighted-average fair value of each option granted iscalculated using the Black-Scholes option-pricing model with the followingweighted-average assumptions used for grants in the following years:

 
| **FISCAL YEAR ENDED OCTOBER 31,** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Risk free interest rates          |       | 4.0      | %          | 4.0      | %          |
| Expected lives                    |       | 7 Years  |       | 7 Years  |       |
| Expected volatility               |       | 156      | %          | 180      | %          |
| Expected dividends                |       | 0        | %          | 0        | %          |

 

**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 December 2003, FASB issued FASBInterpretation No. 46R, “Consolidation of Variable Interest Entities” (FIN46R).  FIN 46R states that companies thathave exposure to the economic risks and potential rewards from another entity’sassets and activities have a controlling financial interest in a variableinterest entity and should consolidate the entity, despite the absence of clearcontrol through a voting equity interest.  The consolidation requirementsapply to all special-purpose entities by the end of the first reporting periodending after December 15, 2003.  FIN 46Rbe applied to all variable interest entities by the

 

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end of thefirst reporting period ending after March 15, 2004, for enterprises that arenot small business issuers or December 15, 2004 for enterprises that are smallbusiness issuers.  The Company does notexpect the adoption of FIN 46R to have a material effect on its financialstatements.

 

In November 2004, FASB issued SFAS No. 151 “InventoryCosts” amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing,”  to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs, and wasted material(spoilage). Paragraph 5 pf ARB 43, Chapter 4, previously stated that under somecircumstances, items such as idle facility expense, excessive spoilage, doublefreight, and rehandling costs may be so abnormal as to require treatment ascurrent period charges.” SFAS No. 151 requires that those items be recognizedas current-period charges regardless of whether they meet the criterion of “soabnormal.” In addition, SFAS No, 151 requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities.  SFAS No.151 shall be effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. Earlier application is permitted for inventorycosts incurred during fiscal years beginning after the date SFAS No. 151 wasissued. SFAS No. 151 shall be applied prospectively.  The Company does not expect the adoption ofSFAS No. 151 to have a material effect on its financial statements.

 

In December 2004, FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” amends APB Opinion No. 29, “Accounting for NonmonetaryTransactions.” APB No. 29 is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. The guidance in that Opinion, however, included certain exceptionsto that principle. SFAS No. 153 amends APB No. 29 to eliminate the exceptionfor nonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance. A nonmonetary exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange.  SFAS No. 153will be effective for nonmonetary asset exchanges occurring in fiscal periodsbeginning after June 15, 2005. Earlier application is permitted for nonmonetaryasset exchanges occurring in fiscal periods beginning after the date SFAS No.153 was issued. SFAS No. 153 shall be applied prospectively.  The Company does not expect the adoption ofSFAS No. 153 to have a material effect on its financial statements.

 

In December 2004, FASB issued SFAS No. 123(revised 2004), “Share-Based Payment”, that focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions.  This statementreplaces SFAS No. 123, “Accounting for Stock-Based Compensation”, andsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”  Beginning with our quarterly period thatbegins February 1, 2006, we will be required to expense the fair value ofemployee stock options and similar awards. As a public company, we are allowed to select from two alternativetransition methods, each having different reporting implications.  The impact of SFAS No. 123R has not beendetermined at this time.

 

**NOTE 2: LIQUIDITY AND CAPITAL RESOURCES**

 

The Company has incurred net losses and negativecash flows from operating activities in each of the past three years and has anaccumulated deficit of $31.5 million at October 31, 2004. During fiscal years2003 and 2002, the Company raised approximately $1.1 million and $4.3 million,respectively, through its Shareholder Rights Offering and subsequent exerciseof warrants to provide for these capital needs. During fiscal 2004 the Company sold its 3D business for $1.0 millionwhich served to strengthen our cash position. As of October 31, 2004, theCompany had $2.6 million of cash, $4.4 million of working capital and nolong-term debt.

 

The Company believes that cash generated fromoperations together with our existing cash balances and other potential sourcesof financing will be sufficient to provide the cash necessary to meet itsoperating, working capital and capital resource obligations through the secondquarter of fiscal 2006. The other sources of financing that are availableinclude sales of its common or preferred stock, external borrowing, customer orvendor financing, customer sponsored research and development projects orinvestments by strategic partners.

 

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**NOTE 3: INVENTORIES**

 

As of October 31, inventories consist of thefollowing:

 
| ** **                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Manufactured and purchased parts |       | $        | 828,000    |     | $          | 595,000 |   |
| Work-in-process                  |       | 105,000  |       | 178,000  |       |
| Finished goods                   |       | 44,000   |       | 91,000   |       |
| Totals                           |       | $        | 977,000    |     | $          | 864,000 |   |

 

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 newly introducedproducts.

 

**NOTE 4: PROPERTY AND EQUIPMENT**

 

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

 
| ** **                    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|
| Equipment                     |       | $          | 3,267,000  |       | $          | 3,176,000 |   |
| Furniture and fixtures        |       | 557,000    |       | 558,000    |       |
|                          |       | 3,824,000  |       | 3,734,000  |       |
| Less accumulated depreciation |       | (3,501,000 | )          | (3,152,000 | )          |
| Totals fixed assets           |       | $          | 323,000    |       | $          | 582,000 |   |

 

Depreciation expense for continuing operations was$371,000 and $719,000 for the years ended October 31, 2004 and 2003,respectively.  During fiscal 2004 and2003, the Company wrote-off fully depreciated properties that were no longer inuse.

 

**NOTE 5: INTANGIBLE ASSETS**

 

Intangible assets at October 31, 2004 and October31, 2003, consisted of the following:

 
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Patent and trademark          |       | $        | 609,000    |     | $          | 629,000 |   |
| Less accumulated amortization |       | (500,000 | )          | (477,000 | )          |
| Totals intangible assets      |       | $        | 109,000    |     | $          | 152,000 |   |

 

Patent and trademark costs are amortized overfive to ten years.  Amortization expensewas approximately $47,000 and $110,000 in the years ended October 31, 2004 and2003, respectively.  Amortization expensefor fiscal 2005, 2006 and 2007 is expected to be approximately $50,000, $50,000and $9,000, respectively.

 

**NOTE 6:  OTHERASSETS**

 

Other assets at October 31, 2004 and October 31,2003, represent an investment of $53,000 in the common stock ofElectro-Sensors, Inc. a related party shareholder of the Company. The Company’spercentage ownership is less than 1% of Electro-Sensors, Inc. outstandingcommon stock. There are no commitments or obligations associated with thisinvestment.  This investment is carriedat cost which approximates market.

 

33

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**NOTE 7: ACCRUED EXPENSES**

 

Accrued expenses at October 31, include:

 
| ** **                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Employee stock purchase plan payroll  deductions |       | $        | 32,000     |     | $          | 46,000 |   |
| Accrued compensation                             |       | 75,000   |       | 78,000   |       |
| Professional Services                            |       | 45,000   |       | 70,000   |       |
| Purchase commitments                             |       | —   |       | 60,000   |       |
| Accrued rent                                     |       | 317,000  |       | 204,000  |       |
| Taxes and other                                  |       | 44,000   |       | 44,000   |       |
| Totals                                           |       | $        | 513,000    |     | $          | 502,000 |   |

 

**NOTE 8: OPERATING LEASES**

 

The Company leases facilities and equipment undernon-cancelable operating lease agreements. The Company leases its primary building under a lease which commenced onJune 1, 1999 at an initial monthly rate of approximately $51,000. During fiscal2004 the monthly rate increased to $54,700. The lease includes a provision that enables the landlord to require usto take an additional 21,000 square feet of space in July, 2005.  The monthly rent on this space would beapproximately $19,000.  Our lease alsoincludes a termination provision that enables us to terminate our leaseeffective May of 2006.  The terminationfee is $500,000.  Rent expense was$716,000 and $702,000 in 2004 and 2003 respectively. Minimum future rentalpayments due under non-cancelable operating lease agreements are as follows(amounts exclude required payments for common area maintenance expenses):

 
| 2005  |   | $       | 783,000   |   |
|-------|--------|---------|-----------|--------|
| 2006  |   | 847,000 |      |
| 2007  |   | 837,000 |      |
| 2008  |   | 837,000 |      |
| 2009  |   | 488,000 |      |
| Total |   | $       | 3,792,000 |   |
|       |        |         |           |        |  |

 

**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, asfollows:

 
| ** **                                           | ** ** | **2004** | ** ** | **2003**  | ** ** |
|------------------------------------------------------|------------|----------|------------|-----------|------------|
| Expected tax benefit at statutory rate               |       | $        | (630,000   | )         | $          | (1,400,000 | ) |
| State income tax benefit, net of federal  tax effect |       | (100,000 | )          | (225,000  | )          |
| Tax credits and other                                |       | 25,000   |       | (25,000   | )          |
| Expiring loss carryforwards                          |       | 320,000  |       | 320,000   |       |
| Increase in valuation allowance                      |       | 385,000  |       | 1,330,000 |       |
| Total income tax expense (benefit)                   |       | $        | —     |      | $          | — |   |

 

Based on an increase in the valuation allowance foreach of the years ended October 31, 2004 and 2003, no benefit for income taxesis applicable for either continuing or discontinued operations.

 

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Deferred tax assets are comprised of the followingat October 31:

 
| **OCTOBER 31,**                                       | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-------------------------------------------------------|------------|-------------|------------|-------------|------------|
| Depreciation and amortization                         |       | $           | 80,000     |        | $          | 250,000 |   |
| Net operating loss carryforwards                      |       | 10,120,000  |       | 9,744,000   |       |
| Income tax credits                                    |       | 1,263,000   |       | 1,288,000   |       |
| Inventory allowances                                  |       | 119,000     |       | 102,000     |       |
| Other                                                 |       | 187,000     |       | —      |       |
| Total deferred tax assets before valuation  allowance |       | 11,769,000  |       | 11,384,000  |       |
| Less valuation allowance                              |       | (11,769,000 | )          | (11,384,000 | )          |
| Net deferred tax asset                                |       | $           | —     |        | $          | — |   |

 

At October 31, 2004, the Company has availablefederal net operating loss, state net operating loss and tax creditcarryforwards for income tax purposes of approximately $28.8 million, $8.5million and $1.3 million, respectively. These carryforwards expire in the yearsending October 31, 2005 through October 31, 2024.  The amount of the federal net operating losscarryforwards that expire in the next five fiscal years are $739,000, $50,000$152,000, $0 and $16,000, respectively. Approximately $0, $26,000, $141,000, $39,000, and $43,000 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**

 

In order to satisfy the Company’s anticipatedworking capital and capital resources needs, the Company initiated andcompleted a Shareholder Rights Offering (“Offering”) during fiscal 2002.  In the Offering, the Board of Directorsauthorized the sale of 5.5 million units at $1 per unit to existingshareholders. Each unit consisted of one share of common stock and a warrant topurchase one-half share of common stock. As a result of the Offering, theCompany issued approximately 4,484,000 shares of common stock and approximately2,242,000 warrants to purchase a share of common stock at $2.50 per share. Thenet proceeds to the Company were approximately $4.3 million after Offeringexpenses.  In the third quarter of fiscal2003 the Board of Directors decided to lower the exercise price of the warrantsissued in connection with the Shareholder Rights Offering to $0.70 pershare.  Warrants to purchase 1.6 millionshares of stock were exercised by the expiration date of September 30,2003.  The net proceeds to the Companywere approximately $1.1 million after expenses. The issuance of the shares of stock and warrants and the related receiptof cash have been reflected in the accompanying financial statements.

 

**STOCK OPTION PLANS**

 

Under the Company’s 2000 Stock Option Plan, 1988Stock Option Plan and 1997 Stock Option Plan the Company may issue options topurchase up to 2,200,000 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.

 

35

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

 
| ** **                  | ** ** | **NUMBER  OF SHARES** | ** ** | **WEIGHTED  AVG.  OPTION PRICE** | ** ** |
|-----------------------------|------------|-----------------------|------------|----------------------------------|------------|
| Balance at October 31, 2002 |       | 842,384               |       | $                                | 2.86       |   |
| Granted                     |       | 388,700               |       | $                                | 0.68       |   |
| Cancelled                   |       | (228,334              | )          | $                                | 2.53       |   |
| Balance at October 31, 2003 |       | 1,002,750             |       | $                                | 2.07       |   |
| Granted                     |       | 141,056               |       | $                                | 1.38       |   |
| Cancelled                   |       | (96,966               | )          | $                                | 3.04       |   |
| Exercised                   |       | (8,890                | )          | $                                | 0.73       |   |
| Balance at October 31, 2004 |       | 1,037,950             |       | $                                | 1.89       |   |

 

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 $5 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, 211,650 stock options were voluntarily cancelled ata weighted average option price of $6.88 and 211,650 stock options weresubsequently granted at an option price of $0.90. This option exchange resultedin variable accounting for 25,000 of the stock options granted under theprogram. Variable accounting will continue until all stock options subject tovariable accounting are exercised, cancelled or forfeited.  In fiscal year ended October 31, 2004, 16,000stock options remain under variable accounting treatment. There was no expenserelated to this variable accounting treatment in fiscal 2004 and an expenseof  $8,000 during fiscal 2003.

 

The estimated weighted average grant-date fair valueof stock options granted is as follows: 2004—$1.38, and 2003 - $0.67.

 

The following table summarizes stock optionsoutstanding and exercisable at October 31, 2004.

 
| ** **                | ** ** | **OUTSTANDING** | ** ** | **EXERCISABLE**                                  | ** ** |
|---------------------------|------------|-----------------|------------|--------------------------------------------------|------------|
| **Exercise  Price Range** | ** ** | **Options**     | ** ** | **Weighted  Avg.  Contractual  Life  Remaining** | ** ** | **Weighted  Avg.  Exercise Price** | ** ** | **Options** | ** ** | **Weighted  Avg.  Exercise Price** | ** ** |
| $ 0.65 - $0.75       |       | 323,000         |       | 5.25                                             |       | $ | 0.68 |   | 119,843 |   | $ | 0.68 |   |
| $ 0.85 - $1.41       |       | 351,350         |       | 4.88                                             |       | $ | 1.11 |   | 271,284 |   | $ | 1.08 |   |
| $ 1.46 - $1.88       |       | 53,000          |       | 6.22                                             |       | $ | 1.59 |   | 0 |   | $ | 0 |   |
| $ 2.13 - $3.34       |       | 52,250          |       | 3.46                                             |       | $ | 2.60 |   | 47,250 |   | $ | 2.55 |   |
| $ 3.56 - $3.88       |       | 165,750         |       | 2.01                                             |       | $ | 3.74 |   | 165,750 |   | $ | 3.74 |   |
| $ 4.43 - $8.70       |       | 92,600          |       | 2.18                                             |       | $ | 5.32 |   | 82,100 |   | $ | 5.37 |   |
|                      |       | 1,037,950       |       | 4.28                                             |       | $ | 1.89 |   | 686,227 |   | $ | 2.27 |   |

 

As of October 31, 2004 there are no warrantsoutstanding.

 

**EMPLOYEE STOCK PURCHASE PLAN**

 

In March 2000, shareholders approved the adoption ofthe 2000 Employee Stock Purchase Plan (the “2000 Plan”) to replace the 1995Employee Stock Purchase Plan (the “1995 Plan”) which by its terms expiredduring 2000. The 2000 Plan was amended in March 2004 to provide for thepurchase of up to 300,000 shares of common stock during a five-year annualoffering period beginning June 1, 2000. Under the terms of the 2000 Plan, eligible employees may purchase commonstock annually 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 last dayof each annual offering period. The 1995 Plan had similar provisions.  In the fiscal years ended

 

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October 31, 2004, and 2003,employees purchased 170,671 and 46,141 shares of stock, respectively.  Through October 31, 2004, 321,119 shares ofstock have been purchased by employees under the 2000 Plan.

 

**NOTE 11: EMPLOYEE SAVINGS PLAN**

 

The Company provides a supplementary retirementsavings plan which 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 currently makes matchingcontributions of one dollar for each dollar contributed by each Planparticipant up to a maximum of $500 annually.

 

The Company’s contributions under this program wereapproximately $25,000, and $36,000 for the years ended October 31, 2004, and2003.  In fiscal 2004 and 2003, $5,000and $21,000, respectively of contributions were funded from accumulatedforfeitures and $20,000 and $15,000, respectively was expensed by the Company.

 

**NOTE 12: SHAREHOLDER RIGHTS PLAN**

 

On June 2, 1999, the Company adopted a ShareholderRights Plan (the “Rights Plan”) designed to deter coercive or unfair takeovertactics and to prevent a person or a group from gaining control of the Companywithout offering a fair price to all shareholders. Under the terms of theRights Plan, a dividend distribution of one Preferred Stock Purchase Right (“Right”)for each outstanding share of the Company’s common stock was made to holders ofrecord on June 22, 1999. These Rights entitle the holder to purchase 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 person orgroup has acquired shares representing 20% or more of the outstanding shares ofcommon stock, or (b) 10 business days following commencement of a tender orexchange offer for 20% or more of such outstanding shares of common stock. TheCompany can redeem the Rights for $0.001 per Right at any time prior to theirbecoming exercisable. The Rights expire on June 2, 2009, unless redeemedearlier by the Company. Under certain circumstances, if a person or groupacquires 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 member ofthe 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 definition ofAcquiring Person, regardless of his share ownership.

 

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**NOTE 13:  NETLOSS PER SHARE**

 

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.

 
| ** **                                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|
| Loss from continuing operations                               |       | $          | (1,055,000 | )          | $          | (2,610,000 | ) |
| Loss from discontinued operations                             |       | (817,000   | )          | (1,513,000 | )          |
| Net loss                                                      |       | $          | (1,872,000 | )          | $          | (4,123,000 | ) |
| Weighted average shares outstanding – basic  and diluted |       | 11,877,570 |       | 10,253,975 |       |
| Basic and diluted loss per share:                             |       |       |       |       |       |
| Continuing operations                                         |       | $          | (0.09      | )          | $          | (0.25 | ) |
| Discontinued operations                                       |       | $          | (0.07      | )          | $          | (0.15 | ) |
| Net loss per share                                            |       | $          | (0.16      | )          | $          | (0.40 | ) |
|                                                               |            |            |            |            |            |  |  |  |

 

For the years ended October 31, 2004, and 2003,options to purchase 1,037,950, and 1,002,750 shares of the Company’s commonstock, respectively, and in fiscal 2003, warrants to purchase 25,000 shares ofthe Company’s common stock, were not included in the calculation of dilutedearnings per share. As the Company had a net loss, the inclusion of theaforementioned shares would have been anti-dilutive.  There are no warrants outstanding at October31, 2004.

 

**NOTE 14: CUSTOMER AND GEOGRAPHIC INFORMATION**

 

**SIGNIFICANT CUSTOMER INFORMATION**

 

During fiscal 2004 revenue from two customersaccounted for 23% and 10% of net revenues. During fiscal 2003 revenue from three customers accounted for 14%, 13%,and 13% of net revenues, respectively.

 

At October 31, 2004 two customers accounted for 16%,and 11% of total accounts receivable.  AtOctober 31, 2003, three customers accounted for 12%, 11%, and 10% of totalaccounts receivable.

 

**CUSTOMER GEOGRAPHIC DATA**

 

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

 
| ** **          | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
| United States       |       | 41       | %          | 49       | %          |
| Europe & Canada |       | 20       | %          | 22       | %          |
| Asia-Pacific        |       | 38       | %          | 28       | %          |
| South America       |       | 1        | %          | 1        | %          |
|                |       | 100      | %          | 100      | %          |

 

**NOTE 15: DISCONTUNUED OPERATIONS**

 

In the fourth quarter of fiscal 2004, theCompany implemented a strategy to focus all of its resources on its core 2Dmachine vision business.  In accordancewith this plan, in the fourth quarter, the Company initiated and completed thesale of its 3D business unit, together with all the related patents,intellectual property, inventory and equipment. The terms of the sale included cash payments of $1.0 million and theopportunity to receive royalties on sales of certain products by the buyer forthe next five years.  As a result of thesale, in accordance with appropriate accounting principles, the Company hasrevised the financial results for all periods presented to include the 3Dbusiness 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 “gain or loss from discontinued operations”.

 

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The following are condensed statements of operations and net assets ofthe discontinued operation:

 

**Statement of Operations**

** **
| ** **                                        | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|---------------------------------------------------|------------|-----------|------------|-----------|------------|
| Revenues                                          |       | $         | 1,939,000  |      | $          | 1,338,000 |   |
| Cost of revenues                                  |       | 378,000   |       | 566,000   |       |
| Gross profit                                      |       | 1,561,000 |       | 772,000   |       |
| Total operating expenses                          |       | 1,327,000 |       | 1,943,000 |       |
| MSD shutdown costs                                |       |      |       | 342,000   |       |
| Net income or loss from operation of 3D  business |       | $         | 234,000    |      | $          | (1,513,000 | ) |
|                                              |       |      |       |      |
| Loss on sale of 3D business:                      |       |      |       |      |
| 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  |      |       |

 

During fiscal 2003, PPT implemented a restructuring plan designed tospecifically focus the Company on its traditional core competencies, improvethe efficiency of its product development and marketing efforts, andsignificantly reduce the Company’s operating cost structure.  Therestructuring plan included the closure of the Microelectronics Systems groupwhich primarily involves the elimination of the PPT861TM  3D inspection product. The costs associatedwith the decision to discontinue the development, sale and manufacture of thePPT861 3D product line totaled $591,000 and include severance costs related to5 positions, inventory and equipment write downs and reductions in the value ofcertain receivables associated with this division.  The portion related to inventory write downsof $249,000 were recorded in Cost of Revenues and the remaining amounts areincluded in MSD Shutdown Costs.

 

Assets and liabilities of the 3D business unit consisted of thefollowing at October 31, 2003:

 
| Accounts receivable           |   | $         | 120,000   |   |
|-------------------------------|--------|-----------|-----------|--------|
| Inventories                   |   | 157,000   |      |
| Properties and equipment, net |   | 126,000   |      |
| Intangible assets, net        |   | 1,988,000 |      |
|                          |   |      |      |
| Total assets                  |   | $         | 2,391,000 |   |
|                          |   |      |      |
| Deferred revenue              |   | $         | 470,000   |   |

 

The only asset of the discontinued 3D business as of October 31, 2004was a receivable from the purchaser of the business in the amount of$200,000.  This amount was received bythe Company in the first quarter of fiscal 2005.

 

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**NOTE 16: QUARTERLY FINANCIAL INFORMATION–UNAUDITED–inthousands**

 
| ** **  | ** ** | **Net  Revenues** | ** ** | **Gross  Profit** | ** ** | **Net Loss** | ** ** | **Basic  and Diluted  Net Loss Per Share** | ** ** |
|-------------|------------|-------------------|------------|-------------------|------------|--------------|------------|--------------------------------------------|------------|
| **Quarter** | ** ** | **2004**          | ** ** | **2003**          | ** ** | **%Change**  | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **%Change** | ** ** | **2004** | ** ** | **2003** | ** ** | **%Change** | ** ** | **2004** | ** ** | **2003** | ** ** | **%Change** | ** ** |
| **First**   |       | $                 | 1,976      |              | $          | 1,442        |       | 37                                         | %          | $ | 904 |   | $ | 686 |   | 32 | % | $ | (345 | ) | $ | (1,187 | ) | 71 | % | $ | (0.03 | ) | $ | (0.12 | ) | 75 | % |
| **Second**  |       | 2,084             |       | 2,036             |       | 2            | %          | 1,114                                      |       | 1,074 |   | 4 | % | (223 | ) | (1,770 | ) | 87 | % | (0.02 | ) | (0.18 | ) | 89 | % |
| **Third**   |       | 2,505             |       | 1,855             |       | 35           | %          | 1,313                                      |       | 983 |   | 34 | % | (243 | ) | (951 | ) | 74 | % | (0.02 | ) | (0.09 | ) | 78 | % |
| **Fourth**  |       | 2,106             |       | 2,167             |       | (3           | )%         | 1,186                                      |       | 1,339 |   | (11 | )% | (1,061 | ) | (215 | ) | (393 | )% | (0.09 | ) | (0.02 | ) | (350 | )% |
| ** **  |       |              |       |              |       |         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total**   |       | $                 | 8,671      |              | $          | 7,500        |       | 16                                         | %          | $ | 4,517 |   | $ | 4,082 |   | 11 | % | $ | (1,872 | ) | $ | (4,123 | ) | 55 | % | $ | (0.16 | ) | $ | (0.41 | ) | 61 | % |

 

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