SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q

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(Check One)



xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended September 30, 2008



oTRANSITION PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT



For the transition period from ______ to ______



COMMISSION FILE NO. (0-16577)



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CYBEROPTICS CORPORATION

(Exact name of registrant as specified in its charter)



Minnesota
        41-1472057(State or other jurisdiction ofincorporation or organization)
        (I.R.S. EmployerIdentification No.)5900 Golden Hills DriveMINNEAPOLIS, MINNESOTA
        55416(Address of principal executive offices)
        (Zip Code)




(763) 542-5000

(Registrants telephone number, including area code)



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

Indicate by check mark
whether the Registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definition of
accelerated filer or large accelerated filer in Rule 12b-2 of the Exchange
Act.

Large accelerated filer oAccelerated filer xNon-accelerated filer o
        Smaller Reporting
Company o

Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No x

Indicate the number of
shares outstanding of each of the issuers classes of common stock, as of the
latest practicable date. At November 5, 2008, there were 6,744,423 shares of
the registrants Common Stock, no par value, issued and outstanding.





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PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS 
CYBEROPTICS CORPORATION 
(Unaudited)

|                                                                                                                                                             |  |                     |        |                    |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------- | ------ | ------------------ | - | ------ | -
|(In
 thousands except share information)                                                                                                                     |  | September 30,
 2008 |        | December 31,
 2007 |  
|                                                                                                                                                             |  |                     |        |                    |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|ASSETS                                                                                                                                                       |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Cash and cash equivalents                                                                                                                                    |  | $                   | 4,277  |                    | $ | 18,864 |  
|Marketable securities                                                                                                                                        |  |                     | 9,759  |                    |   | 11,953 |  
|Accounts receivable, net                                                                                                                                     |  |                     | 10,369 |                    |   | 9,781  |  
|Inventories                                                                                                                                                  |  |                     | 9,990  |                    |   | 10,640 |  
|Other current assets                                                                                                                                         |  |                     | 1,672  |                    |   | 1,466  |  
|Deferred tax assets                                                                                                                                          |  |                     | 2,575  |                    |   | 2,575  |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Total current assets                                                                                                                                         |  |                     | 38,642 |                    |   | 55,279 |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Marketable securities                                                                                                                                        |  |                     | 15,192 |                    |   | 21,801 |  
|Equipment and leasehold improvements, net                                                                                                                    |  |                     | 2,694  |                    |   | 1,944  |  
|Intangible and other assets, net                                                                                                                             |  |                     | 1,001  |                    |   | 1,069  |  
|Goodwill                                                                                                                                                     |  |                     | 4,979  |                    |   | 5,207  |  
|Other assets                                                                                                                                                 |  |                     | 190    |                    |   |       |  
|Deferred tax assets                                                                                                                                          |  |                     | 1,739  |                    |   | 1,739  |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Total assets                                                                                                                                                 |  | $                   | 64,437 |                    | $ | 87,039 |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                         |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Accounts payable                                                                                                                                             |  | $                   | 2,686  |                    | $ | 3,209  |  
|Advance customer payments                                                                                                                                    |  |                     | 640    |                    |   | 794    |  
|Accrued expenses                                                                                                                                             |  |                     | 2,912  |                    |   | 3,337  |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Total current liabilities                                                                                                                                    |  |                     | 6,238  |                    |   | 7,340  |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Other liabilities                                                                                                                                            |  |                     | 1,362  |                    |   | 1,583  |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Total liabilities                                                                                                                                            |  |                     | 7,600  |                    |   | 8,923  |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Commitments and contingencies                                                                                                                                |  |                     |       |                    |   |       |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Stockholders equity:                                                                                                                                        |  |                     |        |                    |   |        |  
|Preferred stock, no par value, 5,000,000 shares
authorized, none
 outstanding                                                                                |  |                     |       |                    |   |       |  
|Common stock, no par value, 37,500,000 shares
authorized, 6,744,423
 shares issued and outstanding at September 30, 2008 and 8,793,059 at December 31,
 2007 |  |                     | 28,959 |                    |   | 49,303 |  
|Accumulated other comprehensive loss                                                                                                                         |  |                     | (432   | )                  |   | (112   | )
|Retained earnings                                                                                                                                            |  |                     | 28,310 |                    |   | 28,925 |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Total stockholders equity                                                                                                                                   |  |                     | 56,837 |                    |   | 78,116 |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  
|Total liabilities and stockholders
equity                                                                                                                   |  | $                   | 64,437 |                    | $ | 87,039 |  
|                                                                                                                                                             |  |                     |        |                    |   |        |  

SEE THE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

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CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS 
CYBEROPTICS CORPORATION 
(Unaudited)

|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|---------------------------------------------- |  | --------------------------------- | ------ | -------------------------------- | - | ------ |  | ---- | ------ | - | - | ------ | 
|                                               |  | Three Months Ended
 September 30, |        | Nine Months Ended
 September 30, |  
|                                               |  |                                   |        |                                  |  
|(In
 thousands, except per share amounts)      |  | 2008                              |        | 2007                             |   | 2008   |  | 2007 |       
|                                               |  |                                   |        |                                  |   |        |  |      |       
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Revenues                                       |  | $                                 | 11,570 |                                  | $ | 16,173 |  | $    | 38,768 |   | $ | 43,888 | 
|Cost of
 revenues                              |  |                                   | 6,578  |                                  |   | 7,910  |  |      | 21,415 |   |   | 21,399 | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Gross margin                                   |  |                                   | 4,992  |                                  |   | 8,263  |  |      | 17,353 |   |   | 22,489 | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Research and
 development expenses             |  |                                   | 2,830  |                                  |   | 2,524  |  |      | 8,002  |   |   | 7,057  | 
|Selling,
 general and administrative expenses  |  |                                   | 3,734  |                                  |   | 3,888  |  |      | 11,029 |   |   | 11,042 | 
|Singapore
 severance and recruitment expenses  |  |                                   | 98     |                                  |   |       |  |      | 476    |   |   |       | 
|Amortization
 of intangibles                   |  |                                   | 46     |                                  |   | 45     |  |      | 136    |   |   | 136    | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Income (loss) from operations                  |  |                                   | (1,716 | )                                |   | 1,806  |  |      | (2,290 | ) |   | 4,254  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Interest
 income and other                     |  |                                   | 276    |                                  |   | 587    |  |      | 1,039  |   |   | 1,705  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Income (loss) before income taxes              |  |                                   | (1,440 | )                                |   | 2,393  |  |      | (1,251 | ) |   | 5,959  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Income tax
 provision (benefit)                |  |                                   | (668   | )                                |   | 920    |  |      | (637   | ) |   | 2,135  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Net income (loss)                              |  | $                                 | (772   | )                                | $ | 1,473  |  | $    | (614   | ) | $ | 3,824  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Net income
 (loss) per share  Basic           |  | $                                 | (0.11  | )                                | $ | 0.17   |  | $    | (0.08  | ) | $ | 0.43   | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Net income
 (loss) per share  Diluted         |  | $                                 | (0.11  | )                                | $ | 0.16   |  | $    | (0.08  | ) | $ | 0.43   | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Weighted
 average shares outstanding  Basic   |  |                                   | 7,208  |                                  |   | 8,924  |  |      | 8,022  |   |   | 8,901  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Weighted
 average shares outstanding  Diluted |  |                                   | 7,208  |                                  |   | 8,991  |  |      | 8,022  |   |   | 8,984  | 
|                                               |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 

SEE THE ACCOMPANYING NOTES TO UNAUDITED
INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

2

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CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS
CYBEROPTICS CORPORATION
(Unaudited)

|                                                                                          |  |                                 |         |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | ---- | - | ------- | -
|                                                                                          |  | Nine Months Ended September 30, |        
|                                                                                          |  |                                 |        
|(In
 thousands)                                                                           |  | 2008                            |         | 2007 |  
|                                                                                          |  |                                 |         |      |  
|                                                                                          |  |                                 |         |      |   |         |  
|CASH FLOWS
 FROM OPERATING ACTIVITIES:                                                    |  |                                 |         |      |   |         |  
|Net income (loss)                                                                         |  | $                               | (614    | )    | $ | 3,824   |  
|Adjustments to reconcile net income to net
 cash provided (used) by operating activities: |  |                                 |         |      |   |         |  
|Depreciation and amortization                                                             |  |                                 | 1,654   |      |   | 1,389   |  
|Provision for doubtful accounts                                                           |  |                                 | (34     | )    |   | 63      |  
|Provision for inventory obsolescence                                                      |  |                                 | 289     |      |   | 293     |  
|Foreign currency transaction (gains)
losses                                               |  |                                 | 176     |      |   | (54     | )
|Stock compensation costs                                                                  |  |                                 | 367     |      |   | 554     |  
|Unrealized loss on available for sale
 equity security                                    |  |                                 | 166     |      |   |        |  
|Realized gains on available for sale
 marketable securities                               |  |                                 | (39     | )    |   |        |  
|Changes in operating assets and
 liabilities:                                             |  |                                 |         |      |   |         |  
|Accounts receivable                                                                       |  |                                 | (554    | )    |   | (3,010  | )
|Inventories                                                                               |  |                                 | (150    | )    |   | (3,442  | )
|Other assets                                                                              |  |                                 | (266    | )    |   | (84     | )
|Accounts payable                                                                          |  |                                 | (527    | )    |   | 694     |  
|Advance customer payments                                                                 |  |                                 | (154    | )    |   | 878     |  
|Accrued expenses                                                                          |  |                                 | (660    | )    |   | (128    | )
|                                                                                          |  |                                 |         |      |   |         |  
|Net cash (used) provided by operating
 activities                                         |  |                                 | (346    | )    |   | 977     |  
|                                                                                          |  |                                 |         |      |   |         |  
|                                                                                          |  |                                 |         |      |   |         |  
|CASH FLOWS
 FROM INVESTING ACTIVITIES:                                                    |  |                                 |         |      |   |         |  
|Proceeds from maturities of available for
 sale marketable securities                     |  |                                 | 11,558  |      |   | 15,430  |  
|Proceeds from sales of available for sale
 marketable securities                          |  |                                 | 6,860   |      |   |        |  
|Purchases of available for sale marketable
 securities                                    |  |                                 | (10,086 | )    |   | (25,971 | )
|Additions to equipment and leasehold
 improvements                                        |  |                                 | (1,568  | )    |   | (845    | )
|Additions to patents                                                                      |  |                                 | (269    | )    |   | (200    | )
|                                                                                          |  |                                 |         |      |   |         |  
|Net cash provided (used) by investing
 activities                                         |  |                                 | 6,495   |      |   | (11,586 | )
|                                                                                          |  |                                 |         |      |   |         |  
|                                                                                          |  |                                 |         |      |   |         |  
|CASH FLOWS
 FROM FINANCING ACTIVITIES:                                                    |  |                                 |         |      |   |         |  
|Proceeds from exercise of stock options                                                   |  |                                 | 12      |      |   | 630     |  
|Excess tax benefit from exercise of stock
 options                                        |  |                                 | 2       |      |   | 28      |  
|Proceeds from issuance of common stock
 under employee stock purchase plan                |  |                                 | 227     |      |   | 306     |  
|Repurchase of common stock                                                                |  |                                 | (20,949 | )    |   | (163    | )
|                                                                                          |  |                                 |         |      |   |         |  
|Net cash (used) provided by financing
 activities                                         |  |                                 | (20,708 | )    |   | 801     |  
|                                                                                          |  |                                 |         |      |   |         |  
|                                                                                          |  |                                 |         |      |   |         |  
|Effects of
 exchange rate changes on cash and cash equivalents                            |  |                                 | (28     | )    |   | (25     | )
|                                                                                          |  |                                 |         |      |   |         |  
|                                                                                          |  |                                 |         |      |   |         |  
|Net decrease
 in cash and cash equivalents                                                |  |                                 | (14,587 | )    |   | (9,833  | )
|                                                                                          |  |                                 |         |      |   |         |  
|Cash and
 cash equivalents  beginning of period                                          |  |                                 | 18,864  |      |   | 30,056  |  
|                                                                                          |  |                                 |         |      |   |         |  
|                                                                                          |  |                                 |         |      |   |         |  
|Cash and
 cash equivalents  end of period                                                |  | $                               | 4,277   |      | $ | 20,223  |  
|                                                                                          |  |                                 |         |      |   |         |  

SEE THE ACCOMPANYING NOTES TO UNAUDITED
INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

3

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS 
CYBEROPTICS CORPORATION

1. INTERIM
REPORTING:

The interim
condensed consolidated financial statements presented herein as of September
30, 2008, and for the three and nine month periods ended September 30, 2008 and
2007, are unaudited, but in the opinion of our management, include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of financial position, results of operations and cash flows
for the periods presented.

The results of
operations for the three and nine month periods ended September 30, 2008 do not
necessarily indicate the results to be expected for the full year. The December
31, 2007 consolidated balance sheet data was derived from audited consolidated
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America. These
unaudited interim condensed consolidated financial statements should be read in
conjunction with our consolidated financial statements and notes thereto,
contained in our Annual Report on Form 10-K for the year ended December 31,
2007.

2. ACCOUNTING
FOR STOCK-BASED COMPENSATION:

Effective
January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment, applying
the modified prospective method. This statement requires all equity-based
payments to employees, including grants of employee stock options, to be
recognized in the consolidated statement of operations based on the grant date
fair value of the award. Under the modified prospective method, we are required
to record equity-based compensation expense for all awards granted after the
date of adoption, and for all unvested shares granted prior to the date of
adoption. We utilize the straight-line method of expense recognition over the
awards service period for our graded vesting options. The fair value of stock
options, granted before and after adoption of SFAS No. 123(R), has been
determined using the Black-Scholes model. The compensation expense recognized
for all equity based awards is net of estimated forfeitures, which were based
on historical data. We have classified equity based compensation within our
statement of operations in the same manner as our cash based employee
compensation costs. No stock options were granted in the nine months ended
September 30, 2008. We did issue 3,000 shares of common stock to our
non-employee directors in connection with our annual meeting in May 2008. The
shares were valued at their fair market value on the date of grant, and
corresponding general and administrative expense of $27,000 was recorded in the
second quarter and is reflected in our results of operations for the nine
months ended September 30, 2008.

The following
tables set forth compensation expense (pre-tax) by segment for our equity-based
awards for the three and nine months ended September 30, 2008 and 2007:

|                                              |  |                                  |    |                  |   |       |  |      |    |      |   |      |  |   |     |  |   |     | 
|--------------------------------------------- |  | -------------------------------- | -- | ---------------- | - | ----- |  | ---- | -- | ---- | - | ---- |  | - | --- |  | - | --- | 
|                                              |  | Three Months Ended September 30, |   
|                                              |  |                                  |   
|(In thousands)                                |  | Electronic
 Assembly             |    | Semi-
 Conductor |   | Total | 
|                                              |  |                                  |    |                  |   |       | 
|                                              |  | 2008                             |    | 2007             |   | 2008  |  | 2007 |    | 2008 |   | 2007 | 
|                                              |  |                                  |    |                  |   |       |  |      |    |      |   |      | 
|Cost of revenues                              |  | $                                | 21 |                  | $ | 27    |  | $    | 3  |      | $ | 3    |  | $ | 24  |  | $ | 30  | 
|Research and development expenses             |  |                                  | 20 |                  |   | 32    |  |      | 7  |      |   | 7    |  |   | 27  |  |   | 39  | 
|Selling, general and administrative
 expenses |  |                                  | 56 |                  |   | 60    |  |      | 5  |      |   | 6    |  |   | 61  |  |   | 66  | 
|                                              |  |                                  |    |                  |   |       |  |      |    |      |   |      |  |   |     |  |   |     | 
|Total                                         |  | $                                | 97 |                  | $ | 119   |  | $    | 15 |      | $ | 16   |  | $ | 112 |  | $ | 135 | 
|                                              |  |                                  |    |                  |   |       |  |      |    |      |   |      |  |   |     |  |   |     | 

|                                              |  |                                 |     |                  |   |       |  |      |    |      |   |      |  |   |     |  |   |     | 
|--------------------------------------------- |  | ------------------------------- | --- | ---------------- | - | ----- |  | ---- | -- | ---- | - | ---- |  | - | --- |  | - | --- | 
|                                              |  | Nine Months Ended September 30, |    
|                                              |  |                                 |    
|(In thousands)                                |  | Electronic
 Assembly            |     | Semi-
 Conductor |   | Total | 
|                                              |  |                                 |     |                  |   |       | 
|                                              |  | 2008                            |     | 2007             |   | 2008  |  | 2007 |    | 2008 |   | 2007 | 
|                                              |  |                                 |     |                  |   |       |  |      |    |      |   |      | 
|Cost of revenues                              |  | $                               | 66  |                  | $ | 77    |  | $    | 10 |      | $ | 9    |  | $ | 76  |  | $ | 86  | 
|Research and development expenses             |  |                                 | 62  |                  |   | 97    |  |      | 20 |      |   | 21   |  |   | 82  |  |   | 118 | 
|Selling, general and administrative
 expenses |  |                                 | 195 |                  |   | 332   |  |      | 14 |      |   | 18   |  |   | 209 |  |   | 350 | 
|                                              |  |                                 |     |                  |   |       |  |      |    |      |   |      |  |   |     |  |   |     | 
|Total                                         |  | $                               | 323 |                  | $ | 506   |  | $    | 44 |      | $ | 48   |  | $ | 367 |  | $ | 554 | 
|                                              |  |                                 |     |                  |   |       |  |      |    |      |   |      |  |   |     |  |   |     | 

4

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Total equity
based compensation expense in the three months ended September 30, 2008
includes $75,000 for stock option awards, $22,000 for our employee stock
purchase plan and $15,000 for unvested restricted stock units. Total equity
based compensation expense in the three months ended September 30, 2007
includes $98,000 for stock option awards, $28,000 for our employee stock
purchase plan and $9,000 for unvested restricted stock units. Total equity
based compensation expense in the nine months ended September 30, 2008 includes
$227,000 for stock option awards, $70,000 for our employee stock purchase plan,
$43,000 for unvested restricted stock units and $27,000 for shares issued to
our non-employee directors. Total equity based compensation expense in the nine
months ended September 30, 2007, includes $442,000 for stock option awards,
$85,000 for our employee stock purchase plan and $27,000 for unvested
restricted stock units.

At September
30, 2008, the total unrecognized compensation cost related to non vested equity
based compensation arrangements was $681,000 and the related weighted average
period over which it is expected to be recognized is 1.5 years.

Stock Grants for Non-Employee Directors

In May 2008
our shareholders approved a Stock Grant plan providing for fully vested annual
stock grants of 1,000 shares to each of our non-employee directors. We issued a
total of 3,000 shares of common stock under this plan in connection with our
annual meeting in May 2008. Grants in future years will occur at the time of
our annual meeting. There are presently 27,000 shares of common stock reserved
in the aggregate for future issuance under this plan.

Stock Options

We have three
stock incentive plans that are administered under the supervision of the
Compensation Committee of the Board of Directors. There are 1,043,882 shares of
common stock reserved in the aggregate for issuance of options and other stock
based benefits under these plans, including restricted stock units to
employees, officers, non-employee directors and others. Reserved shares
underlying canceled options are available for future grant under our active
plans. Options are granted at an option price per share equal to or greater
than the market value at the date of grant. Generally, options granted to
employees vest over a four-year period and expire five, seven, or ten years
after the date of grant. No stock options were granted during the nine months
ended September 30, 2008. As of September 30, 2008, there were 440,866 shares
of common stock available under these plans for future issuance to employees,
officers and others. There are no shares available under these plans for future
issuance to non-employee directors. In addition, there are 50,000 shares
reserved and included in the plan summaries below that are not part of the
three stock incentive plans.

The following
is a summary of stock option activity during the nine months ended September
30, 2008:

|                                 |  |                      |         |                                            |   |       | 
|-------------------------------- |  | -------------------- | ------- | ------------------------------------------ | - | ----- | 
|                                 |  | Options
 Outstanding |         | Weighted Average
 Exercise Price Per Share |  
|                                 |  |                      |        
|                                 |  |                      |         |                                            |   |       | 
|Outstanding,
 December 31, 2007  |  |                      | 607,346 |                                            | $ | 11.71 | 
|Granted                          |  |                      |        |                                            |   |      | 
|Exercised                        |  |                      | (2,250  | )                                          | $ | 5.20  | 
|Forfeited or
 expired            |  |                      | (19,200 | )                                          | $ | 13.13 | 
|                                 |  |                      |         |                                            |   |       | 
|Outstanding,
 September 30, 2008 |  |                      | 585,896 |                                            | $ | 11.69 | 
|                                 |  |                      |         |                                            |   |       | 
|                                 |  |                      |         |                                            |   |       | 
|Exercisable,
 September 30, 2008 |  |                      | 495,243 |                                            | $ | 11.50 | 
|                                 |  |                      |         |                                            |   |       | 

The intrinsic value
of an option is the amount by which the fair value of the underlying stock
exceeds its exercise price. The weighted average remaining contractual term and
aggregate intrinsic value for options outstanding at September 30, 2008 was
3.26 years and $292,115. The weighted average remaining contractual term and
aggregate intrinsic value of options exercisable at September 30, 2008 was 2.94
years and $292,115. The aggregate intrinsic value of stock options exercised in
the nine months ended September 30, 2008 was $11,790. During the nine months
ended September 30, 2008, we received total proceeds of $12,000 from the
exercise of stock options and the excess tax benefit recognized as a credit to
stockholders equity was $2,000.

5

---



Restricted Stock Units

Our 1998 Stock
Incentive Plan also permits our Compensation Committee to grant other
stock-based benefits, including restricted stock units. Restricted stock units
are valued at a price equal to the fair market value of our common stock on the
date of grant, vest over a four year period and entitle the holders to one
share of our common stock for each restricted stock unit. The aggregate
intrinsic value of outstanding restricted stock units as of September 30, 2008
was $154,080. There were no grants or forfeitures of restricted stock units and
none of the restricted stock units vested in the nine months ended September
30, 2008.

A summary of
activity in non vested restricted stock units for the nine months ended
September 30, 2008 is as follows:

|                                   |  |        |        |                                           |   |       | 
|---------------------------------- |  | ------ | ------ | ----------------------------------------- | - | ----- | 
|Non vested
 restricted stock units |  | Shares |        | Weighted  Average
 Grant Date Fair Value |  
|                                   |  |        |        |                                           |  
|                                  
|Non vested
 at December 31, 2007   |  |        | 17,120 |                                           | $ | 12.65 | 
|Granted                            |  |        |       |                                           |   |      | 
|Vested                             |  |        |       |                                           |   |      | 
|Forfeited                          |  |        |       |                                           |   |      | 
|                                   |  |        |        |                                           |   |       | 
|Non vested
 at September 30, 2008  |  |        | 17,120 |                                           | $ | 12.65 | 
|                                   |  |        |        |                                           |   |       | 

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan available to eligible U.S.
employees. Under terms of the plan, eligible employees may designate from 1% to
10% of their compensation to be withheld through payroll deductions, up to a
maximum of $6,500 in each plan year, for the purchase of common stock at 85% of
the lower of the market price on the first or last day of the offering period.
There were 28,505 shares issued under this plan in the nine months ended
September 30, 2008 and 28,859 shares issued in the nine months ended September
30, 2007. As of September 30, 2008, 112,812 shares remain available for future
issuance under this plan.

3. CERTAIN
BALANCE SHEET COMPONENTS:

Inventories consist of the following:

|                                   |  |                     |       |                    |   |        | 
|---------------------------------- |  | ------------------- | ----- | ------------------ | - | ------ | 
|(In thousands)                     |  | September 30,
 2008 |       | December 31,
 2007 |  
|                                   |  |                     |       |                    |  
|                                  
|Raw
 materials and purchased parts |  | $                   | 4,183 |                    | $ | 4,563  | 
|Work in
 process                   |  |                     | 889   |                    |   | 1,280  | 
|Finished
 goods                    |  |                     | 4,918 |                    |   | 4,797  | 
|                                   |  |                     |       |                    |   |        | 
|                                   |  |                     |       |                    |   |        | 
|Total inventories                  |  | $                   | 9,990 |                    | $ | 10,640 | 
|                                   |  |                     |       |                    |   |        | 

6

---



Warranty
costs:

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

|                                   |  |                                   |      |                                  |   |      |   |      |      |   |   |      |  
|---------------------------------- |  | --------------------------------- | ---- | -------------------------------- | - | ---- | - | ---- | ---- | - | - | ---- | -
|                                   |  | Three Months Ended
 September 30, |      | Nine Months Ended
 September 30, |  
|                                   |  |                                   |      |                                  |  
|(In
 thousands)                    |  | 2008                              |      | 2007                             |   | 2008 |   | 2007 |     
|                                   |  |                                   |      |                                  |   |      |   |      |     
|                                  
|Balance at
 beginning of period    |  | $                                 | 751  |                                  | $ | 905  |   | $    | 819  |   | $ | 796  |  
|Accrual for warranties             |  |                                   | 245  |                                  |   | 88   |   |      | 683  |   |   | 591  |  
|Settlements made during the period |  |                                   | (226 | )                                |   | (87  | ) |      | (732 | ) |   | (481 | )
|                                   |  |                                   |      |                                  |   |      |   |      |      |   |   |      |  
|                                   |  |                                   |      |                                  |   |      |   |      |      |   |   |      |  
|Balance at
 end of period          |  | $                                 | 770  |                                  | $ | 906  |   | $    | 770  |   | $ | 906  |  
|                                   |  |                                   |      |                                  |   |      |   |      |      |   |   |      |  

4. INTANGIBLE
ASSETS and GOODWILL:

Intangible
assets consist of the following:

|                        |  |                          |        |                           |   |        |   |                        |       |                           |   |        |  |   |        |   |   |       | 
|----------------------- |  | ------------------------ | ------ | ------------------------- | - | ------ | - | ---------------------- | ----- | ------------------------- | - | ------ |  | - | ------ | - | - | ----- | 
|                        |  | As of September 30, 2008 |        | As of December 31, 2007   |  
|                        |  |                          |        |                           |  
|(In
 thousands)         |  | Gross Carrying
 Amount   |        | Accumulated
 Amortization |   | Net    |   | Gross Carrying
 Amount |       | Accumulated
 Amortization |   | Net    | 
|                        |  |                          |        |                           |   |        |   |                        |       |                           |   |        | 
|                        |  |                          |        |                           |   |        |   |                        |       |                           |   |        |  |   |        |   |   |       | 
|Developed
 technology   |  | $                        | 7,775  |                           | $ | (7,258 | ) | $                      | 517   |                           | $ | 7,775  |  | $ | (7,122 | ) | $ | 653   | 
|Patents and
 trademarks |  |                          | 2,831  |                           |   | (2,347 | ) |                        | 484   |                           |   | 2,562  |  |   | (2,146 | ) |   | 416   | 
|                        |  |                          |        |                           |   |        |   |                        |       |                           |   |        |  |   |        |   |   |       | 
|Total                   |  | $                        | 10,606 |                           | $ | (9,605 | ) | $                      | 1,001 |                           | $ | 10,337 |  | $ | (9,268 | ) | $ | 1,069 | 
|                        |  |                          |        |                           |   |        |   |                        |       |                           |   |        |  |   |        |   |   |       | 

Amortization
expense for the three and nine month periods ended September 30, 2008 and 2007
is as follows:

|                        |  |                                   |     |                                  |   |      |  |      |     |  |   |     | 
|----------------------- |  | --------------------------------- | --- | -------------------------------- | - | ---- |  | ---- | --- |  | - | --- | 
|                        |  | Three Months Ended
 September 30, |     | Nine Months Ended
 September 30, |  
|                        |  |                                   |     |                                  |  
|(In
 thousands)         |  | 2008                              |     | 2007                             |   | 2008 |  | 2007 |    
|                        |  |                                   |     |                                  |   |      |  |      |    
|                        |  |                                   |     |                                  |   |      |  |      |     |  |   |     | 
|Developed
 technology   |  | $                                 | 46  |                                  | $ | 45   |  | $    | 136 |  | $ | 136 | 
|Patents and
 trademarks |  |                                   | 70  |                                  |   | 61   |  |      | 201 |  |   | 181 | 
|                        |  |                                   |     |                                  |   |      |  |      |     |  |   |     | 
|                        |  |                                   |     |                                  |   |      |  |      |     |  |   |     | 
|Total                   |  | $                                 | 116 |                                  | $ | 106  |  | $    | 337 |  | $ | 317 | 
|                        |  |                                   |     |                                  |   |      |  |      |     |  |   |     | 

As required by
SFAS 142, we periodically reassess the carrying value, useful lives and
classification of identifiable intangible assets. Amortization of patents and
trademarks has been classified as research and development expense in the
accompanying statement of operations. Estimated aggregate amortization expense
based on current intangibles for the next four years is expected to be as
follows: $100,000 for the remainder of 2008 and $343,000 in 2009, $343,000 in
2010, and $215,000 in 2011.

Given the downward trend in the stock
market subsequent to September 30, 2008, there is an increased risk we could have an
impairment with our nearly $6 million of goodwill and intangible assets when we complete
our annual test in the quarter ending December 31, 2008.

Goodwill,
which is solely related to our electronic assembly segment, decreased by
$228,000 in the nine months ended September 30, 2008 solely as the result of
the translation impact on foreign denominated goodwill balances.

7

---



5. BUSINESS
SEGMENTS AND SIGNIFICANT CUSTOMERS:

Our electronic
assembly segment is the design, manufacture and sale of optical process control
sensors and inspection systems for the electronics assembly equipment market.
The semiconductor segment is the design, manufacture and sale of optical and
other process control sensors and related equipment for the semiconductor
capital equipment market. Information regarding our segments is as follows:

|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|----------------------------------- |  | --------------------------------- | ------ | -------------------------------- | - | ------ |  | ---- | ------ | - | - | ------ | 
|                                    |  | Three Months Ended
 September 30, |        | Nine Months Ended
 September 30, |  
|                                    |  |                                   |        |                                  |  
|(In
 thousands)                     |  | 2008                              |        | 2007                             |   | 2008   |  | 2007 |       
|                                    |  |                                   |        |                                  |   |        |  |      |       
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Revenue                             |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Electronic
 Assembly                |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|OEM Sensors                         |  | $                                 | 4,527  |                                  | $ | 10,128 |  | $    | 17,289 |   | $ | 24,811 | 
|SMT Systems                         |  |                                   | 5,785  |                                  |   | 4,719  |  |      | 17,475 |   |   | 14,970 | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Total Electronic Assembly           |  |                                   | 10,312 |                                  |   | 14,847 |  |      | 34,764 |   |   | 39,781 | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Semiconductor                       |  |                                   | 1,258  |                                  |   | 1,326  |  |      | 4,004  |   |   | 4,107  | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Total                               |  | $                                 | 11,570 |                                  | $ | 16,173 |  | $    | 38,768 |   | $ | 43,888 | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Income
 (loss) from operations      |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Electronic
 Assembly                |  | $                                 | (1,673 | )                                | $ | 1,758  |  | $    | (2,292 | ) | $ | 4,155  | 
|Semiconductor                       |  |                                   | (43    | )                                |   | 48     |  |      | 2      |   |   | 99     | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Total income (loss) from operations |  |                                   | (1,716 | )                                |   | 1,806  |  |      | (2,290 | ) |   | 4,254  | 
|Interest
 income and other          |  |                                   | 276    |                                  |   | 587    |  |      | 1,039  |   |   | 1,705  | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Income (loss) before taxes          |  | $                                 | (1,440 | )                                | $ | 2,393  |  | $    | (1,251 | ) | $ | 5,959  | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Depreciation
 and amortization:     |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Electronic
 Assembly                |  | $                                 | 483    |                                  | $ | 452    |  | $    | 1,456  |   | $ | 1,222  | 
|Semiconductor                       |  |                                   | 68     |                                  |   | 57     |  |      | 198    |   |   | 167    | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 
|Total                               |  | $                                 | 551    |                                  | $ | 509    |  | $    | 1,654  |   | $ | 1,389  | 
|                                    |  |                                   |        |                                  |   |        |  |      |        |   |   |        | 

Export sales
were 84% of revenue in the three months ended September 30, 2008 and 86% of
revenue in the nine months ended September 30, 2008. Export sales were 85% of
revenue in the three months ended September 30, 2007 and 87% of revenue in the
nine months ended September 30, 2007. All of our export sales are negotiated,
invoiced and paid in U.S. dollars. Export sales by geographic area are
summarized as follows:

|                   |  |                                   |       |                                  |   |        |  |      |        |  |   |        | 
|------------------ |  | --------------------------------- | ----- | -------------------------------- | - | ------ |  | ---- | ------ |  | - | ------ | 
|                   |  | Three Months Ended
 September 30, |       | Nine Months Ended
 September 30, |  
|                   |  |                                   |       |                                  |  
|(In
 thousands)    |  | 2008                              |       | 2007                             |   | 2008   |  | 2007 |       
|                   |  |                                   |       |                                  |   |        |  |      |       
|                   |  |                                   |       |                                  |   |        |  |      |        |  |   |        | 
|Americas           |  | $                                 | 340   |                                  | $ | 11     |  | $    | 1,433  |  | $ | 914    | 
|Europe             |  |                                   | 3,976 |                                  |   | 5,017  |  |      | 12,620 |  |   | 14,447 | 
|Asia               |  |                                   | 5,434 |                                  |   | 8,732  |  |      | 19,226 |  |   | 22,845 | 
|Other              |  |                                   | 6     |                                  |   | 20     |  |      | 10     |  |   | 20     | 
|                   |  |                                   |       |                                  |   |        |  |      |        |  |   |        | 
|                   |  |                                   |       |                                  |   |        |  |      |        |  |   |        | 
|Total export sales |  | $                                 | 9,756 |                                  | $ | 13,780 |  | $    | 33,289 |  | $ | 38,226 | 
|                   |  |                                   |       |                                  |   |        |  |      |        |  |   |        | 

We are
dependent upon two electronic assembly customers, Assembleon and Juki, for a
significant portion of our revenue. Sales to Juki accounted for 21% of our
total revenue in the nine months ended September 30, 2008 and 28% of our total
revenue in the year ended December 31, 2007. Sales to Assembleon accounted for
16% of our total revenue in the nine months ended September 30, 2008 and 20% of
our total revenue in the year ended December 31, 2007.

8

---



Assembleon has
notified us that it is developing new pick and place technology for future
generations of its equipment. We have decided not to pursue new alignment
sensor and fiducial cameras for use with this technology. Sales of alignment
sensors and fiducial cameras that are impacted by this decision represented
approximately 12% of our total revenue in the nine months ended September 30,
2008 and 12% of our total revenue in the year ended December 31, 2007. We
believe that Assembleons transition away from our alignment sensors and
fiducial cameras will not occur until late 2009.

Our results of
operations and cash flows would be further negatively impacted if Assembleon or
Juki are unsuccessful in selling the products into which our sensors are
incorporated, if Assembleon transitions away from our products sooner than
expected, or if Juki designs their products to function without our sensors,
purchases sensors from other suppliers, or otherwise terminates their
relationship with us.

6. NET INCOME
(LOSS) PER SHARE:

Basic net income
(loss) per share is computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed by dividing net income by the weighted average
number of common and common equivalent shares outstanding during the period.
Common equivalent shares consist of common shares to be issued upon exercise of
stock options, restricted stock units and from participation in our employee
stock purchase plan, as calculated using the treasury stock method.

Common
equivalent shares are excluded from the calculation of net loss per diluted
share due to their anti-dilutive effect. As a result, no common equivalent
shares were included in the calculation of net loss per diluted share for the three
and nine months ended September 30, 2008. The calculation of diluted net income
per common share includes 67,000 common equivalent shares for the three months
ended September 30, 2007 and 83,000 common equivalent shares for the nine
months ended September 30, 2007.

The
calculation of diluted net income (loss) per common share excludes 635,000
potentially dilutive shares for the three months ended September 30, 2008,
316,000 potentially dilutive shares for the three months ended September 30,
2007, 643,000 potentially dilutive shares for the nine months ended September
30, 2008 and 314,000 potentially dilutive shares for the nine months ended
September 30, 2007, because their effect would be anti-dilutive.

7.
COMPREHENSIVE INCOME:

Components of
comprehensive income (loss) include net income (loss), foreign-currency
translation adjustments and unrealized gains and losses on our
available-for-sale marketable securities. Total comprehensive income (loss)
amounted to $(1,178,000) for the three months ended September 30, 2008 and
$1,799,000 for the three months ended September 30, 2007. Total comprehensive
income (loss) amounted to $(927,000) for the nine months ended September 30,
2008 and $4,132,000 for the nine months ended September 30, 2007. At December
31, 2007 and September 30, 2008, components of accumulated other comprehensive
loss is as follows:

|                            |  |                                |      |                                 |   |                                         |   |   |      |  
|--------------------------- |  | ------------------------------ | ---- | ------------------------------- | - | --------------------------------------- | - | - | ---- | -
|(In
 thousands)             |  | Foreign
 Currency
 Translation |      | Unrealized Gains
 on Securities |   | Accumulated
 Other
 Comprehensive
 Loss |  
|                            |  |                                |      |                                 |   |                                         |  
|                            |  |                                |      |                                 |   |                                         |   |   |      |  
|Balance
 December 31, 2007  |  | $                              | (368 | )                               | $ | 256                                     |   | $ | (112 | )
|Current year
 change        |  |                                | (106 | )                               |   | (214                                    | ) |   | (320 | )
|                            |  |                                |      |                                 |   |                                         |   |   |      |  
|                            |  |                                |      |                                 |   |                                         |   |   |      |  
|Balance
 September 30, 2008 |  | $                              | (474 | )                               | $ | 42                                      |   | $ | (432 | )
|                            |  |                                |      |                                 |   |                                         |   |   |      |  

Included in the current year
change for unrealized gains on securities is $3,000 of unrealized losses which
existed in the December 31, 2007 balance. These securities were either sold in
2008 or the amount of unrealized loss at December 31, 2007 was included in the
adjustment described in Note 16.

9

---



8. INCOME
TAXES:

We recorded a
tax provision in the nine months ended September 30, 2008 at an effective tax
rate of 51%. This compared to an effective tax rate of 36% in the nine month
period ended September 30, 2007. The change in the effective tax rate is due to
the impact of recorded discrete items as described below, partially offset by
projected losses in 2008 for which a tax benefit has not been recognized due to
certain nondeductible expenses and elimination of the research and
experimentation (R&D) tax credit. In October 2008, the R&D tax credit
was signed into law, retro-active to the beginning of 2008. As a result, we
presently expect to recognize a benefit from the R&D tax credit in the
fourth quarter of 2008.

During the
three and nine months ended September 30, 2008 we recognized a $257,000 income
tax benefit as a discrete item resulting from a reduction in our reserves for
income tax exposures under Financial Accounting Interpretation No. 48
Accounting for Uncertainty in Income Taxes (FIN #48) due to an expiring
domestic statute of limitations. During the three and nine months ended
September 30, 2007 we recognized additional income tax expense of $64,000 as a
discrete item due to a reduction in deferred tax assets resulting from a tax
law change in the United Kingdom. Other discrete items impacting the effective
tax rate in the three and nine months ended September 30, 2008 and 2007 were
inconsequential.

We have been
notified that the Internal Revenue Service intends to audit our 2006 federal
income tax return. The audit is expected to begin in November 2008. We
presently anticipate that the audit will not have a material impact on our
results of operations or financial position.

9. DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES:

We enter into
foreign currency swap agreements to hedge short term inter-company financing
transactions with our subsidiary in the United Kingdom. These currency swap
agreements are structured to mature near the last day of each quarter, and are
designated as cash flow hedges. At September 30, 2008, we had one open swap
agreement that was purchased on September 30, 2008, the fair value of which was
inconsequential.

In the three
months ended September 30, 2008, we recognized a net gain of $93,000 from the
settlement of foreign currency swap agreements that partially offset a
corresponding transaction loss on the underlying inter-company balance of
$139,000. In the nine months ended September 30, 2008, we recognized a net gain
of $79,000 from the settlement of foreign currency swap agreements that
partially offset a corresponding transaction loss on the underlying
inter-company balance of $140,000. Foreign currency swap agreements, and the
impact of currency fluctuations on the underlying inter-company balance were
insignificant in the three and nine months ended September 30, 2007.

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

10.
CONTINGENCIES:

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

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

10

---



11. RECENT
ACCOUNTING DEVELOPMENTS:

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

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

12. REPURCHASE
OF COMMON STOCK AND MODIFIED DUTCH AUCTION TENDER OFFER:

During the nine
months ended September 30, 2008 we spent $20,949,000 to repurchase a total of
2,082,391 shares of our common stock. We repurchased 1,499,996 shares of our
common stock at a price of $10.00 per share in the third quarter of 2008 under
a modified Dutch auction tender. We repurchased 582,395 shares of our common
stock in the first and second quarters of 2008 under share repurchase
authorizations approved by our board of directors in October 2007 and February
2008. No share repurchase authorizations are currently in effect.

13. SINGAPORE
TRANSITION AND RELATED ACCRUALS:

In February
2008, we announced our intention to move our systems related research and
development and manufacturing operations for our electronic assembly segment to
Singapore. Our Singapore based research and development organization will be
fully staffed by the end of 2008, with the transition of systems related
manufacturing scheduled for completion by mid 2009. The move will enable us to
become more responsive to the needs of our growing base of Asian SMT systems
customers, permit core optical engineering resources in Minneapolis to work on
anticipated new OEM and end user inspection opportunities, and attain future
cost savings.

Transition
costs of approximately $1.7 million are expected in 2008 for redundant
headcount and other expenses as we build our new Singapore based research and
development staff, and phase out the employees and contractors that we have
been using in Minneapolis. Included in this estimate are costs of approximately
$1.1 million for wages, benefits, travel and other expenses while we train our
new employees and establish operations in Singapore. Virtually all of these
costs will be classified as research and development in our statement of
operations. In addition, we expect severance costs of up to $350,000 and
recruitment costs of up to $250,000 related to our Singapore transition. These
costs will be classified as severance and recruitment in our statement of
operations. No costs were incurred prior to 2008. During the three months ended
September 30, 2008, transition costs related to our move to Singapore totaled
$650,000, including $98,000 of costs classified as severance and recruitment,
$502,000 of costs classified as research and development and $50,000 of costs
classified as general and administrative. During the nine months ended
September 30, 2008, transition costs totaled $1,442,000, including $476,000 of
costs classified as severance and recruitment, $879,000 of costs classified as
research and development and $87,000 of costs classified as general and
administrative. Unpaid severance and recruitment costs are included as a
component of accrued expenses in our balance sheet.

A summary of
our Singapore severance and recruitment accruals is as follows:

|                               |  |                                       |     |                                      |   |       |   |           |     |            |   |       |   |   |      |   |   |      |  
|------------------------------ |  | ------------------------------------- | --- | ------------------------------------ | - | ----- | - | --------- | --- | ---------- | - | ----- | - | - | ---- | - | - | ---- | -
|                               |  | Three Months Ended September 30, 2008 |     | Nine Months Ended September 30, 2008 |  
|                               |  |                                       |     |                                      |  
|(In thousands)                 |  | Severance                             |     | Recruiting                           |   | Total |   | Severance |     | Recruiting |   | Total |  
|                               |  |                                       |     |                                      |   |       |   |           |     |            |   |       |  
|                               |  |                                       |     |                                      |   |       |   |           |     |            |   |       |   |   |      |   |   |      |  
|Balance at Beginning of Period |  | $                                     | 156 |                                      | $ | 3     |   | $         | 159 |            | $ |      |   | $ |     |   | $ |     |  
|Costs incurred                 |  |                                       | 76  |                                      |   | 22    |   |           | 98  |            |   | 261   |   |   | 215  |   |   | 476  |  
|Payments made                  |  |                                       |    |                                      |   | (25   | ) |           | (25 | )          |   | (29   | ) |   | (215 | ) |   | (244 | )
|                               |  |                                       |     |                                      |   |       |   |           |     |            |   |       |   |   |      |   |   |      |  
|Balance at September 30, 2008  |  | $                                     | 232 |                                      | $ |      |   | $         | 232 |            | $ | 232   |   | $ |     |   | $ | 232  |  
|                               |  |                                       |     |                                      |   |       |   |           |     |            |   |       |   |   |      |   |   |      |  

11

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14. NEW LEASE
COMMITMENT:

We have
entered into a lease agreement for a new facility in Singapore that provides
for a 3 year term from May 15, 2008, annual rent of approximately $350,000 and
a two year renewal option. Rent expense has been computed on a straight-line
basis from our effective occupancy date of April 1, 2008. Costs for initial
leasehold improvements and equipment related to the new Singapore facility were
$276,000. Except for this new lease, there have been no other significant
changes to our contractual obligations in the nine months ended September 30,
2008, and we have not entered into any other material commitments for capital
expenditures.

15. FAIR VALUE
MEASUREMENTS:

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

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

The following
table provides information regarding fair value measurements for our cash
equivalents and marketable securities as of September 30, 2008 according to the
three-level fair value hierarchy:

|                                        |  |                              |        |                                                                   |                                                 |                                                  |  |                                              |        |  |   |   | 
|--------------------------------------- |  | ---------------------------- | ------ | ----------------------------------------------------------------- | ----------------------------------------------- | ------------------------------------------------ |  | -------------------------------------------- | ------ |  | - | - | 
|                                        |  |                              |        |                                                                   |                                                 |                                                  |  |                                              |        |  |   |   | 
|                                        |  |                              |        |                                                                   | Fair Value Measurements at Reporting Date Using |                                                 
|                                        |  |                              |        |                                                                   |                                                 |                                                 
|(in
 thousands)                         |  | Balance
 September 30,
 2008 |        | Quoted Prices in
 Active Markets for
 Identical Assets
 (Level 1) |                                                 | Significant Other
 Observable
 Inputs
 (Level 2) |  | Significant
 Unobservable
 Inputs
 (Level 3) |       
|                                        |  |                              |        |                                                                   |                                                 |                                                  |  |                                              |       
|                                        |  |                              |        |                                                                   |                                                 |                                                  |  |                                              |        |  |   |   | 
|Cash
 equivalents                       |  | $                            | 2,452  |                                                                   | $                                               |                                                 |  | $                                            | 2,452  |  | $ |  | 
|U.S.
 government and agency obligations |  | $                            | 20,103 |                                                                   | $                                               |                                                 |  | $                                            | 20,103 |  | $ |  | 
|Corporate
 debt securities              |  | $                            | 3,072  |                                                                   | $                                               |                                                 |  | $                                            | 3,072  |  | $ |  | 
|Asset backed
 securities                |  | $                            | 1,727  |                                                                   | $                                               |                                                 |  | $                                            | 1,727  |  | $ |  | 
|Equity
 securities                      |  | $                            | 49     |                                                                   | $                                               | 49                                               |  | $                                            |       |  | $ |  | 

Changes in the
fair value of these investments for the three and nine months ended September
30, 2008, resulting from our adoption of SFAS No. 157, had no impact on our
consolidated financial statements. Our foreign currency swap agreements are
structured to mature on the last day of each quarter. As a result, the fair
value associated with these agreements is inconsequential.

In February
2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, which provides companies with an option to
report selected financial assets and liabilities at fair value. This standard
was effective beginning after December 31, 2007. We elected not to adopt the
provisions of SFAS No. 159 in the nine months ended September 30, 2008.

12

---



16. MARKETABLE
SECURITIES:

Interest
income and other for the nine months ended September 30, 2008 includes a
$166,000 unrealized loss on an available for sale equity security, recognized
in the second quarter of 2008, resulting from a decline in market value which
was determined to be other than temporary. At September 30, 2008, this security
had a remaining carrying value of approximately $49,000, and we had no other
investments in marketable equity securities.

13

---



ITEM 2 -
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

The
preparation of the financial information contained in this 10-Q requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. We evaluate these estimates on an ongoing basis, including
those related to allowances for doubtful accounts and returns, warranty
obligations, inventory valuation, the carrying value and any impairment of
intangible assets, and income taxes. These critical accounting policies are
discussed in more detail in the Managements Discussion and Analysis of
Financial Condition and Results of Operations contained in our Form 10-K for
the year ended December 31, 2007.

FORWARD LOOKING STATEMENTS:

The
following managements discussion and analysis contains a number of estimates
and predictions that are forward looking rather than based on historical fact.
Among other matters, we discuss (i) our expectations regarding the transfer of
our research and development and manufacturing operations for our systems products
to Singapore and the costs we expect to incur this year, and avoid in the
future, because of that transfer; (ii) our anticipated revenues and losses for
the fourth quarter of 2008; (iii) the timing of introduction of and the
potential margin improvement resulting from our next-generation solder paste
inspection system; (iv) other new technologies that we have under development;
(v) the potential effect, if any, of our sensors not being used in the future
by a significant customer; (vi) our expectations regarding market acceptance of
WaferSenseTM and our other semiconductor
products; (vii) our beliefs regarding trends in the general economy and its
impact on markets for our equipment; (viii) the impact of currency fluctuations
on our operations, and: (iv) the potential impact, if any, of a pending
Internal Revenue Service audit of our 2006 federal income tax return. Although
we have made these statements based on our experience and best estimate of
future events, there may be events or factors that we have not anticipated, and
the accuracy of our statements and estimates are subject to a number of risks,
including those identified in Item 1A of this Form 10-Q and in our Annual
Report on Form 10-K.

REPURCHASE
OF COMMON STOCK AND MODIFIED DUTCH TENDER OFFER:

As described
in Note 12 of the accompanying consolidated financial statements, we completed
a $15.0 million modified Dutch tender offer for our common stock in the third
quarter of 2008, resulting in our repurchase of 1.5 million shares of our
common stock at a price of $10.00 per share. All common share repurchase
programs have been canceled and we presently have no authorization from our
board of directors to repurchase shares of our common stock.

RESULTS OF OPERATIONS:

General

Our
revenues were $11.6 million in the quarter ended September 30, 2008, down from
$16.2 million in the same period last year. We lost $1.7 million from
operations in the quarter ended September 30, 2008, down from operating income
of $1.8 million in the quarter ended September 30, 2007.

There
were a number of factors contributing to our loss in the third quarter of 2008.
Revenue from our higher margin electronic assembly sensors were down 55% when
compared to the third quarter of 2007. In addition, our lower margin next
generation LNC 60 sensor constituted a higher percentage of our electronic
assembly sensor sales in the third quarter of 2008. We experienced continuing
price pressures in the third quarter of 2008, particularly for our SMT system
products. Income from operations was also impacted by $650,000 of total
expenses related to the transition of research and development and
manufacturing operations for our system products to Singapore.

Our
order rate decreased 20% in the third quarter of 2008 to $11.3 million from
$14.2 million in the second quarter of 2008, and our backlog decreased 5% to
$5.2 million at September 30, 2008 from $5.5 million at June 30, 2008,
reflecting the impact of the sluggish global economy on sales of the pick and
place machines into which our electronic assembly sensors are installed and the
need for additional printed circuit production lines that use our SMT
inspection system products. As global economic conditions deteriorate, the
demand for additional capacity to produce printed circuit boards slows, which
has a negative impact on our revenue. We expect market conditions to
deteriorate further, at least through the fourth quarter of 2008. We also
anticipate continued gross margin pressures, ongoing investment in next
generation systems and new inspection technologies, as well as total pre-tax
costs of approximately $250,000 associated with the transition to Singapore.
Due to these factors, we are presently forecasting revenue of $9.5 - $8.5
million and a loss of $0.16 to $0.21 per share for the quarter ending December
31, 2008.

14

---



We
believe that 2008 will be a year of transition for CyberOptics. We are on
schedule to have our Singapore based research and development organization for
our systems products fully staffed by the end of 2008, with manufacturing for
all systems products scheduled for Singapore by mid 2009. We had incurred
Singapore transition costs of $1.4 million through September 30, 2008 and
expect transition costs of approximately $1.7 million for the full year, for
redundant headcount, training and other costs as we build our new Singapore
based research and development organization and phase out employees and
contractors in Minneapolis. We anticipate that the transition to Singapore will
result in annual research and development cost savings of approximately $1.5
million starting in 2009.

Introduction
of our next generation solder paste inspection system, which incorporates a
cost-reduced platform with enhanced performance, is now scheduled for introduction
in the second quarter of 2009. Previously, this system had been scheduled for
introduction in the fourth quarter of 2008. We believe this new platform, which
replaces our current SE 300 Ultra product, will relieve some of the margin
pressure and also provide continued revenue growth from solder paste
inspection. At the same time, we are pursuing several promising new inspection
opportunities with OEM and end user customers. Our research and development
efforts are creating new technologies for both OEM and end user markets which
we believe will lower the cost of inspection and provide faster production
through-put speeds, better ease of use, and improved resolution for inspecting
progressively smaller electronic components.

In
addition, we have decided not to pursue new alignment sensor products for use
with evolving pick and place technology being developed by one of our key OEM
customers, Assembleon, for future generations of its equipment. We will
continue to work with Assembleon and others to integrate our new OEM inspection
technologies into their platforms. Although alignment sensor sales to
Assembleon constituted 12% of our revenue in the nine months ended September
30, 2008 and 12% of our revenue in 2007, we believe their transition away from
our alignment sensors will not occur until late 2009 and will be offset by
sales of new inspection products.

15

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Segment Results

Operating
results for our electronic assembly and semiconductor segments for the three
and nine month periods ended September 30, 2008 and 2007 are as follows:

|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|--------------------------------------------- |  | ------------------------------------- | ------ | ------------------------------------- | - | ----- | - | -------------------- | ------ | ---------------- | - | ------ |  | - | ----- |  | - | ------ | 
|                                              |  | Three months ended September 30, 2008 |        | Three months ended September 30, 2007 |  
|                                              |  |                                       |        |                                       |  
|(In
 thousands)                               |  | Electronic
 Assembly                  |        | Semi-
 Conductor                      |   | Total |   | Electronic
 Assembly |        | Semi-
 Conductor |   | Total  | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|Revenue                                       |  | $                                     | 10,312 |                                       | $ | 1,258 |   | $                    | 11,570 |                  | $ | 14,847 |  | $ | 1,326 |  | $ | 16,173 | 
|Cost of revenue                               |  |                                       | 6,055  |                                       |   | 523   |   |                      | 6,578  |                  |   | 7,432  |  |   | 478   |  |   | 7,910  | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|Gross profit                                  |  |                                       | 4,257  |                                       |   | 735   |   |                      | 4,992  |                  |   | 7,415  |  |   | 848   |  |   | 8,263  | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|Research and development expenses             |  |                                       | 2,424  |                                       |   | 406   |   |                      | 2,830  |                  |   | 2,099  |  |   | 425   |  |   | 2,524  | 
|Selling, general and administrative
 expenses |  |                                       | 3,380  |                                       |   | 354   |   |                      | 3,734  |                  |   | 3,531  |  |   | 357   |  |   | 3,888  | 
|Singapore severance and recruitment expenses  |  |                                       | 98     |                                       |   |      |   |                      | 98     |                  |   |       |  |   |      |  |   |       | 
|Amortization of intangibles                   |  |                                       | 28     |                                       |   | 18    |   |                      | 46     |                  |   | 27     |  |   | 18    |  |   | 45     | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 
|Income (loss) from operations                 |  | $                                     | (1,673 | )                                     | $ | (43   | ) | $                    | (1,716 | )                | $ | 1,758  |  | $ | 48    |  | $ | 1,806  | 
|                                              |  |                                       |        |                                       |   |       |   |                      |        |                  |   |        |  |   |       |  |   |        | 

|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|--------------------------------------------- |  | ------------------------------------ | ------ | ------------------------------------ | - | ----- |  | -------------------- | ------ | -------------- | - | ------ |  | - | ----- |  | - | ------ | 
|                                              |  | Nine months ended September 30, 2008 |        | Nine months ended September 30, 2007 |  
|                                              |  |                                      |        |                                      |  
|(In
 thousands)                               |  | Electronic
 Assembly                 |        | Semi-
 Conductor                     |   | Total |  | Electronic
 Assembly |        | Semi-Conductor |   | Total  | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|Revenue                                       |  | $                                    | 34,764 |                                      | $ | 4,004 |  | $                    | 38,768 |                | $ | 39,781 |  | $ | 4,107 |  | $ | 43,888 | 
|Cost of revenue                               |  |                                      | 19,869 |                                      |   | 1,546 |  |                      | 21,415 |                |   | 19,966 |  |   | 1,433 |  |   | 21,399 | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|Gross profit                                  |  |                                      | 14,895 |                                      |   | 2,458 |  |                      | 17,353 |                |   | 19,815 |  |   | 2,674 |  |   | 22,489 | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|Research and development expenses             |  |                                      | 6,703  |                                      |   | 1,299 |  |                      | 8,002  |                |   | 5,757  |  |   | 1,300 |  |   | 7,057  | 
|Selling, general and administrative
 expenses |  |                                      | 9,926  |                                      |   | 1,103 |  |                      | 11,029 |                |   | 9,821  |  |   | 1,221 |  |   | 11,042 | 
|Singapore severance and recruitment expenses  |  |                                      | 476    |                                      |   |      |  |                      | 476    |                |   |       |  |   |      |  |   |       | 
|Amortization of intangibles                   |  |                                      | 82     |                                      |   | 54    |  |                      | 136    |                |   | 82     |  |   | 54    |  |   | 136    | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 
|Income (loss) from
operations                 |  | $                                    | (2,292 | )                                    | $ | 2     |  | $                    | (2,290 | )              | $ | 4,155  |  | $ | 99    |  | $ | 4,254  | 
|                                              |  |                                      |        |                                      |   |       |  |                      |        |                |   |        |  |   |       |  |   |        | 

16

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Revenues

Our
revenues decreased by 28% to $11.6 million in the three months ended September
30, 2008 from $16.2 million in the three months ended September 30, 2007, and
decreased by 12% to $38.7 million in the nine months ended September 30, 2008
from $43.9 million in the nine months ended September 30, 2007. The following
table sets forth revenues by product line for the three and nine month periods
ended September 30, 2008 and 2007:

|                           |  |                                   |        |                                  |   |        |  |      |        |  |   |        | 
|-------------------------- |  | --------------------------------- | ------ | -------------------------------- | - | ------ |  | ---- | ------ |  | - | ------ | 
|                           |  | Three Months Ended
 September 30, |        | Nine Months Ended
 September 30, |  
|                           |  |                                   |        |                                  |  
|(In
 thousands)            |  | 2008                              |        | 2007                             |   | 2008   |  | 2007 |       
|                           |  |                                   |        |                                  |   |        |  |      |       
|                           |  |                                   |        |                                  |   |        |  |      |        |  |   |        | 
|Electronic
 Assembly       |  |                                   |        |                                  |   |        |  |      |        |  |   |        | 
|OEM Sensors                |  | $                                 | 4,527  |                                  | $ | 10,128 |  | $    | 17,289 |  | $ | 24,811 | 
|SMT Systems                |  |                                   | 5,785  |                                  |   | 4,719  |  |      | 17,475 |  |   | 14,970 | 
|                           |  |                                   |        |                                  |   |        |  |      |        |  |   |        | 
|Total
 Electronic Assembly |  |                                   | 10,312 |                                  |   | 14,847 |  |      | 34,764 |  |   | 39,781 | 
|Semiconductor              |  |                                   | 1,258  |                                  |   | 1,326  |  |      | 4,004  |  |   | 4,107  | 
|                           |  |                                   |        |                                  |   |        |  |      |        |  |   |        | 
|Total                      |  | $                                 | 11,570 |                                  | $ | 16,173 |  | $    | 38,768 |  | $ | 43,888 | 
|                           |  |                                   |        |                                  |   |        |  |      |        |  |   |        | 

Electronic
Assembly

Revenues
from our electronic assembly OEM sensors decreased by 55% to $4.5 million in
the three months ended September 30, 2008 from $10.1 million in the three
months ended September 30, 2007 and decreased by 30% to $17.3 million in the
nine months ended September 30, 2008 from $24.8 million in the nine months
ended September 30, 2007. Revenues from our electronic assembly sensors
historically have been cyclical in nature, with periods of growth as worldwide
capacity is added to support increased consumer demand for electronic products,
and new capital equipment is purchased as a result of technology changes in
electronic components, such as miniaturization and changing production
requirements. These periods of growth have historically been followed by periods
of excess capacity and reduced capital spending. Sales of electronic assembly
sensors were somewhat sluggish throughout the last quarter of 2007 and the
first half of 2008, after peaking in the third quarter of 2007. Sales of
electronic assembly sensors declined significantly further in the third quarter
of 2008, reflecting the impact of a sluggish global economy and a cyclical
slowdown in the market for automated pick and place equipment.

Revenues
from our SMT systems products, which are not solely dependent on
expansions of SMT production capacity since a substantial portion of our
systems business involves retrofitting existing production lines with our
solder paste or AOI inspection systems or both, increased by 23% to $5.8 million in the three months ended
September 30,
2008 from $4.7 million in the three months ended September 30, 2007 and
increased by 17% to $17.5 million in the nine months ended September 30, 2008
from $15.0 million in the nine months ended September 30, 2007. Sales of SMT
systems products for the three and nine months ended September 30, 2008 were
positively impacted by new products and enhancements, including our new Flex
Ultra HR inspection system. Sales of AOI inspection systems increased by
$700,000 or 64% in the three months ended September 30, 2008 and by $2.0
million or 52% in the nine months ended September 30, 2008 when compared to the
same periods of last year. Sales of solder paste inspection systems and SMT
service for both the three and nine months ended September 30, 2008 were
comparable to 2007. During the past year we have invested heavily in the
development and enhancement of our SE 300 Ultra solder paste inspection system
and Flex Ultra automated optical inspection (AOI) system. We believe that these
new product developments and enhancements have led to higher revenue from sales
of SMT inspection systems in 2008 compared to 2007. However, we believe that
sales of SMT inspection systems will decline in the fourth quarter of 2008,
from sales levels in both the third quarter of 2008 and the fourth quarter of
2007, reflecting the negative impact of the sluggish global economy on
the need for additional printed circuit board production lines that use our SMT
inspection systems. We expect market conditions and demand for our electronic
assembly sensors and SMT systems products to deteriorate further, at least
through the fourth quarter of 2008.

Export
revenue from electronic assembly sensors and SMT systems totaled $9.1 million
or 88% of revenue in the three months ended September 30, 2008, compared to
$13.4 million or 90% of revenue in the three months ended September 30, 2007.
Export revenue from electronic assembly sensors and SMT systems totaled $31.5
million or 91% of revenue in the nine months ended September 30, 2008, compared
to $37.0 million or 93% of revenue in the nine months ended September 30, 2007.
The international markets of China and the rest of Asia, Japan and Europe
account for a significant portion of the production capability of capital
equipment for the manufacture of electronics, the primary market for our
electronic assembly sensor and SMT system product lines. An increasing
proportion of our sales have been to international customers as manufacturing
of electronic components has migrated offshore, particularly to China and other
areas of Asia.

17

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Semiconductor

Revenues
from semiconductor products decreased by 8% to $1.2 million in the three months
ended September 30, 2008 from $1.3 million in the three months ended September
30, 2007 and decreased by approximately 3% to $4.0 million in the nine months
ended September 30, 2008 from $4.1 million in the nine months ended September
30, 2007. The decrease in the three and nine months ended September 30, 2008
was due to lower revenue from our wafer mapping and frame grabber products,
offset in part by increased sales of our new WaferSense products.

Our
wafer mapping and frame grabber products are relatively mature. We anticipate
that future growth in our semiconductor revenues exclusive of changes related
to capital procurement cycles will come from our new WaferSenseÔ products.
WaferSenseÔ is a family of wireless, wafer like precision
measurement tools for in-situ setup, calibration and process optimization in
semiconductor processing equipment. We are currently working on, or recently
introduced, several new additions to the WaferSenseÔ product line, including
additional leveling
sensors, along with new gapping, teaching and vibration sensors. Sales of
WaferSense products totaled $391,000 and $1.1 million in the three and nine
months ended September 30, 2008 compared to $277,000 and $662,000 in the three
and nine months ended September 30, 2007.

Export
revenue as a percentage of total semiconductor revenue totaled $651,000 or 52%
of revenue in the three months ended September 30, 2008, compared to $428,000
or 32% of revenue in the three months ended September 30, 2007. Export revenue
as a percentage of semiconductor revenue totaled $1.8 million or 45% of revenue
in the nine months ended September 30, 2008, compared to $1.2 million or 30% of
revenue in the nine months ended September 30, 2007. The increase in export
revenue as a percentage of total semiconductor revenue in the three and nine
months ended September 30, 2008 was due to higher sales of WaferSense in Asia
and lower sales of wafer mapping sensors, which do not generate significant
export revenue.

Gross Margin

Electronic
Assembly

Gross
margin as a percentage of electronic assembly sales was 42% in the three months
ended September 30, 2008, compared to 50% in the three months ended September
30, 2007. Gross margin as a percentage of electronic assembly sales was 43% in
the nine months ended September 30, 2008, compared to 50% in the nine months
ended September 30, 2007. The reduction in gross margin percentage during the
three and nine months ended September 30, 2008 was due to significantly lower
sales of higher margin electronic assembly sensors, greater sales of our lower
margin next generation LNC 60 sensor to Juki and greater sales of lower margin
SMT system products when compared to the same periods in 2007. We also
continued to experience price pressure throughout 2008, particularly with
respect to our SMT system products. The nine months ended September 30, 2007
also includes a $250,000 benefit from a warranty recovery.

Planned
cost reductions for the new fifth generation LNC 60 sensor, combined with
increased volume as Juki utilizes this sensor in new platforms, will improve
the economics of this product in future periods. With respect to our electronic
assembly SMT system products, the number of machines sold in a given
transaction, the geographic area where the sale occurs, and whether the product
is sold direct to the end user customer or through a distributor can impact our
gross margins. The market for SMT inspection system products, including both
our solder paste and automated optical inspection (AOI) system products is
becoming increasingly competitive, both in terms of technology and pricing. The
increasing competition in the SMT system market has had a negative impact on
our SMT systems gross margins compared to prior periods. We anticipate that
pricing pressures will continue due to the heightened competition in the
marketplace. Our next-generation solder paste inspection system, which
incorporates a cost-reduced platform with enhanced performance, is scheduled
for introduction in the second quarter of 2009. We believe this new platform,
which will replace our current SE 300 Ultra product, will relieve some of the
margin pressure, while also enabling continued revenue growth from solder paste
inspection.

Semiconductor

Gross
margin as a percentage of semiconductor sales was 58% in the three months ended
September 30, 2008, compared to 64% in the three months ended September 30,
2007. Gross margin as a percentage of semiconductor sales was 61% in the nine
months ended September 30, 2008, compared to 66% in the nine months ended September
30, 2007. The decrease in gross margin as a percentage of semiconductor sales
in 2008, compared to 2007, is due to a change in product mix, with our highest
margin wafer mapping sensors representing a smaller percentage of total
semiconductor revenue and lower production volumes over which to spread fixed
manufacturing overhead costs that do not vary with activity levels.

18

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Operating Expenses

We
believe continued investment in research and development of new products,
coupled with continued investment and development of our sales channels, is
critical to future growth and profitability. We maintain research and
development and sales and marketing expenses at relatively high levels, even
during periods of downturn in our electronic assembly and semiconductor capital
equipment markets, as we continue to fund development of important new
products, and continue to invest in our sales channels and develop new sales
territories. We are continually evaluating existing and new research and development
projects, and may elect to increase or decrease expenditures based on an
assessment of the future revenue and profit potential of these projects.

In
February 2008, we announced our intention to move our systems related research
and development and manufacturing operations to Singapore. Our Singapore based
research and development organization will be fully staffed by the end of 2008,
with the transition of systems related manufacturing scheduled for completion
by mid 2009. The move will enable us to become more responsive to the needs of
our growing base of Asian SMT systems customers, permit core optical
engineering resources in Minneapolis to work on anticipated new OEM and end
user inspection opportunities, and attain future cost savings. We anticipate
additional total costs associated with our transition to Singapore of
approximately $250,000 during the fourth quarter of 2008. We estimate total
costs associated with the transition to Singapore in 2008 of approximately $1.7
million. We anticipate future annual research and development savings from this
transition of approximately $1.5 million per year starting in 2009.

During
the three months ended September 30, 2008, transition costs related to our move
to Singapore totaled $650,000, including $98,000 of costs classified as
severance and recruitment, $502,000 of costs classified as research and
development and $50,000 of costs classified as general and administrative.
During the nine months ended September 30, 2008, transition costs totaled $1.4
million, including $476,000 of costs classified as severance and recruitment,
$879,000 of costs classified as research and development and $87,000 of costs
classified as general and administrative.

Electronic Assembly

Electronic
assembly research and development expenses were $2.4 million or 24% of revenue
in the three months ended September 30, 2008, compared to $2.1 million or 14%
of revenue in the three months ended September 30, 2007. Research and
development expenses were $6.7 million or 19% of revenue in the nine months
ended September 30, 2008, compared to $5.8 million or 14% of revenue in the
nine months ended September 30, 2007. The 10% and 5% increases in electronic
assembly research and development expense in the three and nine months ended
September 30, 2008, compared to the same periods of 2007, resulted from costs
to transition our systems related research and development to Singapore and
increased contract labor and prototype expense for further R&D investment
in our SMT inspection system products, primarily our next generation solder
paste inspection system. Singapore transition costs included in research and
development expense for wages, training and related travel and other costs
totaled $502,000 in the three months ended September 30, 2008 and $879,000 in
the first nine months of 2008.

Our
new cost-reduced, enhanced performance solder paste inspection system,
scheduled for introduction in the second quarter of 2009, should relieve some
of the margin pressure we experience with our current SE 300 Ultra solder paste
inspection system and also provide for continued revenue growth. Our research
and development efforts are also creating new technologies for both OEM and end
user markets which we believe will lower the cost of inspection and provide
faster production through-put speeds, better ease of use, and improved
resolution for inspecting progressively smaller electronic components.

Electronic
assembly selling, general and administrative expenses were $3.4 million or 33%
of revenue in the three months ended September 30, 2008, compared to $3.5
million or 24% of revenue in the three months ended September 30, 2007.
Selling, general and administrative expenses were $9.9 million or 29% of
revenue in the nine months ended September 30, 2008, compared to $9.8 million
or 25% of revenue in the nine months ended September 30, 2007. Selling, general
and administrative expenses in the third quarter of 2007 included approximately
$200,000 of costs related to a canceled acquisition. Excluding the impact of
these costs on 2007 expenses, selling, general and administrative expenses were
up slightly in the three and nine months ended September 30, 2008 compared to
the same periods in 2007. The increase was due to higher sales commissions for
third party sales representatives resulting from the increase in SMT system
sales and the cost of additional field sales personnel added during the last
year to support higher SMT system sales.

19

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Semiconductor

Semiconductor
research and development expenses were $406,000 or 32% of revenue in the three
months ended September 30, 2008, compared to $425,000 or 32% of revenue in the
three months ended September 30, 2007. Research and development expenses were
$1.3 million or 32% of revenue in the nine months ended September 30, 2008,
compared to $1.3 million or 32% of revenue in the nine months ended September
30, 2007. During 2008 and 2007, research and development efforts were primarily
focused on development of new products for the semiconductor market, including
enhancements to the WaferSense auto leveling sensor (ALS) first introduced in
late 2004 and extensions to the WaferSense family of products, including new
gapping, teaching and vibration sensors.

Semiconductor
selling, general and administrative expenses were $354,000 or 28% of revenue in
the three months ended September 30, 2008, compared to $357,000 or 27% of
revenue in the three months ended September 30, 2007. Selling, general and
administrative expenses were $1.1 million or 28% of revenue in the nine months
ended September 30, 2008, compared to $1.2 million or 30% of revenue in the
nine months ended September 30, 2007. The decrease in selling, general and
administrative expenses in the nine months ended September 30, 2008, compared
to the same period of 2007, was due to a small reduction in general and
administrative headcount which occurred in the first quarter of 2007.

Severance and Recruitment Costs

Total
costs of approximately $1.7 million are anticipated in 2008 as we transition
our systems related research and development and manufacturing to Singapore.
The portion classified as severance and recruitment is expected to total up to
$600,000, consisting of severance costs of $350,000 and recruitment costs of
$250,000. Virtually all remaining costs associated with our transition to
Singapore will be classified as research and development in our statement of
operations. Severance and recruitment costs related to our electronic assembly
segment in the three months ended September 30, 2008 include $76,000 for
severance and $22,000 for recruitment. Severance and recruitment costs related
to our electronic assembly segment in the nine months ended September 30, 2008
include $261,000 for severance and $215,000 for recruitment.

Interest and Other

Interest
income and other includes interest earned on investments, realized gains and
losses from sales of investments, gains and losses associated with foreign
currency transactions and in 2008, an unrealized loss on an available for sale
equity security. Interest income and other decreased during the three and nine
months ended September 30, 2008 compared to the same periods of 2007 due to
lower rates of interest earned on invested funds and lower invested balances of
cash equivalents and marketable securities, primarily resulting from
repurchases of our commons stock. In addition, we recognized a $166,000
unrealized loss on an available for sale equity security in the second quarter
of 2008. The decline in market value for this security was determined to be
other than temporary resulting in recognition of the unrealized loss in our
statement of operations.

We
anticipate that interest income and other will decline in the fourth quarter of
2008 when compared to earlier periods in 2008 and the fourth quarter of 2007,
due to lower available balances of cash and marketable securities resulting
from repurchases of our common stock, as well as lower rates of interest earned
on invested funds.

Provision for Income Taxes and Effective
Income Tax Rate

We
recorded a tax provision in the nine months ended September 30, 2008 at an
effective tax rate of 51%. This compared to an effective tax rate of 36% in the
nine month period ended September 30, 2007. The change in the effective tax
rate is due to the impact of recorded discrete items as described below,
partially offset by projected losses in 2008 for which a tax benefit has not
been recognized due to certain nondeductible expenses and elimination of the
research and experimentation (R&D) tax credit. In October 2008, the R&D
tax credit was signed into law, retro-active to the beginning of 2008. As a
result, we presently expect to recognize a benefit from the R&D tax credit
in the fourth quarter of 2008.

During
the three and nine months ended September 30, 2008 we recognized a $257,000
income tax benefit as a discrete item resulting from a reduction in our
reserves for income tax exposures under Financial Accounting Interpretation No.
48 Accounting for Uncertainty in Income Taxes (FIN #48) due to an expiring
domestic statute of limitations. During the three and nine months ended
September 30, 2007 we recognized additional income tax expense of $64,000 as a
discrete item due to a reduction in deferred tax assets resulting from a tax
law change in the United Kingdom. Other discrete items impacting the effective
tax rate in the three and nine months ended September 30, 2008 and 2007 were
inconsequential.

20

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We
have been notified that the Internal Revenue Service intends to audit our 2006
federal income tax return. The audit is expected to begin in November 2008. We
presently anticipate that the audit will not have a material impact on our
results of operations or financial position.

Order Rate and Backlog

Our
orders totaled $11.3 million in the three months ended September 30, 2008,
compared to $14.2 million in the three months ended June 30, 2008 and $15.7
million in the three months ended September 30, 2007. Backlog totaled $5.2
million at September 30, 2008, $5.5 million at June 30, 2008 and $8.1 million
at September 30, 2007. The scheduled shipment (or estimated timing of revenue
for systems recognized upon acceptance) for backlog at September 30, 2008 is as
follows:

|                            |  |         |       | 
|--------------------------- |  | ------- | ----- | 
|(In
 thousands)             |  | Backlog |      
|                            |  |         |      
|                            |  |         |       | 
|4th
 Quarter 2008           |  | $       | 4,335 | 
|1st
 Quarter 2009 and after |  |         | 840   | 
|                            |  |         |       | 
|Total backlog               |  | $       | 5,175 | 
|                            |  |         |       | 

LIQUIDITY AND CAPITAL RESOURCES

Our
cash and cash equivalents decreased by $14.6 million in the nine month period
ended September 30, 2008 primarily due to $20.9 million of common stock
repurchases, capital purchases of $1.8 million and cash used by operating
activities of $346,000, offset in part by marketable security maturities and
sales of $8.3 million, net of purchases. Our cash and cash equivalents
fluctuate in part because of maturities of marketable securities and investment
of cash balances resulting from those maturities or from other sources of cash
in addition to marketable securities. Accordingly, we believe the combined
balances of cash and marketable securities provide a more reliable indication
of our available liquidity. Our combined balances of cash and marketable
securities decreased $23.4 million to $29.2 million as of September 30, 2008
from $52.6 million as of December 31, 2007, resulting primarily from our common
stock repurchases.

Operations
used $346,000 of cash in the nine months ended September 30, 2008. Cash used by
operations included a net loss of $614,000, which included $2.6 million of net
non-cash expenses for depreciation and amortization, provisions for inventory
obsolescence and doubtful accounts, foreign currency transactions, stock
compensation costs and realized gains and unrealized losses on available for
sale securities. Changes in operating assets and liabilities included increases
in accounts receivable of $554,000, inventories of $150,000 and other assets of
$266,000 and decreases in accounts payable of $527,000, advance customer
payments of $154,000 and accrued expenses of $660,000. Increases in accounts
receivable resulted from SMT systems representing a higher percentage of our
sales in 2008 compared to 2007. These customers typically take longer to pay
their receivables than our OEM sensor customers. The small increase in
inventory was due to lower sales resulting from the sluggish global economy and
the impact of a cyclical slowdown in our markets. Other assets were higher
because of rent deposits for our new facility in Singapore. Accounts payable
were lower due to a reduction in recent inventory purchases and the timing of
vendor payments, reflecting our expectation for lower sales levels in the
fourth quarter of 2008. The decrease in accrued expenses resulted from payment
of 2007 annual incentive compensation during the nine months ended September 30,
2008. The decrease in advance customer payments is due to recognition of
revenue in 2008 for a sale that was partially paid at the end of 2007.

We
generated $1.0 million of cash from operations during the nine months ended
September 30, 2007. Cash generated from operations primarily included net
income of $3.8 million, which included $2.2 million of net non-cash expenses,
increases in accounts payable of $694,000 and advance customer payments of
$878,000. This cash generated was offset by increases in accounts receivable of
$3.0 million, inventories of $3.4 million and other assets of $84,000 and
decreases in accrued expenses of $128,000.

We
used $6.5 million of cash for investing activities in the nine months ended
September 30, 2008 compared to $11.6 million of cash for investing activities
during the same period in 2007. Changes in the level of investment in
marketable securities resulting from purchases, maturities and sales of those
securities generated $8.3 million of cash in 2008 and used $10.5 million of
cash during the same period of 2007. We used $1.8 million of cash for the
purchase of fixed assets and capitalized patent costs in the nine months ended
September 30, 2008, compared to $1.0 million of cash for these items in the
nine months ended September 30, 2007. Expenditures for fixed assets in the nine
months ended September 30, 2008 include initial fit out costs and leasehold
improvements for our new facility in Singapore and initial lab and test systems
for our new cost reduced, enhanced performance solder paste inspection system.

21

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Financing
activities used $20.7 million of cash in the nine months ended September 30,
2008, compared to generating $801,000 of cash in the nine months ended
September 30, 2007. We used $20.9 million of cash to repurchase 2,082,391
shares of our common stock in the nine months ended September 30, 2008,
compared to using $163,000 of cash to repurchase 13,066 shares of our common
stock in the nine months ended September 30, 2007. Proceeds from the exercise
of stock options, including excess tax benefits from the exercise of those
options, and issuance of shares under our Employee Stock Purchase Plan totaled
$241,000 in the nine months ended September 30, 2008 compared to $964,000 in the
nine months ended September 30, 2007.

A
table of our contractual obligations was provided in Item 7 in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2007. During the
nine months ended September 30, 2008 we entered into a lease agreement for a
new facility in Singapore. The lease provides for a 3 year term from May 15,
2008, annual rent of approximately $350,000 and a two year renewal option.
There have been no other significant changes to our contractual obligations in the
nine months ended September 30, 2008 or other material commitments for capital
expenditures. Purchase commitments for inventory can vary based on the volume
of revenue and resulting inventory requirements.

Our
cash, cash equivalents and marketable securities totaled $29.2 million at
September 30, 2008. We believe that our available balances of cash, cash
equivalents and marketable securities will be adequate to fund any costs
related to our new operations and facility in Singapore and any other cash flow
needs for the foreseeable future.

At
September 30, 2008, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have been
established for the purpose of establishing off-balance sheet arrangements or
other contractually narrow or limited purposes. As such, we are not exposed to
the financing, liquidity, market or credit risk that could arise if we had engaged
in such relationships.

OTHER FACTORS

We
believe that inflation has not had any significant effect on operations. All of
our international export sales are negotiated, invoiced and paid in U.S.
dollars. Accordingly, although currency fluctuations do not significantly
affect our revenue and income, they can influence the price competitiveness of
our products and the willingness of existing and potential customers to
purchase our products.

FAIR VALUE MEASUREMENTS

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

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

22

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The
following table provides information regarding fair value measurements for our
cash equivalents and marketable securities as of September 30, 2008 according
to the three-level fair value hierarchy:

|                                       |  |                              |        |                                                                   |   |                                                  |  |                                              |        |  |   |   | 
|-------------------------------------- |  | ---------------------------- | ------ | ----------------------------------------------------------------- | - | ------------------------------------------------ |  | -------------------------------------------- | ------ |  | - | - | 
|                                       |  |                              |        |                                                                   |   |                                                  |  |                                              |       
|                                       |  |                              |        | Fair Value Measurements at Reporting Date Using                   |  
|                                       |  |                              |        |                                                                   |  
|(in
 thousands)                        |  | Balance
 September 30,
 2008 |        | Quoted Prices in
 Active Markets for
 Identical Assets
 (Level 1) |   | Significant Other
 Observable
 Inputs
 (Level 2) |  | Significant
 Unobservable
 Inputs
 (Level 3) |       
|                                       |  |                              |        |                                                                   |   |                                                  |  |                                              |       
|                                       |  |                              |        |                                                                   |   |                                                  |  |                                              |        |  |   |   | 
|Cash equivalents                       |  | $                            | 2,452  |                                                                   | $ |                                                 |  | $                                            | 2,452  |  | $ |  | 
|U.S. government and agency obligations |  | $                            | 20,103 |                                                                   | $ |                                                 |  | $                                            | 20,103 |  | $ |   | 
|Corporate debt securities              |  | $                            | 3,072  |                                                                   | $ |                                                 |  | $                                            | 3,072  |  | $ |  | 
|Asset backed securities                |  | $                            | 1,727  |                                                                   | $ |                                                 |  | $                                            | 1,727  |  | $ |  | 
|Equity securities                      |  | $                            | 49     |                                                                   | $ | 49                                               |  | $                                            |       |  | $ |  | 

Changes
in the fair value of these investments for the three and nine months ended
September 30, 2008 resulting from our adoption of SFAS No. 157 had no impact on
our consolidated financial statements. Our foreign currency swap agreements are
structured to mature on the last day of each quarter. As a result, the fair
value associated with these agreements is inconsequential.

In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities, which provides companies with an
option to report selected financial assets and liabilities at fair value. This
standard was effective beginning after December 31, 2007. We elected not to
adopt the provisions of SFAS No. 159 in the nine months ended September 30,
2008.

RECENT ACCOUNTING DEVELOPMENTS

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

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

ITEM 7A
- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We
invest excess funds not required for current operations in marketable
securities. The investment policy for these marketable securities is approved
annually by the Board of Directors and administered by management. A third
party, approved by our Board of Directors, manages the portfolio at the
direction of management. The investment policy dictates that marketable
securities consist of U.S. Government or U.S. Government agency securities,
various tax exempt securities or certain approved corporate instruments with
maturities of five years or less and an average portfolio maturity of not more
than 18 months. The policy also provides for investment in certain specified
marketable equity securities. As of September 30, 2008, our portfolio of
marketable securities had an average term to maturity of 1.3 years. All
marketable securities are classified as available for sale and carried at fair
value. We estimate that a hypothetical 1% increase in market interest rates
would result in a decrease in the market value of the portfolio of marketable
securities of approximately $400,000. If such a rate increase occurred, our net
income would only be impacted if securities were sold prior to maturity.

23

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We
enter into foreign currency swap agreements to hedge short term inter-company
financing transactions with our subsidiary in the United Kingdom. These
currency swap agreements are structured to mature near the last day of each
quarter, and are designated as cash flow hedges. At September 30, 2008, we had
one open swap agreement that was purchased on September 30, 2008, the fair
value of which was inconsequential.

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

ITEM 4 
CONTROLS AND PROCEDURES

a.          Under
the supervision and with the participation of our management, including our
Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and procedures
(as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the
Exchange Act)). Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered by
this report, our disclosure controls and procedures were effective in ensuring
that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in applicable rules and forms and that such
information is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, in a manner that allows
timely decisions regarding required disclosure.

b.          During
the quarter ended September 30, 2008, there has been no change in our internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

PART
II. OTHER INFORMATION

ITEM 1A
 RISK FACTORS

We
are dependent upon two electronic assembly customers, Assembleon and Juki, for
a significant portion of our revenue. Sales to Juki accounted for 21% of our
sales in the nine months ended September 30, 2008 and 28% of our total revenue
in 2007, while sales to Assembleon accounted for 16% of our sales in the nine
months ended September 30, 2008 and 20% of our total revenue in 2007.

Assembleon
has notified us that it is developing new pick and place technology for future
generations of its equipment. We have decided not to pursue new alignment
sensor and fiducial cameras for use with this technology. Sales of alignment
sensors and fiducial cameras that are impacted by this decision represented
approximately 12% of revenue in the nine months ended September 30, 2008 and
12% of our total revenue in 2007. We believe that Assembleons transition away
from our alignment sensors and fiducial cameras will not occur until late 2009.

Our
results of operations and cash flows would be further negatively impacted if
Assembleon or Juki are unsuccessful in selling the products into which our
sensors are incorporated, if Assembleon transitions away from our products
sooner than expected, or if Juki designs their products to function without our
sensors, purchases sensors from other suppliers, or otherwise terminates their
relationship with us.

In
addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I  Item 1A. Risk Factors in
our Annual Report on Form 10-K for the year ended December 31, 2007, which
could materially affect our business, financial condition or future results. The
risks described in our Annual Report on Form 10-K are not the only risks facing
our Company. Additional risks and uncertainties not currently known to us or
that we currently deem to be immaterial also may adversely affect our business,
financial condition and/or operating results.

24

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ITEM 2 
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

|    |                                         
|--- | ----------------------------------------
|(c) | Company
 Repurchase of Equity Securities

|                                        |  |                                          |           |                                     |   |                                                                                                    |  |                                                                                                  |           |  |  |   | 
|--------------------------------------- |  | ---------------------------------------- | --------- | ----------------------------------- | - | -------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------ | --------- |  |  | - | 
|Period                                  |  | (a)
 Total
 Number of
 Shares
 Purchased |           | (b)
 Average Price
 Paid per
 Share |   | (c)
 Total
 Number of
 Shares
 Purchased
 as Part of
 Publicly
 Announced
 Plans
 or Programs
 (1) |  | (d)
 Maximum
 Number of
 Shares that
 May
 Yet Be
 Purchased
 Under the
 Plans
 or Programs
 (1) |          
|                                        |  |                                          |           |                                     |   |                                                                                                    |  |                                                                                                  |          
|July 1, 2008 to July 31, 2008           |  |                                          | 1,499,996 |                                     | $ | 10.00                                                                                              |  |                                                                                                  | 1,499,996 |  |  |  | 
|August 1, 2008 to August 31, 2008       |  |                                          |          |                                     | $ |                                                                                                   |  |                                                                                                  |          |  |  |  | 
|September 1, 2008 to September 30, 2008 |  |                                          |          |                                     | $ |                                                                                                   |  |                                                                                                  |          |  |  |  | 
|                                        |  |                                          |           |                                     |   |                                                                                                    |  |                                                                                                  |           |  |  |   | 
|                                        |  |                                          |           |                                     |   |                                                                                                    |  |                                                                                                  |           |  |  |   | 
|Total                                   |  |                                          | 1,499,996 |                                     | $ | 10.00                                                                                              |  |                                                                                                  | 1,499,996 |  |  |  | 
|                                        |  |                                          |           |                                     |   |                                                                                                    |  |                                                                                                  |           |  |  |   | 

|    |                                                                                                                                                                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In June
 2008, our board of directors authorized a $15.0 million modified Dutch
 auction tender offer. The Dutch auction tender offer expired on July 29, 2008
 and resulted in the repurchase of 1.5 million shares of our common stock at a
 price of $10.00 per share.

25

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ITEM 6  EXHIBITS

|      |                                                                                                                                              
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------
|31.1: | Certification
 of Chief Executive Officer pursuant to Rule 15d-14(a)(17 CFR 240.15d-14(a))
 and Section 302 of the Sarbanes Oxley Act of 2002
|      |                                                                                                                                              
|31.2: | Certification
 of Chief Financial Officer pursuant to Rule 15d-14(a)(17 CFR 240.15d-14(a))
 and Section 302 of the Sarbanes Oxley Act of 2002
|      |                                                                                                                                              
|32:   | Certification
 of Chief Executive Officer and Chief Financial Officer Pursuant to Section
 906 of the Sarbanes Oxley Act of 2002             

26

---



SIGNATURES

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

|                         |                                                             | 
|------------------------ | ----------------------------------------------------------- | 
|                         | CYBEROPTICS
 CORPORATION                                   
|                         |                                                             | 
|                         | /s/ Kathleen
 P. Iverson                                    | 
|                         |                                                             | 
|                         | By Kathleen
 P. Iverson, President and CEO                 
|                         | (Principal
 Executive Officer and Duly Authorized Officer) 
|                         |                                                             | 
|                         |                                                             | 
|                         | /s/ Jeffrey
 A. Bertelsen                                   | 
|                         |                                                             | 
|                         | By Jeffrey
 A. Bertelsen, Chief Financial Officer          
|                         | (Principal
 Accounting Officer and Duly Authorized Officer)
|                         |                                                             | 
|Dated:
 November 5, 2008 |                                                             | 

27

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