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

General Overview

Our products are sold primarily into the electronics assembly, semiconductor DRAM memory, and semiconductor fabrication capital equipment markets, where we sell products both to original equipment manufacturers of production equipment and to end-user customers that produce circuit boards and semiconductor wafers and devices. Historically these markets have been very cyclical, with periods of rapid growth as worldwide capacity is added to support increased consumer demand for electronic products, and new capital equipment is purchased as a result of technology changes in electronics components, such as miniaturization, and changing production requirements. These periods of growth have historically been followed by periods of excess capacity and reduced capital spending.

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

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

† In February 2008, we announced plans to move a significant portion of our systems related product development and manufacturing for all system products to Singapore, the location of our Asian sales office. The transition of systems related product development to Singapore was substantially complete by the end of the fourth quarter of 2008. We anticipate that the transition of manufacturing for our system products will be complete by the middle of 2009. We estimate that the transition to Singapore increased our 2008 expenses by approximately $1.5 million. Transition costs in 2009 are not expected to be significant.

† The weakness in the United States capital markets caused by the deepening global recession, as well as our reduced level of profitability, caused a significant drop in our market capitalization, resulting in a $3.9 million non-cash pre-tax goodwill impairment charge in the fourth quarter of 2008. We presently anticipate that significant weakness in our markets and the global economy will continue, at least through the first half of 2009.

† In addition to the impact of global economic conditions on our sales, we have determined not to pursue new alignment products for use with future generations of equipment being developed by Assembleon. Sales of alignment products to Assembleon constituted 10% of revenue in 2008. Assembleon has informed us that they currently plan to start transitioning away from our alignment products in the third quarter of 2009, with the transition continuing into the second quarter of 2010. The timing of Assembleon's transition away from our sensor products, combined with the sharp drop-off in orders in the fourth quarter of 2008 and our expectation for continued weakness into 2009, resulted in a $650,000 charge for excess and obsolete inventory in the fourth quarter of 2008.

† In response to the significant weakness in our markets and the global economy, we reduced our workforce by approximately 20 employees or 10% in November 2008, resulting in a $234,000 severance charge in the fourth quarter of 2008. Further cost savings measures were implemented in February 2009, including additional workforce and salary reductions, consolidation of manufacturing operations for our semi-conductor products into our Minneapolis Minnesota facility and reductions in spending for non-labor costs such as travel, supplies and the like.

† From the start of the fourth quarter of 2008 through the end of the second quarter of 2009, we will have reduced our workforce by 50 employees or approximately 25%, resulting from the move to Singapore, relocation of manufacturing for our semiconductor operations, and the November 2008 and February 2009 workforce reductions.

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

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

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

Segment Results

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

                                                   Year Ended December 31,
         (In thousands)                          2008        2007       2006

         Revenue:
         Electronic assembly                   $  40,193   $ 53,203   $ 51,142
         Semiconductor                             5,259      5,573      5,947
         Total                                 $  45,452   $ 58,776   $ 57,089

         Gross margin:
         Electronic assembly                   $  15,867   $ 26,631   $ 25,926
         Semiconductor                             3,198      3,616      3,975
         Total                                 $  19,065   $ 30,247   $ 29,901

         Operating expense:
         Electronic assembly                   $  26,206   $ 21,223   $ 18,110
         Semiconductor                             3,322      3,484      4,670
         Total                                 $  29,528   $ 24,707   $ 22,780

         Income (loss) from operations:
         Electronic assembly                   $ (10,339 ) $  5,408   $  7,816
         Semiconductor                              (124 )      132       (695 )
         Total income (loss) from operations   $ (10,463 ) $  5,540   $  7,121
         Interest income and other                 1,193      2,214      1,943
         Income (loss) before income taxes     $  (9,270 ) $  7,754   $  9,064

Revenues

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


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

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

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

We believe that increased use of outsourcing for circuit board assembly, production difficulties associated with smaller component sizes, increased production speeds and increased cost pressure on companies manufacturing circuit boards caused increased demand for our inspection equipment, prior to the recent global economic recession. However, our revenue has been impacted by increasing competition and price pressure on our SMT inspection systems, particularly in Asia.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We started to incur severance costs in February 2008 in connection with our decision to move a significant portion of development and manufacturing for our systems products to Singapore. The transition of development was substantially complete by the fourth quarter of 2008; and transition of manufacturing is expected to be complete by the middle of 2009. Severance costs incurred in 2008 in connection with the February 2008 decision totaled $302,000. We also incurred expenses totaling $234,000 for outside service providers to assist us with recruitment of our new Singapore based development and manufacturing team. We maintained our Minneapolis-based systems development team while we trained our new Singapore based team, resulting in extra costs totaling $879,000 for wages, training, travel, and other costs, during the initial start-up and training period. These costs have been classified in our statement of operations as . . .