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, 2008.

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 2009; (iii) the potential margin improvement resulting from our SE500 next-generation solder paste inspection system; (iv) the timing of initial revenue and margin improvements from other new products that we have under development or expect to introduce in 2009 and 2010; (v) our expectations regarding market acceptance of WaferSenseTM and our other semiconductor products; (vi) our beliefs regarding trends in the general economy and its impact on markets for our equipment; and (vii) the impact of currency fluctuations on our operations. 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.

RESULTS OF OPERATIONS:

General

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 through the first quarter of 2009, 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 sharply late in the fourth quarter of 2008 as the global economy fell into a severe recession. Our results for the nine months ended September 30, 2009 continued to be adversely affected by ongoing weakness in the global electronics market. Revenues were $8.6 million in the quarter ended September 30, 2009, down 26% from $11.6 million in the same period last year. We lost $1.7 million from operations in the quarter ended September 30, 2009, approximately the same amount as the quarter ended September 30, 2008 when $650,000 of extra costs where incurred to transition our systems related product development and manufacturing to Singapore.

We are seeing early signs of strengthening in the global electronics market. Manufacturers of SMT assembly equipment, who did not place sensor orders in this year's first half, resumed ordering in the third quarter. In addition, demand for SE500 solder paste inspection and AOI systems is improving. For the quarter ending December 31, 2009, we are forecasting revenue of $8.0-$9.0 million, up from revenue of $6.7 million in the quarter ending December 31, 2008. We are however still forecasting a loss for the quarter ending December 31, 2009.

• In February 2008, we announced plans to move a significant portion of our systems-related product development and manufacturing to Singapore. The transition of systems related product development to Singapore was substantially complete by the end of the fourth quarter of 2008 and transition of manufacturing for our system products was substantially complete by the end of the first quarter of 2009. Remaining transition costs in 2009 are not expected to be significant. The realignment of our systems-related product development and manufacturing to Singapore has resulted in lower costs and a more focused R&D effort.

• In response to the significant weakness in our markets and the global economy, we implemented workforce reductions in November 2008 and February 2009. Additional cost savings measures were implemented in February 2009, including salary reductions, consolidation of manufacturing operations for our semiconductor 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. We incurred a $363,000 charge for severance in the nine months ended September 30, 2009 related to these actions. We do not expect implementation of these cost reduction actions to impact our strategic growth programs.

We also continued to work on our next generation inspection technology and various other growth programs. Significant initiatives undertaken by us in 2008 and 2009 and other events impacting our future prospects include the following:

• In addition to signs of strengthening in the global electronics market, we announced in September 2009 that Assembleon has elected to continue to use us as its sole supplier for the alignment products deployed on its current and future pick-and-place platforms. We previously disclosed in 2008 that Assembleon intended to start transitioning away from our current alignment products when it introduced its next generation of equipment in 2010. Sales of new alignment sensors to Assembleon accounted for 10% of total revenue in 2008.

• During 2008, we invested heavily in our recently introduced next-generation SE500 solder paste inspection system. Based on a new cost-reduced platform, we believe the SE500 is the fastest and most accurate solder paste inspection system available on the market. Given its industry-leading inspection capabilities, we believe the SE500 will command improved pricing in comparison to the existing SE300. We believe the SE500 has been favorably received in the market since its recent introduction and that it should enable us to gain a larger share of the global solder paste inspection market.

• Our strategy is based in large part on increasing the size of our addressable market for inspection solutions. The foundation of this strategy is a next-generation common hardware platform for inspection, whereby essentially the same sensor technology can be utilized across a variety of applications. We expect this initiative to enable us to remove significant cost from several new products, resulting in both improved margins and a menu of tiered offerings for automated optical inspection (AOI) and solder paste inspection systems at various price points for different market segments. By expanding our addressable market to electronics manufacturers requiring a lower-cost inspection solution and to those who currently do not use any form of inspection, we believe this highly targeted approach to our markets can yield significant long-term returns on our R&D investments.

• Our next-generation AOI system, which will be introduced in November 2009, will be the first product utilizing our common hardware platform for inspection. In addition to its reduced cost, we believe this new product will exceed many of the performance metrics of our current AOI offering and those of our competitors.

• We continue to pursue several promising growth opportunities for our next generation inspection technologies. Reflecting our progress with these R&D initiatives, we have signed two new OEM development contracts in the past year with manufacturers of electronic assembly equipment. One of these new products is based on our next-generation common hardware platform for inspection, while the other is based on our embedded process verification technology. Both of these products expand our addressable market for inspection solutions. Significant revenue from these products is not anticipated until 2010.

• We also recently signed a third OEM development contract for an embedded sensor for the photovoltaic solar market. This new product will further diversify our revenue base beyond the electronic assembly market. Initial revenue from this product is not anticipated until late 2010.

We believe our strategy to increase the size of our addressable market for inspection solutions, the revenue potential and improved margins from anticipated new products, new OEM development contracts and our strategic repositioning in Asia, will lead to improved operating results as the global electronics market continues to recover from the current economic recession.

We have no debt and our cash and marketable securities of $22.8 million at September 30, 2009 are more than adequate to fund our operations and various growth opportunities for an extended period of time, even given our expectation for continued weak financial results in the fourth quarter of 2009.

Segment Results

Operating results for our electronic assembly and semiconductor segments for the
three and nine month periods ended September 30, 2009 and 2008 are as follows:


                                Three months ended September 30, 2009              Three months ended September 30, 2008
                             Electronic         Semi-                           Electronic         Semi-
(In thousands)                Assembly        Conductor          Total           Assembly        Conductor          Total

Revenues                   $        7,766    $        784    $        8,550   $       10,312    $      1,258    $       11,570
Cost of revenues                    5,369             244             5,613            6,055             523             6,578
Gross margin                        2,397             540             2,937            4,257             735             4,992

Research and development
expenses                            1,478             335             1,813            2,424             406             2,830
Selling, general and
administrative expenses             2,523             312             2,835            3,380             354             3,734
Severance and
recruitment expenses                  (32 )             -               (32 )             98               -                98
Amortization of
intangibles                            27              18                45               28              18                46

Loss from operations       $       (1,599 )  $       (125 )  $       (1,724 ) $       (1,673 )  $        (43 )  $       (1,716 )


                                 Nine months ended September 30, 2009               Nine months ended September 30, 2008
                             Electronic         Semi-                           Electronic         Semi-
(In thousands)                Assembly        Conductor          Total           Assembly        Conductor          Total

Revenue                    $       15,975    $      2,116    $       18,091   $       34,764    $      4,004    $       38,768
Cost of revenue                    11,349             829            12,178           19,869           1,546            21,415
Gross profit                        4,626           1,287             5,913           14,895           2,458            17,353

Research and development
expenses                            4,748             872             5,620            6,703           1,299             8,002
Selling, general and
administrative expenses             8,523             946             9,469            9,926           1,103            11,029
Severance and
recruitment expenses                  249             114               363              476               -               476
Amortization of
intangibles                            82              54               136               82              54               136

Income (loss) from
operations                 $       (8,976 )  $       (699 )  $       (9,675 ) $       (2,292 )  $          2    $       (2,290 )

Revenues

Our revenues decreased by 26% to $8.6 million in the three months ended
September 30, 2009 from $11.6 million in the three months ended September 30,
2008, and decreased by 53% to $18.0 million in the nine months ended September
30, 2009 from $38.8 million in the nine months ended September 30, 2008. The
following table sets forth revenues by product line for the three and nine month
periods ended September 30, 2009 and 2008:


                              Three Months Ended       Nine Months Ended
                                September 30,            September 30,
(In thousands)                 2009         2008        2009        2008

Electronic Assembly
OEM Sensors                 $    2,599    $  4,527   $    5,243   $ 17,289
SMT Systems                      5,167       5,785       10,732     17,475
Total Electronic Assembly        7,766      10,312       15,975     34,764
Semiconductor                      784       1,258        2,116      4,004
Total                       $    8,550    $ 11,570   $   18,091   $ 38,768

Revenues from our electronic assembly OEM sensors decreased by 43% to $2.6 million in the three months ended September 30, 2009 from $4.5 million in the three months ended September 30, 2008 and decreased by 70% to $5.2 million in the nine months ended September 30, 2009 from $17.3 million in the nine months ended September 30, 2008. Revenues from our SMT systems products, decreased by 11% to $5.2 million in the three months ended September 30, 2009 from $5.8 million in the three months ended September 30, 2008 and decreased by 39% to $10.7 million in the nine months ended September 30, 2009 from $17.5 million in the nine months ended September 30, 2008.

The severe weakness in the global economy and electronics markets experienced late in 2008 continued into the first nine months of 2009, causing the significant declines in revenue from both our electronic assembly OEM sensors and SMT system products when compared with the first nine months of 2008. We are seeing early signs of strengthening in the global electronics market. Manufacturers of SMT assembly equipment, who did not place sensor orders in this year's first half, resumed ordering in the third quarter. In addition, demand for SE500 solder paste inspection and AOI systems from Asian original design manufacturers is improving. We are forecasting higher levels of revenue for the quarter ending December 31, 2009, when compared to the same period in 2008, primarily from increased SMT system sales.

Export revenue from electronic assembly sensors and SMT systems totaled $6.9 million or 88% of revenue in the three months ended September 30, 2009, compared to $9.1 million or 88% of revenue in the three months ended September 30, 2008. Export revenue from electronic assembly sensors and SMT systems totaled $13.6 million or 85% of revenue in the nine months ended September 30, 2009, compared to $31.5 million or 91% of revenue in the nine months ended September 30, 2008. Sales to international customers continue to be significant, as manufacturing of electronic components has migrated offshore, particularly to China and other areas of Asia.

Although our markets have contracted with decreased demand for consumer and commercial electronics, we believe the trend toward automated inspection using SMT inspection systems will continue due to ongoing miniaturization of SMT circuit board components. Required for downsizing products, many SMT circuit board 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. We believe, supported by increased competition in our markets, that automated inspection has become the only viable means for inspecting SMT circuit boards with such tiny components. Although we will be required to continue to innovate to grow in this increasingly competitive market, we believe that our SMT systems products will be one of our primary growth drivers over the next few years.

Revenues from semiconductor products decreased by 38% to $784,000 in the three months ended September 30, 2009 from $1.2 million in the three months ended September 30, 2008 and decreased by 47% to $2.1 million in the nine months ended September 30, 2009 from $4.0 million in the nine months ended September 30, 2008. The decrease in revenue was due to severe weakness in the global economy, difficult conditions in the market for semiconductor fabrication equipment and declining revenue from our older wafer mapper and frame grabber products.

Export revenue from semiconductor products totaled $308,000 or 39% of revenue in the three months ended September 30, 2009, compared to $651,000 or 52% of revenue in the three months ended September 30, 2008. Export revenue from semiconductor products totaled $636,000 or 30% of revenue in the nine months ended September 30, 2009, compared to $1.8 million or 45% of revenue in the nine months ended September 30, 2008.

Cost of Revenue and Gross Margin

Gross margin as a percentage of electronic assembly sales was 31% in the three months ended September 30, 2009, compared to 42% in the three months ended September 30, 2008. Gross margin as a percentage of electronic assembly sales was 29% in the nine months ended September 30, 2009, compared to 43% in the nine months ended September 30, 2008. The reduction in gross margin percentage during the three and nine months ended September 30, 2009 was due to significantly lower sales of higher margin electronic assembly sensors, substantially lower production volumes over which to spread fixed manufacturing overhead costs, continued competitive pricing pressure for our products, particularly older generation versions that are being replaced, and the overall impact of the global recession. We believe the recession will continue to impact our ability to market these products and margins will be depressed until the economy begins to recover.

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 reduced our manufacturing workforce by over 30 employees or 45% by the end of the second quarter of 2009. In addition, by the end of the second quarter of 2009, we completed consolidating our Portland-based semiconductor manufacturing into our Minneapolis facility, a move that has further streamlined our cost structure. These actions have reduced our overall manufacturing costs and have better leveraged our manufacturing operations, thereby favorably impacting our gross margins not only in the second half of 2009, but also in future periods. We estimate factory cost savings starting in the third quarter of 2009 from our cost reduction actions and transition of systems-related manufacturing to Singapore of close to $2.0 million per year.

We compensate for pricing pressure by introducing new products with more features and improved performance and through manufacturing cost reduction programs. For example, we believe our recently introduced next-generation SE500 solder paste inspection system, which is cost reduced and manufactured in Singapore, is the fastest and most accurate solder paste inspection system available on the market. Our next generation AOI system, that we expect to introduce in the fourth quarter of 2009, utilizes our common hardware platform for inspection and combines a reduction in cost with enhanced performance. We expect to introduce several new products in the future based on our common hardware platform for inspection that will allow for reduced cost, enhanced performance and improvement in margins.

Gross margin as a percentage of semiconductor sales was 69% in the three months ended September 30, 2009, compared to 58% in the three months ended September 30, 2008. Gross margin as a percentage of semiconductor sales was 61% in the nine months ended September 30, 2009, compared to 61% in the nine months ended September 30, 2008. Gross margin as a percentage of semiconductor sales increased in the three months ended September 30, 2009 due to the cost benefit from consolidation of manufacturing for our semiconductor products into our Minneapolis, Minnesota headquarters facility.

Operating Expenses

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

In 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 reduced our workforce by 50 employees or 25% (over 30 in manufacturing and approximately 20 in development, selling, general and administrative) 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 have reduced 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 aggregate annual expense savings of almost $5.0 million per year, of which approximately $3.0 million will be operating expense savings and $2.0 million will be the factory cost savings discussed above under gross margin.

Implementation of the cost reduction actions discussed above will not impact any of our strategic growth programs; work on our common hardware platform for inspection, next generation inspection technologies, or pursuit of new OEM contracts.

Research and development expenses for our electronic assembly segment were $1.5 million in the three months ended September 30, 2009, compared to $2.4 million in the three months ended September 30, 2008. Research and development expenses for our electronic assembly segment were $4.7 million in the nine months ended September 30, 2009, compared to $6.7 million in the nine months ended September 30, 2008. The 39% and 29% decrease in research and development expenses in 2009 resulted from a more focused and efficient research and development effort due to transition of systems related research and development to Singapore, as well as transition costs incurred in 2008. Singapore transition costs classified as research and development expense were $502,000 and $879,000 in the three and nine months ended September 30, 2008. No transition costs were incurred in 2009. In addition, the cost reduction actions implemented in November 2008 and February 2009 contributed to the lower level of spending in the three and nine months ended September 30, 2009.

Selling, general and administrative expenses for our electronic assembly segment were $2.5 million in the three months ended September 30, 2009, compared to $3.4 million in the three months ended September 30, 2008. Selling, general and administrative expenses for our electronic assembly segment were $8.5 million in the nine months ended September 30, 2009, compared to $9.9 million in the nine months ended September 30, 2008. Selling, general and administrative expenses for the nine months ended September 30, 2009 includes an $800,000 provision for doubtful accounts related to a key distributor of our SMT system products. The distributor remains in business, and is committed to paying us the amount owed. The increase in the provision for doubtful accounts was mostly offset by reductions in travel costs, commissions for third party sales representatives resulting from the lower level of SMT system sales and lower foreign sales office expenses resulting from favorable foreign exchange rates.

Research and development expenses for our semiconductor segment were $335,000 in the three months ended September 30, 2009 compared to $406,000 in the three months ended September 30, 2008. Research and development expenses for our semiconductor segment were $872,000 in the nine months ended September 30, 2009 . . .