United States Securities And Exchange Commission

FORM 10-K

	þ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the fiscal year ended December 31, 2004.
	o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from                     to                     .

Commission File Number 0-12728

INTEGRAL VISION, INC.

Registrant’s telephone number, including area code: (248) 471-2660

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, No Par Value, Stated Value $.20 Per Share

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 and (2) has been subject to the filing requirements for at least the past 90 days. YES þ  NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
YES o   NO þ

The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 23, 2005:

Common Stock, No Par Value, Stated Value $.20 Per Share - $15,468,220

The number of shares outstanding on each of the issuer’s classes of common stock, as of March 23, 2005:

Common Stock, No Par Value, Stated Value $.20 Per Share – 14,877,638

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Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties. Generally, the words “anticipate”, “expect”, “intend”, “believe” and similar expressions identify forward-looking statements. The information included in this Form 10-K is as of the filing date with the Securities and Exchange Commission and future events or circumstances could differ significantly from the forward-looking statements included herein. Accordingly, we caution readers not to place undue reliance on such statements.

Part I

ITEM 1. Business

General

Integral Vision, Inc. (or the “Company”) develops, manufactures and markets microprocessor-based process monitoring and inspection systems for use in industrial manufacturing environments. The principle application for the Company’s products is optical display inspection (“machine vision products”). The Company’s products are generally sold as capital goods. Depending on the application, machine vision systems have an indefinite life. Machine vision applications are more likely to require replacement due to possible technological obsolescence than physical wear.

Overview

Integral Vision is a supplier of machine vision systems used to ensure product quality during the manufacturing process.

Machine vision has become a necessity for manufacturers who need to continually improve production efficiency to meet the increasing demand for high quality products. The Company’s vision systems automatically identify, gauge or inspect parts with speed and accuracy. Quantitative information about each part is evaluated for functional or cosmetic defects. Our systems can be configured to statistically monitor the production process and send data to other equipment in the manufacturing cell. Such data could be used, for example, by a diverter to send defective parts to a reject bin, or by process controllers to automatically adjust process variables.

The Company markets its turnkey systems to the flat panel display industry. Applications development software, such as our Industrial Vision Controller (IVC) technology, can be applied to an extensive array of applications in industries that run the gamut from aerospace to medical to textiles.

Products

Flat Panel Display Inspection
Integral Vision has over nine years of experience in the display industry. Our initial product, LCI-Professional, is used for inspection of LCD Displays as components or final assemblies. Applications include cell phones, car radios, pagers, electronic organizers and hand-held video games. Integral Vision’s display inspection systems are designed to detect two classes of defects: cosmetic and functional. Cosmetic defects do not affect the functionality of the display, but they cause user annoyance and reduce product value. Functional defects are flaws that cause the device to be inoperable or have a significant effect on functionality.

Integral Vision’s SharpEye provides Flat Panel Display (FPD) inspection for reflective, emissive and transmissive display technologies. SharpEye is designed for the detection of functional and cosmetic defects in LCOS, OLED, Poly OLED, DMD, EL, HTPS, LTPS, LCD and other emerging display technologies. These technologies are applied to consumer products such as camcorders, rear projection computer monitors, digital still cameras, HDTV, projectors, video

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headsets and video telephones. The core technology of SharpEye inspection algorithms is the ability to quantize data to the level of a single display pixel. SharpEye can be configured for production inspection or for display evaluation in a laboratory based on the equipment configuration selected.

Integral Vision’s ChromaSee, introduced in 2003, provides luminance, color matching and defect inspections for FPD displays. Defect detection includes functional (e.g. failed pixels, icons) and cosmetic (e.g. scratches) defects. ChromaSee integrates with production equipment to allow inline or offline testing. A configuration interface (Task Sequencer) uses a familiar “Tree View” representation of the inspection sequence flow. For deployment into production, the operator’s interface provides essential views of results, images and statistics for production floor personnel.

Production and Suppliers

The Company’s production process consists principally of assembling standard electrical, electronic and optical components and hardware subassemblies purchased from suppliers into finished products. When proprietary circuit boards are needed, the Company generally contracts for outside vendors to build the boards based on internal company designs.

The Company generally does not rely on a single source for parts and subassemblies, although certain components and subassemblies included in the Company’s products may only be obtained from a limited number of suppliers. Management believes alternative sources or designs could be developed for any of the components used in its products thereby mitigating any exposure to product interruption from shortages of parts or limited suppliers.

Intellectual Property

Management believes that the technology incorporated in its products gives it advantages over its competitors and prospective competitors. Protection of technology is attempted through a combination of patents, applied for patents, confidentiality agreements and trade secrets. The Company presently has 14 patents. There can be no assurance that the Company will have the resources to defend its patents or that patents the Company holds will be considered valid if challenged. In addition, it is possible that some patents will be rendered worthless as the result of technological obsolescence.

Marketing

The Company generally markets its vision products to end users, but the Company has had success integrating its products with OEM’s in certain circumstances. Although sales are made worldwide, the Company’s strongest presence is maintained in the US (through Company employees), and in Europe and Asia (through sales representatives).

Product Development

The market for Machine Vision is characterized by rapid and continuous technological development and product innovation. The Company believes that continued and timely development of new products and enhancements to existing products is necessary to maintain its competitive position. Accordingly, the Company devotes a significant portion of its personnel and financial resources to product development programs and seeks to maintain close relationships with customers to remain responsive to their needs. The Company’s net engineering and development costs amounted to $909,000, $663,000, and $852,000 in 2004, 2003, and 2002, respectively. The Company’s current product development efforts are primarily directed to Flat Panel Display Inspection products.

Environmental Factors

The costs to the Company of complying with federal, state and local provisions regulating protection of the environment are not material.

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Competition

The Company experiences competition in all areas in which it operates. Competition for Flat Panel Display Inspection comes primarily from Westar Display Technologies, Inc. Cognex Corp. competes either directly or indirectly via systems integrators in certain general vision application work, as do numerous niche producers of machine vision solutions.

Export Sales

Sales outside of the United States accounted for 67%, 13% and 54% of the Company’s net sales in 2004, 2003 and 2002, respectively. Management expects that such sales will continue to represent a significant percentage of its net sales. Most of the Company’s export billings are denominated in US dollars. On occasion other export billings are denominated in the currency of the customer’s country.

See Note I to the Consolidated Financial Statements Part II – ITEM 8 for details of geographic area information.

Major Customers

The nature of the Company’s product offerings may produce sales to one or a limited number of customers in excess of 10% of total consolidated sales in any one year. It is possible that the specific customers reaching this threshold may change from year to year. Loss of any one of these customers could have a material impact on the Company’s results of operations. For the year ended December 31, 2004 sales to Philips represented 80% of consolidated sales. There were no amounts due from this customer at December 31, 2004. For the year ended December 31, 2003 sales to Intel Corporation, Owens Brockway and Toyo Corporation represented 63%, 14%, and 11% of consolidated sales, respectively. There were no amounts due from these customers at December 31, 2003. For the year ended December 31, 2002 sales to Ness Display Co., LTD and Uniax Corporation represented 13% and 14% of consolidated sales, respectively. Amounts due from these customers represented 3% of the respective outstanding trade receivable balance at December 31, 2002.

Backlog

As of December 31, 2004, the Company had an order backlog of approximately $518,000 compared to $1.6 million at December 31, 2003. Management expects that the Company will ship products representing this entire backlog in 2005.

Employees

As of February 28, 2005, the Company had 16 permanent employees, as compared to 12 at February 28, 2004 and 13 at February 28, 2003. None of the Company’s employees are represented by a labor union.

ITEM 2. Properties

Manufacturing, engineering and administrative functions of Integral Vision are performed at an approximately 5,000 square foot facility leased by the Company in Farmington Hills, Michigan.

ITEM 3. Legal Proceedings

The Company is not currently involved in any material litigation.

ITEM 4. Submission of Matters to a Vote of Security Holders

     None.

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Part II

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock is traded on the Over the Counter Bulletin Board (OTCBB) under the symbol INVI. As of March 15, 2004, there were approximately 3,000 stockholders of the Company including individual participants in security position listings.

The Company’s common stock was moved to the Over the Counter Bulletin Board (OTCBB) effective with its delisting from The Nasdaq SmallCap Market with the open of business August 16, 2001. The Company was informed by Nasdaq that the delisting was decided by the Nasdaq Listing Qualifications panel which approved the Nasdaq’s staff decision to delist the stock due to its failing to maintain a minimum bid price of $1.00 for 30 consecutive trading days as required by Marketplace Rule 4450(a)(5) for continued listing.

Information on the current quotes on the stock, which will continue to use the ticker symbol INVI, are available at the OTCBB’s website, www.otcbb.com and most financial information portals, such as that provided at http://finance.yahoo.com or http://quote.bloomberg.com. Integral Vision will continue to provide information through filings with the Securities and Exchange Commission (SEC) as required for continued listing on the OTCBB. These filings can be found at the SEC’s website at www.sec.gov.

The table below shows the high and low sales prices for the Company’s common stock for each quarter in the past two years. The closing sales price for the Company’s common stock on March 23, 2005 was $1.65 per share.

The market for securities of small market-capitalization companies has been highly volatile in recent years, often for reasons unrelated to a company’s results of operations. Management believes that factors such as quarterly fluctuations in financial results, failure of new products to develop as expected, sales of common stock by existing shareholders, and substantial product orders may contribute to the volatility of the price of the Company’s common stock. General economic trends such as recessionary cycles and changing interest rates may also adversely affect the market price of the Company’s common stock. No cash dividends on common stock have been paid during any period.

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ITEM 6. Summary of Selected Financial Data

The above selected financial data should be read in conjunction with Consolidated Financial Statements, including the notes thereto (Part II - ITEM 8) and Management’s Discussion and Analysis of Financial Condition and Results of Operations (Part II - ITEM 7). The Company has never paid a dividend and does not anticipate doing so in the foreseeable future. The Company expects to retain earnings, if any, to finance the expansion and its development of business.

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Integral Vision, Inc. develops, manufactures and markets microprocessor-based process monitoring and inspection products for use in industrial manufacturing environments. The Company’s revenues are primarily derived from the sale of flat panel display inspection equipment. Except for the historical information contained herein, the matters discussed in this document are forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such factors and uncertainties include, but are not limited to: the impact of the level of the Company’s indebtedness; the Company’s ability to obtain the cash needed to allow it to continue as a going concern; general economic conditions and conditions in the specific industries in which the Company has significant customers; price fluctuations in the materials purchased by the Company for assembly into final products; competitive conditions in the Company’s markets and the effect of competitive products and pricing; and technological development by the Company, its customers and its competition. As a result, the Company’s results may fluctuate. Additional information concerning risk factors that could cause actual results to differ materially from those projected in the forward-looking statements is contained in

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the Company’s filings with the Securities and Exchange Commission. These forward-looking statements represent the Company’s best estimates as of the date of this document. The Company assumes no obligation to update such estimates except as required by the rules and regulations of the Securities and Exchange Commission.

Results of Operations

The following table sets forth for the periods indicated certain items from the Company’s Statements of Operations as a percentage of net revenues. The impact of inflation for the periods presented was not significant.

Year Ended December 31, 2004, compared to the year ended December 31, 2003

Net revenues increased $901,000 (141%) to $1.5 million in 2004 from $641,000 in 2003. Net revenue is reported net of sales commission expense of approximately $19,000 in 2004 compared to $11,000 in 2003. The increase was primarily due to increased sales of the Company’s flat panel display inspection product. Sales from the flat panel display inspection product line accounted for approximately $1.4 million and $497,000 of the Company’s net revenue in 2004 and 2003, respectively. The Company’s revenue from other applications was approximately $152,000 and $85,000 in 2004 and 2003, respectively. The Company’s revenue from software was approximately $33,000 and $43,000 in 2004 and 2003, respectively. The Company’s revenue from service activities was approximately $18,000 in 2003. There was no such revenue in 2004.

Direct costs of sales increased $726,000 (120%) to $1.3 million (approximately 86.3% of sales) in 2004 from $604,000 (approximately 94.2% of sales) in 2003. This was primarily attributable to the higher sales volume. Management periodically performs an analysis of the net realizable value of capitalized patent costs. In 2002, management determined that capitalized patent costs exceeded the estimated net realizable value of amounts capitalized and a write-down was necessary. In 2002, $74,000 of additional amortization was included in costs of sales as a result of this determination.

Marketing costs increased 17.0%, or $38,000, to $261,000 in 2004 compared to $223,000 in 2003. This increase is primarily attributable to additional staffing due to increased sales activity.

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Employee related costs in the marketing division were $54,000 higher in 2004 compared to 2003 levels. Advertising costs were $15,000 lower in 2004 compared to 2003 levels.

General and administrative costs increased 49.0%, or $393,000, to $1.2 million in 2004 compared to $802,000 in 2003. This was primarily due to an increase in legal, stockholder relations, and professional fees totaling $183,000 in 2004. Employee related costs in the general and administrative division were $124,000 higher in 2004 compared to 2003 levels.

Engineering and development expenditures increased 37.1%, or $246,000, to $909,000 in 2003 compared to $663,000 in 2003. Employee related costs in the engineering and development division were $130,000 higher in 2004 compared to 2003 levels. Approximately $109,000 of this variance was attributable to engineering work done due to increased sales in the third quarter.

On September 9, 2002, DaTARIUS Technologies Inc., a subsidiary of global test equipment manufacturer DaTARIUS Technologies GmbH, purchased Integral Vision’s assets related to inspection systems for the optical disc industry, including the names “Automatic Inspection Systems” and “AID.” The sale included Integral Vision’s optical disc scanner products as well as its range of print and identification code products used to inspect the printing stage of disc manufacture. The consideration the Company received for the technology consisted of a non-refundable $100,000 advanced minimum royalty payment in addition to future royalties. The Company received approxmiately $61,000 in royalties in 2004 and expects to receive additional royalties of approximately $30,000 in 2005. Additionally, the Company received $25,000 from the sale of equipment to DaTARIUS. The Company recognized a gain on the transaction of approximately $112,000, which is included in gain on sale of assets in 2002, primarily attributable to the advanced minimum royalty payment received. The proceeds from the transaction were used primarily to fund current operations.

Other income(expense) was $129,000 in 2004 of which approximately $61,000 was royalty income.

Interest expense increased $66,000 to $436,000 in 2004 compared to $370,000 in 2003. The increase is primarily attributable to the interest on Class 1, Class 2, and Class 3 Notes that were placed subsequent to September 30, 2003 (see Note C to consolidated financial statements).

Year Ended December 31, 2003, compared to the year ended December 31, 2002

Net revenues decreased $938,000 (59%) to $641,000 in 2003 from $1.6 million in 2002. Net revenue is reported net of sales commission expense of approximately $11,000 in 2003 compared to $83,000 in 2002. The decrease in net revenue was partially attributable to the fact that the Company sold its disc identification/print inspection (CDiD/CDiP) product line in 2002 (see Note J to consolidated financial statements). Sales from the Company’s disc identification/print inspection (CDiD/CDiP) product line accounted for $743,000 of the net revenue in 2002. This decrease was partially offset by increased sales of the Company’s flat panel display inspection product. Sales from the flat panel display inspection product line accounted for approximately $497,000 and $447,000 of the Company’s net revenue in 2003 and 2002, respectively. The Company’s revenue from other applications was approximately $85,000 and $139,000 in 2003 and 2002, respectively. The Company’s revenue from software was approximately $43,000 and $62,000 in 2003 and 2002, respectively. The Company’s revenue from service activities was approximately $18,000 and $398,000 in 2003 and 2002, respectively.

Direct costs of sales decreased $572,000 (49%) to $604,000 (approximately 94.2% of sales) in 2003 from $1.2 million (approximately 74.5% of sales) in 2002. This was primarily attributable to the lower sales volume and smaller structure required to support it as well as lower patent amortization expense in the 2003 period. Management periodically performs an analysis of the net realizable value of capitalized patent costs. In 2002, management determined that capitalized patent costs exceeded the estimated net realizable value of amounts capitalized and a write-down was necessary. In the year ended December 31, 2002, $74,000 of additional amortization was included in costs of sales as a result of this determination.

Marketing costs decreased 60.0%, or $334,000, to $223,000 in 2003 compared to $557,000 in 2002. This decrease is primarily attributable to workforce reductions resulting from the

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implementation of a cost reduction plan by Management in late 2000 and throughout 2001. Employee related costs in the marketing division were $143,000 lower in 2003 compared to 2002 levels. The plan also called for workforce reductions in both the general and administrative department and the engineering department, as evidenced by the figures below. Advertising costs were $62,000 lower in 2003 compared to 2002 levels.

General and administrative costs decreased 23.4%, or $252,000, to $802,000 in 2003 compared to $1.1 million in 2002. The costs for outside services were $107,000 lower in 2003 compared to 2002 levels. Legal expenses were $33,000 lower in 2003 compared to 2002. Additionally bad debts expense in the general and administrative division decreased 98.1% or $97,000 in 2003.

Engineering and development expenditures decreased 22.1%, or $189,000, to $663,000 in 2003 compared to $852,000 in 2002. Facilities expenses were $123,000 lower in 2003 compared to 2002. The costs for outside services were $64,000 lower in 2003 compared to 2002 levels.

On September 9, 2002, DaTARIUS Technologies Inc., a subsidiary of global test equipment manufacturer DaTARIUS Technologies GmbH, purchased Integral Vision’s assets related to inspection systems for the optical disc industry, including the names “Automatic Inspection Systems” and “AID.” The sale included Integral Vision’s optical disc scanner products as well as its range of print and identification code products used to inspect the printing stage of disc manufacture. The consideration the Company received for the technology consisted of a non-refundable $100,000 advanced minimum royalty payment in addition to future royalties. The Company received approxmiately $54,000 in royalties in 2003 and expects to receive additional royalties of approximately $60,000 in 2004 and $30,000 in 2005. Additionally, the Company received $25,000 from the sale of equipment to DaTARIUS. The Company recognized a gain on the transaction of approximately $112,000, which is included in gain on sale of assets in 2002, primarily attributable to the advanced minimum royalty payment received. The proceeds from the transaction were used primarily to fund current operations.

Other income(expense) in 2003 includes approximately $54,000 of royalty income and $18,000 for engineering fees in connection with the DaTARIUS Technologies transaction.

Interest income decreased to $320 in 2003 compared to $11,000 in 2002. The income in the 2002 period is primarily attributable to interest charged on the officers’ notes receivable. The decrease in interest income from the prior year period is primarily attributable to the of the officers’ notes receivable in 2003.

Interest expense increased $119,000 to $370,000 in 2003 compared to $251,000 in 2002. The increase is primarily attributable to the interest on the debentures and Class 2 notes that were sold under the 2001 Note and Warrant Purchase Agreement (see Note C to consolidated financial statements) and the discount on the debentures amortized in 2003.

In June 2002, Integral Vision, Inc. wrote-off an inter-company receivable due from Integral Vision Ltd., its subsidiary in the United Kingdom. As the consolidated financial statements include the accounts of both entities, upon consolidation, the charge recorded by Integral Vision, Inc., approximately $3.1 million, was eliminated against the gain recorded by Integral Vision Ltd. However, previously unrecognized losses that resulted from foreign currency translation adjustments were recognized in the June 30, 2002 quarter and totaled approximately $208,000.

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Quarterly Information

The following table sets forth Consolidated Statements of Operations data for each of the eight quarters in the two-year period ended December 31, 2004. The unaudited quarterly information has been prepared on the same basis as the annual information and, in management’s opinion, includes all adjustments necessary for a fair presentation of the information for the quarters presented.

Seasonality and Quarterly Fluctuations

The Company’s revenues and operating results have varied substantially from quarter to quarter and management believes these fluctuations may continue. The Company’s reliance on large orders has contributed to the variability of the Company’s operating results.

Liquidity and Capital Resources

Operating activities for 2004 used cash of approximately $2.2 million primarily due to the Company’s loss from operations. Net loss, after non-cash adjustments of $297,000, was $2.2 million. Increases in accounts receivable and inventories used cash of $264,000 while a decrease in prepaid and other assets and an increase in accounts payable generated $234,000.

The Company’s investing activities included primarily the purchase of approximately $15,000 of equipment in 2004.

The Company’s financing activities included proceeds of $1.5 million from the issuance of restricted common stock. These shares cannot be transferred without registration or pursuant to an applicable exemption from registration. The Company received $775,000 and $478,000 from the sale of Class 2 Notes and Class 3 Notes, respectively. The Company made principal payments of approximately $290,000 on its Class 2 Notes in the period. The Company made principal payments of approximately $137,000 on other long term notes in the period. Additionally, employee stock options were exercised during the period generating approximately $28,000.

For further discussion regarding the Company’s obligations, see Note C to consolidated financial statements.

At December 31, 2004, under the terms of the Company’s Note and Warrant Purchase agreement, as amended, the Company could issue up to $5.5 million of senior debentures, which consists of Class 1, Class 2, and Class 3 Notes which are secured by all intellectual property of the Company. Class 2 Notes are working capital notes, are secured by accounts receivable of the Company, and are subordinated to the Class 1 Notes issued prior to April 16, 2002. In September 2003, the holders of all of the then outstanding Class 2 Notes agreed to modify the

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maturity dates of those Notes to April 30, 2004. In December 2003, certain of the Class 2 Notes were amended to have maturity dates of May 31, 2004. The purchasers of the Class 2 Notes receive warrants for the purchase of the Company’s common stock when the Note is repaid. Class 2 Warrants entitle the holder to purchase one share of Common Stock for each $1 in value of the Class 2 Note multiplied by a fraction, the numerator of which is the number of days such Class 2 note is outstanding and the denominator of which is 365. The price of these shares shall be approximately 150% of the recent fair market value of the Common Stock as of the date of the issuance of the Class 2 Note. Based on their respective maturity dates, the number of common shares that could be purchased with Class 2 warrants as of December 31, 2004 is estimated to be 1,448,580. In August 2003, the holders of those Notes agreed to a modification to the Note and Warrant Purchase Agreement that created a new Class 3 Note which is convertible into Integral Vision, Inc. common stock at a conversion rate set by the Company’s board of directors at the date of issuance. Class 1 Notes issued have maturities of up to four years, an interest rate of 10%, and the purchasers of the Notes receive warrants for the purchase of the Company’s common stock. The value assigned to warrants is included in additional paid-in capital and the discount is amortized over the life of the note. Additionally, the directors will determine the conversion rate at the date of issuance, subject to change in the event additional shares are issued in the future. In March 2004, the holders of the Class 1 and Class 2 Notes agreed to an additional modification to the Note and Warrant Purchase Agreement that increased the maximum amount of the Notes outstanding to $5.5 million. The maturity date on substantially all of the then outstanding Class 2 Notes was extended to December 31, 2005. The amended Note and Warrant Purchase Agreement provides that, as a result of the Company’s shareholders’ approval of management’s proposal to increase the Company’s authorized stock to 31,000,000 shares at the Company’s annual meeting of its shareholders that was held on May 6, 2004, the following has occurred:

	•	The accrued interest on outstanding Class 1 Notes as of December 31, 2003 in the amount of approximately $331,000 has been exchanged for new Class 3 Notes due July 3, 2006 with interest at 8% payable semi-annually beginning April 1, 2005 and convertible into shares of the Company’s common stock at $0.75 per share.
	•	The initial interest payment due on Class 1 Notes for interest accruing after December 31, 2003 is due April 1, 2005.
	•	Quarterly principal payments on Class 1 Notes have been eliminated, with all principal due at maturity.
	•	$330,000 of principal on Class 1 Notes issued prior to April 16, 2002 has been exchanged for Class 3 Notes due February 27, 2007 with interest at 8% payable semi-annually beginning April 1, 2005 and convertible into shares of the Company’s common stock at $0.75 per share.
	•	Class 2 Notes outstanding at February 29, 2004, plus interest then accrued, may be exchanged for Class 3 Notes due December 31, 2005 with interest at 8% payable semi-annually beginning April 1, 2005 and convertible into shares of the Company’s common stock at $0.75 per share.

On the modification date, the market price of the Company’s common stock was approximately $1.50 per share. The Board considered the $0.75 conversion price was justified given the concessions received in connection with the debt, the fact that the shares are restricted, and other factors.

The following table details the projected principal and interest payments to be paid in 2005:

The notes and warrants referenced above were sold in private transactions exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. There are fifteen purchasers,

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some of whom have purchased on more than one occasion. Of these, three of the purchasers are related entities or insiders of the Company. Eleven of the purchasers are either a client, or relative of the principal, of one State of California registered investment advisor. To the best of the Company’s knowledge, all of the purchasers are either “accredited investors” as that term is defined in Regulation D under the Securities Act of 1933 or, either alone or with their purchaser representative, have such knowledge and experience in financial and business matters that they are capable of evaluating the merits and risks of the investment.

During the quarter ended June 2004, the Company sold 1,223,000 shares of unregistered shares of its common stock at $1.23 per share in private transactions exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The securities were sold to four investment firms, one of which purchased in excess of 800,000 shares.

These shares, and the shares to be issued pursuant to the notes and warrants discussed above, are restricted from being transferred without registration or pursuant to an exemption from registration. After one year, the shares could be sold in unsolicited broker transactions pursuant to Rule 144 under the Securities Act of 1933 (“Rule 144”), which includes restrictions on the number of shares that may be sold in any three month period. For those holders who are not affiliates of the Company, after the restricted shares have been held for at least two years, many of the restrictions of Rule 144, including the restriction on the number of shares which may be sold, will no longer apply.

Under the terms of the Note and Warrant Purchase Agreement and the agreements for the sale of the restricted shares, the Company was obligated to use its best efforts to register the restricted shares and the shares issuable upon exercise of the notes and warrants by September 30, 2004. Although the deadline has passed, the Company still anticipates filing a registration statement to fulfill this obligation. Such registration would eliminate the restrictions on transfer.

Management is projecting a cash shortfall over the next twelve months of approximately $1.3 million based on the existing capital structure of the Company, including $820,000 due to be paid on various dates between March 31, 2005 and April 30, 2005. The holders of this debt have agreed to allow the Company to defer these payments until April 30, 2005. Management is currently in negotiations with potential investors to place a minimum of $5.0 million in unregistered convertible preferred stock and common stock equivalents. If successful, the proceeds generated from this sale would be used to retire certain notes as well as provide additional working capital. Alternatively, management plans to seek additional investors of its debentures to cover the anticipated shortfall, which would bring the amount of debentures outstanding to $4.7 million. Additionally, if necessary, management would attempt to obtain any additional cash needed to enable the Company to continue as a going concern through possible joint ventures and other strategic alliances. Additional financing may or may not be available through banks. There can be no assurance that management will be able to successfully execute any of these plans before the Company has exhausted all of its resources. These uncertainties raise substantial doubt about the Company’s ability to continue as a going concern.

Impact of Inflation

The amounts presented in the financial statements do not provide for the effect of inflation on the Company’s operations or its financial position. Amounts shown for property, plant and equipment and for costs and expenses reflect historical cost and do not necessarily represent replacement cost or charges to operations based on replacement cost. The Company’s operations together with other sources are intended to provide funds to replace property, plant and equipment as necessary. Net income would be lower than reported if the effects of inflation were reflected either by charging operations with amounts that represent replacement costs or by using other inflation adjustments.

Recently Issued Accounting Standards

In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 151 Inventory Costs, an Amendment of ARB No. 43, Chapter 4. SFAS 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) be recognized as current period charges. It also requires that allocation of fixed production overheads to the costs of conversion

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be based on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe that the adoption of SFAS 151 will have a material impact on its results of operations or financial position.

In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment, (SFAS 123R). SFAS 123R addresses the accounting for share-based payments to employees, including grants of employee stock options. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Instead, companies will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. SFAS 123R will be effective for periods beginning after June 15, 2005 and allows, but does not require, companies to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS 123R. The Company has not yet determined which fair-value method and transitional provision it will follow. However, the Company expects that the adoption of SFAS123R will not have a significant impact on its results of operations nor does it expect that the adoption of SFAS 123R will impact its overall financial position. See Note 8 for the proforma impact on net income and net income per share from calculating stock-based compensation costs under the fair value alternative of SFAS 123. However, the calculation of compensation cost for share-based payment transactions after the effective date of SFAS 123R may be different from the calculation of compensation cost under SFAS 123, but such differences have not yet been quantified.

In December 2004, the FASB issued SFAS 153 Exchanges of Nonmonetary Assets, and Amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in APB Opinion No. 29, however, included certain exceptions to the principle. SFAS 153 amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. The Company does not believe that the adoption of SFAS 153 will have a material impact on its results of operations or financial position.

Management is aware of the requirements of Section 404 of the Sarbanes-Oxley act and is in the process of evaluating its plans to comply with those requirements. The Company must begin to comply with the internal control over financial reporting requirements in 2006.

Management’s Discussion of Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The accounting policies discussed below are considered by management to be the most important to an understanding of our financial statements, because their application places the most significant demands on management’s judgment and estimates about the effect of matters that are inherently uncertain. Our assumptions and estimates were based on the facts and circumstances known at December 31, 2004, future events rarely develop exactly as forecast, and the best estimates routinely require adjustment. These policies are also discussed in Note A of the Notes to Consolidated Financial Statements included in Item 8 of this report.

Revenue Recognition

The Company recognizes revenue in accordance with SOP 97-2, Software Revenue Recognition and Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement exists,

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delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured.

The Company accounts for certain product sales of its flat panel display inspection systems as multiple-element arrangements. If specific customer acceptance requirements are met, the Company recognizes revenue for a portion of the total contract price due and billable upon shipment, with the remainder recognized when it becomes due (generally upon acceptance). The Company recognizes all other product sales with customer acceptance provisions upon final customer acceptance. The Company recognizes revenue from the sale of spare parts upon shipment. Revenue from service contracts is recognized over the life of the contract. Revenue is reported net of sales commissions.

Inventories

Inventories are stated at the lower of standard cost, which approximates actual cost determined on a first-in, first-out basis, or market. Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating these components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves for obsolete and slow-moving parts ranging from 0% for active parts with sufficient forecasted demand up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.

Impairment of Long-lived Assets

The Company reviews its long-lived assets, including property, equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount of the asset.

Contingencies and Litigation

The Company makes an assessment of the probability of an adverse judgment resulting from current and threatened litigation. The Company accrues the cost of an adverse judgment if, in Management’s estimation, an adverse settlement is probable and Management can reasonably estimate the ultimate cost of such litigation. The Company has made no such accruals at December 31, 2004.

ITEM 7a. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risk stemming from changes in foreign exchange rates, interest rates and prices of inventory purchased for assembly into finished products. Changes in these factors could cause fluctuations in earnings and cash flows. In the normal course of business, exposure to interest rates is managed by fixing the interest rates on the Company’s long-term debt whenever possible. The Company does not generally enter into long-term purchase contracts but instead purchases inventory to fill specific sales contracts thereby minimizing risks with respect to inventory price fluctuations.

While sales are generally denominated in US dollars, from time to time the Company may denominate sales in the following additional currencies:

	v	US Dollars
	v	Pound Sterling
	v	Euros
	v	Yen

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In management’s opinion, as the currencies of Western Europe and the UK are generally stable, there is no significant exposure to losses due to currency fluctuations. However, because the Yen has not been stable over the past several years, the Company does enter into forward sales contracts equal to the future amount of Yen to be received at the time the order is accepted. These hedging transactions are on an order by order basis and at no time are they speculative in nature. At December 31, 2004, the Company had no open positions and had no sales denominated in a foreign currency.

ITEM 8. Financial Statements and Supplementary Data

Financial statements and quarterly results of operations are submitted in separate sections of this report.

ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

Moore Stephens Doeren Mayhew, the Company’s independent auditors, (“Doeren”) resigned following completion of its audit of the Company’s financial statements for the year ended December 31, 2002. Doeren’s resignation was based on its decision to terminate its engagements with any publicly owned companies.

Doeren’s report on the Company’s consolidated financial statements for the year ended December 31, 2002 was qualified as to uncertainty regarding the Company’s ability to continue as a going concern. The report did not contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to any other uncertainty or as to audit scope, or accounting principles. In connection with the audit of the Company’s consolidated financial statements for the year ended December 31, 2002, there were no disagreements between the Company and Doeren on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to the satisfaction of Doeren, would have caused Doeren to make reference to the matter in its report.

Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, the Company is responsible for listing the non-audit services approved by the Company’s Audit Committee to be performed by Rehmann Robson, the Company’s independent registered public accounting firm. Non-audit services are defined as services other than those provided in connection with an audit or a review of the financial statements of the Company. In the period covered by this filing, the Audit Committee approved the following non-audit services currently being rendered to the Company by Rehmann Robson, or to be rendered to the Company by Rehmann Robson:

	•	preparation of tax returns, and tax advice in preparing for and in connection therewith;
	•	review of quarterly financial statements.

ITEM 9A. Controls and Procedures

Controls and Procedures

 a)   Evaluation of disclosure controls and procedures

Our chief executive officer and chief financial officer have each reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a date within 90 days before the filling date of this report. Based on that evaluation, our chief executive officer and chief financial officer have each concluded that our current disclosure controls and procedures are effective to ensure that information required to be disclosed in our periodic reports filed under the Exchange Act is recorded, processed, summarized, and reported, in each case, within the time period specified by the SEC’s rules and regulations.

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     b) Changes in internal controls

There have not been any significant changes in our internal controls