CYBEROPTICS CORP - Quarter Report: 2007 September (Form 10-Q)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Check One)

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

o    TRANSITION PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT

For the transition period from ______ to ______

COMMISSION FILE NO. (0-16577)

CYBEROPTICS CORPORATION

(Exact name of registrant as specified in its charter)

(763) 542-5000

(Registrant’s telephone number, including area code)

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. At October 31, 2007, there were 8,934,555 shares of the registrant’s Common Stock, no par value, issued and outstanding.

PART I.  FINANCIAL INFORMATION

ITEM 1.   CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

CYBEROPTICS CORPORATION

(Unaudited)

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

CONDENSED CONSOLIDATED INCOME STATEMENTS

CYBEROPTICS CORPORATION

(Unaudited)

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

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

CYBEROPTICS CORPORATION

(Unaudited)

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

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NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CYBEROPTICS CORPORATION

(In thousands, except share and per share amounts)

1.   INTERIM REPORTING:

The interim condensed consolidated financial statements presented herein as of September 30, 2007, and for the three and nine month periods ended September 30, 2007 and 2006, are unaudited, but in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of financial position, results of operations and cash flows for the periods presented.

The results of operations for the three and nine month periods ended September 30, 2007 do not necessarily indicate the results to be expected for the full year. The December 31, 2006, condensed consolidated balance sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. These unaudited interim condensed consolidated financial statements should be read in conjunction with our condensed consolidated financial statements and notes thereto, contained in our Annual Report on Form 10-K for the year ended December 31, 2006.

2.   ACCOUNTING FOR STOCK-BASED COMPENSATION:

Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,” applying the modified prospective method. This statement requires all equity-based payments to employees, including grants of employee stock options, to be recognized in the consolidated statement of earnings based on the grant date fair value of the award. Under the modified prospective method, we are required to record equity-based compensation expense for all awards granted after the date of adoption, and for all unvested shares granted prior to the date of adoption. We utilize the straight-line method of expense recognition over the award’s service period for our graded vesting options. The fair value of stock options, granted before and after adoption of SFAS No. 123(R), has been determined using the Black-Scholes model. The compensation expense recognized for all equity based awards is net of estimated forfeitures, which were based on historical data. We have classified equity based compensation within our statement of operations in the same manner as our cash based employee compensation costs.

The following tables set forth compensation expense (pre-tax) by segment for our equity-based awards for the three and nine months ended September 30, 2007 and 2006 (in thousands):

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Total equity based compensation expense in the three months ended September 30, 2007 includes $98,000 for stock option awards, $28,000 for our employee stock purchase plan and $9,000 for unvested restricted stock units. Total equity based compensation expense in the three months ended September 30, 2006 includes $107,000 for stock option awards, and $33,000 for our employee stock purchase plan. Total equity based compensation expense in the nine months ended September 30, 2007 includes $442,000 for stock option awards, $85,000 for our employee stock purchase plan, and $27,000 for unvested restricted stock units. Total equity based compensation expense in the nine months ended September 30, 2006, includes $546,000 for stock option awards, and $91,000 for our employee stock purchase plan.

At September 30, 2007, the total unrecognized compensation cost related to non vested equity based compensation arrangements was $849,000 and the related weighted average period over which it is expected to be recognized is 1.4 years.

Stock Options

We have three stock incentive plans that are administered under the supervision of the Compensation Committee of the Board of Directors. There are 1,102,372 shares of common stock reserved in the aggregate for issuance of options and other stock based benefits, including restricted stock units, to employees, directors, officers and others. Reserved shares underlying canceled options are available for future grant under our active plans. Options are granted at an option price per share equal to or greater than the market value at the date of grant. Generally, options granted to employees vest over a four-year period and expire five, seven or ten years after the date of grant. Each of our outside directors receives a stock option grant with immediate vesting for 4,500 shares on the day of our annual meeting. The plans allow for option holders to tender shares of our common stock as consideration for the option price provided that the tendered shares have been held by the option holder at least six months. The only stock options granted during the nine months ended September 30, 2007 were the annual grants to our outside directors on May 21, 2007, aggregating 18,000 shares. As of September 30, 2007, there are 446,911 shares of common stock available under these plans for future issuance to employees and 66,300 shares of common stock available for future issuance to our outside directors. In addition, there are 50,000 shares reserved and included in the plan summaries below that are not part of the three stock incentive plans.

The following is a summary of stock option activity during the nine months ended September 30, 2007:

The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. The weighted average remaining contractual term and aggregate intrinsic value for options outstanding at September 30, 2007 was 4.02 years and $358,000. The weighted average remaining contractual term and aggregate intrinsic value of options exercisable at September 30, 2007 was 3.77 years and $385,204. The aggregate intrinsic value of stock options exercised in the nine months ended September 30, 2007 was $132,000. During the nine months ended September 30, 2007, we received total proceeds of $630,000 from the exercise of stock options and the excess tax benefit recognized as a credit to stockholders equity was $28,000.

Restricted Stock Units

Our 1998 Stock Incentive Plan also permits our Compensation Committee to grant other stock-based benefits, including restricted stock units. Restricted stock units are valued at a price equal to the fair market value of our common stock on the date of grant. In December 2006, we awarded 11,740 restricted stock units to our officers and certain key employees. The restricted stock units vest over a four year period and entitle the holders to one share of our common stock for each restricted unit. The fair value of each restricted stock unit on the date of grant was $12.95, and the aggregate intrinsic value of outstanding restricted stock units as of September 30, 2007 was $144,000. There were no grants or forfeitures of restricted stock units in the nine months ending September 30, 2007. As of September 30, 2007, none of the restricted stock units were vested.

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A summary of activity in non vested restricted stock units for the nine months ended September 30, 2007 follows:

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan available to eligible U.S. employees. Under terms of the plan, eligible employees may designate from 1% to 10% of their compensation to be withheld through payroll deductions, up to a maximum of $6,500 in each plan year, for the purchase of common stock at 85% of the lower of the market price on the first or last day of the offering period. Under the plan, 800,000 shares of common stock have been reserved for issuance. Share issuances under this plan were 28,859 in the nine months ended September 30, 2007 and 29,398 in the nine months ended September 30, 2006. As of September 30, 2007, 141,317 shares remain available for future issuance under this plan.

3.   CERTAIN BALANCE SHEET COMPONENTS:

Inventories consist of the following:

Warranty liabilities:

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

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4.   INTANGIBLE ASSETS AND GOODWILL:

Intangible assets consist of the following:

Amortization expense for the three and nine months ended September 30, 2007 and 2006 is as follows:

As required by SFAS 144, we periodically reassess the carrying value, useful lives and classification of identifiable intangible assets. Estimated aggregate amortization expense based on current intangibles for the next five years is expected to be as follows: $106,000 for the remainder of 2007 and $336,000 in 2008, $336,000 in 2009, $198,000 in 2010 and $121,000 in 2011. The preceding expected amortization expense is an estimate. Actual amortization expense may differ from estimates due to additional intangible asset additions, impairment of intangible assets, accelerated amortization of intangible assets and other events.

Goodwill related to our electronic assembly segment increased by $111,000 in the nine months ended September 30, 2007 solely as the result of the translation impact on foreign denominated goodwill balances.

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5.   BUSINESS SEGMENTS AND SIGNIFICANT CUSTOMERS:

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

Export sales were 85% of revenue in the three months ended September 30, 2007 and 87% of revenue in the nine months ended September 30, 2007. Export sales were 85% of revenue in the three months ended September 30, 2006 and 84% of revenue in the nine months ended September 30, 2006. All of our export sales are negotiated, invoiced and paid in U.S. dollars. Export sales by geographic area are summarized as follows:

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6.   NET INCOME PER SHARE:

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of common and common equivalent shares outstanding. Common equivalent shares consist of common shares to be issued upon exercise of stock options, restricted stock units and from participation in our employee stock purchase plan, as calculated using the treasury stock method. The calculation of diluted net income per common share includes 67,000 common equivalent shares for the three months ended September 30, 2007 and 71,000 common equivalent shares for the three months ended September 30, 2006. The calculation of diluted net income per common share includes 83,000 common equivalent shares for the nine months ended September 30, 2007 and 97,000 common equivalent shares for the nine months ended September 30, 2006. The calculation of diluted net income per common share excludes 316,000 potentially dilutive shares for the three months ended September 30, 2007 and 294,000 potentially dilutive shares for the three months ended September 30, 2006. The calculation of diluted net income per common share excludes 314,000 potentially dilutive shares for the nine months ended September 30, 2007 and 217,000 potentially dilutive shares for the nine months ended September 30, 2006, because their effect would be anti-dilutive.

7.   COMPREHENSIVE INCOME:

Components of comprehensive income include net income, foreign-currency translation adjustments and unrealized gains and losses on our available-for-sale marketable securities. Total comprehensive income amounted to $1,799,000 for the three months ended September 30, 2007 and $1,792,000 for the three months ended September 30, 2006. Total comprehensive income totaled $4,132,000 for the nine months ended September 30, 2007 and $5,170,000 for the nine months ended September 30, 2006. At December 31, 2006 and September 30, 2007, components of accumulated other comprehensive loss is as follows:

8. INCOME TAXES:

Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” an interpretation of FASB Statement No. 109 “Accounting for Income Taxes”. FASB Interpretation No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109. The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

As a result of our adoption of FIN 48, we recognized a $32,000 increase in our liability for unrecognized income tax benefits with a corresponding decrease in beginning retained earnings on January 1, 2007. At the adoption date of January 1, 2007, we had $2,095,000 of gross unrecognized tax benefits, $1,246,000 of which would affect our effective tax rate if recognized. At September 30, 2007, we have $2,252,000 of gross unrecognized tax benefits. Consistent with the requirements of FIN 48, our net unrecognized tax benefits have been classified as a long term liability in our balance sheet.

We recognize interest and penalties related to uncertain tax positions as a component of income tax expense. At adoption of FIN 48 on January 1, 2007, we had approximately $143,000 of accrued interest and penalties related to uncertain tax positions. The tax years 2003-2006 remain open to examination by the major taxing jurisdictions to which we are subject.

We have recorded a tax provision at an estimated annual effective tax rate of 35.8% in the nine months ended September 30, 2007 compared to an estimated annual effective tax rate of 31.5% in the nine months ended September 30, 2006.

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During the three and nine months ended September 30, 2007, we recognized additional income tax expense of $64,000 as a discrete item due to a reduction in deferred tax assets resulting from a tax law change in the United Kingdom. As a result, the effective tax rate for the three months ended September 30, 2007 was 38.4%.

During the three and nine months ended September 30, 2006, we recognized an income tax benefit of $232,000 as a discrete item resulting from a reduction in a tax contingency accrual for prior year’s income taxes. The discrete benefit in 2006 was primarily related to the expiration of the domestic statute of limitations applicable to actions that may be brought for certain prior years. As a result, the effective tax rate for the three months ended September 30, 2006 was 25.3%.

9.   DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES:

We enter into foreign currency swap agreements to hedge short term inter-company financing transactions with our subsidiary in the United Kingdom. These currency swap agreements are structured to mature on or about the last day of each quarter, and are designated as cash flow hedges. At September 30, 2007, we had one open swap agreement that was purchased on September 28, 2007, the fair value of which was inconsequential. The gains or losses from the settlement of foreign currency swap agreements, and the impact of currency fluctuations on the underlying inter-company balance, were insignificant in the three and nine months ended September 30, 2007.

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

10.   CONTINGENCIES:

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

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

11.   RECENT ACCOUNTING DEVELOPMENTS:

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157 “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 will apply whenever another standard requires (or permits) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value to any new circumstances, and is effective beginning after December 31, 2007. We are currently evaluating the impact of adopting SFAS No. 157 on our financial position and results of operations.

12.   BOARD AUTHORIZATION OF STOCK REPURCHASE:

Our board of directors has approved a stock repurchase program, effective October 29, 2007 for a period of one year, under which we are allowed to acquire up to 500,000 shares of our common stock from time to time in open market transactions, block purchases and other transactions. We have adopted a structured trading plan to implement the repurchase program.

During the nine months ended September 30, 2007, we repurchased 13,066 shares of our common stock for $163,000 under a stock repurchase program that expired in July 2007.

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ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

The preparation of the financial information contained in this 10-Q requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate these estimates on an ongoing basis, including those related to allowances for doubtful accounts and returns, warranty obligations, inventory valuation, the carrying value and any impairment of intangible assets, and income taxes. These critical accounting policies are discussed in more detail in the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Form 10-K for the year ended December 31, 2006.

RESULTS OF OPERATIONS:

General

Our revenues increased 15% to $16.2 million in the quarter ended September 30, 2007 and increased slightly by 1% to $43.9 million for the nine months ended September 30, 2007 from the same periods last year. Our income from operations was $1.8 million in the quarter ended September 30, 2007 unchanged from the quarter ended September 30, 2006. Our income from operations decreased to $4.3 million in the nine months ended September 30, 2007 from $6.1 million in the nine months ended September 30, 2006.

The market for automated pick and place machines into which we sell our electronic assembly sensors rebounded in the third quarter of 2007, after being sluggish in the first half of 2007. Sales of electronic assembly sensors to our primary OEM customers in the third quarter of 2007 were at their highest level within the past two years. Sales of electronic assembly sensors accounted for all of the increase in revenue in the third quarter of 2007, compared to the same period last year. Sales volume of SMT inspection system products continued to be strong, although these sales transactions are impacted by the timing of revenue recognition of several large sales.

Because of the sluggishness in the first half of 2007, our revenue for the nine months ended September 30, 2007 was essentially unchanged from revenue during the first nine months of 2006. With increased investment in research and development for our SMT systems products in 2007, continuing price pressure on our SMT systems products, and non-recurring expenses from due diligence and other activities related to a cancelled acquisition in the third quarter of 2007, we recorded lower income from operations during the nine months ended September 30, 2007. Nevertheless, we believe SMT inspection systems have the potential to be a consistent source of future revenue growth. We have increased research and development spending on current and next generation SMT inspection system products in order to keep our offerings on the leading edge of inspection technology.

Although our order rate during, and our backlog at the end of, the third quarter of 2007, declined slightly from the second quarter of 2007, our third quarter order rate and backlog remain high in comparison to recent quarterly periods. We expect demand for electronic assembly sensors to remain solid, although we do anticipate the order rate to moderate somewhat in the fourth quarter of 2007. Worldwide demand for cell phones, laptops and other consumer electronics remain strong, along with the economies in the countries where most of our products are sold. We are optimistic that these factors will continue to drive demand for our electronic assembly and semiconductor products, and we will continue to see strength in our global markets for electronic assembly and semiconductor capital equipment.

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Segment Results

Operating results for our electronic assembly and semiconductor segments for the three and nine months ended September 30, 2007 and 2006 were as follows (in thousands):