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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K (Mark One) x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003 or 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: 0-28236 INVISION TECHNOLOGIES, INC.  DELAWARE
(State or Other Jurisdiction of
Incorporation or Organization)
    
    94-3123544
(I.R.S. Employer
Identification No.)
 7151 GATEWAY BOULEVARD, NEWARK, CALIFORNIA 94560  (510) 739-2400
(Registrants Telephone Number, Including Area Code) Securities Registered Pursuant to Section 12(b) of the Act:NONE Securities Registered Pursuant to Section 12(g) of the Act:COMMON STOCK, $0.001 PAR VALUE 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 for 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of 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. x Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes x No o On June 27, 2003, which was the last business day of the registrants most
recently completed second fiscal quarter, the registrant had 17,259,884 shares
of common stock outstanding, and the aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately $375.7 million
(based on the closing price of $24.55 on that day). For purposes of this
computation, voting stock held by directors and executive officers of the
registrant and stockholders holding 5% or more of the registrants outstanding
common stock has been excluded. Such exclusion is not intended, and shall not
be deemed, to be an admission that such directors, executive officers and
stockholders are affiliates of the registrant. On
March 1, 2004, there were 17,297,789 shares of the registrants common
stock outstanding.




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INVISION TECHNOLOGIES, INC
TABLE OF CONTENTS




TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 6. SELECTED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESPART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KSIGNATURESEXHIBIT INDEXEXHIBIT 2.2EXHIBIT 10.34EXHIBIT 14.1EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1    Table of Contents  PART I.Item1.
    
    Business2.
    
    Properties3.
    
    Legal Proceedings4.
    
    Submission of Matters to a Vote of Security HoldersPART II.Item5.
    
    Market for Registrants Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities6.
    
    Selected Financial Data7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations7A.
    
    Quantitative and Qualitative Disclosures About Market Risk8.
    
    Financial Statements and Supplementary Data9.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure9A.
    
    Controls and ProceduresPART III.Item10.
    
    Directors and Executive Officers of the Registrant11.
    
    Executive Compensation12.
    
    Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters13.
    
    Certain Relationships and Related Transactions14.
    
    Principal Accountant Fees and ServicesPART IV.Item15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-KSignature Page
 InVision, Quantum Magnetics, Yxlon, Hapeg, CTX, CTX 5500 DS, CTX 9000 DSi,
QScan, QScan QR 2000S, XES 3000 and XES 3500, among others, are trademarks of
InVision Technologies, Inc. or one of its subsidiaries in the United States and
other countries. InVision, Quantum Magnetics, Yxlon and QScan, among others,
are registered trademarks marks of InVision Technologies, Inc. or one of its
subsidiaries in the United States.




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PART I. 
 ITEM 1. BUSINESS References to we, us and our mean InVision Technologies, Inc. and
its consolidated subsidiaries, including Yxlon International X-Ray GmbH, Yxlon
International Security GmbH, Quantum Magnetics, Inc. and Inovec, Inc. Forward Looking Statements This Annual Report on Form 10-K of InVision Technologies, Inc. includes
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. We intend
these forward-looking statements to be covered by the safe harbor provisions
for forward-looking statements contained in the Private Securities Litigation
Reform Act of 1995, and we are including this statement for purposes of
complying with these safe harbor provisions. We have based these
forward-looking statements on our current expectations and projections about
future events. These forward-looking statements are not guarantees of future
performance and are subject to risks, uncertainties and assumptions, including
those in the section entitled Risk Factors at the end of this Item 1. Actual
results may vary materially from these forward-looking statements as a result
of these and other risks. Words such as expect, anticipate, intend, plan, believe,
estimate and variations of these words and similar expressions are intended
to identify forward-looking statements. We undertake no obligations to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise, unless we are required to do so by
law. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed below might not occur. We were incorporated in Delaware in 1990. We maintain our principal
offices at 7151 Gateway Boulevard, Newark, California 94560, and our telephone
number is (510) 739-2400. Our website is located at www.invision-tech.com.
Information contained on our website does not constitute part of this annual
report. Introduction We are the leading provider of Transportation Security Administration, or
TSA (formerly Federal Aviation Administration, or FAA) certified explosives
detection systems, or EDS, used at airports for screening checked passenger
baggage. From inception through December 31, 2003, we shipped 872 EDS for
installation at U.S. airports and 202 EDS for installation in airports outside
of the United States. We believe that the EDS products we have shipped through
December 31, 2003 represent approximately two-thirds of the total number of
FAA/TSA-certified EDS products delivered for screening checked baggage at U.S.
airports and an even larger percentage of the total number of FAA/TSA-certified
EDS products delivered internationally. Our EDS products are based on advanced computed tomography, or CT, which
is the only technology for bulk explosives detection that has met the FAA/TSA
certification standards. We were the first manufacturer, and are currently one
of only two manufacturers, whose EDS products have been certified by the
FAA/TSA for screening checked baggage for bulk explosives. Our installed base
of EDS products provides us with significant opportunities for recurring
revenue through our offering of aftermarket services and hardware and software
upgrades. We offer to our customers the opportunity to buy a service contract
from us, which provides for scheduled maintenance, repairs and parts, and field
service once a warranty period on one of our CTX products has expired (which is
typically a one-year period). Through our acquisition of Yxlon International Holding GmbH, a privately
held company based in Hamburg, Germany, on March 31, 2003, we now offer a wide
range of non-destructive testing, or NDT, systems. Our NDT products are based
on X-ray and CT technologies and are used for inspection of finished products
and materials in a wide range of industries. Our NDT equipment is used in more
than sixty countries, including the United States. 1




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In addition, we offer explosives detection products based on Yxlons X-ray
based diffraction, or XRD, technology and products using quadrupole resonance,
or QR, and magnetic sensing technologies for the inspection, detection and
analysis of explosives, concealed weapons and other materials. We also offer
products, some of which are based on other technologies, that are used for
non-aviation applications, including landmine detection and maximization of
timber industry output. Products and Technologies Explosives and Weapons Detection Products We provide explosives and weapons detection products for use at key
security checkpoints within airports, including checked baggage, carry-on
baggage and passenger screening. The following table summarizes our key
products, as well as their applications and key features: Products
    
    Status
    
    Applications
    
    Key FeaturesCTX 9000 DSi
    
    In use; FAA certified in 1999
    
    Explosives detection for checked
baggage
    
    

    
    Utilizes CT technology
Designed for integration into baggage
handling systems with a unique, 1-meter-wide
gantry aperture
    
    FAA-certified at 542 bags per hourCTX 5500 DS
    
    In use; FAA certified in 1998
    
    Explosives detection for
    
    
    
    Utilizes CT technologychecked baggage
    
    
    
    Can be configured as integrated or
stand-alone system
    
    FAA-certified at 362 bags per hourCTX 2500
    
    In use; FAA certified in 1999
    
    Explosives detection for
    
    
    
    Utilizes CT technologychecked and carry-on baggage
    
    
    
    Designed for small airports and low-traffic
areas
    
    Designed for stand-alone lobby installation
    
    FAA-certified at 128 bags per hourCTX 1000
    
    In development; TSA
    
    Explosives detection for
    
    
    
    Utilizes CT technologycertification expected in 2004
    
    checked and carry-on baggage
    
    
    
    Designed for small airports and low-traffic
areas
    
    Designed for stand-alone lobby installation
    
    Compact, portable, low costXES 3500
    
    In development
    
    Explosives detection for
    
    
    
    Utilizes XRD technologychecked baggage
    
    
    
    High detection rate with low false alarm rate
    
    More compact, lighter and faster throughput
than XES 3000XES 3000
    
    In use in Europe; TSA
    
    Explosives detection for
    
    
    
    Utilizes XRD technologycertification expected in first half of 2004
    
    checked baggage
    
    
    
    High detection rate with low false alarm rateQScan QR 2000S
    
    In test markets
    
    Explosives detection for
    
    
    
    Utilizes QR technologycarry-on baggage and mail packages
    
    
    
    Compact, lightweight designQR Wand
    
    In development
    
    Weapons and explosives detection
    
    
    
    Utilizes QR technologyfor personnel screening
    
    
    
    Non-intrusive detection
 2




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Products
    
    Status
    
    Applications
    
    Key FeaturesQR Portal
    
    In development
    
    Explosives detection for
    
    
    
    Utilizes QR technologypersonnel screening
    
    
    
    Rapid, accurate scanning of personnelQR Shoe Scanner
    
    In development
    
    Explosives detection for
    
    
    
    Utilizes QR and metal detection technologyscreening of shoes
    
    
    
    Non-intrusive detection
 Products Based on CT Technology.We began developing our CT-based EDS
technology in 1990, pioneering our proprietary combination of X-ray and CT
technology with sophisticated image processing capabilities in a two-step
process for the detection of explosives. CT technology uses a source of X-rays
rotating around an object to create multiple two-dimensional images, commonly
known as slices, of the density distribution of the object in cross-section.
CT technology compares parameters derived from the analysis of the density
images to a database of explosives density characteristics. CT is the only
technology to base its detection on the density of the object examined. We
believe that our EDS products produce higher resolution images than our
competitors products by displaying more pixels and providing more useful views
of suspicious objects. Our FAA/TSA-certified EDS product offering, the CTX series, consists of
our CTX 9000 DSi, CTX 5500 DS and CTX 2500 products. Our CTX series is designed
to provide a family of checked baggage explosives detection systems for
airports of various sizes and design. For example, we offer variations in
throughput speeds, belt width and aperture size, installation and integration
options and price through the different products in the series. We believe that
all of our CTX products feature, in comparison to our competition, an ability
to detect the greatest variety and smallest amount of explosives, a lower false
alarm rate and greater operational reliability. We believe customers favor our
CTX products over competitors products because of our experience in installing
systems in airports, our service engineering force and the reliable performance
of our CTX products. The following provides a more detailed description of our
CTX series:  
    
    The CTX 9000 DSi model, certified in 1999, is designed to have
significantly higher throughput and to be more easily integrated into
airports baggage handling systems than other CT-based explosives
detection systems. It also has a larger aperture than competing
CT-based products that matches the width of conveyor belts in airport
baggage handling systems, and a compact active curtain that allows the
system to provide proper X-ray shielding during high throughput
operation. The system has an FAA-certified throughput of 542 bags per
hour.  
    
    The CTX 5500 DS model was certified in 1998 as an upgraded version
of our first EDS product, the CTX 5000 model, which was certified in
1994. The CTX 5500 DS system can be integrated into baggage handling
systems or used as a stand-alone machine. The system has an
FAA-certified throughput of 362 bags per hour.  
    
    The CTX 2500 model, also certified in 1999, is a less expensive EDS
operating at slower throughputs with a smaller footprint than other
CT-based explosives detection systems. The CTX 2500 system is designed
for use in small airports and low-traffic stations within larger
airports. The system has an FAA-certified throughput of 128 bags per
hour. In May 2000, we were selected as one of three participants in an
FAA-funded research program known as ARGUS. The FAA asked participants to
develop a smaller EDS, which would be less expensive than existing products,
and which could be used to scan carry-on baggage in addition to scanning
checked baggage for low throughput applications in small airports. We developed
our CTX 1000 model under this program. We have submitted our CTX 1000 model to
the TSA for certification, and expect to obtain TSA certification in 2004. We continue to incorporate improvements into our CTX series based upon
customer requirements, operational airport experience, a need for more advanced
detection capabilities and a number of TSA re-certifications of various models.
For example, we are developing new upgrades for our EDS products, which are
designed to significantly 3




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reduce false alarm rates and increase throughput rates. This detection
upgrade has been submitted to the TSA for certification. Products Based on XRD Technology.We offer explosives detection products
based XRD technology that has been developed by Yxlon or licensed from Philips.
Yxlons XRD technology utilizes an energy-dispersive diffraction technique to
precisely identify the chemical composition of a wide range of explosive
substances, even in small quantities. Explosives detection products with
Yxlons XRD technology offer three dimensional threat resolution with high
detection rate for explosives and low false-alarm rates. XRD-based systems can be used alone or to complement existing CT-based
screening systems. The current system available for sale is the XES 3000 system
to screen checked baggage at airports. Yxlon has received orders for 18 of its
XES systems from six European airports and the Israeli Airport Authority.
Yxlons XES system is currently undergoing certification testing by the TSA,
and we anticipate that it will receive TSA certification during the first half
of 2004. We are currently developing the XES 3500 system, which is intended to
be more compact and lighter while providing faster throughput than the XES 3000
system. Products Based on QR Technology.We offer entry point screening systems
based on QR technology, developed by Quantum. QR detection is based on
molecular structure, while CT detection is based on density. QR technology has
a high detection rate for specific explosives combined with a low false alarm
rate. In particular, QR technology has significant detection capabilities to
identify components typically found in the most difficult types of explosives
to detect. QR technology is a form of magnetic resonance, similar to medical
magnetic resonance imaging. The QR detector sends out specially tuned low
frequency radio waves into the material. The nuclei in the material align and
then as they relax to their previous state, they emit a unique radio wave
response, which is analyzed and compared to a database of known threats. Our QR
systems can be used alone or to complement existing CT or X-ray screening
systems. The current system available for sale is the QScan QR 2000S, a
successor to the QScan QR 160 system, to screen mail, parcels and personal
items at secure facilities and carry-on baggage at airports. With funding from the Department of State Technical Support Working Group,
Quantum is developing an explosives detection portal using QR technology. We
anticipate that, once QR is developed as a personnel screening technology, it
will be combined with other detection technologies in a multi-sensor portal to
screen people at airport checkpoints. As of December 31, 2002, we commenced in-airport testing of a prototype
system consisting of a QScan system coupled to a CTX product, known as QRCT.
This test system is planned for certification testing following further
development. We believe the advantages of such a system include automated
resolution of alarms, leading to lower operational cost and more efficient
throughput of checked baggage. Quantum has developed a prototype explosives detection handheld wand based
on QR technology, which can be utilized to detect explosives carried by or
concealed on people, including those that may be hidden in shoes. We are also
currently developing a shoe scanner based on metal detection and QR technology,
which can be utilized to detect explosives concealed in shoes. Non-Destructive Testing Products We offer X-ray based non-destructive testing, or NDT, equipment. Yxlons
NDT technology has wide industrial applications, including testing the internal
structural integrity of tires, structural castings and mechanical and
electrical components; verifying maintenance work, welds and wall thickness;
and testing for corrosion. Yxlons NDT equipment is used in more than sixty
countries, including Denmark, Germany, Japan and the United States. 4




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Products
    
    Applications
    
    Key FeaturesStationary X-ray Systems
    
    Non-destructive testing of materials for defects
    
    
    
    Detailed resolution
    
    System components are protected against the influence of dust and waterPortable and Mobile
    
    Non-destructive testing of materials for
    
    
    
    Compact, low weight and optimum access in confined spacesX-ray Systems
    
    defects; used in the field
    
    
    
    System components are protected against the influence of dust and waterStandard Cabinets
    
    Non-destructive testing of materials for
    
    
    
    Compact cabinet dimensionsdefects in the automotive,
aircraft and aerospace industries
    
    
    
    High-resolution images
    
    Range of pre-defined solutionsTire Systems
    
    Non-destructive testing of tires for defects
    
    
    
    Inspection of wide variety of tire types and materialsWheel Systems
    
    Non-destructive testing of cast or forged
    
    
    
    Automated image analysis software to avoid operator interferencewheels for defects, primarily for the automotive industry
    
    
    
    Innovative wheel positioning conceptsCustomized Solutions
    
    Customized non-destructive testing systems
    
    Examples include:for the automotive, aircraft and steel industries
    
    
    
    Creation of system for complete scanning of critical regions without
dismantling of an airplane
    
    Systems with retrieval and manipulation by robot, including version
integrated directly into a plants conveyor system
    
    Pipe weld X-ray inspection system
 In August 2003, Yxlon acquired German-based Hattinger Pruf- und
Entwicklungs- GmbH, or Hapeg, a private engineering and systems company that
designs and develops CT-based NDT systems for the automotive and aerospace
industries for clients, including DaimlerChrysler and Goodyear. The use of CT
imaging in industrial testing and evaluation permits the inspection and
calculation of distances, surfaces and volumes inside volumetric objects such
as cast parts, turbines and tires. Its uses include rapid prototyping, casting
simulations, design-phase testing and virtual CAD modeling of existing objects. Other Products Landmine Detection Systems.With funding from the Department of Defense,
we have developed and continue to improve QR-based landmine detection
technology. Most current landmines possess low metal content, forcing current
metal detection devices to be very sensitive to metal, which creates high false
alarm rates and slow clearing times. QR technology does not detect explosives
based on metal content and therefore exhibits much lower false alarm rates and
faster clearing times than metal detectors. We believe the current QR prototype
system is able to detect the vast majority of all landmines deployed throughout
the world and that QR technology can operate in almost all soil conditions,
including saturated soils, as well as through fresh water. Through December 31,
2003, Quantum has received $43.9 million in government funding for the
development of landmine detection systems. Due to current regulations, our
ability to export our landmine detection technology outside of the United
States is limited. Wood Products.Our subsidiary, Inovec, currently offers systems for
forest product maximization, which use laser scanners to measure the dimensions
of logs or sawn wood before further sawing. Our current Inovec products include
the StereoScan 3-D log scanner optimizer, the YieldMaster headrig carriage
optimizer, the LogMaster small log optimizer, the TrimMaster trimmer optimizer,
the CantMaster cant optimizer and the WaneMaster edger optimizer. These systems
use laser scanners to measure the dimensions of logs or sawn wood before
further sawing. Using proprietary optimizing algorithms, the systems develop
cutting solutions to maximize the volume of usable wood, and then control the
relative positions of the saw and the wood. Advanced Personnel Checkpoint Systems.Current passenger checkpoint
security technology is capable of identifying only metallic weapons. SafeView,
Inc. is commercializing an advanced passenger checkpoint portal system 5




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that uses millimeter wave holographic technology to screen passengers for
weapons, explosives and other contraband material, including ceramic, plastic
and other non-metallic weapons. The SafeView portal system transmits ultrahigh
frequency, extremely low powered waves as a person passes through the
checkpoint portal. These millimeter waves penetrate clothing and reflect off a
persons skin and the items he or she may be carrying. An array of sensors
captures the reflected waves, which are processed and analyzed in real time, to
produce a high-resolution, three-dimensional image from the signals. An
operator then uses software-based threat detection algorithms to screen the
image for suspicious materials. We will be the exclusive distributor of portal
systems utilizing SafeViews technology in commercial aviation and airport
markets in North America and Europe. Industry Segments We determine our segments based on how our Chief Executive Officer and
Chief Operating Officer assess performance and allocate resources. Through the
first quarter of 2003, we presented segment information based on three
reportable segments: EDS, Quantum and Wood. As a result of the acquisition of
Yxlon, we now have two reportable segments, EDS and NDT. The EDS segment is
comprised of the business unit that is engaged in the development,
manufacturing, marketing and support of explosives detection systems based on
advanced computed tomography technology. The NDT segment is comprised of the
Yxlon business unit that is engaged in the development, manufacturing,
marketing and support of non-destructive testing systems for a wide range of
industrial applications. Other segments including Quantum, Wood and XRD were
aggregated to form an All Other category as they did not meet the threshold
for a reportable segment. Financial information for each segment, including
revenues, net income (loss) and total assets, is reported in Note 11 of the
consolidated financial statements in this annual report. EDS.The EDS segment develops, manufactures, markets and supports
explosives detection systems for civil aviation security based on advanced CT
technology. Our products were the first automated explosives detection system
to be certified by the FAA. From inception through December 31, 2003 we have
shipped 1,074 systems to the FAA and the TSA, to foreign aviation security
agencies and to domestic and foreign airports and airlines. Our EDS product
sales accounted for 72.7% of our total revenues in 2003, 91.8% of our total
revenues in 2002 and 49.1% of our total revenues in 2001, and our EDS service
revenues accounted for 9.9% of our total revenues in 2003, 3.1% of our total
revenues in 2002 and 12.9% of our total revenues in 2001. As a result, we are
substantially dependent on the TSA for the majority of our EDS business. NDT.The NDT segment is comprised of the Yxlon business unit that is
engaged in the development, manufacturing, marketing and support of
non-destructive testing systems for a wide range of industrial applications.
Our NDT products are based on X ray and CT technologies that are used for
inspection of finished products and materials in a wide range of industries.
NDT accounted for 10.4% of our total revenues in 2003 and 17.2% of our total
revenues in the nine-month period since completion of our acquisition of Yxlon. Other segments, including Quantum, Wood and XRD, are aggregated to form an
All Other category as they did not meet the threshold for a reportable
segment. Customers EDS From inception through December 31, 2003, we shipped 1,074 EDS units for
installation. Substantially all purchases of EDS products for U.S. airports are
made by the TSA. Prior to the establishment of the TSA, substantially all
purchases of EDS products for U.S. airports were made by the FAA. Of the total
EDS products shipped, 872 were shipped to the FAA, the TSA and U.S. airlines
for installation at commercial U.S. airports. For security reasons, the FAA and
the TSA will not divulge the deployment schedule or locations of these systems.
We had EDS sales to the TSA and the FAA of $268.1 million in 2003, $356.7
million in 2002, and $20.0 million in 2001. We believe future sales of our EDS equipment will be driven primarily by
demand for the installation of in-line automated EDS into the baggage handling
systems of airports, which will achieve the highest level of security, vastly 6




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improve passenger convenience and lower operating costs. However, the
timing of revenues is highly dependent on the budget process and the ultimate
level of funding commitment. We continue to remain in active discussions with
the TSA regarding the U.S. governments needs for additional systems.
Additional orders for EDS equipment will depend on various factors, including
future U.S. government funding appropriations. From inception to December 31, 2003, we shipped 202 EDS products to
customers in Belgium, Canada, Chile, China, France, Greece, Hong Kong, Israel,
Italy, Japan, Malaysia, the Netherlands, the Philippines, South Africa, South
Korea, Spain, Sweden, Taiwan and the United Kingdom. We typically bill our customers in three stages, as generally provided in
our contracts with our customers:  
    
    amounts to cover the bill of materials when materials are received
from suppliers, typically 30% to 40% of the total system price;
    
    an additional amount upon factory acceptance or shipment, ranging from 30% to 60%; and
    
    the balance upon installation and site acceptance, ranging from 5% to 30%. NDT Our NDT product and service revenues are primarily derived from sales of
X-ray based NDT products primarily to the automotive and aerospace industries.
There were no NDT customers who accounted for more than 10% of total revenues
since the acquisition of Yxlon on March 31, 2003. We had NDT equipment sales
of $34.6 million since completion of our acquisition of Yxlon on March 31,
2003. We believe future sales of our NDT equipment will be driven primarily by
overall economic and industrial activity in the countries in which we market
our NDT equipment. Sales and Marketing EDS We market our EDS products and services both directly through internal
sales personnel and indirectly through authorized agents, distributors and EDS
systems integrators. For EDS sales through our authorized representatives and
distributors, we are generally directly involved in developing proposal
documents and negotiating contract terms. The selling process often involves a team comprised of individuals from
sales and marketing, engineering, customer service and support, legal and
senior management. The team frequently engages in a multi-level sales effort
directed toward a variety of constituents, including government regulators, the
local airport operator or authority, systems and conveyor integrators, and
individual airlines. We provide our sales representatives with training,
promotional literature, a multi-media presentation, videos and competitive
analysis. The sales process includes assisting customers to design baggage
handling system configurations, including the use of computer modeling,
educating customers on the system and technology, and supporting the
implementation and integration process. The combination of the high average selling prices, the time needed for
various agencies to secure funding for systems, and the negotiation and
execution of actual contracts historically has led to a typical sales cycle
lasting from six to twelve months, or more, after initial contact with a
customer. For repeat orders from existing customers, we can sometimes expedite
the sales cycle by utilizing existing contracts and contract extensions. NDT We market our NDT products and services directly through internal sales
personnel and indirectly through authorized agents and distributors. As of
December 31, 2003, Yxlon employed approximately 33 employees in NDT 7




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sales and marketing. For NDT sales through our authorized representatives
and distributors, we are generally directly involved in developing proposal
documents and negotiating contract terms. Research and Development We continue to make substantial investments to enhance the performance,
functionality and reliability of our products. We believe that continued and
timely development of new products and enhancements to existing products is
necessary to maintain our competitive position. Accordingly we devote a
significant portion of our personnel and financial resources to engineering and
research and development programs. As of December 31, 2003, we had 235
employees engaged in research and development and product development
activities. We are also using the services of 18 specialized contract employees
and consultants in this area. For the year ended December 31, 2003, we spent
$29.4 million on total research and development activities, of which $3.1
million was funded by the FAA, the TSA and other agencies under development
contracts and grants. For the year ended December 31, 2002, we spent $21.2
million on total research and development activities, of which $566,000 was
funded by the FAA, the TSA and other agencies under development contracts and
grants. For the year ended December 31, 2001, we spent $13.7 million on total
research and development activities, of which $5.7 million was funded by the
FAA and other agencies under development contracts and grants. Competition EDS We believe that the market for explosives detection systems will become
increasingly competitive. Several advanced explosives detection technologies
have been developed to attempt to address the need for effective explosives
detection for checked baggage, including CT technology and other technologies
described below:  
    
    Dual energy X-ray systems measure the X-ray absorption properties
of a bags contents at two different X-ray energies using one or two
views to determine if any of the contents have the physical
characteristics of explosive materials.
    
    Multi-view X-ray, which is like dual energy X-ray, except that it
uses three or more views in an effort to approximate cross-sectional
data. This method gathers more two-dimensional data than conventional
single- or double-view dual energy X-ray systems.
    
    X-ray diffraction systems use a single energy source to take
hundreds of measurements of the angular scatter patterns of a bags
contents to determine if any of the contents have the chemical
characteristics of explosive materials. Only explosives detection systems based on CT technology have been
certified by the FAA/TSA for bulk explosives detection. Competitors have
attempted to obtain FAA/TSA certification of systems for bulk explosives
detection based on non-CT technology in the past without success. To meet the
increased demand for EDS products, the TSA may change its certification
standards and certify non-CT-based technology or other CT-based products. We believe that the primary competitive factor, especially in the United
States, is obtaining FAA/TSA certification. Additional factors are price,
throughput rates, ease of integration into baggage handling systems and the
size of baggage that can be screened. We believe that we compare favorably with
both our CT-based and non-CT-based competitors on these factors. Our primary
competitors in EDS are:  
    
    CT-Based Competition. Our only competitor that has developed a
CT-based EDS is L-3 Communications Holdings, Inc., which has obtained
FAA certification for two of its EDS products, including a product
developed for the FAA ARGUS program. We and L-3 (which acquired the
former PerkinElmer, Inc. Detection Systems Group during 2002) are
participating in the ARGUS program for the development and
certification of a smaller EDS. 8




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
    
    Dual Energy X-ray and Multi-View Competition. Competitors such as
L-3 Communications Holdings, Inc. and Heimann Systems GmbH offer
non-certified explosives detection systems using dual energy X-ray
technology.
    
    X-ray Diffraction Competition. Heimann Systems GmbH offers an X-ray
diffraction system that can be used in combination with one of its
dual-energy X-ray units. The primary competition for our QR-based products in the area of checked
and carry-on baggage currently includes the large installed base of
conventional X-ray scanners and trace detection systems for commercial
aviation. In addition, other companies are developing QR technology in these
markets, including QR Sciences Limited (formerly Thorlock International Ltd.).
We believe that government requirements to screen carry-on baggage for
explosives are needed to increase demand for our QR technology products. If
demand increases, we believe that the competitive factors in these markets will
be government certification, if any, performance, price and ease of use. NDT We believe that the market for NDT equipment is primarily divided into
competitors offering both standard and customized solutions and competitors
offering only standard products or offering products to local markets. Our
primary global competitors include GE Inspection Technologies and Boselli. We
believe that the competitive factors in these markets are performance, service
and price. We believe that we compare favorably against our competitors on
performance and service, although our products are generally priced higher than
those of our competitors. To some extent, our NDT products, which are based on X-ray and CT
technologies, compete with products based on other non-destructive techniques
such as ultrasound, eddy current, magnetic particle and dye penetration.
However, for many applications those alternative techniques offer inferior
performance. Often, our NDT products are complementary to products based on
alternative techniques and customers will use our NDT products as well as
products based on these alternatives. Manufacturing Our manufacturing operations consist primarily of materials management,
assembly, test and quality control of complete systems and final system
testing. Using our designs and specifications, subcontractors assemble some
mechanical and electrical sub-components, and in times of peak production, we
engage subcontractors to assemble entire CTX products. We perform all final
assembly and testing of products prior to shipment. Because quality and
reliability over the life of our products are vital to customer satisfaction
and repeat purchases, we believe our quality assurance program is a key
component of our EDS business strategy. Suppliers EDS.We outsource certain materials management processes, and certain
manufacturing processes, including mechanical sub-assemblies, sheet metal
fabrication, cables and assembled printed circuit boards. We generally purchase
major contracted assemblies from single source suppliers. We review our single
source procurements on a case by case basis, where feasible, and have qualified
second sources for certain contracted assemblies. We have entered into an
agreement with CoorsTek under which CoorsTek performs supply chain management
services. We have experienced delays in obtaining a few of our single source
assemblies. We cannot assure you that we will not face further shortages of one
or more of these systems in the future. NDT.We outsource certain manufacturing processes, including electronic
boards, mechanical sub-assemblies and cabling. We generally purchase major
contracted assemblies from single source suppliers, although we are in the
process of qualifying second sources for certain components. 9




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Intellectual Property and Proprietary Rights We seek to protect our intellectual property through various methods such
as patents and patent applications, trademarks, copyrights, non-disclosure
agreements and trade secrets. We cannot assure you that the steps taken by us
to protect our proprietary technology will be adequate or that our competitors
will not be able to develop similar, functionally equivalent or superior
technology. EDS.We have relied primarily on copyrights and trade secrets for the
protection of our EDS technology. We have two U. S. patents for automatic
concealed object detection systems using a pre-scan stage as used in the CTX
Series. These patents expire in 2010 and 2011. The patents have not prevented
competition from developing CT-based products which do not use a pre-scan
stage. The time period for filing foreign counterparts of our two U.S. EDS
patents has expired, and we did not seek or obtain patent protection. The
absence of foreign counterparts to our patents could adversely affect our
ability to prevent a competitor from using technology similar to technology
used in our CTX Series. We also have a U.S. patent for a mechanical radiation
shield for our CTX 9000 DSi model, which expires in 2021. We rely on this
technology to increase the speed of the baggage inspection process. We have
filed other applications in the United States and Europe for patents covering
other features contained in our CTX 9000 DSi model. In connection with our formation, in 1990, we entered into a licensing
agreement with Imatron, Inc. Under the agreement, as amended and currently in
effect, we have an exclusive, worldwide and fully-paid license to use Imatrons
CT technology in products for the scanning of mail, freight, parcels, baggage
and wood, and in compact medical scanners for military field applications. In
exchange, we granted to Imatron under this agreement an exclusive, worldwide
and fully-paid license to use, in products for the medical industry, any CT
scanning technology that we develop during the term of the agreement. The
license agreement expires in 2009. We believe that by the time the license
expires in 2009, we will not be using any of the original Imatron technology in
our products. NDT.We have relied on copyrights and trade secrets for the protection of
our NDT technology. In addition, we have three groups of NDT patents and
patent applications. The first group of U.S. and foreign patents relates to the
usage of Compton Backscatter X-ray technology applicable for the inspection of
aircraft fuselages and other surface near areas of extended objects. A
sub-patent relates to a device for a generation of a scanning X-ray beam with a
small cross-section to be used for the area inspection of large, extended
objects. These patents expire between 2005 and 2010. The second group of
patents, which has been issued in Europe and is pending in the United States,
relates to a method for high speed object manipulation to increase the
through-put of automated in-line X-ray inspection systems for small and
mid-size parts. The patents expire in 2021. The third group of patents covers
the design and construction of a three-dimensional test object with artificial
defects dedicated for the automated, regular performance check of in-line
inspection machines during operation. Patents are pending in Europe and the
United States. Government rights to use our technology.In accordance with the terms
of our development contracts with the FAA and the TSA, the U.S. government has
rights to the use of our proprietary technology developed after the award of
the contracts and funded by the contracts. The U.S. government may use these
rights to produce or have produced competing products for it using such
technology. Backlog We measure our backlog of product revenues as orders for systems and
upgrades for which contracts or purchase orders have been signed, but which
have not yet been shipped. We measure our backlog of service revenues as orders
for maintenance related to product support for which contracts have been
signed, but maintenance service has not yet been performed. We typically ship
our products within three to twelve months after receiving an order. However,
such shipments may be affected by delays which occur in the delivery of
components to us or our readiness to accept delivery of components for reasons
of site preparation or otherwise. In some instances, shipments may be made more
quickly depending on our ability to build machines to order and our customers
demand for immediate delivery. 10




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As of December 31, 2003, our EDS product and service revenue backlog was
$65.6 million, compared to $246.6 million as of December 31, 2002. As of
December 31, 2003, our NDT product and service revenues backlog was
approximately $21.6 million. As of December 31, 2003, our product and service
revenues backlog from other segments was approximately $15.6 million, compared
to $13.1 million as of December 31, 2002. As of December 31, 2003, our contract
research and development backlog from other segments was $13.1 million, $7.7
million of which is funded. Any failure by us to meet an agreed upon schedule for the delivery of our
EDS products could lead to the cancellation of the related order. Variations in
the size, complexity and delivery requirements of the customer order may result
in substantial fluctuations in backlog from period to period. In addition, all
orders are subject to cancellation or delay by the customer and, accordingly,
we cannot assure investors that our backlog will eventually result in revenues.
For these reasons, we believe that backlog cannot be considered a meaningful
indicator of our performance on an annual or quarterly basis. Employees As of December 31, 2003, we directly employed 1,009 people, of whom 235
were primarily engaged in research and development activities, 43 in marketing
and sales, 344 in customer support and field service, 247 in manufacturing, 20
in quality assurance and 120 in administration and finance. In addition, we
utilized the services of 50 full-time consultants and temporary employees. The
number of our EDS customer support and field service personnel was
significantly increased in 2003 in response to a greater number of our EDS in
the field. In addition, the number of our EDS manufacturing personnel
increased in 2003 as we relied on our internal manufacturing personnel for
final assembly instead of contract manufacturers. The aggregate number of
employees also increased due to our acquisition of Yxlon. We believe that our
relationship with our employees is good. Long-Lived Assets For 2001, 2002 and 2003, substantially all of our long-lived assets were
located in the United States. Available Information We file electronically with the Securities and Exchange Commission our
annual reports on From 10-K, quarterly reports on Form 10-Q, current reports on
From 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of
the Securities Exchange Act of 1934. We make available on our website at
http://www.invision-tech.com, free of charge, copies of these reports as soon
as reasonably practicable after filing or furnishing the information to the
SEC. You can also request copies of such documents by contacting our Investor
Relations Department at (510) 739-2200 or sending an email to
investor_relations@invision.iip.com. Risk Factors Many factors, including those described below, could cause actual results
to differ materially from those discussed in any forward-looking statements. Risks Related to Our Business A number of factors that affect our revenues make our future results difficult
to predict, and therefore we may not meet expectations for a particular period. We believe that our revenues have the potential to vary significantly from
time to time. For example, our total revenues were $89.4 million for the second
quarter of fiscal 2003, $165.2 million for the first quarter of fiscal 2003 and
$220.4 million for the fourth quarter of fiscal 2002, and were $416.5 million
for fiscal 2003, $439.1 million for fiscal 2002 and $74.3 million for fiscal
2001. We believe that these variations may result from many factors, including:  
    
    the timing, size and mix of orders from our major customers,
including in particular, the TSA and agencies of other governments; 11




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
    
    legislative or other government actions driven, in part, by the
publics perception of the threats facing commercial aviation, leading
to fluctuations in demand for aviation security products and services;
    
    delays in product shipments caused by the inability of airports to
install or integrate our products in a timely fashion;
    
    the availability and cost of key components;
    
    the timing of completion of acceptance testing for some of our products;
    
    the introduction and acceptance, including certification by the
TSA, of new products or enhancements to existing products offered by us
or our competitors;
    
    changes in pricing policies by us, our competitors or our
suppliers, including possible decreases in average selling prices of
our products caused by customer volume orders or in response to
competitive pressures;
    
    our sales mix to domestic and international customers; and
    
    fluctuations in currency exchange rates, particularly exchange rate of the U.S. dollar against the euro. Further, we depend on a small number of customers for a substantial
portion of our revenues. In the past, the number of orders placed by these
customers has changed significantly from period to period, and we expect that
this may continue in the future. A significant portion of our quarterly and annual operating expenses is,
and will continue to be, relatively fixed in nature. This means that revenue
fluctuations will cause our quarterly and annual operating results to vary
substantially. We also may choose to increase spending to pursue new market
opportunities, which may negatively affect our financial results. Accordingly, we believe that period-to-period comparisons of our results
of operations cannot be relied upon as indicators of future performance.
Because of all of the foregoing factors, our operating results have from time
to time in the past been, and may again in the future be, different from
expectations of public market analysts and investors. Failure to meet market
expectations has in the past resulted, and may again in the future result, in
fluctuations in the trading price of our common stock. We are anticipating decreased EDS sales in 2004 and increased difficulty in
predicting future gross margins, which may cause our stock price to decline. We anticipate a decline in EDS revenues for 2004 compared to 2003 and, as
a result, we are planning to reduce costs. However, our ability to control
costs during a period of further declining sales is difficult to predict. This
difficulty is a result of factors such as our ability to increase our operating
efficiency and further reduce the costs of components. We may be unable to
reduce costs as much as we anticipate. As a consequence, the gross margins for
our products and services may vary significantly from our anticipated gross
margins and the gross margins of our products and services in recent periods.
If, as a result of these uncertainties, our gross margins, operating results or
earnings per share are below the expectations of market analysts and investors,
the trading price of our common stock may decline. Governmental agencies, the primary customers for our EDS and other products,
are subject to budget processes which could limit the demand for these
products. Substantially all of the customers for our EDS products and our other
products under development to date have been public agencies or quasi-public
agencies, such as the FAA, the TSA and airport authorities. Public agencies are
subject to budgetary processes and expenditure constraints. In the past, many
domestic and foreign government agencies have experienced budget deficits that
have led to decreased capital expenditures in certain areas. The funding of government programs is subject to legislative
appropriation. Budgetary allocations for EDS depend, in part, upon governmental
policies, which fluctuate from time to time in response to political and other
factors, including the publics perception of the threat of commercial airline
bombings. For example, the terrorist 12




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attacks of September 11, 2001 resulted in the passage of the Aviation and
Transportation Security Act of 2001, or Transportation Security Act, mandating
a small surcharge on each airline ticket purchase to fund airline security.
This surcharge was suspended from June 1, 2003 to September 30, 2003. We cannot
assure investors that the surcharge will not again be suspended or that the
funds generated by these surcharges will be used to purchase our EDS products.
We cannot assure investors that funds will continue to be appropriated by
Congress or allocated by the TSA or other agencies for the purchase of EDS
products. Legislative actions could lead to fluctuations in demand for aviation security
products and services. In addition to the Congressional budgetary process, other legislation
could be introduced that would impact demand for aviation security products and
services. In response to fluctuation in concern on the part of voters about
aviation security and competing homeland security demands, or for other
reasons, the plans for deployment of EDS to screen baggage could be changed.
Budgetary debates and delays could result in fewer EDS being sold to the TSA
and elected officials who support the EDS program could fail to maintain their
offices, any of which events could cause a decrease in the demand for our EDS
products. Governmental agencies have special contracting requirements, which create
additional risks. In contracting with public agencies, we are subject to public agency
contract requirements that vary from jurisdiction to jurisdiction. Future sales
to public agencies will depend, in part, on our ability to meet public agency
contract requirements, certain of which may be onerous or even impossible for
us to satisfy. Government contracts typically contain termination provisions unfavorable
to us and are subject to audit and modification by the government at its sole
discretion, which subject us to additional risks. These risks include the
ability of the U.S. government to unilaterally:  
    
    suspend or prevent us for a set period of time from receiving new
contracts or extending existing contracts based on violations or
suspected violations of laws or regulations;
    
    terminate our existing contracts;
    
    reduce the scope and value of our existing contracts;
    
    audit and object to our contract-related costs and fees, including allocated indirect costs;
    
    control and potentially prohibit the export of our products; and
    
    change certain terms and conditions in our contracts. The U.S. government can terminate any of its contracts with us either for
its convenience or if we default by failing to perform in accordance with the
contract schedule and terms. Termination for convenience provisions generally
enable us to recover only our costs incurred or committed, and settlement
expenses and profit on the work completed prior to termination. Termination for
default provisions do not permit these recoveries and make us liable for excess
costs incurred by the U.S. government in procuring undelivered items from
another source. Our contracts with foreign governments may contain similar
provisions. Consequently, our backlog is not necessarily indicative of future
revenues. The governments termination of one or more of the contracts for our
EDS products or our other products under development would harm our business. In addition, U.S. government contracts are conditioned upon the continuing
availability of Congressional appropriations. Congress usually appropriates
funds annually for a given program on a September 30 fiscal year-end basis,
even though contract performance may take years. Consequently, our contracts
with the TSA may only be partially funded at the outset, and additional monies
are normally committed to the contract by the TSA only as appropriations are
made by Congress for future periods. The governments failure to fully fund one
or more of the contracts for our EDS products or our other products under
development would harm our business. 13




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Under our new three-year agreement with the TSA announced on August 12,
2003, the TSA has the right to purchase system options and accessories,
engineering and installation support and 550 CTX units, principally our CTX
9000 DSi systems, over the three-year term. While the TSA placed
delivery orders totaling 162.8 million under the new agreement, the TSA has no obligation
to place additional delivery orders or purchase additional engineering and
installation support under the new agreement. We cannot assure you that the TSA
will make any additional delivery orders under the new agreement or will not
cancel its existing order. The new agreement is subject to all of the
limitations and restrictions that apply to U.S. government contracts, including
those described above. Because we contract with the U.S. government, we are subject to periodic
audits and reviews. Based on the results of its audits, the U.S. government may
adjust our contract-related costs and fees, including allocated indirect costs.
In the future, government audits and reviews could result in adjustments to our
revenues and cause other adverse effects, particularly to our relationship with
the TSA. In addition, under U.S. government purchasing regulations, some of our
costs, including most financing costs, amortization of intangible assets,
portions of our research and development costs, and some marketing expenses may
not be reimbursable or allowed in our negotiation of fixed-price contracts.
Further, because we contract with the U.S. government, we are subject to an
increased risk of investigations, criminal prosecution, civil fraud,
whistleblower lawsuits and other legal actions and liabilities to which purely
private sector companies are not. In addition, public agency contracts are frequently awarded only after
formal competitive bidding processes, which are often protracted and typically
contain provisions that permit cancellation in the event that funds are
unavailable to the public agency. We may not be awarded any of the contracts
for which our products are bid. Even if we are awarded contracts, substantial
delays or cancellations of purchases could result from protests initiated by
losing bidders. Our growth depends on our introduction of new products and services, which may
be costly to develop and may not achieve market acceptance. As part of our strategy for growth, we intend to develop products to
address additional aviation security opportunities, such as passenger, carry-on
baggage and air cargo screening. We also intend to address homeland security
requirements beyond aviation, such as screening at border checkpoints,
government offices and transportation terminals and ports. We will be required
to spend significant funds to develop or acquire technologies and products for
these initiatives, and these initiatives may divert our development and
management resources away from our core EDS products. In addition, we have
acquired, rather than developed internally, some of our technologies in
connection with our acquisitions of companies and businesses, and these
technologies may not perform as we expect. The development of new products may
require greater time and financial resources than we currently anticipate and,
despite significant investments in research and development, may not yield
commercially successful products. The development of our products for explosives and weapons detection is
highly complex. Successful product development and market acceptance of any new
products and services that we develop depend on a number of factors, including:  
    
    our timely completion and introduction of new products;
    
    our accurate prediction of the demand for homeland security
products and the changing requirements of the homeland security
industry, including certification or other required performance
standards;
    
    the availability of key components of our products;
    
    the quality, price and operating performance of our products and those of our competitors;
    
    our customer service capabilities and responsiveness; and
    
    the success of our relationships with existing and potential customers; 14




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Finally, new products for aviation security applications may require
certification or approval by the TSA, and we believe that the TSA does not
currently have standards for the certification of aviation security products
other than bulk explosives detection systems and explosives trace detectors, or
ETD. Other products, such as metal detectors, are subject to TSA testing prior
to approval. Market acceptance of new products may be limited if the TSA has
not developed standards for certification or approval of such products, and
even if it does develop such standards, we may be unable to obtain any such
certification or approval, which could materially limit market acceptance of
such products. If we fail to timely introduce new products or if these products
fail to gain market acceptance, our results of operations would be harmed. In addition, even if successful in the United States, new products that we
develop may not achieve market acceptance outside of the United States. Unlike
the U.S. government, foreign governments may be unwilling to commit financial
resources to purchase our new products, which would reduce our potential
revenues and harm our business. We depend upon a limited number of suppliers for components of our products,
and if we are unable to obtain parts from these suppliers on a timely basis,
then we may not be able to deliver our products as required. Key components used in our products have been designed by us to our
specifications and are currently available only from one or a limited number of
suppliers. We currently do not have long-term agreements with any of these
suppliers. In addition, some of the suppliers of the key components used in our
products are our competitors, and they may be motivated not to supply us with
the components we need. Our inability to develop alternative sources for single
or sole source components, to find alternative third party manufacturers or
sub-assemblers, or to obtain sufficient quantities of these components, could
result in delays or interruptions in product shipments, which could cause
current or potential customers to seek other suppliers of our products. In view
of the high cost of many of these components, we strive to avoid excess
supplies. If our suppliers experience financial, operational, production or
quality assurance difficulties, or our sole source suppliers are acquired or
otherwise influenced by our competitors, the supply of components to us would
be reduced or interrupted. In the event that a supplier ceases operations,
discontinues a product or withholds or interrupts supply for any reason, we may
be unable to acquire the product from alternative sources within a reasonable
period of time. Our future EDS products may fail to obtain certification by the TSA. We plan to continue to develop new models for our family of EDS products,
including systems utilizing X-ray based diffraction, or XRD, technology, of our
subsidiary, Yxlon International Security GmbH, and to continue our
participation in the ARGUS program, an FAA/TSA-sponsored program designed to
develop a smaller, low-cost EDS product. However, we cannot be certain that any
new EDS product, including systems utilizing Yxlons XRD technology or our CTX
1000 (ARGUS) system, will be certified by the TSA. The failure to gain
certification for an EDS product would harm our ability to sell the product,
and recognize associated revenues. Our existing EDS products may fail to obtain re-certification by the TSA for
changes in the EDS systems. Our existing EDS products can be required to be re-certified by the TSA.
This can happen when a critical component is changed, or we wish to make other
changes to the EDS products. When this happens, the affected EDS model requires
re-certification by the TSA. The failure or delay in gaining re-certification
for an existing EDS product could harm our ability to continue to sell the
product and recognize associated revenues. Our major customer, the TSA, is a part of the Department of Homeland Security,
a relatively new agency that has experienced, and may continue to experience,
delays in its operations, which may cause delays in our receiving orders from
the TSA. The TSA is a relatively new agency that was created in November 2001 by
the Transportation Security Act. As a result, it has experienced, and may
continue to experience, delays in fulfilling its mandate as a result of delays
in establishing the necessary infrastructure to operate in an efficient manner.
This may result in delays in our receiving orders for our EDS products.
Further, the TSA is now a part of the Department of Homeland Security, which
was 15




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created subsequent to the creation of the TSA and is therefore in an
earlier stage of formation, which may further create delays in our receiving
orders as this agency is organized. Future sales of our EDS products will depend on the ability of airports to
secure funding to build baggage handling systems and to integrate our EDS
products into such systems, which they may not be able to do. Future sales will depend, in part, on installing our EDS products into
airport lobbies or integrating them into existing baggage handling systems. If
an airport is not configured for these systems, deployment of our EDS products
may require changes in the airport infrastructure, such as reinforced airport
lobby floors and baggage platforms. If our EDS products cannot easily be
installed in airport lobbies or integrated into existing baggage handling
systems, we may experience reduced sales of our EDS products or these sales may
be delayed. In addition, installations and integrations are currently partially
funded by the TSA in the United States. Legislation established a letter of
intent program under which an airport can present a request to the TSA for
reimbursement of up to 90% of costs incurred by the airport in improving
baggage handling systems to increase security. There can be no assurance that
the government will continue to fund installations, integrations and
reimbursements at the current level or at all. If there is a reduction in
funding, we may experience reduced sales of our EDS products or these sales may
be delayed. We believe that a substantial opportunity exists for our CTX 9000 DSi
model to be integrated into baggage handling systems. If airports determine, in
conjunction with governmental authorities, that they will be unable or
unwilling to modify or finance such in-line baggage handling systems, this
opportunity may be limited. As a result of the Transportation Security Act, our EDS products are undergoing
substantially increased usage per day, which could cause unforeseen problems
with their ability to sustain this increased usage. As required by the Transportation Security Act, as of December 31, 2002,
100% of checked baggage must undergo screening. As a result, our EDS products
in operation are being used more hours per day than before, which places a
burden on them not previously experienced. This has resulted in an increase in
the amount of maintenance required to keep them operating, and may result in
unforeseen problems. If this were to occur, our customers could perceive that
there are reliability problems with our EDS products, which could reduce the
demand for our products. In addition, our CTX 9000 DSi product is a relatively
new model with which we have limited experience in sustaining extensive usage.
As a result, our CTX 9000 DSi product may experience maintenance needs and
increased down time beyond that experienced by our CTX 2500 and CTX 5500 DS
products. Further, because the CTX 9000 DSi product is designed to be
integrated into an airports baggage handling system, it has, in addition to
the detection function and mechanisms, components that integrate it into the
baggage handling system, which also require maintenance and may also contribute
to increased maintenance needs and down time. If our CTX 9000 DSi product does
experience additional maintenance needs beyond that of our CTX 2500 and CTX
5500 DS products, our customers may not purchase this product in favor of our
CTX 2500 and CTX 5500 DS products or the products of our competitors. We may seek to grow by acquisition, which subjects us to substantial risks,
including the failure to successfully integrate an acquired business. As part of our growth strategy, we may expand our business by pursuing
selected acquisitions of technologies and companies that offer complementary
products, services, technologies or market access. Our ability to grow by
acquisition depends upon the availability of acquisition candidates at
acceptable prices. We may incur costs in connection with our pursuit of
acquisitions for which we are responsible regardless of whether the
acquisitions are actually consummated. Future acquisitions by us could result
in dilutive issuances of equity securities, the incurrence of debt and
contingent liabilities and expenses related to acquired operations and assets,
any of which could harm our business and our operating results. Acquisitions
entail numerous risks and we may not realize the expected benefits of these
transactions. These risks include:  
    
    difficulties in the assimilation of acquired operations, technologies and products;
    
    diversion of managements attention from other business concerns; 16




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
    
    lack of experience operating in the geographic market or industry sector of acquired companies;
    
    exposure to unanticipated contingent liabilities of acquired companies; and
    
    potential loss of key employees of acquired companies. The process of integrating supply and distribution channels, computer and
accounting systems and other aspects of operations, while managing a larger
entity, may present a significant challenge to our management. We may not be
able to successfully integrate any businesses, products, technologies or
personnel that might be acquired in the future. In such case, we would not
fully realize the anticipated benefits of a business combination, and the
failure of such efforts would harm our business. Maintaining uniform standards,
controls, procedures and policies may be harder than we anticipate and
interfere with efficient administration of the company as a whole. For example, on March 31, 2003, we completed the acquisition of Yxlon
International Holding GmbH. Yxlon is active in businesses that are new to us
and present a challenge to our management. In order to successfully integrate
Yxlons security technologies and products, we must, among other things,
integrate these into our suite of products, both from an engineering and a
sales and marketing perspective. As a result, we may take longer to develop and
introduce new products than we anticipate. In addition, we do not have
experience developing, marketing and selling products in the non-destructive
testing business, and we may not be successful competing for customers in
industries with which we are unfamiliar. The difficulties of integration of
Yxlon may be further complicated by the geographic distance between our U.S.
offices and Yxlons headquarters, which are located in Germany. If we are not
successful in integrating Yxlons security technologies into our product line,
or in managing Yxlons non-destructive testing business, we may incur
additional expenses or lose revenue opportunities for Yxlon and us, and our
business results may suffer. Our strategic investments may not provide any of the benefits we anticipate,
and as a result, we may incur economic losses or be required to write-down
these investments. From time to time, we consider strategic investments in development-stage
companies that we believe provide strategic opportunities for us, such as our
recent investment in SafeView, Inc., which is developing portal systems for
passenger screening. Although we intend that these investments will provide
access to new technologies and emerging markets, we cannot assure you that
these investments will create opportunities for us to increase our sales. If
these companies are unsuccessful in their product development efforts or are
unable to obtain additional private financing, we may be required to write-down
these investments or we may lose some or all of these investments, which would
harm our results. If our EDS products fail to detect explosives, we could be exposed to product
liability and related claims for which we may not have adequate insurance
coverage, and we may lose current and potential customers. Our business exposes us to potential product liability risks, which are
inherent in the manufacturing, sale and maintenance of EDS products. Our
machines are not designed to detect, and FAA/TSA certification does not
require, 100% detection of any and all explosives contained in scanned baggage.
For this reason, or if our products malfunction, it is possible that explosive
material could pass undetected through our products, which could lead to
product liability claims. There are also many other factors beyond our control
that could lead to liability claims, such as the reliability and competence of
the customers operators and the training of the operators. InVision and our subsidiary, Quantum Magnetics, were named as defendants
in a number of lawsuits relating to the terrorist acts of September 11, 2001.
The cost of defending these and other product liability claims brought against
us could be significant and any adverse determination may result in liabilities
in excess of our insurance coverage. We currently have product liability
insurance in the amount of $200.0 million. We also have war and terrorism
insurance in the amount of $200.0 million, including up to $50.0 million under
our product liability insurance. We cannot be certain that our current
insurance can be maintained, or additional insurance coverage could be
obtained, on acceptable terms, if at all. In addition, the failure of any EDS product to detect explosives, even if
due to operator error and not to the mechanical failure of an EDS product,
could result in public and customer perception that our products do not work 17




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effectively, which may cause potential customers to not place orders and
current customers to cancel orders already placed or to not place additional
orders, any of which would harm our business and financial results. We substantially depend on large orders from a limited number of customers. As
a result, order cancellations from any of our customers or the failure of these
customers to continue to purchase EDS products could have a material negative
impact on our business and financial results. In any given fiscal quarter or year, our revenues are derived from orders
of multiple units of our EDS products from a limited number of customers.
Through September 28, 2003, substantially all of our orders from U.S. customers
have been funded by the FAA and the TSA, which allocate our products to
airports in the United States. EDS product and service sales to the FAA, and
following the formation of the TSA, to the TSA, accounted for 64.4% of our
total revenues in the year ended December 31, 2003 and 81.2% of our total
revenues in the year ended December 31, 2002. In the year ended December 31,
2003, 18 customers accounted for all of our EDS units sold during the year, and
in the year ended December 31, 2002, ten customers accounted for all of our EDS
products sold during the year. The failure of these customers, particularly the
U.S. government, to continue to purchase our EDS products or the cancellation
of existing orders would harm our business. The U.S. governments right to use technology developed by us, but funded by
the U.S. government, limits our intellectual property rights. In accordance with Federal Acquisition Regulations included in our
development contracts with the FAA, the U.S. government has rights to use our
proprietary technologies developed after the award of the development contract
and funded by the development contract. The U.S. government may use these
rights to produce or have produced for the U.S. government competing products
using CT technology found in our existing EDS products as well as our CTX 1000
model, which has not yet been certified by the TSA. With respect to Quantum,
the U.S. government retains the same rights to the passive magnetic technology
found in the quadrupole resonance, or QR, technology. In the event that the
U.S. government were to exercise these rights, our competitive position in
supplying the U.S. government with certified CT-based explosives detection
systems and/or the Quantum products would be harmed. The sales cycle for our EDS products is lengthy, and we may expend a
significant amount of effort in obtaining sales orders and not receive them. The sales cycle of our EDS products is often lengthy due to the protracted
approval process that typically accompanies large capital expenditures and the
time required to manufacture and install our EDS products. Typically, six to
twelve months may elapse between a new customers initial evaluation of our
systems and the execution of a contract. Another three months to a year may
elapse prior to shipment of our EDS products as the customer site is prepared
and our EDS products are manufactured. In addition, in the United States,
budgetary debates in Congress, may result in additional delays in the purchase
of additional EDS products. During the sales cycle we expend substantial funds
and management resources but recognize no associated revenue. Our backlog is not necessarily indicative of future revenues. We measure our backlog of product revenues as orders for systems and
upgrades for which contracts or purchase orders have been signed, but which
have not yet been shipped. We measure our backlog of service revenues as orders
for maintenance related to product support for which contracts have been
signed, but maintenance service has not yet been performed. We typically ship
our products within three to twelve months after receiving an order. However,
such shipments may be affected by delays which occur in the delivery of
components to us or our readiness to accept delivery of components for reasons
of site preparation or otherwise. In some instances, shipments may be made more
quickly depending on our ability to build machines to order and our customers
demand for immediate delivery. Quantums contract research and development backlog includes funded and
unfunded awards from government agencies for which services have not yet been
performed. At December 31, 2003, our Quantum contract research and development
backlog was $13.0 million, $7.7 million of which was funded. 18




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Any failure by us to meet an agreed upon schedule could lead to the
cancellation of the related order. Variations in the size, complexity and
delivery requirements of the customer order may result in substantial
fluctuations in backlog from period to period. In addition, all orders are
subject to cancellation or delay by the customer and, accordingly, we cannot
assure investors that our backlog will eventually result in revenues. For these
reasons, we believe that backlog cannot be considered a meaningful indicator of
our performance on an annual or quarterly basis. Our international sales subject us to risks that could materially harm our
business. Sales to countries other than the United States accounted for 29.0% of our
revenues in the year ended December 31, 2003. It is part of our growth strategy
to increase our international operations. A number of factors related to our
international sales and operations could adversely affect our business,
including:  
    
    changes in domestic and foreign regulatory requirements;
    
    political instability in the countries where we sell products;
    
    possible foreign currency controls;
    
    fluctuations in currency exchange rates;
    
    our ability to protect and utilize our intellectual property in foreign jurisdictions;
    
    tariffs, embargoes or other barriers;
    
    difficulties in staffing and managing foreign operations;
    
    difficulties in obtaining and managing distributors; and
    
    potentially negative tax consequences. Further, the sale of some of our products outside the United States is
subject to compliance with the U.S. International Traffic in Arms Regulations
and Export Administration Regulations. Our failure to obtain the requisite
licenses, meet registration standards or comply with other government export
regulations, may affect our ability to generate revenues from the sale of our
products outside the United States, which could harm our business. In
particular, some of our EDS products and our landmine detection equipment are
deemed regulated military devices subject to export restrictions under the U.S.
Department of State regulations. Consequently, these regulations may make these
products more difficult to sell to a number of countries. Compliance with
government regulations may also subject us to additional fees and costs. The
absence of comparable restrictions on competitors in other countries may
adversely affect our competitive position. Exchange rate fluctuations could cause a decline in our financial condition and
results of operations. In 2003, the cost of certain international currencies has increased due to
fluctuations in the exchange rate of the U.S. dollar against the euro. As a
result of our international operations and Yxlon operations, we generate a
significant portion of our net sales and incur a significant portion of our
expenses in currencies other than the U.S. dollar, primarily the euro. Future
fluctuations in this exchange rate could adversely affect our results because
we pay our non-U.S. employees and certain suppliers in local currencies, and,
in some cases, our sales contracts are denominated in local currencies. From
time to time, as and when we determine it is appropriate and advisable to do
so, we will seek to mitigate the effect of exchange rate fluctuations through
the use of derivative financial instruments. We cannot assure you, however,
that we will continue this practice or be successful in these efforts. Yxlon generally transacts business in euros. Consequently, its financial
condition and results of operations are reported in euros and then translated
into U.S. dollars at the applicable exchange rate for inclusion in our
consolidated financial statements. As a result, appreciation of the U.S. dollar
against the euro will have a negative impact on our reported revenues and
operating profit while depreciation of the U.S. dollar against the euro will
have 19




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a positive effect on reported revenues and operating profit. However, Yxlons
customer contracts that are denominated n U.S. dollars will be adversely
affected by the depreciation of the U.S. dollar. We may have warranty claims that exceed our reserves. Our EDS products are typically sold with one-year warranties. We have
established reserves for the liability associated with product warranties based
on historical experience with warranty claims. However, our actual warranty
costs, including actual material usage or service delivery costs, may exceed
our reserves, which could have an adverse effect on our operating results. We may not be selected to provide post-warranty service on our CTX products,
and if we are selected to provide post-warranty services, these services may
not be profitable for us. We offer to our customers the opportunity to buy a service contract from
us, which provides for scheduled maintenance, repairs and parts once a warranty
period on a CTX product has expired (which is typically a one-year period). If
we are not selected to provide post-warranty service, this would harm our
business. Some of our post-warranty service contracts contain fixed pricing
terms. If our actual costs, including actual material usage or service delivery
costs, exceed our revenues under these service agreements, our operating
results could be adversely affected. We are currently in negotiations for the
renewal of our agreement to provide service to our CTX products owned by the
TSA. We cannot assure investors that the agreement will be renewed, or will be
renewed on financial advantageous terms. In addition, historically, we have
sold service contracts on most eligible CTX products deployed internationally.
We may not achieve this level of service contract sales in the future. Our inability to adapt to rapid technological change could impair our ability
to remain competitive. The EDS industry may undergo significant technological development in
response to increased demand for aviation security products. A fundamental
shift in technology in our product markets could harm us, because we derive
substantially all of our revenues from sales of EDS products and services. We anticipate that we will incur significant expenses in the design and
initial manufacturing and marketing of new products and services. Our
competitors may implement new technologies before we are able to, allowing them
to provide more effective products at more competitive prices. Future
technological developments could:  
    
    adversely impact our competitive position;
    
    require write-downs of obsolete technology;
    
    require us to discontinue production of obsolete products before we
can recover any or all of our related research, development and
commercialization expenses; or
    
    require significant capital expenditures beyond those currently
contemplated. We cannot assure investors that we will be able to achieve the
technological advances to remain competitive and profitable, that new products
and services will be developed and manufactured on schedule or on a
cost-effective basis, that anticipated markets will exist or develop for new
products or services, or that our existing products and services will not
become technologically obsolete. The EDS industry is highly competitive. Given the anticipated continuing demand
for airport security products, competition may increase. The EDS industry is intensely competitive and we may not compete
successfully. As a result of increased demand for security systems, additional
companies may enter the EDS industry. Some of our competitors, including L-3
Communications Holdings, Inc. and many of the potential new entrants into the
EDS industry, have financial, technical, production and other resources
substantially greater than ours. We believe that some of our competitors 20




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have EDS products undergoing TSA certification. Our failure to compete
successfully could result in lost sales and could hamper our financial results. We depend on key management and personnel and may not be able to retain those
employees or recruit additional qualified personnel. We believe that our future success will be due, in part, to the continued
services of our senior management team. We do not have long-term employment
agreements with any of our executive officers. Losing the services of one or
more members of our management team could negatively affect our business and
our expansion efforts. We do not maintain key person life insurance policies
for members of our management. We could be seriously harmed by the loss of any
of our executive officers. The implementation of our growth strategy will
require that we recruit additional members of our senior management team. In
addition, in order to manage our growth, we will need to recruit and retain
additional skilled personnel, such as advanced engineering professionals. Our
failure to recruit qualified employees in a timely manner and retain them could
harm our business and our ability to continue to grow. Natural disasters, including earthquakes, may damage our facilities. Our corporate and manufacturing facilities in California are located near
major earthquake faults, which have experienced earthquakes in the past. In the
event of a major earthquake or other natural disaster, our facilities may
sustain significant damage and our operations could be harmed. Our business could be harmed if we fail to properly protect our intellectual
property. Our success depends in part on our ability to protect our intellectual
property. Although we attempt to protect our intellectual property in the
United States and other countries through various methods such as patents and
patent applications, trademarks, copyrights and non-disclosure agreements,
there can be no assurance that we will successfully protect our technology or
that competitors will not be able to develop similar technology independently. We have two U.S. patents for automatic concealed object detection systems
using a pre-scan stage as used in our CTX products. These patents expire in
2010 and 2011. The patents have not prevented competitors from developing
CT-based products which do not use a pre-scan stage. The time period for filing
foreign counterparts of our two U.S. EDS patents has expired, and we did not
seek or obtain patent protection. The absence of foreign counterparts to our
patents could adversely affect our ability to prevent a competitor from using
technology similar to technology used in our CTX products. We also have a U.S.
patent for a mechanical radiation shield for our CTX 9000 DSi model, which
expires in 2021. We rely on this technology to increase the speed of the
baggage inspection process. We have filed other applications in the United
States and Europe for patents covering other features contained in our CTX 9000
DSi model. We cannot assure investors that the claims allowed under any patents
held by us will be sufficiently broad to protect our technology against
competition from third parties with similar technologies or products. In
addition, we cannot assure investors that any patents issued to us will not be
challenged, invalidated or circumvented or that the rights granted under these
patents will provide a competitive advantage to us. Moreover, the laws of some
foreign countries do not protect intellectual property rights to the same
extent as the laws of the United States, and we could experience various
obstacles and high costs in protecting our intellectual property rights in
foreign countries. If we are unable to obtain or maintain these protections, we
may not be able to prevent third parties from using our intellectual property. We also rely on trade secrets, proprietary know-how and continuing
technological innovation to remain competitive. We have taken measures to
protect our trade secrets and know-how, including the use of confidentiality
agreements with our employees. It is possible that these agreements may be
breached and that the available remedies for any breach will not be sufficient
to compensate us for damages incurred. Litigation may be necessary to enforce or defend against claims of intellectual
property infringement, which could be expensive and, if we lose, could prevent
us from selling our products. Litigation may be necessary in the future to enforce our patents and other
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. Any litigation,
regardless 21




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of the outcome, could be costly and require significant time and attention of
key members of our management and technical personnel. Our domestic and international competitors, many of whom have
substantially greater resources and have made substantial investments in
competing technologies, may have patents that will prevent, limit or interfere
with our ability to manufacture and sell our products. We have not conducted an
independent review of patents issued to third parties. Because of the perceived
market opportunity we face, companies possessing technology rights that they
believe we might be infringing will now be much more motivated to assert
infringement of their rights. These third parties may assert infringement or
invalidity claims against us and litigation may be necessary to defend against
these claims. An adverse outcome in the defense of a patent suit could subject
us to significant liabilities to third parties, require disputed rights to be
licensed from third parties or require us to cease selling our products. Even
successful defenses of patent suits can be costly and time-consuming. We have received significant amounts of funding from government grants and
contracts. We cannot assure investors that we will continue to receive this
level of funding for future product development. The U.S. government currently plays an important role in funding the
development of EDS technology and sponsoring its deployment in U.S. airports.
We performed reimbursable research and development for EDS products pursuant to
FAA and TSA grants and contracts totaling $3.1million for the year ended
December 31, 2003, and $886,000 for the year ended December 31, 2002. This is a
significant reduction from the $8.3 million for reimbursable research and
development for EDS products from FAA grants and contracts in the year ended
December 31, 2001. We are also aware that other competitors and potential
competitors in the EDS market have received FAA and TSA development grants. The
U.S. government also currently funds almost all of the development of Quantum
products, including QR and passive magnetic sensing. We had contract research
and development revenues from the U.S. government for the development of
Quantum products of $13.1 million for the year ended December 31, 2003 and of
$12.1 million for the year ended December 31, 2002. We cannot assure investors
that additional research and development funds from the government will become
available in the future or that we will receive any of these additional funds.
If the government fails to continue to sponsor our technology, we would have to
expend more resources on product development, which could adversely affect our
business. In addition, any future grants to our competitors may improve their
ability to develop and market advanced detection products and cause our
customers to delay any purchase decisions, which could harm our ability to
market our products. Substantial leverage and debt service obligations may adversely affect our cash
flow. As a result of the convertible debt offering that we completed in
September 2003, our debt service obligations increased substantially. There is
the possibility that we may be unable to generate cash sufficient to pay the
principal of, interest on and other amounts due in respect of our indebtedness
when due. We may also add equipment loans and lease lines to finance capital
expenditures and may obtain additional long-term debt, working capital lines of
credit and lease lines. Our substantial leverage could have significant negative consequences,
including:  
    
    increasing our vulnerability to general adverse economic and industry conditions;
    
    limiting our ability to obtain additional financing;
    
    requiring the dedication of a portion of our expected cash flow
from operations to service our indebtedness, thereby reducing the
amount of our expected cash flow available for other purposes,
including capital expenditures;
    
    limiting our flexibility in planning for, or reacting to, changes
in our business and the industry in which we compete; and
    
    placing us at a possible competitive disadvantage relative to less
leveraged competitors and competitors that have better access to
capital resources. 22




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Risks Related to Ownership of Our Common Stock The price of our common stock may fluctuate significantly. The trading price of our common stock has been and may continue to be
subject to large fluctuations, which may result in losses to investors. Our
stock price may increase or decrease in response to a number of events and
factors, including:  
    
    the level and changing nature of terrorist activity;
    
    legislative and regulatory developments related to anti-terrorism efforts or aviation security;
    
    our quarterly operating results or those of other explosives detection companies;
    
    the publics reaction to our press releases, announcements and our
filings with the Securities and Exchange Commission;
    
    our announcement of an acquisition or strategic investment;
    
    changes in earnings estimates or recommendations by research analysts;
    
    changes in our relationships with customers; and
    
    developments affecting our competitors. The market price of our common stock has fluctuated dramatically since the
terrorist attacks of September 11, 2001. For example, immediately prior to
September 11, 2001, our common stock closed at $3.11 per share. Since that
date, our closing stock price has risen to a high of $48.29 per share on March
12, 2002. During 2003, our closing stock price has fluctuated from a low of
$20.33 per share to a high of $34.41 per share. In addition, the stock market
has periodically experienced significant price and volume fluctuations that
have particularly affected the market prices of common stock of technology
companies. These changes have often been unrelated to the operating performance
of particular companies. These broad market fluctuations may also negatively
affect the market price of our common stock and the notes. Delaware law and our charter documents may impede or discourage a takeover,
which could cause the market price of our shares to decline. We are a Delaware corporation and the anti-takeover provisions of Delaware
law impose various impediments on the ability of a third party to acquire
control of us, even if a change in control would be beneficial to our existing
stockholders. Our certificate of incorporation provides for 5,000,000 shares of
preferred stock which our board of directors may issue with terms determined by
them without stockholder approval, a classified board of directors serving
staggered three-year terms, restrictions on who may call a special meeting of
stockholders and a prohibition on stockholder action by written consent. These
provisions of Delaware law and in our charter documents could impede a merger,
takeover or other business combination involving us or discourage a potential
acquirer from making a tender offer for our common stock, which, under certain
circumstances, could reduce the market value of our common stock and the notes. We may not pay cash dividends. We have not declared or paid any cash dividends on our capital stock
previously, and we have agreed not to pay cash dividends under our current bank
line of credit. Historically, we have retained earnings, if any, to support the
development of our business. Payment of future dividends, if any, will be at
the discretion of our board of directors after taking into account various
factors, including our financial condition, operating results and current and
anticipated cash needs. 23




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We may become subject to costly and time-consuming class action litigation
following significant changes in our stock price. In the past, following periods of volatility in the market price of a
companys securities, securities class action litigation has often been
instituted against such a company. Were such litigation to be commenced against
us, we would incur substantial costs and there would be diversion of our
managements attention and resources, which could materially harm our business,
results of operations and financial condition. 
 ITEM 2. PROPERTIES Our principal corporate office and EDS manufacturing facility are located
in Newark, California, and consist of approximately 112,000 square feet under a
lease that expires in August 2007. We have an option to extend the lease for
five years. We also entered into an amendment to the original Newark agreement
to lease a second facility consisting of 18,700 square feet. The lease for the
second facility expires in September 2004. Yxlons principal office and primary NDT manufacturing facility are
located in Hamburg, Germany, and consist of approximately 64,000 square feet
under a lease that expires in March 2009. Yxlon also leases a 16,000 square
foot facility in Hamburg for its XRD business on a month-to-month basis with a
three-month termination clause. Yxlon leases a manufacturing facility in
Copenhagen, Denmark, consisting of approximately 37,000 square feet under a
month-to-month lease that may be terminated with six months notice. Yxlon
International Inc., the NDT sales company in the United States, leases a
facility in Akron, Ohio consisting of approximately 61,000 square feet under a
lease that expires in October 2005. Yxlon leases sales offices in Japan
consisting of 3,000 square feet under leases that expire in January 2005. Quantums principal office and manufacturing facility are located in San
Diego, California, and consist of approximately 58,400 square feet under a
lease that expires in December 2012, with a one-time option to extend the lease
another ten years. Inovecs principal office and manufacturing facilities are located in
Eugene, Oregon in several buildings consisting of one building of approximately
5,000 square feet under a lease that expires in April 2005, and three buildings
of approximately 10,000 square feet, 4,500 square feet, and 4,000 square feet,
all on a month-to-month basis. In February 2004, Inovec signed a new lease for
a facility of approximately 33,000 square feet. The lease commences in May
2004 and expires in April 2009. Inovec expects to completely move out of its
current facilities by the end of the second quarter of 2004. We believe our facilities are adequate for our current and near-term
needs, and that we will be able to locate additional facilities as needed.
See Note 8 of the notes to the consolidated financial statements for more
information about our lease commitments. 
 ITEM 3. LEGAL PROCEEDINGS InVision and our subsidiary, Quantum Magnetics, together with many other
entities, were named as defendants in a number of lawsuits in approximately 110
products liability lawsuits by individual plaintiffs seeking damages for
wrongful death relating to the terrorist acts of September 11, 2001. The
litigation in connection with the terrorist acts of September 11, 2001 have
been consolidated in In re: September 11 Litigation, 21 MC 97 (AKH); Lopez, et
al v. United Airlines, et al., 1:02-cv-458, United States District Court for
the Southern District of New York. InVision and Quantum Magnetics
have been served with 39 complaints that remain active. Each
of the active complaints with which we have been served alleges that the
defendants breached a duty to airplane passengers and others by failing to
properly screen passengers and carry-on baggage for dangerous weapons. We
believe that the plaintiffs claims lack merit, especially in light of the fact
that we did not, as of September 11, 2001, have any passenger or carry-on
baggage screening equipment at security checkpoints in any of the airports from
which the hijacked airplanes departed. We have recently been advised
by the Plaintiffs' Executive Committee that InVision and Quantum
Magnetics will be dismissed as defendants from all active complaints
on or before March 31, 2004, plaintiffs' deadline to file and serve
amended Master Complaints. If InVision and Quantum Magnetics are not
dismissed, we must answer or otherwise respond to any amended Master
Complaints in which we are listed as defendants by April 30, 2004 and
must answer or otherwise respond to plaintiffs' individual complaints
by May 15, 2004. We intend to vigorously defend any of these lawsuits
in which InVision or Quantum Magnetics continue to be named as defendants. 24




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We also are involved in legal proceedings, claims and litigation arising
in the ordinary course of business. While the outcome of these matters is
currently not determinable, management does not believe that the ultimate cost
to resolve these matters will have a material adverse effect on our
consolidated financial condition, results of operations or cash flows. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 
 PART II. 
 ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information Our common stock has been traded on the Nasdaq National Market under the
symbol INVN since May 15, 1997. Prior to that date, our common stock had been
traded on the Nasdaq SmallCap Market under the symbol INVN since April 23,
1996. The following table sets forth for the periods indicated the high and low
sale prices for our common stock, as reported by the Nasdaq National Market. On
March 1, 2004, the last reported sale price of our common stock on the Nasdaq
National Market was $36.19. High
    
    LowYear ended December 31, 2003First Quarter
    
    $
    29.70
    
    
    $
    19.82Second Quarter
    
    $
    25.10
    
    
    $
    20.65Third Quarter
    
    $
    27.97
    
    
    $
    22.02Fourth Quarter
    
    $
    34.72
    
    
    $
    24.08Year ended December 31, 2002First Quarter
    
    $
    49.76
    
    
    $
    24.70Second Quarter
    
    $
    43.40
    
    
    $
    17.42Third Quarter
    
    $
    37.25
    
    
    $
    21.60Fourth Quarter
    
    $
    37.50
    
    
    $
    22.78
 Stockholders As of March 1, 2004, we had approximately 160 record holders of our common
stock. Dividends We have not declared or paid any cash dividends on our capital stock
previously, and we have agreed not to pay cash dividends under our current bank
line of credit. Historically, we have retained earnings, if any, to support the
development of our business. Payment of future dividends, if any, will be at
the discretion of our board of directors after taking into account various
factors, including our financial condition, operating results and current and
anticipated cash needs. 
 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data is qualified by
reference to, and should be read in conjunction with, Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations, and
the consolidated financial statements and notes thereto and the other
information contained in this annual report. 25




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The selected consolidated balance sheet data as of December 31, 2003 and
2002 and the selected consolidated statement of operations data for each year
in the three years ended December 31, 2003, have been derived from our audited
consolidated financial statements appearing elsewhere in this annual report.
The selected consolidated balance sheet data as of December 31, 2001, 2000 and
1999 and the consolidated statement of operations data for the years ended
December 2000 and 1999 have been derived from our audited consolidated
financial statements not included in this annual report. Historical results are
not necessarily indicative of future results. Product cost of revenues is net
of reimbursable ramp up costs from the TSA of $11.0 million in 2002. Cost of
revenues and operating expenses are net of amounts reimbursed under contracts
and grants with governmental agencies of $3.1 million in 2003, $866,000 in
2002, $8.3 million in 2001, $1.7 million in 2000, and $865,000 in 1999. We
acquired Yxlon at the beginning of the second quarter of 2003. Yxlons results
are only accounted for in the consolidated results starting in the second
quarter of 2003. Yxlon acquired Hapeg during the third quarter of 2003. Hapeg
results are consolidated with Yxlons results from the date of acquisition. We
acquired Inovec, which was accounted for as a purchase effective January 1,
2000 and, accordingly, Inovecs results of operations are only included in the
consolidated statement of operations data for the years ended December 31,
2003, 2002, 2001 and 2000. Year Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(In thousands, except per share data)Consolidated Statement of Operations DataRevenues:Product revenues
    
    $
    351,573
    
    
    $
    411,426
    
    
    $
    46,536
    
    
    $
    58,713
    
    
    $
    43,160Service revenues
    
    
    51,793
    
    
    
    15,622
    
    
    
    11,239
    
    
    
    9,801
    
    
    
    4,582Contract research and development revenues
    
    
    13,131
    
    
    
    12,083
    
    
    
    16,556
    
    
    
    10,632
    
    
    
    10,694Total revenues
    
    
    416,497
    
    
    
    439,131
    
    
    
    74,331
    
    
    
    79,146
    
    
    
    58,436Cost of revenues:Product costs
    
    
    204,419
    
    
    
    234,767
    
    
    
    28,782
    
    
    
    39,333
    
    
    
    24,886Service costs
    
    
    31,166
    
    
    
    10,761
    
    
    
    7,162
    
    
    
    6,512
    
    
    
    3,678Contract research and development costs
    
    
    8,396
    
    
    
    8,708
    
    
    
    13,010
    
    
    
    7,849
    
    
    
    7,739Total cost of revenues
    
    
    243,981
    
    
    
    254,236
    
    
    
    48,954
    
    
    
    53,694
    
    
    
    36,303Gross profit
    
    
    172,516
    
    
    
    184,895
    
    
    
    25,377
    
    
    
    25,452
    
    
    
    22,133Operating expenses:Research and development
    
    
    26,323
    
    
    
    20,622
    
    
    
    7,979
    
    
    
    11,039
    
    
    
    10,443Selling, general and administrative
    
    
    45,232
    
    
    
    31,744
    
    
    
    14,727
    
    
    
    16,551
    
    
    
    11,767In process research and development (Yxlon)
    
    
    4,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    75,855
    
    
    
    52,366
    
    
    
    22,706
    
    
    
    27,590
    
    
    
    22,210Income (loss) from operations
    
    
    96,661
    
    
    
    132,529
    
    
    
    2,671
    
    
    
    (2,138
    )
    
    
    (77
    )Interest expense
    
    
    (1,693
    )
    
    
    (399
    )
    
    
    (289
    )
    
    
    (195
    )
    
    
    (227
    )Interest and other income, net
    
    
    3,903
    
    
    
    38
    
    
    
    570
    
    
    
    527
    
    
    
    754Income (loss) before income taxes
    
    
    98,871
    
    
    
    132,168
    
    
    
    2,952
    
    
    
    (1,806
    )
    
    
    450Provision (benefit) for income taxes
    
    
    41,925
    
    
    
    53,874
    
    
    
    (4,571
    )
    
    
    
    
    
    
    67Net income (loss)
    
    $
    56,946
    
    
    $
    78,294
    
    
    $
    7,523
    
    
    
    ($1,806
    )
    
    $
    383Net income (loss) per share:Basic
    
    $
    3.32
    
    
    $
    4.90
    
    
    $
    0.58
    
    
    
    ($0.14
    )
    
    $
    0.03Diluted
    
    $
    3.10
    
    
    $
    4.40
    
    
    $
    0.52
    
    
    
    ($0.14
    )
    
    $
    0.03Weighted average shares outstanding:Basic
    
    
    17,132
    
    
    
    15,987
    
    
    
    12,998
    
    
    
    12,510
    
    
    
    12,133Diluted
    
    
    18,368
    
    
    
    17,803
    
    
    
    14,343
    
    
    
    12,510
    
    
    
    12,751
 26




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December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(In thousands)Consolidated Balance Sheet DataCash, cash equivalents and short-term investments
    
    $
    276,939
    
    
    $
    159,736
    
    
    $
    13,378
    
    
    $
    11,908
    
    
    $
    24,169Working capital
    
    $
    364,793
    
    
    $
    227,074
    
    
    $
    49,634
    
    
    $
    37,672
    
    
    $
    40,913Total assets
    
    $
    486,068
    
    
    $
    417,787
    
    
    $
    89,733
    
    
    $
    69,332
    
    
    $
    62,987Long-term liabilities
    
    $
    127,244
    
    
    $
    653
    
    
    $
    680
    
    
    $
    1,861
    
    
    $
    1,181Total stockholders equity
    
    $
    290,681
    
    
    $
    236,713
    
    
    $
    61,420
    
    
    $
    47,504
    
    
    $
    47,485
 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For a more complete understanding of our financial condition and results
of operations, and some of the risks that could affect future results, see
BusinessRisk Factors in Item 1. This section should also be read in
conjunction with the consolidated financial statements and related notes in
Item 8. Overview We are the leading provider of Transportation Security Administration, or
TSA (formerly Federal Aviation Administration, or FAA) certified explosives
detection systems, or EDS, used at airports for screening checked passenger
baggage. In September 2003, we completed a private offering of $125.0 million
aggregate principal amount of our 3% convertible senior notes due 2023. The
notes are convertible into our common stock, under certain circumstances, at an
initial conversion rate of 31.25 shares per $1,000 principal amount of notes,
subject to adjustment. At the initial conversion rate, the notes will be
convertible into common stock at a conversion price of $32.00 per share. The
notes will be redeemable for cash at our option beginning on October 1, 2008.
Holders of the notes have the option to require us to purchase the notes in
cash, in whole or in part, on October 1 in each of 2008, 2013 and 2018. The
holders of the notes will also have the ability to require us to purchase the
notes in the event that we undergo a change in control. In each such case, the
redemption or purchase price would be at 100% of the principal amount of the
notes, plus accrued and unpaid interest to, but excluding, the redemption or
purchase date, as the case may be. On March 31, 2003, we completed the acquisition of Yxlon International
Holding GmbH for $41.7 million in cash, calculated at the then effective
conversion rate for the euro, incurred additional acquisition costs of $2.1
million, and paid a subsequent purchase price adjustment of $483,000 in
December 2003, for a total purchase price of $44.3 million. Yxlon develops,
manufactures, markets and supports X-ray based non-destructive testing, or NDT,
systems for a wide range of industrial applications, and systems that use X-ray
based diffraction, or XRD, technology for explosives detection. We would make
an additional payment of ¬5.0 million if Yxlons XRD system is certified
for explosives detection by the TSA by June 30, 2004. On August 1, 2003, we
completed the acquisition of Hattinger Pruf- und Entwicklungs- GmbH, or Hapeg,
an engineering and systems company that provides industrial testing and
evaluation solutions utilizing computed tomography for ¬2.9 million or $3.4
million in cash, calculated at the then effective conversion rate for the euro. Our goodwill and intangible assets increased by $33.9 million from $1.6
million at December 31, 2002 to $35.5 million at December 31, 2003, primarily
as a result of $31.7 million of goodwill and intangible assets acquired
pursuant to our acquisition of Yxlon, partially offset by the amortization of
our intangible assets. Based on an independent valuation, the intangible
assets we acquired included $8.7 million of developed and core technology, $2.8
million of trademarks, $18.7 million of goodwill and $1.5 million of other
intangible assets. We determine our segments based on how our Chief Executive Officer and
Chief Operating Officer assess performance and allocate resources. Through the
first quarter of 2003, we presented segment information based on three
reportable segments: EDS, Quantum and Wood. As a result of the acquisition of
Yxlon, we now have two reportable segments, EDS and NDT. The EDS segment is
comprised of the business unit that is engaged in the development,
manufacturing, marketing and support of explosives detection systems based on
advanced computed 27




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tomography technology. The NDT segment is comprised of the Yxlon
business unit that is engaged in the development, manufacturing, marketing and
support of non-destructive testing systems for a wide range of industrial
applications. Other segments including Quantum, Wood and XRD were aggregated
to form an All Other category as they did not meet the threshold for a
reportable segment. See Note 11 of the consolidated financial statements for
additional information about our reportable segments. As a result of the completion of the initial deployment following the
September 11, 2001 terrorist attacks and the time it takes to construct
modifications to retrofit airports to accommodate in-line EDS equipment, the
market for many of our products is in a period of transition. The demand for a
significant portion of our products is also subject to the budgetary process of
the federal government. We anticipate a decline in EDS revenues for 2004. As a
result, we are planning to reduce costs. Our ability to reduce costs will be critical to maintaining our gross
margins and desired level of earnings. Due to a number of factors including the
timing, size and mix of orders from our relatively small number of customers,
particularly the TSA, our revenues have varied significantly from time to time.
We expect that trend to continue. In addition, substantial components of our
quarterly and annual operating expenses are, and will continue to be,
relatively fixed in nature. This means that revenue fluctuations will cause our
quarterly and annual operating results to vary substantially. Our ability to
increase our operating efficiency, further reduce the costs of components and
otherwise control costs during a period of further declining sales in a
business already characterized by significant fluctuations in volume is
difficult to predict. Our revenues are primarily comprised of:  
    
    EDS product revenues, which include revenues from sales of CTX
products, accessories and related installation and configuration, and
EDS service revenues, which include revenues from maintenance contracts
related to product support, integration and other services, including
those complex integrations and configurations that are separate from
product revenues; and
    
    NDT product revenues, which include revenues from the design,
assembly and installation of X-ray systems and associated components
for industrial NDT, and NDT service revenues, which include revenues
from maintenance contracts related to product support. We market our products and services directly through internal sales
personnel and indirectly through authorized agents, distributors and system
integrators. In the United States, we market our products and services
primarily through direct sales personnel. Internationally, we use a direct
sales force and authorized representatives to sell our products. International
sales represented 29.0% of total revenues for the year ended December 31, 2003,
11.7 % of total revenues for the year ended December 31, 2002, and 32.5 % of
total revenues for the year ended December 31, 2001. EDS. In any given fiscal quarter or year, our EDS product revenues are
derived from orders of multiple units of our products from a limited number of
customers. For example, in 2003 eighteen customers accounted for all of our
EDS products sold. The number of our customers does not vary widely from
period to period. Therefore, a cancellation or delay of an order from a
customer could have a significant negative impact on our operations in a given
period. EDS product and service sales to the FAA and, following the formation
of the TSA, to the TSA, accounted for 77.9% of our EDS revenues for the year
ended December 31, 2003, 85.6% of our EDS revenues in the year ended December
31, 2002, and 43.4% of our EDS revenues in the year ended December 31, 2001.
There were no other EDS customers who accounted for more than 10% of total
revenues in the years ended December 31, 2003, 2002 and 2001. We typically bill our customers in three stages, as generally provided in
our contracts with our customers:  
    
    amounts to cover the bill of materials when materials are received
from suppliers, typically 30% to 40% of the total system price;
    
    an additional amount upon factory acceptance or shipment ranging from 30% to 60%; and 28




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
    
    the balance upon installation and site acceptance, ranging from 5% to 30%. These payment terms generally provide the necessary working capital for
acquisition of materials and funding inventory during the manufacturing cycle.
We anticipate that potential future orders from the TSA will continue to
provide payment terms which provide the necessary working capital for us and
our suppliers, even if production volumes were to rapidly increase. If future
orders from the TSA contain different payment terms, a major increase in
production rates may require substantial additional working capital. Payment terms for TSA invoices are net 30 days, while terms for
international invoices vary from amounts due upon receipt of invoice to 160
days. NDT. Our NDT product and service revenues are primarily derived from
sales of X-ray based NDT products primarily to the automotive and aerospace
industries. There were no NDT customers who accounted for more than 10% of
total revenues since the acquisition of Yxlon on March 31, 2003. Results of Operations The following table sets forth certain income and expenditure items from
our consolidated statements of operations expressed as a percentage of total
revenues for the periods indicated. Year Ended December 31,2003
    
    2002
    
    2001Revenues:Product revenues
    
    
    84.4
    %
    
    
    93.7
    %
    
    
    62.6
    %Service revenues
    
    
    12.4
    
    
    
    3.6
    
    
    
    15.1Contract research and development revenues
    
    
    3.2
    
    
    
    2.7
    
    
    
    22.3Total revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Cost of revenues:Product costs
    
    
    49.1
    
    
    
    53.5
    
    
    
    38.8Service costs
    
    
    7.5
    
    
    
    2.5
    
    
    
    9.6Contract research and development costs
    
    
    2.0
    
    
    
    2.0
    
    
    
    17.5Total cost of revenues
    
    
    58.6
    
    
    
    58.0
    
    
    
    65.9Gross margin
    
    
    41.4
    
    
    
    42.0
    
    
    
    34.1Operating expenses:Research and development
    
    
    6.3
    
    
    
    4.7
    
    
    
    10.7Selling, general and administrative
    
    
    10.9
    
    
    
    7.2
    
    
    
    19.8In process research and development (Yxlon)
    
    
    1.0
    
    
    
    
    
    
    
    Total operating expenses
    
    
    18.2
    
    
    
    11.9
    
    
    
    30.5Income from operations
    
    
    23.2
    
    
    
    30.1
    
    
    
    3.6Interest expense
    
    
    (0.4
    )
    
    
    (0.1
    )
    
    
    (0.4
    )Interest and other income, net
    
    
    1.0
    
    
    
    
    
    
    
    0.8Income before income taxes
    
    
    23.8
    
    
    
    30.0
    
    
    
    4.0Provision for (benefit from) income taxes
    
    
    10.1
    
    
    
    12.2
    
    
    
    (6.1
    )Net income
    
    
    13.7
    %
    
    
    17.8
    %
    
    
    10.1
    %
 On March 31, 2003, the first day of our second quarter, we acquired Yxlon.
Yxlons results have been included in our results since the acquisition date,
and the operating results for the NDT segment also have been included only for
the last three quarters of 2003. Comparison of Fiscal Years 2003 and 2002 Revenues.EDS product revenues were $303.0 million in 2003, a decrease of
24.8% from $403.1 million in 2002. The revenue decrease was mainly due to the
fulfillment by the end of the second quarter of 2003 of several 29




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large orders received from the TSA during 2002. We anticipate that EDS
product revenues will continue to decline in 2004. The decline in revenues is
primarily being driven greater demand for our in-line EDS compared to our
stand-alone EDS as a result of the completion of the initial deployment
following the September 11, 2001 terrorist attacks and the time it takes to
construct modifications to retrofit airports to accommodate in-line EDS
equipment. EDS service revenues were $41.2 million in 2003, an increase of 199.5%
from $13.7 million in 2002. The revenue increase results primarily from a
larger number of units installed in the United States, and from services
provided for our EDS products owned by the TSA in the United States and its
territories, including extended-hour service. We anticipate that service
revenues will increase in 2004 compared to 2003 primarily due to a larger
installed based of EDS coming off of warranty. As of December 31, 2003, we had
in backlog EDS equipment orders and service agreements of $65.6 million,
primarily consisting of orders for EDS systems and services from international
customers. We are in negotiations to renew our contract to service our EDS
products owned by the TSA in the United States and its territories, and we do
not anticipate disruption of service as a result of these discussions. NDT product revenues were $34.6 million in the nine-month period since the
acquisition of Yxlon, and NDT service revenues were $8.7 million for the same
period. As of December 31, 2003, we had in backlog NDT equipment orders and
service agreements of $21.6 million, primarily consisting of orders for
standard industrial and custom NDT systems. Gross Profit.Cost of EDS product revenues primarily consists of purchased
materials procured for use in the assembly of our products, as well as
manufacturing labor and overhead, contract manufacturing services,
installation, training and warranty. Cost of EDS service revenues primarily
consists of direct labor and materials and customer support overhead. In any
given period, our gross profit for products and services may be affected by
several factors, including product mix, volume of systems manufactured in the
period, product configuration, location of the installation and complexity of
integration into various environments. Gross profit for EDS products was $135.1 million in 2003, a decrease of
22.4% from $174.3 million in 2002. Gross margin percentages for EDS products
were 44.6% in 2003 and 43.2% in 2002. The decrease in gross profit was due to
decreased sales of our CTX products. Product gross margin percentages for the
year remained approximately the same primarily as a result of improved
manufacturing overhead per unit, offset by decreases in sales price as a result
of volume orders from the TSA. Gross profit for EDS services were $16.9 million in 2003, an increase of
334.6% from $3.9 million in 2002. Gross margin percentages for EDS services
were 41.0% in 2003 and 28.2% in 2002. The increase in gross profit for EDS
services was primarily due to increased EDS service revenues from the growing
installed base of domestic systems covered by our agreement to service our EDS
products owned by the TSA in the United States and its territories, which calls
for extended 24-hour coverage beyond the standard warranty coverage, and
service agreements from international customers. Gross margin percentages
improved primarily as the result of service overhead costs being spread over a
larger base of installed units. In addition, during 2002, we incurred costs
associated with the expansion of our customer support staff in anticipation of
an increase in EDS services as more units were sold. Cost of NDT product revenues primarily consists of purchased materials
procured for use in the assembly of our products, as well as manufacturing
labor and overhead, installation, training and warranty. Cost of NDT services
revenues primarily consists of direct labor and materials and customer support
overhead. Gross profit for NDT products was $7.9 million in the nine-month
period since the acquisition of Yxlon. Gross margin percentage for NDT
products was 22.8% for the same period. We are in the process of developing
parts cost reduction programs for NDT. We believe these programs will
improve gross margins for NDT products commencing in the third
quarter of 2004, although such anticipated improvements may be
reduced due to exchange rate fluctuations. Gross profit for NDT service was $3.2 million in the nine-month period
since the acquisition of Yxlon. Gross margin percentage for NDT services was
37.0% for the same period. We do not anticipate meaningful changes in gross
margin for NDT services in 2004. 30




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Research and Development.Research and development expenses consist
primarily of compensation paid to personnel engaged in research and development
activities, amounts paid for outside services and costs of materials utilized
in the development of hardware products, including prototype units. Research
and development expenditures are partially offset by amounts reimbursed by the
TSA and other government agencies and private entities under research and
development contracts and grants. These services are provided and reimbursed
on a cost basis. Net research and development expenses for EDS were $20.4 million in 2003,
an increase of 15.8% from $17.7 million in 2002. The net numbers reflect
amounts reimbursed by the TSA and other government agencies of $3.1 million in
2003 and $566,000 in 2002. Net research and development expenses for EDS as a
percentage of EDS revenues were 5.9% in 2003 and 4.2% in 2002. The increase in
research and development expenses for EDS in 2003 was primarily due to
increased spending on several initiatives to support our growth, partially
offset by the receipt of $3.1 million of government funding for research
projects. With the goal of 100% checked baggage screening in U.S. airports, we
expect that our EDS machines will be operated at or near capacity for extended
periods. We are continuing to invest in sustaining engineering efforts to
ensure that our products achieve high levels of serviceability and reliability
when operating at capacity, although we anticipate that amounts spent on
sustaining engineering efforts will decrease in 2004. We are also continuing
to develop product enhancements for our existing line of EDS machines. In
addition, we are continuing our development of our CTX 1000 system under the
ARGUS program, an FAA-sponsored program designed to develop a smaller, low-cost
EDS product to scan checked baggage in small airports and low-traffic stations
within larger airports. Research and development expenses for NDT were $2.4 million in the
nine-month period since the acquisition of Yxlon. Research and development
expenses for NDT as a percentage of NDT revenues were 5.6% for the period. In
order to strengthen our role as world leading supplier of X-ray solutions for
NDT applications, we plan to increase the research and development expenses for
NDT in 2004. Selling, General and Administrative.Selling, general and administrative
expenses consist primarily of compensation paid to direct and indirect sales
and marketing personnel, administrative personnel, including directors,
consultant fees, professional service fees, insurance costs, travel, selling
and distribution costs, and other general expenses. Selling, general and administrative expenses for EDS were $26.8 million in
2003, an increase of 9.2% from $24.6 million in 2002. Selling, general and
administrative expenses for EDS as a percentage of EDS revenues were 7.8% in
2003 and 5.9% in 2002. The increase in selling, general and administrative
expenses for EDS in absolute dollars in 2003 was primarily due to an increase
in headcount and employee-related expenses in 2003 as compared to the prior
year. Selling, general and administrative expenses for NDT were $11.9 million in
the nine-month period since the acquisition of Yxlon. Selling, general and
administrative expenses for NDT as a percentage of NDT revenues were 27.4% for
the period. We anticipate that the selling, general and administrative
expenses as a percentage of NDT revenues will decline in 2004 due to an
expected increase in NDT sales volume compared to 2003. Interest Expense.Interest expense was $1.7 million in 2003 and $399,000
in 2002. Interest expense resulted primarily from the issuance of $125.0
million of convertible senior notes in September 2003, along with fees
associated with our working capital lines of credit, equipment term loans,
capital leases and financing for insurance premiums and interest expense
associated with long term debt. Interest and Other Income, Net.Interest and other income, net, was $3.9
million in 2003 and $38,000 in 2002. The amount for 2003 consisted of interest
income on cash, cash equivalents and short-term investments of $2.1 million,
and other income of $1.8 million, including a net $1.5 million in foreign
exchange gain. The amount for 2002 consisted primarily of interest income on
cash and cash equivalents of $1.9 million, offset by other expenses of $1.9
million, primarily consisting of $1.2 million of net foreign exchange losses
primarily related to foreign exchange contracts entered into in advance of
adopting hedge accounting in May 2002 and a contingent settlement amount of
$700,000. The increase in interest income on cash, cash equivalents and
short-term investments was in part due to interest on the proceeds received in
September 2003 from the offering of our 3% convertible senior notes due 2023,
which we also anticipate will lead to an increase in such interest income in
2004. 31




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Provision for Income Taxes.The provision for income taxes was $41.9
million in 2003 and $53.9 million in 2002. Our effective tax rate was 42.4% in
2003 and 40.8% in 2002. The increase in the effective tax rates in 2003
compared to 2002 was mainly due to a $4.3 million expense for in-process
research and development associated with the acquisition of Yxlons X-ray
diffraction business, which was not tax deductible. Our effective tax rate was
different than statutory tax rates primarily due to the in-process research and
development expense described above, along with certain other permanent
differences between book and taxable income. We expect that our effective tax
rate will be reduced to a limited extent in future years. At December 31,
2003, we had federal, state and foreign net operating loss carryforwards of
approximately $1.2 million, $321,000 and $15.8 million available to reduce
future federal, state and foreign taxable income, respectively. Our federal
net operating loss carryforwards begin to expire in 2010 and our state net
operating loss carryforwards expire in 2011. The foreign net operating loss
carryforwards may be carried over indefinitely and will not expire. The tax
benefit of the net operating loss carryforwards may be limited due to the
impact of the Tax Reform Act of 1986. Events which may cause the tax benefit
to be limited include, but are not limited to, a cumulative stock ownership
change of more than 50% over a three-year period and the timing of utilization
of various tax benefits carried forward. Comparison of Fiscal Years 2002 and 2001 Revenues.EDS product revenues were $403.1 million in 2002, an increase
of 1,004% from $36.5 million in 2001. This increase in system sales and
related accessories reflects the orders received from the FAA and the TSA
during 2002, as well as international customers in late 2001 and 2002,
resulting from the increased focus on aviation security following the terrorist
attacks of September 11, 2001. The increase in EDS product revenues was
slightly offset by volume discounts. EDS service revenues were $13.7 million
in 2002, an increase of 43.4% from $9.6 million in 2001. The increase in
service revenues was a result of signing an agreement with Siemens, which was
retroactive to November 2002, to service our EDS units owned by the FAA and the
TSA in the United States and its territories and service contract revenues from
international customers for new support and maintenance agreements for CTX
products for which warranty periods expired during the year. Gross Profit.Gross profit for EDS products was $174.3 million in 2002,
an increase of 1,125% from $14.2 million in 2001. Gross margins for EDS
products were 43.2% in 2002 and 39.0% in 2001. In addition to significant TSA
shipments in 2002, the improvement in EDS product gross profit was partially
due to amounts reimbursable from the TSA for ramp up costs, which consist of
consulting expenses, vendor expedite charges and subcontractor manufacturing
set-up costs, totaling $11.0 million. If this amount were not reimbursable,
these elements of ramp up costs would have been expensed. The overall
improvement in product gross profit was partially offset by $5.3 million in
inventory write downs and accrued vendor cancellation fees. During 2002, in
anticipation of receiving additional TSA orders for our CTX 5500 DS model, we
purchased and made commitments to purchase large quantities of critical
components to build CTX 5500 DS machines. These anticipated TSA orders were
largely replaced by orders for our CTX 9000 DSi model and, at year-end, our CTX
5500 DS raw material inventory levels were in excess of our anticipated
requirements. Accordingly, we wrote down a portion of our CTX 5500 DS
inventory and accrued cancellation fees which taken together totaled $5.3
million during 2002. The improvement in EDS product gross margin percentages
was primarily due to lower manufacturing overhead per unit, resulting from a
larger increase in units produced relative to the increase in fixed costs
during 2002. Gross profit for EDS services was $3.9 million in 2002, an increase of
20.2% from $3.2 million in 2001. Gross margins for EDS services were 28.2% in
2002 and 33.7% in 2001. The decrease in gross margin percentages was primarily
due to the need to increase EDS customer support overhead costs necessary to
support an increasing installed base of EDS units. Because product sales are
initially covered for support services under warranty, there is approximately a
15 to 18 month time lag from shipment to recognizing significant service
contract revenue tied to the increased sales of EDS products. However, the EDS
product customer is not obligated to purchase support services from us after
the warranty period, so additional service contract revenues are not assured by
product sales. The increased support costs with no immediate service revenue
for recent product sales was the primary reason for lower gross margin for 2002
compared to that in 2001. Research and Development.Gross research and development expenses for
EDS were $18.2 million in 2002, an increase of 70.9% from $10.7 million in
2001. Gross research and development expenses for EDS as a percentage of EDS
revenues were 4.4% in 2002 and 23.1% in 2001. Net research and development
expenses for EDS were $17.7 million in 2002, an increase of 254.8% compared to
$5.0 million in 2001. Net research and development 32




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expenses for EDS as a percentage of EDS revenues were 4.2% in 2002 and 10.8% in
2001. The increase in gross research and development expenses for EDS was
primarily due to an increased focus on several initiatives to support our
growth. The increase in net research and development expenses for EDS was
primarily due to Quantums development of an upgrade to the CTX family of
explosives detection systems utilizing QR and less funding received from the
ARGUS grant in the current year compared to the prior year. The decrease of
gross and net research and development expenses for EDS as a percentage of
revenues was primarily due to a significant increase in revenues. Selling, General and Administrative.Selling, general and administrative
expenses for EDS were $24.6 million in 2002, an increase of 186.0% from $8.6
million in 2001. Selling, general and administrative expenses for EDS as a
percentage of EDS revenues were 5.9% in 2002 and 18.6% in 2001. Part of the
increase in expenses for EDS was the result of an increase in expenditures to
consultants and professional fees of $4.5 million, such as investigations
relating to potential acquisitions and investor and public relations, employee
headcount of $3.3 million, insurance costs of $2.2 million and sales
commissions of $2.1 million, all related to the growth of our business compared
to the prior year. The decrease in selling, general and administrative expenses
for EDS as a percentage of revenues was primarily due to the increase in EDS
revenues. Interest Expense.Interest expense increased to $399,000 in 2002 from
$289,000 in 2001. The increase in interest expense was primarily due to
increased activities within our financing for insurance premiums, and increased
activities within our lines of credit, such as more standby letters of credit
issued to secure guarantees to customers, in 2002 compared to that in 2001. Interest and Other Income, Net.Interest and other income, net was
$38,000 in 2002 compared to $570,000 in 2001. The 2002 amount consists of
interest income on cash, cash equivalents and short-term investments of $1.9
million, offset by other expenses of $1.9 million, primarily consisting of $1.2
million of net foreign exchange losses primarily related to foreign exchange
contracts entered into in advance of adopting hedge accounting in May 2002 and
a contingent settlement amount of $700,000. The 2001 amount consists primarily
of interest income on cash equivalents and short-term investments of $297,000
and other income (net) of $273,000, primarily the reversal of a reserve due to
a favorable outcome of an international claim, partially offset by foreign
exchange losses. Provision for (Benefit from) Income Taxes.We recorded an income tax
provision of $53.9 million in 2002 compared with an income tax benefit of $4.6
million in 2001. At December 31, 2002, we had federal and state net operating
loss carryforwards of approximately $1.8 million and $321,000, respectively,
available to reduce future federal and state taxable income. Our federal net
operating loss carryforwards begin to expire in 2010 and our state net
operating loss carryforwards expire in 2011. The tax benefit of the net
operating loss carryforwards may be limited due to the impact of the Tax Reform
Act of 1986. Events which may cause the tax benefit to be limited include, but
are not limited to, a cumulative stock ownership change of more than 50% over a
three-year period and the timing of utilization of various tax benefits carried
forward. Liquidity and Capital Resources At December 31, 2003, we had $276.9 million in cash, cash equivalents and
short-term investments, compared to $159.7 million in cash and cash equivalents
at December 31, 2002. Net cash provided by operating activities was $51.4 million in 2003,
compared to $65.4 million provided by operating activities in 2002. Cash
provided by operating activities in 2003 primarily resulted from significant
accounts receivable collections from the TSA resulting in a $100.6 million
decrease in accounts receivable. Other significant items include net income of
$56.9 million, enhanced by the non-cash effects of the $5.9 million of
depreciation and amortization, and the $4.3 million in-process research and
development expense related to the Yxlon acquisition. Partially offsetting
these increases to net cash provided by operating activities was a $79.8
million decrease in deferred revenue, primarily due to the shipment of units to
the TSA for which deposits had been received in prior periods for long-lead
shipments. A $62.4 million decrease in accounts payable and accrued
liabilities also contributed to decreasing the net cash provided by operating
activities. 33




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Cash provided by operating activities in 2002 primarily resulted from a $81.9 million increase in deferred revenues, consisting primarily of long-lead
deposits on delivery orders from the TSA, a $70.3 million increase in accounts
payable and accrued liabilities, net income of $78.3 million enhanced by the
$9.2 million effect of income tax benefits from employee stock transactions,
and the $3.6 million non-cash effect of depreciation and amortization,
partially offset by a $118.4 million increase in accounts receivable, a $37.7
million increase in inventories, and a $11.0 million increase in other current
assets, primarily consisting of $8.3 million in prepaid inventory purchases,
$1.6 million of ramp up costs to be recovered from the TSA and $1.0 million in
recoverable value-added tax. Net cash used in investing activities was $145.2 million in 2003, compared
to $2.9 million in 2002. Net cash used in investing activities in 2003
resulted primarily from purchase of short-term investments of $94.7 million and
from payments of $42.3 million, net of cash acquired, in connection with the
Yxlon acquisition. In addition, other net cash uses were $3.3 million in
acquisition of capital equipment, a $1.5 million payment for an equity
investment and product distribution rights in SafeView, Inc., a company
developing an advanced personnel screening portal system, and $3.4 million for
the Hapeg acquisition. Net cash used in investing activities in 2002 resulted
primarily from $4.7 million in purchases of capital equipment, offset by
proceeds from the sale of short-term investments of $1.9 million. Net cash provided by financing activities was $115.8 million in 2003,
compared to $85.9 million in 2002. Net cash provided by financing activities
in 2003 primarily resulted from the issuance of $125.0 million of convertible
senior debt, offset by related debt issuance costs of $4.5 million and a stock
repurchase of $12.5 million. In addition, there was $3.5 million in net
proceeds from short-term borrowings and $4.6 million in net proceeds from the
sale of common stock under our employee stock purchase plan and exercises of
stock options. Net cash provided by financing activities in 2002 primarily
resulted from $87.8 million in net proceeds from the sale of common stock to
the public and under our employee stock purchase plan and exercises of stock
options, partially offset by $1.9 million in repayments of long-term and
short-term debt, net of proceeds. Effective December 2003, we had a line of credit agreement for our U.S.
operations that provides for maximum borrowings in an amount up to $30.0
million. Borrowings under this agreement bear interest at the banks prime
rate minus 0.5% (3.5% at December 31, 2003). The agreement expires in December
2005 and require that the EDS segment maintain certain levels of tangible net
worth. We may use proceeds of loans under this line of credit for general
corporate purposes. At December 31, 2003, we had no borrowings outstanding
under these agreements. However, at December 31, 2003, we had outstanding
guarantees to customers through the issuance of letters of credit for which a
partial reserve of $17.0 million is secured by the lines of credit, and foreign
exchange contracts for which a 10% reserve of $1.7 million is secured by the
lines of credit. We had remaining available borrowing capacity under the line
of credit of $11.3 million at December 31, 2003. As of December 31, 2003, we had letters of credit totaling $17.0 million
as guarantees primarily to customers for performance and delivery commitments,
and to foreign creditors to our subsidiary entities. In addition, we have one
guarantee to an insurance carrier for premium payment commitments. The
guarantees range from two months to nine years from December 31, 2003 until
expiration. As of December 31, 2003, we had two primary sources of financing from
German banks for Yxlon. The first agreement is a line of credit that provides
for maximum borrowings in an amount up to 6.6 million or $8.3 million at
December 31, 2003. The second agreement is also a line of credit that provides
for maximum borrowings in an amount up to 5.2 million, or $6.6 million, at
December 31, 2003. The expiration date for each of these agreements is March
2004. Borrowings under these agreements bear interest at a rate of 5.75%. At
December 31, 2003, we had debt balances of $5.3 million outstanding under these
agreements. In addition, at December 31, 2003, we had outstanding guarantees
to customers through the issuance of letters of credit for which a reserve of
$3.9 million is secured by the lines of credit. Therefore, we had remaining
available borrowing capacity under the lines of credit of approximately 4.5
million, or $5.7 million, at December 31, 2003. 34




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Contractual Obligations and Commitments The following table depicts our contractual obligations as of December 31,
2003 (in thousands): Payment Due by PeriodLess than
    
    1-3
    
    More thanContractual Obligations
    
    Total
    
    1 year
    
    years
    
    3 yearsLong-term debt
    
    $
    125,000
    
    
    $
    
    
    
    $
    
    
    
    $
    125,000Operating leases
    
    
    22,286
    
    
    
    4,815
    
    
    
    7,465
    
    
    
    10,006Short-term debt
    
    
    5,581
    
    
    
    5,581
    
    
    
    
    
    
    
    Other long-term liabilities
    
    
    1,390
    
    
    
    
    
    
    
    
    
    
    
    1,390Capital lease obligations
    
    
    619
    
    
    
    287
    
    
    
    332
    
    
    
    Total contractual cash obligations
    
    $
    154,876
    
    
    $
    10,683
    
    
    $
    7,797
    
    
    $
    136,396
 At December 31, 2003, we had commitments of $17.3 million for foreign
exchange forward contracts, which are used to hedge against existing
receivables and orders. These contracts expire within one year, when we will
need to provide the euro currency from forecasted customer receipts to receive
$17.3 million. We have no material obligations or commitments other than the
obligations specified in the table above and the commitments specified in this
paragraph. We believe that existing cash, cash equivalents and short-term
investments, available borrowings under our lines of credits and funds expected
to be generated from operations will be sufficient to finance our working
capital and capital expenditure requirements for at least the next twelve
months. However, if we fail to meet required financial covenants in our credit
agreements, or our receivables do not support the upper limits of these credit
agreements, then we may not be able to have access to further funds under these
agreements. In addition, if we are unable to deliver EDS units in a timely
manner under our recent orders from the TSA or if we fail to adhere to the
terms of the licensing agreement with the TSA, the TSA may cancel its orders or
not place additional orders. If any of these events occur, our capital
resources would be significantly impaired. Inflation The impact of inflation has not been material on our operations, cash flow
or liquidity to date. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in conformity with accounting principles generally accepted in the
United States of America. Our preparation of these consolidated financial
statements requires us to make judgments and estimates that affect the reported
amounts of assets and liabilities, 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. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from such
estimates under different assumptions or conditions. The following summarizes
our critical accounting policies and significant estimates used in preparing
our consolidated financial statements: Revenue Recognition.We recognize revenues when persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
price is fixed and determinable and collectibility is reasonably assured. For
sales of EDS products to the TSA that have been demonstrated to meet product
specifications prior to shipment, we recognize product revenues at shipment and
defer the portion of revenues relating to installation and training until these
services are performed and accepted by the customer. The deferred installation
and training revenues are based on the fair value of these services and
generally represent less than 5% of these arrangements. Installation is
generally completed within a relatively short period of time, typically less
than one week. We have a consistent history of completing routine installations
and obtaining customer acceptance for domestic and international sales. Some
airport installations require more involved integration with baggage handling
systems and take longer than 35




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most routine installations. Integration services are separately priced from
products in sales agreements and we recognize service revenues under these
agreements as services are performed. Sales of EDS and NDT products and services to customers in foreign
countries have varying contractual terms and are governed, in part, by
regulations in foreign jurisdictions. Accordingly, we recognize revenue based
on the specific facts and circumstances surrounding each transaction. Revenue
recognition on foreign sales is affected by our determination of when legal
title and risk of loss pass to foreign customers as well as by our evaluation
of our enforceable rights to unbilled amounts at the balance sheet date for
transactions that have been recognized as revenues. For foreign sales of EDS
and NDT products that have been demonstrated to meet product specifications
prior to shipment, where title and risk of loss pass to the customer at
shipment, and where we either have an enforceable claim at the balance sheet
date for remaining unbilled amounts or have the ability to invoice the customer
for any unbilled amounts after a fixed period of time regardless of whether
installation is completed, we recognize product revenue at shipment and defer
and recognize the fair value of installation and training revenue, if any, as
services are performed. For sales of EDS and NDT products to foreign customers
where title and risk of loss for such products pass upon completion of
installation, we recognize product revenues at the completion of installation
and acceptance by the customer. In other sales of EDS and NDT products to
foreign customers where a portion of the contract price is withheld until
installation is completed and where we do not believe we have an enforceable
claim at the balance sheet date through which we can realize some or all of the
withheld amount, we defer and recognize as revenue the greater of that portion
of the contract price or the fair value of the installation and training at the
completion of installation and acceptance by the customer. Inventory.Our inventory purchases and commitments are made in order to
build inventory to meet future shipment schedules based on actual and
forecasted demand for our products. The business environment in which we
operate is subject to rapid changes in customer demand. We perform a detailed
assessment of inventory by segment each period, which includes a review of,
among other factors, demand requirements, product life cycle and development
plans, component cost trends, product pricing and quality issues. Based on
this analysis, we may record a write down to inventory for excess, obsolescence
or impairment, when appropriate, to reflect inventory at net realizable value. Accrued Warranty Reserves.We accrue the estimated cost of product
warranties at the time revenues are recognized. While we engage in extensive
product quality programs and processes, including actively monitoring and
evaluating the quality of our component suppliers, our warranty obligation is
affected by actual warranty costs, including usage of material and labor and
service delivery costs incurred in correcting a product failure. If actual
material usage or service delivery costs differ from our estimates, revisions
to the estimated warranty liability would be required. Deferred Tax Asset Valuation Allowance.We record a valuation allowance
to reduce our deferred tax assets when it is more likely than not, based upon
currently available evidence and other factors, that we will not realize some
portion or all of our deferred tax assets. We base our determination of the
need for a valuation allowance on an on-going evaluation of current evidence
including, among other things, estimates of future earnings, the backlog of
customer orders and the expected timing of deferred tax asset reversals. We
charge or credit adjustments to the valuation allowance to income tax expense
in the period in which these determinations are made. If we determine that we
would be able to realize our deferred tax assets in the future in excess of its
net recorded amount, an adjustment to the deferred tax asset would increase
income in the period this determination was made. Likewise, if we determine
that we would not be able to realize all or part of our net deferred tax assets
in the future, we would charge to operations an adjustment to the deferred tax
asset in the period this determination was made. Valuation of Long-Lived Assets, Including Goodwill and Purchased
Intangible Assets. We review property, plant and equipment, goodwill and
purchased intangible assets for impairment whenever events or changes in
circumstances indicate the carrying value of an asset may not be recoverable.
Our asset impairment review assesses the fair value of the assets based on the
future cash flows the assets are expected to generate. An impairment loss is
recognized when estimated discounted future cash flows expected to result from
the use of the asset plus net proceeds expected from disposition of the asset,
if any, are less than the carrying value of the asset. This approach uses our
estimates of future market growth, forecasted revenue and costs, expected
periods the assets will be utilized and appropriate discount rates. Such
evaluations of impairment of long-lived assets, including goodwill and
purchased intangible assets are an integral part of, but not limited to, our
strategic reviews of our business and 36




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operations. When an impairment is identified, the carrying amount of the
asset is reduced to its estimated fair value. Deterioration of our business in
a geographic region or within a business segment in the future could also lead
to impairment adjustments as such issues are identified. Recently Issued Accounting Standards Revenue Arrangements with Multiple Deliverables.In November 2002, the
Emerging Issues Task Force, or EITF, reached a consensus on Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables, or EITF 00-21. EITF 00-21
addresses certain aspects of the accounting by a vendor for arrangements under
which the vendor will perform multiple revenue generating activities. EITF
00-21 is effective for fiscal periods beginning after June 15, 2003. There was
no impact from the adoption of EITF 00-21 on our consolidated financial
statements. Accounting and Disclosure Requirements for Guarantees.In December 2002,
we adopted Financial Accounting Standards Board, or FASB, Interpretation No.
45, Guarantors Accounting and Disclosure Requirement for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, or FIN 45. FIN 45
requires that, upon issuance of a guarantee, the guarantor must recognize a
liability for the fair value of the obligation it assumes under that guarantee.
The provisions for initial recognition and measurement are effective on a
prospective basis for guarantees that are issued or modified after December 31,
2002, irrespective of a guarantors year-end. We adopted the disclosure
requirements of FIN 45 in the fourth quarter of 2002. The adoption of FIN 45
did not materially impact our consolidated financial statements. Accounting for Costs Associated with Exit or Disposal Activities.On
January 1, 2003, we adopted SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, or SFAS 146, which addresses accounting for
restructuring and similar costs. SFAS 146 supersedes previous accounting
guidance, principally EITF Issue No. 94-3, or EITF 94-3. SFAS 146 requires
that the liability for costs associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF 94-3, a liability for
exit costs was recognized at the date of a companys commitment to an exit
plan. SFAS 146 also establishes that the liability should initially be
measured and recorded at fair value. Accordingly, SFAS 146 may affect the
timing of recognizing future restructuring costs as well as the amounts
recognized. There was no effect on our consolidated financial statements from
the adoption of SFAS 146. Consolidation of Variable Interest Entities.The FASB issued
Interpretation No. 46, Consolidation of Variable Interest Entities, or FIN
46, in January 2003, and a revised interpretation of FIN 46, or FIN 46-R, in
December 2003. FIN 46 requires certain variable interest entities, or VIEs, to
be consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The provisions of FIN 46 are effective immediately for all
arrangements entered into after January 31, 2003. Since January 31, 2003, we
have not invested in any entities it believes are variable interest entities
for which we are the primary beneficiary. For all arrangements entered into
after January 31, 2003, we are required to continue to apply FIN 46 through the
end of the first quarter of fiscal 2004. We are required to adopt the
provisions of FIN 46-R for those arrangements in the second quarter of fiscal
2004. For arrangements entered into prior to February 1, 2003, we are required
to adopt the provisions of FIN 46-R in the second quarter of fiscal 2004. We do
not expect the adoption of FIN 46-R to have an impact on our consolidated
financial statements. Accounting for Derivative Instruments and Hedging Activities.In April
2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities, or SFAS 149. SFAS No. 149 amends and
clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS 133. SFAS No. 149 is generally effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. There was no impact from the adoption of SFAS No. 149 on our
consolidated financial statements. Accounting for Financial Instruments with Characteristics of both
Liabilities and Equity.In May 2003, the FASB issued SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity, or SFAS 150, which requires that certain financial instruments be
presented as liabilities that were previously presented as equity or as
temporary equity. Such instruments include mandatory redeemable preferred and
common stock, and certain options and warrants. SFAS 150 is effective for
financial instruments entered into or 37




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modified after May 31, 2003 and was effective at the beginning of the first
interim period beginning after June 15, 2003. In November 2003, the FASB
issued FASB Staff Position No. 150-3, Effective Date, Disclosures, and
Transition for Mandatorily Redeemable Financial Instruments of Certain
Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests
under SFAS No. 150, or FSP 150-3, which defers the effective date for various
provisions of SFAS No. 150. The adoption of SFAS 150, as modified by FSP
150-3, did not have a material impact on our consolidated financial statements. Revenue Recognition. In December 2003, the SEC staff issued Staff
Accounting Bulletin No. 104, Revenue Recognition, Corrected Copy, or SAB 104,
which revises or rescinds portions of the revenue recognition interpretive
guidance included in the Staff Accounting Bulletin codification to make it
consistent with current authoritative accounting and auditing guidance and SEC
rules and regulations. The principal revisions relate to revenue recognition
guidance no longer necessary due to developments in U.S. GAAP. SAB 104 also
rescinds the Frequently Asked Questions and Answers document issued in
conjunction with the release of Staff Accounting Bulletin No. 101. The
adoption of SAB 104 did not materially impact our consolidated financial
statements. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We consider investments purchased with an original or remaining maturity
of less than three months at the date of purchase to be cash equivalents. We
maintain an investment portfolio of various holdings, types, and maturities.
(See Note 16 to the consolidated financial statements). These securities are
classified as available for sale and consequently are recorded on the
consolidated balance sheets at fair value with unrealized gains or losses
reported as a separate component of accumulated other comprehensive income
(loss), net of tax. The following table summarizes our cash, cash equivalents
and short-term investments for the periods indicated (in thousands): December 31,2003
    
    2002Cash and cash equivalents
    
    $
    182,382
    
    
    $
    159,736Short-term investments
    
    
    94,557
    
    
    
    Total
    
    $
    276,939
    
    
    $
    159,736
 At any time, a sharp rise in interest rates could have a material adverse
impact on the fair value of our investment portfolio. Conversely, declines in
interest rates could have a material impact on interest earnings for our
investment portfolio. We do not currently hedge these interest rate exposures.
The following table presents the changes in fair value in investment
securities held at December 31, 2003 that are sensitive to changes in interest
rates (in thousands) based on hypothetical adjustments in the applicable
interest rates: Valuation of securities
    
    
    
    
    
    Valuation of securitiesgiven an interest rate
    
    Fair Value as of
    
    given an interest rateincrease of basis points
    
    December 31,
    
    decrease of basis points150 BPS*
    
    100 BPS
    
    50 BPS
    
    2003
    
    (50 BPS)
    
    (100 BPS)
    
    (150 BPS)*Total
    
    $
    275,836
    
    
    $
    276,367
    
    
    $
    276,905
    
    
    $
    276,939
    
    
    $
    277,902
    
    
    $
    278,559
    
    
    
    N/A
    *
  *
    
    A shift of minus 150 basis points is highly unlikely due to the low interest rates in effect as of
December 31, 2003. These instruments are not leveraged and are held for purposes other than
trading. The modeling technique used measures the change in fair value arising
from selected potential changes in interest rates, using a three-month
investment horizon and hypothetical parallel shifts in the yield curve of plus
or minus 50 basis points (BPS), 100 BPS and 150 BPS. Our international system sales and maintenance contracts are generally
denominated in U.S. dollars. In instances where there are significant
international system sales contracts denominated in a foreign currency, we
often enter into forward contracts to mitigate foreign exchange risk. We do not
enter into market risk sensitive 38




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instruments for trading purposes. During the year ended December 31, 2003,
we entered into foreign exchange forward contracts with a total notional value
of approximately $6.3 million to hedge against foreign exchange risk for
contracts with international customers denominated in euros and, at December
31, 2003, December 31, 2002 and December 31, 2001, we had outstanding contracts
to convert euros to dollars with notional values totaling $17.3 million, $34.7
million and $16.9 million, respectively, with a negative fair value of
approximately $1.4 million, $4.9 million and a positive fair value of $47,000,
respectively. The following table depicts the maturities of the outstanding
contract amounts (in thousands): Within 3Contract Maturity
    
    months
    
    4-6 months
    
    7-9 months
    
    10-12 months
    
    13 monthsAmount at 12/31/03
    
    $
    16,738
    
    
    $
    588
    
    
    $
    
    
    
    $
    
    
    
    $
    Amount at 12/31/02
    
    
    13,884
    
    
    
    18,020
    
    
    
    2,653
    
    
    
    99
    
    
    
    Amount at 12/31/01
    
    
    5,623
    
    
    
    110
    
    
    
    2,194
    
    
    
    2,179
    
    
    
    6,841
 Purchases of raw materials and other inventory components are primarily
denominated in U.S dollars and, when purchased in foreign currencies, are
generally made on an as needed basis. We have some advance purchase commitments
in foreign currencies with a few European suppliers. We currently do not hedge
against these purchase commitments, as the foreign exchange rate fluctuations
have not had a material adverse impact on these purchases; however, we will
continue to monitor the foreign exchange rates and may enter into forward
contracts to mitigate foreign exchange risk as appropriate. Certain costs of providing warranty and maintenance services for systems
sold to foreign countries are denominated in local currencies. To the extent
exchange rates fluctuate, it could become more expensive to provide these
services. To date, these costs have not been significant; however, we expect
they will increase as our installed base increases. We are exposed to foreign currency exchange rate risk inherent in our
sales commitments, anticipated sales, anticipated purchases and assets and
liabilities denominated in currencies other than the U.S. dollar. We transact
business primarily in four currencies worldwide, of which the most significant
to our operations is the euro. In some situations, we are a net receiver of
foreign currencies and therefore benefit from a weaker U.S. dollar and are
adversely affected by a stronger U.S. dollar relative to those foreign
currencies in which we transact significant amounts of business. We performed a
sensitivity analysis as of December 31, 2003, December 31, 2002 and December
31, 2001, using a modeling technique that measures the change in the fair
values arising from a hypothetical 10% and 15% adverse movement in the levels
of foreign currency exchange rates relative to the U.S. dollar (that is,
strengthening of the U.S. dollar) with all other variables held constant. The
analysis covers all of our foreign exchange forward contracts offset by the
underlying exposures. The analysis excludes balances and transactions
pertaining to Yxlon. Foreign exchange rate risk is relatively low for Yxlon
given that it primarily transacts business in euros. The cash flow impacts of our sensitivity analysis as of December 31, 2003
are summarized in the following table (the foreign currency exchange rates used
were based on market rates in effect at December 31, 2003): Contract
    
    Fair Value asof Dec. 31,
    
    Cash flow impact of change in exchange rates(in thousands)
    
    Amount
    
    2003
    
    10% Change
    
    15% ChangeForeign exchange forward contracts
    
    $
    17,326
    
    
    $
    (1,410
    )
    
    $
    1,877
    
    
    $
    2,816Accounts receivable
    
    
    17,703
    
    
    
    20,174
    
    
    
    (2,017
    )
    
    
    (3,026
    )Firm orders*
    
    
    10,749
    
    
    
    14,358
    
    
    
    (1,436
    )
    
    
    (2,154
    )Other working capital balances, net
    
    
    1,366
    
    
    
    1,325
    
    
    
    (133
    )
    
    
    (199
    )Total
    
    
    
    
    
    
    
    
    
    $
    (1,709
    )
    
    $
    (2,563
    )
   * Firm orders represent orders for which we have received a signed purchase
order. 39




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##### Table of Contents



The cash flow impact of changes in exchange rates at December 31, 2003 is
not significantly different from the cash flow impact of changes in exchange
rates at December 31, 2002. We do not expect the impact of changes in interest
rates to have a material impact on our operations, cash flow or liquidity. The cash flow impact of changes in exchange rates at December 31, 2002 is
not significantly different from the cash flow impact of changes in exchange
rates at December 31, 2001. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our consolidated financial statements and notes thereto and supplementary
financial data appear on pages F-1 to F-31 of this annual report and are
incorporated by reference herein. 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, we are responsible
for listing the non-audit services approved by our Audit Committee to be
performed by Deloitte & Touche LLP, our external auditor. Non-audit services
are defined as services other than those provided in connection with an audit
or a review of our financial statements. Since the filing of our Quarterly
Report on Form 10-Q for the quarter ended September 28, 2003, the Audit
Committee approved engagements of Deloitte & Touche LLP for the following
non-audit services: tax services, which includes services related to the
review of tax returns of Yxlon International Holding GmbH. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 
 ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Based on our managements evaluation (with the participation of our
principal executive officer and principal financial officer) of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange Act)), as of the
end of the period covered by this annual report, our principal executive
officer and principal financial officer have concluded that such disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. Changes in Internal Control Over Financial Reporting There was no change in our internal control over financial reporting
during our fourth fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting. 
 PART III. 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors and Officers The following table shows our executive officers, key employees and
directors as of March 1, 2004. Name
    
    Age
    
    PositionSergio Magistri
    
    
    51
    
    
    President, Chief Executive Officer and DirectorDonald E. Mattson
    
    
    71
    
    
    Senior Vice President and Chief Operating OfficerRoss Mulholland
    
    
    61
    
    
    Senior Vice President and Chief Financial OfficerDavid M. Pillor
    
    
    49
    
    
    Senior Vice President, Sales and Marketing and Director
 40




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##### Table of Contents



Name
    
    Age
    
    PositionAndrew D. Siegel
    
    
    38
    
    
    Senior Vice President, Corporate DevelopmentRoelof van Ark
    
    
    52
    
    
    President, Aviation SecurityGiovanni Lanzara
    
    
    64
    
    
    Chairman of the Board of DirectorsStephen Blum
    
    
    62
    
    
    DirectorDouglas P. Boyd
    
    
    62
    
    
    DirectorMorris D. Busby
    
    
    65
    
    
    DirectorBruno Trezza
    
    
    67
    
    
    DirectorLouis A. Turpen
    
    
    60
    
    
    Director
 Sergio Magistrihas served as our President, Chief Executive Officer and a
director since December 1992. From June 1991 to November 1992, he was a Project
Manager with AGIE, Switzerland, a manufacturer of high precision tooling
equipment, responsible for all aspects of a family of new products for high
precision electro-erosion machining with sub-micron precision. From 1988 to
June 1991, Dr. Magistri was a consultant to high technology companies. As a
consultant, Dr. Magistri was involved in the formation of InVision, including
the development of our business plan and our technology. From 1983 to 1988, Dr.
Magistri held various positions with Imatron, including Engineering Physicist
and Manager of Advanced Reconstruction Systems, and Director of Computer
Engineering. Dr. Magistri holds a degree in Electrical Engineering and a
doctorate in Biomedical Engineering from the Swiss Institute of Technology,
Zurich, Switzerland. Donald E. Mattsonhas served as our Senior Vice President and Chief
Operating Officer since November 2000. Mr. Mattson previously served as our
Interim Vice President of Operations in 1998. In addition to his position with
us, from 1992 to 2000, Mr. Mattson was a management consultant and held a
number of different positions, including, among others, interim management
assignments as Executive Officer of Microware Distributors, Inc., a computer
distribution company, President of SyDos, a disk drive sub-systems company, and
Vice President of operations of Quantum, a tape drive manufacturing company.
Prior to 1992, Mr. Mattson held senior management positions at Microware
Distributors, Inc., Optical Data, Inc., Media Technology Corporation, Verbatim
Corporation, Memorex Corporation and Varian Associates. Mr. Mattson holds a
bachelors degree in Industrial Management and Technology and an MBA from the
University of California at Berkeley. Ross Mulhollandhas served as our Senior Vice President and Chief
Financial Officer since March 2001. From January 2000 to October 2000, Mr.
Mulholland was Chief Financial Officer and Vice President of Operations of
TechPlanet, a Silicon Valley private company providing information technology
services. In 2001, TechPlanet filed for bankruptcy protection under Chapter 7.
Before that, he was Vice President and Chief Financial Officer at Silicon
Entertainment, a technology-based specialty retailer, from 1998 to 2000, and
Senior Vice President and Chief Financial Officer for The Nature
Company/Discovery Channel Stores, a specialty retailer and direct marketing
company, from 1995 to 1997. He has also held senior management positions with
several leading national retailers, including Dayton-Hudson Corporation. Mr.
Mulholland holds a bachelors degree in Liberal Arts and an MBA from Wayne
State University. David M. Pillorjoined InVision in July 1994 as Vice President, Sales and
Marketing, and has served as our Senior Vice President, Sales and Marketing
since November 1995 and as a director since 1999. From 1988 to July 1994, Mr.
Pillor held various positions including Area Sales Manager, National Sales
Manager and Vice President of Sales of Technomed International, a medical
products company. Mr. Pillor holds a bachelors degree in Chemistry from the
University of Maryland. Andrew D. Siegelhas served as our Senior Vice President, Corporate
Development since April 2003. Mr. Siegel joined us in 2002 and was our Vice
President, Business Development from May 2002 to December 2002 and Vice
President, Corporate Development from January 2003 to March 2003. From April
2000 to February 2002, Mr. Siegel was a Vice President in the corporate and
institutional client group of Merrill Lynch & Co., an investment bank. From
December 1998 to January 2000, he was Vice President of Granite Associates, a
private investment firm in Liberty, New York. Prior to then, Mr. Siegel was an
attorney at Skadden Arps Slate Meagher and Flom LLP, specializing in mergers
and acquisitions. Mr. Siegel received a Juris Doctor from New York University
School of Law and a bachelors degree in political science and communications
from Syracuse University. 41




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##### Table of Contents



Roelof van Arkjoined InVision in August 2003 as President, Aviation
Security. From May 1999 to November 2002 , Mr. van Ark was President and Chief
Executive Officer of Siemens Transportation Systems, a subsidiary of Siemens, a
company that supplies capital equipment to transit and rail authorities in
North America and some regions of South America. From October 1995 to April
1999, he served as President of the Turnkey Transportation Systems Group,
Siemens AG, a supplier of turnkey rail-transportation projects world wide. Mr.
van Ark holds a bachelors degree in Electrical Engineering and an MBA from the
University of the Witwatersrand, Johannesburg. Giovanni Lanzarahas served as a director since September 1990 and as
Chairman of the board of directors since March 1994. Since 1978, he has served
as a professor and President of the Transportation Engineering Department at
the University of Aquila, Rome, Italy. Dr. Lanzara has been President of the
International Center for Transportation Studies since 1987. Dr. Lanzara served
as a director of Imatron from August 1993 to June 1996. Stephen Blumhas served as a director since June 2001. Since April 2003,
Mr. Blum has served as Managing Director of Chai Tech LLC, which provides
consulting services in technology transfers and licensing and strategic
relationships. From 2001 to April 2003, Mr. Blum became Vice President of
Tejas Securities Group. From 1990 to 2002, he served as President of Donald &
Co. Securities, Inc., an investment banking and brokerage firm that ceased
operations in September 2002. In connection with Donald & Co. Securities, Inc.
ceasing operations as a brokerage firm, the National Association of Securities
Dealers, Inc. fined Mr. Blum and suspended him from running a brokerage firm
for three months because of the failure of Donald & Co. Securities, Inc. to
meet net capital requirements. From August 2001 to January 2003, Mr. Blum
served as a director and officer of THCG, Inc., which provided investment
banking and other financing advisory services. Mr. Blum holds a bachelors
degree from New York Universitys School of Commerce. Douglas P. Boydhas served as a director since June 1993 and previously
served as a director from September 1990 to December 1992. Dr. Boyd was a
founder of Imatron in 1981 and has held various positions at Imatron, including
as the Chairman of its board of directors, through its acquisition by General
Electric Medical Systems in December 2001. Since the acquisition, Dr. Boyd has
been employed by GE Imatron, a GE Medical Systems Company, as Chief Scientist. Morris D. Busbyhas served as a director since March 1998. Since 1995,
Ambassador Busby has served as President of BGI, Inc., an international
consulting firm. From 1991 to 1994 he was ambassador to the Republic of
Colombia and from 1989 to 1991 he was the U.S. governments U.S. coordinator
for counter-terrorism and directed the international efforts against terrorism
during the Persian Gulf War. Prior to that time, he was Principal Deputy
Assistant Secretary of State for Inter-American Affairs. From 1984 to 1987 he
was Deputy Chief of Mission in Mexico City. Ambassador Busby holds a bachelors
degree from Marshall University and a masters degree from George Washington
University. Bruno Trezzahas served as a director since November 1993. Since 1974, he
has served as a professor of economics at the University La Sapienza in Rome,
Italy. From 1980 to 1981, Dr. Trezza served as an economic advisor to the
Italian Prime Minister. From 1974 to 1983, he served as a member of the
Committee for Economic Planning of the Italian Ministry of Planning. He has
served as a director of several private companies and public institutions in
Italy. Dr. Trezza holds a degree in law from the University of Napoli, a
masters degree in economics from Cambridge University and a doctorate degree
in economics from the Italian Ministry of Public Education. Louis A. Turpenhas served as a director since August 2001 and previously
served as a director from 1992 to 1995. He has served as the President and
Chief Executive Officer of the Greater Toronto Airports Authority since
November 1995. Prior to that, he served as Chief Executive Officer of San
Francisco International Airport for fourteen years. Mr. Turpen holds a
bachelors degree in Civil Engineering from the United States Air Force Academy
and an MBA from Roosevelt University. Audit Committee The Audit Committee currently consists of Dr. Douglas Boyd, Dr. Bruno
Trezza and Stephen Blum, each of whom is independent under current listing
standards of The Nasdaq Stock Market. In addition, the board of directors 42




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has reviewed the qualifications and experience of Dr. Boyd, including his
experience in supervising and evaluating the preparation of audited financial
statements, and has determined that Dr. Boyd qualifies as an audit committee
financial expert within the meaning of the current rules of the Securities and
Exchange Commission. Each of the current Audit Committee members served
throughout fiscal 2003. The Audit Committee:  
    
    meets with our independent auditors at least annually to review the
results of the annual audit and to discuss the financial statements;
    
    hires and has the power to terminate the independent auditors;
    
    oversees the independence of the independent auditors;
    
    evaluates the independent auditors performance; and
    
    receives and considers the independent auditors comments as to
internal controls, accounting and operational matters, management
performance, and procedures in connection with audits and reviews. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, or the 1934 Act,
requires our directors and executive officers, and persons who own more than
10% of our common stock, to file with the Securities and Exchange Commission
initial reports of ownership and reports of changes in ownership of our common
stock and other equity securities. Officers, directors and greater than 10%
stockholders are required by regulation of the Securities and Exchange
Commission to furnish us with copies of all Section 16(a) forms they file. To our knowledge, based solely on a review of the copies of such reports
furnished to us and written representations that no other reports were
required, during the fiscal year ended December 31, 2003, all Section 16(a)
filing requirements applicable to our officers, directors and greater than 10%
beneficial owners were complied with. Code of Ethics We have adopted a code of ethics that applies to all members of our board
of directors and all of our employees, including our principal executive
officer, principal financial officer and controller. A copy of this code is
available on the Company section of our website at www.invision-tech.com and
is filed as an exhibit to this annual report. We intend to disclose any changes
in or waivers from our code of ethics required to be publicly disclosed by
posting such information on our website or by filing a Form 8-K. 
 ITEM 11. EXECUTIVE COMPENSATION Compensation of Directors In 2003, non-employee directors received a $60,000 annual retainer as
compensation for their services as members of the board of directors, and the
Chairman of the board of directors received an additional $10,000 annual
retainer as compensation for his services as the Chairman of the Board. Each
non-employee director also received $16,000 annually for services as members of
committees of the board of directors. In addition, each non-employee director
was issued stock options to purchase 25,000 shares of our common stock in
connection with their services as directors. These directors were also
reimbursed for expenses incurred in connection with the performance of services
as directors. In addition, directors were entitled to an allowance of
$5,000 for tax planning and preparation services in 2003. Such
allowance has been increased to $15,000 for 2004. Compensation Committee Interlocks and Insider Participation During fiscal 2003, Dr. Lanzara and Mr. Blum served as members of the
compensation committee of our board of directors. The Compensation Committee
did not meet during 2003, and all compensation matters were handled by the
board of directors. No member of the board of directors or compensation
committee serves as an executive officer of any other entity that has one or
more of our executive officers serving as a member of the board of directors or
compensation committee of the other entity. Only Dr. Magistri and Mr. Pillor
are directors who are or have been executive officers of InVision. 43




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##### Table of Contents



Named Executive Officer Compensation The following table sets forth certain compensation earned during 2003,
2002 and 2001 by our Chief Executive Officer and our four other executive
officers whose salary and bonus for the year ended December 31, 2003 exceeded
$100,000, referred to as the Named Executive Officers: Long-TermCompensationAwardsName and
    
    
    
    
    
    Annual Compensation
    
    SecuritiesUnderlying
    
    All OtherPrincipal Position
    
    Year
    
    Salary ($)
    
    Bonus ($)
    
    Option (#)
    
    Compensation ($)*Sergio Magistri
    
    
    2003
    
    
    
    445,385
    
    
    
    225,000
    
    
    
    80,000
    
    
    
    7,525
    (1)President and
    
    
    2002
    
    
    
    321,146
    
    
    
    450,000
    
    
    
    80,000
    
    
    
    8,747
    (1)Chief Executive Officer
    
    
    2001
    
    
    
    240,192
    
    
    
    182,000
    
    
    
    100,000
    
    
    
    4,391
    (1)Donald Mattson
    
    
    2003
    
    
    
    327,000
    
    
    
    220,350
    
    
    
    64,000
    
    
    
    10,677
    (2)Senior Vice President and
    
    
    2002
    
    
    
    255,804
    
    
    
    380,000
    
    
    
    64,000
    
    
    
    10,548
    (2)Chief Operating Officer
    
    
    2001
    
    
    
    212,403
    
    
    
    169,000
    
    
    
    6,300
    
    
    
    8,075
    (2)Ross Mulholland
    
    
    2003
    
    
    
    254,077
    
    
    
    161,500
    
    
    
    35,000
    
    
    
    8,505
    (3)Senior Vice President and
    
    
    2002
    
    
    
    220,769
    
    
    
    185,000
    
    
    
    54,000
    
    
    
    9,557
    (3)Chief Financial Officer
    
    
    2001
    
    
    
    155,653
    
    
    
    89,900
    
    
    
    80,000
    
    
    
    4,919
    (3)David Pillor
    
    
    2003
    
    
    
    247,692
    
    
    
    352,668
    (4)
    
    
    45,000
    
    
    
    19,743
    (5)Senior Vice President,
    
    
    2002
    
    
    
    198,077
    
    
    
    819,861
    (4)
    
    
    54,400
    
    
    
    19,399
    (5)Sales and Marketing
    
    
    2001
    
    
    
    143,592
    
    
    
    364,272
    (4)
    
    
    68,500
    
    
    
    3,705
    (5)Andrew Siegel (6)
    
    
    2003
    
    
    
    213,231
    
    
    
    269,500
    
    
    
    40,000
    
    
    
    6,205
    (7)Senior Vice President,
Corporate Development
    (1)
    
    For 2003, represents matching contributions by us to employees accounts
under our 401(k) plan of $7,000 and premiums for employees group term
life insurance of $525. For 2002, represents matching contributions by us
to employees accounts under our 401(k) plan of $4,777, fees for
professional tax services of $3,265, premiums for employees group term
life insurance of $355 and airline membership fees of $350. For 2001,
represents matching contributions by us to employees accounts under our
401(k) plan of $4,035 and premiums for employees group term life
insurance of $356.(2)
    
    For 2003, represents matching contributions by us to employees accounts
under our 401(k) plan of $5,980 and premiums for employees group term
life insurance of $4,697. For 2002, represents matching contributions by
us to employees accounts under our 401(k) plan of $5,520, premiums for
employees group term life insurance of $4,878 and fees for professional
tax services of $150. For 2001, represents matching contributions by us
to employees accounts under our 401(k) plan of $5,290 and premiums for
employees group term life insurance of $2,785.(3)
    
    For 2003, represents matching contributions by us to employees accounts
under our 401(k) plan of $7,000 and premiums for employees group term
life insurance of $1,505. For 2002, represents matching contributions by
us to employees accounts under our 401(k) plan of $5,539, fees for
professional tax services of $3,000 and premiums for employees group term
life insurance of $1,018. For 2001, represents matching contributions by
us to employees accounts under our 401(k) plan of $4,165 and premiums for
employees group term life insurance of $754.(4)
    
    For 2003, represents commissions of $83,918 and a bonus of $268,750. For
2002 and 2001, represents commissions earned. For 2000, represents
commissions of $100,362 and a bonus of $23,000. 44




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##### Table of Contents



(5)
    
    For 2003, represents annual rent for an apartment of $15,600, matching
contributions by us to employees accounts under our 401(k) plan of $3,788
and premiums for employees group term life insurance of $355. For 2002,
represents annual rent for an apartment of $15,600, matching contributions
by us to employees accounts under our 401(k) plan of $3,404 and premiums
for employees group term life insurance of $395. For 2001, represents
matching contributions by us to employees accounts under our 401(k) plan
of $3,231 and premiums for employees group term life insurance of $474.
For 2000, represents matching contributions by us to employees accounts
under our 401(k) plan of $3,202 and premiums for employees group term
life insurance of $485.  (6)
    
    In April 2003, Mr. Siegel became our Senior Vice President, Corporate
Development.  (7)
    
    For 2003, represents matching contributions by us to employees accounts
under our 401(k) plan of $6,000 and premiums for employees group term
life insurance of $205.  *
    
    In addition to the amounts presented in the table, each of
the named executive officers was entitled to an allowance of $5,000
for tax planning and preparation services in 2003. Such allowance
has been increased to $15,000 for 2004. Stock Option Grants We grant options to our executive officers under the 2000 Equity Incentive
Plan. No options were granted under our previous incentive plan, the 1991
Equity Incentive Plan, in the year ended December 31, 2003. As of December 31,
2003, options to purchase a total of 856,017 shares were outstanding under the
1991 Equity Incentive Plan and options to purchase a total of 2,459,761 shares
were outstanding under our 2000 Equity Incentive Plan. As of December 31, 2003,
1,224,704 shares remained available for grant under the 2000 Equity Incentive
Plan. The following table shows for the fiscal year ended December 31, 2003,
certain information regarding options granted to, and held at year-end by, the
Named Executive Officers. The exercise price of each option was equal to the fair market value of
our common stock as valued by the board of directors on the date of grant. The
exercise price may be paid in cash, promissory notes, in shares of our common
stock valued at fair market value on the exercise date or, if permissible,
through a cashless exercise procedure involving a same-day sale of the
purchased shares. The options granted vest as to 25% of the shares one year
from the date of grant and 1/48th of the shares each month thereafter. Each of
the options has a ten-year term, subject to earlier termination if the
optionees service with us ceases. The potential realizable value is calculated based on the ten-year term of
the option at the time of grant. Stock price appreciation of 5% and 10% is
assumed pursuant to rules promulgated by the Securities and Exchange Commission
and does not represent our prediction of stock price performance. The potential
realizable values at 5% and 10% appreciation are calculated by assuming that
the stock price on the date of grant appreciates at the indicated annual rate,
compounded annually for the entire term of the option and that the option is
exercised and sold on the last day of the term for the appreciated stock price. Percentages shown under Percentage of Total Options Granted to Employees
in 2003 are based on an aggregate of 1,126,500 options granted to our
employees, consultants and directors under the 2000 Equity Incentive Plan
during 2003. Potential RealizableValue at AssumedIndividual Grants
    
    
    
    
    
    Annual Rates ofStock PriceNumber of
    
    Percentage of Total
    
    
    
    
    
    
    
    
    
    Appreciation forSecurities
    
    Options Granted to
    
    
    
    
    
    
    
    
    
    Option TermUnderlying Options
    
    Employees in
    
    Exercise
    
    ExpirationName
    
    Granted
    
    2003 (%)
    
    Price per Share
    
    Date (1)
    
    5%($)
    
    10% ($)Sergio Magistri
    
    
    80,000
    
    
    
    7.1
    
    
    $
    24.94
    
    
    Feb. 5, 2013
    
    $
    1,254,771
    
    
    $
    3,179,830Donald Mattson
    
    
    64,000
    
    
    
    5.7
    
    
    $
    24.94
    
    
    Feb. 5, 2013
    
    $
    1,003,816
    
    
    $
    2,543,864Ross Mulholland
    
    
    35,000
    
    
    
    3.1
    
    
    $
    24.94
    
    
    Feb. 5, 2013
    
    $
    548,962
    
    
    $
    1,391,176David Pillor
    
    
    45,000
    
    
    
    4.0
    
    
    $
    24.94
    
    
    Feb. 5, 2013
    
    $
    705,808
    
    
    $
    1,788,654Andrew Siegel
    
    
    40,000
    
    
    
    3.6
    
    
    $
    24.94
    
    
    Feb. 5, 2013
    
    $
    627,385
    
    
    $
    1,589,915
 45




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(1) See the discussion of our Change in Control Equity Acceleration Plan
under Employment Agreements and Change of Control Agreements. Aggregated Option Exercises in Fiscal 2003 and December 31, 2003 Option Values The following table sets forth information with respect to options
exercised by the Named Executive Officers during 2003, the number of securities
underlying unexercised options held by the Named Executive Officers as of
December 31, 2003, and the value of unexercised in-the-money options as of
December 31, 2003. Amounts shown under the column Value Realized are based on the price at
which the shares were sold less the exercise price. Amounts shown under the
column Value of Unexercised In-the-Money Options at December 31, 2003 are
based on the closing price of our common stock on December 31, 2003, which was
$33.57, less the exercise price, without taking into account any taxes that may
be payable in connection with the transaction, multiplied by the number of
shares underlying the option. Number of Securities
    
    Value of UnexercisedUnderlying Unexercised
    
    In-the-Money OptionsShares Acquired on
    
    Value
    
    Options at December 31, 2003
    
    at December 31, 2003Name
    
    Exercise
    
    Realized ($)
    
    Exercisable
    
    Unexercisable
    
    Exercisable ($)
    
    Unexercisable ($)Sergio Magistri
    
    
    14,000
    (1)
    
    
    469,980
    
    
    
    386,158
    
    
    
    160,122
    
    
    
    10,359,620
    
    
    
    1,780,466Donald Mattson
    
    
    22,000
    
    
    
    527,274
    
    
    
    45,331
    
    
    
    126,969
    
    
    
    548,215
    
    
    
    1,407,790Ross Mulholland
    
    
    10,000
    
    
    
    
    
    
    
    38,625
    
    
    
    90,375
    
    
    
    467,925
    
    
    
    1,081,925David M. Pillor
    
    
    20,000
    
    
    
    655,539
    
    
    
    247,988
    
    
    
    98,829
    
    
    
    6,879,409
    
    
    
    1,202,576Andrew Siegel
    
    
    
    
    
    
    
    
    
    
    30,000
    
    
    
    90,000
    
    
    
    428,400
    
    
    
    1,059,200
  (1)
    
    The Value Realized is based on the closing sale price of $34.12 on
December 30, 2003, the date on which Dr. Magistri exercised his option.
Dr. Magistri has not sold the shares underlying such option. Employment Agreements and Change of Control Agreements We have entered into employment agreements with Dr. Magistri and Messrs.
Mattson, Mulholland, Pillor and Siegel that provide for salaries and other
employment terms. These agreements each provide that, if we terminate the
employees employment without cause, the employee is entitled to a severance
payment equal to his annual base salary for six, nine or twelve months,
depending on whether such employees tenure with us has been less than four
years, between four and eight years or over eight years, respectively. All of
the employment agreements are terminable at the will of either the employee or
us, with or without cause. In each case, termination by the employee requires
ninety days notice to us. In addition, under our Change in Control Equity Acceleration Plan, the
vesting of stock option awards granted to the Named Executive Officers under
our equity incentive plans shall accelerate in full following the effective
date of a change in control of InVision, subject to reduction if appropriate to
receive better tax treatment. A change of control will occur, generally, in
the event of a merger, sale of our assets or a stock acquisition in which
following the transaction the stockholders of our company will hold less than
50% of the stock of the acquiring company following the transaction. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth certain information regarding the ownership
of our common stock as of March 1, 2004 by: (1) each director and nominee for
director; (2) the Chief Executive Officer and four other most highly
compensated executive officers whose total cash compensation exceeded $100,000
during our last completed fiscal year; (3) all of our executive officers and
directors as a group; and (4) all those known by us to be beneficial owners of
more than 5% of our common stock. 46




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Beneficial Ownership (1)Beneficial Owner
    
    Number of Shares
    
    Percent of TotalHARAX
Holdings S.A. (2)22, Rue Marie Adelaide, L-2128
Luxembourg
    
    
    1,401,582
    
    
    
    8.1
    %Wellington
Management Company LLP75 State Street
Boston, MA 02109
    
    
    1,179,580
    
    
    
    6.8
    %Neuberger
Berman, LLC (3)605 Third Avenue
New York, NY, 10158-3698
    
    
    1,179,000
    
    
    
    6.8
    %Sergio Magistri (4)
    
    
    444,626
    
    
    
    2.5
    %Giovanni Lanzara (5)
    
    
    256,409
    
    
    
    1.5
    %Bruno Trezza (6)
    
    
    254,715
    
    
    
    1.5
    %David M. Pillor (7)
    
    
    253,488
    
    
    
    1.4
    %Morris D. Busby (8)
    
    
    72,013
    
    
    
    *Donald Mattson (9)
    
    
    66,523
    
    
    
    *Stephen Blum (10)
    
    
    66,250
    
    
    
    *Douglas P. Boyd (11)
    
    
    58,085
    
    
    
    *Andrew Siegel (12)
    
    
    49,566
    
    
    
    *Louis A. Turpen (13)
    
    
    46,250
    
    
    
    *Ross Mulholland (14)
    
    
    42,718
    
    
    
    *All executive officers and directors as a group (11 persons) (15)
    
    
    1,610,643
    
    
    
    8.6
    %
 
 * Less than 1%.  (1)
    
    This table is based upon information supplied by officers, directors and
principal stockholders and Schedules 13D and 13G filed with the Securities
and Exchange Commission. Unless otherwise indicated in the footnotes to
this table and subject to community property laws where applicable, we
believe that each of the stockholders named in this table has sole voting
and investment power with respect to the shares indicated as beneficially
owned. Beneficial ownership is determined in accordance with the rules of
the Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Beneficial ownership also
includes shares of stock subject to options and warrants currently
exercisable or exercisable within 60 days of the date of this table.
Applicable percentages are based on 17,297,789 shares of our common stock
outstanding on March 1, 2004.  (2)
    
    All of the shares are held directly by HARAX Holdings S.A. The directors
of HARAX vote and invest the shares held by HARAX, and two of three
directors must concur to take these actions. The current three directors
of HARAX are Luisella Moreschi, Sandrine Klusa and Angela Cinarelli.
Arsene Kronshagen is the sole stockholder of HARAX, and as such may also
be deemed to have voting and investment power over the shares. The
directors disclaim beneficial ownership of the shares held by HARAX.  (3)
    
    Neuberger Berman, LLC is deemed to be a beneficial owner for purpose of
Rule 13(d) since it has shared power to make decisions whether to retain
or dispose of, and in some cases the sole power to vote, the securities of
many unrelated clients. Neuberger Berman, LLC does not, however, have any
economic interest in the securities of those clients. In addition,
Neuberger Berman, LLC and Neuberger Berman Management Inc. are deemed to
be beneficial owners for purposes of Rule 13(d) of 764,100 shares since
they both have shared power to make decisions whether to retain or dispose
and vote the securities. Neuberger Berman, LLC and Neuberger Berman
Management Inc. serve as sub-adviser and investment manager, respectively,
of Neuberger Bermans various mutual funds which hold such shares in the
ordinary course of their business.  (4)
    
    Includes 393,315 shares issuable pursuant to options exercisable within
60 days of March 1, 2004. 47




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(5)
    
    Includes 41,886 shares held by PASTEC Holdings, S.A. Giovanni Lanzara is
the controlling stockholder of PASTEC. Also includes 156,080 shares
issuable pursuant to options exercisable within 60 days of March 1, 2004.  (6)
    
    Includes 85,474 shares held by HAKON Holdings, S.A. Bruno Trezza is the
controlling stockholder of HAKON. Also includes 169,241; shares issuable
pursuant to options exercisable within 60 days of March 1, 2004.  (7)
    
    Includes 251,243 shares issuable pursuant to options exercisable within
60 days of March 1, 2004.  (8)
    
    Includes 327 shares held by BGI, Inc. Ambassador Busby is President and a
controlling stockholder of BGI. Also includes 71,686 shares issuable
pursuant to options exercisable within 60 days of March 1, 2004.  (9)
    
    Includes of 65,975 shares issuable pursuant to options exercisable within
60 days of March 1, 2004.  (10)
    
    Consists of shares issuable pursuant to options exercisable within 60
days of March 1, 2004.  (11)
    
    Consists of shares issuable pursuant to options exercisable within 60
days of March 1, 2004.  (12)
    
    Includes 46,666 shares issuable pursuant to options exercisable within 60
days of March 1, 2004.  (13)
    
    Consists of shares issuable pursuant to options exercisable within 60
days of March 1, 2004.  (14)
    
    Includes 42,214 shares issuable pursuant to options exercisable within 60
days of March 1, 2004.  (15)
    
    Includes 1,367,005 shares issuable pursuant to options exercisable within
60 days of March 1, 2004. See Notes 3-14 above. Change in Control Arrangement On
March 15, 2004, we entered into an Agreement and Plan of Merger with
General Electric Company, or GE, under which, GE would acquire us through the
merger of a wholly owned subsidiary of GE with and into InVision,
and each outstanding share of our common stock would be converted into the
right to receive $50.00 in cash. The merger is subject to customary closing
conditions, including the approval of our stockholders and the expiration or
termination of waiting periods under U.S. and applicable foreign antitrust
laws. The Agreement and Plan of Merger is attached as
Exhibit 2.2 to this annual report. The foregoing description is qualified in its entirety by reference to
the full text of the agreement. In connection with the proposed merger, we intend to file a proxy
statement and other relevant materials with the Securities and Exchange
Commission, or SEC. BEFORE MAKING ANY VOTING DECISION WITH RESPECT TO THE
PROPOSED MERGER, WE URGE OUR STOCKHOLDERS TO READ THE PROXY STATEMENT AND OTHER
RELEVANT MATERIALS BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT THE
PROPOSED MERGER. The proxy statement and other relevant materials, and any
other documents filed by us with the SEC, may be obtained free of charge at the
SECs website at www.sec.gov. In addition, our stockholders may obtain free
copies of the documents filed with the SEC by contacting our Investor
Relations at (510) 739-2511 or InVision Technologies, Inc., 7151 Gateway
Boulevard, Newark, CA 94560. Any reports, statements and other information
filed by us with the SEC may be copied or read at the SEC public
reference room at 450 Fifth Street, N.W. Room 1200, Washington, D.C. 20549.
Please call the SEC at 1-800-SEC-0330 or visit the SECs website for further
information on its public reference room. We
and our executive officers and directors may be deemed to be
participants in the solicitation of proxies from our stockholders in favor
of the proposed merger. Some of our executive officers and directors have
interests in the merger that may differ from the interests of our stockholders
generally, including acceleration of vesting of stock options and continuation
of director and officer insurance and indemnification. See, for example, the
discussion of our Change in Control Equity Acceleration Plan under  -
Employment Agreements and Change of Control Agreements. These interests will
be described in the proxy statement when it becomes available. Securities Authorized for Issuance Under Equity Compensation Plans As of December 31, 2003, we maintained the 1991 Equity Incentive Plan, the
2000 Equity Incentive Plan and the 2002 Employee Stock Purchase Plan, all of
which were approved by our stockholders, and the 2000 Non-Officer Equity
Incentive Plan, which is not subject to stockholder approval. Number ofSecuritiesRemaining AvailableNumber of
    
    
    
    
    
    for Future IssuanceSecurities to be
    
    
    
    
    
    Under EquityIssued Upon
    
    Weighted-Average
    
    Compensation PlansExercise of
    
    Exercise Price of
    
    (ExcludingOutstanding
    
    Outstanding
    
    SecuritiesOptions, Warrants
    
    Options, Warrants
    
    Reflected in columnPlan Category
    
    and Rights
    
    and Rights
    
    (a))(a)
    
    (b)
    
    (c)Equity compensation plans approved
by security holders:1991 Equity Incentive Plan
    
    
    856,017
    
    
    $
    4.1393
    
    
    
    2000 Equity Incentive Plan (1)
    
    
    2,459,761
    
    
    $
    25.0678
    
    
    
    1,224,7042002 Employee Stock Purchase Plan
    
    
    
    
    
    
    
    
    
    
    96,561Equity compensation plans approved
by security holders; aggregated
    
    
    3,315,778
    
    
    $
    19.6648
    
    
    
    1,321,265Equity compensation plans not
approved by security holders (2)
    
    
    272,145
    
    
    $
    21.6323
    
    
    
    3,794Total
    
    
    3,587,923
    
    
    
    
    
    
    
    1,325,059
  (1)
    
    Under our 2000 Equity Incentive Plan, at the end of each calendar year
there will automatically be added on that date an additional number
of shares of common stock for issuance pursuant to awards. The additional
number of shares of common stock will be equal to the lesser of 5% of the
number of shares of common Stock issued and outstanding on that date, and
the number obtained by subtracting the number of shares of common stock
then 48




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reserved under the plan, but not subject to outstanding awards, from 8% of
the number of shares of common stock issued and outstanding on that date.(2)
    
    Reflects options outstanding under our 2000 Non-Officer Equity Incentive
Plan. See below for a description of this plan. We have also assumed
options granted by Quantum Magnetics, Inc., which we acquired in 1997. Of
these assumed options, an aggregate of 6,837 shares at a weighted average
exercise price of $3.5175 per share were outstanding at December 31, 2003.
These options are not included in the table. 2000 Non-Officer Equity Incentive Plan Our 2000 Non-Officer Equity Incentive Plan, or the 2000 Plan, was adopted
by our board of directors in February 2000. The 2000 Plan was designed to meet
the broadly based plans exemption from the stockholder approval requirements
for stock option plans under the Nasdaq Stock Market listing requirements. As
such, we did not seek stockholder approval of the 2000 Plan. General The 2000 Plan provides for the grant of nonstatutory stock options, stock
bonuses and rights to acquire restricted stock (collectively, Awards).
Nonstatutory stock options granted under the 2000 Plan are not intended to
qualify as incentive stock options under the Internal Revenue Code of 1986, as
amended, or the Code. To date, except for the grant of a stock bonus of 8,000
shares to a consultant, we have granted only stock options under the 2000 Plan. Purpose The board of directors adopted the 2000 Plan to provide a means by which
employees and consultants of InVision and InVisions affiliates may be given an
opportunity to purchase our common stock, to assist in retaining the services
of such persons, to secure and retain the services of persons capable of
filling such positions and to provide incentives for such persons to exert
maximum efforts for our success. Administration The board of directors administers the 2000 Plan. Subject to the
provisions of the 2000 Plan, the board of directors has the power to construe
and interpret the 2000 Plan and to determine the persons to whom and the dates
on which Awards will be granted, the number of shares of common stock to be
subject to each Award, whether an Award will be a nonstatutory stock option, a
stock bonus, a right to purchase restricted stock or a combination of the
foregoing, the time or times during the term of each Award within which all or
a portion of such Award may be exercised, the exercise price, the type of
consideration and other terms of the Award. The board of directors has the
power to delegate administration of the 2000 Plan to a committee composed of
one or more members of the board of directors. Stock Subject to the 2000 Plan An aggregate of 400,000 shares of common stock are currently reserved for
issuance under the 2000 Plan. If Awards granted under the 2000 Plan expire or
otherwise terminate without being exercised, the shares of common stock not
acquired pursuant to such Awards again become available for issuance under the
2000 Plan. If we reacquire unvested stock issued under the 2000 Plan, the
reacquired stock will not again become available for reissuance under the 2000
Plan. The common stock subject to the 2000 Plan may be unissued shares or
reaquired shares, bought in the market or otherwise. Eligibility Awards may be granted under the 2000 Plan only to employees of InVision
and InVisions affiliates. No Awards may be granted under the 2000 Plan to any
person who, at the time of the grant, is an officer or director of InVision or
subject to Section 16 of the Securities Exchange Act of 1934. 49




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Terms of Options The following is a description of the permissible terms of options under
the 2000 Plan. Individual option grants may be more restrictive as to any or
all of the permissible terms described below. Exercise Price; Payment.The exercise price of nonstatutory options
under the 2000 Plan shall be determined by the board of directors, provided
that the exercise price may not be less than 85% of the fair market value of
our common stock on the date of grant. As of March 1, 2004, the closing price
of our common stock as reported on the Nasdaq National Market System was $36.19
per share. The exercise price of options granted under the 2000 Plan must be
paid either in cash at the time the option is exercised or at the discretion of
the board of directors, (1) by delivery of other common stock, (2) pursuant to
a deferred payment arrangement, or (3) in any other form of legal consideration
acceptable to the board of directors. Option Exercise.Options granted under the 2000 Plan may become
exercisable in cumulative increments (vest) as determined by the board of
directors, provided that each option grant is subject to option provisions
governing the minimum number of shares as to which an option may be exercised.
Shares covered by currently outstanding options under the 2000 Plan typically
vest at the rate of 25% of the shares subject to the option on the first
anniversary of the date of grant and either 1/16th of such shares at the end of
each quarter thereafter or 1/48th of such shares at the end of each month
thereafter during the participants employment by, or service as an employee or
consultant to, us or an affiliate (collectively, service). Shares covered by
options granted in the future under the 2000 Plan may be subject to different
vesting terms. The board of directors has the power to accelerate the time
during which an option may vest or be exercised. In addition, options granted
under the 2000 Plan may permit exercise prior to vesting, but in such event the
participant may be required to enter into an early exercise stock purchase
agreement that allows us to repurchase unvested shares, generally at their
exercise price, should the participants service terminate before vesting. To
the extent provided by the terms of an option, a participant may satisfy any
federal, state or local tax withholding obligation relating to the exercise of
such option by a cash payment upon exercise, by authorizing us to withhold a
portion of the stock otherwise issuable to the participant, by delivering
already-owned common stock of us or by a combination of these means. Term.The maximum term of options under the 2000 Plan is ten years.
Options under the 2000 Plan generally terminate three months after termination
of the participants service unless (1) such termination is due to the
participants permanent and total disability (as defined in the Code), in which
case the option may, but need not, provide that it may be exercised (to the
extent the option was exercisable at the time of the termination of service) at
any time within six months of such termination; (2) the participant dies before
the participants service has terminated, or within three months after
termination of such service, in which case the option may, but need not,
provide that it may be exercised (to the extent the option was exercisable at
the time of the participants death) within twelve months of the participants
death by the person or persons to whom the rights to such option pass by will
or by the laws of descent and distribution; or (3) the option by its terms
specifically provides otherwise. A participant may designate a beneficiary who
may exercise the option following the participants death. Individual option
grants by their terms may provide for exercise within a longer period of time
following termination of service. Terms of Stock Bonuses and Purchases of Restricted Stock Payment.The board of directors determines the purchase price under a
restricted stock purchase agreement but the purchase price may not be less than
85% of the fair market value of our common stock on the date such award is made
or at the time the purchase is consummated. The board of directors may award
stock bonuses in consideration of past services without a purchase payment. The purchase price of stock acquired pursuant to a restricted stock
purchase agreement under the 2000 Plan must be paid either in cash at the time
of purchase or at the discretion of the board of directors, (1) by delivery of
other of our common stock, (2) pursuant to a deferred payment arrangement, or
(3) in any other form of legal consideration acceptable to the board of
directors. Vesting.Shares of stock sold or awarded under the 2000 Plan may, but
need not be, subject to a repurchase option in our favor in accordance with a
vesting schedule as determined by the board of directors. The board of 50




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directors has the power to accelerate the vesting of stock acquired pursuant to
a restricted stock purchase agreement under the 2000 Plan. Restrictions on Transfer The board of directors may grant nonstatutory stock options that are
transferable to the extent provided in the stock option agreement. Shares
subject to repurchase by us under an early exercise stock purchase agreement
may be subject to restrictions on transfer that the board of directors deems
appropriate. Rights under a stock bonus or restricted stock purchase agreement
may not be transferred except where such assignment is required by law or
expressly authorized by the terms of the applicable stock bonus or restricted
stock purchase agreement. Adjustment Provisions Transactions not involving receipt of consideration by us, such as a
merger, consolidation, reorganization, stock dividend, or stock split, may
change the type(s), class(es) and number of shares of common stock subject to
the 2000 Plan and outstanding Awards. In that event, the 2000 Plan will be
appropriately adjusted as to the type(s), class(es) and the maximum number of
shares of common stock subject to the 2000 Plan, and outstanding Awards will be
adjusted as to the type(s), class(es), number of shares and price per share of
common stock subject to such Awards. Effect of Certain Corporate Events In the event of (1) a merger or consolidation in which we are not the
surviving corporation or (2) a reverse merger in which we are the surviving
corporation but the shares of common stock outstanding immediately preceding
the merger are converted by virtue of the merger into other property whether in
the form of securities, cash or otherwise, or similar transactions (in each
case, a Corporate Transaction), then any surviving or acquiring corporation
may continue or assume Awards outstanding under the 2000 Plan or may substitute
similar Awards. If any surviving or acquiring corporation does not assume such
Awards or substitute similar Awards, then with respect to Awards held by
participants whose service with us or an affiliate has not terminated prior to
the Corporate Transaction, the vesting of such Awards (and, if applicable, the
time during which such Awards may be exercised) will be accelerated in full and
the Awards will terminate if not exercised (if applicable) at or prior to the
Corporate Transaction. The 2000 Plan provides that, in the event of our
dissolution or liquidation, then all outstanding Awards shall terminate
immediately prior to such event. The acceleration of an Award in the event of a Corporate Transaction may
be viewed as an anti-takeover provision, which may have the effect of
discouraging a proposal to acquire or otherwise obtain control of us. Duration, Amendment and Termination. The board of directors may suspend or terminate the 2000 Plan without
stockholder approval or ratification at any time or from time to time. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS There were no transactions that involved more than $60,000 between
InVision and a Named Executive Officer, director or 5% stockholder or any of
their immediate family members that have been entered into since the beginning
of fiscal 2003 or that involved indebtedness to or payments from us during
fiscal 2003, other than compensation paid in connection with employment or
service as a member of the board of directors. For information about salary,
bonuses, other compensation and option grants for Named Executive Officers and
directors, see Executive Compensation. We have entered into indemnity agreements with certain of our officers and
directors which provide, among other things, that we will indemnify such
officer or director, under the circumstances and to the extent provided for
therein, for expenses, damages, judgments, fines and settlements he may be
required to pay in actions or proceedings which he is or may be made a party by
reason of his position as our director, officer or other agent, and otherwise
to the full extent permitted under Delaware law and our bylaws. 51




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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Fees Paid to Deloitte & Touche LLP The following table shows fees for professional services rendered by
Deloitte & Touche LLP for 2003 and 2002: Fee Category
    
    2003
    
    2002Audit Fees
    
    $
    445,723
    
    
    $
    257,810Audit-Related Fees
    
    
    718,682
    
    
    
    821,650Tax Fees
    
    
    258,033
    
    
    
    91,453All Other Fees
    
    
    34,144
    
    
    
    335,494Total
    
    $
    1,456,582
    
    
    $
    1,506,407
 Audit Fees.Consists of fees for professional services rendered for the
audit of our financial statements and review of the interim financial
statements included in quarterly reports. Audit-Related Fees.Consists of fees for assurance and related services
that are reasonably related to the performance of the audit or review of our
financial statements that are not reported under Audit Fees, and services
that are normally provided by Deloitte & Touche LLP in connection with
statutory and regulatory filings or engagements. These services include
consultations in connection with acquisitions and consultations concerning
financial accounting and reporting standards. Tax Fees.Consists of fees for professional services for tax compliance,
tax advice and tax planning. These services include tax planning, assistance
with the preparation of various tax returns, services rendered in connection
with acquisitions and advice on other tax-related matters. All Other Fees.Consists of other fees not reported in the above
categories. In 2003, these services were in connection with tax consultation
for our board of directors and the review of our government contracts. In
2002, these services were in connection with the review of our accounting
processes, compensation and infrastructure. Policy on Audit Committee Pre-Approval of Services Performed by the Independent
Auditors The Audit Committees policy is to pre-approve at the beginning of each
fiscal year audit services to be provided by the independent auditors during that
fiscal year. In addition, the Audit Committee pre-approves all other non-audit
services on a case-by-case basis. 
 PART IV. 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements The consolidated financial statements required by this item are submitted
in a separate section beginning on page F-1 immediately following the signature
page of this annual report and are incorporated by reference herein. Deloitte & Touche LLP, Independent Auditors Report
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Operations for the Years Ended December 31,
2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31,
2003, 2002 and 2001
Consolidated Statements of Stockholders Equity for the Years Ended
December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements (a)(2) Financial Statement Schedule IIValuation and Qualifying Accounts 52




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The schedule listed above is set forth immediately following the
consolidated financial statements following the signature page of this
annual report and is incorporated by reference herein. Schedules not
listed above have been omitted because they are not applicable or the
required information is shown in the consolidated financial statements or
in the notes thereto. (a)(3) Exhibits  2.1
    
    Share and Purchase Transfer Agreement dated as of February 21, 2003 among the registrant, Yxlon
Beteiligungs-Verwaltung GmbH, NDT International Holdings A.S, Yxlon International Holding GmbH,
Yxlon International X-Ray GmbH, Joseph Kosanetzky, Reinhard Bonisch and Botts & Company Ltd.
Certain schedules have been omitted. The registrant agrees to furnish supplementally a copy of any
omitted schedule to the Commission upon request. (1)2.2
    
    Agreement and Plan of Merger, dated as of March 15,
2004, among the registrant, General Electric Company and Jet Acquisition Sub, Inc.3.1
    
    Amended and Restated Certificate of Incorporation of the registrant. (2)3.2
    
    Amendment to Amended and Restated Certificate of Incorporation of the registrant. (3)3.3
    
    Bylaws of the registrant, as amended. (4)4.1
    
    Reference is made to Exhibits 3.1 through 3.3.4.2
    
    Indenture, dated as of September 19, 2003, between the registrant and U.S. Bank National
Association, as Trustee. (5)4.3
    
    Registration Rights Agreement, dated as of September 19, 2003 between the registrant and Merrill
Lynch, Pierce, Fenner & Smith Incorporated. (5)4.4
    
    Form of Note for the registrants 3% Convertible Senior Notes due October 1, 2023. (5)10.1
    
    Technology License Agreement, dated September 11, 1990, by and between the registrant and Imatron,
Inc. (6)10.2
    
    Registrants 2000 Equity Incentive Plan, as amended. (7) 10.3
    
    Registrants 2002 Employee Stock Purchase Plan. (8) 10.4
    
    Lease, dated as of February 11, 1997, between the registrant and WHLNF Real Estate L.P. (9)10.5
    
    Amendment No. 1 to Technology License Agreement between the registrant and Imatron, Inc. dated July
12, 1999. (10)10.6
    
    Form of Indemnity Agreement between the registrant and each of Sergio Magistri, David Pillor,
Giovanni Lanzara, Bruno Trezza, Douglas Boyd and Morris Busby. (10) 10.7
    
    Registrants 1991 Equity Incentive Plan. (11) 10.8
    
    Registrants 2000 Non-Officer Equity Incentive Plan, adopted February 14, 2000. (12)10.9
    
    Form of Indemnity Agreement between the registrant and each of Donald E. Mattson and Ross
Mulholland. (13) 10.10
    
    Delivery Order #2 from the TSA. (15) *10.11
    
    Delivery Order #3 from the TSA. (15) *10.12
    
    Amended Delivery Order #2 from the TSA. (16) *10.13
    
    Amended Delivery Order #3 from the TSA. (16) *10.14
    
    Delivery Order #4 from the TSA. (16) *10.15
    
    Amendment to Delivery Order #2. (16) *10.16
    
    Amendment to Delivery Order #3. (16) * 53




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##### Table of Contents



10.17
    
    First Amendment to Lease Agreement, dated December 10, 1997, between the registrant and WHLNF Real
Estate Limited Partnership. (16)10.18
    
    Second Amendment to Lease Agreement, dated July 1, 2002, between the registrant and DMV SUB 4 LLC.
(16)10.19
    
    Change in Control Equity Acceleration Plan. (17) 10.20
    
    Senior Management Key Employee Agreement dated as of September 20, 2002 between the registrant and
Sergio Magistri. (17) 10.21
    
    Senior Management Key Employee Agreement dated as of September 20, 2002 between the registrant and
David Pillor. (17) 10.22
    
    Senior Management Key Employee Agreement dated as of September 29, 2002 between the registrant and
Ross Mulholland. (17) 10.23
    
    Senior Management Key Employee Agreement dated as of
October 4, 2002 between the registrant and
Don Mattson. (17) 10.24
    
    Delivery Order #5 from the TSA. (17) *10.25
    
    Delivery Order #6 from the TSA. (17) *10.26
    
    Single-Tenant Net Lease Agreement executed on October 4, 2002 between Carmel Mountain #8
Associates, L.P. and Quantum Magnetics, Inc. (18)10.27
    
    Vice President Key Employee Agreement dated as of May 1, 2002 between the registrant and Andrew
Siegel. (1) 10.28
    
    Solicitation, Offer and Award dated August 5, 2003, between the registrant and the TSA (the Frame
Agreement). (5) *10.29
    
    Delivery Order #1 from the TSA under the Frame Agreement. (5) *10.30
    
    Amendment of Solicitation/Modification of Contract between the Company and the TSA (the
Definitized Letter Agreement). (5) *10.31
    
    Delivery Order #8 from the TSA under the Definitized Letter Agreement. (5) *10.32
    
    Amendment to Delivery Order #5 from the TSA under the Definitized Letter Agreement. (5) *10.33
    
    Amendment to Delivery Order #3 from the TSA under the Definitized Letter Agreement.
(5) *10.34
    
    Loan and Security Agreement, dated December 8, 2003, between the registrant and Silicon Valley Bank.14.1
    
    Code of Ethics and Business Conduct.21.1
    
    Subsidiaries of the registrant.23.1
    
    Consent of Deloitte & Touche LLP, Independent Auditors.31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Financial Officer.32.1
    
    Certificate of Chief Executive Officer and Chief Financial Officer.  (1)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended March 30, 2003 and incorporated herein by
reference.(2)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-05517) and incorporated herein by reference.(3)
    
    Filed as an exhibit to the registrants Amendment No. 1 to Annual Report
on Form 10-K/A for the year ended December 31, 2001 and incorporated
herein by reference. 54




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##### Table of Contents



(4)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended June 29, 2003 and incorporated herein by
reference.(5)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-3 (No. 333-110289) and incorporated herein by reference.(6)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-380) and incorporated herein by reference.(7)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-8 (No. 333-103016) filed February 6, 2003 and incorporated herein by
reference.(8)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-8 (No. 333-91154) filed June 25, 2002 and incorporated herein by
reference.(9)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-23413) and incorporated herein by reference.(10)
    
    Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 1999 and incorporated herein by reference.(11)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-8 (No. 333-56340) filed February 28, 2001 and incorporated herein by
reference.(12)
    
    Filed as an exhibit to registrants Quarterly Report on Form 10-Q for the
quarter ended April 2, 2000 and incorporated herein by reference.(13)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended April 1, 2001 and incorporated herein by
reference.(14)
    
    Filed as an exhibit to registrants Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2001 and incorporated herein by
reference.(15)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2002 and incorporated herein by
reference.(16)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 2002 and incorporated herein by
reference.(17)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended September 29, 2002 and incorporated herein by
reference.(18)
    
    Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 2002 and incorporated herein by reference.
    
    Items that are management contracts or compensatory plans or arrangements
required to be filed as exhibits pursuant to Item 15(c) of Form 10-K.*
    
    Confidential treatment has been requested for portions of this exhibit. (b) Reports on Form 8-K On February 11, 2004, we filed a current report on Form 8-K, pursuant to
Item 12 thereof, furnishing a copy of a press release titled InVision
Technologies Reports Fourth Quarter and Year-End 2003 Results and dated
February 11, 2004. (c) See Exhibits listed under Item 15(a)(3). (d) The financial statement schedules required by the Item are listed under
Item 15(a)(2). 55




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this annual report to be
signed on its behalf by the undersigned, thereunto duly authorized. INVISION TECHNOLOGIES, INC.Date: March 15, 2004
    
    By:
    
    /s/ SERGIO MAGISTRISergio Magistri, Ph.D.President and Chief Executive Officer
 POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Sergio
Magistri and Ross Mulholland, his true and lawful attorney-in-fact and agent,
each acting alone, with full power of substitution and resubstitution, for him
and in his name, place and stead, in any and all capacities, to sign any or all
amendments to the Annual Report on Form 10-K and to file the same, with all
exhibits thereto, and all documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this
annual report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ SERGIO MAGISTRI

Sergio Magistri, Ph.D.
    
    President, Chief Executive
Officer and Director (Principal
Executive Officer)
Senior Vice President and Chief
    
    March 15, 2004/s/ ROSS MULHOLLAND

Ross Mulholland
    
    Senior Vice President and Chief Financial Officer (Principal
Financial and Accounting Officer)
    
    March 15, 2004/s/ DAVID M. PILLOR

David M. Pillor
    
    Senior Vice President, Sales and
Marketing, and Director
    
    March 15, 2004/s/ GIOVANNI LANZARA

Giovanni Lanzara, Ph.D.
    
    Chairman of the Board of Directors
    
    March 15, 2004/s/ STEPHEN BLUM

Stephen Blum
    
    Director
    
    March 15, 2004/s/ DOUGLAS P. BOYD

Douglas P. Boyd, Ph.D.
    
    Director
    
    March 15, 2004/s/ BRUNO TREZZA

Bruno Trezza, Ph.D.
    
    Director
    
    March 15, 2004/s/ LOUIS A. TURPEN

Louis A. Turpen
    
    Director
    
    March 15, 2004/s/ MORRIS BUSBY

Morris Busby
    
    Director
    
    March 15, 2004
 56




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INDEPENDENT AUDITORS REPORT To the Board of Directors and Stockholders of
InVision Technologies, Inc. We have audited the accompanying consolidated balance sheets of InVision
Technologies, Inc. and subsidiaries (the Company) as of December 31, 2003 and
2002, and the related consolidated statements of operations, stockholders
equity, and cash flows for each of the three years in the period ended December
31, 2003. Our audits also included the financial statement schedule listed in
the Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2003 at Item 15(a)(2). These financial statements and financial statement
schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of InVision Technologies, Inc. and
subsidiaries at December 31, 2003 and 2002, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2003, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein. As discussed in Note 2 to the financial statements, in 2002 the Company changed
its method of accounting for goodwill and other intangible assets to conform to
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets. As discussed in Note 16
to the financial statements, on March 15, 2004, the Company
entered into an Agreement and Plan of Merger to be acquired. /s/ DELOITTE & TOUCHE LLP San Jose, California
March 15, 2004 F-1




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##### Table of Contents



InVision Technologies, Inc.
Consolidated Balance Sheets
(In thousands, except share data) December 31,
    
    December 31,2003
    
    2002AssetsCurrent assets:Cash and cash equivalents
    
    $
    182,382
    
    
    $
    159,736Short-term investments
    
    
    94,557
    
    
    
    Accounts receivable, net
    
    
    56,951
    
    
    
    146,295Inventories
    
    
    78,894
    
    
    
    64,764Deferred income taxes
    
    
    14,283
    
    
    
    20,889Other current assets
    
    
    5,666
    
    
    
    15,811Total current assets
    
    
    432,733
    
    
    
    407,495Property and equipment, net
    
    
    11,605
    
    
    
    7,225Deferred income taxes
    
    
    
    
    
    
    1,050Goodwill
    
    
    21,474
    
    
    
    681Intangible assets, net
    
    
    13,978
    
    
    
    922Other assets
    
    
    6,278
    
    
    
    414Total assets
    
    $
    486,068
    
    
    $
    417,787Liabilities and stockholders equityCurrent liabilities:Accounts payable
    
    $
    13,761
    
    
    $
    28,477Accrued liabilities
    
    
    35,058
    
    
    
    65,364Deferred revenue
    
    
    13,277
    
    
    
    86,284Short-term debt
    
    
    5,581
    
    
    
    184Current maturities of long-term obligations
    
    
    263
    
    
    
    112Total current liabilities
    
    
    67,940
    
    
    
    180,421Long-term obligations
    
    
    127,244
    
    
    
    653Deferred income taxes
    
    
    203
    
    
    
    Total
liabilities
    
    
    195,387
    
    
    
    181,074Commitments and contingenciesStockholders equity:Preferred stock, $0.001 par value, 5,000,000 shares authorized;
no shares issued and outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value, 60,000,000 shares authorized;
17,782,000 and 17,243,000 shares issued; 17,095,000 and
17,008,000 shares outstanding
    
    
    18
    
    
    
    17Additional paid-in capital
    
    
    173,968
    
    
    
    166,243Deferred stock compensation expense
    
    
    (271
    )
    
    
    (406
    )Accumulated other comprehensive loss
    
    
    (125
    )
    
    
    (1,783
    )Retained earnings
    
    
    131,782
    
    
    
    74,836Treasury stock, at cost (687,000 and 235,000 shares)
    
    
    (14,691
    )
    
    
    (2,194
    )Total stockholders equity
    
    
    290,681
    
    
    
    236,713Total liabilities and stockholders equity
    
    $
    486,068
    
    
    $
    417,787
 The accompanying notes are an integral part of these consolidated financial statements. F-2




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##### Table of Contents



InVision Technologies, Inc.
Consolidated Statements of Operations
(In thousands, except per share data) Year Ended December 31,2003
    
    2002
    
    2001Revenues:Product revenues
    
    $
    351,573
    
    
    $
    411,426
    
    
    $
    46,536Service revenues
    
    
    51,793
    
    
    
    15,622
    
    
    
    11,239Contract research and development revenues
    
    
    13,131
    
    
    
    12,083
    
    
    
    16,556Total revenues
    
    
    416,497
    
    
    
    439,131
    
    
    
    74,331Cost of revenues:Product costs
    
    
    204,419
    
    
    
    234,767
    
    
    
    28,782Service costs
    
    
    31,166
    
    
    
    10,761
    
    
    
    7,162Contract research and development costs
    
    
    8,396
    
    
    
    8,708
    
    
    
    13,010Total cost of revenues
    
    
    243,981
    
    
    
    254,236
    
    
    
    48,954Gross profit
    
    
    172,516
    
    
    
    184,895
    
    
    
    25,377Operating expenses:Research and development
    
    
    26,323
    
    
    
    20,622
    
    
    
    7,979Selling, general and administrative
    
    
    45,232
    
    
    
    31,744
    
    
    
    14,727In-process research and development (Yxlon)
    
    
    4,300
    
    
    
    
    
    
    
    Total operating expenses
    
    
    75,855
    
    
    
    52,366
    
    
    
    22,706Income from operations
    
    
    96,661
    
    
    
    132,529
    
    
    
    2,671Interest expense
    
    
    (1,693
    )
    
    
    (399
    )
    
    
    (289
    )Interest and other income, net
    
    
    3,903
    
    
    
    38
    
    
    
    570Income before provision for income taxes
    
    
    98,871
    
    
    
    132,168
    
    
    
    2,952Provision for (benefit from) income taxes
    
    
    41,925
    
    
    
    53,874
    
    
    
    (4,571
    )Net income
    
    $
    56,946
    
    
    $
    78,294
    
    
    $
    7,523Net income per share:Basic
    
    $
    3.32
    
    
    $
    4.90
    
    
    $
    0.58Diluted
    
    $
    3.10
    
    
    $
    4.40
    
    
    $
    0.52Weighted average shares outstanding:Basic
    
    
    17,132
    
    
    
    15,987
    
    
    
    12,998Diluted
    
    
    18,368
    
    
    
    17,803
    
    
    
    14,343
 The accompanying notes are an integral part of these consolidated financial statements. F-3




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##### Table of Contents



InVision Technologies, Inc.
Consolidated Statements of Cash Flows
(In thousands) Year Ended December 31,2003
    
    2002
    
    2001Cash flows from operating activities:Net income
    
    $
    56,946
    
    
    $
    78,294
    
    
    $
    7,523Adjustments to reconcile net income to net cash provided by operating activitiesDepreciation and amortization
    
    
    5,893
    
    
    
    3,605
    
    
    
    3,816Deferred income taxes
    
    
    4,960
    
    
    
    (14,393
    )
    
    
    (5,822
    )Loss on disposal of fixed assets
    
    
    517
    
    
    
    459
    
    
    
    Bad debt expense
    
    
    300
    
    
    
    170
    
    
    
    168Income tax benefit from employee stock transactions
    
    
    2,942
    
    
    
    9,185
    
    
    
    2,160Stock compensation expense
    
    
    328
    
    
    
    829
    
    
    
    148In-process research and development (Yxlon)
    
    
    4,300
    
    
    
    
    
    
    
    Impairment of goodwill
    
    
    
    
    
    
    2,100
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    100,641
    
    
    
    (118,415
    )
    
    
    (4,860
    )Inventories
    
    
    7,518
    
    
    
    (37,660
    )
    
    
    (6,830
    )Other assets
    
    
    9,314
    
    
    
    (10,953
    )
    
    
    (2,568
    )Accounts payable
    
    
    (23,645
    )
    
    
    20,102
    
    
    
    3,022Accrued liabilities
    
    
    (38,719
    )
    
    
    50,159
    
    
    
    1,479Deferred revenues
    
    
    (79,836
    )
    
    
    81,907
    
    
    
    2,239Other liabilities
    
    
    (30
    )
    
    
    (8
    )
    
    
    44Net cash provided by operating activities
    
    
    51,429
    
    
    
    65,381
    
    
    
    519Cash flows from investing activities:Purchases of property and equipment
    
    
    (3,335
    )
    
    
    (4,671
    )
    
    
    (1,900
    )Proceeds from short-term investments
    
    
    160
    
    
    
    1,939
    
    
    
    (1,992
    )Purchase of short-term investments
    
    
    (94,714
    )
    
    
    
    
    
    
    Purchase of Yxlon, net of cash acquired
    
    
    (42,349
    )
    
    
    
    
    
    
    Purchase of Hapeg, net of cash acquired
    
    
    (3,424
    )
    
    
    
    
    
    
    Equity investment in SafeView
    
    
    (1,500
    )
    
    
    (183
    )
    
    
    (267
    )Net cash used in investing activities
    
    
    (145,162
    )
    
    
    (2,915
    )
    
    
    (4,159
    )Cash flows from financing activities:Net proceeds from (repayments of) short-term debt
    
    
    3,486
    
    
    
    (1,696
    )
    
    
    990Proceeds from issuance of long-term debt
    
    
    125,000
    
    
    
    
    
    
    
    Repayments of long-term debt
    
    
    (276
    )
    
    
    (195
    )
    
    
    (403
    )Debt issuance costs
    
    
    (4,527
    )
    
    
    
    
    
    
    Repurchase of common stock
    
    
    (12,497
    )
    
    
    
    
    
    
    Proceeds from common stock issuances or capital contributions
    
    
    4,594
    
    
    
    87,775
    
    
    
    2,531Net cash provided by financing activities
    
    
    115,780
    
    
    
    85,884
    
    
    
    3,118Effect of exchange rate changes on cash and cash equivalents
    
    
    599
    
    
    
    
    
    
    
    Net change in cash and cash equivalents for the year
    
    
    22,646
    
    
    
    148,350
    
    
    
    (522
    )Cash and cash equivalents at beginning of year
    
    
    159,736
    
    
    
    11,386
    
    
    
    11,908Cash and cash equivalents at end of year
    
    $
    182,382
    
    
    $
    159,736
    
    
    $
    11,386Supplemental disclosures of cash flow information:Interest paid
    
    $
    890
    
    
    $
    343
    
    
    $
    288Income taxes paid, net of refunds
    
    $
    52,410
    
    
    $
    41,282
    
    
    $
    116
 F-4




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##### Table of Contents



Year Ended December 31,2003
    
    2002
    
    2001Supplemental disclosures of noncash investing and financing activities:Issuance of common stock in connection with acquisition of subsidiary
    
    $
    
    
    
    $
    1,199
    
    
    $
    933Cash and stock payable in connection with acquisition of subsidiary
    
    $
    
    
    
    $
    
    
    
    $
    366Warrant issued in connection with investment advisory services and
financing-related services
    
    $
    
    
    
    $
    
    
    
    $
    650Capital lease obligations incurred for new equipment
    
    $
    668
    
    
    $
    111
    
    
    $
    Issuance of common stock in connection with the exercise of warrants
    
    $
    
    
    
    $
    995
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. F-5




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##### Table of Contents



InVision, Technologies, Inc.
Consolidated Statements of Stockholders Equity
(In thousands) Deferred
    
    Accumulated
    
    RetainedCommon Stock
    
    AdditionalPaid-In
    
    StockCompensation
    
    OtherComprehensive
    
    Earnings(Accumulated
    
    Treasury Stock
    
    Total StockholdersShares
    
    Amount
    
    Capital
    
    Expense
    
    Loss
    
    Deficit)
    
    Shares
    
    Amount
    
    EquityBalance at December 31, 2000
    
    
    12,814
    
    
    $
    13
    
    
    $
    59,671
    
    
    $
    
    
    
    $
    
    
    
    $
    (10,981
    )
    
    
    (201
    )
    
    $
    (1,199
    )
    
    $
    47,504Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,523
    
    
    
    
    
    
    
    
    
    
    
    7,523Exercise of common stock options
    
    
    463
    
    
    
    1
    
    
    
    2,266
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,267Shares issued under the employee stock purchase plan
    
    
    132
    
    
    
    
    
    
    
    264
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264Issuance of common stock related to an acquisition
    
    
    321
    
    
    
    
    
    
    
    933
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    933Issuance of warrants and options to consultants
    
    
    
    
    
    
    
    
    
    
    717
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    717Issuance of stock to a consultant
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    52
    
    
    
    52Income tax benefit of employee stock transactions
    
    
    
    
    
    
    
    
    
    
    2,160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,160Balance at December 31, 2001
    
    
    13,730
    
    
    $
    14
    
    
    $
    66,011
    
    
    $
    
    
    
    $
    
    
    
    $
    (3,458
    )
    
    
    (191
    )
    
    $
    (1,147
    )
    
    $
    61,420Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    78,294
    
    
    
    
    
    
    
    
    
    
    
    78,294Unrealized loss on cash flow hedges, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,274
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,274
    )Less: reclassification of loss on cash flow hedges, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    491
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    491Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    76,511Issuance of common stock pursuant to secondary public offering, net
    
    
    2,500
    
    
    
    2
    
    
    
    84,630
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    84,632Exercise of common stock options
    
    
    680
    
    
    
    1
    
    
    
    2,055
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,056Deferred stock compensation
    
    
    
    
    
    
    
    
    
    
    542
    
    
    
    (406
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136Shares issued under the employee stock purchase plan
    
    
    172
    
    
    
    
    
    
    
    949
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    949Issuance of common stock related to an acquisition
    
    
    32
    
    
    
    
    
    
    
    1,199
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,199Issuance of warrants and options to consultants
    
    
    100
    
    
    
    
    
    
    
    1,384
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34
    )
    
    
    (995
    )
    
    
    389Issuance of stock to a consultant
    
    
    29
    
    
    
    
    
    
    
    288
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    (52
    )
    
    
    236Income tax benefit of employee stock transactions
    
    
    
    
    
    
    
    
    
    
    9,185
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,185Balance at December 31, 2002
    
    
    17,243
    
    
    $
    17
    
    
    $
    166,243
    
    
    $
    (406
    )
    
    $
    (1,783
    )
    
    $
    74,836
    
    
    
    (235
    )
    
    $
    (2,194
    )
    
    $
    236,713Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,946
    
    
    
    
    
    
    
    
    
    
    
    56,946Unrealized loss on cash flow hedges, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,003
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,003
    )Less: reclassification of loss on cash flow hedges, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    847
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    847Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,814
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,814Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58,604Exercise of common stock options
    
    
    408
    
    
    
    1
    
    
    
    1,969
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,970Deferred stock compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    135
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    135Shares issued under the employee stock purchase plan
    
    
    131
    
    
    
    
    
    
    
    2,621
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,621Repurchase of stock related to debt issuance
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (452
    )
    
    
    (12,497
    )
    
    
    (12,497
    )Issuance of warrants and options to consultants
    
    
    
    
    
    
    
    
    
    
    193
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    193Income tax benefit of employee stock transactions
    
    
    
    
    
    
    
    
    
    
    2,942
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,942Balance at December 31, 2003
    
    
    17,782
    
    
    $
    18
    
    
    $
    173,968
    
    
    $
    (271
    )
    
    $
    (125
    )
    
    $
    131,782
    
    
    
    (687
    )
    
    $
    (14,691
    )
    
    $
    290,681
 The accompanying notes are
an integral part of these consolidated financial statements. F-6




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##### Table of Contents



INVISION TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. DESCRIPTION OF BUSINESS InVision Technologies, Inc. (the Company) was incorporated in Delaware
in 1990 and its principal business is to manufacture computed tomography, or
CT, based detection products used by the aviation industry to screen baggage.
The Companys headquarters and principal manufacturing facilities are located
in Newark, California. In 1997, the Company acquired Quantum Magnetics, Inc.
(Quantum) as a wholly-owned subsidiary. Quantum is a California corporation
with its headquarters and manufacturing facilities located in San Diego,
California. In 2000, the Company acquired Inovec, Inc. (Inovec) as a
wholly-owned subsidiary. Inovec is a Delaware corporation with its headquarters
and manufacturing facilities located in Eugene, Oregon. In 2003, the Company
acquired Yxlon International Holding GmbH (Yxlon) as a wholly-owned
subsidiary. Yxlon is a company organized under the laws of Germany with its
headquarters and manufacturing facilities located in Hamburg, Germany. Through the first quarter of 2003, the Company presented segment
information based on three reportable segments: explosives detection systems
(EDS), Quantum and Wood. As a result of the acquisition of Yxlon, the
Company now has two reportable segments, EDS and non-destructive testing
(NDT). The EDS segment is comprised of the business unit that is engaged
in the development, manufacturing, marketing and support of explosives
detection systems based on advanced computed tomography technology. The NDT
segment is comprised of the Yxlon business unit that is engaged in the
development, manufacturing, marketing and support of non-destructive testing
systems for a wide range of industrial applications. Other segments including
Quantum, Wood and XRD were aggregated to form an All Other category as they
did not meet the threshold for a reportable segment. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the financial statements of
the Company and its wholly-owned subsidiaries. Intercompany accounts and
transactions are eliminated in consolidation. Financial Statement Estimates The Companys preparation of these consolidated financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, 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. Such estimates
include inventory valuation, allowances for potentially uncollectible accounts
receivable, accrued warranty, certain accrued liabilities, valuation allowances
for deferred tax assets, total estimated costs at completion for contracts
accounted for using the percentage-of-completion method and goodwill
impairment. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Short-Term Investments Short-term investments consist primarily of U.S. government and corporate
notes and bonds and are classified as available-for-sale. Such short-term
investments are carried at fair value with unrealized gains or losses reported
as a separate component of accumulated other comprehensive income (loss), net
of tax. F-7




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##### Table of Contents



The following table summarizes the Companys short-term investments as of
December 31, 2003 (in thousands): Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S. government notes and bonds
    
    $
    16,953
    
    
    $
    17
    
    
    $
    (12
    )
    
    $
    16,958Corporate notes and bonds
    
    
    77,604
    
    
    
    79
    
    
    
    (84
    )
    
    
    77,599Municipal notes and bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total investments
    
    $
    94,557
    
    
    $
    96
    
    
    $
    (96
    )
    
    $
    94,557
 The following table summarizes the maturities of the Companys notes and
bond investments at December 31, 2003 (in thousands): Amortized
    
    FairCost
    
    ValueDue between 91 - 365 days
    
    
    32,189
    
    
    
    32,177Due between 1 - 2 years
    
    
    42,192
    
    
    
    42,209Due between 2 - 3 years
    
    
    20,176
    
    
    
    20,171Total
    
    $
    94,557
    
    
    $
    94,557
 Concentration of Credit Risk Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash and cash equivalents,
short-term investments and accounts receivable. The Company limits the amount
of credit exposure of cash balances and short-term investments by maintaining
its accounts in high credit quality financial institutions. With respect to
accounts receivable, the Company regularly performs evaluations of its
customers financial condition and credit worthiness. Inventories Inventories are stated at the lower of cost or market. Cost is determined
on a first-in, first-out basis, and includes materials, labor and overhead.
During the years ended December 31, 2003, 2002 and 2001, the Company recorded
excess and obsolete inventory write down expenses of $1.3 million, $4.5 million
and $429,000, respectively. Property and Equipment Property and equipment are recorded at cost. Depreciation and amortization
is computed using the straight-line method based upon the estimated useful
lives of the assets, which range from two to seven years, or the lease term of
the respective assets, if less than the useful life. Intangible Assets The Company has patents, licenses, developed technologies and a covenant
not to compete, which are being amortized over their estimated useful lives on
a straight-line basis ranging from three to seven years. Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS
142). SFAS 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination and the accounting
for goodwill and other intangible assets subsequent to their acquisition. SFAS
142 provides that intangible assets with finite useful lives be amortized and
that goodwill and intangible assets with indefinite lives will not be
amortized, but will rather be tested at least annually for impairment. An
impairment loss is recorded when the net book value of the reporting unit
exceeds its estimated fair value. The Company determines its fair value using
the discounted future cash flows method. F-8




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##### Table of Contents



Upon the adoption of SFAS 142, the Company ceased amortization of the
carrying values of goodwill of $2.5 million and acquired workforce of $331,000,
and reclassified the net carrying amount of acquired workforce to goodwill.
The adoption of SFAS 142 resulted in a reduction in annual amortization expense
of $426,000. In the fourth quarter of 2002, the Company performed the annual
impairment test required by the standard, and recorded a $2.1 million
impairment of goodwill, relating to the Inovec reporting unit. The following reconciles reported net income and net income per share to
the adjusted net income and net income per share as if the Company had followed
the amortization provisions of SFAS 142 for the periods presented below (in
thousands, except per share data): Year Ended December 31,2003
    
    2002
    
    2001Net income:As reported
    
    $
    56,946
    
    
    $
    78,294
    
    
    $
    7,523add: goodwill amortization expense, net of taxes
    
    
    
    
    
    
    
    
    
    
    261add: acquired workforce amortization expense,
net of taxes
    
    
    
    
    
    
    
    
    
    
    166As adjusted
    
    $
    56,946
    
    
    $
    78,294
    
    
    $
    7,950Basic net income per share:As reported
    
    $
    3.32
    
    
    $
    4.90
    
    
    $
    0.58As adjusted
    
    $
    3.32
    
    
    $
    4.90
    
    
    $
    0.61Diluted net income per share:As reported
    
    $
    3.10
    
    
    $
    4.40
    
    
    $
    0.52As adjusted
    
    $
    3.10
    
    
    $
    4.40
    
    
    $
    0.55
 Impairment of Long-Lived Assets Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144). SFAS 144 removes goodwill from its scope and
retained the requirements of SFAS 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, to (1)
recognize an impairment loss only if the carrying amount of the long-lived
asset is not recoverable from its undiscounted cash flows and (2) measure an
impairment loss as the difference between the carrying amount and the fair
value of the asset. The Company evaluates its long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of that asset may not be recoverable. The adoption of this statement did not
have a material impact on the consolidated financial statements. Accrued Warranty Estimated warranty costs are recorded on product revenues and adjusted
periodically based on historical and anticipated experience. The Company
accrues the estimated cost of product warranties at the time revenues are
recognized. Although the Company engages in extensive product quality programs
and processes, including actively monitoring and evaluating the quality of
component suppliers, the warranty obligation is affected by actual warranty
costs, including usage of material and labor and service delivery costs
incurred in correcting a product failure. The following is a reconciliation of the changes in the accrued warranty
as of and for the years ended December 31, 2003, 2002 and 2001: Increase resulting
    
    Changes in accrualsfrom Yxlon
    
    related toBalance at beginning
    
    Accruals for
    
    Reduction for
    
    acquisition on
    
    pre-existing
    
    Balance atof year
    
    warranties issued
    
    payments made
    
    March 31, 2003
    
    warranties
    
    end of yearAccrued Warranty2003
    
    $
    19,890
    
    
    $
    19,254
    
    
    $
    (26,347
    )
    
    $
    925
    
    
    $
    537
    
    
    $
    14,2592002
    
    $
    3,175
    
    
    $
    26,428
    
    
    $
    (9,887
    )
    
    $
    
    
    
    $
    174
    
    
    $
    19,8902001
    
    $
    4,198
    
    
    $
    2,208
    
    
    $
    (3,285
    )
    
    $
    
    
    
    $
    54
    
    
    $
    3,175
 F-9




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##### Table of Contents



Revenue Recognition

Revenues are recognized when persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, the price is fixed and
determinable and collectibility is reasonably assured. For sales of EDS
products to the FAA, the TSA and other domestic customers that have been
demonstrated to meet product specifications prior to shipment, product revenues
are recognized at shipment and the portion of revenues relating to installation
and training are deferred until such services are performed and accepted by the
customer. The deferred installation and training revenues are based on the fair
value of such services when performed separately for customers. Installation is
generally not complex and is completed within a relatively short period of
time, typically less than one week. The Company has a consistent history of
completing routine installations and obtaining customer acceptance for domestic
and international sales. Certain airport installations require more involved
integration with baggage handling systems and take longer than most routine
installations. Such integration services are separately priced from products in
sales agreements and the Company recognizes service revenues under these
agreements as services are performed.

Sales of EDS and NDT products and services to customers in foreign
countries have varying contractual terms and are governed, in part, by
regulations in foreign jurisdictions; accordingly, revenue is recognized based
on the specific facts and circumstances surrounding each transaction. For
foreign sales of EDS and NDT products that have been demonstrated to meet
product specifications prior to shipment to customers, where title and risk of
loss pass to the customer at shipment, and where the Company either has an
enforceable claim at the balance sheet date for remaining unbilled amounts or
has the ability to invoice the customer for any unbilled amounts after a fixed
period of time regardless of whether installation is completed, product revenue
is recognized at shipment and the fair value of installation and training
revenue, if any, is deferred and recognized as services are performed. For
sales of EDS and NDT products to foreign customers where title and risk of loss
for such products pass upon completion of installation, product and service
revenues are recognized at the completion of installation and acceptance by the
customer. In other sales of EDS and NDT products to foreign customers where a
portion of the contract price is withheld until installation is completed and
where the Company does not believe it has an enforceable claim at the balance
sheet date through which it can realize some or all of the withheld amount, the
greater of that portion of the contract price or the fair value of the
installation and training is deferred and recognized as revenue at the
completion of installation and acceptance by the customer. Deferred revenues
from EDS product sales arise from advance payments received from customers for
systems not yet delivered.

Revenues from separate EDS service maintenance contracts are recognized
ratably over the term of the agreements. For other services, service revenues
are recognized as the services are performed. Deferred revenue for EDS services
arises from advance payments received from customers for services not yet
performed.

Revenues from Quantum contract research and development and from Inovec
product sales of automation and control systems are recognized using the
percentage-of-completion method based on costs incurred to date as a percentage
of total estimated costs at completion. Provisions for estimated losses are
accrued on those contracts that are anticipated to result in losses at the
completion of the contract. Deferred revenue is recorded as advance payments
are received for work not yet performed.

Research and Development Costs

Research and development costs are charged to operations as incurred.
Contractually reimbursable costs for certain research and development
activities are reflected as a reduction to research and development expense in
the period the related costs are incurred.

Stock-Based Compensation

The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the fair value of the shares at the date of
grant. The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees (APB 25). The Company accounts for stock-based awards to
non-employees in accordance with Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation (SFAS 123) and Emerging
Issues

F-10



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##### Table of Contents



Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services. The Companys disclosures are in accordance with Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation and Disclosure  An Amendment of FASB Statement No. 123 (SFAS
148).

Had compensation cost for options granted and shares issued in 2003, 2002
and 2001 under the Companys stock option plans (the Equity Plans) and
employee stock purchase plans (the Purchase Plans) been determined based on
the fair value at the grant and issue dates, as prescribed in SFAS 123 and SFAS
148, the Companys net income and pro forma net income per share would have
been as follows (in thousands, except per share data):

|                                |             |                                                                                 |   |                         |        |      |   |        |        |   |   |       |        |  
|------------------------------- | ----------- | ------------------------------------------------------------------------------- | - | ----------------------- | ------ | ---- | - | ------ | ------ | - | - | ----- | ------ | -
|                                |             |                                                                                 |   | Year Ended December 31,
|                                |             |                                                                                 |   |                        
|                                |             |                                                                                 |   | 2003                    |        | 2002 |   | 2001  
|                                |             |                                                                                 |   |                         |        |      |   |       
|Net income:                     |             |                                                                                 |   |                         |        |      |   |        |        |   |   |      
|                                | As reported |                                                                                 | $ | 56,946                  |        |      | $ | 78,294 |        |   | $ | 7,523 |       
|                                |             | add: stock compensation as reported, net of tax effects                         |   |                         | 190    |      |   |        | 81     |   |   |       |        |  
|                                |             | less: stock compensation determined using fair value
method, net of tax effects |   |                         | (9,836 | )    |   |        | (6,409 | ) |   |       | (1,106 | )
|                                |             |                                                                                 |   |                         |        |      |   |        |        |   |   |       |        |  
|                                | Pro forma   |                                                                                 | $ | 47,300                  |        |      | $ | 71,966 |        |   | $ | 6,417 |       
|                                |             |                                                                                 |   |                         |        |      |   |        |        |   |   |       |        |  
|Pro forma net income per share: |             |                                                                                 |   |                         |        |      |   |        |        |   |   |      
|Basic:                          |             |                                                                                 |   |                         |        |      |   |        |        |   |   |      
|                                | As reported |                                                                                 | $ | 3.32                    |        |      | $ | 4.90   |        |   | $ | 0.58  |       
|                                | Pro forma   |                                                                                 | $ | 2.76                    |        |      | $ | 4.50   |        |   | $ | 0.49  |       
|Diluted:                        |             |                                                                                 |   |                         |        |      |   |        |        |   |   |      
|                                | As reported |                                                                                 | $ | 3.10                    |        |      | $ | 4.40   |        |   | $ | 0.52  |       
|                                | Pro forma   |                                                                                 | $ | 2.58                    |        |      | $ | 4.05   |        |   | $ | 0.45  |       

The fair value of each option grant and share granted is estimated on the
date of grant using the Black-Scholes option pricing model with the following
assumptions used for grants during the applicable period:

|                                      |  |            |           |            |  |            |           |   |  |  |           |  
|------------------------------------- |  | ---------- | --------- | ---------- |  | ---------- | --------- | - |  |  | --------- | -
|                                      |  | 2003       |           | 2002       |  | 2001      
|                                      |  |            |           |            |  |           
|Option Grants                         |  |            |           |            |  |            |           |   |  |  |           |  
|Average risk free rate of return      |  |            | 2.31-3.00 | %          |  |            | 3.50-4.39 | % |  |  | 4.46-4.98 | %
|Weighted average expected option life |  | 4.0 years  |           | 4.0 years  |  | 4.0 years 
|Volatility rate                       |  |            | 88        | %          |  |            | 83        | % |  |  | 88        | %
|Dividend yield                        |  |            | 0         | %          |  |            | 0         | % |  |  | 0         | %
|Purchase Plan Shares Granted          |  |            |           |            |  |            |           |   |  |  |           |  
|Average risk free rate of return      |  |            | 0.92-1.19 | %          |  |            | 1.25-1.65 | % |  |  | 1.91-5.01 | %
|Weighted average expected option life |  | 3.0 months |           | 3.0 months |  | 3.0 months
|Volatility rate                       |  |            | 17-30     | %          |  |            | 31-33     | % |  |  | 32-125    | %
|Dividend yield                        |  |            | 0         | %          |  |            | 0         | % |  |  | 0         | %

Income Taxes

The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, which
prescribes the use of the asset and liability method whereby deferred tax asset
or liability account balances are calculated at the balance sheet date using
current tax laws and rates in effect. Valuation allowances are established when
necessary to reduce deferred tax assets when it is more likely than not that a
portion or all of the deferred tax assets will not be realized.

Certain Significant Risks and Uncertainties

The Company operates in a dynamic and highly competitive industry and,
accordingly, can be affected by a variety of factors. For example, management
of the Company believes that changes in any of the following areas

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could have a significant negative effect on the Company in terms of its future
financial position, results of operations and cash flows: dependence upon a
limited number of suppliers for component parts; risks associated with budget
processes of governmental agencies which could limit product demand;
legislative actions; the ability of airports to integrate the Companys EDS
units into their baggage handling systems; unforeseen problems relating to the
ability of the Companys EDS products to sustain increased usage; management of
the expansion of the Companys operations; growth of the service organization;
risks associated with integration of acquired businesses; product liability and
related claims if products fail; limited number of customers; the exercise of
the royalty-bearing license granted to the TSA; limitations on the Companys
intellectual property rights; a lengthy sales cycle which could result in not
being able to obtain sales orders; risks associated with international sales
including, but not limited to, political instability, changes in regulatory
requirements, foreign currency risk, tariffs and other barriers, and negative
tax consequences; the Companys relationships with international customers may
be damaged if it is required to fulfill TSA orders at the expense of
international orders; the selection of another company to provide post-warranty
service on the Companys CTX products; the Companys future products or product
modifications fail to obtain TSA certification; inability to adapt to rapid
technological change; competition in the industry; retaining key management
personnel and employees; natural disasters; risks associated with special
contracting requirements by governmental agencies; failure to properly protect
the Companys intellectual property or having to enforce or defend against
claims of intellectual property infringement; and the availability of future
government funding for product development.

Comprehensive Income

Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. Such items may include
foreign currency translation adjustments, unrealized gains/losses from
investing and hedging activities and other transactions.

Segment Information

Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information, requires disclosures of
segment information under a management approach. As discussed in Note 1, the
Company has two reportable segments based on financial information regularly
reviewed by the Companys chief operating decision makers in deciding how to
assess performance and allocate resources.

Fair Value of Financial Instruments

The Companys financial instruments include cash and cash equivalents,
short-term investments, accounts receivable, accounts payable and accrued
liabilities, short-term debt and long-term debt. The carrying values of cash
and cash equivalents, short-term investments and accounts receivable
approximate their fair values based on quoted market values or due to their
short-term maturities. The carrying values of short-term debt and long-term
debt approximate fair value due to their variable interest rates which
approximate market rates.

Net Income Per Share

Basic net income per share is computed by dividing income available to
common stockholders by the weighted-average shares of common stock outstanding
for the period. Diluted net income per share reflects the weighted-average
shares of common stock outstanding plus the potential effect of dilutive
securities or contracts which are convertible to shares of common stock such as
options, warrants, convertible debt (other than the Companys convertible
senior notes due 2023) and preferred stock (using the treasury stock method)
and shares issuable in future periods, except in cases where the effect would
be anti-dilutive. Shares of common stock into which the Companys convertible
senior notes due 2023 can convert are included in the calculation of diluted
net income per share for a fiscal quarter if the Companys closing stock price
equals or exceeds $35.20 for at least 20 days in the last 30 trading days of
that fiscal quarter.

Derivative Instruments and Hedging Activities

On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133). SFAS 133 requires that every derivative instrument,
including certain derivative instruments embedded in other contracts, be
recorded on the balance sheet at

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its fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether
a derivative is designated as part of a hedge transaction and, if it is, the
type of hedge transaction. SFAS 133 requires that the Company formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. The Company adopted SFAS 133 on January 1, 2001 and did not
elect hedge accounting as defined by SFAS 133. The adoption of this statement
did not have a material impact on the Companys financial position or results
of operations.

During the year ended December 31, 2003, the Companys derivatives
consisted only of foreign exchange forward contracts. In May 2002, the Company
designated certain foreign exchange forward contracts as cash flow hedges of
foreign exchange risk for international sales contracts and began applying
hedge accounting as defined by SFAS 133. Accordingly, as of December 31, 2003,
the Company recorded $1,940,000 of other comprehensive loss, net of income
taxes of $1,428,000, representing the net change in the fair value of the
foreign exchange forward contracts that were designated as and qualified for
hedge accounting. The amounts deferred in other comprehensive loss are
reclassified to earnings upon the recognition of hedged revenue. During the
year ended December 31, 2003, the Company also recorded $34,395 as the
ineffectiveness under hedge accounting. At December 31, 2003, some of the
changes in fair value of certain forward contracts are offset by the
measurement of associated accounts receivable amounts. The maturity of foreign
exchange forward contracts as of December 31, 2003 is consistent with the
contractual or expected timing of the transactions being hedged, principally
receipt of customer payments. These foreign exchange forward contracts all
mature within twelve months. As of December 31, 2003, the Company anticipates
reclassifying the full amount included within other comprehensive loss to
earnings within the next twelve months.

The Company does not enter into market risk sensitive instruments for
trading purposes. The Company had aggregate foreign exchange forward contracts
with notional amounts of $20.7 million and $34.7 million at December 31, 2003
and 2002, respectively. The fair value of these instruments, included in the
consolidated balance sheets, was a net liability balance of $1.1 million and
$4.9 million at December 31, 2003 and 2002, respectively.

Recently Issued Accounting Standards

Revenue Arrangements with Multiple Deliverables

In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables
(EITF 00-21). EITF 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which the vendor will perform multiple revenue
generating activities. EITF 00-21 is effective for fiscal periods beginning
after June 15, 2003. There was no impact from the adoption of EITF 00-21 on
the Companys consolidated financial statements.

Accounting and Disclosure Requirements for Guarantees

In December 2002, the Company adopted Financial Accounting Standards Board
(FASB) Interpretation No. 45, Guarantors Accounting and Disclosure
Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45). FIN 45 requires that, upon issuance of a guarantee, the
guarantor must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The provisions for initial recognition and
measurement are effective on a prospective basis for guarantees that are issued
or modified after December 31, 2002, irrespective of a guarantors year-end.
The Company adopted the disclosure requirements of FIN 45 in the fourth quarter
of 2002. The adoption of FIN 45 did not materially impact the Companys
consolidated financial statements.

Accounting for Costs Associated with Exit or Disposal Activities

On January 1, 2003, the Company adopted SFAS No. 146, Accounting for
Costs Associated with Exit or Disposal Activities (SFAS 146), which
addresses accounting for restructuring and similar costs. SFAS 146 supersedes
previous accounting guidance, principally EITF Issue No. 94-3 (EITF 94-3).
SFAS 146 requires that the liability for costs associated with an exit or
disposal activity be recognized when the liability is incurred. Under EITF
94-3, a liability for exit costs was recognized at the date of a companys
commitment to an exit plan. SFAS 146 also establishes that the liability
should initially be measured and recorded at fair value. Accordingly,

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SFAS 146 may affect the timing of recognizing future restructuring costs as
well as the amounts recognized. There was no effect on the Companys
consolidated financial statements from the adoption of SFAS 146.

Consolidation of Variable Interest Entities

The FASB issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46) in January 2003, and a revised interpretation of FIN 46
(FIN 46-R) in December 2003. FIN 46 requires certain variable interest
entities (VIEs) to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The provisions of FIN 46 are effective immediately
for all arrangements entered into after January 31, 2003. Since January 31,
2003, the Company has not invested in any entities it believes are variable
interest entities for which the Company is the primary beneficiary. For all
arrangements entered into after January 31, 2003, the Company is required to
continue to apply FIN 46 through the end of the first quarter of fiscal 2004.
The Company is required to adopt the provisions of FIN 46-R for those
arrangements in the second quarter of fiscal 2004. For arrangements entered
into prior to February 1, 2003, the Company is required to adopt the provisions
of FIN 46-R in the second quarter of fiscal 2004. The Company does not expect
the adoption of FIN 46-R to have an impact on the Companys consolidated
financial statements.

Accounting for Derivative Instruments and Hedging Activities

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities (SFAS 149). SFAS No. 149
amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under SFAS 133. SFAS No. 149 is generally effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. There was no impact from the adoption of SFAS
No. 149 on the Companys consolidated financial statements.

Accounting for Financial Instruments with Characteristics of both
Liabilities and Equity

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150), which requires that certain financial instruments be presented as
liabilities that were previously presented as equity or as temporary equity.
Such instruments include mandatory redeemable preferred and common stock, and
certain options and warrants. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003 and was effective at the beginning
of the first interim period beginning after June 15, 2003. In November 2003,
the FASB issued FASB Staff Position No. 150-3, Effective Date, Disclosures,
and Transition for Mandatorily Redeemable Financial Instruments of Certain
Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests
under SFAS No. 150 (FSP 150-3), which defers the effective date for various
provisions of SFAS 150. The adoption of SFAS 150, as modified by FSP 150-3,
did not have a material impact on the Companys consolidated financial
statements.

Revenue Recognition

In December 2003, the SEC staff issued Staff Accounting Bulletin No. 104,
Revenue Recognition, Corrected Copy (SAB 104), which revises or rescinds
portions of the revenue recognition interpretive guidance included in the Staff
Accounting Bulletin codification to make it consistent with current
authoritative accounting and auditing guidance and SEC rules and regulations.
The principal revisions relate to revenue recognition guidance no longer
necessary due to developments in U.S. GAAP. SAB 104 also rescinds the
Frequently Asked Questions and Answers document issued in conjunction with the
release of Staff Accounting Bulletin No. 101. The adoption of SAB 104 did not
materially impact the Companys consolidated financial statements.

NOTE 3. BUSINESS COMBINATIONS

In accordance with Statement of Financial Accounting Standards No. 141,
Business Combinations (SFAS 141) the Company allocates the purchase price
of its acquisitions to the tangible assets, liabilities and intangible assets
acquired, as well as in-process research and development, based on their
estimated fair values. The

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excess purchase price over those fair values is recorded as goodwill. The
fair value assigned to intangible assets acquired is based on valuations
prepared by independent third party appraisal firms using estimates and
assumptions provided by management. In accordance with SFAS 142, goodwill and
purchased intangibles with indefinite lives acquired after June 30, 2001 are
not amortized but will be reviewed periodically for impairment. Purchased
intangibles with finite lives will be amortized on a straight-line basis over
their estimated useful lives.

Yxlon International Holding GmbH

On March 31, 2003, the Company completed its acquisition of Yxlon, a
company based in Hamburg, Germany. Yxlon develops, manufactures, markets and
supports X-ray based non-destructive testing (NDT) systems for a wide range
of industrial applications, and systems that use X-ray based diffraction
(XRD) technology for explosives detection. The Company acquired Yxlon for
38.6 million in cash, or $41.7 million, incurred additional acquisition costs
of $2.1 million, and paid a subsequent purchase price adjustment of $483,000 in
December 2003 for a total purchase price of $44.3 million. The Company is
required to make an additional payment of 5.0 million if Yxlons XRD system is
certified for explosives detection by the Transportation Security
Administration (TSA) by June 30, 2004. If the XRD system is certified for
explosives detection by the TSA, the Company would record the additional
consideration as intangible assets.

An independent valuation to determine the allocation of the fair value of
the net assets acquired was completed in September 2003. The total purchase
price of $44.3 million has been allocated as follows (in thousands):

|                                         |                               |   |         |        | 
|---------------------------------------- | ----------------------------- | - | ------- | ------ | 
|Cash and cash equivalents                |                               | $ | 1,946   |       
|Current assets                           |                               |   | 29,101  |       
|Other non-current assets                 |                               |   | 1,726   |       
|Amortizable intangible assets:           |                               |   |         |       
|                                         | Developed and core technology |   |         | 8,700  | 
|                                         | Other                         |   |         | 1,480  | 
|Intangible assets with indefinite lives: |                               |   |         |       
|                                         | Goodwill                      |   |         | 18,736 | 
|                                         | Trademark                     |   |         | 2,780  | 
|Current liabilities                      |                               |   | (22,866 | )     
|Other non-current liabilities            |                               |   | (1,644  | )     
|In-process research and development      |                               |   | 4,300   |       
|                                         |                               |   |         |       
|Total purchase price                     |                               | $ | 44,259  |       
|                                         |                               |   |         |       

Amortizable Intangible Assets

Of the total purchase price, approximately $10.2 million has been
allocated to amortizable intangible assets, including maintenance contracts and
renewals, contract backlog, direct customer relationships, supplier agreements
and developed and core technology. The maintenance contracts and renewals
represent a value assigned to the revenue stream estimated from existing
maintenance contracts as of the acquisition date with an assumed renewal rate.
Contract backlog represents the gross contract backlog to be recognized over
the twelve-month period following the close of the acquisition. Direct
customer relationships represent the sale of products and services by Yxlons
internal sales and marketing force. Supplier agreements represent the value in
material supplier agreements where Yxlon receives below market rates on
inventory component purchases. The Company is amortizing the fair value
of these assets on a straight-line basis over estimated useful lives ranging
from twelve months to six years.

Developed and core technology, which consists of products that have
reached technological feasibility, includes Yxlons XRD system and NDT system
products. The Company is amortizing the fair value of the developed and core
technology on a straight-line basis over an estimated useful life of seven
years.

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Intangible Assets With Indefinite Lives

The estimated fair value of intangible assets with indefinite lives was
$18.7 million for goodwill and $2.8 million for the Yxlon trade name. These
intangible assets will not be amortized because the assets have indefinite
useful lives based on many factors and considerations, including the length of
time that the Yxlon name has been in use, the Yxlon brand awareness and market
position and the plans for continued use of the Yxlon brand within a portion of
the Companys overall product portfolio.

In-Process Research and Development

Of the total purchase price, $4.3 million has been allocated to in-process
research and development (IPR&D) and was expensed in the second quarter of
fiscal 2003. There were two projects expected to be completed between 2004 and
2007. Projects that qualify as IPR&D represent those that have not yet reached
technological viability. Technological viability is defined as being
equivalent to a beta-phase working prototype in which there is lower remaining
risk relating to the development.

The value assigned to IPR&D was determined by considering the importance
of each project to the overall development plan, estimating costs to develop
the purchased IPR&D into commercially viable products, estimating the resulting
net cash flows from the projects when completed and discounting the net cash
flows to their present value. The revenue estimates used to value the
purchased IPR&D were based on estimates of the relevant market sizes and growth
factors, expected trends in technology and the nature and expected timing of
new product introductions by Yxlon.

The rates utilized to discount the net cash flows to their present values
are based on Yxlons weighted average cost of capital of 25%. The weighted
average cost of capital was adjusted to reflect the difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility, the percentage of completion of each project, anticipated market
acceptance and penetration, market growth rates and risks related to the impact
of potential changes in future target markets.

Pro Forma Results (Unaudited)

The unaudited pro forma financial information presented below combine the
actual results of operations of the Company and the historical results of
operations of Yxlon for the respective periods as if the acquisition of Yxlon
had occurred at the beginning of each of the periods presented. Adjustments of
$285,000 and $6.2 million have been made to the combined results of operations
for the twelve-month periods ended December 31, 2003 and December 31, 2002,
respectively, reflecting amortization of purchased intangibles, net of tax,
timing of acquisition-related in-process research and development expense
recognition, and bank settlement fees for debt as a result of acquisition, net
of tax, as if the acquisition had occurred at the beginning of each of the
periods presented. The unaudited pro forma financial information is not
intended to represent or be indicative of the consolidated results of
operations or financial condition of the Company that would have been reported
had the acquisition been completed as of the dates presented, and should not be
taken as representative of the future consolidated results of operations or
financial condition of the Company.

|                                          |  |                                          |         |      |  |   |         | 
|----------------------------------------- |  | ---------------------------------------- | ------- | ---- |  | - | ------- | 
|                                          |  | 2003                                     |         | 2002
|                                          |  |                                          |         |     
|                                          |  | (in thousands, except per share amounts)
|Revenues                                  |  | $                                        | 432,697 |      |  | $ | 492,728 | 
|Net income                                |  |                                          | 57,169  |      |  |   | 65,686  | 
|Basic                                     |  | $                                        | 3.34    |      |  | $ | 4.11    | 
|Diluted                                   |  | $                                        | 3.11    |      |  | $ | 3.69    | 
|Basic weighted average shares outstanding |  |                                          | 17,132  |      |  |   | 15,987  | 
|Diluted shares                            |  |                                          | 18,368  |      |  |   | 17,803  | 

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Hattinger Pruf- und Entwicklungs- GmbH

Effective August 1, 2003, Yxlon International X-Ray GmbH, an indirect
wholly owned subsidiary of the Company, acquired Hattinger Pruf- und
Entwicklungs- GmbH (Hapeg), a private engineering and systems company that
provides industrial testing and evaluation solutions utilizing computed
tomography, for approximately 2.9 million or $3.4 million. The acquisition
was accounted for using the purchase method of accounting. The excess purchase
price over the fair value of the underlying net assets of $2.3 million was
allocated to goodwill and other intangible assets and property based upon an
independent valuation of fair values. Amortization expense of $122,000 was
recorded during the fiscal year ended 2003. The unaudited pro forma results
were not provided as they were not deemed to be material.

Inovec, Inc.

The Company acquired Inovec, a manufacturer of yield enhancement equipment
for sawmills, for an initial purchase price of $5.2 million in cash and stock,
payable over a two-year period. The acquisition of Inovec was accounted for as
a purchase effective January 1, 2000. The Company paid the purchase price with
$2.4 million in cash and $2.8 million through issuance of 506,000 shares of
common stock to the former shareholders of Inovec.

In addition, the Company was contingently liable under the purchase
agreement in the event that Inovec achieved certain operating milestones during
the years ended December 31, 2001 and 2000. Inovec achieved certain of these
milestones and an additional $366,000 and $533,000 was recorded as additional
goodwill at December 31, 2001 and 2000, respectively. As a result, the Company
paid $267,000 in cash and $266,000 through issuance of 91,000 shares of common
stock in 2001. The remaining obligation of $366,000 was paid $183,000 in cash
and $183,000 through issuance of 5,000 shares of common stock in April 2002.

The transaction has been accounted for as a purchase and, accordingly, the
results of operations of Inovec are included in the consolidated financial
statements for the years ended December 31, 2002, 2001 and 2000. The Company
allocated the purchase price based on the fair value of assets acquired and
liabilities assumed. Portions of the purchase price, including intangible
assets, were identified by independent appraisers utilizing accepted valuation
procedures and techniques. These intangible assets included approximately $1.5
million for developed technologies, $662,000 for the acquired workforce,
$50,000 for covenants not to compete and the remaining $2.9 million for
goodwill. These intangibles are being amortized over their estimated useful
lives ranging from three to ten years. With the adoption of SFAS 142, the
Company no longer amortizes the carrying values of goodwill of $2.5 million or
acquired workforce of $331,000 at January 1, 2002, resulting in a reduction in
annual amortization expense of $426,000. In the fourth quarter of 2002, the
Company performed the annual impairment tests required by the standard, and
recorded a $2.1 million impairment of goodwill.

NOTE 4. GOVERNMENT CONTRACTS AND GRANTS

The Company has been awarded various research and development contracts
and grants by the FAA, the TSA and other government agencies to share in the
costs of developing and enhancing the Companys products. During 2003, 2002 and
2001, the Company recorded reimbursements of $3.1 million, $886,000 and $8.3
million, respectively, under research and development contracts and grants.
Such reimbursements for direct costs, overhead and general and administrative
expenses, have been reflected as a reduction to research and development
expense, selling, general and administrative expense, and against the
manufacturing and customer support overhead pools, in each period presented.
Billings under such research and development contracts and grants are submitted
to the FAA, the TSA and other government agencies monthly on the basis of
actual costs incurred. At December 31, 2003 and 2002, the related receivable
balances from these contracts and grants were $1.1 million and $0,
respectively.

In addition, under a letter contract dated February 19, 2002 and a
subsequent delivery order, the FAA and, following the formation of the TSA, the
TSA agreed to reimburse the Company for certain ramp up costs incurred to meet
the TSAs product order demand for 2002. Ramp up costs consist of consulting
expenses, vendor expedite charges and subcontract manufacturing set up costs.
The Company recorded $1.0 million in 2003 and $9.3 million in 2002 in
reimbursable expenses. At December 31, 2003, there was no outstanding balance
for future invoicing of ramp up related costs.

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NOTE 5. FINANCING ARRANGEMENTS

On September 19, 2003, the Company completed a private offering of $125.0
million aggregate principal amount of its 3% convertible senior notes due 2023.
The notes are convertible into the Companys common stock, under certain
circumstances, at an initial conversion rate of 31.25 shares per $1,000
principal amount of notes, subject to adjustment. At the initial conversion
rate, the notes will be convertible into common stock at a conversion price of
$32.00 per share. The notes will be redeemable for cash at the Companys
option beginning on October 1, 2008. Holders of the notes have the option to
require the Company to purchase the notes in cash, in whole or in part, on
October 1 in each of 2008, 2013 and 2018. The holders of the notes will also
have the ability to require the Company to purchase the notes in the event that
the Company undergoes a change in control. In each such case, the redemption or
purchase price would be at 100% of the principal amount of the notes, plus
accrued and unpaid interest to, but excluding, the redemption or purchase date,
as the case may be. In connection with the issuance of the notes, the Company
incurred $4.5 million in debt issuance costs to be amortized over the term of
the notes.

Effective December 2003, the Company had a line of credit agreement for
the U.S. operations that provides for maximum borrowings in an amount up to
$30.0 million. Borrowings under these agreements bear interest at the banks
prime rate minus 0.5% (3.5% at December 31, 2003). The agreement expires in
July 2005 and requires that the EDS segment maintain certain levels of tangible
net worth. The Company may use proceeds of loans under this line of credit for
general corporate purposes. At December 31, 2003, the Company had no
borrowings outstanding under these agreements. However, at December 31, 2003,
the Company had outstanding guarantees to customers through the issuance of
letters of credit for which a partial reserve of $17.0 million is secured by
the lines of credit, and foreign exchange contracts for which a 10% reserve of
$1.7 million is secured by the lines of credit. The Company had remaining
available borrowing capacity under the lines of credit of $11.3 million at
December 31, 2003.

As of December 31, 2003, the Company had letters of credit totaling $17.0
million as guarantees primarily to customers for performance and delivery
commitments, and to foreign creditors to our subsidiary entities. In addition,
the Company has one guarantee to an insurance carrier for premium payment
commitments. The guarantees range from two months to nine years from December
31, 2003 until expiration.

As of December 31, 2003, the Company had two primary sources of financing
from German banks for Yxlon. The first agreement is a line of credit that
provides for maximum borrowings in an amount up to 6.6 million or
approximately $8.3 million at December 31, 2003. The second agreement is also
a line of credit that provides for maximum borrowings in an amount up to 5.2
million or approximately $6.6 million at December 31, 2003. The expiration
date for each of these agreements is March 2004. Borrowings under these
agreements bear interest at 5.75%. At December 31, 2003, the Company had debt
balances of $5.3 million outstanding under these agreements. In addition, at
December 31, 2003, we had outstanding guarantees to customers through the
issuance of letters of credit for which a reserve of $3.9 million is secured by
the lines of credit. Therefore, we had remaining available borrowing capacity
under the lines of credit of approximately 4.5 million or $5.7 million at
December 31, 2003.

NOTE 6. STOCKHOLDERS EQUITY

In connection with the issuance of the $125.0 million aggregate principal
amount of 3% convertible senior notes due 2023 discussed in Note 5, the Company
repurchased 452,000 shares of its common stock at a price of $27.65 per share,
for an aggregate price of $12.5 million.

In March 2003 and July 2003, the Company issued non-qualified stock
options to two consultants to each purchase 10,000 shares of common stock at a
price of $21.87 and $24.59 per share, respectively. The options vest 25% after
one year and monthly thereafter over the next 3 years. The options expire ten
years from date of issuance. The Company recorded compensation expense over
the vesting period of the option, for which the fair value is adjusted for
changes in the fair value of common stock in subsequent periods. During the
2003, the Company recorded compensation expense of $193,000, which was
estimated as of December 31, 2003 using the Black-Scholes option pricing model
with the following assumptions: no dividends, risk-free interest rate of 2.45%,
volatility of 85% and a contractual life of ten years.

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On February 28, 2002, the Companys stockholders approved an increase in
the number of authorized shares of common stock, previously approved by the
board of directors, from 20,000,000 shares to 60,000,000 shares and the Company
filed an amendment to its certificate of incorporation effecting this increase.

On March 27, 2002, the Company filed an amended Form S-3 Registration
Statement under the Securities Act of 1933 and announced the public offering of
3,000,000 shares of its common stock to the public at a price of $36.50 per
share. In this offering, which closed on April 2, 2002, the Company sold
2,500,000 shares and received proceeds of $84.6 million, net of issuance costs.
A selling stockholder sold another 500,000 shares of common stock in the
offering and certain selling stockholders sold 450,000 shares to underwriters
who exercised their over-allotment option. The Company did not receive any
proceeds from the sale of the shares by selling stockholders.

In September 2001, the Company entered into an agreement with Donald & Co.
for investment advisory and financing related services. Steven Blum, one of the
members of the Companys board of directors, was the president of Donald & Co.
at such time. Under this agreement, Donald & Co. received a $50,000 cash
retainer and a fully-vested warrant to purchase 100,000 shares of the Companys
common stock at a price of $9.95 per share, the closing price of the Companys
common stock on the day prior to the date of issuance. The warrant expires five
years from date of issuance. The fair value of the warrant was $650,000, which
was estimated on the date of grant using the Black-Scholes option pricing model
with the following assumptions: no dividends, risk-free interest rate of 3.94%,
volatility of 78% and a contractual life of five years. In September 2002, the
Company issued 100,000 shares of common stock under the warrant. However, in
lieu of paying cash for the shares, 34,153 shares valued at $29.13 per share
were returned to the Company to settle the transaction. Such shares were
recorded as treasury stock. One-half of the cash retainer and warrant, related
to on-going investment and financial advisory services, was recorded in other
current assets and was amortized over the one-year term of the agreement. The
Company recorded amortization expense of $262,000 and $88,000 in 2002 and 2001,
respectively. The remaining balance of $350,000, related to services provided
in connection with the Companys follow-on offering in April 2002 was netted
against the proceeds from the offering.

In October 2001, the Company issued a non-qualified stock option to a
consultant to purchase 15,000 shares of common stock at a price of $14.06 per
share. The option has a one-year cliff vesting term and expires ten years from
date of issuance. The fair value of the option at the end of the one-year cliff
vesting term as of October 27, 2002 was $456,000, which was estimated as of
October 27, 2002 using the Black-Scholes option pricing model with the
following assumptions: no dividends, risk-free interest rate of 4.11%,
volatility of 86% and a contractual life of nine years. The Company recorded
compensation expense over the vesting period of the option, for which the fair
value is adjusted for changes in the fair value of common stock in subsequent
periods. During the years ended December 31, 2002 and 2001, the Company
recorded compensation expense of $389,000 and $67,000, respectively.

From 2000 through 2002, under the terms of the agreement relating to the
acquisition of Inovec, the Company issued 602,000 shares of common stock to the
former shareholders of Inovec.

In September 1997, under the terms of the agreement relating to the
acquisition of Quantum, 777,000 shares of common stock were either issued to
Quantum shareholders in exchange for all of the Quantum capital stock
outstanding or reserved for issuance in connection with Quantum common stock
options outstanding prior to the acquisition which were converted into options
to purchase InVision common stock.

At December 31, 2003, the Company has reserved shares of common stock for
issuance as follows:

|                                                                                                             |  |  |           | 
|------------------------------------------------------------------------------------------------------------ |  |  | --------- | 
|Options outstanding under stock option plans                                                                 |  |  | 3,594,760 | 
|Shares reserved for future issuance under stock option plans                                                 |  |  | 1,248,337 | 
|Shares reserved for sale under employee stock purchase plan                                                  |  |  | 96,561    | 
|Shares reserved to be exchanged for Quantum stock
certificates that have not
yet been turned in for exchange |  |  | 896       | 
|                                                                                                             |  |  |           | 
|Total                                                                                                        |  |  | 4,940,554 | 
|                                                                                                             |  |  |           | 

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NOTE 7. EMPLOYEE STOCK AND BENEFIT PLANS

Equity Incentive Plans

The Equity Plans provide for the granting to officers, employees,
consultants and directors of the Company and its subsidiaries of incentive and
non-qualified stock options, stock bonus awards, rights to purchase restricted
stock and stock appreciation rights (together Stock Awards) for the purchase
of up to an aggregate of 7,520,635 shares of the Companys common stock by
officers, employees, consultants and directors of the Company and its
subsidiaries. The board of directors is responsible for administration of the
Equity Plans and also determines the terms of each Stock Award. Options granted
under the Equity Plans generally vest over a four-year period. In the event of
a change in control transaction, Stock Awards then outstanding shall be
continued or assumed by the surviving entity or similar awards shall be
substituted therefor. If the surviving entity refuses to do so, then the
vesting of or rate of lapse of repurchase rights on such Stock Awards shall
accelerate in full to the date immediately prior to the effective date of such
change in control transaction. With respect to senior vice presidents and
specified vice presidents, even if the surviving entity continues, assumes or
substitutes Stock Awards, the vesting or rate of lapse of repurchase rights on
such Stock Awards shall accelerate in full following the effective date of the
change in control transaction. With respect to specified vice presidents, even
if the surviving entity continues, assumes or substitutes Stock Awards, the
vesting or rate of lapse of repurchase rights on such Stock Awards shall
accelerate in full upon an involuntary termination without cause or a
constructive termination, as those terms are defined in the Companys Change
in Control Equity Acceleration Plan, within a year following the effective date
of the change in control transaction.

Non-qualified stock options may be granted at an exercise price per share
of not less than 85% of the fair value per share of common stock on the date of
the grant. Incentive stock options may be granted at an exercise price per
share of not less than 100% of the fair value per share of common stock on the
date of grant (not less than 110% of the fair value in the case of holders of
more than 10% of the Companys voting stock). Options granted under the Equity
Plans generally expire ten years from the date of the grant (five years for
incentive stock options granted to holders of more than 10% of the Companys
voting stock). Options granted generally vest 25% one year after issuance and
1/48th each month thereafter for three years.

The activity under the Equity Plans was as follows (in thousands, except
per share data):

|                                                                          |                     |  |                         |       |       |   |          |       |       |  |        |       |          |   |       |       |  |  |          |      |   |   |      |      | 
|------------------------------------------------------------------------- | ------------------- |  | ----------------------- | ----- | ----- | - | -------- | ----- | ----- |  | ------ | ----- | -------- | - | ----- | ----- |  |  | -------- | ---- | - | - | ---- | ---- | 
|                                                                          |                     |  | Year Ended December 31,
|                                                                          |                     |  |                        
|                                                                          |                     |  | 2003                    |       | 2002  |   | 2001    
|                                                                          |                     |  |                         |       |       |   |         
|                                                                          |                     |  |                         |       |       |   | Weighted |       |       |  |        |       | Weighted |   |       |       |  |  | Weighted
|                                                                          |                     |  |                         |       |       |   | Average  |       |       |  |        |       | Average  |   |       |       |  |  | Average 
|                                                                          |                     |  |                         |       |       |   | Exercise |       |       |  |        |       | Exercise |   |       |       |  |  | Exercise
|                                                                          |                     |  | Shares                  |       | Price |   | Shares   |       | Price |  | Shares |       | Price   
|                                                                          |                     |  |                         |       |       |   |          |       |       |  |        |       |         
|Outstanding at beginning of period                                        |                     |  | 3,098                   |       |       | $ | 16.52    |       |       |  | 2,596  |       |          | $ | 3.82  |       |  |  | 2,831    |      |   | $ | 4.07 |     
|                                                                          | Granted             |  |                         | 1,173 |       |   | $        | 24.85 |       |  |        | 1,229 |          |   | $     | 35.16 |  |  |          | 827  |   |   | $    | 4.02 | 
|                                                                          | Exercised           |  |                         | (407  | )     |   | $        | 4.84  |       |  |        | (665  | )        |   | $     | 3.09  |  |  |          | (463 | ) |   | $    | 4.54 | 
|                                                                          | Canceled (unvested) |  |                         | (270  | )     |   | $        | 27.06 |       |  |        | (56   | )        |   | $     | 8.11  |  |  |          | (414 | ) |   | $    | 4.38 | 
|                                                                          | Expired (vested)    |  |                         |      |       |   | $        |      |       |  |        | (6    | )        |   | $     | 4.03  |  |  |          | (185 | ) |   | $    | 5.27 | 
|                                                                          |                     |  |                         |       |       |   |          |       |       |  |        |       |          |   |       |       |  |  |          |      |   |   |      |     
|Outstanding at end of period                                              |                     |  | 3,594                   |       |       | $ | 19.78    |       |       |  | 3,098  |       |          | $ | 16.51 |       |  |  | 2,596    |      |   | $ | 3.82 |     
|                                                                          |                     |  |                         |       |       |   |          |       |       |  |        |       |          |   |       |       |  |  |          |      |   |   |      |     
|Options exercisable at period end                                         |                     |  | 1,744                   |       |       | $ | 14.53    |       |       |  | 1,268  |       |          | $ | 6.51  |       |  |  | 1,203    |      |   | $ | 3.52 |     
|Weighted average grant date fair value of
options granted during the year |                     |  |                         |       |       | $ | 17.86    |       |       |  |        |       |          | $ | 21.91 |       |  |  |          |      |   | $ | 2.55 |     

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Information relating to stock options outstanding under the Equity Plans
at December 31, 2002 is as follows (share data in thousands):

|               |  |                     |       |                     |  |                |     |             |  |                |       |  |  |          |       |  |  |   |       | 
|-------------- |  | ------------------- | ----- | ------------------- |  | -------------- | --- | ----------- |  | -------------- | ----- |  |  | -------- | ----- |  |  | - | ----- | 
|               |  | Options Outstanding |       | Options Exercisable
|               |  |                     |       |                    
|               |  |                     |       |                     |  | Weighted       |     |             |  |                |       |  |  |          |       |  |  |  
|               |  |                     |       |                     |  | Average        |     | Weighted    |  |                |       |  |  | Weighted
|Range of       |  | Number              |       | Remaining           |  | Average        |     | Number      |  | Average       
|Exercise Price |  | Outstanding         |       | Contractual Life    |  | Exercise Price |     | Exercisable |  | Exercise Price
|               |  |                     |       |                     |  |                |     |             |  |               
|$0.55 - 1.10   |  |                     | 265   |                     |  |                | 1.7 |             |  | $              | 0.97  |  |  |          | 265   |  |  | $ | 0.97  | 
|$1.44 - 2.31   |  |                     | 371   |                     |  |                | 7.1 |             |  | $              | 2.26  |  |  |          | 207   |  |  | $ | 2.28  | 
|$2.38 - 5.25   |  |                     | 505   |                     |  |                | 6.1 |             |  | $              | 4.22  |  |  |          | 413   |  |  | $ | 4.40  | 
|$5.38 - 21.87  |  |                     | 450   |                     |  |                | 6.1 |             |  | $              | 12.70 |  |  |          | 290   |  |  | $ | 8.55  | 
|$22.40 - 24.72 |  |                     | 298   |                     |  |                | 9.1 |             |  | $              | 23.44 |  |  |          | 29    |  |  | $ | 23.23 | 
|$24.94 - 24.94 |  |                     | 634   |                     |  |                | 9.1 |             |  | $              | 24.94 |  |  |          | 125   |  |  | $ | 24.94 | 
|$25.16 29.82   |  |                     | 383   |                     |  |                | 9.0 |             |  | $              | 27.94 |  |  |          | 71    |  |  | $ | 28.69 | 
|$30.34 - 41.99 |  |                     | 147   |                     |  |                | 8.5 |             |  | $              | 35.78 |  |  |          | 56    |  |  | $ | 36.37 | 
|$43.00 43.00   |  |                     | 30    |                     |  |                | 8.2 |             |  | $              | 43.00 |  |  |          | 13    |  |  | $ | 43.00 | 
|$43.34 - 43.34 |  |                     | 511   |                     |  |                | 8.1 |             |  | $              | 43.34 |  |  |          | 275   |  |  | $ | 43.34 | 
|               |  |                     |       |                     |  |                |     |             |  |                |       |  |  |          |       |  |  |   |       | 
|               |  |                     | 3,594 |                     |  |                | 7.4 |             |  | $              | 19.78 |  |  |          | 1,744 |  |  | $ | 14.53 | 
|               |  |                     |       |                     |  |                |     |             |  |                |       |  |  |          |       |  |  |   |       | 

Employee Stock Purchase Plans

The Company reserved a total of 850,000 shares of common stock for
issuance under the Purchase Plans. As of December 31, 2003, 753,107 shares have
been issued under the Purchase Plans.

Employee 401(k) Plan

The InVision Technologies, Inc. 401(k) Plan (the 401(k) Plan) was
established in 1992 to provide retirement and incidental benefits for its
employees. As allowed under Section 401(k) of the Internal Revenue Code, the
401(k) Plan provides tax-deferred salary deductions for eligible employees.
Employees may contribute up to 20% of their annual compensation to the 401(k)
Plan, limited to a maximum amount as set periodically by the Internal Revenue
Service. Beginning in July 1997, the Company began matching employee
contributions at the rate of $0.50 on the dollar up to a maximum of 6% of the
employees gross compensation. All matching contributions vest immediately.
Company matching contributions to the 401(k) Plan totaled $1.1 million,
$707,000 and $524,000 in 2003, 2002 and 2001, respectively.

NOTE 8. COMMITMENTS

The Company leases facilities and equipment under non-cancelable leases
expiring at various times through 2012. The existing facilities lease for the
corporate facility in Newark, California includes an option to renew for an
additional five years through 2012. Future minimum lease payments under these
leases at December 31, 2003 are as follows (in thousands):

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|                                                   |                                     |        |           |        |         |   |      |     | 
|-------------------------------------------------- | ----------------------------------- | ------ | --------- | ------ | ------- | - | ---- | --- | 
|                                                   |                                     |        | Operating |        | Capital
|Year Ending December 31,                           |                                     | Leases |           | Leases
|                                                   |                                     |        |           |       
|2004                                               |                                     | $      | 4,815     |        |         | $ | 287  |    
|2005                                               |                                     |        | 4,086     |        |         |   | 262  |    
|2006                                               |                                     |        | 3,379     |        |         |   | 70   |    
|2007                                               |                                     |        | 2,756     |        |         |   |     |    
|2008                                               |                                     |        | 1,901     |        |         |   |     |    
|Years thereafter                                   |                                     |        | 5,349     |        |         |   |     |    
|                                                   |                                     |        |           |        |         |   |      |    
|                                                   |                                     | $      | 22,286    |        |         |   | 619  |    
|                                                   |                                     |        |           |        |         |   |      |    
|Less: amount representing interest                 |                                     |        |           |        |         |   | (38  | )  
|                                                   |                                     |        |           |        |         |   |      |    
|Present value of net minimum lease payments        |                                     |        |           |        |         |   | 581  |    
|Less: current portion of capital lease
obligations |                                     |        |           |        |         |   | (263 | )  
|                                                   |                                     |        |           |        |         |   |      |    
|                                                   | Long-term capital lease obligations |        |           |        |         |   | $    | 318 | 
|                                                   |                                     |        |           |        |         |   |      |    

Rent expense for facilities located in Newark, California; San Diego,
California; Eugene, Oregon; Akron, Ohio; France; United Kingdom; Germany;
Denmark; and Japan was $4,106,000, $1,903,000 and $1,646,000, for the years
ended December 31, 2003, 2002 and 2001, respectively.

The leases on the corporate offices and manufacturing facilities in
Newark, California and San Diego, California include scheduled base rent
increases over the term of the leases. The total amount of base rent payments
is being charged to expense on the straight-line method over the term of the
leases. In addition to the base rent payment, the Company pays a monthly
allocation of the buildings operating expenses. At December 31, 2003 and 2002,
the Company has recorded deferred rent of $535,000 and $576,000, respectively,
to reflect the excess of rent expense over cash payments since inception of the
lease as a long-term liability.

NOTE 9. NET INCOME PER SHARE

The following is a reconciliation between the components of the basic and
diluted net income per share calculations for the periods presented below (in
thousands, except per share data):

|                               |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |        |        |       |  |   |       |   |  |   |       |  |  |       |        |  |  |   |       |  
|------------------------------ | ---------------------------------------------------------------- |  | ----------------------- | ------ | ------ |  | ------ | ------ | ------ |  | ------ | ----- | ------ |  | ------ | ------ | ------ |  | ------ | ------ | ----- |  | - | ----- | - |  | - | ----- |  |  | ----- | ------ |  |  | - | ----- | -
|                               |                                                                  |  | Year Ended December 31,
|                               |                                                                  |  |                        
|                               |                                                                  |  | 2003                    |        | 2002   |  | 2001  
|                               |                                                                  |  |                         |        |        |  |       
|                               |                                                                  |  |                         |        |        |  |        |        |        |  | Per    |       |        |  |        |        |        |  |        |        | Per   |  |   |       |   |  |   |       |  |  | Per  
|                               |                                                                  |  |                         |        |        |  |        |        |        |  | Share  |       |        |  |        |        |        |  |        |        | Share |  |   |       |   |  |   |       |  |  | Share
|                               |                                                                  |  | Income                  |        | Shares |  | Amount |        | Income |  | Shares |       | Amount |  | Income |        | Shares |  | Amount
|                               |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |       
|Basic net income per share:    |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |        |        |       |  |   |       |   |  |   |       |  |  |       |        |  |  |   |      
|                               | Income available to common
stockholders                          |  | $                       | 56,946 |        |  |        | 17,132 |        |  | $      | 3.32  |        |  | $      | 78,294 |        |  |        | 15,987 |       |  | $ | 4.90  |   |  | $ | 7,523 |  |  |       | 12,998 |  |  | $ | 0.58  |  
|Effect of dilutive securities: |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |        |        |       |  |   |       |   |  |   |       |  |  |       |        |  |  |   |      
|                               | Options and warrants                                             |  |                         |        |        |  |        | 1,236  |        |  |        | (0.22 | )      |  |        |       |        |  |        | 1,811  |       |  |   | (0.50 | ) |  |   |      |  |  |       | 1,081  |  |  |   | (0.05 | )
|                               | Stock payable in connection
with acquisition of subsidiary       |  |                         |        |        |  |        |        |        |  |        |      |        |  |        |       |        |  |        | 5      |       |  |   |      |   |  |   |      |  |  |       | 264    |  |  |   | (0.01 | )
|                               |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |        |        |       |  |   |       |   |  |   |       |  |  |       |        |  |  |   |       |  
|Diluted net income per share:  |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |        |        |       |  |   |       |   |  |   |       |  |  |       |        |  |  |   |      
|                               | Income available to common
stockholders plus assumed
conversions |  | $                       | 56,946 |        |  |        | 18,368 |        |  | $      | 3.10  |        |  | $      | 78,294 |        |  |        | 17,803 |       |  | $ | 4.40  |   |  | $ | 7,523 |  |  |       | 14,343 |  |  | $ | 0.52  |  
|                               |                                                                  |  |                         |        |        |  |        |        |        |  |        |       |        |  |        |        |        |  |        |        |       |  |   |       |   |  |   |       |  |  |       |        |  |  |   |       |  

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NOTE 10. INCOME TAXES

The provision for (benefit from) income taxes for 2003, 2002 and 2001
consists of the following (in thousands):

|                |         |   |                         |        |      |   |        |         |   |   |        |        |  
|--------------- | ------- | - | ----------------------- | ------ | ---- | - | ------ | ------- | - | - | ------ | ------ | -
|                |         |   | Year Ended December 31,
|                |         |   |                        
|                |         |   | 2003                    |        | 2002 |   | 2001  
|                |         |   |                         |        |      |   |       
|Current:        |         |   |                         |        |      |   |        |         |   |   |        |       
|                | Federal |   | $                       | 29,761 |      |   | $      | 55,631  |   |   | $      | 887    |  
|                | State   |   |                         | 7,042  |      |   |        | 12,636  |   |   |        | 364    |  
|                | Foreign |   |                         | 162    |      |   |        |        |   |   |        |       |  
|                |         |   |                         |        |      |   |        |         |   |   |        |        |  
|                |         | $ | 36,965                  |        |      | $ | 68,267 |         |   | $ | 1,251  |       
|Deferred:       |         |   |                         |        |      |   |        |         |   |   |        |       
|                | Federal |   |                         | 5,937  |      |   |        | (11,921 | ) |   |        | (4,631 | )
|                | State   |   |                         | 1,101  |      |   |        | (2,472  | ) |   |        | (1,191 | )
|                | Foreign |   |                         | (2,078 | )    |   |        |        |   |   |        |       |  
|                |         |   |                         |        |      |   |        |         |   |   |        |        |  
|Total provision |         | $ | 41,925                  |        |      | $ | 53,874 |         |   | $ | (4,571 | )     
|                |         |   |                         |        |      |   |        |         |   |   |        |        |  

The Companys effective tax rate for 2003, 2002 and 2001 differs from the
U.S. federal statutory income tax rate as follows:

|                                  |                    |  |                         |      |      |  |      |      |   |  |        |        |   
|--------------------------------- | ------------------ |  | ----------------------- | ---- | ---- |  | ---- | ---- | - |  | ------ | ------ | --
|                                  |                    |  | Year Ended December 31,
|                                  |                    |  |                        
|                                  |                    |  | 2003                    |      | 2002 |  | 2001
|                                  |                    |  |                         |      |      |  |     
|U.S. federal statutory rate       |                    |  | 35.0                    | %    |      |  | 35.0 | %    |   |  | 35.0   | %     
|State taxes, net of federal taxes |                    |  | 5.3                     |      |      |  | 5.0  |      |   |  | 1.4    |       
|Non-deductible intangible assets  |                    |  | 0.1                     |      |      |  | 0.6  |      |   |  | 10.5   |       
|Change in valuation allowance     |                    |  | 0.5                     |      |      |  |     |      |   |  | (194.1 | )     
|Research and development credit   |                    |  |                        |      |      |  |     |      |   |  | (4.1   | )     
|Other                             |                    |  | 1.5                     |      |      |  | 0.2  |      |   |  | (3.5   | )     
|                                  |                    |  |                         |      |      |  |      |      |   |  |        |       
|                                  | Effective tax rate |  |                         | 42.4 | %    |  |      | 40.8 | % |  |        | (154.8 | )%
|                                  |                    |  |                         |      |      |  |      |      |   |  |        |       

Deferred tax assets at December 31, 2003 and 2002 consist of the following
(in thousands):

|                                               |                                  |                                    |        |              |        |      |        |        |        | 
|---------------------------------------------- | -------------------------------- | ---------------------------------- | ------ | ------------ | ------ | ---- | ------ | ------ | ------ | 
|                                               |                                  |                                    |        | December 31,
|                                               |                                  |                                    |        |             
|                                               |                                  |                                    |        | 2003         |        | 2002
|                                               |                                  |                                    |        |              |        |     
|Assets:                                        |                                  |                                    |        |              |        |      |        |       
|                                               | Reserves and accruals            |                                    | $      | 14,816       |        |      | $      | 20,863 |       
|                                               | Net operating loss carryforwards |                                    |        | 7,251        |        |      |        | 649    |       
|                                               | Other                            |                                    |        | 692          |        |      |        | 1,691  |       
|                                               |                                  |                                    |        |              |        |      |        |        |       
|                                               |                                  |                                    | 22,759 |              |        |      | 23,203 |       
|Liabilities:                                   |                                  |                                    |        |              |        |      |        |       
|                                               | Intangibles and fixed assets     |                                    |        | (5,938       | )      |      |        |       |       
|                                               | Other                            |                                    |        | (1,120       | )      |      |        | (1,264 | )     
|                                               | Valuation allowance              |                                    |        | (1,621       | )      |      |        |       |       
|                                               |                                  |                                    |        |              |        |      |        |        |       
|Net deferred tax assets                        |                                  | $                                  | 14,080 |              |        | $    | 21,939 |       
|                                               |                                  |                                    |        |              |        |      |        |        |       
|As reported in the consolidated balance sheet: |                                  |                                    |        |              |        |      |        |       
|                                               |                                  | Deferred income taxes, current     |        | $            | 14,283 |      |        | $      | 20,889 | 
|                                               |                                  | Deferred income taxes, non-current |        |              | (203   | )    |        |        | 1,050  | 
|                                               |                                  |                                    |        |              |        |      |        |        |       
|                                               |                                  | Net deferred tax assets            |        | $            | 14,080 |      |        | $      | 21,939 | 
|                                               |                                  |                                    |        |              |        |      |        |        |       

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A valuation allowance is required if management concludes that it is more
likely than not that a deferred tax asset will not be realized. As of December
31, 2003, the Company has a valuation allowance of $1,621,000, reducing the net
deferred income taxes to $14,080,000. The realization of tax loss
carryforwards is dependent on generating sufficient taxable income in certain
tax jurisdictions prior to the expiration of the loss carryforwards. As of
December 31, 2003, management has determined that estimates of future taxable
income in certain foreign jurisdictions make it more likely than not that some
of the foreign tax loss carryforwards may not be realized.

At December 31, 2003, the Company had federal, state and foreign net
operating loss carryforwards of approximately $1.2 million, $321,000 and $15.8
million, respectively, available to reduce future federal, state and foreign
taxable income. The Companys federal net operating loss carryforwards begin
to expire in 2010 and its state net operating loss carryforwards expire in
2011. The foreign net operating loss carryovers may be carried over
indefinitely and will not expire. The tax benefit of the federal and state net
operating loss carryforwards may be limited due to the impact of the Tax Reform
Act of 1986. Events which may cause the tax benefit to be limited include, but
are not limited to, a cumulative stock ownership change of more than 50% over a
three-year period and the timing of utilization of various tax benefits carried
forward.

The Companys income taxes payable have been reduced by the income tax
benefits associated with employee stock transactions. These benefits were
credited directly to stockholders equity and amounted to $2.9 million in 2003
and $9.2 million in 2002.

NOTE 11. INDUSTRY SEGMENTS, MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION

The Company determines its segments based on how its Chief Executive
Officer and its Chief Operating Officer assess performance and allocate
resources. Through the first quarter of 2003, the Company presented segment
information based on three reportable segments: EDS, Quantum and Wood. As a
result of the acquisition of Yxlon at the outset of the second fiscal quarter
of 2003, the Company now has two reportable segments, EDS and NDT. The EDS
segment is comprised of the business unit that is engaged in the development,
manufacturing, marketing and support of explosives detection systems based on
advanced computed tomography technology. The NDT segment is comprised of the
Yxlon business unit that is engaged in the development, manufacturing,
marketing and support of non-destructive testing systems for a wide range of
industrial applications. Other segments, including Quantum, Wood and XRD, were
aggregated to form an All Other category as they did not meet the threshold
for a reportable segment.

Segment financial data for years ended December 31, 2002 and 2001 have
been restated to reflect the change in reportable segments. As of the second
quarter of 2003, a reportable segment line item also has been changed from net
income (loss) to income (loss) from operations.

Financial information by segment is as follows (in thousands):

|                              |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   |               |        |   |   |         |         | 
|----------------------------- | ------------------------------------------ | - | ------- | ------- | --- | - | ------ | ------ | ------------ | - | ------ | ------ |  | - | ------------- | ------ | - | - | ------- | ------- | 
|                              |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   | Consolidating |        |   |   |        
|                              |                                            |   | EDS     |         | NDT |   | Other  |        | Eliminations |   | Total 
|                              |                                            |   |         |         |     |   |        |        |              |   |       
|2003                          |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   |               |        |   |   |         |        
|Revenues:                     |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   |               |        |   |   |         |        
|                              | Product revenues                           |   | $       | 302,961 |     |   | $      | 34,639 |              |   | $      | 13,973 |  |   | $             |       |   |   | $       | 351,573 | 
|                              | Service revenues                           |   |         | 41,158  |     |   |        | 8,656  |              |   |        | 1,979  |  |   |               |       |   |   |         | 51,793  | 
|                              | Contract research and development revenues |   |         |        |     |   |        |       |              |   |        | 13,131 |  |   |               |       |   |   |         | 13,131  | 
|                              | Intercompany revenues                      |   |         | 52      |     |   |        |       |              |   |        | 3,462  |  |   |               | (3,514 | ) |   |         |        | 
|                              |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   |               |        |   |   |         |         | 
|Total revenues                |                                            | $ | 344,171 |         |     | $ | 43,295 |        |              | $ | 32,545 |        |  | $ | (3,514        | )      |   | $ | 416,497 |        
|Income (loss) from operations |                                            | $ | 104,746 |         |     | $ | (3,163 | )      |              | $ | (4,922 | )      |  | $ |              |        |   | $ | 96,661  |        
|December 31, 2003             |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   |               |        |   |   |         |        
|Total assets                  |                                            | $ | 436,914 |         |     | $ | 57,809 |        |              | $ | 18,757 |        |  | $ | (27,412       | )      |   | $ | 486,068 |        
|                              |                                            |   |         |         |     |   |        |        |              |   |        |        |  |   |               |        |   |   |         |         | 

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|                              |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |         | 
|----------------------------- | ------------------------------------------ | - | ------- | ------- | --- | - | ----- | - | ------------ | - | ------ | ------ |  | - | ------------- | ------ | - | - | ------- | ------- | 
|                              |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   | Consolidating |        |   |   |        
|                              |                                            |   | EDS     |         | NDT |   | Other |   | Eliminations |   | Total 
|                              |                                            |   |         |         |     |   |       |   |              |   |       
|2002                          |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |        
|Revenues:                     |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |        
|                              | Product revenues                           |   | $       | 403,074 |     |   | $     |  |              |   | $      | 8,352  |  |   | $             |       |   |   | $       | 411,426 | 
|                              | Service revenues                           |   |         | 13,742  |     |   |       |  |              |   |        | 1,880  |  |   |               |       |   |   |         | 15,622  | 
|                              | Contract research and development revenues |   |         |        |     |   |       |  |              |   |        | 12,083 |  |   |               |       |   |   |         | 12,083  | 
|                              | Intercompany revenues                      |   |         | 705     |     |   |       |  |              |   |        | 2,652  |  |   |               | (3,357 | ) |   |         |        | 
|                              |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |         | 
|Total revenues                |                                            | $ | 417,521 |         |     | $ |      |   |              | $ | 24,967 |        |  | $ | (3,357        | )      |   | $ | 439,131 |        
|Income (loss) from operations |                                            | $ | 135,912 |         |     | $ |      |   |              | $ | (3,383 | )      |  | $ |              |        |   | $ | 132,529 |        
|December 31, 2002             |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |        
|Total assets                  |                                            | $ | 422,389 |         |     | $ |      |   |              | $ | 9,732  |        |  | $ | (14,334       | )      |   | $ | 417,787 |        
|                              |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |         | 
|2001                          |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |        
|Revenues:                     |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |        
|                              | Product revenues                           |   | $       | 36,505  |     |   | $     |  |              |   | $      | 10,031 |  |   | $             |       |   |   | $       | 46,536  | 
|                              | Service revenues                           |   |         | 9,584   |     |   |       |  |              |   |        | 1,655  |  |   |               |       |   |   |         | 11,239  | 
|                              | Contract research and development revenues |   |         |        |     |   |       |  |              |   |        | 16,556 |  |   |               |       |   |   |         | 16,556  | 
|                              | Intercompany revenues                      |   |         | 22      |     |   |       |  |              |   |        | 110    |  |   |               | (132   | ) |   |         |        | 
|                              |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |         | 
|Total revenues                |                                            | $ | 46,111  |         |     | $ |      |   |              | $ | 28,352 |        |  | $ | (132          | )      |   | $ | 74,331  |        
|Income (loss) from operations |                                            | $ | 3,888   |         |     | $ |      |   |              | $ | (1,217 | )      |  | $ |              |        |   | $ | 2,671   |        
|December 31, 2001             |                                            |   |         |         |     |   |       |   |              |   |        |        |  |   |               |        |   |   |         |        
|Total assets                  |                                            | $ | 86,814  |         |     | $ |      |   |              | $ | 13,740 |        |  | $ | (10,821       | )      |   | $ | 89,733  |        

At December 31, 2003, the Company has accounts receivable from customers
located in the United States, Europe, the Middle East, Asia Pacific and other
areas of $24.4 million, $27.6 million, $559,000, $3.9 million and $415,000,
respectively. The only customer that represented 10% or more of total revenues
was the FAA/TSA with 57%, 82% and 29% for 2003, 2002 and 2001, respectively.

The Company markets its products both domestically and internationally.
Total revenues by geographic region, based on the location of the customer
placing the order, are as follows (in thousands):

|              |                             |   |                         |         |      |   |         |         |  |   |        |        | 
|------------- | --------------------------- | - | ----------------------- | ------- | ---- | - | ------- | ------- |  | - | ------ | ------ | 
|              |                             |   | Year Ended December 31,
|              |                             |   |                        
|              |                             |   | 2003                    |         | 2002 |   | 2001   
|              |                             |   |                         |         |      |   |        
|United States |                             | $ | 295,896                 |         |      | $ | 387,810 |         |  | $ | 50,157 |       
|              |                             |   |                         |         |      |   |         |         |  |   |        |        | 
|Europe        |                             |   | 81,068                  |         |      |   | 38,473  |         |  |   | 17,099 |       
|Middle East   |                             |   | 5,224                   |         |      |   | 3,214   |         |  |   | 3,170  |       
|Asia Pacific  |                             |   | 20,219                  |         |      |   | 3,483   |         |  |   | 1,099  |       
|Other         |                             |   | 14,090                  |         |      |   | 6,151   |         |  |   | 2,806  |       
|              |                             |   |                         |         |      |   |         |         |  |   |        |       
|              | Total all foreign countries |   |                         | 120,601 |      |   |         | 51,321  |  |   |        | 24,174 | 
|              |                             |   |                         |         |      |   |         |         |  |   |        |       
|              | Total worldwide revenues    |   | $                       | 416,497 |      |   | $       | 439,131 |  |   | $      | 74,331 | 
|              |                             |   |                         |         |      |   |         |         |  |   |        |       

Substantially all of the Companys long-lived assets are located in the
United States.

NOTE 12. RELATED PARTY TRANSACTIONS

In connection with Messrs. Blum and Turpen joining the Companys board of
directors in 2001, each of these directors received a grant to purchase 20,000
shares of the Companys common stock, which grants vested over a four-year
period. In February 2002, the board of directors amended these grants to cause
them to vest over a one-year period. If either Mr. Blum or Mr. Turpen ceases to
be a director prior to four years from the original date of grant, we will be
required to take a compensation charge equal to the difference between the fair
market value of our common stock on the date of the amendment and the exercise
price of the option, multiplied by the number of vested shares that would not
have vested had the option not been amended.

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In late September 2001, the Company entered into an agreement with Donald
& Co. for investment advisory services related to a potential acquisition and
fundraising activities. The Company considered other alternatives and chose
Donald & Co. to provide these services because time was of the essence and it
was able to react quickly to meet the Companys business requirements based on
its familiarity with the Companys business. Steven Blum, one of the members of
the Companys board of directors, was the president of Donald & Co. at such
time. The board approved this agreement with Mr. Blum abstaining. Under this
agreement, Donald & Co. received a $50,000 cash retainer and a fully-vested
warrant to purchase 100,000 shares of the Companys common stock at a price of
$9.95 per share, the closing price of the Companys common stock on the day
prior to the date of issuance. The board considered this fee to be comparable
to other alternatives given the circumstances of the engagement. The warrant
expires five years from date of issuance. The fair value of the warrant was
$650,000, which was estimated on the date of grant using the Black-Scholes
option pricing model with the following assumptions: no dividends, risk-free
interest rate of 3.94%, volatility of 78% and a contractual life of five years.
In September 2002, the Company issued 100,000 shares of common stock under the
warrant. However, in lieu of paying cash for the shares, 34,153 shares valued
at $29.13 per share were returned to the Company to settle the transaction.
Such shares were recorded as treasury stock. The Company has allocated
one-half of the cash retainer and warrant to on-going investment and financial
advisory services, which was originally recorded in other current assets and
then amortized over the one-year term of the agreement. The Company recorded
amortization expense of $262,000 in 2002 and $88,000 in 2001. The Company has
allocated the remaining balance of $350,000 to services provided in connection
with the Companys follow-on offering in April 2002, which was netted against
the proceeds from the offering.

In August 1996, January 1997 and January 1999, the Company entered into
consulting agreements with BGI, Inc., a Virginia-based international consulting
firm, to assist it with the marketing of its EDS products to the U.S.
government. Under these agreements, the Company agreed to pay an annual
retainer to BGI and a success fee payable 25% in stock or stock options. In
November 2000, BGI agreed to convert all of the accrued stock portion of its
accumulated success fees and agreed to cancel an option to purchase 6,586
shares of common stock in consideration for an agreement by the Company to
issue 20,468 shares of common stock to BGI. In 2000, the Company recorded
consulting expenses of $108,000 for this common stock. The Company issued 9,552
shares of common stock in 2001 and the remaining 10,916 shares of common stock
in 2002. In March 1998, Morris Busby, president and a controlling shareholder
of BGI, was elected to the Companys board of directors. Following Ambassador
Busbys election, the Company continued this arrangement because it felt that
BGI continued to provide needed services to it at comparable market rates. The
Company paid consulting fees to BGI of $120,000 in 2000. This arrangement
expired on December 31, 2000.

NOTE 13. LICENSE AGREEMENTS

In connection with the formation of the Company, the Company obtained an
exclusive, worldwide, and fully-paid license from Imatron, Inc. regarding its
patents and know-how related to (1) scanners for inspection of mail, freight,
parcels, baggage and wood products, and (2) compact medical scanners for
military field applications. The license allows the Company to develop,
manufacture and sell systems based on a different type of CT technology than is
currently incorporated in the Companys CTX Series. The Company, in exchange,
granted to Imatron an exclusive, worldwide and fully paid license under the
Companys then existing or future patents and know-how to permit Imatron to
utilize such technology in medical scanners other than compact medical scanners
for military field applications. The license expires in 2009. No royalties have
been paid under this license.

In April 1998, Yxlon entered into an LI-Contribution Contract with Philips
GmbH (Philips). This agreement is a non-exclusive, worldwide license for
coherent scatter X-ray technology. Yxlon is subject to royalty payments based
upon the net sales price of certain products sold by Yxlon. There is no minimum
royalty payment. Since the acquisition of Yxlon on March 31, 2003, Yxlon has
paid 149,169 under this license.

In April 1999, Quantum entered into a Technology License Agreement with
International Business Machines Corporation (IBM). This agreement is a
ten-year, non-exclusive, non-transferable, worldwide license for certain
detection technology. A one-time license fee was paid to IBM. Quantum is
subject to royalty payments based upon the net sales price of certain products
sold or otherwise transferred by IBM. There is no minimum royalty payment. No
royalties have been paid under this license.

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In June 1997, Quantum entered into a joint venture to perform research and
development related to certain detection technologies. In exchange for a 38%
ownership interest in the joint venture, Quantum granted a non-exclusive,
royalty free, perpetual, transferable sub-license on the Superconductor
Technology, agreed that the joint venture will be the sole source of
fabrication and testing of products developed by the joint venture, and agreed
to guarantee one-half of a $200,000 working capital loan to the joint venture.
In connection with the formation of the joint venture, Quantum sold equipment
to the joint venture in exchange for an eleven-year note receivable of
$100,000, bearing interest at 6.7% per annum. In January 1999, Quantum sold
sufficient shares to reduce its ownership in the joint venture to 10% and was
released from its obligation to guarantee one-half of the working capital loan
to the joint venture.

In March 1995, Quantum executed a ten-year exclusive license agreement
with a third party. Quantum is subject to royalty payments based on a
percentage of the net sales price of certain products made, used or sold.
Minimum annual royalties of $20,000 are due beginning in calendar year 1997
through the remaining term of the agreement. Quantum did not incur royalty
expense under this agreement in 1995 or 1996, and paid the minimum royalty of
$20,000 in 1997 and 1998. In January 1999, Quantum and the licensor agreed to
modify the license by expanding the field of use, increasing the minimum annual
royalty to $70,000 and extending the term until January 2009. Quantum paid a
one-time fee of $50,000 to obtain such modification and extension and made the
minimum annual royalty of $70,000 for each of the years 1999 through 2003.

NOTE 14. CONTINGENCIES

InVision and its subsidiary, Quantum Magnetics, together with many other
entities, were named as defendants in a number of lawsuits in approximately 110
products liability lawsuits by individual plaintiffs seeking damages for
wrongful death relating to the terrorist acts of September 11, 2001. The
litigation in connection with the terrorist acts of September 11, 2001 have
been consolidated in In re: September 11 Litigation, 21 MC 97 (AKH); Lopez, et
al v. United Airlines, et al., 1:02-cv-458, United States District Court for
the Southern District of New York. InVision and Quantum Magnetics
have been served with 39 complaints that remain active. Each of the active complaints with which the Company has been served
alleges that the defendants breached a duty to airplane passengers and others
by failing to properly screen passengers and carry-on baggage for dangerous
weapons. The Company believes that the plaintiffs claims lack merit,
especially in light of the fact that the Company did not, as of September 11,
2001, have any passenger or carry-on baggage screening equipment at security
checkpoints in any of the airports from which the hijacked airplanes departed.
The Company was recently advised by the Plaintiffs' Executive
Committee that InVision and Quantum Magnetics will be dismissed as
defendants from all active complaints on or before March 31, 2004,
plaintiffs' deadline to file and serve amended Master Complaints. If
InVision and Quantum Magnetics are not dismissed, the Company must
answer or otherwise respond to any amended Master Complaints in which
we are listed as defendants by April 30, 2004 and must answer or
otherwise respond to plaintiffs' individual complaints by May 15,
2004. The Company intends to vigorously defend any of these lawsuits
in which InVision or Quantum Magnetics continue to be named as
defendants.

The Company is involved in legal proceedings, claims and litigation
arising in the ordinary course of business. While the outcome of these matters
is currently not determinable, the Companys management does not believe that
the ultimate cost to resolve these matters will have a material adverse effect
on the Companys consolidated financial condition, results of operations or
cash flows.

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NOTE 15. BALANCE SHEET COMPONENTS

(in thousands)

|                                      |                                                 |          |      |              |        |      |      |         |         | 
|------------------------------------- | ----------------------------------------------- | -------- | ---- | ------------ | ------ | ---- | ---- | ------- | ------- | 
|                                      |                                                 |          |      | December 31,
|                                      |                                                 |          |      |             
|                                      |                                                 |          |      | 2003         |        | 2002
|                                      |                                                 |          |      |              |        |     
|Accounts receivable, net:             |                                                 |          |      |              |        |      |      |        
|                                      | Billed                                          |          | $    | 45,368       |        |      | $    | 89,241  |        
|                                      | Unbilled                                        |          |      | 9,687        |        |      |      | 54,396  |        
|                                      | Other receivables                               |          |      | 2,726        |        |      |      | 3,042   |        
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Subtotal |      |              | 57,781 |      |      |         | 146,679 | 
|Less: allowance for doubtful accounts |                                                 |          | (830 | )            |        |      | (384 | )      
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Total    |      | $            | 56,951 |      |      | $       | 146,295 | 
|                                      |                                                 |          |      |              |        |      |      |         |        
|Inventories:                          |                                                 |          |      |              |        |      |      |        
|                                      | Raw material and purchased components           |          | $    | 22,821       |        |      | $    | 22,696  |        
|                                      | Field service spare parts                       |          |      | 27,805       |        |      |      | 16,145  |        
|                                      | Work-in-process                                 |          |      | 10,123       |        |      |      | 21,927  |        
|                                      | Finished goods                                  |          |      | 18,145       |        |      |      | 3,996   |        
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Total    |      | $            | 78,894 |      |      | $       | 64,764  | 
|                                      |                                                 |          |      |              |        |      |      |         |        
|Property and equipment, net:          |                                                 |          |      |              |        |      |      |        
|                                      | Machinery and equipment                         |          | $    | 20,962       |        |      | $    | 10,864  |        
|                                      | Self constructed assets                         |          |      | 3,770        |        |      |      | 5,670   |        
|                                      | Furniture and fixtures                          |          |      | 1,524        |        |      |      | 1,383   |        
|                                      | Leasehold improvements                          |          |      | 4,578        |        |      |      | 3,804   |        
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Subtotal |      |              | 30,834 |      |      |         | 21,721  | 
|                                      | Less: accumulated depreciation and amortization |          |      | (19,229      | )      |      |      | (14,496 | )      
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Total    |      | $            | 11,605 |      |      | $       | 7,225   | 
|                                      |                                                 |          |      |              |        |      |      |         |        
|Intangible assets                     |                                                 |          |      |              |        |      |      |        
|                                      | Developed technologies                          |          | $    | 11,325       |        |      | $    | 1,535   |        
|                                      | Trademarks                                      |          |      | 2,796        |        |      |      |        |        
|                                      | Patents                                         |          |      | 510          |        |      |      | 428     |        
|                                      | Other                                           |          |      | 2,480        |        |      |      | 133     |        
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Subtotal |      |              | 17,111 |      |      |         | 2,096   | 
|                                      | Less: accumulated amortization                  |          |      | (3,133       | )      |      |      | (1,174  | )      
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Total    |      | $            | 13,978 |      |      | $       | 922     | 
|                                      |                                                 |          |      |              |        |      |      |         |        
|Accrued liabilities:                  |                                                 |          |      |              |        |      |      |        
|                                      | Warranty and other reserves                     |          | $    | 14,259       |        |      | $    | 19,890  |        
|                                      | Accrued employee compensation                   |          |      | 10,409       |        |      |      | 7,540   |        
|                                      | Income taxes                                    |          |      | 255          |        |      |      | 17,919  |        
|                                      | Foreign exchange forward contracts              |          |      | 1,436        |        |      |      | 4,948   |        
|                                      | Other                                           |          |      | 8,699        |        |      |      | 15,067  |        
|                                      |                                                 |          |      |              |        |      |      |         |        
|                                      |                                                 | Total    |      | $            | 35,058 |      |      | $       | 65,364  | 
|                                      |                                                 |          |      |              |        |      |      |         |        

Unbilled receivables are comprised of those amounts billable to customers
upon satisfaction of certain activities, such as installation and final
acceptance, amounts under percentage-of-completion contracts which are not yet
billed at the balance sheet date and other amounts not yet billed due to timing
of invoice preparation.

Self-constructed assets are manufactured by the Company for use in system
testing and support, and include the cost of parts and materials and an
overhead allocation. The Company depreciates self-constructed assets over their
respective estimated useful lives, which range from three to five years.

F-28



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##### Table of Contents



During the years ended December 31, 2003, 2002 and 2001, the Company
recorded amortization expense for its intangible assets of $1,959,000,
$324,000 and $794,000, respectively. Expected future amortization expense for
intangibles balances at December 31, 2003 are as follows:

|                                     |  |      |       |      |  |      |       |      |  |      |       |            |  |   |       |  |  |   |       |  |  |   |       | 
|------------------------------------ |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ----- | ---------- |  | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|(in thousands)                       |  | 2004 |       | 2005 |  | 2006 |       | 2007 |  | 2008 |       | Thereafter
|                                     |  |      |       |      |  |      |       |      |  |      |       |           
|Expected future
amortization
expense |  | $    | 2,256 |      |  | $    | 1,813 |      |  | $    | 1,711 |            |  | $ | 1,668 |  |  | $ | 1,590 |  |  | $ | ,1984 | 

At December 31, 2003 and 2002, the Company had $882,000 and $366,000,
respectively, of capitalized lease equipment and related accumulated
amortization of $326,000 and $250,000, respectively.

NOTE 16.  SUBSEQUENT EVENTS

Product Delivery Order

On March
12, 2004, the TSA issued a delivery order to the Company
for CTX 9000 DSi systems for integration into the baggage handling
systems of certain airports in the United States. The delivery order
for the new systems is valued at $108.0 million. This delivery order
was made under a new three year agreement with the TSA announced by
the Company on August 12, 2003, and includes $3.2 million for
reliability improvements measured over the next twelve months. The
TSA has no obligation to place additional delivery orders or purchase
additional engineering and installation support under that agreement.

Change in Control Arrangement

On
March 15, 2004, the Company entered into an Agreement and Plan of Merger
(the Merger Agreement) with GE and Jet Acquisition Sub, Inc., a wholly owned
subsidiary of GE (Merger Sub). Pursuant to, and subject to the conditions
contained in, the Merger Agreement: (i) GE would acquire the
Company through the
merger of Merger Sub with and into the Company (the Merger) and (ii) at the
effective time of the Merger, each outstanding share of the Companys common stock
would be converted into the right to receive $50.00 in cash. The Merger is
subject to customary closing conditions, including the approval of
the Companys
stockholders and the expiration or termination of waiting periods under U.S.
and applicable foreign antitrust laws.

F-29



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##### Table of Contents



SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

|                                      |  |         |         |         |  |          |        |         |  |   |        |  |  |   |        | 
|------------------------------------- |  | ------- | ------- | ------- |  | -------- | ------ | ------- |  | - | ------ |  |  | - | ------ | 
|Quarter ended 2003                    |  | Mar. 30 |         | Jun. 29 |  | Sept. 28 |        | Dec. 31
|                                      |  |         |         |         |  |          |        |        
|(in thousands, except per share data) |  |         |         |         |  |          |        |         |  |   |        | 
|Total revenues                        |  | $       | 165,168 |         |  | $        | 89,427 |         |  | $ | 86,118 |  |  | $ | 75,784 | 
|Gross profit                          |  |         | 73,358  |         |  |          | 35,875 |         |  |   | 33,697 |  |  |   | 29,586 | 
|Net income                            |  |         | 34,407  |         |  |          | 6,975  |         |  |   | 9,276  |  |  |   | 6,288  | 
|Basic income per share                |  |         | 2.02    |         |  |          | 0.41   |         |  |   | 0.54   |  |  |   | 0.37   | 
|Diluted income per share              |  |         | 1.87    |         |  |          | 0.38   |         |  |   | 0.50   |  |  |   | 0.34   | 

|                                      |  |         |        |         |  |          |        |         |  |   |         |  |  |   |         | 
|------------------------------------- |  | ------- | ------ | ------- |  | -------- | ------ | ------- |  | - | ------- |  |  | - | ------- | 
|Quarter ended 2002                    |  | Mar. 31 |        | Jun. 30 |  | Sept. 29 |        | Dec. 31
|                                      |  |         |        |         |  |          |        |        
|(in thousands, except per share data) |  |         |        |         |  |          |        |         |  |   |         | 
|Total revenues                        |  | $       | 33,198 |         |  | $        | 68,426 |         |  | $ | 117,060 |  |  | $ | 220,447 | 
|Gross profit                          |  |         | 13,424 |         |  |          | 28,436 |         |  |   | 50,043  |  |  |   | 92,992  | 
|Net income                            |  |         | 2,818  |         |  |          | 9,606  |         |  |   | 21,473  |  |  |   | 44,397  | 
|Basic income per share                |  |         | 0.21   |         |  |          | 0.58   |         |  |   | 1.28    |  |  |   | 2.62    | 
|Diluted income per share              |  |         | 0.17   |         |  |          | 0.52   |         |  |   | 1.17    |  |  |   | 2.40    | 

F-30



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##### Table of Contents



InVision Technologies, Inc.
Schedule II  Valuation and Qualifying Accounts
Years Ended December 31, 2003, 2002, and 2001
(in thousands)

|                                |  |            |     |            |  |            |     |            |  |                   |    |                         |  |            |     |  |  |   |     |  |  |   |     | 
|------------------------------- |  | ---------- | --- | ---------- |  | ---------- | --- | ---------- |  | ----------------- | -- | ----------------------- |  | ---------- | --- |  |  | - | --- |  |  | - | --- | 
|                                |  |            |     |            |  | Additions  |     |            |  |                   |    |                         |  |            |     |  |  |  
|                                |  |            |     |            |  |            |     |            |  |                   |    |                         |  |            |     |  |  |  
|                                |  | Balance at |     | Charged to |  | Charged to |     |            |  |                   |    | Increase resulting from |  | Balance at
|                                |  | beginning  |     | costs and  |  | other      |     |            |  |                   |    | Yxlon acquisition       |  | end of    
|                                |  | of period  |     | expenses   |  | accounts   |     | Deductions |  | on March 31, 2003 |    | period                 
|                                |  |            |     |            |  |            |     |            |  |                   |    |                        
|Allowance for doubtful accounts |  |            |     |            |  |            |     |            |  |                   |    |                         |  |            |     |  |  |   |     |  |  |   |     | 
|2003                            |  | $          | 384 |            |  | $          | 300 |            |  | $                 | 11 |                         |  | $          | 335 |  |  | $ | 470 |  |  | $ | 830 | 
|2002                            |  | $          | 355 |            |  | $          | 170 |            |  | $                 |   |                         |  | $          | 141 |  |  | $ |    |  |  | $ | 384 | 
|2001                            |  | $          | 302 |            |  | $          | 168 |            |  | $                 |   |                         |  | $          | 115 |  |  | $ |    |  |  | $ | 355 | 

F-31



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##### Table of Contents






EXHIBIT INDEX

|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|2.1         |  | Share and Purchase Transfer Agreement dated as of February 21, 2003 among the registrant,
Yxlon Beteiligungs-Verwaltung GmbH, NDT International Holdings A.S, Yxlon International
Holding GmbH, Yxlon International X-Ray GmbH, Joseph Kosanetzky,
Reinhard Bonisch and Botts &
Company Ltd. Certain schedules have been omitted. The registrant agrees to furnish
supplementally a copy of any omitted schedule to the Commission upon request. (1)
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|2.2         |  | Agreement and Plan of Merger, dated as of March 15, 2004, among
the registrant, General Electric Company and Jet Acquisition Sub, Inc.                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|3.1         |  | Amended and Restated Certificate of Incorporation of the registrant. (2)                                                                                                                                                                                                                                                                                                                                                                            
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|3.2         |  | Amendment to Amended and Restated Certificate of Incorporation of the registrant. (3)                                                                                                                                                                                                                                                                                                                                                               
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|3.3         |  | Bylaws of the registrant, as amended. (4)                                                                                                                                                                                                                                                                                                                                                                                                           
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|4.1         |  | Reference is made to Exhibits 3.1 through 3.3.                                                                                                                                                                                                                                                                                                                                                                                                      
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|4.2         |  | Indenture, dated as of September 19, 2003, between the registrant and U.S. Bank National
Association, as Trustee. (5)                                                                                                                                                                                                                                                                                                                               
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|4.3         |  | Registration Rights Agreement, dated as of September 19, 2003 between the registrant and
Merrill Lynch, Pierce, Fenner & Smith Incorporated. (5)                                                                                                                                                                                                                                                                                                    
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|4.4         |  | Form of Note for the registrants 3% Convertible Senior Notes due October 1, 2023. (5)                                                                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.1        |  | Technology License Agreement, dated September 11, 1990, by and between the registrant and
Imatron, Inc. (6)                                                                                                                                                                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.2        |  | Registrants 2000 Equity Incentive Plan, as amended. (7)                                                                                                                                                                                                                                                                                                                                                                                           
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.3        |  | Registrants 2002 Employee Stock Purchase Plan. (8)                                                                                                                                                                                                                                                                                                                                                                                                
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.4        |  | Lease, dated as of February 11, 1997, between the registrant and WHLNF Real Estate L.P. (9)                                                                                                                                                                                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.5        |  | Amendment No. 1 to Technology License Agreement between the registrant and Imatron, Inc.
dated July 12, 1999. (10)                                                                                                                                                                                                                                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.6        |  | Form of Indemnity Agreement between the registrant and each of Sergio Magistri, David Pillor,
Giovanni Lanzara, Bruno Trezza, Douglas Boyd and Morris Busby. (10)                                                                                                                                                                                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.7        |  | Registrants 1991 Equity Incentive Plan. (11)                                                                                                                                                                                                                                                                                                                                                                                                      
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.8        |  | Registrants 2000 Non-Officer Equity Incentive Plan, adopted February 14, 2000. (12)                                                                                                                                                                                                                                                                                                                                                                
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.9        |  | Form of Indemnity Agreement between the registrant and each of Donald E. Mattson and Ross
Mulholland. (13)                                                                                                                                                                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.10       |  | Delivery Order #2 from the TSA. (15) *                                                                                                                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.11       |  | Delivery Order #3 from the TSA. (15) *                                                                                                                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.12       |  | Amended Delivery Order #2 from the TSA. (16) *                                                                                                                                                                                                                                                                                                                                                                                                      
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.13       |  | Amended Delivery Order #3 from the TSA. (16) *                                                                                                                                                                                                                                                                                                                                                                                                      
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.14       |  | Delivery Order #4 from the TSA. (16) *                                                                                                                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.15       |  | Amendment to Delivery Order #2. (16) *                                                                                                                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.16       |  | Amendment to Delivery Order #3. (16) *                                                                                                                                                                                                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.17       |  | First Amendment to Lease Agreement, dated December 10, 1997, between the registrant and WHLNF
Real Estate Limited Partnership. (16)                                                                                                                                                                                                                                                                                                                 





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##### Table of Contents



|            |  |                                                                                                                                           
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                               
|            |  |                                                                                                                                           
|10.18       |  | Second Amendment to Lease Agreement, dated July 1, 2002, between the registrant and DMV SUB 4
LLC. (16)                                   
|            |  |                                                                                                                                           
|10.19       |  | Change in Control Equity Acceleration Plan. (17)                                                                                         
|            |  |                                                                                                                                           
|10.20       |  | Senior Management Key Employee Agreement dated as of September 20, 2002 between the
registrant and Sergio Magistri. (17)                 
|            |  |                                                                                                                                           
|10.21       |  | Senior Management Key Employee Agreement dated as of September 20, 2002 between the
registrant and David Pillor. (17)                    
|            |  |                                                                                                                                           
|10.22       |  | Senior Management Key Employee Agreement dated as of September 29, 2002 between the
registrant and Ross Mulholland. (17)                 
|            |  |                                                                                                                                           
|10.23       |  | Senior Management Key Employee Agreement dated as of October 4, 2002 between the
registrant and Don Mattson. (17)                        
|            |  |                                                                                                                                           
|10.24       |  | Delivery Order #5 from the TSA. (17) *                                                                                                    
|            |  |                                                                                                                                           
|10.25       |  | Delivery Order #6 from the TSA. (17) *                                                                                                    
|            |  |                                                                                                                                           
|10.26       |  | Single-Tenant Net Lease Agreement executed on October 4, 2002 between Carmel Mountain #8
Associates, L.P. and Quantum Magnetics, Inc. (18)
|            |  |                                                                                                                                           
|10.27       |  | Vice President Key Employee Agreement dated as of May 1, 2002 between the registrant and
Andrew Siegel. (1)                              
|            |  |                                                                                                                                           
|10.28       |  | Solicitation, Offer and Award dated August 5, 2003, between the registrant and the TSA (the
Frame Agreement). (5) *                     
|            |  |                                                                                                                                           
|10.29       |  | Delivery Order #1 from the TSA under the Frame Agreement. (5) *                                                                           
|            |  |                                                                                                                                           
|10.30       |  | Amendment of Solicitation/Modification of Contract between the Company and the TSA (the
Definitized Letter Agreement). (5) *            
|            |  |                                                                                                                                           
|10.31       |  | Delivery Order #8 from the TSA under the Definitized Letter Agreement. (5) *                                                              
|            |  |                                                                                                                                           
|10.32       |  | Amendment to Delivery Order #5 from the TSA under the Definitized Letter
Agreement. (5) *                                                 
|            |  |                                                                                                                                           
|10.33       |  | Amendment to Delivery Order #3 from the TSA under the Definitized Letter
Agreement. (5) *                                                 
|            |  |                                                                                                                                           
|10.34       |  | Loan and Security Agreement, dated December 8, 2003, between the registrant and Silicon
Valley Bank.                                      
|            |  |                                                                                                                                           
|14.1        |  | Code of Ethics and Business Conduct.                                                                                                      
|            |  |                                                                                                                                           
|21.1        |  | Subsidiaries of the registrant.                                                                                                           
|            |  |                                                                                                                                           
|23.1        |  | Consent of Deloitte & Touche LLP, Independent Auditors.                                                                                   
|            |  |                                                                                                                                           
|31.1        |  | Section 302 Certification of Chief Executive Officer.                                                                                     
|            |  |                                                                                                                                           
|31.2        |  | Section 302 Certification of Chief Financial Officer.                                                                                     
|            |  |                                                                                                                                           
|32.1        |  | Certificate of Chief Executive Officer and Chief Financial Officer.                                                                       



|(1) |  | Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended March 30, 2003 and incorporated herein by
reference.         
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-05517) and incorporated herein by reference.                                  
|   
|(3) |  | Filed as an exhibit to the registrants Amendment No. 1 to Annual Report
on Form 10-K/A for the year ended December 31, 2001 and incorporated
herein by reference.
|   
|(4) |  | Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended June 29, 2003 and incorporated herein by
reference.          





---



##### Table of Contents





|(5)  |  | Filed as an exhibit to the registrants Registration Statement on Form
S-3 (No. 333-110289) and incorporated herein by reference.                            
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(6)  |  | Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-380) and incorporated herein by reference.                               
|    
|(7)  |  | Filed as an exhibit to the registrants Registration Statement on Form
S-8 (No. 333-103016) filed February 6, 2003 and incorporated herein by
reference.     
|    
|(8)  |  | Filed as an exhibit to the registrants Registration Statement on Form
S-8 (No. 333-91154) filed June 25, 2002 and incorporated herein by
reference.         
|    
|(9)  |  | Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-23413) and incorporated herein by reference.                             
|    
|(10) |  | Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 1999 and incorporated herein by reference.                
|    
|(11) |  | Filed as an exhibit to the registrants Registration Statement on Form
S-8 (No. 333-56340) filed February 28, 2001 and incorporated herein by
reference.     
|    
|(12) |  | Filed as an exhibit to registrants Quarterly Report on Form 10-Q for the
quarter ended April 2, 2000 and incorporated herein by reference.                  
|    
|(13) |  | Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended April 1, 2001 and incorporated herein by
reference.     
|    
|(14) |  | Filed as an exhibit to registrants Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2001 and incorporated herein by
reference.    
|    
|(15) |  | Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2002 and incorporated herein by
reference.    
|    
|(16) |  | Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 2002 and incorporated herein by
reference.     
|    
|(17) |  | Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarterly period ended September 29, 2002 and incorporated herein by
reference.
|    
|(18) |  | Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 2002 and incorporated herein by reference.                
|    
|    |  | Items that are management contracts or compensatory plans or arrangements
required to be filed as exhibits pursuant to Item 15(c) of Form 10-K.              
|    
|*    |  | Confidential treatment has been requested for portions of this exhibit.