**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC  20549**

 

 

**FORM 10-Q**

 

**(MarkOne)**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**Forthe quarterly period ended June 30, 2002 or**

 

| **o**  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                  |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | **For  the transition period  from          to          ** |

 

**CommissionFile Number: 0-28236**

 

 

**INVISION TECHNOLOGIES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    |
|-----------------------------------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |
|                                                            |
| **94-3123544**                                                  |
| (I.R.S. Employer  Identification No.)                           |
|                                                            |
| **7151 Gateway Boulevard, Newark, CA  94560**                   |
| (Address of  principal executive offices, including zip code)   |
|                                                            |
| **(510) 739-2400**                                              |
| (Registrant’s telephone  number, including area code)      |

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  ý  No  o

 

On August 8, 2002, therewere 16,697,370 shares of the Registrant’s Common Stock outstanding.

 

 

----

 

**InVision Technologies, Inc.**

**Form10-Q**

**INDEX**

 
| **Part  I.   FINANCIAL INFORMATION** |                                                                                        |
|------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                           |                                                                                        |   |
| **Item**                                       |                                                                                        |
|                                           |                                                                                        |   |
| 1.                                             | Financial Statements  (Unaudited)                                                           |   |
|                                           |                                                                                        |   |
|                                           | a.                                                                                          | Condensed  Consolidated Balance Sheets - June 30, 2002 and December 31, 2001 |
|                                           |                                                                                        |   |
|                                           | b.                                                                                          | Condensed  Consolidated Statements of Operations - Three months and six months ended  June 30, 2002 and July 1, 2001 |
|                                           |                                                                                        |   |
|                                           | c.                                                                                          | Condensed  Consolidated Statements of Cash Flows - Six months ended June 30, 2002 and  July 1, 2001 |
|                                           |                                                                                        |   |
|                                           | d.                                                                                          | Notes  to Condensed Consolidated Financial Statements |
|                                           |                                                                                        |   |
| 2.                                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                           |                                                                                        |   |
| 3.                                             | Quantitative  and Qualitative Disclosures about Market Risk                                 |   |
|                                           |                                                                                        |   |
| **Part  II.   OTHER INFORMATION**    |                                                                                        |
|                                           |                                                                                        |   |
| **Item**                                       |                                                                                        |
|                                           |                                                                                        |   |
| 1.                                             | Legal Proceedings                                                                           |   |
|                                           |                                                                                        |   |
| 2.                                             | Changes  in Securities and Use of Proceeds                                                  |   |
|                                           |                                                                                        |   |
| 3.                                             | Defaults Upon  Senior Securities                                                            |   |
|                                           |                                                                                        |   |
| 4.                                             | Submission  of Matters to a Vote of Security Holders                                        |   |
|                                           |                                                                                        |   |
| 5.                                             | Other Information                                                                           |   |
|                                           |                                                                                        |   |
|                                           |                                                                                        |   |
| 6.                                             | Exhibits and Reports  on Form 8-K                                                           |   |
|                                           |                                                                                        |   |
| Signature Page                                 |                                                                                        |
|                                                |                                                                                             |  |  |

 

2

----

 

**PARTI.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**InVisionTechnologies, Inc.**

**CondensedConsolidated Balance Sheets**

**(Inthousands, except share data)**

**(Unaudited)**

 
|                                                                                                                                                                  |   | **June 30,  2002** |       | **December 31,  2001** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                                                                  |   |               | ** ** |                   | ** ** |
| **Assets**                                                                                                                                                            |   |               |       |                   |       |
|                                                                                                                                                                  |   |               |       |                   |       |
| Current  assets:                                                                                                                                                      |   |               |       |                   |       |
| Cash  and cash equivalents                                                                                                                                            |   | $                  | 187,010    |                   | $          | 11,386 |   |
| Short-term  investments                                                                                                                                               |   | —             |       | 1,992                  |       |
| Accounts  receivable, net                                                                                                                                             |   | 54,200             |       | 27,239                 |       |
| Inventories                                                                                                                                                           |   | 65,472             |       | 27,104                 |       |
| Deferred  income taxes                                                                                                                                                |   | 4,975              |       | 4,082                  |       |
| Other  current assets                                                                                                                                                 |   | 15,484             |       | 5,464                  |       |
| Total  current assets                                                                                                                                                 |   | 327,141            |       | 77,267                 |       |
|                                                                                                                                                                  |   |               |       |                   |       |
| Property  and equipment, net                                                                                                                                          |   | 6,236              |       | 5,713                  |       |
| Deferred  income taxes                                                                                                                                                |   | 1,289              |       | 2,237                  |       |
| Intangible  assets, net                                                                                                                                               |   | 3,859              |       | 4,011                  |       |
| Other  assets                                                                                                                                                         |   | 154                |       | 505                    |       |
| Total  assets                                                                                                                                                         |   | $                  | 338,679    |                   | $          | 89,733 |   |
|                                                                                                                                                                  |   |               |       |                   |       |
| **Liabilities and stockholders’ equity**                                                                                                                         |   |               |       |                   |       |
|                                                                                                                                                                  |   |               |       |                   |       |
| Current  liabilities:                                                                                                                                                 |   |               |       |                   |       |
| Accounts  payable                                                                                                                                                     |   | $                  | 31,512     |                   | $          | 8,375 |   |
| Accrued  liabilities                                                                                                                                                  |   | 23,965             |       | 12,822                 |       |
| Deferred  revenue                                                                                                                                                     |   | 116,037            |       | 4,377                  |       |
| Short-term  debt                                                                                                                                                      |   | 1,364              |       | 1,880                  |       |
| Current  maturities of long-term obligations                                                                                                                          |   | 184                |       | 179                    |       |
| Total  current liabilities                                                                                                                                            |   | 173,062            |       | 27,633                 |       |
|                                                                                                                                                                  |   |               |       |                   |       |
| Long-term  obligations                                                                                                                                                |   | 670                |       | 680                    |       |
|                                                                                                                                                                  |   |               |       |                   |       |
| Commitments  and contingencies                                                                                                                                        |   |               |       |                   |       |
|                                                                                                                                                                  |   |               |       |                   |       |
| Stockholders’  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 and 20,000,000 shares authorized;  16,876,000 and 13,730,000 shares issued; 16,675,000 and 13,539,000 shares  outstanding |   | 17                 |       | 14                     |       |
| Additional  paid-in capital                                                                                                                                           |   | 159,548            |       | 66,011                 |       |
| Deferred  stock compensation expense                                                                                                                                  |   | (474               | )          | —                 |       |
| Accumulated  other comprehensive loss                                                                                                                                 |   | (1,911             | )          | —                 |       |
| Retained  earnings (accumulated deficit)                                                                                                                              |   | 8,966              |       | (3,458                 | )          |
| Treasury  stock, at cost (201,000 and 191,000 shares)                                                                                                                 |   | (1,199             | )          | (1,147                 | )          |
| Total  stockholders’ equity                                                                                                                                      |   | 164,947            |       | 61,420                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                      |   | $                  | 338,679    |                   | $          | 89,733 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

3

----

 

**InVisionTechnologies, Inc.**

**CondensedConsolidated Statements of Operations**

**(Inthousands, except per share data)**

**(Unaudited)**

 
|                                       |   | **Three Months Ended** |       | **Six Months Ended** |       |
|--------------------------------------------|--------|------------------------|------------|----------------------|------------|
|                                       |   | **June 30,  2002**     |       | **July 1,  2001**    |       | **June 30,  2002** |   | **July 1,  2001** |   |
|                                       |   |                   | ** ** |                 | ** ** |   | ** ** |   | ** ** |
| Revenues:                                  |   |                   |       |                 |       |   |   |   |   |
| Product  revenues                          |   | $                      | 62,001     |                 | $          | 10,587 |   | $ | 88,096 |   | $ | 21,808 |   |
| Service  revenues                          |   | 3,423                  |       | 2,847                |       | 6,889 |   | 5,404 |   |
| Government  contract revenues              |   | 3,002                  |       | 3,966                |       | 6,639 |   | 7,685 |   |
| Total  revenues                            |   | 68,426                 |       | 17,400               |       | 101,624 |   | 34,897 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Cost  of revenues:                         |   |                   |       |                 |       |   |   |   |   |
| Product  costs                             |   | 35,007                 |       | 6,941                |       | 49,924 |   | 13,356 |   |
| Service  costs                             |   | 2,994                  |       | 1,866                |       | 5,308 |   | 3,699 |   |
| Government  contract costs                 |   | 1,989                  |       | 3,256                |       | 4,532 |   | 6,077 |   |
| Total  cost of revenues                    |   | 39,990                 |       | 12,063               |       | 59,764 |   | 23,132 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Gross  profit                              |   | 28,436                 |       | 5,337                |       | 41,860 |   | 11,765 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Operating  expenses:                       |   |                   |       |                 |       |   |   |   |   |
| Research  and development                  |   | 4,718                  |       | 1,907                |       | 8,030 |   | 4,757 |   |
| Selling,  general and administrative       |   | 6,655                  |       | 3,141                |       | 12,034 |   | 6,611 |   |
| Total  operating expenses                  |   | 11,373                 |       | 5,048                |       | 20,064 |   | 11,368 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Income  from operations                    |   | 17,063                 |       | 289                  |       | 21,796 |   | 397 |   |
| Interest  expense                          |   | (116                   | )          | (83                  | )          | (210 | ) | (148 | ) |
| Interest  and other (expenses) income, net |   | (694                   | )          | —               |       | (564 | ) | 105 |   |
| Income  before provision for income taxes  |   | 16,253                 |       | 206                  |       | 21,022 |   | 354 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Provision  for income taxes                |   | 6,647                  |       | 62                   |       | 8,598 |   | 121 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Net  income                                |   | $                      | 9,606      |                 | $          | 144 |   | $ | 12,424 |   | $ | 233 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Net  income per share:                     |   |                   |       |                 |       |   |   |   |   |
| Basic                                      |   | $                      | 0.58       |                 | $          | 0.01 |   | $ | 0.82 |   | $ | 0.02 |   |
| Diluted                                    |   | $                      | 0.52       |                 | $          | 0.01 |   | $ | 0.73 |   | $ | 0.02 |   |
|                                       |   |                   |       |                 |       |   |   |   |   |
| Weighted  average shares outstanding:      |   |                   |       |                 |       |   |   |   |   |
| Basic                                      |   | 16,579                 |       | 12,932               |       | 15,132 |   | 12,784 |   |
| Diluted                                    |   | 18,387                 |       | 13,835               |       | 17,124 |   | 13,789 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

4

----

 

**InVisionTechnologies, Inc.**

**CondensedConsolidated Statements of Cash Flow**

**(Inthousands)**

**(Unaudited)**

 
|                                                                                         |   | **Six  Months Ended** |       |
|----------------------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                                         |   | **June 30,  2002**    |       | **July 1,  2001** |   |
|                                                                                         |   |                  | ** ** |   | ** ** |
| **Cash flows from operating activities:**                                                    |   |                  | ** ** |   | ** ** |
| Net  income                                                                                  |   | $                     | 12,424     |   | $ | 233 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities |   |                  |       |   |   |
| Depreciation  and amortization                                                               |   | 1,383                 |       | 1,407 |   |
| Amortization  of capitalized software development costs                                      |   | 150                   |       | 70 |   |
| Amortization  of intangible assets                                                           |   | 162                   |       | 383 |   |
| Deferred  income taxes                                                                       |   | 55                    |       | — |   |
| Loss  on disposal of fixed assets                                                            |   | 430                   |       | (7 | ) |
| Bad  debt expense                                                                            |   | 32                    |       | 45 |   |
| Income  tax benefits from employee stock transactions                                        |   | 5,088                 |       | — |   |
| Stock  compensation expense                                                                  |   | 572                   |       | — |   |
|                                                                                         |   |                  |       |   |   |
| Changes  in operating assets and liabilities:                                                |   |                  |       |   |   |
| Accounts  receivable                                                                         |   | (26,530               | )          | (2,845 | ) |
| Inventories                                                                                  |   | (38,358               | )          | (3,937 | ) |
| Other  current assets                                                                        |   | (10,345               | )          | (534 | ) |
| Accounts  payable                                                                            |   | 23,137                |       | 506 |   |
| Accrued  liabilities                                                                         |   | 10,207                |       | (225 | ) |
| Deferred  revenues                                                                           |   | 111,660               |       | (531 | ) |
| Other                                                                                        |   | 328                   |       | 10 |   |
| Net  cash provided by (used in) operating activities                                         |   | 90,395                |       | (5,425 | ) |
|                                                                                         |   |                  |       |   |   |
| **Cash flows from investing activities:**                                                    |   |                  |       |   |   |
| Purchases  of property and equipment                                                         |   | (2,239                | )          | (1,006 | ) |
| Proceeds  from short-term investments, net                                                   |   | 1,992                 |       | — |   |
| Purchase  of subsidiary, net of cash acquired                                                |   | (183                  | )     | (267 | ) |
| Net  cash used in investing activities                                                       |   | (430                  | )          | (1,273 | ) |
|                                                                                         |   |                  |       |   |   |
| **Cash flows from financing activities:**                                                    |   |                  |       |   |   |
| Net  proceeds from (repayments of) short-term debt                                           |   | (516                  | )          | 3,840 |   |
| Repayments  of long-term debt                                                                |   | (99                   | )          | (216 | ) |
| Proceeds  from issuance of common stock, net                                                 |   | 86,274                |       | 147 |   |
| Net  cash provided by financing activities                                                   |   | 85,659                |       | 3,771 |   |
|                                                                                         |   |                  |       |   |   |
| Net  change in cash and cash equivalents for the period                                      |   | 175,624               |       | (2,927 | ) |
| Cash  and cash equivalents at beginning of period                                            |   | 11,386                |       | 11,908 |   |
| **Cash and cash equivalents at end of period**                                               |   | $                     | 187,010    |   | $ | 8,981 |   |
|                                                                                         |   |                  |       |   |   |
| **Supplemental disclosures of cash flow information:**                                       |   |                  |       |   |   |
| Interest  paid                                                                               |   | $                     | 258        |   | $ | 104 |   |
| Income  taxes paid                                                                           |   | $                     | 2          |   | $ | 442 |   |
|                                                                                         |   |                  |       |   |   |
| **Supplemental disclosures of noncash investing and financing  activities:**                 |   |                  |       |   |   |
| Issuance  of common stock in connection with acquisition of subsidiary                       |   | $                     | 1,199      |   | $ | 933 |   |
| Financing  obligations incurred for the purchase of new equipment                            |   | $                     | 86         |   | $ | — |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

5

----

 

**InVision Technologies, Inc.**

**Notesto Condensed Consolidated Financial Statements**

**(Unaudited)**

 

**1.****             Summary ofSignificant Accounting Policies**

 

**Interim Unaudited FinancialInformation**

 

The accompanying interimunaudited condensed consolidated****financial statements have been prepared inaccordance with accounting principles generallyaccepted in the United States of America (“generally accepted accountingprinciples”) for interim financial information and in accordance with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not contain all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements reflect all adjustments (consisting only of normalrecurring adjustments) considered necessary for a fair presentation.  These financial statements should be read inconjunction with the audited consolidated financial statements of InVisionTechnologies, Inc. and its subsidiaries (the “Company”) as of December 31, 2001and 2000 and for each of the three years in the period ended December 31, 2001,including the notes thereto, included in the Company’s Annual Report on Form10-K/A filed on May 8, 2002. 

 

Operating results for thethree and six month periods ended June 30, 2002 may not necessarily beindicative of the results that may be expected for the year ended December 31,2002 or any other future period.

 

**Business Combinations and Goodwill and Other IntangibleAssets**

 

On January 1, 2002, the Company adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other IntangibleAssets.”   This standard addresses theinitial recognition and measurement of intangible assets acquired outside of abusiness combination and the accounting for goodwill and other intangibleassets subsequent to their acquisition. SFAS 142 provides that intangible assets with finite useful lives beamortized and that goodwill and intangible assets with indefinite lives not beamortized, but will rather be tested at least annually for impairment.  The Company performed the impairment testsrequired by the standard and noted no impairment as of January 1, 2002.  Since adopting SFAS 142, the Company nolonger amortizes the carrying value of goodwill of $2.5 million or acquiredworkforce of $331,000 at January 1, 2002, resulting in a reduction in annualamortization expense of $426,000. The Company also evaluated its otherintangible assets and determined that all such assets have determinable lives.

 

The following reconcilesreported net income and net income per share to the adjusted net income and netincome per share as if the Company had followed the amortization provisions ofSFAS 142 for the periods presented below (in thousands, except per share data):

 
|                                                              |   | **Three Months Ended** |       | **Six Months Ended** |       |
|-------------------------------------------------------------------|--------|------------------------|------------|----------------------|------------|
|                                                              |   | **June 30,  2002**     |       | **July 1,  2001**    |       | **June 30,  2002** |   | **July 1,  2001** |   |
|                                                              |   |                   | ** ** |                 | ** ** |   | ** ** |   | ** ** |
| Net  income:                                                      |   |                   |       |                 |       |   |   |   |   |
| As  reported                                                      |   | $                      | 9,606      |                 | $          | 144 |   | $ | 12,424 |   | $ | 233 |   |
| add:  goodwill amortization expense, net of  taxes           |   | —                 |       | 65                   |       | — |   | 130 |   |
| add:  acquired workforce amortization expense,  net of taxes |   | —                 |       | 41                   |       | — |   | 82 |   |
| As  adjusted                                                      |   | $                      | 9,606      |                 | $          | 250 |   | $ | 12,424 |   | $ | 445 |   |
|                                                              |   |                   |       |                 |       |   |   |   |   |
| Basic  net income per share:                                      |   |                   |       |                 |       |   |   |   |   |
| As  reported                                                      |   | $                      | 0.58       |                 | $          | 0.01 |   | $ | 0.82 |   | $ | 0.02 |   |
| As  adjusted                                                      |   | $                      | 0.58       |                 | $          | 0.02 |   | $ | 0.82 |   | $ | 0.03 |   |
|                                                              |   |                   |       |                 |       |   |   |   |   |
| Diluted  net income per share:                                    |   |                   |       |                 |       |   |   |   |   |
| As  reported                                                      |   | $                      | 0.52       |                 | $          | 0.01 |   | $ | 0.73 |   | $ | 0.02 |   |
| As  adjusted                                                      |   | $                      | 0.52       |                 | $          | 0.02 |   | $ | 0.73 |   | $ | 0.03 |   |

 

6

----

 

**Accountingfor the Impairment or Disposal of Long-Lived Assets**

 

On January 1, 2002, theCompany adopted SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets.”  SFAS 144 supersedesSFAS 121, “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to be Disposed Of,” and the accounting and reportingprovisions of Accounting Principles Board Opinion No. 30, “Reporting theResults of Operations – Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions.”  SFAS 144 addressesfinancial accounting and reporting for the impairment or disposal of long-livedassets.  The adoption of this statementdid not have a material impact on the Company’s financial position or resultsof operations.

 

**Derivative Instruments and HedgingActivities**

 

On January 1, 2001, theCompany adopted SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities.”  SFAS 133, asamended, requires that every derivative instrument, including certainderivative instruments embedded in other contracts, be recorded on the balancesheet at its fair value.  Changes in thefair value of derivatives are recorded each period on current earnings or othercomprehensive income, depending on whether a derivative is designated as partof a hedge transaction and, if it is, the type of hedge transaction.  SFAS 133, as amended, requires that theCompany formally document, designate, and assess the effectiveness oftransactions that receive hedge accounting. The Company adopted SFAS 133, as amended, on January 1, 2001 and did notelect hedge accounting as defined by SFAS 133. The adoption of this standard did not have a material impact on theCompany’s financial position or results of operations.

 

In May 2002, the Companydesignated certain derivatives as cash flow hedges of foreign exchange risk forcontracts with international customers and began applying hedge accounting asdefined by SFAS 133.  Accordingly,during the period from May 15, 2002 to June 30, 2002 the Company recorded $1.9million of other comprehensive loss, representing the net change in the fairvalue of derivative instruments that were designated and that qualified forhedge accounting and the related receivables. During the six months ended June 30, 2002, the Company’s derivative contractsconsisted only of foreign exchange forward contracts to mitigate certainexposures to future foreign currency rate movements on receivables related tointernational sales contracts. The maturity of foreign exchange forwardcontracts held as of June 30, 2002 is consistent with the contractual orexpected timing of the transactions being hedged, principally receipt ofcustomer payments.  These foreignexchange forward contracts all mature within twelve months.  As of June 30, 2002, the Company anticipatesreclassifying the full amount included within other comprehensive loss toearnings in the next twelve months.

 

**Accounting for Costs Associated withExit or Disposal Activities**

 

In June 2002, the FASBissued SFAS 146, “Accounting for Costs Associated with Exit or DisposalActivities”, which addresses accounting for restructuring and similarcosts.  SFAS 146 supersedes previousaccounting guidance, principally Emerging Issues Task Force Issue No.94-3.  The Company will adopt theprovisions of SFAS 146 for restructuring activities initiated after December31, 2002.  SFAS 146 requires that theliability for costs associated with an exit or disposal activity be recognizedwhen the liability is incurred.  UnderIssue 94-3, a liability for an exit cost was recognized at the date of theCompany’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially bemeasured and recorded at fair value. Accordingly, SFAS 146 may affect the timing of recognizing futurerestructuring costs as well as the amounts recognized.

 

**2.****             NetIncome Per Share**

 

Basic net income pershare is computed by dividing income available to common stockholders by theweighted-average common shares outstanding for the period.  Diluted net income per share reflects theweighted-average common shares outstanding plus the potential effect ofdilutive securities or contracts, which are convertible to common shares suchas options, warrants, convertible debt and preferred stock (using the treasurystock method) and shares issuable in future periods, except in cases where theeffect would be anti-dilutive.

 

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

 
|                                                        |   | **Three Months Ended** |   | **Six Months Ended** |   |
|-------------------------------------------------------------|--------|------------------------|--------|----------------------|--------|
|                                                        |   | **June 30, 2002**      |   | **July 1, 2001**     |   | **June 30, 2002** |   | **July 1, 2001** |   |
|                                                        |   | **Income**             |   | **Shares**           |   | **Per  Share  Amount** |   | **Income** |   | **Shares** |   | **Per  Share  Amount** |   | **Income** |   | **Shares** |   | **Per  Share  Amount** |   | **Income** |   | **Shares** |   | **Per  Share  Amount** |   |
| Basic net income per share                                  |   | $                      | 9,606  |                 | 16,579 |   | $ | 0.58 |   | $ | 144 |   | 12,932 |   | $ | 0.01 |   | $ | 12,424 |   | 15,132 |   | $ | 0.82 |   | $ | 233 |   | 12,784 |   | $ | 0.02 |   |
| Effect of dilutive securities:                              |   |                   |   |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Options and warrants                                        |   | —                 |   | 1,808                |   | (0.06 | ) | — |   | 639 |   | — |   | — |   | 1,977 |   | (0.09 | ) | — |   | 548 |   | — |   |
| Stock payable in connection with acquisition of  subsidiary |   | —                 |   | —               |   | — |   | — |   | 264 |   | — |   | — |   | 15 |   | — |   | — |   | 457 |   | — |   |
| Diluted net income per share                                |   | $                      | 9,606  |                 | 18,387 |   | $ | 0.52 |   | $ | 144 |   | 13,835 |   | $ | 0.01 |   | $ | 12,424 |   | 17,124 |   | $ | 0.73 |   | $ | 233 |   | 13,789 |   | $ | 0.02 |   |

 

7

----

 

**3.****             SegmentInformation**

 

The Company has three reportable segments.  The “EDS” segment is comprised of thebusiness unit that is engaged in the development, manufacturing, marketing andsupport of explosives detection systems based on advanced computed tomography(“CT”) technology.  The “Quantum”segment is comprised of the business unit that is engaged in funded researchand the development of technology for inspection, detection and analysis of explosives,concealed weapons and other materials based on quadrupole resonance technologyand passive magnetic sensing.  The“Wood” segment is comprised of those business units that are engaged in themanufacture of systems using laser-based technologies to improve sawmill yield,and the research and development of CT and X-ray technology to increase thevalue of harvested timber.

 

Financial information by business segment is asfollows (in thousands):

 
|                          |   | **EDS** |    | **Ouantum** |   | **Wood** |   | **Total** |   |
|-------------------------------|--------|---------|---------|-------------|--------|----------|--------|-----------|--------|
|                          |   |    |    |        |   |     |   |      |   |
| **Second quarter 2002**       |   |    |    |        |   |     |   |      |   |
| Revenues:                     |   |    |    |        |   |     |   |      |   |
| Product  revenues             |   | $       | 60,615  |        | $      | 129      |   | $         | 1,257  |   | $ | 62,001 |   |
| Service  revenues             |   | 2,878   |    | 96          |   | 449      |   | 3,423     |   |
| Government  contract revenues |   | —  |    | 3,002       |   | —   |   | 3,002     |   |
| Total  revenues               |   | $       | 63,493  |        | $      | 3,227    |   | $         | 1,706  |   | $ | 68,426 |   |
|                          |   |    |    |        |   |     |   |      |   |
| Net  income (loss)            |   | $       | 10,609  |        | $      | 174      |   | $         | (1,177 | ) | $ | 9,606 |   |
|                          |   |    |    |        |   |     |   |      |   |
| **June 30, 2002**             |   |    |    |        |   |     |   |      |   |
| Total  assets                 |   | $       | 330,541 |        | $      | 4,663    |   | $         | 3,475  |   | $ | 338,679 |   |
|                          |   |    |    |        |   |     |   |      |   |
| **Second quarter 2001**       |   |    |    |        |   |     |   |      |   |
| Revenues:                     |   |    |    |        |   |     |   |      |   |
| Product  revenues             |   | $       | 7,346   |        | $      | 54       |   | $         | 3,187  |   | $ | 10,587 |   |
| Service  revenues             |   | 2,466   |    | 26          |   | 355      |   | 2,847     |   |
| Government  contract revenues |   | —  |    | 3,966       |   | —   |   | 3,966     |   |
| Total  revenues               |   | $       | 9,812   |        | $      | 4,046    |   | $         | 3,542  |   | $ | 17,400 |   |
|                          |   |    |    |        |   |     |   |      |   |
| Net  income (loss)            |   | $       | 390     |        | $      | 189      |   | $         | (435   | ) | $ | 144 |   |
|                          |   |    |    |        |   |     |   |      |   |
| **December 31, 2001**         |   |    |    |        |   |     |   |      |   |
| Total  assets                 |   | $       | 76,431  |        | $      | 4,935    |   | $         | 8,367  |   | $ | 89,733 |   |
|                          |   |    |    |        |   |     |   |      |   |
| **Six months 2002**           |   |    |    |        |   |     |   |      |   |
| Revenues:                     |   |    |    |        |   |     |   |      |   |
| Product  revenues             |   | $       | 83,793  |        | $      | 781      |   | $         | 3,522  |   | $ | 88,096 |   |
| Service  revenues             |   | 5,913   |    | 108         |   | 868      |   | 6,889     |   |
| Government  contract revenues |   | —  |    | 6,639       |   | —   |   | 6,639     |   |
| Total  revenues               |   | $       | 89,706  |        | $      | 7,528    |   | $         | 4,390  |   | $ | 101,624 |   |
|                          |   |    |    |        |   |     |   |      |   |
| Net  income (loss)            |   | $       | 13,706  |        | $      | 438      |   | $         | (1,720 | ) | $ | 12,424 |   |
|                          |   |    |    |        |   |     |   |      |   |
| **Six months 2001**           |   |    |    |        |   |     |   |      |   |
| Revenues:                     |   |    |    |        |   |     |   |      |   |
| Product  revenues             |   | $       | 16,740  |        | $      | 54       |   | $         | 5,014  |   | $ | 21,808 |   |
| Service  revenues             |   | 4,616   |    | 26          |   | 762      |   | 5,404     |   |
| Government  contract revenues |   | —  |    | 7,685       |   | —   |   | 7,685     |   |
| Total  revenues               |   | $       | 21,356  |        | $      | 7,765    |   | $         | 5,776  |   | $ | 34,897 |   |
|                          |   |    |    |        |   |     |   |      |   |
| Net  income (loss)            |   | $       | 1,185   |        | $      | 267      |   | $         | (1,219 | ) | $ | 233 |   |

 

Substantially all of the Company’s long-lived assetsare located in the United States.

 

8

----

 

**4.****             Stockholders’Equity**

 

On February 28, 2002, the Company’s stockholdersapproved an increase in the number of authorized shares of common stock,previously approved by the Board of Directors, from 20,000,000 shares to60,000,000 shares and the Company filed an amendment to its certificate ofincorporation effecting this increase.

 

On March 27, 2002, the Company filed an amended FormS-3 Registration Statement under the Securities Act of 1933 and announced thepublic offering of 3,000,000 shares of its common stock to the public at a priceof $36.50 per share.  In this offering,which closed on April 2, 2002, the Company sold 2,500,000 shares and receivedproceeds of approximately $85 million, net of issuance costs. The Companyexpects to use these proceeds for general corporate purposes, including workingcapital and capital expenditures, and to acquire other complementary products,technologies or businesses when the opportunity arises.   A selling stockholder sold another 500,000shares of common stock in the offering and certain selling stockholders sold450,000 shares to underwriters who exercised their over-allotment option.  The Company did not receive any proceedsfrom the sale of the shares by selling stockholders.

 

**5.**             **Inventories**

 

The components ofinventory consist of the following (in thousands):

 
|                                   |   | **June 30,  2002** |   | **December 31,  2001** |   |
|----------------------------------------|--------|--------------------|--------|------------------------|--------|
| Inventories:                           |   |               |   |                   |   |
| Raw material and  purchased components |   | $                  | 26,744 |                   | $      | 8,148 |   |
| Field service  spare parts             |   | 12,229             |   | 9,877                  |   |
| Work-in-process                        |   | 20,722             |   | 5,794                  |   |
| Finished goods                         |   | 5,777              |   | 3,285                  |   |
| Total                                  |   | $                  | 65,472 |                   | $      | 27,104 |   |

 

**6.**             **Accrued Liabilities**

 

The components of accruedliabilities consist of the following (in thousands):

 
|                                |   | **June 30,  2002** |   | **December  31,  2001** |   |
|-------------------------------------|--------|--------------------|--------|-------------------------|--------|
| Accrued  liabilities:               |   |               |   |                    |   |
| Warranty and  other reserves        |   | $                  | 6,513  |                    | $      | 3,175 |   |
| Accrued and  other reserves         |   | 5,959              |   | 5,499                   |   |
| Income taxes                        |   | 3,716              |   | 210                     |   |
| Foreign currency  forward contracts |   | 3,819              |   | —                  |   |
| Other                               |   | 3,958              |   | 3,938                   |   |
| Total                               |   | $                  | 23,965 |                    | $      | 12,822 |   |

 

**7.****             Litigation**

 

The Company is involvedin routine civil litigation arising in the ordinary course of business.  Management believes that collectively theseproceedings will not have a material effect on the Company’s business,financial condition or results of operations.

 

**8.****                                      SubsequentEvent**

 

In July 2002,****theCompany received additional orders from the Transportation SecurityAdministration ("TSA") for $106.8 million in completed systems andparts.

 

9

----

 

**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

*The discussion below includes forward-looking statementsthat involve risks and uncertainties. When used in this discussion, the words“anticipate,” “believe,” “estimate,” and “expect” and similar expressionsidentify these forward-looking statements. Our actual results, performance, orachievements could differ materially from the results expressed in, or impliedby, these forward-looking statements.* F*actors that could cause or contribute to suchdifferences are discussed in “Business Risks” below.*

 

**Overview**

 

InVision Technologies,Inc. is organized under three segments. Our EDS business manufactures computed tomography (“CT”) based detectionproducts used by the aviation industry to screen baggage for explosives.  Our wholly-owned subsidiary, QuantumMagnetics, or Quantum, utilizes quadrupole resonance ("QR") andmagnetic sensing technologies for the inspection, detection and analysis ofexplosives, concealed weapons and other materials.  Our Wood division consists of Inovec, Inc., or Inovec, whichmanufactures systems using laser-based technologies to improve sawmill yield,and WoodVision, which is developing our CT andX–ray technology to increase the value of harvested timber.

 

Our revenues areprimarily comprised of:

 

•                  EDSproduct revenues, which include revenues from sales of CTX systems,accessories, and related installation and configuration, and EDS servicerevenues, which include revenues from maintenance contracts related to productsupport, integration and other services, including those complex integrationsand configurations that are separate from product revenues.  EDS product sales accounted for 88.6% of ourtotal revenues in the second quarter of 2002 and  42.2% of our total revenues in the second quarter of 2001.  EDS product revenues accounted for 82.5% ofour total revenues for the first six months of 2002 and 48.0% of our totalrevenues for the first six months of 2001. EDS service revenues accounted for 4.2% of our total revenues in the secondquarter of 2002 and 14.2% of our total revenues in the second quarter of2001.  EDS service revenues accountedfor 5.8% of total revenues for the first six months of 2002 and 13.2% of totalrevenues for the first six months of 2001;

 

•                  Quantumgovernment contract revenues, which include revenues primarily from developmentcontracts utilizing quadrapole resonance (QR) technology (a derivative ofmedical MRI) and magnetic sensing technologies with government agencies andprivate entities, and Quantum product revenues, which include revenues fromsales of Q-Scan and portal systems for commercial use.  Our Quantum government contract revenuesaccounted for 4.4% of our total revenues in the second quarter in 2002 and22.8% of our total revenues in the second quarter in 2001.  Quantum government contract revenuesaccounted for 6.5% of our total revenues for the first six months of 2002 and22.0% of our total revenues for the first six months of  2001;

 

•                  Woodproduct revenues, which include revenues from the sales of control andautomation systems for material processing equipment and related accessories,installation and configuration, and Wood service revenues, which includerevenues from repairs and other service related to product support.  Our Wood product sales accounted for 1.8% ofour total revenues in the second quarter of 2002 and 18.3% of our totalrevenues in the second quarter of 2001.  Wood product salesaccounted for 3.5% of total revenues for the first six months of 2002 and 14.4%of total revenues for the first six months of 2001.

 

We market our productsand services directly through internal sales personnel and indirectly throughauthorized agents, distributors and system integrators.  In the United States, we market our productsand services primarily through direct sales personnel.  Internationally, we use a direct sales forceand authorized representatives to sell our products.  International sales represented 25.3% of total revenues in thefirst six months of 2002 and 23.6% of total revenues in the first six months of2001.

 

In any given fiscalquarter or year, our EDS product revenues are derived from orders of multipleunits of our products from a limited number of customers.  For example, during the second quarter in2002, six customers accounted for all of our EDS units sold during the quarter,and for the fiscal year 2001, seven customers accounted for all of our EDSunits sold during the year.  The numberof our customers does not vary widely from period to period, and we aredependent on multiple orders from a small number of customers for a substantialportion of our revenues.  Therefore, acancellation or delay of an order from a customer could have a significantnegative impact on our operations in a given period. For the first six monthsin 2002, we generated $62.0 million from EDS sales to our largest customer, theFAA, and subsequent to the formation of the TSA, to the TSA, representing 61.0%of total revenues.  For the first sixmonths in 2001, we generated $12.3 million from EDS sales to the FAA,representing 35.2% of total revenues. There were no other EDS customers who

 

10

----

 

accounted for morethan 10% of total revenues in the first six months of 2002 and 2001. As of June30, 2002, we had in backlog EDS equipment orders and service agreements of $367million, primarily consisting of two orders from the TSA for multiple CTX 2500and CTX 5500 systems and for parts sufficient to build an additional 100 CTXsystems.  Subsequent to the first sixmonths of 2002, the Company received additional orders from the TSA for $106.8millions in completed systems and parts. Additional orders for CTX equipment, including systems from the partsordered, will be dependent on various factors, including future U.S. governmentfunding appropriations.

 

**Results of Operations**

 

The followingtable sets forth certain income and expenditure items from our condensedconsolidated statements of operations expressed as a percentage of totalrevenues for the periods indicated.

 
|                                       |   | **Three Months Ended** |   | **Six Months Ended** |   |
|--------------------------------------------|--------|------------------------|--------|----------------------|--------|
|                                       |   | **June 30,  2002**     |   | **July 1,  2001**    |   | **June 30,  2002** |   | **July 1,  2001** |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Revenues:                                  |   |                   |   |                 |   |   |   |   |   |
| Product revenues                           |   | 90.6                   | %      | 60.8                 | %      | 86.7 | % | 62.5 | % |
| Service revenues                           |   | 5.0                    |   | 16.4                 |   | 6.8 |   | 15.5 |   |
| Government contract revenues               |   | 4.4                    |   | 22.8                 |   | 6.5 |   | 22.0 |   |
| Total  revenues                            |   | 100.0                  |   | 100.0                |   | 100.0 |   | 100.0 |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Cost  of revenues:                         |   |                   |   |                 |   |   |   |   |   |
| Product costs                              |   | 51.2                   |   | 39.9                 |   | 49.1 |   | 38.3 |   |
| Service costs                              |   | 4.4                    |   | 10.7                 |   | 5.2 |   | 10.6 |   |
| Government contract costs                  |   | 2.9                    |   | 18.7                 |   | 4.5 |   | 17.4 |   |
| Total  cost of revenues                    |   | 58.5                   |   | 69.3                 |   | 58.8 |   | 66.3 |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Gross  margin                              |   | 41.5                   |   | 30.7                 |   | 41.2 |   | 33.7 |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Operating  expenses:                       |   |                   |   |                 |   |   |   |   |   |
| Research  and development                  |   | 6.9                    |   | 11.0                 |   | 7.9 |   | 13.6 |   |
| Selling,  general and administrative       |   | 9.7                    |   | 18.1                 |   | 11.8 |   | 18.9 |   |
| Total  operating expenses                  |   | 16.6                   |   | 29.1                 |   | 19.7 |   | 32.5 |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Income  from operations                    |   | 24.9                   |   | 1.6                  |   | 21.5 |   | 1.2 |   |
| Interest  expense                          |   | (0.2                   | )      | (0.5                 | )      | (0.2 | ) | (0.4 | ) |
| Interest  and other income (expenses), net |   | (1.0                   | )      | —               |   | (0.6 | ) | 0.3 |   |
| Income  before provision for income taxes  |   | 23.7                   |   | 1.1                  |   | 20.7 |   | 1.1 |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Provision  for income taxes                |   | 9.7                    |   | 0.4                  |   | 8.5 |   | 0.3 |   |
|                                       |   |                   |   |                 |   |   |   |   |   |
| Net  income                                |   | 14.0                   | %      | 0.7                  | %      | 12.2 | % | 0.8 | % |

 

11

----

 

**Comparison of the Three Months Ended June 30, 2002 to theThree Months Ended July 1, 2001**

 

*Revenues.* EDSproduct revenues were $60.6 million in the second quarter of 2002, an increaseof 725% from $7.3 million in the second quarter of 2001.  This increase in system sales and relatedaccessories is reflective of the orders received from the TSA in the firstquarter of 2002, as well as international customers in late 2001 and 2002,resulting from the increased focus on aviation security due to the terroristattacks of September 11, 2001.  EDSservice revenues were $2.9 million for the second quarter of 2002, an increaseof 16.7% from $2.5 million in the second quarter of 2001.  As a result of warranty periods expired onsystems installed a year ago, we have experienced increased service contractrevenues for new support and maintenance agreements and more billable time andmaterial type of services provided on a greater installed base of systems.  As of June 30, 2002, we had in backlog EDSequipment orders and service agreements of $367 million, primarily consistingof two orders from the TSA for multiple CTX 2500 and CTX 5500 systems and forparts sufficient to build an additional 100 CTX systems.

 

Quantum’s governmentcontract revenues were $3.0 million in the second quarter of 2002, a decreaseof 24.3% from $4.0 million in the second quarter of 2001.  During the second quarter of 2002, $1.9million of our government contract revenues from the U.S. government were forthe development of landmine technologies, representing 59.1% of Quantumrevenues, and during the second quarter of 2001, $3.2 million of our governmentcontract revenues from the U.S. government were for the development of landminetechnologies, representing 79.1% of Quantum revenues.  As of June 30, 2002, we had Quantum government contract backlogof approximately $7.0 million, primarily for development of landmine detectiontechnologies.  We anticipate thatgovernment contract revenues for landmine detection technologies will continueto decrease in 2002 compared to the previous year.  This is the result of a reduced need for subcontract support forthe landmines contracts in 2002, as outsourced milestones are completed.  A reduction in such support needs reducesthe amounts of revenue recognized in re-billing subcontract support cost backto the government. In addition, Quantum is shifting internal resources todevelop an upgrade to the CTXTM family of explosives detection systems utlizingQR.  This project to combine QR and CTtechnology is partially funded by a grant of $1 million by the TSA, and partlyfunded by InVision.  To the extent thatQuantum provides future EDS research on an intercompany basis to InVision, theexpense of this effort will be reflected as EDS segment R&D expense, andwill not be reflected as Quantum revenue. Quantum’s product revenues were $129,000 in the second quarter of 2002,an increase of 139% from $54,000 in the second quarter of 2001.

 

Wood product revenues,all contributed to Inovec, were $1.3 million in the second quarter of 2002, adecrease of 60.6% from $3.2 million in the second quarter of 2001.  The decrease in Wood product revenues isprimarily due to softness in the wood products industry. Wood service revenueswere $449,000 in the second quarter of 2002, an increase of 26.5% from $355,000in the second quarter of 2001.  As ofJune 30, 2002, backlog in Inovec equipment orders and service agreementstotaled $1.2 million.

 

*Gross Profit.*  Cost of EDS product revenues primarilyconsists of purchased materials procured for use in the assembly of ourproducts, as well as manufacturing labor and overhead, installation, trainingand warranty.  Cost of EDS servicerevenues primarily consists of direct labor and materials and customer supportoverhead.  In any given period, ourgross profit for products and services may be affected by several factors,including product mix, volume pricing discounts, volume of systems manufacturedin the period, product configuration, location of the installation andcomplexity of integration into various environments.

 

Gross profit for EDSproducts was $26.6 million in the second quarter of 2002, an increase of 929%from $2.6 million in the second quarter of 2001.  Gross margin percentages for EDS products were 43.9% in thesecond quarter of 2002 and 35.2% in the second quarter of 2001.  The increase in gross profit for EDSproducts is due to higher EDS product revenues in the second quarter of 2002compared to the same period a year ago. The improvement in EDS product gross margin percentages is primarily dueto lower manufacturing overhead per unit, resulting from a larger increase inunits produced relative to the increase in fixed costs in the second quarter of2002 compared to the same period a year ago. The change in gross margin percentages is also affected to a lesserextent by variations in the mix of product types and pricing factors amongdomestic and international customers in the second quarter of 2002.  In addition, EDS product gross margins inthe prior-year period were negatively impacted due to additional warrantyprovisions recorded to upgrade certain previously sold CTX 9000 systems tocurrent manufacturing standards.  Weexpect that gross margins will continue to improve as fixed costs are spreadover larger quantities of units produced, with the improvement partially offsetby volume-based price reductions in sales to the TSA.  To support the expansion of production capacity of our EDSproducts, we entered into a Products and Services Agreement with CoorsTek, Inc.in the second quarter of 2002 to provide services as a supply chain manager andcontract manufacturer.

 

Gross profit for EDSservices was $137,000 in the second quarter of 2002, a decrease of 82.1% from$766,000 in the second quarter of 2001. Gross margin percentages for EDSservices were 4.8% in the second quarter of 2002 and 31.1% in the secondquarter of 2001.  The decrease in grossprofit for EDS services is primarily due to increased EDS customer supportoverhead costs necessary to support an increasing installed base of EDS units.  Because product sales are initially coveredfor support services under warranty, there is approximately a 15 to 18 monthtime lag from shipment to recognizing any additional service contract revenuetied to the increased sales of EDS products. However, the EDS product customer is not obligated to purchase supportservices from us after the warranty period, so additional service contractrevenues are not guaranteed by sales. The increased support costs with no immediate service revenue for recentproduct sales was the primary reason for lower gross profit and gross marginfor the second quarter of 2002 compared to that in the same period in 2001.

 

Cost of Quantumgovernment contract revenues primarily consists of direct labor, purchasedmaterials, subcontract labor and the applicable overhead required to supportgovernment funded research.  Cost ofQuantum product revenues

 

12

----

 

primarily consists ofdirect labor and materials, overhead, installation, training and warranty.  Gross profit for government contracts was$1.0 million in the second quarter of 2002, a 42.7% increase from $710,000 inthe second quarter of 2001.  Gross marginpercentages were 33.7% in the second quarter of 2002 and 17.9% in the second quarterof 2001.  The increase in gross profitand the improvements in gross margin percentages for government contracts areprimarily due to fewer outside engineering services being required on alandmines contract, in which related services typically carry a slightly lowermargin, in the second quarter of 2002 compared to the same period a yearago.  Our contract with an outsideservices firm was substantially completed in early 2002 upon completion ofcertain milestones in the vehicle-mounted landmines detection contract.  We do not expect to utilize significantlevels of outside services in our current research and, consequently, weanticipate lower Quantum government contract revenues with slightly highergross margins.

 

Cost of Wood productrevenues primarily consists of purchased materials, manufacturing labor andoverhead.  Gross profit for Woodproducts was $316,000 in the second quarter of 2002, a decrease of 68.5% from$1.0 million  in the second quarter of2001.  Gross margin percentages were25.1% in the second quarter of 2002 and 31.5% in the second quarter of2001.  The decrease in gross profit andgross margin percentages for Wood products is primarily due to softness in theindustry. Gross profit for Wood services was $258,000 in the second quarter of2002 and $201,000 in the second quarter of 2001.  Gross margin percentages for Wood services were 57.5% in thesecond quarter of 2002 and 56.6% in the second quarter of 2001.

 

*Research and Development.*  Research and development expenses consistprimarily of compensation paid to personnel engaged in sustaining engineering,as well as new product development activities, amounts paid for outsideservices, and costs of materials utilized in the development of hardwareproducts, including prototype units. Research and development expenditures are partially offset by amountsreimbursed by the FAA and other government agencies and private entities underresearch and development contracts and grants. These services are provided and reimbursed on a cost basis.

 

Gross research anddevelopment expenses for EDS were $4.1 million in the second quarter of 2002,an increase of 54.2% from $2.6 million in the second quarter of 2001.  Research and development contracts andgrants from the FAA and other government agencies funded $51,000 of our grossresearch and development expenses for EDS in the second quarter of 2002 and$1.5 million in the second quarter of 2001. Net research and developmentexpenses for EDS were $4.0 million in the second quarter of 2002, an increaseof 250% from $1.2 million in the second quarter of 2001.  Net research and development expenses forEDS as a percentage of EDS revenues were 6.4% in the second quarter of 2002 and11.7% in the second quarter of 2001. The increase in gross research and development expenses for EDS isprimarily due to an increased focus on several initiatives to support ourgrowth.  With the goal of 100% screeningin U.S. airports, we expect that our EDS machines will be operated at or nearcapacity for extended periods.  We areinvesting in sustaining engineering efforts to ensure that our products achievehigh levels of serviceability and reliability when operated at capacity.  We are also devoting significant engineeringresources to support the rapid expansion of our manufacturing capacity, and arecontinuing our development of ARGUS and product enhancements for our existingline of EDS machines.  The increase innet research and development expenses for EDS is primarily due to less fundingreceived from the ARGUS grant in the current quarter compared to the sameperiod a year ago.  We anticipate thatwe will continue to incur unfunded costs for the continued development of theARGUS program over the next few quarters as we approach the end of the program.

 

Research and developmentexpenses for Quantum were $216,000 in the second quarter of 2002, an increaseof 173% from $79,000 in the second quarter of 2001.  Research and development expenses for Quantum as a percentage ofQuantum revenues were 6.7% in the second quarter of 2002 and 2.0% in the secondquarter of 2001.  The increase inexpenses is primarily due to more internal costs incurred for the developmentand commercialization of products, such as the *i*-Portal 100 system, in thesecond quarter of 2002 compared to the same period a year ago.

 

Research and developmentexpenses for Wood were $469,000 in the second quarter of 2002, a decrease of30.6% from $676,000 in the second quarter of 2001.  Research and development expenses for Wood as a percentage ofWood revenues were 27.5% in the second quarter of 2002 and 19.1% in the secondquarter of 2001.  The decrease inexpenses is primarily due to a temporary reallocation of engineering resourcesto support the rapid growth of the EDS business from Wood development efforts.

 

*Selling, general and administrative.*  Selling, general and administrative expensesconsist primarily of compensation paid to direct and indirect sales andmarketing personnel, administrative personnel, including directors, consultantfees, professional service fees, insurance costs, travel, selling anddistribution costs, and other general expenses.

 

Selling, general andadministrative expenses for EDS were $5.1 million in the second quarter of2002, an increase of 206% from $1.7 million in the second quarter of 2001.  Selling, general and administrative expensesfor EDS as a percentage of EDS revenues were 8.0% in the second quarter of 2002and 17.0% in the second quarter of 2001. The increase in selling, general and administrative expenses for EDS inabsolute dollars is primarily due to increases in consultants and professionalfees, such as investor and public relations, sales commissions, insurancecosts, and employee headcount, all related to the growth of our businessresulting from the increase in orders received from the FAA, TSA, andinternational customers, in the second quarter of 2002 compared to the sameperiod a year ago.  The decrease inselling, general and administrative expenses for EDS as a percentage ofrevenues is primarily due to the increase in EDS revenues.

 

13

----

 

Selling, general andadministrative expenses for Quantum were $701,000 in the second quarter of2002, an increase of 37.7% from $509,000 in the second quarter of 2001.  Selling, general and administrative expensesfor Quantum as a percentage of Quantum revenues were 21.7% in the secondquarter of 2002 and 12.6% in the second quarter of 2001.  The increase in expenses in absolute dollarsis primarily due to an increase in marketing activities associated withcommercial products, and the increase in selling, general and administrativeexpenses as a percentage of Quantum revenues is due both to the increase inabsolute dollars and to the decrease in Quantum revenues.

 

Selling, general andadministrative expenses for Wood were $851,000 in the second quarter of 2002, adecrease of 11.7% from $964,000 in the second quarter of 2001.  Selling, general and administrative expensesfor Wood as a percentage of Wood revenues were 49.9% in the second quarter of2002 and 27.2% in the second quarter of 2001. The decrease in expenses is primarily due to a reduction of amortizationexpense for goodwill and certain intangibles of approximately $106,000 in accordancewith Statement of Financial Accounting Standards, or SFAS, No. 142, which waseffective on January 1, 2002.  SFAS 142provides that goodwill and intangible assets with indefinite lives will not beamortized, but will rather be tested at least annually for impairment.  The increase in selling, general andadministrative expenses as a percentage of Wood revenues is primarily due tothe decrease in Wood revenues.

 

*Interest Expense.*  Interest expense was $116,000 in the secondquarter of 2002 and $83,000 in the second quarter of 2001. The increase ininterest expense is primarily due to increased financing for insurancepremiums, and increased activities within our lines of credit, such as morestandby letters of credit issued to secure guarantees to customers, in thesecond quarter of 2002 compared to the same period a year ago.

 

*Interest and Other (Expenses)Income, Net.*  Interestand other (expenses) income, net, decreased to a net expense of $694,000 in thesecond quarter of 2002 from $0 in the second quarter of 2001.  The 2002 amount consists primarily ofinterest income on cash, cash equivalents and short-term investments of$467,000, more than offset by other expenses (net) of $1.2 million, including anet $759,000 in foreign exchange losses, primarily on outstanding foreignexchange forward contracts at June 30, 2002. The 2001 amount consists primarily of interest income on cash, cashequivalents and short-term investments of $80,000, offset by other expense(net) of $80,000.

 

*Provision for Income Taxes.*  The provision for income taxes was $6.6million in the second quarter of 2002 and $62,000 in the second quarter of2001.  Our effective tax rate was 40.9%in the second quarter of 2002 and 30.1% in the second quarter of 2001.  At December 31, 2001, we had federal netoperating loss carryforwards of approximately $5.0 million and state netoperating loss carryforwards of approximately $1.1 million available to reducefuture federal and state taxable income. Our federal net operating loss carryforwards expire from 2010 to 2021and our state net operating loss carryforwards expire in 2011.  Our tax credit carryforwards of $1.3 millionexpire from 2005 to 2021.

 

**Comparison of the Six Months Ended June 30, 2002 to the SixMonths Ended July 1, 2001**

 

*Revenues.* EDSproduct revenues were $83.8 million in the first six months of 2002, anincrease of 401% from $16.7 million in the first six months of 2001.  This increase in system sales and relatedaccessories is reflective of the increase in orders received from the FAA andTSA, as well as international customers, in late 2001 and 2002, resulting fromthe increased focus on aviation security due to the terrorist attacks ofSeptember 11, 2001.  EDS servicerevenues were $5.9 million for the first six months of 2002, an increase of28.1% from $4.6 million in the first six months of 2001.  As a result of warranty periods expired onsystems installed a year ago, we have experienced increased service contractrevenues for new support and maintenance agreements and more billable time andmaterial type of services provided on a greater installed base of systems.

 

Quantum’s governmentcontract revenues were $6.6 million for the first six months of 2002, adecrease of 13.6% from $7.7 million in the first six months of 2001.  During the first six months of 2002, $4.7million of our government contract revenues from the U.S. government were forthe development of landmine technologies, representing 61.8% of Quantumrevenues, and during the first six months of 2001, $5.9 million of ourgovernment contract revenues from the U.S. government were for the developmentof landmine technologies, representing 76.6% of Quantum revenues. We anticipatethat government contract revenues for landmine detection technologies willcontinue to decrease in 2002 compared to the previous year.  This is the result of a reduced need forsubcontract support for the landmines contracts in 2002, as outsourcedmilestones are completed.  A reductionin such support needs reduces the amounts of revenue recognized in re-billingsubcontract support cost back to the government. In addition, Quantum isshifting internal resources to develop an upgrade to the CTXTM family ofexplosives detection systems utilizing QR. This project to combine QR and CT technology is partially funded by agrant of $1 million by the TSA, and partly funded by InVision.  To the extent that Quantum provides futureEDS research on an intercompany basis to InVision, the expense of this effortwill be reflected as EDS segment R&D expense, and will not be reflected asQuantum revenue.  Quantum’s productrevenues were $781,000 in the first six months of 2002.  Quantum’s product revenues were $54,000 inthe first six months of 2001.

 

Wood product revenues,all attributed to Inovec, were $3.5 million in the first six months of 2002, adecrease of 29.8% from $5.0 million in the first six months of 2001.  The decrease in Wood product revenues isprimarily due to continued softness in the wood

 

14

----

 

products industry. Woodservice revenues increased to $868,000 in the first six months of 2002, anincrease of 13.9% from $762,000 in the first six months of 2001.

 

*Gross Profit.*Gross profit for EDS products was $37.0 million in the first six months of2002, an increase of 450% from the $6.7 million in the first six months of2001.  Gross margin percentages for EDSproducts were 44.2% in the first six months of 2002 and 40.2% in the first sixmonths of 2001.  The increase in grossprofit for EDS products is due to higher EDS product revenues in the first sixmonths of 2002 compared to the same period a year ago.  The improvement in EDS product gross marginpercentages is primarily due to lower manufacturing overhead per unit,resulting from a larger increase in units produced relative to the increase infixed costs in the first six months of 2002 compared to the same period a yearago.  The change in gross marginpercentages is also affected to a lesser extent by variations in the mix ofproduct types and pricing factors among domestic and international customers inthe first six months of 2002.  Inaddition, EDS product gross margins in the prior-year period were negativelyimpacted due to additional warranty provisions recorded to upgrade certainpreviously sold CTX 9000 systems to current manufacturing standards.  We expect that gross margins will continueto improve as fixed costs are spread over larger quantities of units produced,with the improvement partially ofset by volume-based price reductions in salesto the TSA.

 

Gross profit for EDS serviceswas $1.1 million in the first six months of 2002, a decrease of 17.7% from $1.3million in the first six months of 2001. Gross margin percentages for EDSservices were 18.1% for the first six months of 2002 and 28.1% for the firstsix months of 2001.  The decrease ingross profit for EDS services is primarily due to increased EDS customersupport overhead costs necessary to support an increasing installed base of EDSunits.  Because product sales areinitially covered for support services under warranty, there is approximately a15 to 18 month time lag from shipment to recognizing any additional servicecontract revenue tied to the increased sales of EDS products.  However, the EDS product customer is not obligatedto purchase support services from us after the warranty period, so additionalservice contract revenues are not guaranted by sales.  The increased support costs with no immediate service revenue forrecent product sales was the primary reason for lower gross profit and grossmargin for first six months of 2002 compared to that in the same period in2001.

 

Gross profit for Quantumgovernment contracts was $2.1 million for the first six months of 2002, a 30.7%increase from $1.6 million for the first six months of 2001.  Gross margin percentages were 31.7% for thefirst six months of 2002 and 20.9% for the first six months of 2001.  The increase in gross profit and theimprovements in gross margin percentages for government contracts are primarilydue to fewer outside engineering services being required on a landminescontract, in which related services typically carry a slightly lower margin, inthe first six months of 2002 compared to the same period a year ago.  Our contract with an outside services firmwas substantially completed in early 2002 upon completion of certain milestonesin the vehicle-mounted landmines detection contract.  We do not expect to utilize significant levels of outsideservices in our current research and, consequently, we anticipate lower Quantumgovernment contract revenues with slightly higher gross margins.

 

Gross profit for Woodproducts was $873,000 for the first six months of 2002, a decrease of 47.8%from $1.7 million for the first six months of 2001.  Gross margin percentages were 24.8% in the first six months of2002 and 33.3% for the first six months of 2001.  The decrease in gross profit and gross margin percentages forWood products is primarily due to softness in the industry. Gross profit forWood services were $474,000 for the first six months of 2002 and $394,000 forthe first six months of 2001.  Grossmargin percentages for Wood services were 54.6% for the first six months of2002 and 51.7% for the first six months of 2001.

 

*Research and Development.*Gross research and development expenses for EDS were $7.0 million for the firstsix months of 2002, an increase of 32.1% from $5.3 million for the first sixmonths of 2001.  Research anddevelopment contracts and grants from the FAA and other government agenciesfunded $540,000 of our gross research and development expenses for EDS for thefirst six months of 2002 and $2.1 million for the first six months of 2001. Netresearch and development expenses for EDS were $6.5 million for the first sixmonths of 2002, an increase of 105% from $3.2 million for the first six monthsof 2001.  Net research and developmentexpenses for EDS as a percentage of EDS revenues were 7.2% for the first sixmonths of 2002 and 14.8% for the first six months of 2001.  The increase in gross research anddevelopment expenses for EDS is primarily due to an increased focus on severalinitiatives to support our growth. With the goal of 100% screening in U.S.airports, we expect that our EDS machines will be operated at or near capacityfor extended periods.  We are investingin sustaining engineering efforts to ensure that our products achieve highlevels of serviceability and reliability when operated at capacity.  We are also devoting significant engineeringresources to support the rapid expansion of our manufacturing capacity, and arecontinuing our development of ARGUS and product enhancements for our existingline of EDS machines.  The increase innet research and development expenses for EDS is primarily due less fundingreceived from the ARGUS grant in the first six months of 2002  compared to the same period a year ago.

 

Research and developmentexpenses for Quantum were $632,000 for the first six months of 2002, anincrease of 134% from $270,000 for the first six months of 2001.  Research and development expenses forQuantum as a percentage of Quantum revenues were 8.4% for the first six monthsof 2002 and 3.5% for the first six month of 2001.  The increase in expenses is primarily due to more internal costsincurred for the development and commercialization of products, such as the *i*-Portal100 system, in the first six months of 2002 compared to the same period a yearago.

 

Research and developmentexpenses for Wood were $945,000 for the first six months of 2002, a decrease of29.2% from $1.3 million for the first six months of 2001.  Research and development expenses for Woodas a percentage of Wood revenues were 21.5% for the first six months of 2002and 23.1% for the first six months of 2001. The decrease in expenses is primarily due to a temporary reallocation ofengineering resources to support the rapid growth of the EDS business from Wooddevelopment efforts.

 

15

----

 

*Selling, general and administrative.*Selling, general and administrative expenses for EDS were $9.0 million for thefirst six months of 2002, an increase of 156% from $3.5 million for the firstsix months of 2001.  Selling, generaland administrative expenses for EDS as a percentage of EDS revenues were 10.0%for the first six months of 2002 and 16.5% for the first six months of2001.  The increase in selling, generaland administrative expenses for EDS in absolute dollars is primarily due toincreases in consultants and professional fees, such as investor and publicrelations, sales commissions, insurance costs, and employee headcount, allrelated to the growth of our business resulting from the increase in ordersreceived from the FAA, TSA, and international customers, in the first sixmonths of 2002 compared to the same period a year ago.  The decrease in selling, general andadministrative expenses for EDS as a percentage of revenues is primarily due tothe increase in EDS revenues.

 

Selling, general andadministrative expenses for Quantum were $1.3 million for the first six monthsof 2002, an increase of 18.4% from $1.1 million for the first six months of2001.  Selling, general andadministrative expenses for Quantum as a percentage of Quantum revenues were17.9% for the first six months of 2002 and 14.7% for the first six months of2001.  The increase in expenses in absolutedollars is primarily due to an increase in marketing activities associated withcommercial products.  The increase inselling, general and administrative expenses as a percentage of Quantumrevenues is due both to a $200,000 increase in absolute dollars and to thedecrease in Quantum revenues.

 

Selling, general andadministrative expenses for Wood were $1.7 million for the first six months of2002, a decrease of 13.7% from $2.0 million for the first six months of2001.  Selling, general and administrativeexpenses for Wood as a percentage of Wood revenues were 38.4% for the first sixmonths 2002 and 33.9% for the first six months of 2001.  The decrease in expenses is primarily due toa reduction of amortization expense for goodwill and certain intangibles ofapproximately $212,000 in accordance with Statement of Financial AccountingStandards, or SFAS, No. 142, which was effective on January 1, 2002.

 

*Interest Expense.*  Interest expense was $210,000 for the firstsix months of 2002, an increase of 41.9% from $148,000 for the first six monthsof 2001.  The increase in interestexpense is primarily due to increased activities within our financing forinsurance premiums, and increased activities within our lines of credit, suchas more standby letters of credit issued to secure guarantees to customers, inthe first six months of 2002 compared to the same period a year ago.

 

*Interest and Other (Expenses)Income, Net.*  Interestand other income (expenses), net, decreased to a net expense of $564,000 in thesix months of 2002 from a net income of $105,000 in the first six months of2001.  The 2002 amount consistsprimarily of interest income on cash, cash equivalents and short-terminvestments of $523,000, more than offset by other expenses (net) of $1.1 million,including a net $688,000 foreign exchange loss, primarily on outstandingforeign exchange forward contracts at June 30, 2002.  The 2001 amount consists primarily of interest income on cash,cash equivalents and short-term investments of $194,000, partially offset byother expense (net) of $89,000, primarily foreign exchange losses.

 

*Provision for Income Taxes.*  We recorded a provision for income taxes of$8.6 million in the first six months of 2002 and $121,000 in the first sixmonths of 2001.  Our effective tax ratefor the first six months of 2002 was 40.9% and 32.4% in the first six months of2001.

 

**Liquidityand Capital Resources**

 

At June 30, 2002, we had$187.0 million in cash, cash equivalents and short-term investments, comparedto $13.4 million at December 31, 2001. Working capital was $154.1 million at June 30, 2002 compared to $49.6million at December 31, 2001.  On April2, 2002, we closed a public offering of shares of our common stock to thepublic, in which we sold 2,500,000 shares at a price of $36.50 per share,resulting in net proceeds to us of approximately $85 million.

 

Net cash provided byoperating activities was $90.2 million in the first six months of 2002,compared to $5.4 million used in operating activities in the first six monthsof 2001.  Cash provided by operatingactivities in the first six months of 2002 primarily resulted from a $111.7million increase in deferred revenues (consisting primarily of long-leaddeposits on delivery orders from the TSA), a $33.2 million increase in accountspayable and accrued liabilities, net income of $12.4 million enhanced by the$5.1 million non-cash effect of income tax benefits from employee stocktransactions, and the $1.7 million non-cash effect of depreciation andamortization, partially offset by a $38.4 million increase in inventories, a$26.5 million increase in accounts receivable, and a $10.3 million increase inother current assets (consisting of approximately $6.0 million of ramp up coststo be recovered from the TSA, and approximately $3.3 million in prepaidinventory purchases).  Cash used inoperating activities in the first six months of 2001 primarily resulted from a$3.9 million increase in inventories, a $2.8 million increase in accountsreceivable, and a $531,000 decrease in deferred revenues, partially offset bynet income of $233,000 and the $1.9 million non-cash effect of depreciation andamortization.

 

16

----

 

Net cash used ininvesting activities was $247,000 in the first six months of 2002, compared to$1.3 million in the first six months of 2001. Net cash used in investing activities in the first six months of 2002resulted from $2.2 million in acquisitions of capital equipment, offset byproceeds from the sale of short-term investments of $2.0 million.  Net cash used in investing activities in thefirst six months of 2001 resulted from $1.0 million in acquisitions of capitalequipment and $267,000 for the payment of an earn-out to the formershareholders of Inovec in accordance with terms in the purchase agreement.

 

Net cash provided fromfinancing activities was $85.7 million in the first six months of 2002,compared to $3.8 million in the first six months of 2001.  Net cash provided by financing activities inthe first six months of 2002 primarily resulted from $86.3 million in netproceeds from the sale of common stock to the public and under the employeestock purchase plan and exercises of incentive stock options, partially offsetby $516,000 in repayments of short-term debt, net of proceeds.  Net cash provided by financing activities inthe first six months of 2001 was primarily due to $3.8 million in proceeds fromborrowings of short-term debt, net of payments, and $147,000 in proceeds fromsales under the employee stock purchase plan and exercises of incentive stockoptions, partially offset by $216,000 in repayments of long-term debt.

 

In March 2002, we amendedour two line of credit agreements with Silicon Valley Bank.  The first agreement provides for maximumborrowings in an amount up to the lower of 80% of eligible domestic EDSreceivables or $12.0 million.  Thesecond agreement is partially guaranteed by the Export-Import Bank, or EXIM, ofthe United States and provides for maximum borrowings in an amount up to the lowerof:  (a) the sum of 70% to 90% ofeligible EDS export accounts receivable plus the lower of: (i) 70% of eligibleraw materials and work-in-process inventory designated for export customers;(ii) 60% of outstanding loans under this agreement, or; (iii) $4.0 million, or;(b) $10.0 million.  Total borrowingsunder both agreements cannot exceed $20.0 million.  Borrowings under these agreements bear interest at the bank’sprime rate plus 1.5%, or the bank’s prime rate plus 1.0% if we maintain atleast 80% of our cash and cash equivalents at Silicon Valley Bank.  Subsequent to the completion of our publicoffering in April 2002, the interest rate is the bank’s prime rate plus 1.5%,or the bank’s prime rate plus 1.0% if we maintain at least 50% of our cash andcash equivalents at Silicon Valley Bank. Borrowings are secured by EDS assets. The agreements expire in February2003 and require that the EDS segment maintain certain levels of tangible networth and intercompany balances from its wholly-owned subsidiaries, and alsoprohibit us from paying cash dividends. We may use proceeds of loans under both lines of credit for generalcorporate purposes in EDS operations. At June 30, 2002, we had no borrowings outstanding under theseagreements.  However, at June 30, 2002,we had outstanding guarantees to customers through issuance of letters ofcredit secured by the lines of credit totaling $5.3 million and foreignexchange contracts for which a 10% reserve of $4.3 million is secured by thelines of credit.  Additionally, we had areserve of $1.4 million against our lines of credit for a draw-down of a letterof credit, which had not been settled by Silicon Valley Bank at June 30,2002.  We had remaining availableborrowing capacity under the lines of credit of $9.1 million at June 30, 2002based on eligible EDS accounts receivable and inventories as of that date.

 

In August 2001, Inovecentered into a line of credit agreement with Pacific Continental Bank.  The agreement provides for a $1.5 millionworking capital line of credit and is secured by assets of Inovec, Inc.  The agreement bears interest at the bank’sprime rate plus 1.0% with an interest rate floor of 7.25%.  The agreement expires in August 2002 andrequires that Inovec maintain certain levels of tangible net worth anddebt/worth ratios.  We may use proceedsfrom loans under the line of credit for general corporate purposes in Inovec’soperations.  We had borrowings of$290,000 outstanding under this agreement at June 30, 2002.

 

We previously borrowedagainst a committed equipment line of credit agreement with Silicon ValleyBank, which converted into a term loan after draw down.  Borrowings are secured by the assetspurchased or financed.  At June 30,2002, we had an outstanding $133,000 term loan due June 2003.  The term loan bears interest at the bank’sprime rate plus 1.5%.

 

We believe that existingcash, cash equivalents and short-term investments, available borrowings underour lines of credits and funds expected to be generated from operations will besufficient to finance our working capital and capital expenditure requirementsfor at least the next 12 months. However, if we fail to meet required financial covenants in our creditagreements, or our receivables do not support the upper limits of these creditagreements, then we may not be able to have access to further funds under theseagreements.  In addition, if we areunable to deliver EDS units in a timely manner under our recent orders from theTSA or if we fail to adhere to the terms of the licensing agreement with theTSA, the TSA may cancel its orders or not place additional orders.  If any of these events occur, our capitalresources would be significantly impaired.

 

17

----

 

**BusinessRisks**

 

**A number of factors that affect ourrevenues make our future results difficult to predict, and therefore we may notmeet expectations for a particular period.**

 

We believe that our revenues have the potential tovary significantly from time to time. We believe that these variations mayresult from many factors including:

 

•                  the timing and size of orders fromour major customers, including most prominently, the TSA, and agencies of othergovernments;

•                  delays in product shipments caused bythe inability of airports to install or integrate our products in a timelyfashion;

•                  our ability to expand manufacturingcapacity sufficiently to meet any increased demand for our products;

•                  the availability and cost of keycomponents;

•                  a push-back in the December 31, 2002deadline for 100% checked baggage screening in American airports, and thepotential deployment of alternative technologies to meet the deadline;

•                  the acceptance and timing ofenhancements to our existing products;

•                  the introduction and acceptance ofnew products offered by us or our competitors;

•                  changes in pricing policies by us,our competitors or our suppliers, including possible decreases in averageselling prices of our products caused by customer volume orders or in responseto competitive pressures;

•                  legislative or other governmentactions leading to fluctuations in demand for aviation security products andservices; and

•                  our sales mix to domestic andinternational customers.

 

A significant portion ofour quarterly and annual operating expenses are, and will continue to be,relatively fixed in nature. This means that revenue fluctuations will cause ourquarterly and annual operating results to vary substantially. We also maychoose to increase spending to pursue new market opportunities, which may negativelyaffect our financial results.

 

Accordingly, we believethat period-to-period comparisons of our results of operations cannot be reliedupon as indicators of future performance. Because of all of the foregoingfactors, our operating results have from time to time in the past been, and mayagain in the future be, different from expectations of public market analystsand 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 ourcommon stock.

 

**We may not have enough capacity to manufacture a sufficientnumber of units of our EDS products to meet increased demand, resulting in lostrevenue opportunities.**

 

If we cannot produceenough explosives detection systems, we may fail to meet the demand for ourproducts, which could result in lost revenue opportunities and market share. Wehave contracted with CoorsTek, an outside contract manufacturer, and we maycontract with other outside manufacturers, to produce EDS units outside of ourown facility to augment our internal production capacity. The increase indemand is placing significant demands on our management, working capital andfinancial and management control systems. For example, to increase productioncapacity, we are hiring and training a significant number of new employees,ordering key components which have long lead times and training and monitoringour outside contract manufacturer. Even with our anticipated increasedcapacity, our total production capacity may not be sufficient to meet thesignificant increase in demand. If the U.S. government is not satisfied that wehave sufficient manufacturing capacity to produce significant numbers of ourEDS products or, if we fail to deliver EDS products on a timely basis, we maynot receive further orders from the U.S. government that we otherwise wouldhave received.

 

**We depend upon a limited number of suppliers for componentsof our EDS products, and if we are unable to obtain parts from these supplierson a timely basis, then we may not be able to deliver our EDS products asrequired.**

 

Key components used inour products have been designed by us to our specifications and are currentlyavailable only from one or a limited number of suppliers. We currently do nothave long-term agreements with these suppliers.  In addition, some of the suppliers of the key components used inour products are our competitors, and they may be motivated not to supply uswith the components we need.  Ourinability to develop alternative sources for single or sole source components,to find alternative third party manufacturers or sub-assemblers, or to obtainsufficient quantities of these components, could result in delays orinterruptions in product shipments, which could cause potential customers toseek other suppliers of EDS products. In view of the high cost of many of thesecomponents, we do not maintain excess supplies. Our demands for large volumesof these key components may strain the abilities of our suppliers to providethese key components on a timely or expedited basis. In addition, we maycompete with other EDS manufacturers to obtain parts for our EDS products.  If our suppliers experience financial,operational, production or quality assurance difficulties,  or our sole source suppliers are acquired orotherwise influenced by our competitors, the supply of components to us 

 

18

----

 

would be reduced orinterrupted. In the event that a supplier ceases operations, discontinues aproduct or withholds or interrupts supply for any reason, we may be unable toacquire the product from alternative sources within a reasonable period oftime.

 

Rapid increases inproduction levels could also result in higher costs for components and otherincreased manufacturing expenses. These higher costs could reduce ourprofitability. Furthermore, if production is increased inefficiently,manufacturing yields could decline, which may also lower our profitability.

 

**A pushback in the December 31, 2002, deadline for 100%screening of checked baggage in the United States could result in volatility inour business.**

 

The Aviation andTransportation Security Act, signed into law in November 2001, calls for 100%checked baggage screening with EDS by December 31, 2002.  Discussion of altering this deadline, eitherpushing it back for a defined period of time, or providing flexibility inmeeting the deadline on a case-by-case basis, are currently underway.  If the deadline were to be pushed back, ourbusiness could be impacted by a slowdown or reduction in future orders, bycosts incurred to reduce manufacturing capacity or declining margins, or thedevelopment of and certification of competitive products.

 

**If the U.S. government purchases non-FAA certified equipment,or if the U.S. government lowers certification standards, to meet the mandateof 100% EDS screening of checked baggage by the end of 2002, we will encounteradditional competition and lose market share.**

 

The Aviation andTransportation Security Act mandates that by the end of 2002, 100% of checkedbaggage must undergo EDS screening. The TSA has announced its intention to meetthe 2002 deadline by purchasing a mix of FAA-certified EDS and non-FAAcertified explosive detection products. In late July 2002, the TSA announced acertification regime for the certification of explosives trace detectiondevices which, together with FAA-certified EDS, would be used to achieve 100%screening of checked baggage. In addition, political pressure to meet thedeadline may cause the FAA to lower its requirements for certification of EDS,which would enable technologies and products that do not meet currentFAA-certification standards to become certified. To the extent that theseevents occur, we would have to compete against suppliers of these products,which may be less expensive than our EDS products, and could decrease ouraverage selling prices, decrease our market share and cause us to sell fewer ofour EDS products than we otherwise would to meet the demand created by the Act.

 

**Legislative actions could lead to fluctuations in demand foraviation security products and services.**

 

In addition to changingthe deadline for screening of checked baggage, other legislation could beintroduced that would impact demand for aviation security products andservices.  In response to publicpressure, fluctuation in concern on the part of voters about aviation security,or for other reasons, the plans for deployment of EDS to screen baggage couldbe changed.  The Aviation andTransportation Security Act (ATSA) could be amended through legislative action,the legislature could exhibit lack of commitment to fulfilling the mandate ofthe ATSA, budgetary debates and delays could result in fewer EDS being sold tothe TSA, and elected officials who support the EDS program could fail tomaintain their offices, any of which events could cause a decrease in thedemand for our EDS products.

 

**Future sales of our EDS products will depend on the abilityof airports to integrate our EDS units into their baggage handling system,which they may not be able to do.**

 

Future sales will depend,in part, on installing our EDS products into airport lobbies or integratingthem into existing baggage handling systems. If an airport is not configuredfor these systems, deployment of our EDS products may require changes in theairport infrastructure, such as reinforced airport lobby floors and baggageplatforms.  The government isresponsible for hiring general contractors to install our EDS products.  If our EDS products cannot easily beinstalled in airport lobbies or integrated into existing baggage handlingsystems, we may experience reduced sales of our EDS products or these sales maybe delayed. In addition, installations and integrations are currently partiallyfunded by the TSA in the United States. There can be no assurance that thegovernment will continue to fund installations and integrations at the currentlevel or at all.  If there is such areduction in funding, we may experience reduced sales of our EDS products orthese sales may be delayed.

 

We believe that asubstantial opportunity exists for InVision CTX 9000 DSitm to beintegrated into baggage handling systems. If airports determine, in conjunction with governmental authorities,that they will be unable or unwilling to modify or finance such modificationsto in-line baggage handling systems, this opportunity may be limited.

 

**We may not be able to grow our service organization quicklyenough to support our EDS units deployed in the field.**

** **

Weare responsible for the installation and warranty of our EDS units.  With the rapid increase in the number ofunits being shipped, we are expanding our service organization's capability.EDS units are relatively complex machines, which employ high-speed conveyorsand sophisticated imaging technology. If we are unable to hire and train sufficient service personnelsupported by an expanded logistical system, the reliability of our machinescould suffer. If this were to occur, there could be a decrease in demand forour products.

 

**If our EDS products fail to detect explosives, we could beexposed to product liability and related claims, and we may not have adequateinsurance coverage.**

 

Our business exposes usto potential product liability risks, which are inherent in the manufacturingand sale of EDS products. Our machines are not designed to detect, and FAAcertification does not require 100% detection of, any and all explosivescontained in scanned baggage. For this reason, or if our products malfunction,it is possible that explosive material could pass undetected through ourproducts, which would lead to product liability claims. There are also manyother factors

 

19

----

 

beyond our control that could lead to liability claims, such as thereliability and competence of the customer’s operators, the training of theoperators, and the maintenance of the products by the customers.

 

If a product liabilityclaim is brought against us, the cost of defending the claim would be significantand any adverse determination may result in liabilities in excess of ourinsurance coverage. We currently have product liability and war and terrorisminsurance in the amount of $150 million. However, since September 11, 2001,insurance rates have increased dramatically, and we cannot be certain that ourcurrent insurance can be maintained, or additional insurance coverage could beobtained, on acceptable terms, if at all.

 

In addition, the failureof any EDS product to detect explosives, even if due to operator error and notto the mechanical failure of an EDS product, could result in public andcustomer perception that our products do not work effectively, which could havea material adverse effect on sales and may cause customers to cancel orders alreadyplaced, either of which would harm our business.

 

**We are substantially dependent on large orders from a limitednumber of customers. As a result, order cancellations from any of our customersor the failure to continue to purchase EDS products from these customers couldhave a significant negative impact on our business.**

 

In any given fiscalquarter or year, our revenues are derived from orders of multiple units of ourEDS products from a limited number of customers.  Through June 30, 2002, substantially all of our orders fromUnited States customers have been funded by the FAA and TSA, which allocatesour products to airports in the United States. EDS sales to the FAA, andsubsequent to the formation of the TSA, to the TSA, accounted for 61.0% of our revenuesin the first six months of 2002 and 26.9% of our revenues in the year endedDecember 31, 2001. In the first six months of 2002, seven customers accountedfor all of our EDS units sold during the period, and similarly for the fiscalyear 2001, seven customers accounted for all of our EDS units sold during theyear. The failure of these customers, particularly the U.S. government tocontinue to purchase our EDS products or the cancellation of existing orderswould harm our business.

 

**We have granted a royalty-bearing license to the U.S.government to have our products produced by other manufacturers and if thesemanufacturers produce our products, we may lose expected revenue opportunities.**

 

In connection with ordersfor EDS units, the TSA required that we grant the TSA a two-yearroyalty-bearing license to enable other manufacturers to build for the TSA EDSproducts based on our technology used in these products. With this license, theTSA may purchase EDS products from other manufacturers rather than us, even ifwe have the manufacturing capacity to build those EDS products. If thishappens, the royalty we receive under the license may not fully compensate usfor the lost business opportunity.

 

Further, since licensedmanufacturers will be building substantially the same products as we build, ifwe fail to timely deliver EDS products which the TSA has ordered from us, theTSA may not give us the opportunity to cure the failure to deliver, and it maytransfer the order from us to a licensed manufacturer.  The TSA has not exercised this license todate.

 

**The sales cycle for our EDS products is lengthy, and we mayexpend a significant amount of effort in obtaining sales orders and not receivethem.**

 

The sales cycle of ourEDS products is often lengthy due to the protracted approval process thattypically accompanies large capital expenditures and the time required tomanufacture and install our EDS products. Typically, six to twelve months mayelapse between a new customer’s initial evaluation of our systems and theexecution of a contract. Another three months to a year may elapse prior toshipment of our EDS products as the customer site is prepared and our EDSproducts are manufactured. In addition, in the United States, the creation ofthe TSA and debate on formation of a Department of Homeland Security, as wellas budgetary debates in congress, may result in additional delays in thepurchase of additional EDS products. During the sales cycle we expendsubstantial funds and management resources but recognize no associated revenue.

 

20

----

 

**Our international sales subject us to risks that could have amaterial adverse effect on our business.**

 

Sales to countries otherthan the United States accounted for 25.3% of our revenues in the first sixmonths of 2002 and 32.5% of our revenues for the year ended December 31, 2001.A number of factors related to our international sales and operations couldadversely affect our business, including:

 

•                  unexpected changes in regulatoryrequirements;

•                  political instability in thecountries where we sell products;

•                  possible foreign currency controls;

•                  fluctuations in currency exchangerates;

•                  our ability to protect and utilizeour intellectual property in foreign jurisdictions;

•                  tariffs, embargoes or other barriers;

•                  difficulties in staffing and managingforeign operations;

•                  difficulties in obtaining andmanaging distributors; and

•                  potentially negative taxconsequences.

 

The sale of some of ourproducts outside the United States is subject to compliance with the UnitedStates International Traffic in Arms Regulations and Export AdministrationRegulations. Our failure to obtain the requisite licenses, meet registrationstandards or comply with other government export regulations, may affect ourability to generate revenues from the sale of our products outside the UnitedStates, which could harm our business. In particular, our EDS products and ourlandmine detection equipment are deemed regulated military devices subject to exportrestrictions under the U.S. Department of State regulations. Consequently,these regulations may make these products more difficult to sell to a number ofcountries. Compliance with government regulations may also subject us toadditional fees and costs. The absence of comparable restrictions oncompetitors in other countries may adversely affect our competitive position.

 

**Because of the increased demand for our EDS products by theU.S. government, we may lose other customers, which could harm our business.**

 

The Aviation andTransportation Security Act mandates 100% EDS screening of checked baggage atU.S. commercial airports by the end of 2002. To meet this mandate the TSA hasbeen authorized by the U.S. Department of Commerce to place a priority ratingon EDS contracts, which would obligate us to timely fulfill the TSA’s ordersand delay any unrated or lower-rated orders. In addition, as part of any futureorders, the TSA may request that we agree to timely fill its orders prior tofulfilling the needs of any other customers. Accordingly, we may not be able tofulfill orders for our EDS products from non-U.S. government customers duringthis period of increased demand from the U.S. government. This could cause ourcurrent and potential non-U.S. government customers to seek EDS products fromother sources. We also may lose our goodwill and relationships with thesecustomers, which could harm our ability to make sales in the future.

 

**The U.S. government’s right to use technology developed byus, but funded by the U.S. government, limits our intellectual property rights.**

 

In accordance withcertain Federal Acquisition Regulations included in our development contractswith the FAA, the U.S. government has rights to use our proprietarytechnologies developed after the award of the development contract and fundedby the development contract. The U.S. government may use these rights toproduce or have produced for the U.S. government competing products using ourCT technology. In the event that the U.S. government was to exercise theserights, our competitive position in supplying the U.S. government withcertified CT-based explosives detection systems would be harmed.

 

**Our future EDS products may fail to obtain certification bythe FAA.**

 

We plan to continue todevelop new models for our family of EDS products, including through ourcurrent participation in the ARGUS program, an FAA-sponsored program designedto develop a smaller, low-cost EDS product to scan checked baggage in smallairports and low-traffic stations within larger airports. However, we cannot becertain that any new product, including the ARGUS system, if completed, will becertified by the FAA. The failure to gain certification for a product wouldharm our ability to sell the product, and recognize associated revenues.

 

**Ourexisting products may fail to obtain re-certification by the FAA for changes insoftware or parts.**

** **

Our existing EDS productscan be required to be re-certified by the FAA. This can happen when a critical component is changed, or we wish to makechanges to the EDS software.  When thishappens, the affected EDS model requires re-certification by the FAA.  The failure or delay in gainingre-certification for an existing EDS product could harm our ability to continueto sell the product and recognize associated revenues.

 

 

**We may seek to grow by acquisition, which subjects us tosubstantial risks, including the failure to successfully integrate an acquiredbusiness.**

 

As part of our growthstrategy, we may expand our business by pursuing selected acquisitions oftechnologies and companies that offer complementary products, services,technologies or market access. Our ability to grow by acquisition is dependentupon the availability of acquisition candidates at reasonable prices and our abilityto obtain acquisition financing

 

21

----

 

on acceptable terms.Future acquisitions by us could result in potentially dilutive issuances ofequity securities, the incurrence of debt and contingent liabilities, andamortization expenses related to intangible assets, any of which could harm ourbusiness. Acquisitions entail numerous risks, including:

 

•                  difficulties in the assimilation ofacquired operations, technologies and products;

•                  diversion of management’s attentionfrom other business concerns;

•                  risks of entering markets in which wehave no or limited prior experience; and

•                  potential loss of key employees ofacquired organizations.

 

The process ofintegrating supply and distribution channels, computer and accounting systemsand other aspects of operations, while managing a larger entity, would presenta significant challenge to our management. We may not be able to successfullyintegrate any businesses, products, technologies or personnel that might beacquired in the future. In such case, the anticipated benefits of a businesscombination would not be fully realized, and the failure of such efforts wouldharm our business.

 

**We depend on key management and personnel and may not be ableto retain those employees or recruit additional qualified personnel.**

 

We believe that ourfuture success will be due, in part, to the continued services of our seniormanagement team. We do not have long-term employment agreements with any of ourexecutive officers. Losing the services of one or more members of ourmanagement team could adversely affect our business and our expansion efforts.We do not maintain key person life insurance policies for members of ourmanagement. In addition, competition for some qualified employees, such assoftware engineers or other advanced engineering professionals, has intensifiedin recent years and may become even more intense in the future as the EDSindustry expands. Our ability to meet substantial anticipated increases indemand is dependent on our ability to hire and retain technically skilledworkers. Our failure to recruit qualified employees in a timely manner andretain them could impair our ability to achieve our growth objectives.

 

**Natural disasters, including earthquakes, may damage ourfacilities.**

 

Our corporate andmanufacturing facilities in California are located near major earthquakefaults, which have experienced earthquakes in the past. In the event of a majorearthquake or other natural disaster, our facilities may sustain significantdamage and our operations could be harmed.

 

**The EDS industry is highly competitive. Given the anticipatedlarge increase in demand for airport security products, competition mayincrease.**

 

The EDS industry isintensely competitive and we may not compete successfully with our competitors.As a result of increased demand for security systems, additional companies mayenter the EDS industry. Some of our competitors, including L-3 CommunicationsHoldings, Inc. and many of the potential new entrants into the EDS industry,have financial, technical, production and other resources substantially greaterthan ours. Our failure to compete successfully could result in lost sales andcould hamper our financial results.

 

**Governmental agencies, the primary customers for our EDS andother products are subject to budget processes, which could limit the demandfor these products.**

 

Substantially all of thecustomers for our EDS products and our other products under development to datehave been public agencies or quasi-public agencies, such as the FAA, TSA andairport authorities. Public agencies are subject to budgetary processes andexpenditure constraints. In the past, many domestic and foreign governmentagencies have experienced budget deficits that have led to decreased capitalexpenditures in certain areas. The funding of government programs is subject tolegislative appropriation. Budgetary allocations for explosives detectionsystems are dependent, in part, upon governmental policies, which fluctuate fromtime to time in response to political and other factors, including the public’sperception of the threat of commercial airline bombings. For example, theterrorist attacks of September 11, 2001, resulted in passage of the Aviationand Transportation Security Act mandating a small surcharge on each airlineticket purchase to fund airline security, which we expect will increase fundingfor explosives detection products and technologies. We cannot assure you thatthese funds will be used to purchase our EDS products, or that other funds willcontinue to be appropriated by Congress or allocated by the TSA or otheragencies for the purchase of EDS products.

 

Although multi-yearcontracts may be authorized in connection with major procurements, governmentsgenerally appropriate funds on a fiscal year basis even though a program maycontinue for several years. Consequently, programs are often only partiallyfunded and additional funds are committed only upon further appropriations.

 

22

----

 

**Governmental agencies have special contracting requirements,which create additional risks.**

 

In contracting withpublic agencies, we are subject to public agency contract requirements thatvary from jurisdiction to jurisdiction. Future sales to public agencies willdepend, 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 contractstypically contain termination provisions unfavorable to us and are subject toaudit and modification by the government at its sole discretion, which subjectus to additional risks. These risks include the ability of the U.S. governmentto unilaterally:

 

•                  suspend or prevent us for a setperiod of time from receiving new contracts or extending existing contractsbased on violations or suspected violations of laws or regulations;

•                  terminate our existing contracts;

•                  reduce the scope and value of ourexisting contracts;

•                  audit and object to ourcontract-related costs and fees, including allocated indirect costs;

•                  control and potentially prohibit theexport of our products; and

•                  change certain terms and conditionsin our contracts.

 

The U.S. government canterminate any of its contracts with us either for its convenience or if wedefault by failing to perform in accordance with the contract schedule andterms. Termination for convenience provisions generally enable us to recoveronly our costs incurred or committed, and settlement expenses and profit on thework completed prior to termination. Termination for default provisions do notpermit these recoveries and make us liable for excess costs incurred by theU.S. government in procuring undelivered items from another source. Ourcontracts with foreign governments may contain similar provisions.

 

Consequently, our backlogis not necessarily indicative of future sales. The government’s termination of,or failure to fully fund, one or more of the contracts for our EDS products orour other products under development would harm our business.

 

As a governmentcontractor, we are subject to periodic audits and reviews. Based on the resultsof its audits, the U.S. government may adjust our contract-related costs andfees, including allocated indirect costs. Although adjustments arising fromgovernment audits and reviews have not seriously harmed our business, futureaudits and reviews could cause adverse effects. In addition, under U.S.government purchasing regulations, some of our costs, including most financingcosts, amortization of intangible assets, portions of our research anddevelopment costs, and some marketing expenses may not be reimbursable orallowed in our negotiation of fixed-price contracts. Further, as a U.S.government contractor, we are subject to an increased risk of investigations,criminal prosecution, civil fraud, whistleblower lawsuits and other legalactions and liabilities to which purely private sector companies are not.

 

In addition, publicagency contracts are frequently awarded only after formal competitive biddingprocesses, which are often protracted and typically contain provisions thatpermit cancellation in the event that funds are unavailable to the publicagency. We may not be awarded any of the contracts for which our products arebid. Even if we are awarded contracts, substantial delays or cancellations ofpurchases could result from protests initiated by losing bidders.

 

**Our business could be harmed if we fail to properly protectour intellectual property.**

 

Our success depends inpart on our ability to protect our intellectual property. Although we attemptto protect our intellectual property in the United States and other countries,there can be no assurance that we will successfully protect our technology orthat competitors will not be able to develop similar technology independently.We cannot assure you that the claims allowed under any patents held by us willbe sufficiently broad to protect our technology against competition from thirdparties with similar technologies or products. In addition, we cannot assureyou that any patents issued to us will not be challenged, invalidated orcircumvented or that the rights granted under these patents will providecompetitive advantages to us. Moreover, the laws of some foreign countries do notprotect intellectual property rights to the same extent as the laws of theUnited States, and we could experience various obstacles and high costs inprotecting our intellectual property rights in foreign countries. If we areunable to obtain or maintain these protections, we may not be able to preventthird parties from using our intellectual property.

 

We also rely on tradesecrets, proprietary know-how and continuing technological innovation to remaincompetitive. We have taken measures to protect our trade secrets and know-how,including the use of confidentiality agreements with our

 

23

----

 

employees. It is possiblethat these agreements may be breached and that the available remedies for anybreach will not be sufficient to compensate us for damages incurred.

 

**Litigation may be necessary to enforce or defend againstclaims of intellectual property infringement, which could be expensive and, ifwe lose, could prevent us from selling our products.**

 

Litigation may benecessary in the future to enforce our patents and other intellectual propertyrights, to protect our trade secrets or to determine the validity and scope ofthe proprietary rights of others. Any litigation, regardless of the outcome,could be costly and require significant time and attention of key members ofour management and technical personnel.

 

Our domestic andinternational competitors, many of whom have substantially greater resourcesand have made substantial investments in competing technologies, may havepatents that will prevent, limit or interfere with our ability to manufactureand sell our products. We have not conducted an independent review of patentsissued to third parties. Because of the perceived market opportunity we face,companies possessing technology rights that they believe we might be infringingwill now be much more motivated to assert infringement of their rights. Thesethird parties may assert infringement or invalidity claims against us andlitigation may be necessary to defend against these claims. An adverse outcomein the defense of a patent suit could subject us to significant liabilities tothird parties, require disputed rights to be licensed from third parties orrequire us to cease selling our products. Even successful defenses of patentsuits can be costly and time-consuming.

 

**Our inability to adapt to rapid technological change couldimpair our ability to remain competitive.**

 

The EDS industry mayundergo significant technological development in response to increased demandfor aviation security products. A fundamental shift in technology in ourproduct markets could harm us, because we derive substantially all of ourrevenues from sales of EDS products.

 

We anticipate that wewill incur significant expenses in the design and initial manufacturing andmarketing of new products and services. Our competitors may implement newtechnologies before we are able to, allowing them to provide more effectiveproducts at more competitive prices. Future technological developments could:

 

•                  adversely impact our competitiveposition;

•                  require write-downs of obsoletetechnology;

•                  require us to discontinue productionof obsolete products before we can recover any or all of our related research,development and commercialization expenses; or

•                  require significant capitalexpenditures beyond those currently contemplated.

 

We cannot assure you thatwe will be able to achieve the technological advances to remain competitive andprofitable, that new products and services will be developed and manufacturedon schedule or on a cost-effective basis that anticipated markets will exist ordevelop for new products or services, or that our existing products andservices will not become technologically obsolete.

 

**We have received significant amounts of funding fromgovernment grants and contracts. We cannot assure you that we will continue toreceive this level of funding for future product development.**

 

The U.S. governmentcurrently plays an important role in funding the development of EDS technologyand sponsoring its deployment in U.S. airports. For the six months ended June30, 2002, we performed reimbursable research and development for EDS productstotaling $832,000 from FAA and TSA grants and contracts, and for the year endedDecember 31, 2001, we performed reimbursable research and development for EDSproducts totaling $8.3 million from FAA grants and contracts. We are also awarethat other competitors in the EDS market have received FAA and TSA developmentgrants. The U.S. government also currently funds almost all of the developmentof Quantum products, including quadrupole resonance and passive magneticsensing. For the six months ended June 30, 2002, we had contract revenues of$6.6 million from the U.S. government for the development of Quantum products,and for the year ended December 31, 2001, we had contract revenues of $16.6million from the U.S. government for development of Quantum products. We cannotassure you that additional research and development funds from the government willbecome available in the future or that we will receive any of these additionalfunds. If the government fails to continue to sponsor our technology, we wouldhave to expend more resources on product development, which could adverselyaffect our business. In addition, any future grants to our competitors mayimprove their ability to develop and market advanced detection products andcause our customers to delay any purchase decisions, which could harm ourability to market our products.

 

24

----

 

**Risks Related to Ownership of OurCommon Stock**

 

**The price of our common stock may fluctuate significantly.**

 

A number of factors couldcause the market price of our common stock to fluctuate significantly,including:

 

•                  terrorist attacks or acts of war;

•                  legislative and regulatorydevelopments related to anti-terrorism efforts or aviation security;

•                  our quarterly operating results orthose of other explosives detection companies;

•                  the public’s reaction to our pressreleases, announcements and our filings with the Securities and ExchangeCommission;

•                  changes in earnings estimates orrecommendations by research analysts;

•                  changes in our relationships withcustomers; and

•                  developments affecting ourcompetitors.

 

For example, immediatelyprior to the terrorist attacks of September 11, 2001, our common stock closedat $3.11 per share. Since that date, our closing stock price has risen to ahigh of $48.29 per share through June 30, 2002, which we believe is based onexpectations of increased governmental and other orders for our EDS products.If these expectations are not met, then our stock price could dropdramatically. In addition, the stock market has periodically experiencedsignificant price and volume fluctuations that have particularly affected themarket prices of common stock of technology companies. These changes have oftenbeen unrelated to the operating performance of particular companies. Thesebroad market fluctuations may also adversely affect the market price of ourcommon stock.

 

**Delaware law and our charter documents may impede ordiscourage a takeover, which could cause the market price of our shares todecline.**

 

We are a Delawarecorporation and the anti-takeover provisions of Delaware law impose various impedimentson the ability of a third party to acquire control of us, even if a change incontrol would be beneficial to our existing stockholders. Our certificate ofincorporation and by-laws provide for 5,000,000 shares of preferred stock whichour board of directors may issue with terms determined by them withoutstockholder approval, a classified board of directors serving staggeredthree-year terms, restrictions on who may call a special meeting ofstockholders and a prohibition on stockholder action by written consent. Theseprovisions of Delaware law and in our charter documents could impede a merger,takeover or other business combination involving us or discourage a potentialacquirer from making a tender offer for our common stock, which, under certaincircumstances, could reduce the market value of our common stock.

 

**We do not anticipate paying cash dividends.**

 

We have never declared orpaid any cash dividends on our capital stock and do not anticipate paying cashdividends in the foreseeable future. We have also agreed not to pay cashdividends under our current bank line of credit. Instead, we intend to applyany earnings to the expansion and development of our business.

 

**We maybecome subject to costly and time-consuming class action litigation followingsignificant 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 suchcompanies. Were such litigation to be commenced against us, we would incursubstantial costs and there would be diversion of our management’s attentionand resources, which could materially adversely affect our business, results ofoperations and financial condition.

 

 

## **Item 3.  Quantitative and QualitativeDisclosures About Market Risk**

###### * *

Our internationalsystem sales and maintenance contracts are generally denominated in U.S.dollars.  In instances where there aresignificant international system sales contracts denominated in a foreigncurrency, we enter into forward contracts to mitigate foreign exchangerisk.  We do not enter into market risksensitive instruments for trading purposes.

 

Purchases of rawmaterials and other inventory components are primarily denominated in U.Sdollars and when purchased in foreign currencies, are generally made on an asneeded basis.  We have some advancepurchase commitments in foreign currencies with a few European suppliers.  We currently do not hedge against thesepurchase commitments, as the

 

25

----

 

foreign exchangerate fluctuations have not had a material adverse impact on these purchases;however, we will continue to monitor the foreign exchange rates and enter intoforward exchange contracts to mitigate foreign exchange risk as appropriate.

 

Certain costs ofproviding warranty and maintenance services for systems sold to foreigncountries are denominated in local currencies. To the extent exchange ratesfluctuate, it could become more expensive to provide these services. To date,these costs have not been significant, however, we expect they will increase asour installed base increases.

 

We currentlytransact business in three foreign currencies worldwide, of which the mostsignificant to our operations is the euro. The cash flow impact of changes in exchange rates represents the netfuture cash flows of a 5% or 10% change in the respective foreign currency forthe market sensitive instruments summarized in the following table:

 
|                                |   |                 |   |                                 |   | **Cash flow  impact of change in  exchange rates** |   |
|-------------------------------------|--------|----------------------|--------|--------------------------------------|--------|----------------------------------------------------|--------|
| **(in thousands)**                  |   | **Contract  Amount** |   | **Fair Value  as of  June 30, 2002** |   | **5% Change**                                      |   | **10% Change** |   |
|                                |   |                 |   |                                 |   |                                               |   |   |   |
| Foreign currency  forward contracts |   | $                    | 42,652 |                                 | $      | (3,819                                             | )      | $ | 2,340 |   | $ | 4,681 |   |
| Accounts  receivable                |   | 15,035               |   | 16,632                               |   | (832                                               | )      | (1,663 | ) |
| Firm orders*                        |   | 31,511               |   | 34,472                               |   | (1,724                                             | )      | (3,447 | ) |
| Accounts payable                    |   | (1,107               | )      | (1,183                               | )      | 59                                                 |   | 118 |   |
|                                |   |                 |   |                                 |   |                                               |   |   |   |
| total                               |   |                 |   |                                 |   | $                                                  | (157   | ) | $ | (311 | ) |
|                                     |        |                      |        |                                      |        |                                                    |        |  |  |  |  |  |  |

 

----

* Firm ordersrepresent orders for which the Company has received a signed purchase order.

 

The cash flow impactof changes in exchange rates at June 30, 2002 is not significantly differentfrom the cash flow impact of changes in exchange rates at December 31,2001.  The impact of changes in interestrates is not expected to have a material impact on our operations orliquidity.  In addition, the impact ofinflation has not been material on our operations or liquidity to date.

 

26

----

 

**PartII.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

We are involved in routine civil litigation arising inthe ordinary course of business. Management believes that collectively these proceedings will not have amaterial adverse effect on our business, financial condition or results ofoperations.

 

## **Item 2.**    Changes in Securities and Use of Proceeds

 

On April 22, 2002, theCompany issued the following amounts of unregistered securities as finalpartial consideration for its acquisition of Inovec, Inc. in 2000:

 

(1)   17,884 shares of common stock to AndrewNowak

(2)           6,927shares of common stock to Alan Bazaaz

(3)           3,540shares of common stock to Jeffrey Franklin

(4)           3,601shares of common stock to Kerry Wilson

 

The shares were issued inreliance on Regulation D promulgated under Section 4(2) of the Securities Actof 1933, in that the recipients of the shares were former shareholders ofInovec, Inc., who were either accredited investors or had an appointedpurchaser’s representative who, with the former shareholders, had the financialsophistication and knowledge required under Regulation D.

 

**Item3.****    DefaultsUpon Senior Securities**

 

Not applicable.

 

**Item4.****    Submissionof Matters to a Vote of Security Holders**

 

The 2002 Annual Meetingof Stockholders was held June 13, 2002. Matters voted upon at that meeting were:

 
| (i)   |   | The election of three directors  to hold office until the 2005 Annual Meeting of Stockholders;                                                                                       |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (ii)  |   | The approval of the  2002 Employee Stock Purchase Plan;                                                                                                                              |
| (iii) |   | The approval of the  2000 Equity Incentive Plan, as amended, to increase the aggregate number of  shares of Common Stock authorized for issuance under such plan by 600,000  shares; |
| (iv)  |   | The ratification of the  selection of Deloitte & Touche LLP as independent auditors of the Company  for its fiscal year ending December 31, 2002.                                |

 

Tabulations for eachproposal were as follows:

*** ***

Proposal I.  Election of three directors to hold officeuntil the 2005 Annual Meeting of Stockholders

 
| **Director**         |   | **For**    |   | **Withheld** |   |
|----------------------|--------|------------|--------|--------------|--------|
| Dr.  Douglas P. Boyd |   | 14,496,681 |   | 90,308       |   |
| Dr.  Bruno Trezza    |   | 14,495,637 |   | 90,352       |   |
| Louis  A. Turpen     |   | 14,492,146 |   | 93,843       |   |

 

Dr. GiovanniLanzara and Ambassador Morris D. Busby continue in office directors until our2004 Annual Meeting.  Dr. SergioMagistri, David M. Pillor and Stephen Blum continue in office as directorsuntil our 2003 Annual Meeting.

 

Proposal II.  To approve the adoption of the 2002 EmployeeStock Purchase Plan

 
| **For**   |   | **Against** |   | **Abstain** |   | **Broker Non-Votes** |   |
|-----------|--------|-------------|--------|-------------|--------|----------------------|--------|
| 6,852,902 |   | 497,871     |   | 53,282      |   | 7,181,934            |   |

 

Proposal III.  To approve the 2000 Equity Incentive Plan,as amended, to increase the aggregate number of shares of Common Stockauthorized for issuance under such plan by 600,000 shares

 

27

----

 
| **For**   |   | **Against** |   | **Abstain** |   | **Broker Non-Votes** |   |
|-----------|--------|-------------|--------|-------------|--------|----------------------|--------|
| 5,022,827 |   | 2,332,001   |   | 49,227      |   | 7,181,934            |   |

 

 

Proposal IV.  Ratification of the selection of Deloitte& Touche LLP

 
| **For**    |   | **Against** |   | **Abstain** |   |
|------------|--------|-------------|--------|-------------|--------|
| 14,464,186 |   | 97,758      |   | 24,045      |   |

 

**Item 5.****    OtherInformation**

 

Not applicable.

 

28

----

 
| **Item 6.** | **Exhibits  and Reports on Form 8-K**                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|-------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |   |   |
| (a)         | Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |   |   |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |   |   |
|        | 2.1                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Agreement and Plan of Merger and Reorganization  dated as of February 23, 2000, among InVision Technologies, Inc., a Delaware  corporation, InVision Acquisition Corporation, a Delaware corporation, and  Inovec, Inc., an Oregon Corporation (1) |
|        | 2.2                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Form of Escrow Agreement between InVision, Merger  Sub, the Shareholders and Greater Bay Trust Company, dated February 23, 2000  (1) |
|        | 3.1                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Amended and Restated Certificate of Incorporation of  the Registrant. (2) |
|        | 3.3                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Amendment to Amended and Restated Certificate of  Incorporation of the Registrant (4) |
|        | 4.1                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Reference is made to Exhibits 3.1 through 3.3. |
|        | 10.54                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Amended Delivery Order #2 from the TSA (5) |
|        | 10.55                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Amended Delivery Order #3 from the TSA (5) |
|        | 10.56                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Delivery Order #4 from the TSA (5) |
|        | 10.57                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Amendment to Delivery Order #2 |
|        | 10.58                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Amendment to Delivery Order #3 |
|        | 10.59                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Agreement for Products and Services between the  Registrant and CoorsTek, Inc., dated June 10, 2002 (5) |
|        | 10.60                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | First Amendment to Lease Agreement, dated December  10, 1997, between the Registrant and WHLNF Real Estate Limited Partnership |
|        | 10.61                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Second Amendment to Lease Agreement, dated July 1,  2002, between the Registrant and DMV SUB 4 LLC |
|        | 99.1                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | Certificate of Chief Executive Officer and Chief  Financial Officer |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | (1) |   | Filed as the like-numbered exhibit to Registrant’s  Current Report on Form 8-K (Commission File No. 0-28236) filed May 18, 2000. |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |   |   |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | (2) |   | Filed as an exhibit to Registrant’s Registration  Statement on Form S-1 (No. 333-380) or amendments thereto and incorporated herein  by reference. |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |   |   |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | (3) |   | Filed as the like-numbered exhibit to 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 the like-numbered exhibit to Registrant’s  Annual Report on Form 10-K for the year ended December 31, 2001 and  incorporated herein by reference. |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |   |   |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | (5) |   | Confidential treatment has been requested for  portions of this exhibit. |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |   |   |
|        | (b)           The  Registrant filed one Current Report on Form 8-K during the quarter ended June  30, 2002.  The Current Report on Form  8-K was filed on April 2, 2002, reporting under Item 5, Other Events, that  InVision had received an order from the Transportation Security  Administration for an additional 300 EDS units, plus 100 parts kits.  The press release announcing the order was  filed as an exhibit to such Current Report. |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |  |  |  |  |

 

29

----

 

# **SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                  | **INVISION TECHNOLOGIES, INC.**                    |
|-----------------------|----------------------------------------------------|
|                  |                                               |
|                  |                                               |
| Date: August 14, 2002 | /s/ *Sergio  Magistri*                             |   |
|                  | Dr. Sergio Magistri                                |
|                  | President and Chief  Executive Officer             |
|                  | *(Principal Executive Officer)*                    |
|                  |                                               |
|                  |                                               |
| Date: August 14, 2002 | */s/ Ross Mulholland*                              |   |
|                  | Ross Mulholland                                    |
|                  | Senior Vice President  and Chief Financial Officer |
|                  | *(Principal Financial and Accounting Officer)*     |
|                       |                                                    |  |  |

 

30

----

 

EXHIBIT INDEX

 

 
| **Exhibit No.** | **Description**                                                                                                                                                                                                                                    |
|-----------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |                                                                                                                                                                                                                                               |   |
| 2.1             | Agreement and Plan of Merger and Reorganization  dated as of February 23, 2000, among InVision Technologies, Inc., a Delaware  corporation, InVision Acquisition Corporation, a Delaware corporation, and  Inovec, Inc., an Oregon Corporation (1) |
| 2.2             | Form of Escrow Agreement between InVision, Merger  Sub, the Shareholders and Greater Bay Trust Company, dated February 23, 2000  (1)                                                                                                               |
| 3.1             | Amended and Restated Certificate of Incorporation of  the Registrant. (2)                                                                                                                                                                          |
| 3.2             | Bylaws of Registrant, as amended. (3)                                                                                                                                                                                                              |
| 3.3             | Amendment to Amended and Restated Certificate of  Incorporation of the Registrant (4)                                                                                                                                                              |
| 4.1             | Reference is made to Exhibits 3.1 through 3.3.                                                                                                                                                                                                     |
| 10.54           | Amended Delivery Order #2 from the TSA (5)                                                                                                                                                                                                         |
| 10.55           | Amended Delivery Order #3 from the TSA (5)                                                                                                                                                                                                         |
| 10.56           | Delivery Order #4 from the TSA (5)                                                                                                                                                                                                                 |
| 10.57           | Amendment to Delivery Order #2                                                                                                                                                                                                                     |
| 10.58           | Amendment to Delivery Order #3                                                                                                                                                                                                                     |
| 10.59           | Agreement for Products and Services between the  Registrant and CoorsTek, Inc., dated June 10, 2002 (5)                                                                                                                                            |
| 10.60           | First Amendment to Lease Agreement, dated December  10, 1997, between the Registrant and WHLNF Real Estate Limited Partnership                                                                                                                     |
| 10.61           | Second Amendment to Lease Agreement, dated July 1,  2002, between the Registrant and DMV SUB 4                                                                                                                                                     |
| 99.1            | Certificate of Chief Executive  Officer and Chief Financial Officer                                                                                                                                                                                |
|            |                                                                                                                                                                                                                                               |
|            | (1)                                                                                                                                                                                                                                                |   | Filed as the like-numbered exhibit to Registrant’s  Current Report on Form 8-K (Commission File No. 0-28236) filed May 18, 2000 |
|            |                                                                                                                                                                                                                                               |   |   |
|            | (2)                                                                                                                                                                                                                                                |   | Filed as an exhibit to Registrant’s Registration  Statement on Form S-1 (No. 333-380) or amendments thereto and incorporated  herein by reference. |
|            |                                                                                                                                                                                                                                               |   |   |
|            | (3)                                                                                                                                                                                                                                                |   | Filed as the like-numbered exhibit to 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 the like-numbered exhibit to Registrant’s  Annual Report on Form 10-K for the year ended December 31, 2001 and  incorporated herein by reference. |
|            |                                                                                                                                                                                                                                               |   |   |
|            | (5)                                                                                                                                                                                                                                                |   | Confidential treatment has been requested for  portions of this exhibit. |
|                 |                                                                                                                                                                                                                                                    |  |  |  |

 

31

----