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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the quarterly period ended March 28, 2004
 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the transition period from                      to
 Commission File Number: 0-28236 INVISION TECHNOLOGIES, INC.  Delaware
(State or other jurisdiction of incorporation or organization) 94-3123544
(I.R.S. Employer Identification No.) 7151 Gateway Boulevard, Newark, CA 94560
(Address of principal executive offices, including zip code) (510) 739-2400
(Registrants telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes x No o On May 1, 2004, there were 17,477,152 shares of the registrants common
stock outstanding.




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InVision Technologies, Inc.
Form 10-Q
INDEX PART I. FINANCIAL INFORMATIONItem 1.   Financial Statementsa.   Condensed Consolidated Balance Sheets (Unaudited)  March 28, 2004 and December 31, 2003b.   Condensed Consolidated Statements of Operations (Unaudited)  Three months ended March
28, 2004 and March 30, 2003c.   Condensed Consolidated Statements of Cash Flows (Unaudited)  Three months ended March
28, 2004 and March 30, 2003d.   Notes to Condensed Consolidated Financial Statements (Unaudited)Item 2.   Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.   Quantitative and Qualitative Disclosures about Market RiskItem 4.   Controls and ProceduresPART II. OTHER INFORMATIONItem 1.   Legal ProceedingsItem 5.   Other InformationItem 6.   Exhibits and Reports on Form 8-KSignature PageEXHIBIT 10.1EXHIBIT 10.2EXHIBIT 10.3EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  InVision, Quantum Magnetics, Yxlon, HAPEG, CTX, CTX 5500 DS, CTX 9000 DSi
and QScan, among others, are trademarks of InVision Technologies, Inc. or one
of its subsidiaries in the United States and other countries. InVision,
Quantum Magnetics, Yxlon and QScan, among others, are registered trademarks of
InVision Technologies, Inc. or one of its subsidiaries in the United States.




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements InVision Technologies, Inc. 
 Condensed Consolidated Balance Sheets
 (In thousands, except share data)
 (Unaudited)
 March 28,
    
    December 31,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    74,891
    
    
    $
    182,382Short-term investments
    
    
    209,719
    
    
    
    94,557Accounts receivable, net
    
    
    72,062
    
    
    
    56,951Inventories
    
    
    74,372
    
    
    
    78,894Deferred income taxes
    
    
    14,392
    
    
    
    14,283Other current assets
    
    
    7,790
    
    
    
    5,666Total current assets
    
    
    453,226
    
    
    
    432,733Property and equipment, net
    
    
    10,968
    
    
    
    11,605Goodwill
    
    
    21,474
    
    
    
    21,474Intangible assets, net
    
    
    13,453
    
    
    
    13,978Other assets
    
    
    6,276
    
    
    
    6,278Total assets
    
    $
    505,397
    
    
    $
    486,068Liabilities and stockholders equityCurrent liabilities:Accounts payable
    
    $
    18,689
    
    
    $
    13,761Accrued liabilities
    
    
    35,419
    
    
    
    35,058Deferred revenue
    
    
    17,569
    
    
    
    13,277Short-term debt
    
    
    2,600
    
    
    
    5,581Current maturities of long-term obligations
    
    
    261
    
    
    
    263Total current liabilities
    
    
    74,538
    
    
    
    67,940Long-term obligations
    
    
    127,126
    
    
    
    127,244Deferred income taxes
    
    
    168
    
    
    
    203Total liabilities
    
    
    201,832
    
    
    
    195,387Commitments and contingenciesStockholders equity:Preferred stock, $0.001 par value, 5,000,000 shares authorized;
no shares issued and outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value, 60,000,000 shares authorized;
18,138,000 and 17,782,000 shares issued; 17,451,000 and
17,095,000 shares outstanding
    
    
    18
    
    
    
    18Additional paid-in capital
    
    
    182,069
    
    
    
    173,968Deferred stock compensation expense
    
    
    (237
    )
    
    
    (271
    )Accumulated other comprehensive loss
    
    
    (555
    )
    
    
    (125
    )Retained earnings
    
    
    136,961
    
    
    
    131,782Treasury stock, at cost (687,000 shares)
    
    
    (14,691
    )
    
    
    (14,691
    )Total stockholders equity
    
    
    303,565
    
    
    
    290,681Total liabilities and stockholders equity
    
    $
    505,397
    
    
    $
    486,068
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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InVision Technologies, Inc. 
 Condensed Consolidated Statements of Operations
 (In thousands, except per share data)
 (Unaudited)
 Three Months EndedMarch 28,
    
    March 30,2004
    
    2003Revenues:Product revenues
    
    $
    53,945
    
    
    $
    152,814Service revenues
    
    
    20,077
    
    
    
    8,909Contract research and development revenues
    
    
    2,873
    
    
    
    3,445Total revenues
    
    
    76,895
    
    
    
    165,168Cost of revenues:Product costs
    
    
    33,603
    
    
    
    84,674Service costs
    
    
    12,173
    
    
    
    5,000Contract research and development costs
    
    
    2,284
    
    
    
    2,136Total cost of revenues
    
    
    48,060
    
    
    
    91,810Gross profit
    
    
    28,835
    
    
    
    73,358Operating expenses:Research and development
    
    
    6,261
    
    
    
    7,355Selling, general and administrative
    
    
    13,363
    
    
    
    9,062Total operating expenses
    
    
    19,624
    
    
    
    16,417Income from operations
    
    
    9,211
    
    
    
    56,941Interest expense
    
    
    (1,293
    )
    
    
    (42
    )Interest and other income, net
    
    
    836
    
    
    
    685Income before provision for income taxes
    
    
    8,754
    
    
    
    57,584Provision for income taxes
    
    
    3,575
    
    
    
    23,177Net income
    
    $
    5,179
    
    
    $
    34,407Net income per share:Basic
    
    $
    0.30
    
    
    $
    2.02Diluted (Note 4)
    
    $
    0.25
    
    
    $
    1.87Weighted average shares outstanding:Basic
    
    
    17,272
    
    
    
    17,067Diluted
    
    
    22,586
    
    
    
    18,379
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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InVision Technologies, Inc. 
 Condensed Consolidated Statements of Cash Flows
 (In thousands)
 (Unaudited)
 March 28,
    
    March 30,2004
    
    2003Cash flow from operating activities:Net income
    
    $
    5,179
    
    
    $
    34,407Adjustments to reconcile net income to net cash provided by (used
in) operating activities:Depreciation and amortization
    
    
    2,613
    
    
    
    780Deferred income taxes
    
    
    438
    
    
    
    (1,632
    )Loss on disposal of fixed assets
    
    
    3
    
    
    
    526Bad debt expense
    
    
    25
    
    
    
    25Income tax benefits from employee stock transactions
    
    
    3,533
    
    
    
    274Stock compensation expense
    
    
    257
    
    
    
    33Changes in assets and liabilities:Accounts receivable
    
    
    (17,454
    )
    
    
    (26,954
    )Inventories
    
    
    3,167
    
    
    
    5,684Other assets
    
    
    (831
    )
    
    
    3,286Accounts payable
    
    
    5,040
    
    
    
    537Accrued liabilities
    
    
    845
    
    
    
    11,159Deferred revenues
    
    
    4,436
    
    
    
    (63,367
    )Other liabilities
    
    
    (18
    )
    
    
    (1
    )Net cash provided by (used in) operating activities
    
    
    7,233
    
    
    
    (35,243
    )Cash flow from investing activities:Purchases of property and equipment
    
    
    (685
    )
    
    
    (1,038
    )Proceeds from sales of short-term investments
    
    
    29,100
    
    
    
    Purchase of short-term investments
    
    
    (144,280
    )
    
    
    Net cash used in investing activities
    
    
    (115,865
    )
    
    
    (1,038
    )Cash flow from financing activities:Net proceeds from (repayments of) short-term debt
    
    
    (2,862
    )
    
    
    248Repayments of long-term debt
    
    
    (255
    )
    
    
    (34
    )Debt issuance costs
    
    
    (59
    )
    
    
    Proceeds from issuance of common stock, net
    
    
    4,344
    
    
    
    1,082Net cash provided by financing activities
    
    
    1,168
    
    
    
    1,296Effect of exchange rate changes on cash
    
    
    (27
    )
    
    
    Net change in cash and cash equivalents for the period
    
    
    (107,491
    )
    
    
    (34,985
    )Cash and cash equivalents at beginning of period
    
    
    182,382
    
    
    
    159,736Cash and cash equivalents at end of period
    
    $
    74,891
    
    
    $
    124,751Supplemental disclosures of cash flow information:Interest paid
    
    $
    581
    
    
    $
    97Income taxes paid
    
    $
    1,014
    
    
    $
    19,508Supplemental disclosures of noncash investing and financing activities:Capital lease obligations incurred for the purchase of new equipment
    
    $
    
    
    
    $
    577
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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InVision Technologies, Inc. 
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)
 1. Summary of Significant Accounting Policies Interim Unaudited Financial Information The accompanying interim unaudited condensed consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America (generally accepted
accounting principles) for interim financial information and in accordance
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not contain all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) considered necessary for a fair presentation. These
financial statements should be read in conjunction with the audited
consolidated financial statements of InVision Technologies, Inc. and its
subsidiaries (the Company) as of December 31, 2003 and 2002 and for each of
the three years in the period ended December 31, 2003, including the notes
thereto, included in the Companys Annual Report on Form 10-K filed on March
15, 2004. Operating results for the three-month period ended March 28, 2004 may not
necessarily be indicative of the results that may be expected for the year
ended December 31, 2004 or any other future period. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Short-Term Investments Short-term investments consist primarily of U.S. government, international
government and corporate notes and bonds and are classified as
available-for-sale. Such short-term investments are carried at fair value with
unrealized gains or losses reported as a separate component of accumulated
other comprehensive income (loss), net of tax. The following table summarizes the Companys short-term investments as of
March 28, 2004 (in thousands): Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S. government notes and bonds
    
    $
    32,371
    
    
    $
    122
    
    
    $
    (224
    )
    
    $
    32,269International government notes and bonds
    
    
    4,798
    
    
    
    45
    
    
    
    
    
    
    
    4,843Corporate notes and bonds
    
    
    170,950
    
    
    
    973
    
    
    
    (234
    )
    
    
    171,689Municipal notes and bonds
    
    
    914
    
    
    
    4
    
    
    
    
    
    
    
    918Total
    
    $
    209,033
    
    
    $
    1,144
    
    
    $
    (458
    )
    
    $
    209,719
 6




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The following table summarizes the maturities of the Companys short-term
investments at March 28, 2004 (in thousands): Amortized
    
    FairCost
    
    ValueDue between 91 - 365 days
    
    $
    47,942
    
    
    $
    47,948Due between 1 - 2 years
    
    
    91,112
    
    
    
    91,141Due between 2 - 3 years
    
    
    69,979
    
    
    
    70,630Total
    
    $
    209,033
    
    
    $
    209,719
 Business Combinations and Goodwill and Other Intangible Assets On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS
142). SFAS 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination and the accounting
for goodwill and other intangible assets subsequent to their acquisition. SFAS
142 provides that intangible assets with finite useful lives be amortized and
that goodwill and intangible assets with indefinite lives not be amortized, but
will rather be tested at least annually for impairment. Since adopting SFAS
142 on January 1, 2002, the Company ceased amortization of the carrying value
of goodwill of $2.5 million and acquired workforce of $331,000 at January 1,
2002, resulting in a reduction in annual amortization expense of $426,000. The
net carrying amount of acquired workforce was also reclassified to goodwill.
In the fourth quarter of 2002, the Company performed the annual impairment test
required by the standard and recorded a $2.1 million impairment of goodwill
relating to the Inovec reporting unit. The Company performed the 2003 annual
impairment test as of the end of the fourth quarter of 2003 resulting in no
impairment assessed on the goodwill related to the Inovec reporting unit. The annual impairment test for the goodwill related to the Yxlon reporting
unit is expected to be performed during the second quarter of 2004. Accounting for Costs Associated with Exit or Disposal Activities On January 1, 2003, the Company adopted SFAS No. 146, Accounting for
Costs Associated with Exit or Disposal Activities (SFAS 146), which
addresses accounting for restructuring and similar costs. SFAS 146 supersedes
previous accounting guidance, principally Emerging Issues Task Force (EITF)
Issue No. 94-3 (EITF 94-3). SFAS 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability
is incurred. Under EITF 94-3, a liability for exit costs was recognized at the
date of the Companys commitment to an exit plan. SFAS 146 also establishes
that the liability should initially be measured and recorded at fair value.
Accordingly, SFAS 146 may affect the timing of recognizing future restructuring
costs as well as the amounts recognized. There was no effect on the Companys
financial statements from the adoption of SFAS 146. Accounting for Stock-Based Compensation In December 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure  an Amendment of FASB Statement 123 (SFAS 148), which provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation. In addition,
SFAS 148 amends the disclosure requirements of SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS 123) to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The amended disclosure requirements of SFAS 148 are effective for
years ending after December 15, 2002. The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the fair value of the shares at the date of
grant. The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees (APB 25). The Company accounts for stock-based awards to
non-employees in accordance with SFAS 123 and 7




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EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services. Had compensation cost for options granted in 2004 and 2003 under the
Companys stock option plans (the Equity Plans) been determined based on the
fair value at the grant and issue dates, as prescribed in SFAS 123, the
Companys net income and pro forma net income per share would have been as
follows (in thousands, except per share data): Three Months EndedMar. 28, 2004
    
    Mar. 30, 2003Net income:As reported
    
    $
    5,179
    
    
    $
    34,407add: stock compensation as reported, net of tax effects
    
    $
    152
    
    
    $
    20less: stock compensation determined using the fair
value method, net of tax effects
    
    
    (4,019
    )
    
    
    (1,877
    )Pro forma
    
    $
    1,312
    
    
    $
    32,550Pro forma net income per share:Basic:As reported
    
    $
    0.30
    
    
    $
    2.02Pro forma
    
    $
    0.08
    
    
    $
    1.91Diluted:As reported
    
    $
    0.25
    
    
    $
    1.87Pro forma
    
    $
    0.08
    
    
    $
    1.77
 Under the intrinsic value method, when the exercise price of the Companys
employee stock options equals or exceeds the market price of the underlying
stock on the date of grant, no compensation expense is recognized. The pro
forma information regarding the results of operations and net income per share
above is determined as if the Company had accounted for its employee stock
options using the fair value method. Under this method, the fair value of each
option granted is estimated on the date of grant using the Black-Scholes option
pricing model. Option valuation models such as Black-Scholes were developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected life of the
option. In managements opinion, the existing models do not necessarily provide
a reliable single measure of the fair value of the Companys employee stock
options because the Companys employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective assumptions required by these models can materially affect the fair
value estimates. The fair value of each option grant is estimated on the date of grant
using the following assumptions used for grants during the applicable period: 2004
    
    2003Option GrantsAverage risk free rate of return
    
    
    2.55
    %
    
    
    2.30-3.00
    %Weighted average expected option life
    
    
    4.0 years
    
    
    
    4.2 yearsVolatility rate
    
    
    92
    %
    
    
    83
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
 Accounting and Disclosure Requirements for Guarantees In December 2002, the Company adopted FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires 8




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that, upon issuance of a guarantee, the guarantor must recognize a
liability for the fair value of the obligation it assumes under that guarantee.
The provisions for initial recognition and measurement are effective on a
prospective basis for guarantees that are issued or modified after December 31,
2002, irrespective of a guarantors year-end. Accrued Warranty Estimated warranty costs are recorded on product revenues and adjusted
periodically based on historical and anticipated experience. The Company
accrues the estimated cost of product warranties at the time revenues are
recognized. Although the Company engages in extensive product quality programs
and processes, including actively monitoring and evaluating the quality of
component suppliers, the warranty obligation is affected by actual warranty
costs, including usage of material and labor and service delivery costs
incurred in correcting a product failure. Information regarding the changes in the Companys warranty liabilities
was as follows for the three months ended March 28, 2004: Changes inBalance at
    
    
    
    
    
    
    
    
    
    Accruals Related
    
    Balance atDec. 31,
    
    Accruals for
    
    Reduction for
    
    to Pre-Existing
    
    Mar. 28,2003
    
    Warranties Issued
    
    Payments Made
    
    Warranties
    
    2004$
    14,259
    
    
    $
    2,909
    
    
    $
    (3,066
    )
    
    $
    (1,216
    )
    
    $
    12,886
 Information regarding the changes in the Companys warranty liabilities
was as follows for the three months ended March 30, 2003: Changes inBalance at
    
    
    
    
    
    
    
    
    
    Accruals Related
    
    Balance atDec. 31,
    
    Accruals for
    
    Reduction for
    
    to Pre-Existing
    
    Mar. 30,2002
    
    Warranties Issued
    
    Payments Made
    
    Warranties
    
    2003$
    19,890
    
    
    $
    8,671
    
    
    $
    (6,197
    )
    
    $
    120
    
    
    $
    22,484
 Revenue Arrangements with Multiple Deliverables In November 2002, the EITF reached a consensus on Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables (EITF 00-21). EITF 00-21
addresses certain aspects of the accounting by a vendor for arrangements under
which the vendor will perform multiple revenue generating activities. EITF
00-21 is effective for fiscal periods beginning after June 15, 2003. There was
no impact from the adoption of EITF 00-21 on the Companys results of
operations or financial position. Derivative Instruments and Hedging Activities The Company is exposed to foreign currency exchange rate risk inherent in
its sales commitments, anticipated sales, anticipated purchases and assets and
liabilities denominated in currencies other than the U.S. dollar. The Company
utilizes foreign exchange forward contracts to limit its exposure to foreign
currency rate fluctuation. The maturity of foreign exchange forward contracts
as of March 28, 2004 is consistent with the contractual or expected timing of
the transactions being hedged, principally receipt of customer payments. These
foreign exchange forward contracts all mature within twelve months. The
Company does not enter into market risk sensitive instruments for trading
purposes. During the three months ended March 28, 2004, the Companys
derivatives consisted only of foreign exchange forward contracts. The Company
had aggregate foreign exchange forward contracts with notional amounts of $46.3
million at March 28, 2004. The fair value of these instruments, included in the
consolidated balance sheets, represented a net liability of $24,000 at March
28, 2004. In May 2002, the Company began applying hedge accounting as defined by
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133) and designated certain foreign exchange forward 9




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contracts as cash flow hedges of foreign exchange risk for international
sales contracts. As of March 28, 2004, the Company has recorded $2.1 million
of other comprehensive loss, net of income taxes of $1.4 million, representing
the net change in the fair value of the foreign exchange forward contracts that
were designated as and qualified for hedge accounting. The amounts deferred in
other comprehensive loss are reclassified to earnings upon the collection of
the hedged contract. As of March 28, 2004, the Company anticipates
reclassifying the full amount included within other comprehensive loss to
earnings within the next twelve months. During the three months ended March
28, 2004, the Company also recorded a $14,000 foreign currency transaction gain
related to the effectiveness under hedge accounting. For the three-month
period ended March 28, 2004, primarily all of the changes in the fair value of
forward contracts not designated for hedge accounting were offset by the
measurement of associated accounts receivable. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities (SFAS 149). SFAS No. 149
amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under SFAS 133. SFAS No. 149 is generally effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. There was no impact from the adoption of SFAS
No. 149 on the Companys operations and financial condition. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS No. 150 requires that certain financial instruments, which
under previous guidance were accounted for as equity, must now be accounted for
as liabilities. The financial instruments affected include mandatorily
redeemable stock, certain financial instruments that require or may require the
issuer to buy back some of its shares in exchange for cash or other assets and
certain obligations that can be settled with shares of stock. SFAS No. 150 is
effective for interim periods beginning after June 15, 2003. In November 2003,
the FASB issued FASB Staff Position No. 150-3, Effective Date, Disclosures,
and Transition for Mandatorily Redeemable Financial Instruments of Certain
Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests
under SFAS No. 150, or FSP 150-3, which defers the effective date for various
provisions of SFAS No. 150. The adoption of SFAS 150, as modified by FSP 150-3,
did not have a material impact on our consolidated financial statements. 2. Business Combinations In accordance with Statement of Financial Accounting Standards No. 141,
Business Combinations (SFAS 141) the Company allocates the purchase price
of its acquisitions to the tangible assets, liabilities and intangible assets
acquired, as well as in-process research and development, based on their
estimated fair values. The excess purchase price over those fair values is
recorded as goodwill. The fair value assigned to intangible assets acquired is
based on valuations prepared by independent third party appraisal firms using
estimates and assumptions provided by management. In accordance with SFAS 142,
goodwill and purchased intangibles with indefinite lives acquired after June
30, 2001 are not amortized but will be reviewed periodically for impairment.
Purchased intangibles with finite lives will be amortized on a straight-line
basis over their estimated useful lives. Yxlon International Holding GmbH On March 31, 2003, the Company completed its acquisition of Yxlon, a
company based in Hamburg, Germany. Yxlon develops, manufactures, markets and
supports X-ray based non-destructive testing (NDT) systems for a wide range
of industrial applications, and systems that use X-ray based diffraction
(XRD) technology for explosives detection. The Company acquired Yxlon for
¬38.6 million in cash, or $41.7 million, incurred additional acquisition
costs of $2.1 million, and paid a subsequent purchase price adjustment of
$483,000 in December 2003 for a total purchase price of $44.3 million. The
Company is required to make an additional payment of ¬5.0 million if Yxlons
XRD system is certified for explosives detection by the Transportation Security
Administration (TSA) by June 30, 2004. If the XRD system is certified for
explosives detection by the TSA, the Company would record the additional
consideration as intangible assets. An independent valuation to determine the allocation of the fair value of
the net assets acquired was completed in September 2003. The total purchase
price of $44.3 million has been allocated as follows (in thousands): 10




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##### Table of Contents



Cash and cash equivalents
    
    $
    1,946Current assets
    
    
    29,101Other non-current assets
    
    
    1,726Amortizable intangible assets:Developed and core technology
    
    
    8,700Other
    
    
    1,480Intangible assets with indefinite lives:Goodwill
    
    
    18,736Trademark
    
    
    2,780Current liabilities
    
    
    (22,866
    )Other non-current liabilities
    
    
    (1,644
    )In-process research and development
    
    
    4,300Total purchase price
    
    $
    44,259
 Amortizable Intangible Assets Of the total purchase price, approximately $10.2 million has been
allocated to amortizable intangible assets, including maintenance contracts and
renewals, contract backlog, direct customer relationships, supplier agreements
and developed and core technology. The maintenance contracts and renewals
represent a value assigned to the revenue stream estimated from existing
maintenance contracts as of the acquisition date with an assumed renewal rate.
Contract backlog represents the gross contract backlog to be recognized over
the twelve-month period following the close of the acquisition. Direct customer
relationships represent the sale of products and services by Yxlons internal
sales and marketing force. Supplier agreements represent the value in material
supplier agreements where Yxlon receives below market rates on inventory
component purchases. The Company is amortizing the fair value of these assets
on a straight-line basis over estimated useful lives ranging from twelve months
to six years. Developed and core technology, which consists of products that have
reached technological feasibility, includes Yxlons XRD system and NDT system
products. The Company is amortizing the fair value of the developed and core
technology on a straight-line basis over an estimated useful life of seven
years. Intangible Assets With Indefinite Lives The estimated fair value of intangible assets with indefinite lives was
$18.7 million for goodwill and $2.8 million for the Yxlon trade name. These
intangible assets will not be amortized because the assets have indefinite
useful lives based on many factors and considerations, including the length of
time that the Yxlon name has been in use, the Yxlon brand awareness and market
position and the plans for continued use of the Yxlon brand within a portion of
the Companys overall product portfolio. In-Process Research and Development Of the total purchase price, $4.3 million has been allocated to in-process
research and development (IPR&D) and was expensed in the second quarter of
fiscal 2003. There were two projects expected to be completed between 2004 and
2007. Projects that qualify as IPR&D represent those that have not yet reached
technological viability. Technological viability is defined as being equivalent
to a beta-phase working prototype in which there is lower remaining risk
relating to the development. The value assigned to IPR&D was determined by considering the importance
of each project to the overall development plan, estimating costs to develop
the purchased IPR&D into commercially viable products, estimating the resulting
net cash flows from the projects when completed and discounting the net cash
flows to their present value. The revenue estimates used to value the purchased
IPR&D were based on estimates of the relevant market sizes and growth factors,
expected trends in technology and the nature and expected timing of new product
introductions by Yxlon. The rates utilized to discount the net cash flows to their present values
are based on Yxlons weighted average cost of capital of 25%. The weighted
average cost of capital was adjusted to reflect the difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility, the percentage of completion of each 11




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project, anticipated market acceptance and penetration, market growth
rates and risks related to the impact of potential changes in future target
markets. Pro Forma Results (Unaudited) The unaudited pro forma financial information presented below combine the
actual results of operations of the Company and the historical results of
operations of Yxlon for the respective years as if the acquisition of Yxlon had
occurred at the beginning of each of the years presented. Adjustments of
$285,000 and $6.2 million have been made to the combined results of operations
for the years ended December 31, 2003 and 2002, reflecting amortization of
purchased intangibles, net of tax, timing of acquisition-related in-process
research and development expense recognition, and bank settlement fees for debt
as a result of acquisition, net of tax, as if the acquisition had occurred at
the beginning of each of the years presented. The unaudited pro forma financial
information is not intended to represent or be indicative of the consolidated
results of operations or financial condition of the Company that would have
been reported had the acquisition been completed as of the dates presented, and
should not be taken as representative of the future consolidated results of
operations or financial condition of the Company. 2003
    
    2002(in thousands, except per share amounts)Revenues
    
    $
    432,697
    
    
    $
    492,728Net income
    
    $
    57,169
    
    
    $
    65,686Basic
    
    $
    3.34
    
    
    $
    4.11Diluted
    
    $
    3.11
    
    
    $
    3.69Basic weighted average shares outstanding
    
    
    17,132
    
    
    
    15,987Diluted shares
    
    
    18,368
    
    
    
    17,803
 Hattinger Pruf- und Entwicklungs- GmbH Effective August 1, 2003, Yxlon International X-Ray GmbH, a wholly owned
subsidiary of the Company, acquired Hattinger Pruf- und Entwicklungs- GmbH
(Hapeg), a private engineering and systems company that provides industrial
testing and evaluation solutions utilizing computed tomography, or CT,
technology for approximately ¬2.9 million or $3.4 million. The acquisition
was accounted for using the purchase method of accounting. The excess purchase
price over the fair value of the underlying net assets of $2.3 million was
allocated to goodwill and other intangible assets and property based upon an
independent valuation of fair values. Amortization expense of $122,000 was
recorded during the fiscal year ended 2003. Unaudited pro forma results were
not provided as they were not deemed to be material. 3. Comprehensive Income The components of comprehensive income are as follows (in thousands): Three Months EndedMarch 28,
    
    March 30,2004
    
    2003Net income
    
    $
    5,179
    
    
    $
    34,407Derivatives classified as cash flow hedges (net of taxes):Unrealized gain (loss) on cash flow hedges
    
    
    229
    
    
    
    (583
    )Reclassification of gain on cash flow hedges
    
    
    34
    
    
    
    197Foreign currency translation adjustment
    
    
    (693
    )
    
    
    Comprehensive income
    
    $
    4,749
    
    
    $
    34,021
 12




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##### Table of Contents



4. Net Income Per Share Basic net income per share is computed by dividing net income by the
weighted-average shares of common stock outstanding for the period. Diluted
net income per share reflects the weighted-average shares of common stock
outstanding plus the potential effect of dilutive securities or contracts which
are convertible to shares of common stock such as options, warrants,
convertible debt and preferred stock (using the treasury stock method) and
shares issuable in future periods, except in cases where the effect would be
anti-dilutive. Specifically, the computation of diluted net income per share
for the three-month period ended March 28, 2004 includes the impact of the
contingent conversion provision related to the Companys 3% convertible senior
notes due 2023. Diluted shares include 3,906,250 shares as if the notes had
been converted at the beginning of the period and diluted net income excludes
$555,000 of avoided interest expense, net of tax. The following is a reconciliation between the components of the basic and
diluted net income per share calculations for the periods presented below (in
thousands, except per share data): Three Months EndedMarch 28, 2004
    
    March 30, 2003Weighted
    
    Per
    
    
    
    
    
    Weighted
    
    PerAverage
    
    Share
    
    
    
    
    
    Average
    
    ShareIncome
    
    Shares
    
    Amount
    
    Income
    
    Shares
    
    AmountBasic net income per share
    
    $
    5,179
    
    
    
    17,272
    
    
    $
    0.30
    
    
    $
    34,407
    
    
    
    17,067
    
    
    $
    2.02Effect of dilutive securities:Options and warrants
    
    
    
    
    
    
    1,408
    
    
    
    (0.02
    )
    
    
    
    
    
    
    1,312
    
    
    
    (0.15
    )Converted debt shares
    
    
    555
    
    
    
    3,906
    
    
    
    (0.03
    )
    
    
    
    
    
    
    
    
    
    
    Diluted net income per share
    
    $
    5,734
    
    
    
    22,586
    
    
    $
    0.25
    
    
    $
    34,407
    
    
    
    18,379
    
    
    $
    1.87
 5. Segment Information The Company determines its segments based on how its Chief Executive
Officer and its Chief Operating Officer assess performance and allocate
resources. Through the first quarter of 2003, the Company presented segment
information based on three reportable segments: EDS, Quantum and Wood. As a
result of the acquisition of Yxlon, the Company now has two reportable
segments, EDS and NDT. The EDS segment is comprised of the business unit
that is engaged in the development, manufacturing, marketing and support of
explosives detection systems based on advanced CT technology. The NDT
segment is comprised of the Yxlon business unit that is engaged in the
development, manufacturing, marketing and support of non-destructive testing
systems for a wide range of industrial applications. Other segments, including
Quantum, Wood and XRD, were aggregated to form an All Other category as they
did not meet the threshold for a reportable segment. Segment financial data for the three-month period ended March 30, 2003 has
been restated to reflect the change in reportable segments. As of the second
quarter of 2003, a reportable segment line item also has been changed from net
income (loss) to income (loss) from operations. Financial information by
segment is as follows (in thousands): 13




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##### Table of Contents



ConsolidatingEDS
    
    NDT
    
    All Other
    
    Eliminations
    
    TotalFirst quarter 2004Revenues:Product revenues
    
    $
    38,957
    
    
    $
    12,955
    
    
    $
    2,033
    
    
    $
    
    
    
    $
    53,945Service revenues
    
    
    16,086
    
    
    
    3,261
    
    
    
    730
    
    
    
    
    
    
    
    20,077Contract research
and development
revenues
    
    
    
    
    
    
    
    
    
    
    2,873
    
    
    
    
    
    
    
    2,873Intercompany revenues
    
    
    97
    
    
    
    
    
    
    
    
    
    
    
    (97
    )
    
    
    Total revenues
    
    $
    55,140
    
    
    $
    16,216
    
    
    $
    5,636
    
    
    $
    (97
    )
    
    $
    76,895Income (loss) from operations
    
    $
    9,799
    
    
    $
    (223
    )
    
    $
    (365
    )
    
    $
    
    
    
    $
    9,211March 28, 2004Total assets
    
    $
    453,961
    
    
    $
    49,012
    
    
    $
    24,756
    
    
    $
    (22,332
    )
    
    $
    505,397First quarter 2003Revenues:Product revenues
    
    $
    151,124
    
    
    $
    
    
    
    $
    1,690
    
    
    $
    
    
    
    $
    152,814Service revenues
    
    
    8,492
    
    
    
    
    
    
    
    417
    
    
    
    
    
    
    
    8,909Contract research
and development
revenues
    
    
    
    
    
    
    
    
    
    
    3,445
    
    
    
    
    
    
    
    3,445Intercompany revenues
    
    
    
    
    
    
    
    
    
    
    537
    
    
    
    (537
    )
    
    
    Total revenues
    
    $
    159,616
    
    
    $
    
    
    
    $
    6,089
    
    
    $
    (537
    )
    
    $
    165,168Income (loss) from operations
    
    $
    57,138
    
    
    $
    
    
    
    $
    (197
    )
    
    $
    
    
    
    $
    56,941December 31, 2003Total assets
    
    $
    436,914
    
    
    $
    57,809
    
    
    $
    18,757
    
    
    $
    (27,412
    )
    
    $
    486,068
 Substantially all of the Companys long-lived assets are located in the
United States. 6. Inventories The components of inventory consist of the following (in thousands): March 28,
    
    December 31,2004
    
    2003Inventories:Raw material and purchased components
    
    $
    22,400
    
    
    $
    22,821Field service spare parts
    
    
    28,139
    
    
    
    27,805Work-in-process
    
    
    8,620
    
    
    
    10,123Finished goods
    
    
    15,213
    
    
    
    18,145Total
    
    $
    74,372
    
    
    $
    78,894
 7. Accrued Liabilities The components of accrued liabilities consist of the following (in
thousands): March 28,
    
    December 31,2004
    
    2003Accrued liabilities:Warranty and other reserves
    
    $
    12,886
    
    
    $
    14,259Accrued employee compensation
    
    
    9,263
    
    
    
    10,409Foreign exchange forward contracts
    
    
    340
    
    
    
    1,436Other
    
    
    12,930
    
    
    
    8,954Total
    
    $
    35,419
    
    
    $
    35,058
 8. Litigation InVision and its subsidiary, Quantum Magnetics, together with many other
entities, were named as defendants in approximately 156 products liability
lawsuits by individual plaintiffs seeking damages for wrongful death in 14




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##### Table of Contents



connection with the terrorist acts of September 11, 2001. The litigation
was consolidated in In re: September 11 Litigation, 21 MC 97 (AKH), United
States District Court for the Southern District of New York. InVision and
Quantum Magnetics have been served with 103 complaints. Each complaint with
which the Company has been served alleges that defendants have breached a duty
to airplane passengers and others by failing to properly screen passengers and
carry-on baggage for dangerous weapons. The Company believes that the
plaintiffs claims lack merit, especially in light of the fact that InVision
and Quantum Magnetics did not, as of September 11, 2001, have any passenger or
carry-on baggage screening equipment at security checkpoints in any of the
airports from which the hijacked airplanes departed. By court order, the
plaintiffs were required to file and serve Amended Master Complaints and
Appendices by March 31, 2004 to reflect all defendants and causes of action in
the In re: September 11 Litigationthat had been added since their original
Master Complaints were filed. InVision and Quantum Magnetics were not included
in plaintiffs Amended Master Complaints and their Appendices. Since these
Amended Master Complaints are controlling over the individual complaints filed
by plaintiffs, all plaintiffs in the In re: September 11 Litigationhave
effectively dismissed their claims against InVision and Quantum Magnetics. To
date, notices of dismissals or dismissal orders have been received in all but
57 of the individual complaints. The Company is currently in the process of
obtaining the remaining dismissals from the remaining plaintiffs. On March 19, 2004, two alleged holders of InVision common stock filed
purported class action lawsuits in California Superior Court for the County of
Alameda. The complaints name as defendants each of the Companys directors as
well as the Company. The complaints allege that, in pursuing the transaction
with General Electric Company (GE) and approving the merger agreement, the
directors violated their fiduciary duties to the holders of InVision common
stock by, among other things, failing to obtain the highest price reasonably
available, tailoring the terms of the transaction to meet GEs needs, engaging
in self-dealing and obtaining personal financial benefits not shared equally by
the plaintiffs and other stockholders. The complaints also allege that the
merger agreement resulted from a flawed process designed to ensure a sale to
one buyer. The lawsuits have been consolidated by stipulation of the parties
under one lead case, Waltman, et al. v. InVision Technologies, Inc., et al.,
Lead Case No. RG04146722. On May 3, 2004, InVision and three directors filed a
demurrer to the consolidated complaint on the grounds that plaintiffs failed to
allege sufficient facts to state a cause of action. The remaining five
directors filed a motion to quash the service of summons because they are not
California residents and, therefore, the court lacks jurisdiction over them.
Plaintiffs have served an initial written discovery request. Based on the
Companys review of the complaints, the Company believes that the allegations
are without merit and intend, along with the directors, to defend the lawsuits
vigorously. The Company is involved in legal proceedings, claims and litigation
arising in the ordinary course of business. While the outcome of these matters
is currently not determinable, the Companys management does not believe that
the ultimate cost to resolve these matters will have a material adverse effect
on the Companys consolidated financial condition, results of operations or
cash flows. 15




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Cautions about Forward-Looking Statements Throughout this Form 10-Q, we make forward-looking statements, or
statements about events or circumstances that have not yet occurred. In some
cases, we identify these statements by forward-looking words such as may,
will, should, plans, believes, predicts, intends or continue, and
other similar terms. These forward-looking statements involve risks and
uncertainties, and our actual results could differ materially. We cannot
guarantee future results or that current expectations will be accurate, and we
will not update information in this Form 10-Q if any forward-looking statement
later turns out to be inaccurate. Important factors that could cause our
results to differ are discussed under the section Risk Factors. Readers
should read this Item 2 in conjunction with the condensed consolidated
financial statements and related notes in Part I, Item 1 of this Form 10-Q, as
well as Managements Discussion and Analysis of Financial Condition and
Results of Operations and the consolidated financial statements and related
notes in our Form 10-K for the fiscal year ended December 31, 2003. We
encourage readers to read these sections carefully. Overview We are the leading provider of Transportation Security Administration, or
TSA (formerly Federal Aviation Administration, or FAA) certified explosives
detection systems, or EDS, used at airports for screening checked passenger
baggage. On March 15, 2004, we entered into an Agreement and Plan of Merger with
General Electric Company, or GE, under which GE would acquire us through the
merger of a wholly owned subsidiary of GE with and into InVision, and each
outstanding share of our common stock would be converted into the right to
receive $50.00 in cash. The merger is subject to customary closing conditions,
including the approval of our stockholders and the expiration or termination of
waiting periods under U.S. and applicable foreign antitrust laws. The Agreement
and Plan of Merger is attached as Exhibit 2.2 to our annual report on Form 10-K
for the year ended December 31, 2003. The foregoing description is qualified in
its entirety by reference to the full text of the agreement. In September 2003, we completed a private offering of $125.0 million
aggregate principal amount of our 3% convertible senior notes due 2023. The
notes are convertible into our common stock, under certain circumstances, at an
initial conversion rate of 31.25 shares per $1,000 principal amount of notes,
subject to adjustment. At the initial conversion rate, the notes will be
convertible into common stock at a conversion price of $32.00 per share. The
notes will be redeemable for cash at our option beginning on October 1, 2008.
Holders of the notes have the option to require us to purchase the notes in
cash, in whole or in part, on October 1 in each of 2008, 2013 and 2018. The
holders of the notes will also have the ability to require us to purchase the
notes in the event that we undergo a change in control. In each such case, the
redemption or purchase price would be at 100% of the principal amount of the
notes, plus accrued and unpaid interest to, but excluding, the redemption or
purchase date, as the case may be. On March 31, 2003, we completed the acquisition of Yxlon International
Holding GmbH for $41.7 million in cash, calculated at the then effective
conversion rate for the euro. We incurred additional acquisition costs of $2.1
million, and paid a subsequent purchase price adjustment of $483,000 in
December 2003, for a total purchase price of $44.3 million. Yxlon develops,
manufactures, markets and supports X-ray based non-destructive testing, or NDT,
systems for a wide range of industrial applications, and systems that use X-ray
based diffraction, or XRD, technology for explosives detection. We would make
an additional payment of ¬5.0 million if Yxlons XRD system is certified for
explosives detection by the TSA by June 30, 2004. On August 1, 2003, we
completed the acquisition of Hattinger Pruf- und Entwicklungs- GmbH, or Hapeg,
an engineering and systems company that provides industrial testing and
evaluation solutions utilizing computed tomography, or CT, technology for
¬2.9 million or $3.4 million in cash, calculated at the then effective
conversion rate for the euro. We determine our segments based on how our Chief Executive Officer and
Chief Operating Officer assess performance and allocate resources. Through the
first quarter of 2003, we presented segment information based on three
reportable segments: EDS, Quantum and Wood. As a result of the acquisition of
Yxlon, we now have two reportable segments, EDS and NDT. The EDS segment is
comprised of the business unit that is engaged in the development,
manufacturing, marketing and support of explosives detection systems based on
advanced CT 16




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##### Table of Contents



technology. The NDT segment is comprised of the Yxlon business unit that
is engaged in the development, manufacturing, marketing and support of
non-destructive testing systems for a wide range of industrial applications.
Other segments including Quantum, Wood and XRD were aggregated to form an All
Other category as they did not meet the threshold for a reportable segment.
See Note 5 to the condensed consolidated financial statements for additional
information about our reportable segments. As a result of the completion of the initial deployment following the
September 11, 2001 terrorist attacks and the time it takes to construct
modifications to retrofit airports to accommodate in-line EDS equipment, the
market for many of our products is in a period of transition. The demand for a
significant portion of our products is also subject to the budgetary process of
the federal government. We anticipate a decline in EDS revenues for the year
ending December 31, 2004, compared to EDS revenues during the year ended
December 31, 2003. As a result, we are planning to reduce costs. Our ability to reduce costs will be critical to maintaining our gross
margins and desired level of earnings. Due to a number of factors including the
timing, size and mix of orders from our relatively small number of customers,
particularly the TSA, our revenues have varied significantly from time to time.
We expect that trend to continue. In addition, substantial components of our
quarterly and annual operating expenses are, and will continue to be,
relatively fixed in nature. This means that revenue fluctuations will cause our
quarterly and annual operating results to vary substantially. Our ability to
increase our operating efficiency, further reduce the costs of components and
otherwise control costs during a period of further declining sales in a
business already characterized by significant fluctuations in volume is
difficult to predict. Our revenues are primarily comprised of:  
    
    EDS product revenues, which include revenues from sales of CTX
products, accessories and related installation and configuration, and
EDS service revenues, which include revenues from maintenance contracts
related to product support, integration and other services, including
those complex integrations and configurations that are separate from
product revenues; and  
    
    NDT product revenues, which include revenues from the design,
assembly and installation of X-ray systems and associated components
for industrial NDT, and NDT service revenues, which include revenues
from maintenance contracts related to product support. We market our products and services directly through internal sales
personnel and indirectly through authorized agents, distributors and system
integrators. In the United States, we market our products and services
primarily through direct sales personnel. Internationally, we use a direct
sales force and authorized representatives to sell our products. International
sales represented 49.1% of total revenues for the first quarter of 2004 and
15.8% of total revenues for the first quarter of 2003. EDS. In any given fiscal quarter or year, our EDS product revenues are
derived from orders of multiple units of our products from a limited number of
customers. For example, in the first quarter of 2003 six customers accounted
for all of our EDS products sold during the quarter, and for the fiscal year
2003 eighteen customers accounted for all of our EDS products sold during the
year. The number of our customers does not vary widely from period to period.
Therefore, a cancellation or delay of an order from a customer could have a
significant negative impact on our operations in a given period. Including
revenues from the Boeing and Siemens subcontracts to provide maintenance
service for TSA-owned EDS systems, EDS sales to the TSA accounted for 53.2% of
our EDS revenues in the first quarter ended March 28, 2004 and 77.0% of our EDS
revenues in the first quarter of 2003. We had one other customer that
accounted for approximately 25.8% of the EDS revenue during the first quarter
of 2004. There were no other EDS customers who accounted for more than 10% of
total revenues in the first quarter of 2004 or the year ended December 31,
2003. We typically bill our customers in three stages, as generally provided in
our contracts with our customers:  
    
    amounts to cover the bill of materials when materials are received
from suppliers, typically 30% to 40% of the total system price; 17




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##### Table of Contents




    
    an additional amount upon factory acceptance or shipment ranging from 30% to 60%; and  
    
    the balance upon installation and site acceptance, ranging from 5% to 30%. These payment terms generally provide the necessary working capital for
acquisition of materials and funding inventory during the manufacturing cycle.
We anticipate that potential future orders from the TSA will continue to
provide payment terms which provide the necessary working capital for us and
our suppliers, even if production volumes were to rapidly increase. If future
orders from the TSA contain different payment terms, a major increase in
production rates may require substantial additional working capital. Payment terms for TSA invoices are net 30 days, while terms for
international invoices vary from amounts due upon receipt of invoice to 160
days. NDT. Our NDT product and service revenues are primarily derived from sales
of X-ray based NDT products primarily to the automotive and aerospace
industries. There were no NDT customers who accounted for more than 10% of
total revenues since the acquisition of Yxlon on March 31, 2003. Results of Operations The following table sets forth certain income and expenditure items from
our consolidated statements of operations expressed as a percentage of total
revenues for the periods indicated. Three Months EndedMarch 28,
    
    March 30,2004
    
    2003Revenues:Product revenues
    
    
    70.2
    %
    
    
    92.5
    %Service revenues
    
    
    26.1
    
    
    
    5.4Contract research and development revenues
    
    
    3.7
    
    
    
    2.1Total revenues
    
    
    100.0
    
    
    
    100.0Cost of revenues:Product costs
    
    
    43.7
    
    
    
    51.3Service costs
    
    
    15.8
    
    
    
    3.0Contract research and development costs
    
    
    3.0
    
    
    
    1.3Total cost of revenues
    
    
    62.5
    
    
    
    55.6Gross margin
    
    
    37.5
    
    
    
    44.4Operating expenses:Research and development
    
    
    8.1
    
    
    
    4.4Selling, general and administrative
    
    
    17.4
    
    
    
    5.5Total operating expenses
    
    
    25.5
    
    
    
    9.9Income from operations
    
    
    12.0
    
    
    
    34.5Interest expense
    
    
    (1.7
    )
    
    
    (0.0
    )Interest and other income, net
    
    
    1.1
    
    
    
    0.4Income before provision for income taxes
    
    
    11.4
    
    
    
    34.9Provision for income taxes
    
    
    4.7
    
    
    
    14.1Net income
    
    
    6.7
    %
    
    
    20.8
    %
 On March 31, 2003, the first day of our second quarter of 2003, we
acquired Yxlon. Yxlons results have been included in our results since the
acquisition date, and the operating results for the NDT segment also have been
included. Revenues EDS product revenues were $39.0 million in the first quarter of 2004, a
decrease of 74.2% from $151.1 million in the first quarter of 2003. The
revenue decrease in the first quarter 2004 is primarily due to decreased EDS
orders from the TSA. The first quarter of 2003 revenues reflected the large
continued deployment of EDS units that had 18




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begun in 2002 after the increased focus on aviation security due to the
terrorist attacks of September 11, 2001. EDS service revenues were $16.1
million for the first quarter of 2004, an increase of 89.4% from $8.5 million
in the first quarter of 2003. The revenue increase in the first quarter of
2004 is primarily due to an increased number of units coming off of warranty
and into contractual service agreements. We anticipate that service revenues
will continue to rise in 2004 compared to 2003 as this trend continues. As of
March 28, 2004, we had in backlog EDS equipment orders and service agreements
of $138.9 million, primarily consisting of orders for EDS equipment from the
TSA and international customers. NDT product revenues were $13.0 million in the first quarter of 2004. NDT
service revenues were $3.3 million in the first quarter of 2004. As of March
28, 2004, we had in backlog NDT equipment orders and service agreements of
$28.4 million, primarily consisting of orders for standard industrial and
custom NDT systems. Gross Profit Cost of EDS product revenues primarily consists of purchased materials
procured for use in the assembly of our products, as well as manufacturing
labor and overhead, contract manufacturing services, installation, training and
warranty. Cost of EDS service revenues primarily consists of direct labor and
materials and customer support overhead. In any given period, our gross profit
for products and services may be affected by several factors, including product
mix, volume of systems manufactured in the period, product configuration,
location of the installation and complexity of integration into various
environments. Gross profit for EDS products was $16.8 million in the first quarter of
2004, a decrease of 75.2% from $67.7 million in the first quarter of 2003.
Gross margin percentages for EDS products were 43.2% in the first quarter of
2004 and 44.8% in the first quarter of 2003. The decrease in gross profit for
the first quarter was due to decreased sales of our CTX products. The decrease
in gross margin percentage was primarily due to a shift in product mix and to
fixed manufacturing overhead costs being spread over fewer units in the first
quarter of 2004 compared to that in 2003. Gross profit for EDS services were $6.7 million in the first quarter of
2004, an increase of 82.7% from $3.7 million in the first quarter of 2003.
Gross margin percentages for EDS services were 41.7% in the first quarter of
2004 and 43.3% in the first quarter of 2003. The increase in gross profit for
EDS services in the first quarter is primarily due to increased EDS service
revenues from the growing installed base of domestic systems and service
agreements from international customers. Gross margin percentages declined due
to an increase in permanent staffing in the first quarter of 2004 compared to
the same period in 2003 to meet the demands of increased support coverage and
the increase in the installed base of EDS units. Cost of NDT product revenues primarily consists of purchased materials
procured for use in the assembly of our products, as well as manufacturing
labor and overhead, installation, training and warranty. Cost of NDT services
revenues primarily consists of direct labor and materials and customer support
overhead. Gross profit for NDT products was $2.9 million in the first quarter
of 2004. Gross margin percentage for NDT products was 22.0% in the first
quarter of 2004. We are in the process of developing parts cost reduction
programs for NDT. We believe these programs will improve gross margins for NDT
products commencing in the third quarter of 2004, although such anticipated
improvements may be reduced due to exchange rate fluctuations. Gross profit for NDT services was $907,000 in the first quarter of 2004.
Gross margin percentage for NDT services was 27.8% in the first quarter of
2004. We do not anticipate meaningful changes in gross margin for NDT services
in 2004. Research and Development Research and development expenses consist primarily of compensation paid
to personnel engaged in research and development activities, amounts paid for
outside services and costs of materials utilized in the development of hardware
products, including prototype units. Research and development expenditures are
partially offset by amounts reimbursed by the TSA and other government agencies
and private entities under research and development contracts and grants.
These services are provided and reimbursed on a cost basis. 19




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Net research and development expenses for EDS were $5.4 million in the
first quarter of 2004, a decrease of 14.8% from $6.3 million in the first
quarter of 2003. The net numbers reflect amounts reimbursed by the TSA of
$524,000 in the first quarter of 2004. There were no reimbursements by the TSA
in the first quarter of 2003. Net research and development expenses for EDS as
a percentage of EDS revenues were 9.7% in the first quarter of 2004 and 3.9% in
the first quarter of 2003. The decrease in research and development expenses
for EDS for the first quarter of 2004 was primarily due to the receipt of
$524,000 of government funding for research projects and the completion of
several initiatives prior to the first quarter of 2004. These decreases were
partially offset by increased effort on projects with Yxlon to develop a
solution that integrates Yxlons X-ray diffraction technology with our CT
technology. With the goal of 100% checked baggage screening in U.S. airports,
we expect that our EDS equipment will be operated at or near capacity for
extended periods. We continue to invest in sustaining engineering efforts to
ensure that our products achieve high levels of serviceability and reliability
when operating at capacity. We are also continuing our development of the
ARGUS program, an FAA-sponsored program designed to develop a smaller, low-cost
EDS product to scan checked baggage in small airports and low-traffic stations
within larger airports. The increase of net research and development expenses
for EDS as a percentage of revenues was primarily due to decreased revenues in
the first quarter of 2004 compared to the first quarter of 2003. Research and development expenses for NDT were $871,000 in the first
quarter of 2004. Research and development expenses for NDT as a percentage of
NDT revenues were 5.4% in the first quarter of 2004. In order to strengthen our
role as a world leading supplier of X-ray solutions for NDT applications, we
plan to increase the research and development expenses for NDT in 2004. Selling, General and Administrative Selling, general and administrative expenses consist primarily of
compensation paid to direct and indirect sales and marketing personnel,
administrative personnel, including directors, consultant fees, professional
service fees, insurance costs, travel, selling and distribution costs, and
other general expenses. Selling, general and administrative expenses for EDS were $8.4 million in
the first quarter of 2004, an increase of 5.7% from $7.9 million in the first
quarter of 2003. Selling, general and administrative expenses for EDS as a
percentage of EDS revenues were 15.3% in the first quarter of 2004 and 5.0% in
the first quarter of 2003. The increase in selling, general and administrative
expenses for EDS in absolute dollars for the first quarter of 2004 compared to
the first quarter of 2003 is primarily due to expenses of approximately $1.8
million associated with the pending acquisition of InVision by General
Electric, offset by a decrease in sales commission payments. The increase in
selling, general and administrative expenses as a percentage of revenue is a
result of decreased revenues in the first quarter of 2004 compared to the first
quarter of 2003. Selling, general and administrative expenses for NDT were $3.1 million in
the first quarter of 2004. Selling, general and administrative expenses for
NDT as a percentage of NDT revenues were 19.2% in the first quarter of 2004. We
anticipate that the selling, general and administrative expenses as a
percentage of NDT revenues will decline in 2004 due to an expected increase in
NDT sales volume compared to 2003. Interest Expense Interest expense was $1.3 million in the first quarter of 2004 and $42,000
in the first quarter of 2003. The increase in interest expense compared to the
first quarter of 2003 is due primarily to approximately $938,000 of interest on
$125.0 million of convertible senior notes issued in September 2003, along with
fees associated with our working capital lines of credit, equipment leases,
capital leases and financing for insurance premiums and interest expense
associated with long-term debt. Interest and Other Income, Net Interest and other income, net was $836,000 in the first quarter of 2004
and $685,000 in the first quarter of 2003. The amount for the first quarter of
2004 consisted primarily of interest income on cash, cash equivalents and
short-term investments of $1.3 million, offset by other expenses of
approximately $500,000, consisting of accruals for litigation. The amount for
the first quarter of 2003 consisted primarily of interest income on cash and
cash 20




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equivalents of $439,000, and other income (net) of $246,000, primarily
consisting of foreign exchange gains on outstanding foreign exchange forward
contracts at March 30, 2003. Provision for Income Taxes The provision for income taxes was $3.6 million in the first quarter of
2004 and $23.2 million in the first quarter of 2003. Our effective tax rate
approximates our statutory tax rate, and was 40.8% in the first quarter of 2004
and 40.2% in the first quarter of 2003. At December 31, 2003, we had federal,
state and foreign net operating loss carryforwards of approximately $1.2
million, $321,000 and $15.8 million available to reduce future federal, state
and foreign taxable income, respectively. Our federal net operating loss
carryforwards begin to expire in 2010 and our state net operating loss
carryforwards expire in 2011. The foreign net operating loss carryforwards may
be carried over indefinitely and will not expire. The tax benefit of the net
operating loss carryforwards may be limited due to the impact of the Tax Reform
Act of 1986. Events which may cause the tax benefit to be limited include, but
are not limited to, a cumulative stock ownership change of more than 50% over a
three-year period and the timing of utilization of various tax benefits carried
forward. Liquidity and Capital Resources At March 28, 2004, we had $284.6 million in cash, cash equivalents and
short-term investments, compared to $276.9 million at December 31, 2003. Net cash provided by operating activities was $7.2 million in the first
quarter of 2004, compared to cash used in operating activities of $35.2 million
in the first quarter of 2003. Cash provided by operating activities in the
first quarter of 2004 primarily resulted from net income of $5.2 million,
enhanced by the non-cash effects of $2.6 million of depreciation and
amortization expense, and $3.5 million in tax benefits from employee stock
transactions. Another contributing factor was a $3.2 million decrease in
inventory due to a reduction in lead time to procure certain inventory
materials from suppliers. In addition, there was a $5.0 million increase in
accounts payable and a $4.4 million increase in deferred revenue. Partially
offsetting these increases to net cash provided by operating activities was a
$17.5 million increase in accounts receivable. This increase was primarily due
to billings to the TSA and other customers for units shipped near the end of
the first quarter of 2004. Cash used in operating activities in the first quarter of 2003 of $35.2
million primarily resulted from cash receipts from customers that were less
than the revenue recognized for the quarter. Cash receipts as it related to
revenue recognition for the quarter was reduced by a $27.0 million increase in
accounts receivable and a $63.4 million decrease in deferred revenue. This was
partially offset by net income of $34.4 million, and changes in other operating
assets and liabilities, such as an $11.2 million increase in accrued
liabilities, a $5.7 million decrease in inventories. Net cash used in investing activities was $115.9 million in the first
quarter of 2004, compared to $1.0 million in the first quarter of 2003. Net
cash used in investing activities in the first quarter of 2004 resulted
primarily from the purchase of short-term investments of $144.3 million offset
by $29.1 million in proceeds from short-term investments. Net cash used in
investing activities in the first quarter of 2003 resulted from $1.0 million in
purchases of capital equipment. Net cash provided by financing activities was $1.2 million in the first
quarter of 2004, compared to $1.3 million in the first quarter of 2003. Net
cash provided by financing activities in the first quarter of 2004 primarily
resulted from $4.3 million in net proceeds from the sale of common stock under
our employee stock purchase plan and exercises of stock options, offset by $2.9
million repayments of short-term debt. Net cash provided by financing
activities in the first quarter of 2003 primarily resulted from $1.1 million in
net proceeds from the sale of common stock under our employee stock purchase
plan and exercises of stock options. As of March 28, 2004, we had a line of credit agreement for our U.S.
operations that provides for maximum borrowings in an amount up to $30.0
million. Borrowings under this agreement bear interest at the banks prime rate
minus 0.5% (3.5% at March 28, 2004). The agreement expires in December 2005 and
requires that the EDS segment maintain certain levels of tangible net worth. We
may use proceeds of loans under this line of credit for general corporate
purposes. At March 28, 2004, we had no borrowings outstanding under this
agreement. However, at 21




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March 28, 2004, we had outstanding guarantees to customers through the
issuance of letters of credit for which a partial reserve of $16.7 million is
secured by the line of credit, and foreign exchange contracts for which a 10%
reserve of $4.6 million is secured by the line of credit. We had remaining
available borrowing capacity under the line of credit of $8.7 million at March
28, 2004. As of March 28, 2004, we had letters of credit totaling $16.7 million as
guarantees primarily to customers for performance and delivery commitments, and
to foreign creditors of Yxlon. In addition, we have one guarantee to an
insurance carrier for premium payment commitments. The guarantees range from
two months to nine years from March 28, 2004 until expiration. As of March 28, 2004, we had two primary sources of financing from German
banks for Yxlon. The first agreement is a line of credit that provides for
maximum borrowings in an amount up to ¬6.6 million or $8.0 million at March
28, 2004. The second agreement is also a line of credit that provides for
maximum borrowings in an amount up to ¬5.2 million, or $6.3 million, at
March 28, 2004. There is currently no expiration date on either of these
agreements. Borrowings under these agreements bear interest at a rate of 5.75%.
At March 28, 2004, we had debt balances of $2.6 million outstanding under these
agreements. In addition, at March 28, 2004, we had outstanding guarantees to
customers through the issuance of letters of credit for which a reserve of $7.2
million is secured by the line of credit. Therefore, we had remaining available
borrowing capacity under the line of credit of approximately ¬3.8 million,
or $4.5 million, at March 28, 2004. We believe that existing cash and cash equivalents, available borrowings
under our lines of credit and funds expected to be generated from operations
will be sufficient to finance our working capital and capital expenditure
requirements for at least the next twelve months. However, if we fail to meet
required financial covenants in our credit agreement, or our receivables do not
support the upper limits of the credit agreement, then we may not be able to
have access to further funds under our credit agreement. In addition, if we
are unable to deliver EDS units in a timely manner under orders from the TSA,
the TSA may cancel its orders or not place additional orders. If any of these
events occur, our capital resources would be significantly impaired. Contractual Obligations and Commitments The following table summarizes our contractual obligations as of March 28,
2004 (in thousands): Payments Due by PeriodLess than
    
    1-3Contractual Obligations
    
    Total
    
    1 year
    
    years
    
    ThereafterLong-term debt
    
    $
    125,000
    
    
    $
    
    
    
    $
    
    
    
    $
    125,000Operating leases
    
    
    21,922
    
    
    
    4,853
    
    
    
    7,585
    
    
    
    9,484Short-term debt
    
    
    2,600
    
    
    
    2,600
    
    
    
    
    
    
    
    Other long-term liabilities
    
    
    1,354
    
    
    
    
    
    
    
    15
    
    
    
    1,339Capital lease obligations
    
    
    547
    
    
    
    282
    
    
    
    265
    
    
    
    Total contractual cash obligations
    
    $
    151,423
    
    
    $
    7,735
    
    
    $
    7,865
    
    
    $
    135,823
 Risk Factors Many factors, including those described below, could cause actual results
to differ materially from those discussed in any forward-looking statements. Risks Related to the Proposed Acquisition of InVision by GE If the proposed merger with GE is not completed, our business and stock price
may be adversely affected. On March 15, 2004, we entered into an Agreement and Plan of Merger with
General Electric Company, or GE, under which GE would acquire us through the
merger of a wholly owned subsidiary of GE with and into InVision, and each
outstanding share of our common stock would be converted into the right to
receive $50.00 in cash. The 22




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merger is subject to customary closing conditions, including the approval of
our stockholders and the expiration or termination of waiting periods under
U.S. and applicable foreign antitrust laws. In addition, two class action
lawsuits have been filed against InVision and our directors that seek
injunctions to prevent the consummation of the proposed merger. See Part II,
Item 1. Therefore, there is a risk that the merger will not be completed or
that it will not be completed in the expected time period. If the merger is
not completed or the completion is substantially delayed, we could be subject
to a number of risks that may adversely affect our business and stock price,
including:  
    
    the market price of our common stock could decline following an
announcement that the merger has been abandoned or substantially
delayed, to the extent that the current market price reflects a market
assumption that the merger will be completed;  
    
    the diversion of management attention and the unavoidable
disruption to our relationships with customers and vendors may detract
from our ability to grow revenues and minimize costs;  
    
    we have and will continue to incur significant expenses related to the merger prior to its closing that may not be
recovered;  
    
    depending on the circumstances, we may be obligated to pay GE a $32.0 million termination fee; and  
    
    we may be unable to respond effectively to competitive pressures,
industry developments and future opportunities. In connection with the proposed merger, we have filed a proxy statement
with the SEC. When the proxy statement has completed review by the SEC, it
will be mailed to all holders of InVision common stock and will contain
important information about InVision, the proposed merger and related matters.
We urge all of our stockholders to read the definitive proxy statement when it
becomes available. The uncertainty created by the proposed merger could have an adverse effect on
our revenue and results of operations. Prior to the closing of the proposed merger or the termination of the
Agreement and Plan of Merger, the proposed merger creates uncertainty about
InVisions future. As a result of this uncertainty, customers may decide to
delay, defer, or cancel purchases of our products pending resolution of the
proposed merger. If these decisions represent a significant portion of our
anticipated revenue, our results of operations and quarterly revenues could be
substantially below the expectations of market analysts. Risks Related to Our Business A number of factors that affect our revenues make our future results difficult
to predict, and therefore we may not meet expectations for a particular period. We believe that our revenues have the potential to vary significantly from
time to time. For example, our total revenues were $76.9 million for the first
quarter of fiscal 2004, $165.2 million for the first quarter of fiscal 2003 and
$33.2 million for the first quarter of fiscal 2002, and were $416.5 million for
fiscal 2003, $439.1 million for fiscal 2002 and $74.3 million for fiscal 2001.
We believe that these variations may result from many factors, including:  
    
    the timing, size and mix of orders from our major customers, including in particular, the TSA and agencies of other
governments;  
    
    legislative or other government actions driven, in part, by the publics perception of the threats facing commercial
aviation, leading to fluctuations in demand for aviation security products and services;  
    
    delays in product shipments caused by the inability of airports to install or integrate our products in a timely fashion; 23




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
    
    the availability and cost of key components;  
    
    the timing of completion of acceptance testing for some of our products;  
    
    the introduction and acceptance, including certification by the TSA, of new products or enhancements to existing products
offered by us or our competitors;  
    
    changes in pricing policies by us, our competitors or our suppliers, including possible decreases in average selling prices
of our products caused by customer volume orders or in response to competitive pressures;  
    
    our sales mix to domestic and international customers; and  
    
    fluctuations in currency exchange rates, particularly the exchange rate
of the U.S. dollar against the euro. Further, we depend on a small number of customers for a substantial
portion of our revenues. In the past, the number of orders placed by these
customers has changed significantly from period to period, and we expect that
this may continue in the future. A significant portion of our quarterly and annual operating expenses is,
and will continue to be, relatively fixed in nature. This means that revenue
fluctuations will cause our quarterly and annual operating results to vary
substantially. We also may choose to increase spending to pursue new market
opportunities, which may negatively affect our financial results. Accordingly, we believe that period-to-period comparisons of our results
of operations cannot be relied upon as indicators of future performance.
Because of all of the foregoing factors, our operating results have from time
to time in the past been, and may again in the future be, different from
expectations of public market analysts and investors. Failure to meet market
expectations has in the past resulted, and may again in the future result, in
fluctuations in the trading price of our common stock. We are anticipating decreased EDS sales in 2004 and increased difficulty in
predicting future gross margins, which may cause our stock price to decline. We anticipate a decline in EDS revenues for 2004 compared to 2003 and, as
a result, we are planning to reduce costs. However, our ability to control
costs during a period of further declining sales is difficult to predict. This
difficulty is a result of factors such as our ability to increase our operating
efficiency and further reduce the costs of components. We may be unable to
reduce costs as much as we anticipate. As a consequence, the gross margins for
our products and services may vary significantly from our anticipated gross
margins and the gross margins of our products and services in recent periods.
If, as a result of these uncertainties, our gross margins, operating results or
earnings per share are below the expectations of market analysts and investors,
the trading price of our common stock may decline. Governmental agencies, the primary customers for our EDS and other products,
are subject to budget processes which could limit the demand for these
products. Substantially all of the customers for our EDS products and our other
products under development to date have been public agencies or quasi-public
agencies, such as the FAA, the TSA and airport authorities. Public agencies
are subject to budgetary processes and expenditure constraints. In the past,
many domestic and foreign government agencies have experienced budget deficits
that have led to decreased capital expenditures in certain areas. The funding of government programs is subject to legislative
appropriation. Budgetary allocations for EDS depend, in part, upon
governmental policies, which fluctuate from time to time in response to
political and other factors, including the publics perception of the threat of
commercial airline bombings. For example, the terrorist attacks of September
11, 2001 resulted in the passage of the Aviation and Transportation Security
Act of 2001, or Transportation Security Act, mandating a small surcharge on
each airline ticket purchase to fund airline security. This surcharge was
suspended from June 1, 2003 to September 30, 2003. We cannot assure investors
that the 24




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surcharge will not again be suspended or that the funds generated by these
surcharges will be used to purchase our EDS products. We cannot assure
investors that funds will continue to be appropriated by Congress or allocated
by the TSA or other agencies for the purchase of EDS products. Legislative actions could lead to fluctuations in demand for aviation security
products and services. In addition to the Congressional budgetary process, other legislation
could be introduced that would impact demand for aviation security products and
services. In response to fluctuation in concern on the part of voters about
aviation security and competing homeland security demands, or for other
reasons, the plans for deployment of EDS to screen baggage could be changed.
Budgetary debates and delays could result in fewer EDS being sold to the TSA
and elected officials who support the EDS program could fail to maintain their
offices, any of which events could cause a decrease in the demand for our EDS
products. Governmental agencies have special contracting requirements, which create
additional risks. In contracting with public agencies, we are subject to public agency
contract requirements that vary from jurisdiction to jurisdiction. Future
sales to public agencies will depend, in part, on our ability to meet public
agency contract requirements, certain of which may be onerous or even
impossible for us to satisfy. Government contracts typically contain termination provisions unfavorable
to us and are subject to audit and modification by the government at its sole
discretion, which subject us to additional risks. These risks include the
ability of the U.S. government to unilaterally:  
    
    suspend or prevent us for a set period of time from receiving new contracts or extending existing contracts based on
violations or suspected violations of laws or regulations;  
    
    terminate our existing contracts;  
    
    reduce the scope and value of our existing contracts;  
    
    audit and object to our contract-related costs and fees, including allocated indirect costs;  
    
    control and potentially prohibit the export of our products; and  
    
    change certain terms and conditions in our contracts. The U.S. government can terminate any of its contracts with us either for
its convenience or if we default by failing to perform in accordance with the
contract schedule and terms. Termination for convenience provisions generally
enable us to recover only our costs incurred or committed, and settlement
expenses and profit on the work completed prior to termination. Termination
for default provisions do not permit these recoveries and make us liable for
excess costs incurred by the U.S. government in procuring undelivered items
from another source. Our contracts with foreign governments may contain
similar provisions. Consequently, our backlog is not necessarily indicative of
future revenues. The governments termination of one or more of the contracts
for our EDS products or our other products under development would harm our
business. In addition, U.S. government contracts are conditioned upon the continuing
availability of Congressional appropriations. Congress usually appropriates
funds annually for a given program on a September 30 fiscal year-end basis,
even though contract performance may take years. Consequently, our contracts
with the TSA may only be partially funded at the outset, and additional monies
are normally committed to the contract by the TSA only as appropriations are
made by Congress for future periods. The governments failure to fully fund
one or more of the contracts for our EDS products or our other products under
development would harm our business. Under our three-year agreement with the TSA announced on August 12, 2003,
the TSA has the right to purchase system options and accessories, engineering
and installation support and 550 CTX units, principally our CTX 9000 DSi
systems, over the three-year term. While the TSA placed delivery orders
totaling $162.8 million 25




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under the agreement, the TSA has no obligation to place additional delivery
orders or purchase additional engineering and installation support under the
agreement. We cannot assure you that the TSA will make any additional delivery
orders under the agreement or will not cancel its existing order. The
agreement is subject to all of the limitations and restrictions that apply to
U.S. government contracts, including those described above. Because we contract with the U.S. government, we are subject to periodic
audits and reviews. Based on the results of its audits, the U.S. government
may adjust our contract-related costs and fees, including allocated indirect
costs. In the future, government audits and reviews could result in
adjustments to our revenues and cause other adverse effects, particularly to
our relationship with the TSA. In addition, under U.S. government purchasing
regulations, some of our costs, including most financing costs, amortization of
intangible assets, portions of our research and development costs, and some
marketing expenses may not be reimbursable or allowed in our negotiation of
fixed-price contracts. Further, because we contract with the U.S. government,
we are subject to an increased risk of investigations, criminal prosecution,
civil fraud, whistleblower lawsuits and other legal actions and liabilities to
which purely private sector companies are not. In addition, public agency contracts are frequently awarded only after
formal competitive bidding processes, which are often protracted and typically
contain provisions that permit cancellation in the event that funds are
unavailable to the public agency. We may not be awarded any of the contracts
for which our products are bid. Even if we are awarded contracts, substantial
delays or cancellations of purchases could result from protests initiated by
losing bidders. Our growth depends on our introduction of new products and services, which may
be costly to develop and may not achieve market acceptance. As part of our strategy for growth, we intend to develop products to
address additional aviation security opportunities, such as passenger, carry-on
baggage and air cargo screening. We also intend to address homeland security
requirements beyond aviation, such as screening at border checkpoints,
government offices and transportation terminals and ports. We will be required
to spend significant funds to develop or acquire technologies and products for
these initiatives, and these initiatives may divert our development and
management resources away from our core EDS products. In addition, we have
acquired, rather than developed internally, some of our technologies in
connection with our acquisitions of companies and businesses, and these
technologies may not perform as we expect. The development of new products may
require greater time and financial resources than we currently anticipate and,
despite significant investments in research and development, may not yield
commercially successful products. The development of our products for explosives and weapons detection is
highly complex. Successful product development and market acceptance of any
new products and services that we develop depend on a number of factors,
including:  
    
    our timely completion and introduction of new products;  
    
    our accurate prediction of the demand for homeland security products and the changing requirements of the homeland security
industry, including certification or other required performance standards;  
    
    the availability of key components of our products;  
    
    the quality, price and operating performance of our products and those of our competitors;  
    
    our customer service capabilities and responsiveness; and  
    
    the success of our relationships with existing and potential customers. Finally, new products for aviation security applications may require
certification or approval by the TSA, and we believe that the TSA does not
currently have standards for the certification of aviation security products
other than bulk explosives detection systems and explosives trace detectors, or
ETD. Other products, such as metal 26




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detectors, are subject to TSA testing prior to approval. Market acceptance of
new products may be limited if the TSA has not developed standards for
certification or approval of such products, and even if it does develop such
standards, we may be unable to obtain any such certification or approval, which
could materially limit market acceptance of such products. If we fail to
timely introduce new products or if these products fail to gain market
acceptance, our results of operations would be harmed. In addition, even if successful in the United States, new products that we
develop may not achieve market acceptance outside of the United States. Unlike
the U.S. government, foreign governments may be unwilling to commit financial
resources to purchase our new products, which would reduce our potential
revenues and harm our business. We depend upon a limited number of suppliers for components of our products,
and if we are unable to obtain parts from these suppliers on a timely basis,
then we may not be able to deliver our products as required. Key components used in our products have been designed by us to our
specifications and are currently available only from one or a limited number of
suppliers. We currently do not have long-term agreements with any of these
suppliers. In addition, some of the suppliers of the key components used in
our products are our competitors, and they may be motivated not to supply us
with the components we need. Our inability to develop alternative sources for
single or sole source components, to find alternative third party manufacturers
or sub-assemblers, or to obtain sufficient quantities of these components,
could result in delays or interruptions in product shipments, which could cause
current or potential customers to seek other suppliers of our products. In
view of the high cost of many of these components, we strive to avoid excess
supplies. If our suppliers experience financial, operational, production or
quality assurance difficulties, or our sole source suppliers are acquired or
otherwise influenced by our competitors, the supply of components to us would
be reduced or interrupted. In the event that a supplier ceases operations,
discontinues a product or withholds or interrupts supply for any reason, we may
be unable to acquire the product from alternative sources within a reasonable
period of time. Our future EDS products may fail to obtain certification by the TSA. We plan to continue to develop new models for our family of EDS products,
including systems utilizing X-ray based diffraction, or XRD, technology, of our
subsidiary, Yxlon International Security GmbH, and to continue our
participation in the ARGUS program, an FAA/TSA-sponsored program designed to
develop a smaller, low-cost EDS product. However, we cannot be certain that
any new EDS product, including systems utilizing Yxlons XRD technology or our
CTX 1000 (ARGUS) system, will be certified by the TSA. The failure to gain
certification for an EDS product would harm our ability to sell the product and
recognize associated revenues. Our existing EDS products may fail to obtain re-certification by the TSA for
changes in the EDS systems. Our existing EDS products can be required to be re-certified by the TSA.
This can happen when a critical component is changed, or we wish to make other
changes to the EDS products. When this happens, the affected EDS model
requires re-certification by the TSA. The failure or delay in gaining
re-certification for an existing EDS product could harm our ability to continue
to sell the product and recognize associated revenues. Our major customer, the TSA, is a part of the Department of Homeland Security,
a relatively new agency that has experienced, and may continue to experience,
delays in its operations, which may cause delays in our receiving orders from
the TSA. The TSA is a relatively new agency that was created in November 2001 by
the Transportation Security Act. As a result, it has experienced, and may
continue to experience, delays in fulfilling its mandate as a result of delays
in establishing the necessary infrastructure to operate in an efficient manner.
This may result in delays in our receiving orders for our EDS products.
Further, the TSA is now a part of the Department of Homeland Security, which
was created subsequent to the creation of the TSA and is therefore in an
earlier stage of formation, which may further create delays in our receiving
orders as this agency is organized. 27




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Future sales of our EDS products will depend on the ability of airports to
secure funding to build baggage handling systems and to integrate our EDS
products into such systems, which they may not be able to do. Future sales will depend, in part, on installing our EDS products into
airport lobbies or integrating them into existing baggage handling systems. If
an airport is not configured for these systems, deployment of our EDS products
may require changes in the airport infrastructure, such as reinforced airport
lobby floors and baggage platforms. If our EDS products cannot easily be
installed in airport lobbies or integrated into existing baggage handling
systems, we may experience reduced sales of our EDS products or these sales may
be delayed. In addition, installations and integrations are currently
partially funded by the TSA in the United States. Legislation established a
letter of intent program under which an airport can present a request to the
TSA for reimbursement of up to 90% of costs incurred by the airport in
improving baggage handling systems to increase security. There can be no
assurance that the government will continue to fund installations, integrations
and reimbursements at the current level or at all. If there is a reduction in
funding, we may experience reduced sales of our EDS products or these sales may
be delayed. We believe that a substantial opportunity exists for our CTX 9000 DSi
model to be integrated into baggage handling systems. If airports determine,
in conjunction with governmental authorities, that they will be unable or
unwilling to modify or finance such in-line baggage handling systems, this
opportunity may be limited. As a result of the Transportation Security Act, our EDS products are undergoing
substantially increased usage per day, which could cause unforeseen problems
with their ability to sustain this increased usage. As required by the Transportation Security Act, as of December 31, 2002,
100% of checked baggage must undergo screening. As a result, our EDS products
in operation are being used more hours per day than before, which places a
burden on them not previously experienced. This has resulted in an increase in
the amount of maintenance required to keep them operating, and may result in
unforeseen problems. If this were to occur, our customers could perceive that
there are reliability problems with our EDS products, which could reduce the
demand for our products. In addition, our CTX 9000 DSi product is a relatively
new model with which we have limited experience in sustaining extensive usage.
As a result, our CTX 9000 DSi product may experience maintenance needs and
increased down time beyond that experienced by our CTX 2500 and CTX 5500 DS
products. Further, because the CTX 9000 DSi product is designed to be
integrated into an airports baggage handling system, it has, in addition to
the detection function and mechanisms, components that integrate it into the
baggage handling system, which also require maintenance and may also contribute
to increased maintenance needs and down time. If our CTX 9000 DSi product does
experience additional maintenance needs beyond that of our CTX 2500 and CTX
5500 DS products, our customers may not purchase this product in favor of our
CTX 2500 and CTX 5500 DS products or the products of our competitors. We may seek to grow by acquisition, which subjects us to substantial risks,
including the failure to successfully integrate an acquired business. As part of our growth strategy, we may expand our business by pursuing
selected acquisitions of technologies and companies that offer complementary
products, services, technologies or market access. Our ability to grow by
acquisition depends upon the availability of acquisition candidates at
acceptable prices. We may incur costs in connection with our pursuit of
acquisitions for which we are responsible regardless of whether the
acquisitions are actually consummated. Future acquisitions by us could result
in dilutive issuances of equity securities, the incurrence of debt and
contingent liabilities and expenses related to acquired operations and assets,
any of which could harm our business and our operating results. Acquisitions
entail numerous risks and we may not realize the expected benefits of these
transactions. These risks include:  
    
    difficulties in the assimilation of acquired operations, technologies and products;  
    
    diversion of managements attention from other business concerns;  
    
    lack of experience operating in the geographic market or industry sector of acquired companies; 28




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
    
    exposure to unanticipated contingent liabilities of acquired companies; and  
    
    potential loss of key employees of acquired companies. The process of integrating supply and distribution channels, computer and
accounting systems and other aspects of operations, while managing a larger
entity, may present a significant challenge to our management. We may not be
able to successfully integrate any businesses, products, technologies or
personnel that might be acquired in the future. In such case, we would not
fully realize the anticipated benefits of a business combination, and the
failure of such efforts would harm our business. Maintaining uniform
standards, controls, procedures and policies may be harder than we anticipate
and interfere with efficient administration of the company as a whole. For example, on March 31, 2003, we completed the acquisition of Yxlon
International Holding GmbH. Yxlon is active in businesses that are new to us
and present a challenge to our management. In order to successfully integrate
Yxlons security technologies and products, we must, among other things,
integrate these into our suite of products, both from an engineering and a
sales and marketing perspective. As a result, we may take longer to develop
and introduce new products than we anticipate. In addition, we do not have
experience developing, marketing and selling products in the non-destructive
testing business, and we may not be successful competing for customers in
industries with which we are unfamiliar. The difficulties of integration of
Yxlon may be further complicated by the geographic distance between our U.S.
offices and Yxlons headquarters, which are located in Germany. If we are not
successful in integrating Yxlons security technologies into our product line,
or in managing Yxlons non-destructive testing business, we may incur
additional expenses or lose revenue opportunities for Yxlon and us, and our
business results may suffer. Our strategic investments may not provide any of the benefits we anticipate,
and as a result, we may incur economic losses or be required to write-down
these investments. From time to time, we consider strategic investments in development-stage
companies that we believe provide strategic opportunities for us, such as our
recent investment in SafeView, Inc., which is developing portal systems for
passenger screening. Although we intend that these investments will provide
access to new technologies and emerging markets, we cannot assure you that
these investments will create opportunities for us to increase our sales. If
these companies are unsuccessful in their product development efforts or are
unable to obtain additional private financing, we may be required to write-down
these investments or we may lose some or all of these investments, which would
harm our results. If our EDS products fail to detect explosives, we could be exposed to product
liability and related claims for which we may not have adequate insurance
coverage, and we may lose current and potential customers. Our business exposes us to potential product liability risks, which are
inherent in the manufacturing, sale and maintenance of EDS products. Our
machines are not designed to detect, and FAA/TSA certification does not
require, 100% detection of any and all explosives contained in scanned baggage.
For this reason, or if our products malfunction, it is possible that explosive
material could pass undetected through our products, which could lead to
product liability claims. There are also many other factors beyond our control
that could lead to liability claims, such as the reliability and competence of
the customers operators and the training of the operators. For example, InVision and our subsidiary, Quantum Magnetics, were named as
defendants in a number of lawsuits relating to the terrorist acts of September
11, 2001, even though InVision and Quantum Magnetics did not, as of September
11, 2001, have any passenger or carry-on baggage screening equipment at
security checkpoints in any of the airports from which the hijacked airplanes
departed. Amended Master Complaints controlling over the individual complaints
filed by plaintiffs in the In re: September 11 Litigationhave effectively
dismissed these claims against InVision and Quantum Magnetics. The cost of
defending product liability claims such as these, and other product liability
claims, brought against us could be significant and any adverse determination
may result in liabilities in excess of our insurance coverage. We currently
have product liability insurance in the amount of $200.0 million. We also have
war and terrorism insurance in the amount of $200.0 million, including up to
$50.0 million under our product liability insurance. We cannot be certain that
our current insurance can be maintained, or additional insurance coverage could
be obtained, on acceptable terms, if at all. 29




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In addition, the failure of any EDS product to detect explosives, even if
due to operator error and not to the mechanical failure of an EDS product,
could result in public and customer perception that our products do not work
effectively, which may cause potential customers to not place orders and
current customers to cancel orders already placed or to not place additional
orders, any of which would harm our business and financial results. We substantially depend on large orders from a limited number of customers. As
a result, order cancellations from any of our customers or the failure of these
customers to continue to purchase EDS products could have a material negative
impact on our business and financial results. In any given fiscal quarter or year, our revenues are derived from orders
of multiple units of our EDS products from a limited number of customers.
Through March 28, 2004, substantially all of our orders from U.S. customers
have been funded by the FAA and the TSA, which allocate our products to
airports in the United States. EDS product and service sales to the FAA, and
following the formation of the TSA, to the TSA, accounted for 38.1% of our
total revenues in the quarter ended March 28, 2004 and 84.2% of our total
revenues in the quarter ended March 30, 2003. In the quarter ended March 28,
2004, six customers accounted for all of our EDS units sold during the quarter,
and in the quarter ended March 30, 2003, eight customers accounted for all of
our EDS products sold during the quarter. The failure of these customers,
particularly the U.S. government, to continue to purchase our EDS products or
the cancellation of existing orders would harm our business. The U.S. governments right to use technology developed by us, but funded by
the U.S. government, limits our intellectual property rights. In accordance with Federal Acquisition Regulations included in our
development contracts with the FAA, the U.S. government has rights to use our
proprietary technologies developed after the award of the development contract
and funded by the development contract. The U.S. government may use these
rights to produce or have produced for the U.S. government competing products
using CT technology found in our existing EDS products as well as our CTX 1000
model, which has not yet been certified by the TSA. With respect to Quantum
Magnetics, the U.S. government retains the same rights to the passive magnetic
technology found in the quadrupole resonance, or QR, technology. In the event
that the U.S. government were to exercise these rights, our competitive
position in supplying the U.S. government with certified CT-based explosives
detection systems and/or the Quantum products would be harmed. The sales cycle for our EDS products is lengthy, and we may expend a
significant amount of effort in obtaining sales orders and not receive them. The sales cycle of our EDS products is often lengthy due to the protracted
approval process that typically accompanies large capital expenditures and the
time required to manufacture and install our EDS products. Typically, six to
twelve months may elapse between a new customers initial evaluation of our
systems and the execution of a contract. Another three months to a year may
elapse prior to shipment of our EDS products as the customer site is prepared
and our EDS products are manufactured. In addition, in the United States,
budgetary debates in Congress, may result in additional delays in the purchase
of additional EDS products. During the sales cycle we expend substantial funds
and management resources but recognize no associated revenue. Our backlog is not necessarily indicative of future revenues. We measure our backlog of product revenues as orders for systems and
upgrades for which contracts or purchase orders have been signed, but which
have not yet been shipped. We measure our backlog of service revenues as
orders for maintenance related to product support for which contracts have been
signed, but maintenance service has not yet been performed. We typically ship
our products within three to twelve months after receiving an order. However,
such shipments may be affected by delays which occur in the delivery of
components to us or our readiness to accept delivery of components for reasons
of site preparation or otherwise. In some instances, shipments may be made
more quickly depending on our ability to build machines to order and our
customers demand for immediate delivery. 30




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Quantum Magnetics contract research and development backlog includes
funded and unfunded awards from government agencies for which services have not
yet been performed. At March 28, 2004, Quantum Magnetics contract research
and development backlog was $10.7 million, $6.0 million of which was funded. Any failure by us to meet an agreed upon schedule could lead to the
cancellation of the related order. Variations in the size, complexity and
delivery requirements of the customer order may result in substantial
fluctuations in backlog from period to period. In addition, all orders are
subject to cancellation or delay by the customer and, accordingly, we cannot
assure investors that our backlog will eventually result in revenues. For
these reasons, we believe that backlog cannot be considered a meaningful
indicator of our performance on an annual or quarterly basis. Our international sales subject us to risks that could materially harm our
business. Sales to countries other than the United States accounted for 49.1% of our
total revenues in the quarter ended March 28, 2004. It is part of our growth
strategy to increase our international operations. A number of factors related
to our international sales and operations could adversely affect our business,
including:  
    
    changes in domestic and foreign regulatory requirements;  
    
    political instability in the countries where we sell products;  
    
    possible foreign currency controls;  
    
    fluctuations in currency exchange rates;  
    
    our ability to protect and utilize our intellectual property in foreign jurisdictions;  
    
    tariffs, embargoes or other barriers;  
    
    difficulties in staffing and managing foreign operations;  
    
    difficulties in obtaining and managing distributors; and  
    
    potentially negative tax consequences. Further, the sale of some of our products outside the United States is
subject to compliance with the U.S. International Traffic in Arms Regulations
and Export Administration Regulations. Our failure to obtain the requisite
licenses, meet registration standards or comply with other government export
regulations, may affect our ability to generate revenues from the sale of our
products outside the United States, which could harm our business. In
particular, some of our EDS products and our landmine detection equipment are
deemed regulated military devices subject to export restrictions under the U.S.
Department of State regulations. Consequently, these regulations may make
these products more difficult to sell to a number of countries. Compliance
with government regulations may also subject us to additional fees and costs.
The absence of comparable restrictions on competitors in other countries may
adversely affect our competitive position. Exchange rate fluctuations could cause a decline in our financial condition and
results of operations. In 2003, the cost of certain international currencies has increased due to
fluctuations in the exchange rate of the U.S. dollar against the euro. As a
result of our international operations and recently acquired Yxlon operations,
we generate a significant portion of our net sales and incur a significant
portion of our expenses in currencies other than the U.S. dollar, primarily the
euro. Future fluctuations in this exchange rate could adversely affect our
results because we pay our non-U.S. employees and certain suppliers in local
currencies, and, in some cases, our sales contracts are denominated in local
currencies. From time to time, as and when we determine it is appropriate and
advisable to do so, we will seek to mitigate the effect of exchange rate
fluctuations through the use of derivative 31




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financial instruments. We cannot assure you, however, that we will continue
this practice or be successful in these efforts. Yxlon generally transacts business in euros. Consequently, its financial
condition and results of operations are reported in euros and then translated
into U.S. dollars at the applicable exchange rate for inclusion in our
consolidated financial statements. As a result, appreciation of the U.S.
dollar against the euro will have a negative impact on our reported revenues
and operating profit while depreciation of the U.S. dollar against the euro
will have a positive effect on reported revenues and operating profit.
However, Yxlons customer contracts that are denominated in U.S. dollars will
be adversely affected by the depreciation of the U.S. dollar. We may have warranty claims that exceed our reserves. Our EDS products are typically sold with one-year warranties. We have
established reserves for the liability associated with product warranties based
on historical experience with warranty claims. However, our actual warranty
costs, including actual material usage or service delivery costs, may exceed
our reserves, which could have an adverse effect on our operating results. We may not be selected to provide post-warranty service on our CTX products,
and if we are selected to provide post-warranty services, these services may
not be profitable for us. We offer to our customers the opportunity to buy a service contract from
us, which provides for scheduled maintenance, repairs and parts once a warranty
period on a CTX product has expired (which is typically a one-year period). If
we are not selected to provide post-warranty service, this would harm our
business. Some of our post-warranty service contracts contain fixed pricing
terms. If our actual costs, including actual material usage or service
delivery costs, exceed our revenues under these service agreements, our
operating results could be adversely affected. We are currently in
negotiations for the renewal of our agreement to provide service to our CTX
products owned by the TSA. We cannot assure investors that the agreement will
be renewed, or will be renewed on financially advantageous terms. In addition,
historically, we have sold service contracts on most eligible CTX products
deployed internationally. We may not achieve this level of service contract
sales in the future. Our inability to adapt to rapid technological change could impair our ability
to remain competitive. The EDS industry may undergo significant technological development in
response to increased demand for aviation security products. A fundamental
shift in technology in our product markets could harm us, because we derive
substantially all of our revenues from sales of EDS products and services. We anticipate that we will incur significant expenses in the design and
initial manufacturing and marketing of new products and services. Our
competitors may implement new technologies before we are able to, allowing them
to provide more effective products at more competitive prices. Future
technological developments could:  
    
    adversely impact our competitive position;  
    
    require write-downs of obsolete technology;  
    
    require us to discontinue production of obsolete products before we can
recover any or all of our related research, development and commercialization
expenses; or  
    
    require significant capital expenditures beyond those currently
contemplated. We cannot assure investors that we will be able to achieve the
technological advances to remain competitive and profitable, that new products
and services will be developed and manufactured on schedule or on a
cost-effective basis, that anticipated markets will exist or develop for new
products or services, or that our existing products and services will not
become technologically obsolete. 32




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The EDS industry is highly competitive. Given the anticipated continuing
demand for airport security products, competition may increase. The EDS industry is intensely competitive and we may not compete
successfully. As a result of increased demand for security systems, additional
companies may enter the EDS industry. Some of our competitors, including L-3
Communications Holdings, Inc. and many of the potential new entrants into the
EDS industry, have financial, technical, production and other resources
substantially greater than ours. We believe that some of our competitors have
EDS products undergoing TSA certification. Our failure to compete successfully
could result in lost sales and could hamper our financial results. We depend on key management and personnel and may not be able to retain those
employees or recruit additional qualified personnel. We believe that our future success will be due, in part, to the continued
services of our senior management team. We do not have long-term employment
agreements with any of our executive officers. Losing the services of one or
more members of our management team could negatively affect our business and
our expansion efforts. We do not maintain key person life insurance policies
for members of our management. We could be seriously harmed by the loss of any
of our executive officers. The implementation of our growth strategy will
require that we recruit additional members of our senior management team. In
addition, in order to manage our growth, we will need to recruit and retain
additional skilled personnel, such as advanced engineering professionals. Our
failure to recruit qualified employees in a timely manner and retain them could
harm our business and our ability to continue to grow. Natural disasters, including earthquakes, may damage our facilities. Our corporate and manufacturing facilities in California are located near
major earthquake faults, which have experienced earthquakes in the past. In
the event of a major earthquake or other natural disaster, our facilities may
sustain significant damage and our operations could be harmed. Our business could be harmed if we fail to properly protect our intellectual
property. Our success depends in part on our ability to protect our intellectual
property. Although we attempt to protect our intellectual property in the
United States and other countries through various methods such as patents and
patent applications, trademarks, copyrights and non-disclosure agreements,
there can be no assurance that we will successfully protect our technology or
that competitors will not be able to develop similar technology independently. We have two U.S. patents for automatic concealed object detection systems
using a pre-scan stage as used in our CTX products. These patents expire in
2010 and 2011. The patents have not prevented competitors from developing
CT-based products which do not use a pre-scan stage. The time period for
filing foreign counterparts of our two U.S. EDS patents has expired, and we did
not seek or obtain patent protection. The absence of foreign counterparts to
our patents could adversely affect our ability to prevent a competitor from
using technology similar to technology used in our CTX products. We also have
a U.S. patent for a mechanical radiation shield for our CTX 9000 DSi model,
which expires in 2021. We rely on this technology to increase the speed of the
baggage inspection process. We have filed other applications in the United
States and Europe for patents covering other features contained in our CTX 9000
DSi model. We cannot assure investors that the claims allowed under any
patents held by us will be sufficiently broad to protect our technology against
competition from third parties with similar technologies or products. In
addition, we cannot assure investors that any patents issued to us will not be
challenged, invalidated or circumvented or that the rights granted under these
patents will provide a competitive advantage to us. Moreover, the laws of some
foreign countries do not protect intellectual property rights to the same
extent as the laws of the United States, and we could experience various
obstacles and high costs in protecting our intellectual property rights in
foreign countries. If we are unable to obtain or maintain these protections,
we may not be able to prevent third parties from using our intellectual
property. We also rely on trade secrets, proprietary know-how and continuing
technological innovation to remain competitive. We have taken measures to
protect our trade secrets and know-how, including the use of 33




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confidentiality agreements with our employees. It is possible that these
agreements may be breached and that the available remedies for any breach will
not be sufficient to compensate us for damages incurred. Litigation may be necessary to enforce or defend against claims of intellectual
property infringement, which could be expensive and, if we lose, could prevent
us from selling our products. Litigation may be necessary in the future to enforce our patents and other
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. Any litigation,
regardless of the outcome, could be costly and require significant time and
attention of key members of our management and technical personnel. Our domestic and international competitors, many of whom have
substantially greater resources and have made substantial investments in
competing technologies, may have patents that will prevent, limit or interfere
with our ability to manufacture and sell our products. We have not conducted
an independent review of patents issued to third parties. Because of the
perceived market opportunity we face, companies possessing technology rights
that they believe we might be infringing will now be much more motivated to
assert infringement of their rights. These third parties may assert
infringement or invalidity claims against us and litigation may be necessary to
defend against these claims. An adverse outcome in the defense of a patent
suit could subject us to significant liabilities to third parties, require
disputed rights to be licensed from third parties or require us to cease
selling our products. Even successful defenses of patent suits can be costly
and time-consuming. We have received significant amounts of funding from government grants and
contracts. We cannot assure investors that we will continue to receive this
level of funding for future product development. The U.S. government currently plays an important role in funding the
development of EDS technology and sponsoring its deployment in U.S. airports.
We performed reimbursable research and development for EDS products pursuant to
FAA and TSA grants and contracts totaling $524,000 in the quarter ended March
28, 2004, $3.1 million for the year ended December 31, 2003, and $886,000 for
the year ended December 31, 2002. This is a significant reduction from the
$8.3 million for reimbursable research and development for EDS products from
FAA grants and contracts in the year ended December 31, 2001. We are also
aware that other competitors and potential competitors in the EDS market have
received FAA and TSA development grants. The U.S. government also currently
funds almost all of the development of Quantum Magnetics products, including QR
and passive magnetic sensing. We had contract research and development
revenues from the U.S. government for the development of Quantum Magnetics
products of $2.9 million for the quarter ended March 28, 2004, $13.1 million
for the year ended December 31, 2003 and of $12.1 million for the year ended
December 31, 2002. We cannot assure investors that additional research and
development funds from the government will become available in the future or
that we will receive any of these additional funds. If the government fails to
continue to sponsor our technology, we would have to expend more resources on
product development, which could adversely affect our business. In addition,
any future grants to our competitors may improve their ability to develop and
market advanced detection products and cause our customers to delay any
purchase decisions, which could harm our ability to market our products. Substantial leverage and debt service obligations may adversely affect our cash
flow. As a result of the convertible debt offering that we completed in
September 2003, our debt service obligations increased substantially. There is
the possibility that we may be unable to generate cash sufficient to pay the
principal of, interest on and other amounts due in respect of our indebtedness
when due. We may also add equipment loans and lease lines to finance capital
expenditures and may obtain additional long-term debt, working capital lines of
credit and lease lines. Our substantial leverage could have significant negative consequences, including:  
    
    increasing our vulnerability to general adverse economic and industry conditions;  
    
    limiting our ability to obtain additional financing; 34




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
    
    requiring the dedication of a portion of our expected cash flow from operations to
service our indebtedness, thereby reducing the amount of our expected cash flow
available for other purposes, including capital expenditures;  
    
    limiting our flexibility in planning for, or reacting to, changes in our business and
the industry in which we compete; and  
    
    placing us at a possible competitive disadvantage relative to less leveraged
competitors and competitors that have better access to capital resources. Risks Related to Ownership of Our Common Stock The price of our common stock may fluctuate significantly. The trading price of our common stock has been and may continue to be
subject to large fluctuations, which may result in losses to investors. If the
proposed merger with GE is not completed, or there is heightened uncertainty
about whether it will be completed, our stock price may increase or decrease in
response to a number of events and factors, including:  
    
    the level and changing nature of terrorist activity;  
    
    legislative and regulatory developments related to anti-terrorism efforts or aviation security;  
    
    our quarterly operating results or those of other explosives detection companies;  
    
    the publics reaction to our press releases, announcements and our
filings with the Securities and Exchange Commission;  
    
    our announcement of an acquisition or strategic investment;  
    
    changes in earnings estimates or recommendations by research analysts;  
    
    changes in our relationships with customers; and  
    
    developments affecting our competitors. The market price of our common stock has fluctuated dramatically since the
terrorist attacks of September 11, 2001. For example, immediately prior to
September 11, 2001, our common stock closed at $3.11 per share. Since that
date, our closing stock price has risen to a high of $48.29 per share on March
12, 2002. During 2003, our closing stock price fluctuated from a low of $20.33
per share to a high of $34.41 per share. During the period from January 1,
2004 through March 12, 2004, the last trading day prior to the announcement of
the proposed acquisition of InVision by GE, our closing stock price fluctuated
from a low of $34.35 per share to a high of $41.58 per share. In addition, the
stock market has periodically experienced significant price and volume
fluctuations that have particularly affected the market prices of common stock
of technology companies. These changes have often been unrelated to the
operating performance of particular companies. These broad market fluctuations
may also negatively affect the market price of our common stock and the notes. Delaware law and our charter documents may impede or discourage a takeover,
which could cause the market price of our shares to decline. We are a Delaware corporation and the anti-takeover provisions of Delaware
law impose various impediments on the ability of a third party to acquire
control of us, even if a change in control would be beneficial to our existing
stockholders. Our certificate of incorporation provides for 5,000,000 shares
of preferred stock which our board of directors may issue with terms determined
by them without stockholder approval, a classified board of directors serving
staggered three-year terms, restrictions on who may call a special meeting of
stockholders and a prohibition 35




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on stockholder action by written consent. These provisions of Delaware law and
in our charter documents could impede a merger, takeover or other business
combination involving us or discourage a potential acquirer from making a
tender offer for our common stock, which, under certain circumstances, could
reduce the market value of our common stock and the notes. We may not pay cash dividends. We have not declared or paid any cash dividends on our capital stock
previously, and we have agreed not to pay cash dividends under our current bank
line of credit. Historically, we have retained earnings, if any, to support
the development of our business. Payment of future dividends, if any, will be
at the discretion of our board of directors after taking into account various
factors, including our financial condition, operating results and current and
anticipated cash needs. We may become subject to costly and time-consuming class action litigation
following significant changes in our stock price. In the past, following periods of volatility in the market price of a
companys securities, securities class action litigation has often been
instituted against such a company. Were such litigation to be commenced
against us, we would incur substantial costs and there would be diversion of
our managements attention and resources, which could materially harm our
business, results of operations and financial condition. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk We consider investments purchased with an original or remaining maturity
of less than three months at the date of purchase to be cash equivalents. We
maintain an investment portfolio of various holdings, types, and maturities.
See Note 1 to the condensed consolidated financial statements. These securities
are classified as available for sale and consequently are recorded on the
consolidated balance sheets at fair value with unrealized gains or losses
reported as a separate component of accumulated other comprehensive income
(loss), net of tax. The following table summarizes our cash, cash equivalents
and short-term investments for the periods indicated (in thousands): March 28,
    
    December 31,2004
    
    2003Cash and cash equivalents
    
    $
    74,891
    
    
    $
    182,382Short-term investments
    
    
    209,719
    
    
    
    94,557Total
    
    $
    284,610
    
    
    $
    276,939
 At any time, a sharp rise in interest rates could adversely impact the
fair value of our investment portfolio. Conversely, declines in interest rates
could have a positive impact on the fair value of our investment portfolio. We
do not currently hedge these interest rate exposures. The following table
presents the changes in fair value in investment securities held at March 28,
2004 that are sensitive to changes in interest rates (in thousands) based on
hypothetical adjustments in the applicable interest rates: Valuation of securities
    
    
    
    
    
    Valuation of securitiesgiven an interest rate
    
    Fair value as of
    
    given an interest rateincrease of X basis points
    
    March 28,
    
    decrease of X basis points150 BPS
    
    100 BPS
    
    50 BPS
    
    2004
    
    (50 BPS)
    
    (100 BPS)
    
    (150 BPS)*Total
    
    $
    280,342
    
    
    $
    281,502
    
    
    $
    282,674
    
    
    $
    284,610
    
    
    $
    285,036
    
    
    $
    286,271
    
    
    $
    287,518
 * A reduction of 150 basis points is unlikely due to the low interest
rates in effect as of March 28, 2004. These instruments are not leveraged and are held for purposes other than
trading. The modeling technique used measures the change in fair value arising
from selected potential changes in interest rates, using a three-month
investment horizon and hypothetical parallel shifts in the yield curve of plus
or minus 50 basis points (BPS), 100 BPS and 150 BPS. 36




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Our international system sales and maintenance contracts are generally
denominated in U.S. dollars. In instances where there are significant
international system sales contracts denominated in a foreign currency, we
often enter into forward contracts to mitigate foreign exchange risk. We do
not enter into market risk sensitive instruments for trading purposes. In the
first quarter of 2004, we entered into foreign exchange forward contracts with
a total notional value of approximately $10.4 million to hedge against foreign
exchange risk for contracts with international customers denominated in euros
and $11.7 million to hedge against foreign exchange risk for anticipated
expenditures denominated in euros. At March 28, 2004, December 31, 2003 and
December 31, 2002, we had outstanding contracts to convert euros to dollars
with notional values totaling $25.9 million, $17.3 million and $34.7 million,
with a positive fair value of approximately $524,000 and negative fair values
of $1.4 million and $4.9 million, respectively. At March 28, 2004, we had
outstanding contracts to convert dollars to euros with notional values totaling
$11.2 million and a negative fair value of $572,000. The following table
depicts the maturities of the outstanding contract amounts (in thousands): Within 3Contract Maturity
    
    Months
    
    4-6 Months
    
    7-9 Months
    
    10-12 Months
    
    13 MonthsAmount at 3/28/04
    
    $
    22,147
    
    
    $
    9,715
    
    
    $
    2,888
    
    
    $
    2,376
    
    
    $
    Amount at 12/31/03
    
    
    16,738
    
    
    
    588
    
    
    
    
    
    
    
    
    
    
    
    Amount at 12/31/02
    
    
    13,884
    
    
    
    18,020
    
    
    
    2,653
    
    
    
    99
    
    
    
    
 Certain costs of providing warranty and maintenance services for systems
sold to foreign countries are denominated in local currencies. To the extent
exchange rates fluctuate, it could become more expensive to provide these
services. To date, these costs have not been significant; however, we expect
they will increase as our installed base increases. We are exposed to foreign currency exchange rate risk inherent in our
sales commitments, anticipated sales, anticipated purchases and assets and
liabilities denominated in currencies other than the U.S. dollar. We transact
business primarily in four currencies worldwide, of which the most significant
to our operations is the euro. In some situations, we are a net receiver of
foreign currencies and therefore benefit from a weaker U.S. dollar and are
negatively affected by a stronger U.S. dollar relative to those foreign
currencies in which we transact significant amounts of business. We performed a
sensitivity analysis as of March 28, 2004 using a modeling technique that
measures the change in the fair values arising from a hypothetical 10% and 15%
adverse movement in the levels of foreign currency exchange rates relative to
the U.S. dollar (that is, strengthening of the U.S. dollar) with all other
variables held constant. The analysis covers all of our foreign exchange
forward contracts offset by the underlying exposures. The analysis excludes
balances and transactions pertaining to Yxlon. Foreign exchange rate risk is
relatively low for Yxlon given that it primarily transacts business in euros. The cash flow impacts of our sensitivity analysis as of March 28, 2004 are
summarized in the following table (the foreign currency exchange rates used
were based on market rates in effect at March 28, 2004): Cash flow impact of change inexchange ratesFair Value as of(in thousands)
    
    Contract Amount
    
    March 28, 2004
    
    10% Change
    
    15% ChangeForeign exchange forward contracts
    
    $
    14,706
    
    
    $
    (48
    )
    
    $
    1,428
    
    
    $
    2,166Accounts receivable
    
    
    12,590
    
    
    
    13,830
    
    
    
    (1,383
    )
    
    
    (2,074
    )Firm orders*
    
    
    8,113
    
    
    
    10,755
    
    
    
    (1,075
    )
    
    
    (1,613
    )Net accounts payable
    
    
    476
    
    
    
    489
    
    
    
    (49
    )
    
    
    (73
    )Total
    
    
    
    
    
    
    
    
    
    $
    (1,079
    )
    
    $
    (1,594
    )
   *
    
    Firm orders represent orders for which we have received a signed purchase
order. The cash flow impact of changes in exchange rates at March 28, 2004 is not
significantly different from the cash flow impact of changes in exchange rates
at December 31, 2003 and 2002. 37




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We do not expect the impact of changes in interest rates to have a
material impact on our operations, cash flow or liquidity. In addition, the
impact of inflation has not been material on our operations, cash flow or
liquidity to date. 
 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Based on our managements evaluation (with the participation of our
principal executive officer and principal financial officer) of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange Act)), as of the
end of the period covered by this quarterly report, our principal executive
officer and principal financial officer have concluded that such disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. Changes in Internal Control Over Financial Reporting There was no change in our internal control over financial reporting
during our first fiscal quarter of 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting. 
 PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings InVision and our subsidiary, Quantum Magnetics, together with many other
entities, were named as defendants in approximately 156 products liability
lawsuits by individual plaintiffs seeking damages for wrongful death in
connection with the terrorist acts of September 11, 2001. The litigation was
consolidated in In re: September 11 Litigation, 21 MC 97 (AKH), United States
District Court for the Southern District of New York. InVision and Quantum
Magnetics have been served with 103 complaints. Each complaint with which we
have been served alleges that defendants have breached a duty to airplane
passengers and others by failing to properly screen passengers and carry-on
baggage for dangerous weapons. We believe that the plaintiffs claims lack
merit, especially in light of the fact that InVision and Quantum Magnetics did
not, as of September 11, 2001, have any passenger or carry-on baggage screening
equipment at security checkpoints in any of the airports from which the
hijacked airplanes departed. By court order, the plaintiffs were required to
file and serve Amended Master Complaints and Appendices by March 31, 2004 to
reflect all defendants and causes of action in the In re: September 11
Litigationthat had been added since their original Master Complaints were
filed. InVision and Quantum Magnetics were not included in plaintiffs Amended
Master Complaints and their Appendices. Since these Amended Master Complaints
are controlling over the individual complaints filed by plaintiffs, all
plaintiffs in the In re: September 11 Litigationhave effectively dismissed
their claims against InVision and Quantum Magnetics. To date, notices of
dismissals or dismissal orders have been received in all but 57 of the
individual complaints. We are currently in the process of obtaining the
remaining dismissals from the remaining plaintiffs. On March 19, 2004, two alleged holders of InVision common stock filed
purported class action lawsuits in California Superior Court for the County of
Alameda. The complaints name as defendants each of our directors as well as
InVision. The complaints allege that, in pursuing the transaction with GE and
approving the merger agreement, the directors violated their fiduciary duties
to the holders of InVision common stock by, among other things, failing to
obtain the highest price reasonably available, tailoring the terms of the
transaction to meet GEs needs, engaging in self-dealing and obtaining personal
financial benefits not shared equally by the plaintiffs and other stockholders.
The complaints also allege that the merger agreement resulted from a flawed
process designed to ensure a sale to one buyer. The lawsuits have been
consolidated by stipulation of the parties under one lead case, Waltman, et al.
v. InVision Technologies, Inc., et al., Lead Case No. RG04146722. On May 3,
2004, InVision and three directors filed a demurrer to the consolidated
complaint on the grounds that plaintiffs failed to allege sufficient facts to
state a cause of action. The remaining five directors filed a motion to quash
the service of summons because they are not California residents, and,
therefore, the court lacks jurisdiction over them. Plaintiffs have served an 38




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initial written discovery request. Based on our review of the complaints,
we believe that the allegations are without merit and intend, along with the
directors, to defend the lawsuits vigorously. We also are involved in legal proceedings, claims and litigation arising
in the ordinary course of business. While the outcome of these matters is
currently not determinable, management does not believe that the ultimate cost
to resolve these matters will have a material adverse effect on our
consolidated financial condition, results of operations or cash flows. 
 Item 5. Other Information Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934,
as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible
for listing the non-audit services approved by our Audit Committee to be
performed by Deloitte & Touche LLP, our external auditor. Non-audit services
are defined as services other than those provided in connection with an audit
or a review of our financial statements. During the quarterly period covered
by this filing, the Audit Committee approved engagements of Deloitte & Touche
LLP for the following non-audit services:  
    
    tax services, which includes consulting related to (1) the review
of federal and state tax returns; (2) general tax consulting; and (3)
sales and use tax consulting; and  
    
    audit-related services, which includes consulting related to the
(1) audit of the financial statements of our subsidiary, Yxlon
International X-Ray GmbH; and (2) review of the reporting package and
consolidation of our German subsidiaries. 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits  2.1
    
    Share and Purchase Transfer Agreement dated as of February 21, 2003 among the
registrant, Yxlon Beteiligungs-Verwaltung GmbH, NDT International Holdings A.S, Yxlon
International Holding GmbH, Yxlon International X-Ray GmbH, Joseph Kosanetzky,
Reinhard Bonisch and Botts & Company Ltd. (1)2.2
    
    Agreement and Plan of Merger, dated as of March 15, 2004, among the registrant,
General Electric Company and Jet Acquisition Sub, Inc. (2)3.1
    
    Amended and Restated Certificate of Incorporation of the registrant. (3)3.2
    
    Amendment to Amended and Restated Certificate of Incorporation of the registrant (4)3.3
    
    Bylaws of the registrant, as amended. (5)4.1
    
    Reference is made to Exhibits 3.1 through 3.3.4.2
    
    Indenture, dated as of September 19, 2003, between the registrant and U.S. Bank
National Association, as Trustee. (6)4.3
    
    Registration Rights Agreement, dated as of September 19, 2003 between the registrant
and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (6)4.4
    
    Form of Note for the registrants 3% Convertible Senior Notes due October 1, 2023. (6)10.1
    
    Amendment dated March 12, 2004 to Solicitation, Offer and Award dated August 5, 2003,
between the registrant and the TSA (the Frame Agreement). *10.2
    
    Delivery Order #4 from the TSA under the Frame Agreement. *10.3
    
    Indemnity Agreement, dated as of February 19, 2004, between the registrant and Andrew
Siegel.31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Financial Officer.32.1
    
    Certificate of Chief Executive Officer and Chief Financial Officer.  (1)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarter ended March 30, 2003 and incorporated herein by reference.(2)
    
    Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 2003 and incorporated herein by reference. 39




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(3)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-05517) and incorporated herein by reference.(4)
    
    Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 2001 and incorporated herein by reference.(5)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarter ended June 29, 2003 and incorporated herein by reference.(6)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-3 (No. 333-110289) and incorporated herein by reference.  *
    
    Confidential treatment has been requested for portions of this exhibit. (b) Report on Form 8-K filed during the fiscal quarter ended March 28, 2004:
On February 11, 2004, we filed a current report on Form 8-K, pursuant to Item
12 thereof, furnishing a copy of a press release titled InVision Technologies
Reports Fourth Quarter and Year-End 2003 Financial Results and dated February
11, 2004. 40




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. INVISION TECHNOLOGIES, INC.Date: May 6, 2004
    
    /s/ Sergio MagistriSergio Magistri, Ph.D.President and Chief Executive Officer(Authorized Officer)Date: May 6, 2004
    
    /s/ Ross MulhollandRoss MulhollandSenior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)
 41




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EXHIBIT INDEX Exhibit2.1
    
    Share and Purchase Transfer Agreement dated as of February 21, 2003 among the
registrant, Yxlon Beteiligungs-Verwaltung GmbH, NDT International Holdings A.S, Yxlon
International Holding GmbH, Yxlon International X-Ray GmbH, Joseph Kosanetzky,
Reinhard Bonisch and Botts & Company Ltd. (1)2.2
    
    Agreement and Plan of Merger, dated as of March 15, 2004, among the registrant,
General Electric Company and Jet Acquisition Sub, Inc. (2)3.1
    
    Amended and Restated Certificate of Incorporation of the registrant. (3)3.2
    
    Amendment to Amended and Restated Certificate of Incorporation of the registrant (4)3.3
    
    Bylaws of the registrant, as amended. (5)4.1
    
    Reference is made to Exhibits 3.1 through 3.3.4.2
    
    Indenture, dated as of September 19, 2003, between the registrant and U.S. Bank
National Association, as Trustee. (6)4.3
    
    Registration Rights Agreement, dated as of September 19, 2003 between the registrant
and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (6)4.4
    
    Form of Note for the registrants 3% Convertible Senior Notes due October 1, 2023. (6)10.1
    
    Amendment dated March 12, 2004 to Solicitation, Offer and Award dated August 5, 2003,
between the registrant and the TSA (the Frame Agreement). *10.2
    
    Delivery Order #4 from the TSA under the Frame Agreement. *10.3
    
    Indemnity Agreement, dated as of February 19, 2004, between the registrant and Andrew
Siegel.31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Financial Officer.32.1
    
    Certificate of Chief Executive Officer and Chief Financial Officer.
  (1)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarter ended March 30, 2003 and incorporated herein by reference.(2)
    
    Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 2003 and incorporated herein by reference.(3)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-1 (No. 333-05517) and incorporated herein by reference.(4)
    
    Filed as an exhibit to the registrants Annual Report on Form 10-K for
the year ended December 31, 2001 and incorporated herein by reference.(5)
    
    Filed as an exhibit to the registrants Quarterly Report on Form 10-Q for
the quarter ended June 29, 2003 and incorporated herein by reference.(6)
    
    Filed as an exhibit to the registrants Registration Statement on Form
S-3 (No. 333-110289) and incorporated herein by reference.  *
    
    Confidential treatment has been requested for portions of this
exhibit. 42