** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**Washington, DC  20549

 

 

**FORM 10–Q**

 

 

| **(Mark One)** |                                                                                                                                                              |   |   |   |
|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|           |                                                                                                                                                              |   |   |   |
| **ý**     | **Quarterly  Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of  1934**                                                                    |
|           | **For the quarterly period ended March 31, 2002 or**                                                                                                              |   |   |
|           |                                                                                                                                                              |   |   |   |
| o              | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**                                                                     |
|           | **For the transition period from             to            ** |   |   |

 

**Commission File Number: 0–28236**

 

 

**INVISION TECHNOLOGIES, INC.**(Exact name of registrant as specified in its charter)

 

**Delaware**

(State or other jurisdiction ofincorporation or organization)

 

**94-3123544**

(I.R.S. Employer IdentificationNo.)

 

**7151 Gateway Boulevard, Newark, CA 94560**

(Address of principal executiveoffices, including zip code)

 

 

**(510) 739-2400**

(Registrant’s telephone number,including area code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý Noo

 

 

OnMay 7, 2002, there were 16,642,169 shares of the Registrant’s Common Stockoutstanding.

 

 

 

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**InVision Technologies, Inc.Form 10-QINDEX**

 

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

 

 

 

 

 

2

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** **

**PART I.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**InVision Technologies, Inc.Condensed Consolidated Balance Sheets(In thousands, except share data)**

**(Unaudited)**

 
|                                                                                                                                                                       |   | **March 31,** |    | **December 31,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|---------|------------------|--------|
|                                                                                                                                                                       |   | **2002**      |    | **2001**         |   |
|                                                                                                                                                                       |   |          |    |             |   |
| **Assets**                                                                                                                                                                 |   |          |    |             |   |
|                                                                                                                                                                       |   |          |    |             |   |
| Current assets:                                                                                                                                                            |   |          |    |             |   |
| Cash and cash  equivalents                                                                                                                                                 |   | $             | 11,755  |             | $      | 11,386 |   |
| Short-term  investments                                                                                                                                                    |   | -             |    | 1,992            |   |
| Accounts  receivable, net                                                                                                                                                  |   | 32,576        |    | 27,239           |   |
| Inventories                                                                                                                                                                |   | 41,002        |    | 27,104           |   |
| Deferred income  taxes                                                                                                                                                     |   | 4,082         |    | 4,082            |   |
| Other current  assets                                                                                                                                                      |   | 6,702         |    | 5,464            |   |
| Total current  assets                                                                                                                                                      |   | 96,117        |    | 77,267           |   |
|                                                                                                                                                                       |   |          |    |             |   |
| Property and  equipment, net                                                                                                                                               |   | 5,815         |    | 5,713            |   |
| Deferred income  taxes                                                                                                                                                     |   | 2,237         |    | 2,237            |   |
| Intangible  assets, net                                                                                                                                                    |   | 3,948         |    | 4,011            |   |
| Other assets                                                                                                                                                               |   | 1,205         |    | 505              |   |
| Total assets                                                                                                                                                               |   | $             | 109,322 |             | $      | 89,733 |   |
|                                                                                                                                                                       |   |          |    |             |   |
| **Liabilities  and stockholders' equity**                                                                                                                                  |   |          |    |             |   |
|                                                                                                                                                                       |   |          |    |             |   |
| Current  liabilities:                                                                                                                                                      |   |          |    |             |   |
| Accounts payable                                                                                                                                                           |   | $             | 16,527  |             | $      | 8,375 |   |
| Accrued  liabilities                                                                                                                                                       |   | 13,134        |    | 12,822           |   |
| Deferred revenue                                                                                                                                                           |   | 12,425        |    | 4,377            |   |
| Short-term debt                                                                                                                                                            |   | 964           |    | 1,880            |   |
| Current  maturities of long-term obligations                                                                                                                               |   | 192           |    | 179              |   |
| Total current  liabilities                                                                                                                                                 |   | 43,242        |    | 27,633           |   |
|                                                                                                                                                                       |   |          |    |             |   |
| Long-term  obligations                                                                                                                                                     |   | 658           |    | 680              |   |
|                                                                                                                                                                       |   |          |    |             |   |
| Commitments and  contingencies                                                                                                                                             |   |          |    |             |   |
|                                                                                                                                                                       |   |          |    |             |   |
| Stockholders'  equity:                                                                                                                                                     |   |          |    |             |   |
| Preferred stock,  $0.001 par value, 5,000,000 shares authorized;no shares issued and outstanding                                                                           |   | —        |    | —           |   |
| Common stock,  $0.001 par value, 60,000,000 and 20,000,000 shares authorized;  14,017,000 and 13,730,000 shares issued; 13,816,000  and 13,539,000 shares outstanding |   | 14            |    | 14               |   |
| Additional  paid-in capital                                                                                                                                                |   | 67,755        |    | 66,011           |   |
| Deferred stock  compensation expense                                                                                                                                       |   | (508          | )       | —           |   |
| Accumulated  deficit                                                                                                                                                       |   | (640          | )       | (3,458           | )      |
| Treasury stock,  at cost (201,000 and 191,000 shares)                                                                                                                      |   | (1,199        | )       | (1,147           | )      |
| Total stockholders'  equity                                                                                                                                                |   | 65,422        |    | 61,420           |   |
| Total  liabilities and stockholders' equity                                                                                                                                |   | $             | 109,322 |             | $      | 89,733 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

** **

** **

 

3

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**InVisionTechnologies, Inc.Condensed Consolidated Statements ofOperations(In thousands, except per share data)(Unaudited)**

 
|                                     |   | **Three  Months Ended** |   |
|------------------------------------------|--------|-------------------------|--------|
|                                     |   | **March 31,**           |   | **April 1,** |   |
|                                     |   | **2002**                |   | **2001** |   |
|                                     |   |                    |   |   |   |
| Revenues:                                |   |                    |   |   |   |
| Product revenues                         |   | $                       | 26,095 |   | $ | 11,221 |   |
| Service revenues                         |   | 3,466                   |   | 2,557 |   |
| Government contract revenues             |   | 3,637                   |   | 3,719 |   |
| Total revenues                           |   | 33,198                  |   | 17,497 |   |
|                                     |   |                    |   |   |   |
| Cost of revenues:                        |   |                    |   |   |   |
| Product costs                            |   | 14,917                  |   | 6,415 |   |
| Service costs                            |   | 2,314                   |   | 1,833 |   |
| Government contract costs                |   | 2,543                   |   | 2,821 |   |
| Total cost of revenues                   |   | 19,774                  |   | 11,069 |   |
|                                     |   |                    |   |   |   |
| Gross profit                             |   | 13,424                  |   | 6,428 |   |
|                                     |   |                    |   |   |   |
| Operating expenses:                      |   |                    |   |   |   |
| Research and development                 |   | 3,312                   |   | 2,850 |   |
| Selling, general and administrative      |   | 5,379                   |   | 3,470 |   |
| Total operating expenses                 |   | 8,691                   |   | 6,320 |   |
|                                     |   |                    |   |   |   |
| Income from operations                   |   | 4,733                   |   | 108 |   |
| Interest expense                         |   | (94                     | )      | (65 | ) |
| Interest and other income, net           |   | 130                     |   | 105 |   |
| Income before provision for income taxes |   | 4,769                   |   | 148 |   |
|                                     |   |                    |   |   |   |
| Provision for income taxes               |   | 1,951                   |   | 59 |   |
|                                     |   |                    |   |   |   |
| Net income                               |   | $                       | 2,818  |   | $ | 89 |   |
|                                     |   |                    |   |   |   |
| Net income per share:                    |   |                    |   |   |   |
| Basic                                    |   | $                       | 0.21   |   | $ | 0.01 |   |
| Diluted                                  |   | $                       | 0.17   |   | $ | 0.01 |   |
|                                     |   |                    |   |   |   |
| Weighted average shares outstanding:     |   |                    |   |   |   |
| Basic                                    |   | 13,684                  |   | 12,635 |   |
| Diluted                                  |   | 16,110                  |   | 13,742 |   |

 

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

 

 

4

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**InVision Technologies, Inc.Condensed Consolidated Statements ofCash Flow(In thousands)(Unaudited)**

 
|                                                                           |   | **Three Months Ended** |       |
|--------------------------------------------------------------------------------|--------|------------------------|------------|
|                                                                           |   | **March 31,**          |       | **April 1,** |   |
|                                                                           |   | **2002**               |       | **2001** |   |
|                                                                           |   |                   | ** ** |   | ** ** |
| **Cash  flows from operating activities:**                                     |   |                   | ** ** |   | ** ** |
| Net income                                                                     |   | $                      | 2,818      |   | $ | 89 |   |
| Adjustments to  reconcile net income to net cash  used in operating activities |   |                   |       |   |   |
| Depreciation and  amortization                                                 |   | 704                    |       | 717 |   |
| Amortization of  capitalized software development costs                        |   | 70                     |       | 40 |   |
| Amortization of  intangible assets                                             |   | 81                     |       | 196 |   |
| Loss on disposal  of fixed assets                                              |   | 4                      |       | 1 |   |
| Bad debt expense                                                               |   | 11                     |       | 24 |   |
| Stock  compensation expense                                                    |   | 279                    |       | — |   |
|                                                                           |   |                   |       |   |   |
| Changes in  operating assets and liabilities:                                  |   |                   |       |   |   |
| Accounts  receivable                                                           |   | (5,348                 | )          | (3,262 | ) |
| Inventories                                                                    |   | (13,908                | )          | (1,426 | ) |
| Other current  assets                                                          |   | (1,369                 | )          | (350 | ) |
| Other noncurrent  assets                                                       |   | (735                   | )          | — |   |
| Accounts payable                                                               |   | 8,152                  |       | 286 |   |
| Accrued  liabilities                                                           |   | 368                    |       | (1,233 | ) |
| Deferred revenue                                                               |   | 8,048                  |       | 96 |   |
| Other long-term  obligations                                                   |   | 4                      |       | 15 |   |
| **Net  cash used in operating activities**                                     |   | (821                   | )          | (4,807 | ) |
|                                                                           |   |                   |       |   |   |
| **Cash  flows from investing activities:**                                     |   |                   |       |   |   |
| Purchases of  property and equipment                                           |   | (762                   | )          | (540 | ) |
| Proceeds from  short-term investments                                          |   | 1,992                  |       | — |   |
| **Net  cash provided by (used in) investing activities**                       |   | 1,230                  |       | (540 | ) |
|                                                                           |   |                   |       |   |   |
| **Cash  flows from financing activities:**                                     |   |                   |       |   |   |
| Net proceeds  from (repayments of) short-term debt                             |   | (916                   | )          | 3,715 |   |
| Repayments of  long-term debt                                                  |   | (54                    | )          | (111 | ) |
| Proceeds from  issuance of common stock                                        |   | 930                    |       | 77 |   |
| **Net  cash provided by (used in) financing activities**                       |   | (40                    | )          | 3,681 |   |
|                                                                           |   |                   |       |   |   |
| Net change in  cash and cash equivalents for the period                        |   | 369                    |       | (1,666 | ) |
| Cash and cash  equivalents at beginning of period                              |   | 11,386                 |       | 11,908 |   |
| **Cash  and cash equivalents at end of period**                                |   | $                      | 11,755     |   | $ | 10,242 |   |
|                                                                           |   |                   |       |   |   |
| **Supplemental  disclosures of cash flow information:**                        |   |                   |       |   |   |
| Interest paid                                                                  |   | $                      | 208        |   | $ | 34 |   |
| Income taxes  paid                                                             |   | $                      | 2          |   | $ | 394 |   |
|                                                                           |   |                   |       |   |   |
| **Supplemental  disclosures of noncash investing and financing activities:**   |   |                   |       |   |   |
| Financing  obligations incurred for the purchase of new equipment              |   | $                      | 41         |   | $ | — |   |
| Issuance of  common stock in connection with consulting agreement              |   | $                      | 56         |   | $ | — |   |

 

The accompanying notesare 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 AccountingPolicies**

 

**                Interim Unaudited FinancialInformation**

 

        The accompanying interimunaudited condensed consolidated****financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“generally accepted accounting principles”) for interim financialinformation and in accordance with the instructions to Form 10-Q andRule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurringadjustments) considered necessary for a fair presentation.  These financial statements should be read inconjunction with the audited consolidated financial statements of InVisionTechnologies, Inc. and its subsidiaries (the “Company”) as of December 31, 2001and 2000 and for each of the three years in the period ended December 31, 2001,including the notes thereto, included in the Company’s Annual Report on Form10-K/A filed on March 27, 2002. 

 

        Operating results for thethree month period ended March 31, 2002 may not necessarily be indicative ofthe results that may be expected for the year ended December 31, 2002 or anyother future period.

 

**BusinessCombinations and Goodwill and Other Intangible Assets**

 

On January 1, 2002, the Company adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other IntangibleAssets.”   This standard addresses theinitial recognition and measurement of intangible assets acquired outside of abusiness combination and the accounting for goodwill and other intangible assetssubsequent to their acquisition.  SFAS142 provides that intangible assets with finite useful lives be amortized andthat goodwill and intangible assets with indefinite lives not be amortized, butwill rather be tested at least annually for impairment.  Since adopting SFAS 142, the Company nolonger amortizes the carrying value of goodwill of $2.5 million or acquiredworkforce of $331,000 at January 1, 2002, resulting in a reduction in annualamortization expense of $426,000.  TheCompany has not yet performed the impairment tests required by the standard.

 

The following reconciles reported net income and netincome per share to the adjusted net income and net income per share as if theCompany had followed the amortization provisions of SFAS 142 for the periodspresented below (in thousands, except per share data):

 
|                                                              |   | **Three  Months Ended** |       |
|-------------------------------------------------------------------|--------|-------------------------|------------|
|                                                              |   | **March 31,  2002**     | ** ** | **April 1,  2001** | ** ** |
|                                                              |   |                    | ** ** |   | ** ** |
| Net income:                                                       |   |                    |       |   |   |
| As reported                                                       |   | $                       | 2,818      |   | $ | 89 |   |
| add:   goodwill amortization expense, net of taxes           |   | —                  |       | 65 |   |
| add:   acquired workforce amortization expense, net of taxes |   | —                  |       | 41 |   |
| As adjusted                                                       |   | $                       | 2,818      |   | $ | 195 |   |
|                                                              |   |                    |       |   |   |
| Basic net income per share:                                       |   |                    |       |   |   |
| As reported                                                       |   | $                       | 0.21       |   | $ | 0.01 |   |
| As adjusted                                                       |   | $                       | 0.21       |   | $ | 0.02 |   |
|                                                              |   |                    |       |   |   |
| Diluted net income per share:                                     |   |                    |       |   |   |
| As reported                                                       |   | $                       | 0.17       |   | $ | 0.01 |   |
| As adjusted                                                       |   | $                       | 0.17       |   | $ | 0.01 |   |

 

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

 

**       **On January 1, 2002, the Company adopted SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”  SFAS 144 supersedes SFAS 121, “Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to beDisposed Of,” and the accounting and reporting provisions of AccountingPrinciples Board Opinion No. 30, “Reporting the Results of Operations —Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events andTransactions.”  SFAS 144 addressesfinancial accounting and reporting for the impairment or disposal of long-livedassets.  The adoption of this statementdid not have a material impact on the Company’s financial position or resultsof operations.

 

**2.             Net Income Per Share**

 

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

 

 

6

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

 
|                                                        |   | **Three  Months Ended** |       |
|-------------------------------------------------------------|--------|-------------------------|------------|
|                                                        |   | **March 31,  2002**     |       | **April 1,  2001** |   |
|                                                        |   |                    |       | **Weighted** |   | **Per** |   |   |   | **Weighted** |   | **Per** |   |
|                                                        |   |                    |       | **Average** |   | **Share** |   |   |   | **Average** |   | **Share** |   |
|                                                        |   | **Income**              |       | **Shares** |   | **Amount** |   | **Income** |   | **Shares** |   | **Amount** |   |
|                                                        |   |                    | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Basic net income per share                                  |   | $                       | 2,818      |   | 13,684 |   | $ | 0.21 |   | $ | 89 |   | 12,635 |   | $ | 0.01 |   |
| Effect of dilutive  securities:                             |   |                    |       |   |   |   |   |   |   |   |   |   |   |
| Options and warrants                                        |   | —                  |       | 2,396 |   | (0.04 | ) | — |   | 457 |   | — |   |
| Stock payable in connection  withacquisition of  subsidiary |   | —                  |       | 30 |   | — |   | — |   | 650 |   | — |   |
|                                                        |   |                    |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net income per  share                               |   | $                       | 2,818      |   | 16,110 |   | $ | 0.17 |   | $ | 89 |   | 13,742 |   | $ | 0.01 |   |

 

**3.             SegmentInformation**

 

The Company has three reportable segments.  The “EDS” segment is comprised of thebusiness unit that is engaged in the development, manufacturing, marketing andsupport of explosives detection systems based on advanced computed tomography(“CT”) technology.  The “Quantum”segment is comprised of the business unit that is engaged in the development oftechnology for inspection, detection and analysis of explosives, concealedweapons and other materials based on quadrupole resonance technology andpassive magnetic sensing.   The “Wood”segment is comprised of those business units that are engaged in thedevelopment of technology to optimize the value and yield of harvested timberbased on different types of scanning technologies, including CT technology.

 

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

 

 

|                         |   | **EDS** |   | **Quantum** |   | **Wood** |   | **Total** |   |
|------------------------------|--------|---------|--------|-------------|--------|----------|--------|-----------|--------|
| **First quarter 2002**       |   |    |   |        |   |     |   |      |   |
| Revenues:                    |   |    |   |        |   |     |   |      |   |
| Product revenues             |   | $       | 23,178 |        | $      | 652      |   | $         | 2,265  |   | $ | 26,095 |   |
| Service revenues             |   | 3,035   |   | 12          |   | 419      |   | 3,466     |   |
| Government contract revenues |   | —  |   | 3,637       |   | —   |   | 3,637     |   |
| Total revenues               |   | $       | 26,213 |        | $      | 4,301    |   | $         | 2,684  |   | $ | 33,198 |   |
|                         |   |    |   |        |   |     |   |      |   |
| Net income (loss)            |   | $       | 3,097  |        | $      | 264      |   | $         | (543   | ) | $ | 2,818 |   |
|                         |   |    |   |        |   |     |   |      |   |
| **March 31, 2002**           |   |    |   |        |   |     |   |      |   |
| Total assets                 |   | $       | 96,288 |        | $      | 5,544    |   | $         | 7,490  |   | $ | 109,322 |   |
|                         |   |    |   |        |   |     |   |      |   |
| **First quarter 2001**       |   |    |   |        |   |     |   |      |   |
| Revenues:                    |   |    |   |        |   |     |   |      |   |
| Product revenues             |   | $       | 9,394  |        | $      | —   |   | $         | 1,827  |   | $ | 11,221 |   |
| Service revenues             |   | 2,150   |   | —      |   | 407      |   | 2,557     |   |
| Government contract revenues |   | —  |   | 3,719       |   | —   |   | 3,719     |   |
| Total revenues               |   | $       | 11,544 |        | $      | 3,719    |   | $         | 2,234  |   | $ | 17,497 |   |
|                         |   |    |   |        |   |     |   |      |   |
| Net income (loss)            |   | $       | 795    |        | $      | 78       |   | $         | (784   | ) | $ | 89 |   |
|                         |   |    |   |        |   |     |   |      |   |
| **December 31, 2001**        |   |    |   |        |   |     |   |      |   |
| Total assets                 |   | $       | 76,431 |        | $      | 4,935    |   | $         | 8,367  |   | $ | 89,733 |   |
|                         |   |    |   |        |   |     |   |      |   |

 

**               **Substantially all of the Company’slong-lived assets are located in the United States.

 

 

7

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**4.             Stockholders’ Equity**

 

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

 

On March 27, 2002, the Company filed an amended FormS-3 Registration Statement under the Securities Act of 1933 and announced thepublic offering of 3,000,000 shares of its common stock to the public at aprice of $36.50 per share.  The offeringwas completed on April 2, 2002 (see Note 8). Of the shares, 2,500,000 shareswere offered by the Company in a new financing and 500,000 shares were offeredby a selling stockholder.  Additionally,certain selling stockholders granted an option to the underwriters to purchaseup to 450,000 shares of common stock at the public offering price, less the underwritingdiscount.  The Company did not receiveany proceeds from the sale of common stock by selling stockholders.

 

 

**5.**             **Inventories**

 

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

 

|                                  |   | **March 31,** |   | **December  31,** |   |
|---------------------------------------|--------|---------------|--------|-------------------|--------|
|                                  |   | **2002**      |   | **2001**          |   |
| Inventories:                          |   |          |   |              |   |
| Raw material and purchased components |   | $             | 15,526 |              | $      | 8,148 |   |
| Field service spare parts             |   | 11,264        |   | 9,877             |   |
| Work-in-process                       |   | 10,626        |   | 5,794             |   |
| Finished goods                        |   | 3,586         |   | 3,285             |   |
| Total                                 |   | $             | 41,002 |              | $      | 27,104 |   |

 

 

**6.**             **AccruedLiabilities**

 

**       **The components of accrued liabilities consist of thefollowing (in thousands):

 

**               **

|                          |   | **March 31,** |   | **December  31,** |   |
|-------------------------------|--------|---------------|--------|-------------------|--------|
|                          |   | **2002**      |   | **2001**          |   |
| Accrued liabilities:          |   |          |   |              |   |
| Warranty and other reserves   |   | $             | 3,827  |              | $      | 3,175 |   |
| Accrued employee compensation |   | 4,161         |   | 5,499             |   |
| Income taxes                  |   | 2,175         |   | 210               |   |
| Other                         |   | 2,971         |   | 3,938             |   |
| Total                         |   | $             | 13,134 |              | $      | 12,822 |   |

 

**7.             Litigation**

 

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

 

**8.             SubsequentEvent**

 

        On April 2, 2002, theCompany closed a public offering of 3,000,000 shares of common stock.  In this offering, the Company sold 2,500,000shares and received net proceeds of approximately $85 million (net of issuancecosts). The Company expects to use these proceeds for general corporatepurposes, including working capital and capital expenditures, and to acquireother complementary products, technologies or businesses when the opportunityarises.   A selling stockholder soldanother 500,000 shares of common stock in the offering and certain sellingstockholders sold 450,000 shares to underwriters who exercised theirover-allotment option.  The Company didnot receive any proceeds from the sale of the shares by selling stockholders.

 

8

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

 

*The discussion below includesforward-looking statements that involve risks and uncertainties. When used inthis discussion, the words “anticipate,” “believe,” “estimate,” and “expect”and similar expressions identify these forward-looking statements. Our actualresults, performance, or achievements could differ materially from the resultsexpressed in, or implied by, these forward-looking statements. Factors thatcould cause or contribute to such differences include:*

 

•                  *The timing and size oforders from our major customers, including most prominently the TransportationSecurity Administration, or TSA, and the Federal Aviation Administration, orFAA;*

•                  *The TSA may decide topurchase non-FAA certified EDS products, or the FAA may lower its requirementsfor certification, which would enable technologies and products that do notmeet current FAA-certification standards to become certified, which couldsubstantially increase competition.*

•                  *If our manufacturingcapacity is not sufficient to meet demand for our EDS products, or our suppliersdo not supply us with components in a timely manner, customers will obtain EDSproducts from other sources;*

•                  *Many of our customersare governmental entities subject to budgeting limitations, which may limit theamount of our products they can purchase;*

•                  *We have granted aroyalty-bearing limited license to the U.S. government to have our productsproduced by other manufacturers, and if these other manufacturers produce ourproducts we may lose expected revenue opportunities;*

•                  *Because of the increasedmarket for our EDS products, new competitors may enter the market, which couldsubstantially increase competition; and*

•                  *We rely on large ordersfrom a few customers, and the loss of any large order would materially hurt ourbusiness.*

 

*Additionalfactors that could cause or contribute to such differences are discussed in“Business Risks” below and are also set forth under the caption “Risk Factors”in “Item 1. Business” of our Annual Report on Form 10-K/A filed with theSecurities and Exchange Commission on March 27, 2002.*

 

## **Overview**

 

                InVision Technologies, Inc. isorganized under three segments.  Our EDSbusiness manufactures CT-based detection products used by the aviation industryto screen baggage for explosives.  Ourwholly-owned subsidiary, Quantum Magnetics, or Quantum, utilizes quadrupoleresonance, or QR, and magnetic sensing technologies for the inspection,detection and analysis of explosives, concealed weapons and othermaterials.  Our Wood division consistsof Inovec, Inc., or Inovec, which manufactures systems using laser-basedtechnologies to improve sawmill yield, and WoodVision, which is developing ourCT technology to increase the value of harvested timber.

 

                Our revenues are primarilycomprised of:

 

•                  EDS product revenues, which include revenues from sales of CTX systems,accessories, and related installation and configuration, and EDS servicerevenues, which include revenues from maintenance contracts related to productsupport, integration and other services, including those complex integrationsand configurations that are separate from product revenues.  Our EDS product sales accounted for 69.8% ofour total revenues in the first quarter of 2002 and 53.7% of our total revenuesin the first quarter of 2001. Our EDS service revenues accounted for 9.1% ofour total revenues in the first quarter of 2002 and 12.3% of our total revenuesin the first quarter of 2001;

 

•                  Quantum government contract revenues, which include revenues primarilyfrom development contracts utilizing QR and magnetic sensing technologies withgovernment agencies and private entities, and Quantum product revenues, whichinclude revenues from sales of Q-Scan and portal systems for commercialuse.  Our Quantum government contract revenuesaccounted for 11.0% of our total revenues in the first quarter in 2002 and21.3% of our total revenues in the first quarter in 2001.  Our Quantum product revenues accounted for2.0% of our total revenues in the first quarter of 2002.  We had no Quantum product revenues in thefirst quarter of 2001;

 

•                  Wood product revenues, which include revenues from the sales of controland automation systems for material processing equipment and relatedaccessories, installation and configuration, and Wood service revenues, whichinclude revenues from repairs and other service related to productsupport.  Our Wood product salesaccounted for 6.8% of our total revenues in the first quarter of 2002 and 10.4%of our total revenues in the first quarter of 2001.

 

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                We market our products andservices directly through internal sales personnel and indirectly throughauthorized agents, distributors and system integrators.  In the United States, we market our productsand services primarily through direct sales personnel.  Internationally, we use a direct sales forceand authorized representatives to sell our products.  International sales represented 32.8% of total revenues in thefirst quarter of 2002 and 18.7% of total revenues in the first quarter of 2001.

 

**               **In any given fiscal quarter or year, ourEDS product revenues are derived from orders of multiple units of our productsfrom a limited number of customers.  Forexample, in the first quarter in 2002, six customers accounted for all of ourEDS units sold during the quarter, and for the fiscal year 2001, sevencustomers accounted for all of our EDS units sold during the year.  The number of our customers does not varywidely from period to period, and we are dependent on multiple orders from asmall number of customers for a substantial portion of our revenues.  Therefore, a cancellation or delay of anorder from a customer could have a significant negative impact on ouroperations in a given period. For the first quarter in 2002, we generated $14.3million from EDS sales to our largest customer, the FAA, and subsequent to theformation of the TSA, to the TSA, representing 43.0% of total revenues.  For the first quarter in 2001, we generated$8.3 million from EDS sales to the FAA, representing 47.2% of total revenues.  There were no other EDS customers whoaccounted for more than 10% of total revenues in the first quarters of 2002 and2001. As of March 31, 2002, we had in backlog EDS equipment orders and serviceagreements of $384 million, primarily consisting of two orders from the TSA formultiple CTX 2500 and CTX 5500 systems and for parts sufficient to build anadditional 100 CTX systems.  Inconnection with these orders, the TSA required that we grant the TSA a royalty-bearinglicense to enable other manufacturers to build EDS products for the TSA basedon our technology.    Additional ordersfor CTX equipment, including systems from the parts ordered, will be dependenton various factors, including future U.S. government funding appropriations.

 

 

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**Results of Operations**

 

                The following tablesets forth certain income and expenditure items from our consolidatedstatements of operations expressed as a percentage of total revenues for theperiods indicated.

 

 
|                                     |   | **Three  Months Ended** |   |
|------------------------------------------|--------|-------------------------|--------|
|                                     |   | **March 31,**           |   | **April 1,** |   |
|                                     |   | **2002**                |   | **2001** |   |
|                                     |   |                    |   |   |   |
| Revenues:                                |   |                    |   |   |   |
| Product revenues                         |   | 78.6                    | %      | 64.1 | % |
| Service revenues                         |   | 10.4                    |   | 14.6 |   |
| Government contract revenues             |   | 11.0                    |   | 21.3 |   |
| Total revenues                           |   | 100.0                   |   | 100.0 |   |
|                                     |   |                    |   |   |   |
| Cost of revenues:                        |   |                    |   |   |   |
| Product costs                            |   | 44.9                    |   | 36.7 |   |
| Service costs                            |   | 7.0                     |   | 10.5 |   |
| Government contract costs                |   | 7.7                     |   | 16.1 |   |
| Total cost of revenues                   |   | 59.6                    |   | 63.3 |   |
|                                     |   |                    |   |   |   |
| Gross margin                             |   | 40.4                    |   | 36.7 |   |
|                                     |   |                    |   |   |   |
| Operating expenses:                      |   |                    |   |   |   |
| Research and development                 |   | 9.9                     |   | 16.3 |   |
| Selling, general and administrative      |   | 16.2                    |   | 19.8 |   |
| Total operating expenses                 |   | 26.1                    |   | 36.1 |   |
|                                     |   |                    |   |   |   |
| Income from operations                   |   | 14.3                    |   | 0.6 |   |
| Interest expense                         |   | (0.3                    | )      | (0.4 | ) |
| Interest and other income, net           |   | 0.4                     |   | 0.6 |   |
| Income before provision for income taxes |   | 14.4                    |   | 0.8 |   |
|                                     |   |                    |   |   |   |
| Provision for income taxes               |   | 5.9                     |   | 0.3 |   |
|                                     |   |                    |   |   |   |
| Net income                               |   | 8.5                     | %      | 0.5 | % |

 

 

**Comparison of the Three Months EndedMarch 31, 2002 to the Three Months Ended April 1, 2001**

 

*                Revenues.* EDS product revenues were $23.2 millionin the first quarter of 2002, an increase of 146.7% from the $9.4 million inthe first quarter of 2001.  Thisincrease in system sales and related accessories is reflective of the increasein orders received from the FAA and TSA, as well as international customers, inlate 2001 and early 2002 resulting from the increased focus on aviationsecurity due to the terrorist attacks of September 11, 2001.  EDS service revenues were $3.0 million forthe first quarter of 2002, an increase of 41.2% from the $2.2 million in thefirst quarter of 2001.  As warrantyperiods expired on systems which were installed a year ago, we have increasedservice contract revenues for new support and maintenance agreements and morebillable time and material type of services provided on a greater installedbase of systems.  As of March 31, 2002,we had in backlog EDS equipment orders and service agreements of $384 million,primarily consisting of  two orders fromthe TSA for multiple CTX 2500 and CTX 5500 systems and for parts sufficient tobuild an additional 100 CTX systems.

 

                Quantum’s government contractrevenues decreased slightly to $3.6 million for the first quarter of 2002 fromthe $3.7 million in the first quarter of 2001. During the first quarter of 2002, $2.7 million of our governmentcontract revenues from the U.S. government were for the development of landminetechnologies, representing 62.8% of Quantum revenues, and during the firstquarter of 2001, $2.7 million of our government contract revenues from the U.S.government were for the development of landmine technologies, representing73.3% of Quantum revenues.   As of March31, 2002, we had Quantum government contract backlog of approximately $9.3million, primarily for development of landmine detection technologies.   We anticipate that government contractrevenues for landmine detection technologies will decrease in 2002 compared tothe previous year.  This is a result ofa reduced need for subcontract support for the landmines contracts in 2002, asoutsourced milestones are completed. However, we expect to receive new grants and awards for otherdevelopment activities in 2002 and continued growth in Quantum’s commercialproduct revenues compared to the prior year. Quantum’s product revenues were $652,000 in the first quarter of 2002.We had no Quantum product revenues in the first quarter of 2001.

 

 

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                Wood product revenues were $2.3million in the first quarter of 2002, an increase of 24.0% from the $1.8million in the first quarter of 2001.  The increase in Wood product revenues is primarily due to more sales ofmachinery that we acquire from vendors and sell to customers withoutmodification by Inovec in the first quarter of 2002 compared to the same perioda year ago, partially offset by a slight decrease in revenues from sales ofequipment manufactured by Inovec.  Woodservice revenues increased slightly to $419,000 in the first quarter of 2002from $407,000 in the first quarter of 2001. As of March 31, 2002, we had in backlog Inovec equipment orders andservice agreements of $725,000.  We arestill developing the CT based log scanner and had no related revenues in thefirst quarter of 2002 or backlog at March 31, 2002.

 

*                GrossProfit.*  Cost of EDS product revenues primarilyconsists of purchased materials procured for use in the assembly of ourproducts, as well as manufacturing labor and overhead, installation, trainingand warranty.  Cost of EDS servicerevenues primarily consists of direct labor and materials and customer supportoverhead.  In any given period, ourgross profit for products and services may be affected by several factors,including revenue mix, volume of systems manufactured in the period, productconfiguration, location of the installation and complexity of integration intovarious environments.

 

                Gross profit for EDS productswas $10.4 million in the first quarter of 2002, an increase of 151.1% from the$4.1 million in the first quarter of 2001. Gross margin percentages for EDS products were 44.8% in the firstquarter of 2002 and 44.1% in the first quarter of 2001.  The increase in gross profit for EDSproducts is due to higher EDS product revenues in the first quarter of 2002compared to the same period a year ago. The improvement in EDS product gross margin percentages is primarily dueto lower manufacturing overhead per unit, resulting from the increasedproduction of more units in the first quarter of 2002 compared to the sameperiod a year ago.  The change in grossmargin percentages are also affected by variations in the mix of product typesand pricing factors among domestic and international customers in the firstquarter of 2002.   To support theexpansion of production capacity of our EDS products, we signed a letter ofintent with CoorsTek, Inc. in the first quarter of 2002 to become a contractmanufacturing partner.

 

                Gross profit for EDS serviceswere $931,000 in the first quarter of 2002, an increase of 75.3% from $531,000in the first quarter of 2001. Gross margin percentages for EDS services were30.7% in the first quarter of 2002 and 24.7% in the first quarter of 2001.  The increase in gross profit for EDSservices is primarily due to increased EDS service revenues in the firstquarter of 2002 compared to the same period a year ago.  The improvement in EDS service gross marginpercentages is primarily due to variations in types of service revenue, such asincreased billed time and materials services, partially offset by increasedcustomer support overhead costs incurred in anticipation of an expectedincrease in EDS services as more units are sold.

 

                Cost of Quantum governmentcontract revenues primarily consists of direct labor, purchased materials,subcontract labor and the applicable overhead required to support governmentfunded activities.    Cost of Quantumproduct revenues primarily consist of direct labor and materials, overhead,installation, training and warranty. Gross profit for government contracts was $1.1 million in the firstquarter of 2002, a 21.8% increase from $898,000 in the first quarter of2001.  Gross margin percentages were30.1% in the first quarter of 2002 and 24.1% in the first quarter of 2001.  The increase in gross profit and the improvementsin gross margin percentages for government contracts are primarily due to feweroutside engineering services being required on a landmines contract, whichservices typically carry a slightly lower margin, in the first quarter of 2002compared to the same period a year ago.  Our contract with an outside services firm was substantially completedin early 2002 upon completion of certain milestones in the vehicle-mountedlandmines detection contract.    Grossprofit for Quantum products was $227,000 and the gross margin percentage was 34.8%in the first quarter of 2002.  Quantumhad no product sales in the first quarter of 2001.

 

                Gross profit for Wood productswas $557,000 in the first quarter of 2002, a decrease of 16.5% from $667,000 inthe first quarter of 2001.  Gross marginpercentages were 24.6% in the first quarter of 2002 and 36.5% in the firstquarter of 2001.  The decrease in grossprofit and gross margin percentages for Wood products is primarily due to ahigher portion of revenues attributable to machinery equipment, which typicallycarry a lower margin than system revenues, in the first quarter of 2002compared to the same period a year ago. Gross profit for Wood services were $216,000 in the first quarter of2002 and $193,000 in the first quarter of 2001.  Gross margin percentages for Wood services were 51.6% in thefirst quarter of 2002 and 47.4% in the first quarter of 2001.

 

*                Researchand Development.*  Research and development expenses consistprimarily of compensation paid to personnel engaged in research and developmentactivities, amounts paid for outside services, and costs of materials utilizedin the development of hardware products, including prototype units.  Research and development expenditures arepartially 

 

 

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offset by amountsreimbursed by the FAA and other government agencies and private entities underresearch and development contracts and grants. These services are provided and reimbursed on a cost basis.

 

                Grossresearch and development expenses for EDS were $2.9 million in the firstquarter of 2002, an increase of 9.9% from the $2.6 million in the first quarterof 2001.  Research and developmentcontracts and grants from the FAA and other government agencies funded $489,000of our gross research and development expenses for EDS in the first quarter of2002 and $646,000 in the first quarter of 2001. Net research and developmentexpenses for EDS were $2.4 million in the first quarter of 2002, an increase of21.0% from the $2.0 million in the first quarter of 2001.  Net research and development expenses forEDS as a percentage of EDS revenues were 9.2% in the first quarter of 2002 and17.3% in the first quarter of 2001.  The increase in gross research and development expenses for EDS isprimarily due to higher costs incurred for the development of ARGUS and anincreased focus on a number of initiatives to support our growth, such asproduct enhancements and sustaining engineering support to the productionprocess, in the first quarter of 2002 compared to the same period a year ago.   The increase in net research anddevelopment expenses for EDS is primarily due to more efforts spent on theARGUS development program, as well as less funding received from the grant,representing our cost-sharing portion of the program, in the current quartercompared to the same period a year ago. We anticipate that we will continue to incur our cost-sharing portion ofcosts for the continued development of the ARGUS program, which will not bereimbursed by the FAA, over the next few quarters as we approach the end of theprogram.

 

                Research and developmentexpenses for Quantum were $416,000 in the first quarter of 2002, an increase of117.8% from $191,000 in the first quarter of 2001.  Research and development expenses for Quantum as a percentage ofQuantum revenues were 9.7% in the first quarter of 2002 and 5.1% in the firstquarter of 2001.  The increase inexpenses is primarily due to more internal costs incurred for the developmentand commercialization of products, such as the *i*-Portal 100 system, in thefirst quarter of 2002 compared to the same period a year ago.

 

***               ***Research and development expenses forWood were $476,000 in the first quarter of 2002, a decrease of 27.8% from$659,000 in the first quarter of 2001. Research and development expenses for Wood as a percentage of Woodrevenues were 17.7% in the first quarter of 2002 and 29.5% in the first quarterof 2001.  The decrease in expenses isprimarily due to a reduced effort on the development of a log scanning system basedon CT technology to optimize the value of harvested timber, resulting from atemporary reallocation of engineering resources to support the rapid growth ofthe EDS business.

 

*                Selling,general and administrative.*  Selling,general and administrative expenses consist primarily of compensation paid todirect and indirect sales and marketing personnel, administrative personnel,including directors, consultant fees, professional service fees, insurancecosts, travel, selling and distribution costs, and other general expenses.

 

                Selling, general andadministrative expenses for EDS were $3.9 million in the first quarter of 2002,an increase of 110.6% from the $1.9 million in the first quarter of 2001.  Selling, general and administrative expensesfor EDS as a percentage of EDS revenues were 14.9% in the first quarter of 2002and 16.0% in the first quarter of 2001. The increase in selling, general and administrative expenses for EDS inabsolute dollars is primarily due to higher sales commissions resulting fromhigher EDS revenues in the current quarter, and also due to increases inemployee headcount, consultants and professional fees, such as investor andpublic relations, and insurance costs, all related to the growth of ourbusiness resulting from the increase in orders received from the FAA, TSA, andinternational customers, in the first quarter of 2002 compared to the sameperiod a year ago.

 

                Selling, general andadministrative expenses for Quantum were $646,000 in the first quarter of 2002,an increase of 2.7% from $629,000 in the first quarter of 2001.  Selling, general and administrative expensesfor Quantum as a percentage of Quantum revenues were 15.0% in the first quarterof 2002 and 16.9% in the first quarter of 2001.  The increase in expenses in absolute dollars is primarily due toan increase of marketing activities associated with commercial products.

 

                Selling, general andadministrative expenses for Wood were $836,000 in the first quarter of 2002, adecrease of 15.6% from $991,000 in the first quarter of 2001.  Selling, general and administrative expensesfor Wood as a percentage of Wood revenues were 31.1% in the first quarter of2002 and 44.4% in the first quarter of 2001. The decrease in expenses is primarily due to a reduction of amortizationexpense for goodwill and certain intangibles of approximately $106,000 inaccordance with Statement of Financial Accounting Standards, or SFAS, No. 142,which is effective on January 1, 2002.  SFAS 142 provides that goodwill and intangible assets with indefinitelives will not be amortized, but will rather be tested at least annually forimpairment.

 

*                InterestExpense.*  Interest expense was $94,000 in the firstquarter of 2002 and $65,000 in the first quarter of 2001. Interest expenseresulted primarily from debt financing associated with our working capitallines of credit, equipment term loans, capital leases and financing forinsurance premiums.  The increase ininterest expense is primarily due to increased 

 

 

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activities withinour lines of credit, such as more standby letters of credit issued to secureguarantees to customers, in the first quarter of  2002 compared to the same period a year ago.

 

                *Interest and Other Income, Net.*  Interest and other income, net, increased to$130,000 in the first quarter of 2002 from $105,000 in the first quarter of2001.  The 2002 amount consistsprimarily of interest income on cash, cash equivalents and short-terminvestments of $57,000 and other income (net) of $73,000, primarily foreignexchange gains on outstanding foreign exchange forward contracts at March 31,2002.  The 2001 amount consistsprimarily of interest income on cash, cash equivalents and short-terminvestments of $114,000, partially offset by other expense (net) of$9,000.  The decrease in interest incomeis primarily due to lower average cash balances and lower interest rates in thefirst quarter of 2002 compared to the first quarter of 2001.

 

*                Provisionfor Income Taxes.*  The provision for income taxes was $2.0million in the first quarter of 2002 and $59,000 in the first quarter of2001.   Our effective tax rate was 40.9%in the first quarter of 2002 and 39.9% in the first quarter of 2001.  Our effective tax rate was different thanstatutory tax rates primarily due to certain permanent differences between bookand taxable income.  At December 31,2001, we had federal net operating loss carryforwards of approximately $5.0million and state net operating loss carryforwards of approximately $1.1million available to reduce future federal and state taxable income.  Our federal net operating loss carryforwardsexpire from 2010 to 2021 and our state net operating loss carryforwards expirein 2011.  Our tax credit carryforwardsof $1.3 million expire from 2005 to 2021.

 

 

## **Liquidity and Capital Resources**

 

                At March 31, 2002, we had $11.8million in cash, cash equivalents and short-term investments, compared to $13.4million at December 31, 2001.  Workingcapital was $52.9 million at March 31, 2002 compared to $49.6 million atDecember 31, 2001.   On April 2, 2002,we closed a public offering of shares of our common stock to the public, inwhich we sold 2,500,000 shares at a price of $36.50 per share, resulting in netproceeds to us of approximately $85 million.

 

                Net cash used in operatingactivities was $821,000 in the first quarter of 2002, compared to $4.8 millionin the first quarter of 2001.  Cash usedin operating activities in the first quarter of 2002 primarily resulted from a$13.9 million increase in inventories, a $5.3 million increase in accountsreceivable and a $2.1 million increase in other current and non-current assets,partially offset by net income of $2.8 million, an $8.5 million increase inaccounts payable and accrued liabilities, an $8.0 million increase in deferredrevenues and the $855,000 non-cash effect of depreciation and amortization.Cash used in operating activities in the first quarter of 2001 primarilyresulted from a $3.3 million increase in accounts receivable, a $1.4 millionincrease in inventories and a $1.2 million decrease in accrued liabilities,partially offset by net income of $89,000 and the $1.0 million non-cash effectof depreciation and amortization.

 

                Net cash provided by investingactivities was $1.2 million in the first quarter of 2002, compared to $540,000 usedin investing activities in the first quarter of 2001.   Net cash provided by investing activities in the first quarterof 2002 resulted from proceeds from the sale of short-term investments of $2.0million, partially offset by $762,000 in acquisitions of capitalequipment.  Net cash used in investingactivities in the first quarter of 2001 resulted from $540,000 in acquisitionsof capital equipment.

 

                Net cash used in financingactivities was $40,000 in the first quarter of 2002, compared to $3.7 millionprovided by financing activities in the first quarter of 2001.  Net cash used in financing activities in thefirst quarter of 2002 primarily resulted from $916,000 in repayments ofshort-term debt and $54,000 in repayments of long-term debt, partially offsetby $930,000 in proceeds from exercises of incentive stock options and salesunder our employee stock purchase plan. Net cash provided by financingactivities in the first quarter of 2001 was primarily due to $3.7 million inproceeds from borrowings (net of repayments) of short-term debt and $77,000 inproceeds from sales under our employee stock purchase plan, partially offset by$111,000 in repayments of long-term debt.

 

                In March 2002, we amended ourtwo line of credit agreements with Silicon Valley Bank.  The first agreement provides for maximumborrowings in an amount up to the lower of 80% of eligible domestic EDSreceivables or $12.0 million.  Thesecond agreement is partially guaranteed by the Export-Import Bank, or EXIM, ofthe United States and provides for maximum borrowings in an amount up to thelower of:  (a) the sum of 70% to 90% ofeligible EDS export accounts receivable plus the lower of: (i) 70% of eligibleraw materials and work-in-process inventory designated for export customers;(ii) 60% of outstanding loans under this agreement, or; (iii) $4.0 million, or;(b) $10.0 million.  Total borrowingsunder both agreements cannot exceed $20.0 million.  Borrowings under these agreements bear interest at the bank’sprime rate plus 1.5%, or the bank’s prime rate plus 1.0% if we maintain atleast 80% of our cash and cash equivalents at Silicon Valley Bank.   Subsequent to the completion of our publicoffering in April 2002, the interest rate is the bank’s prime rate 

 

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plus 1.5%, or thebank’s prime rate plus 1.0% if we maintain at least 50% of our cash and cashequivalents at Silicon Valley Bank. Borrowings are secured by EDS assets. The agreements expire in February2003 and require that the EDS segment maintain certain levels of tangible networth and intercompany balances from its wholly-owned subsidiaries, and alsoprohibit us from paying cash dividends. We may use proceeds of loans under both lines of credit for generalcorporate purposes in EDS operations. At March 31, 2002, we had no borrowings outstanding under theseagreements.  However, at March 31, 2002,we had outstanding guarantees to customers through issuance of letters ofcredit secured by the lines of credit totaling $7.9 million and foreignexchange contracts for which a 10% reserve of $1.2 million is secured by thelines of credit.  Additionally, we had areserve of $1.4 million against our lines of credit for a draw-down of a letterof credit which had not been settled by Silicon Valley Bank at March 31,2002.  We had remaining availableborrowing capacity under the lines of credit of $9.5 million at March 31, 2002based on eligible EDS accounts receivable and inventories as of that date.

 

                In August 2001, Inovec enteredinto a line of credit agreement with Pacific Continental Bank.  The agreement provides for a $1.5 millionworking capital line of credit and is secured by assets of Inovec, Inc.  The agreement bears interest at the bank’sprime rate plus 1.0% with an interest rate floor of 7.25%.  The agreement expires in August 2002 andrequires that Inovec maintain certain levels of tangible net worth anddebt/worth ratios.  We may use proceedsfrom loans under the line of credit for general corporate purposes in Inovec’soperations.  We had borrowings of$360,000 outstanding under this agreement at March 31, 2002.

 

                We previously borrowed against acommitted equipment line of credit agreement with Silicon Valley Bank, whichconverted into a term loan after draw down. Borrowings are secured by the assets purchased or financed.  At March 31, 2002, we had an outstanding$166,000 term loan due June 2003.  Theterm loan bears interest at the bank’s prime rate plus 1.5%.

 

                We believe that existing cash,cash equivalents and short-term investments together with net proceeds from ourpublic offering of common stock of approximately $85 million in April 2002,available borrowings under our lines of credits and funds expected to begenerated from operations will be sufficient to finance our working capital andcapital expenditure requirements for at least the next 12 months.  However, if we fail to meet requiredfinancial covenants in our credit agreements, or our receivables do not supportthe upper limits of these credit agreements, then we may not be able to haveaccess to further funds under these agreements.  In addition, if we are unable to deliver EDS units in a timelymanner under our recent orders from the TSA or if we fail to adhere to theterms of the licensing agreement with the TSA, the TSA may cancel its orders ornot place additional orders.  If any ofthese events occur, our capital resources would be significantly impaired.

 

**Business Risks**

 

**Ouroperating results are difficult to predict and may vary from investorexpectations, which could cause our stock price to drop.**

 

Our past operating results have been, and we expectour future operating results to be, subject to fluctuations resulting from anumber of factors. We reported net income from 1997 through 1999, we reported anet loss for 2000 and we reported net income for the year ended December 31,2001 and the quarter ended March 31, 2002. The factors that may cause ourresults to fluctuate include:

 

•                  the timing and size of orders from our major customers, including most prominently,the FAA, the TSA, and other government agencies;

•                  public awareness of aviation security and legislative actions leadingto fluctuations in demand for aviation security products and services;

•                  delays in product shipments caused by the inability of airports toinstall or integrate our products in a timely fashion;

•                  our ability to expand manufacturing capacity sufficiently to meet anyincreased demand for our products;

•                  the availability and cost of key components;

•                  the acceptance and timing of software and hardware enhancements to ourexisting products;

•                  the introduction and acceptance of new products offered by us or ourcompetitors;

•                  changes in pricing policies by us, our competitors or our suppliers,including possible decreases in average selling prices of our products causedby customer volume orders or in response to competitive pressures; and

•                  our sales mix to domestic and international customers.

 

A significant portion of our quarterly and annualoperating expenses are, and will continue to be, relatively fixed in nature.This means that revenue fluctuations will cause our quarterly and annualoperating results to vary substantially. We also may choose to increasespending to pursue new market opportunities, which may negatively affect ourfinancial results. 

 

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Accordingly, we believe that period-to-period comparisons of ourresults of operations are not meaningful and cannot be relied upon asindicators of future performance. Because of all of the foregoing factors, ouroperating results have from time to time in the past been, and may again in thefuture be, below the expectations of public market analysts and investors.Failure to meet market expectations has in the past resulted, and may again inthe future result, in a decline in the trading price of our common stock.

 

**We maynot have enough capacity to manufacture a sufficient number of units of our EDSproducts to meet increased demand, resulting in lost revenue opportunities.**

 

If we cannot increase production rapidly enough, wemay fail to meet the demand for our products, which could result in lostrevenue opportunities and market share. During the first quarter of 2002, wemanufactured a total of 40 EDS units. We currently have plans that would allowus to expand our internal production capacity to approximately 50 EDS units permonth by the end of 2002. We intend to contract with outside manufacturers,including CoorsTek, to produce approximately 100 additional EDS units per monthby the end of 2002. The increase in demand is placing significant demands onour management, working capital and financial and management control systems.For example, to increase production capacity, we are hiring and training asignificant number of new employees, ordering key components which have longlead times and training and monitoring our outside contract manufacturers. Evenwith our anticipated increased capacity, our total production capacity may notbe sufficient to meet the significant increase in demand. If the U.S.government is not satisfied that we have sufficient manufacturing capacity toproduce significant numbers of our EDS products or, if we fail to deliver EDSproducts on a timely basis, we may not receive further orders from the U.S.government that we otherwise would have received.

 

For example, in the first quarter of 2002, the TSAordered 400 of our EDS units to be delivered at specific dates through the endof the third quarter of 2002. If we do not meet the deadline for delivery ofthese EDS units, the TSA may not place additional orders with us.

 

Rapid increases in production levels could also resultin higher costs for components and other increased manufacturing expenses.These higher costs could reduce our profitability. Furthermore, if productionis increased inefficiently, manufacturing yields could decline, which may alsolower our profitability.

 

**Wedepend upon a limited number of suppliers for components of our EDS 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 EDS products as required.**

 

Key components used in our products have been designedby us to our specifications and are currently available only from one or alimited number of suppliers. We currently do not have long-term agreements withthese suppliers. Our inability to develop alternative sources for single orsole source components, to find alternative third party manufacturers orsubassemblers, or to obtain sufficient quantities of these components, couldresult in delays or interruptions in product shipments, which could causepotential customers to seek other suppliers of EDS products. In view of thehigh cost of many of these components, we do not maintain excess supplies. Ourdemands for large volumes of these key components may strain the abilities ofour suppliers to provide these key components on a timely or expeditedbasis.   In addition, we may competewith other EDS manufacturers to obtain parts for our EDS products.  If our suppliers experience financial,operational, production or quality assurance difficulties, the supply ofcomponents to us would be reduced or interrupted. In the event that a supplierceases operations, discontinues a product or withholds or interrupts supply forany reason, we may be unable to acquire the product from alternative sourceswithin a reasonable period of time.

 

**Futuresales for our EDS products will depend on the ability of airports to integrateour EDS units into their baggage handling system, which they may not be able todo.**

 

Future sales will depend, in part, on the ability ofairports to easily install our EDS products into airport lobbies or integratethem into existing baggage handling systems. If an airport is not configuredfor these systems, deployment of our EDS products may require changes in theairport infrastructure, such as reinforced airport lobby floors and baggageplatforms. If airports cannot easily install our EDS products in airportlobbies or integrate them into existing baggage handling systems, we mayexperience reduced sales of our EDS products or these sales may be delayed.

 

**If ourEDS products fail to detect explosives, we could be exposed to productliability and related claims, and we may not have adequate insurance coverage.**

 

Our business exposes us to potential product liabilityrisk, which are inherent in the manufacturing and sale of EDS products. Ourmachines are not designed to detect, and FAA certification does not require100% detection of, any and all explosives contained in scanned baggage. Forthis reason, or if our products malfunction, it is possible that explosivematerial could pass 

 

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undetected through our products, which would lead to product liabilityclaims. There are also many other factors beyond our control that could lead toliability claims, such as the reliability and competence of the customer’soperators, the training of the operators, and the maintenance of the productsby the customers.

 

If a product liability claim is brought against us,the cost of defending the claim would be significant and any adversedetermination may result in liabilities in excess of our insurance coverage. Wecurrently have product liability and war and terrorism insurance in the amountof $150 million. However, since September 11, 2001, insurance rates haveincreased dramatically, and we cannot be certain that our current insurance canbe maintained, or additional insurance coverage could be obtained, on acceptableterms, if at all.

 

In addition, the failure of any EDS product to detectexplosives, even if due to operator error and not to the mechanical failure ofan EDS product, could result in public and customer perception that ourproducts do not work effectively, which could have a material adverse effect onsales and may cause customers to cancel orders already placed, either of whichwould harm our business.

 

**We aresubstantially dependent on orders from the U.S. government, and if the U.S.government fails to continue purchasing our products or cancel existing orders,our business will be harmed.**

 

Through March 31, 2002, substantially all of ourorders from United States customers have been funded by the FAA or the TSA,which allocates our products to airports in the United States. EDS sales to theFAA, and subsequent to the formation of the TSA, to the TSA, accounted for43.0% of our revenues in the first quarter of 2002 and 26.9% of our revenues inthe year ended December 31, 2001. The TSA has placed orders with us for 400 EDSunits to be delivered at specific dates through the end of the third quarter of2002, and has placed an order to acquire parts sufficient to build anadditional 100 EDS units. The failure of the U.S. government to continue topurchase our EDS products or the cancellation of existing orders would harm ourbusiness.

 

As a result of the Transportation Security Act, theTSA has replaced the FAA as the primary purchasing agent for the U.S.government for our EDS products. We have developed relationships with currentFAA personnel over the years regarding the purchase of our products. These FAApersonnel may not transfer to the TSA and new individuals may assume authorityfor purchasing aviation security products at this new agency. Accordingly, ourability to receive future orders from the U.S. government may depend, in part,on our ability to establish new relationships within the TSA.

 

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

 

The Transportation Security Act mandates that by theend of 2002, 100% of checked baggage must undergo EDS screening. The TSA hasannounced its intention to meet the 2002 deadline by purchasing a mix ofFAA-certified EDS and non-FAA certified explosive detection products. Inaddition, political pressure to meet the deadline may cause the FAA to lowerits requirements for certification, which would enable technologies andproducts that do not meet current FAA-certification standards to becomecertified. To the extent that these events occur, we would have to competeagainst suppliers of these lesser products, which are cheaper than our EDSproducts, and could decrease our average selling prices, decrease our marketshare and cause us to sell fewer of our EDS products than we otherwise would tomeet the demand created by the Transportation Security Act.

 

**We havegranted a royalty-bearing license to the U.S. government to have our productsproduced by other manufacturers and if these manufacturers produce ourproducts, we may lose expected revenue opportunities.**

 

In connection with orders for 400 EDS units, the TSArequired that we grant the TSA a royalty-bearing license to enable othermanufacturers to build EDS products based on our technology for the TSA.  With this license, the TSA may purchase EDSproducts from other manufacturers rather than us, even if we have themanufacturing capacity to build those EDS products. If this happens, theroyalty we receive under the license may not fully compensate us for the lostbusiness opportunity.

 

Further, since licensed manufacturers will be buildingsubstantially the same products as us, if we fail to timely deliver EDSproducts which the TSA has ordered from us, the TSA may not give us theopportunity to cure the failure to deliver, and it may transfer the order fromus to a licensed manufacturer.

 

 

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**Asubstantial number of sales of our EDS products are large orders from a limitednumber of customers. As a result, order cancellations from any of our customerscould have a significant negative impact on our business.**

 

In any given fiscal quarter or year, our revenues arederived from orders of multiple units of our EDS products from a limited numberof customers. For example, we recently received orders from the TSA for 400 EDSunits, which exceeds the total number of units sold by us during the past twoyears. In the first quarter of 2002, six customers accounted for all of our EDSunits sold during the quarter, and for the fiscal year 2001, seven customersaccounted for all of our EDS units sold during the year. The number of ourcustomers does not vary widely from period to period, and we are dependent onmultiple orders from a small number of customers for a substantial portion ofour revenues. Therefore, a cancellation or delay of an order from a customer couldhave a significant negative impact on our operations in a given period.

 

**Thesales cycle for our EDS products is lengthy, and we may expend a significantamount of effort in obtaining sales orders and not receive them.**

 

The sales cycle of our EDS products is often lengthydue to the protracted approval process that typically accompanies large capitalexpenditures and the time required to manufacture, install and assimilate ourEDS products. Typically, six to twelve months may elapse between a new customer’sinitial evaluation of our systems and the execution of a contract. Anotherthree months to a year may elapse prior to shipment of our EDS products as thecustomer site is prepared and our EDS products are manufactured. In addition,the creation of the TSA may result in additional delays as it develops policiesand procedures relating to aviation safety and obtains funding for its safetyinitiatives, including the purchase of additional EDS products. During thesales cycle we expend substantial funds and management resources but recognizeno associated revenue.

 

**Ourinternational sales subject us to risks that could have a material adverseeffect on our business.**

 

Sales to countries other than the United Statesaccounted for 32.8% of our revenues in the first quarter of 2002 and 32.5% ofour revenues for the year in 2001. A number of factors related to ourinternational sales and operations could adversely affect our business,including:

 

•                  unexpected changes in 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 foreignjurisdictions;

•                  tariffs, embargoes or other barriers;

•                  difficulties in staffing and managing foreign operations;

•                  difficulties in obtaining and managing distributors; and

•                  potentially negative tax consequences.

 

The sale of some of our products outside the UnitedStates is subject to compliance with the United States International Traffic inArms Regulations and Export Administration Regulations. Our failure to obtainthe requisite licenses, meet registration standards or comply with othergovernment export regulations, may affect our ability to generate revenues fromthe sale of our products outside the United States, which could harm ourbusiness. In particular, our EDS products and our landmine detection equipmentare deemed regulated military devices subject to export restrictions under theU.S. Department of State regulations. Consequently, these regulations may makethese products more difficult to sell to a number of countries. Compliance withthe government regulations may also subject us to additional fees and costs.The absence of comparable restrictions on competitors in other countries mayadversely affect our competitive position.

 

**Becauseof the increased demand for our EDS products by the U.S. government, we maylose other customers which could harm our business.**

 

The Transportation Security Act mandates 100% EDSscreening of checked baggage at U.S. commercial airports by the end of 2002. Tomeet this mandate the TSA has been authorized by the U.S. Department ofCommerce to place a priority rating on EDS contracts, which would obligate usto timely fulfill the TSA’s orders and delay any unrated or lower-rated orders.In addition, as part of any future orders, the TSA may request that we agree totimely fill its orders prior to fulfilling the needs of any other customers.Accordingly, we may not be able to fulfill orders for our EDS products fromnon-U.S. government customers during this period of increased demand from theU.S. government. This could cause our current and potential non-U.S. governmentcustomers to seek EDS products from other sources. We also may lose ourgoodwill and relationships with these customers, which could harm our abilityto make sales in the future.

 

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

 

**Our newEDS products may fail to attain certification by the FAA.**

 

We plan to continue to develop new models for ourfamily of EDS products, including through our current participation in theARGUS program, an FAA-sponsored program designed to develop a smaller, low-costEDS product to scan checked baggage in small airports and low-traffic stationswithin larger airports. However, we cannot be certain that any new product,including the ARGUS system, if completed, will be certified by the FAA. Thefailure to gain certification for a product would harm our ability to sell theproduct, which could lower our future revenues.

 

**We mayseek to grow by acquisition, which subjects us to substantial risks, includingthe failure to successfully integrate an acquired business.**

 

As part of our growth strategy, we may expand ourbusiness by pursuing selected acquisitions of technologies and companies thatoffer complementary products, services, technologies or market access. Ourability to grow by acquisition is dependent upon the availability ofacquisition candidates at reasonable prices and our ability to obtainacquisition financing on acceptable terms. Future acquisitions by us couldresult in potentially dilutive issuances of equity securities, the incurrenceof debt and contingent liabilities, and amortization expenses related tointangible assets, any of which could harm our business. Acquisitions entailnumerous risks, including:

•                  difficulties in the assimilation of acquired operations, technologiesand products;

•                  diversion of management’s attention from other business concerns;

•                  risks of entering markets in which we have no or limited priorexperience; and

•                  potential loss of key employees of acquired organizations.

 

The process of integrating supply and distributionchannels, computer and accounting systems and other aspects of operations,while managing a larger entity, would present a significant challenge to ourmanagement. We may not be able to successfully integrate any businesses,products, technologies or personnel that might be acquired in the future. Insuch case, the anticipated benefits of a business combination would not befully realized, and the failure of such efforts would harm our business.

 

**Wedepend on key management and personnel and may not be able to retain thoseemployees or recruit additional qualified personnel.**

 

We believe that our future success will be due, inpart, to the continued services of our senior management team. We do not havelong term employment agreements with any of our executive officers. Losing theservices of one or more members of our management team could adversely affectour business and our expansion efforts. We do not maintain key person lifeinsurance policies for members of our management. In addition, competition forsome qualified employees, such as software engineers or other advancedengineering professionals, has intensified in recent years and may become evenmore intense in the future as the EDS industry expands. Our ability to meetsubstantial anticipated increases in demand is dependent on our ability to hireand retain technically skilled workers. Our failure to recruit qualifiedemployees in a timely manner and retain them could impair our ability toachieve our growth objectives.

 

**Naturaldisasters, including earthquakes, may damage our facilities.**

 

Our corporate and manufacturing facilities inCalifornia are located near major earthquake faults which have experiencedearthquakes in the past. In the event of a major earthquake or other naturaldisaster, our facilities may sustain significant damage and our operationscould be harmed.

 

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**The EDSindustry is highly competitive. Given the anticipated large increase in demandfor airport security products, competition may increase.**

 

                The EDS industryis intensely competitive and we may not compete successfully with ourcompetitors. As a result of increased demand for security systems, additionalcompanies may enter the EDS industry. Some of our competitors, including L-3Communications Holdings, Inc. and many of the potential new entrants into the EDSindustry, have financial, technical, production and other resourcessubstantially greater than ours. For example, L-3 Communications has recentlyentered into an agreement to purchase the Detection Systems Group ofPerkinElmer, Inc.

 

**Governmentalagencies, the primary customers for our EDS and other products, are subject tobudget processes, which could limit the demand for these products.**

 

Substantially all of the customers for our EDSproducts and our other products under development to date have been publicagencies or quasi-public agencies, such as the FAA, TSA and airportauthorities. Public agencies are subject to budgetary processes and expenditureconstraints. In the past, many domestic and foreign government agencies haveexperienced budget deficits that have led to decreased capital expenditures incertain areas. The funding of government programs is subject to legislativeappropriation. Budgetary allocations for explosives detection systems aredependent, in part, upon governmental policies which fluctuate from time totime in response to political and other factors, including the public’sperception of the threat of commercial airline bombings. For example, theterrorist attacks of September 11, 2001, have resulted in passage of theTransportation Security Act that mandates a small surcharge on each airlineticket purchase to fund airline security, which we expect will increase fundingfor explosives detection products and technologies. We cannot assure you thatthese funds will be used to purchase our EDS products, or that other funds willcontinue to be appropriated by Congress or allocated by the TSA or otheragencies for the purchase of EDS products.

 

Although multi-year contracts may be authorized inconnection with major procurements, governments generally appropriate funds ona fiscal year basis even though a program may continue for several years.Consequently, programs are often only partially funded and additional funds arecommitted only upon further appropriations.

 

Under the terms of our contracts with the U.S.government, the government may cancel orders and need only reimburse us for ourcosts incurred to the date of cancellation of our orders. Consequently, ourbacklog is not necessarily indicative of future sales. The government’s terminationof, or failure to fully fund, one or more of the contracts for our EDS productsor our other products under development would harm our business.

 

**Governmentalagencies have special contracting requirements, which create additional risks.**

 

In contracting with public agencies, we are subject topublic agency contract requirements that vary from jurisdiction tojurisdiction. Future sales to public agencies will depend, in part, on ourability to meet public agency contract requirements, certain of which may beonerous or even impossible for us to satisfy.

 

Government contracts typically contain terminationprovisions unfavorable to us and are subject to audit and modification by thegovernment at its sole discretion, which subject us to additional risks. Theserisks include the ability of the U.S. government to unilaterally:

 

•                  suspend or prevent us for a set period of time from receiving newcontracts or extending existing contracts based on violations or suspectedviolations 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, includingallocated 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 contractswith us either for its convenience or if we default by failing to perform inaccordance with the contract schedule and terms. Termination for convenienceprovisions 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 usliable for excess costs incurred by the U.S. government in procuringundelivered items from another source. Our contracts with foreign governmentsmay contain similar provisions.

 

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As a government contractor, we are subject to periodicaudits and reviews.  Based on theresults of its audits, the U.S. government may adjust our contract-relatedcosts and fees, including allocated indirect costs. Although adjustmentsarising from government audits and reviews have not seriously harmed ourbusiness, future audits and reviews could cause adverse effects. In addition,under U.S. government purchasing regulations, some of our costs, including mostfinancing costs, amortization of intangible assets, portions of our research anddevelopment costs, and some marketing expenses may not be reimbursable orallowed in our negotiation of fixed-price contracts. Further, as a U.S.government contractor, we are subject to an increased risk of investigations,criminal prosecution, civil fraud, whistleblower lawsuits and other legalactions and liabilities to which purely private sector companies are not.

 

In addition, public agency contracts are frequentlyawarded only after formal competitive bidding processes, which are oftenprotracted and typically contain provisions that permit cancellation in theevent that funds are unavailable to the public agency. We may not be awardedany of the contracts for which our products are bid. Even if we are awardedcontracts, substantial delays or cancellations of purchases could result fromprotests initiated by losing bidders.

 

**Ourbusiness could be harmed if we fail to properly protect our intellectualproperty.**

 

Our success depends in part on our ability to protectour intellectual property. Although we attempt to protect our intellectualproperty in the United States and other countries, there can be no assurancethat we will successfully protect our technology or that competitors will notbe able to develop similar technology independently. We cannot assure you thatthe claims allowed under any patents held by us will be sufficiently broad toprotect our technology against competition from third parties with similartechnologies or products. In addition, we cannot assure you that any patentsissued to us will not be challenged, invalidated or circumvented or that therights granted under these patents will provide competitive advantages to us.Moreover, the laws of some foreign countries do not protect intellectualproperty rights to the same extent as the laws of the United States, and wecould experience various obstacles and high costs in protecting ourintellectual property rights in foreign countries. If we are unable to obtainor maintain these protections, we may not be able to prevent third parties fromusing our intellectual property.

 

We also rely on trade secrets, proprietary know-howand continuing technological innovation to remain competitive. We have takenmeasures to protect our trade secrets and know-how, including the use ofconfidentiality agreements with our employees. It is possible that theseagreements may be breached and that the available remedies for any breach willnot be sufficient to compensate us for damages incurred.

 

**Litigationmay be necessary to enforce or defend against claims of intellectual propertyinfringement, which could be expensive and, if we lose, could prevent us fromselling our products.**

 

Litigation may be necessary in the future to enforceour patents and other intellectual property rights, to protect our tradesecrets or to determine the validity and scope of the proprietary rights ofothers. Any litigation, regardless of the outcome, could be costly and requiresignificant time and attention of key members of our management and technicalpersonnel.

 

Our domestic and international competitors, many ofwhich have substantially greater resources and have made substantialinvestments in competing technologies, may have patents that will prevent,limit or interfere with our ability to manufacture and sell our products. Wehave not conducted an independent review of patents issued to third parties.Because of the perceived market opportunity we face, companies possessingtechnology rights that they believe we might be infringing will now be muchmore motivated to assert infringement of their rights. These third parties mayassert infringement or invalidity claims against us and litigation may benecessary to defend against these claims. An adverse outcome in the defense ofa patent suit could subject us to significant liabilities to third parties,require disputed rights to be licensed from third parties or require us tocease selling our products. Even successful defenses of patent suits can becostly and time-consuming.

 

**Ourinability to adapt to rapid technological change could impair our ability toremain competitive.**

 

The EDS industry may undergo significant technologicaldevelopment in response to anticipated increased demand for aviation securityproducts. A fundamental shift in technology in our product markets could harmus, because we derive substantially all of our revenues from sales of EDSproducts.

 

 

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We anticipate that we will incur significant expensesin the design and initial manufacturing and marketing of new products andservices. 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 canrecover any or all of our related research, development and commercializationexpenses; or

•                  require significant capital expenditures beyond those currentlycontemplated.

 

We cannot assure you that we will be able to achievethe technological advances to remain competitive and profitable, that newproducts and services will be developed and manufactured on schedule or on acost-effective basis, that anticipated markets will exist or develop for newproducts or services, or that our existing products and services will notbecome technologically obsolete.

 

**We havereceived significant amounts of funding from government grants and contracts.We cannot assure you that we will continue to receive this level of funding forfuture product development.**

 

The U.S. government currently plays an important rolein funding the development of EDS technology and sponsoring its deployment inU.S. airports. For the three months ended March 31, 2002, we performedreimbursable research and development for EDS products totaling $713,000 fromFAA grants and contracts, and for the year ended December 31, 2001, weperformed reimbursable research and development for EDS products totaling $8.3million from FAA grants and contracts. We are also aware that other competitorsin the EDS market have received FAA development grants. The U.S. governmentalso currently funds almost all of the development of Quantum products,including quadrupole resonance and passive magnetic sensing. For the threemonths ended March 31, 2002, we had contract revenues of $3.6 million from theU.S. government for the development of Quantum products, and for the year endedDecember 31, 2001, we had contract revenues of $16.6 million from the U.S.government for development of Quantum products. We cannot assure you thatadditional research and development funds from the government will becomeavailable 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 toexpend more resources on product development, which could adversely affect ourbusiness. In addition, any future grants to our competitors may improve theirability to develop and market advanced detection products and cause ourcustomers to delay any purchase decisions, which could harm our ability tomarket our products.

 

**Risks Related to Ownership of Our Common Stock**

 

**Theprice of our common stock may fluctuate significantly.**

 

A number of factors could cause the market price ofour common stock to fluctuate significantly, including:

 

•                  terrorist attacks or acts of war;

•                  legislative and regulatory developments related to anti-terrorismefforts;

•                  our quarterly operating results or those of other explosives detectioncompanies;

•                  the public’s reaction to our press releases, announcements and ourfilings with the Securities and Exchange Commission;

•                  changes in earnings estimates or recommendations by research analysts;

•                  changes in our relationships with customers; and

•                  developments affecting our competitors.

 

For example, immediately prior to the terroristattacks of 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 pershare through March 31, 2002, which we believe is based on expectations as toincreased governmental and other orders for our EDS products. If theseexpectations are not met, then our stock price could drop dramatically. Inaddition, the stock market has periodically experienced significant price andvolume fluctuations that have particularly affected the market prices of commonstock of technology companies. These changes have often been unrelated to theoperating performance of particular companies. These broad market fluctuationsmay also adversely affect the market price of our common stock.

 

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**Delawarelaw and our charter documents may impede or discourage a takeover, which couldcause the market price of our shares to decline.**

 

We are a Delaware corporation and the anti-takeoverprovisions of Delaware law impose various impediments on the ability of a thirdparty to acquire control of us, even if a change in control would be beneficialto our existing stockholders. Our certificate of incorporation and by-lawsprovide for 5,000,000 shares of preferred stock which our board of directorsmay issue with terms determined by them without stockholder approval, aclassified board of directors serving staggered three-year terms, restrictionson who may call a special meeting of stockholders and a prohibition onstockholder action by written consent. These provisions of Delaware law and inour charter documents could impede a merger, takeover or other businesscombination involving us or discourage a potential acquirer from making atender offer for our common stock, which, under certain circumstances, couldreduce the market value of our common stock.

 

**We donot anticipate paying cash dividends.**

 

We have never declared or paid any cash dividends onour capital stock and do not anticipate paying cash dividends in theforeseeable future. We have also agreed not to pay cash dividends under ourcurrent bank line of credit. Instead, we intend to apply any earnings to theexpansion and development of our business.

 

 

## **Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

###### *Foreign ExchangeRisk and Impact of Inflation*

 

                Our international system salesand maintenance contracts are generally denominated in U.S. dollars.   In instances where there are significantinternational system sales contracts denominated in a foreign currency, weenter into forward contracts to mitigate foreign exchange risk.   We do not enter into market risk sensitiveinstruments for trading purposes.  Inthe first quarter of 2002, we entered into foreign exchange forward contractswith notional values of approximately $2.4 million to hedge against foreignexchange risk for contracts with international customers, and at March 31,2002, we had outstanding contracts totaling $12.2 million with a fair value ofapproximately $228,000.

 

                Purchases of raw materials andother inventory components are primarily denominated in U.S dollars and whenpurchased in foreign currencies, are generally made on an as needed basis.  We have some advance purchase commitments inforeign currencies with a few European suppliers.   We currently do not hedge against these purchase commitments, asthe foreign exchange rate fluctuations have not had a material adverse impacton these purchases; however, we will continue to monitor the foreign exchangerates and enter into forward exchange contracts to mitigate foreign exchangerisk as appropriate.

 

                Certain costs of providingwarranty and maintenance services for systems sold to foreign countries aredenominated in local currencies. To the extent exchange rates fluctuate, itcould become more expensive to provide these services. To date, these costshave not been significant, however, we expect they will increase as ourinstalled base increases.

 

                The impact of inflation has notbeen material on our operations or liquidity to date.

 

 

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**Part II.  OTHER INFORMATION**

 

 

**Item 1. Legal Proceedings**

 

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

 

## **Item 2.    Changes in Securities andUse of Proceeds**

 

In November 2000 we entered into an agreement withBGI, Inc., pursuant to which BGI agreed to accept 20,468 shares of our commonstock in consideration for services rendered to us by BGI under severalconsulting agreements and the cancellation of stock options to purchase 6,586shares of our common stock received by BGI for services previously rendered. Werelied on Section 4(2) of the Securities Act of 1933 for the issuance of these shares,in that BGI is controlled by Morris Busby, one of our directors, and is anaccredited investor. We issued 9,552 of these shares in 2001 and issued theremaining 10,589 of these shares in the first quarter of 2002.

 

**Item 3.    DefaultsUpon Senior Securities**

 

                Not applicable.

 

**Item4.    Submission of Matters to a Vote ofSecurity Holders**

 

A Special Meeting of Stockholders was held on February28, 2002.  The matter voted at thatmeeting was to approve an amendment to our Certificate of Incorporation to increase the authorized number of sharesof common stock from 20,000,000 shares to 60,000,000 shares.

 

Tabulations for the proposal were as follows:

 

 

| For       |   | Against   |   | Abstain |
|-----------|--------|-----------|--------|---------|
| 8,467,499 |   | 1,232,362 |   | 29,481  |

 

 

**Item5.    Other Information**

 

                Not applicable.

 

 

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**Item 6. Exhibitsand Reports on Form 8-K**

 

(a)                                  Exhibits

 

| 2.1    |   | Agreement  and Plan of Merger and Reorganization dated as of February 23, 2000, among  InVision                   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------|
|   |   | Technologies,  Inc., a Delaware corporation, InVision Acquisition Corporation, a Delaware                         |
|   |   | corporation,  and Inovec, Inc., an Oregon Corporation (1)                                                         |
| 2.2    |   | Form  of Escrow Agreement between InVision, Merger Sub, the Shareholders and  Greater Bay Trust                   |
|   |   | Company,  dated February 23, 2000 (1)                                                                             |
| 3.1    |   | Amended  and Restated Certificate of Incorporation of the Registrant. (2)                                         |
| 3.2    |   | Bylaws  of Registrant, as amended. (3)                                                                            |
| 3.3    |   | Amendment  to Amended and Restated Certificate of Incorporation of the Registrant (4)                             |
| 4.1    |   | Reference is made to Exhibits 3.1 through 3.3.                                                                    |
| 10.49  |   | Letter Contract between the Registrant and the TSA, dated February 19,  2002 (5)                                  |
| 10.50  |   | Delivery Order #2 from the TSA (5)                                                                                |
| 10.51  |   | Delivery Order #3 from the TSA (5)                                                                                |
| 10.52  |   | Amendment to Loan Documents, dated March 4, 2002, between the Registrant  and Silicon Valley Bank.                |
| 10.53  |   | Amendment to Loan Documents (EXIM Program), dated March 4, 2002, between  the Registrant and Silicon Valley Bank. |

 

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| (1)    |   | Filed as the  like-numbered exhibit to Registrant’s Current Report on Form 8-K (Commission  File No. 0-28236) filed May 18, 2000.                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                  |
| (2)    |   | Filed as an exhibit to  Registrant’s Registration Statement on Form S-1 (No. 333-380) or amendments  thereto and incorporated herein by reference.                               |
|   |   |                                                                                                                                                                                  |
| (3)    |   | Filed as the  like-numbered exhibit to Registrant’s Amendment No. 1 to Annual Report on  Form 10-K/A for the year ended December 31, 2001 and incorporated herein by  reference. |
|   |   |                                                                                                                                                                                  |
| (4)    |   | Filed as the  like-numbered exhibit to Registrant’s Annual Report on Form 10-K for the year  ended December 31, 2001 and incorporated herein by reference.                       |
|   |   |                                                                                                                                                                                  |
| (5)    |   | Confidential treatment  has been requested for portions of this exhibit.                                                                                                              |

 

 

(b)                                 The Registrant filed the followingReports on Form 8-K during the quarter ended March 31, 2002:

 

(1)          Current Report on Form 8-K dated March 7, 2002 (Item5. Other Events — Description of Capital Stock);

(2)          Current Report on Form 8-K dated March 15, 2002 (Item5.  Other Events — Letter of Intent forContract Manufacturing with  CoorsTek,Inc.); and

(3)          Current Report on Form 8-K dated April 2, 2002 (Item5.  Other Events — Order from TSA).

 

25

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# **SIGNATURES**

 

 

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

 

 

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

 

 

26

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EXHIBITINDEX

 
| Exhibit No. |   | Description                                                                                                                                                                                                                                          |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                 |
| 2.1         |   | Agreement  and Plan of Merger and Reorganization dated as of February 23, 2000, among  InVision Technologies, Inc., a Delaware corporation, InVision Acquisition  Corporation, a Delaware

corporation,  and Inovec, Inc., an Oregon Corporation (1) |
| 2.2         |   | Form  of Escrow Agreement between InVision, Merger Sub, the Shareholders and  Greater Bay Trust Company, dated February 23, 2000 (1)                                                                                                                 |
| 3.1         |   | Amended  and Restated Certificate of Incorporation of the Registrant. (2)                                                                                                                                                                            |
| 3.2         |   | Bylaws of Registrant, as amended. (3)                                                                                                                                                                                                                |
| 3.3         |   | Amendment to Amended and Restated Certificate of Incorporation  of the Registrant (4)                                                                                                                                                                |
| 4.1         |   | Reference is made to Exhibits 3.1 through 3.3.                                                                                                                                                                                                       |
| 10.49       |   | Letter Contract between the Registrant and the TSA,  dated February 19, 2002 (5)                                                                                                                                                                     |
| 10.50       |   | Delivery Order #2 from the TSA (5)                                                                                                                                                                                                                   |
| 10.51       |   | Delivery Order #3 from the TSA (5)                                                                                                                                                                                                                   |
| 10.52       |   | Amendment to Loan Documents, dated March 4, 2002,  between the Registrant and Silicon Valley Bank.                                                                                                                                                   |
| 10.53       |   | Amendment to Loan Documents (EXIM Program), dated  March 4, 2002, between the Registrant and Silicon Valley Bank.                                                                                                                                    |

 

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| (1)    | Filed as the like-numbered  exhibit to Registrant's Current Report on Form 8-K (Commission File No.  0-28236) filed May 18, 2000.                                               |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                            |
| (2)    | Filed as an exhibit to  Registrant's Registration Statement on Form S-1 (No. 333-380) or amendments  thereto and incorporated herein by reference.                              |
|   |                                                                                                                                                                            |
| (3)    | Filed as the like-numbered exhibit to Registrant's  Amendment No. 1 to Annual Report on Form 10-K/A for the year ended December  31, 2001 and incorporated herein by reference. |
|   |                                                                                                                                                                            |
| (4)    | Filed as the like-numbered exhibit to Registrant’s  Annual Report on Form 10-K for the year ended December 31, 2001 and  incorporated herein by reference.                 |
|   |                                                                                                                                                                            |
| (5)    | Confidential treatment has been requested for  portions of this exhibit.                                                                                                        |
|   |                                                                                                                                                                            |

 

 

 

 

 

 

 

 

 

 

 

27

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