**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  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 September 28, 2003**                                                                                                        |
|       |                                                                                                                                                              |
| **or**     |
|       |                                                                                                                                                              |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                |
|       | **For the transition period from             to            ** |

 

**Commission File Number: 0-28236**

 

**INVISIONTECHNOLOGIES, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes   ý   No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

Yes  ý    No  o

 

On October 31, 2003,there were 16,918,645 shares of the registrant’s common stock outstanding.

 

 

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**InVision Technologies, Inc.**

**Form 10-Q**

**INDEX**

 
| **PART  I.   FINANCIAL INFORMATION** |                                                                                        |
|------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                           |                                                                                        |   |
| **Item**                                       |                                                                                        |   |
|                                           |                                                                                        |
| 1.                                             | Financial  Statements                                                                       |   |
|                                           |                                                                                        |
|                                           | a.                                                                                          | Condensed Consolidated  Balance Sheets (Unaudited) - September 28, 2003 and December 31,  2002 |
|                                           |                                                                                        |   |
|                                           | b.                                                                                          | Condensed  Consolidated Statements of Operations (Unaudited) - Three and nine months  ended September 28, 2003 and September 29, 2002 |
|                                           |                                                                                        |   |
|                                           | c.                                                                                          | Condensed  Consolidated Statements of Cash Flows (Unaudited) - Nine months ended  September 28, 2003 and September 29, 2002 |
|                                           |                                                                                        |   |
|                                           | d.                                                                                          | Notes  to Condensed Consolidated Financial Statements (Unaudited) |
|                                           |                                                                                        |
| 2.                                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                           |                                                                                        |   |
| 3.                                             | Quantitative  and Qualitative Disclosures about Market Risk                                 |
|                                           |                                                                                        |   |
| 4.                                             | Controls  and Procedures                                                                    |
|                                           |                                                                                        |   |
| **PART  II.   OTHER INFORMATION**    |                                                                                        |
|                                           |                                                                                        |   |
| **Item**                                       |                                                                                        |
|                                           |                                                                                        |   |
| 1.                                             | Legal  Proceedings                                                                          |   |
|                                           |                                                                                        |   |
| 2.                                             | Changes  in Securities                                                                      |   |
|                                           |                                                                                        |   |
| 5.                                             | Other  Information                                                                          |   |
|                                           |                                                                                        |   |
| 6.                                             | Exhibits  and Reports on Form 8-K                                                           |   |
|                                           |                                                                                        |   |
| Signature Page                                 |                                                                                        |
|                                                |                                                                                             |  |  |  |

 

InVision, QuantumMagnetics, Yxlon, HAPEG, CTX, CTX 5500 DS, CTX 9000 DSi and QScan, amongothers, are trademarks of InVision Technologies, Inc. or one of itssubsidiaries in the United States and other countries.  InVision, Quantum Magnetics, Yxlon andQScan, among others, are registered trademarks marks of InVision Technologies,Inc. or one of its subsidiaries in the United States.

 

----

 

**PARTI.  FINANCIAL INFORMATION**

 

### **Item** 1.  FinancialStatements

 

**InVision Technologies, Inc.**

**Condensed Consolidated Balance Sheets**

**(In thousands, except share data)**

**(Unaudited)**

 
|                                                                                                                                                  |   | **September 28,  2003** |    | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|-----------------------------|--------|
| **Assets**                                                                                                                                            |   |                         |    |                        |   |
| Current  assets:                                                                                                                                      |   |                         |    |                        |   |
| Cash  and cash equivalents                                                                                                                            |   | $                            | 282,383 |                        | $      | 159,736 |   |
| Short-term  investments                                                                                                                               |   | —                       |    | —                      |   |
| Accounts  receivable, net                                                                                                                             |   | 65,894                       |    | 146,295                     |   |
| Inventories                                                                                                                                           |   | 76,383                       |    | 64,764                      |   |
| Deferred  income taxes                                                                                                                                |   | 18,677                       |    | 20,889                      |   |
| Other  current assets                                                                                                                                 |   | 9,223                        |    | 15,811                      |   |
| Total  current assets                                                                                                                                 |   | 452,560                      |    | 407,495                     |   |
| Property  and equipment, net                                                                                                                          |   | 11,678                       |    | 7,225                       |   |
| Deferred  income taxes                                                                                                                                |   | —                       |    | 1,050                       |   |
| Goodwill                                                                                                                                              |   | 21,036                       |    | 681                         |   |
| Intangible  assets, net                                                                                                                               |   | 14,805                       |    | 922                         |   |
| Other  assets                                                                                                                                         |   | 6,159                        |    | 414                         |   |
| Total  assets                                                                                                                                         |   | $                            | 506,238 |                        | $      | 417,787 |   |
| **Liabilities  and stockholders’ equity**                                                                                                        |   |                         |    |                        |   |
| Current  liabilities:                                                                                                                                 |   |                         |    |                        |   |
| Accounts  payable                                                                                                                                     |   | $                            | 17,383  |                        | $      | 28,477 |   |
| Accrued  liabilities                                                                                                                                  |   | 49,191                       |    | 65,364                      |   |
| Deferred  revenue                                                                                                                                     |   | 23,523                       |    | 86,284                      |   |
| Short-term  debt                                                                                                                                      |   | 7,365                        |    | 184                         |   |
| Current  maturities of long-term obligations                                                                                                          |   | 261                          |    | 112                         |   |
| Total  current liabilities                                                                                                                            |   | 97,723                       |    | 180,421                     |   |
| Long-term  obligations                                                                                                                                |   | 126,621                      |    | 653                         |   |
| Deferred  income taxes                                                                                                                                |   | 1,221                        |    | —                      |   |
| Total  liabilities                                                                                                                                    |   | 225,565                      |    | 181,074                     |   |
| Commitments  and contingencies (see Note 8)                                                                                                           |   | —                       |    | —                      |   |
| 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 shares authorized; 17,594,000 and  17,243,000 shares issued; 16,907,000 and 17,008,000 shares outstanding |   | 17                           |    | 17                          |   |
| Additional  paid-in capital                                                                                                                           |   | 171,257                      |    | 166,243                     |   |
| Deferred  stock compensation expense                                                                                                                  |   | (305                         | )       | (406                        | )      |
| Accumulated  other comprehensive loss                                                                                                                 |   | (1,099                       | )       | (1,783                      | )      |
| Retained  earnings                                                                                                                                    |   | 125,494                      |    | 74,836                      |   |
| Treasury  stock, at cost (687,000 and 235,000 shares)                                                                                                 |   | (14,691                      | )       | (2,194                      | )      |
| Total  stockholders’ equity                                                                                                                      |   | 280,673                      |    | 236,713                     |   |
| Total  liabilities and stockholders’ equity                                                                                                      |   | $                            | 506,238 |                        | $      | 417,787 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

3

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**InVision Technologies, Inc.**

**CondensedConsolidated Statements of Ope****rations**

**(In thousands, except per share data)**

**(Unaudited)**

 
|                                         |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |       |
|----------------------------------------------|--------|------------------------------|--------|------------------------------|------------|
|                                         |   | **September 28,  2003** |   | **September 29,  2002** | ** ** | **September 28,  2003** | ** ** | **September 29,  2002** | ** ** |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Revenues:                                    |   |                         |   |                         |       |   |   |   |   |
| Product  revenues                            |   | $                            | 69,281 |                         | $          | 111,159 |   | $ | 297,090 |   | $ | 199,255 |   |
| Service  revenues                            |   | 13,745                       |   | 3,567                        |       | 34,167 |   | 10,456 |   |
| Contract  research and development revenues  |   | 3,092                        |   | 2,334                        |       | 9,456 |   | 8,973 |   |
| Total  revenues                              |   | 86,118                       |   | 117,060                      |       | 340,713 |   | 218,684 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Cost  of revenues:                           |   |                         |   |                         |       |   |   |   |   |
| Product  costs                               |   | 42,285                       |   | 62,860                       |       | 171,411 |   | 112,784 |   |
| Service  costs                               |   | 8,330                        |   | 2,598                        |       | 20,497 |   | 7,906 |   |
| Contract  research and development revenues  |   | 1,806                        |   | 1,559                        |       | 5,875 |   | 6,091 |   |
| Total  cost of revenues                      |   | 52,421                       |   | 67,017                       |       | 197,783 |   | 126,781 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Gross  profit                                |   | 33,697                       |   | 50,043                       |       | 142,930 |   | 91,903 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Operating  expenses:                         |   |                         |   |                         |       |   |   |   |   |
| Research  and development                    |   | 5,268                        |   | 5,762                        |       | 20,269 |   | 14,219 |   |
| Selling,  general and administrative         |   | 12,280                       |   | 8,897                        |       | 31,778 |   | 20,931 |   |
| In-process  research and development (Yxlon) |   | —                       |   | —                       |       | 4,300 |   | — |   |
| Total  operating expenses                    |   | 17,548                       |   | 14,659                       |       | 56,347 |   | 35,150 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Income  from operations                      |   | 16,149                       |   | 35,384                       |       | 86,583 |   | 56,753 |   |
| Interest  expense                            |   | (343                         | )      | (107                         | )          | (488 | ) | (316 | ) |
| Interest  and other income, net              |   | 667                          |   | 510                          |       | 2,022 |   | 373 |   |
| Income  before provision for income taxes    |   | 16,473                       |   | 35,787                       |       | 88,117 |   | 56,810 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Provision  for income taxes                  |   | 7,197                        |   | 14,314                       |       | 37,459 |   | 22,912 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Net  income                                  |   | $                            | 9,276  |                         | $          | 21,473 |   | $ | 50,658 |   | $ | 33,898 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Net  income per share:                       |   |                         |   |                         |       |   |   |   |   |
| Basic                                        |   | $                            | 0.54   |                         | $          | 1.28 |   | $ | 2.95 |   | $ | 2.16 |   |
| Diluted                                      |   | $                            | 0.50   |                         | $          | 1.17 |   | $ | 2.75 |   | $ | 1.93 |   |
|                                         |   |                         |   |                         |       |   |   |   |   |
| Weighted  average shares outstanding:        |   |                         |   |                         |       |   |   |   |   |
| Basic                                        |   | 17,269                       |   | 16,740                       |       | 17,182 |   | 15,671 |   |
| Diluted                                      |   | 18,450                       |   | 18,430                       |       | 18,415 |   | 17,561 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

4

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**InVision Technologies, Inc.**

**Condensed Consolidated Statements of Cas****h Flow**

**(In thousands)**

**(unaudited)**

 
|                                                                                            |   | **Nine  Months Ended**       |       |
|-------------------------------------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                                            |   | **September 28,  2003** |       | **September 29,  2002** | ** ** |
| **Cash  flow from operating activities:**                                                       |   |                         | ** ** |   | ** ** |
| Net  income                                                                                     |   | $                            | 50,658     |   | $ | 33,898 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:              |   |                         |       |   |   |
| Depreciation  and amortization                                                                  |   | 4,318                        |       | 2,635 |   |
| Deferred  income taxes                                                                          |   | 1,311                        |       | (4,365 | ) |
| Loss  on disposal of fixed assets                                                               |   | 456                          |       | 460 |   |
| Bad  debt expense                                                                               |   | 156                          |       | 53 |   |
| Income  tax benefit from employee stock transactions                                            |   | 1,662                        |       | 5,802 |   |
| Stock  compensation expense                                                                     |   | 206                          |       | 885 |   |
| In-process  research and development (Yxlon)                                                    |   | 4,300                        |       | — |   |
| Changes  in operating assets and liabilities:                                                   |   |                         |       |   |   |
| Accounts  receivable                                                                            |   | 90,390                       |       | (62,485 | ) |
| Inventories                                                                                     |   | 7,593                        |       | (55,917 | ) |
| Other  current assets                                                                           |   | 7,835                        |       | (23,357 | ) |
| Other  noncurrent assets                                                                        |   | —                       |       | — |   |
| Accounts  payable                                                                               |   | (19,055                      | )          | 18,977 |   |
| Accrued  liabilities                                                                            |   | (24,046                      | )          | 27,994 |   |
| Deferred  revenues                                                                              |   | (69,161                      | )          | 72,376 |   |
| Other                                                                                           |   | 39                           |       | (26 | ) |
| Net  cash provided by operating activities                                                      |   | 56,662                       |       | 16,930 |   |
| **Cash  flow from investing activities:**                                                       |   |                         |       |   |   |
| Purchases  of property and equipment                                                            |   | (2,627                       | )          | (3,387 | ) |
| Proceeds  from short-term investments                                                           |   | —                       |       | 1,992 |   |
| Purchase  of Inovec subsidiary                                                                  |   | —                       |       | (183 | ) |
| Purchase  of Yxlon subsidiary, net of cash acquired                                             |   | (41,830                      | )          | — |   |
| Purchase  of Hapeg subsidiary, net of cash acquired                                             |   | (3,424                       | )          | — |   |
| Investment  in SafeView                                                                         |   | (1,500                       | )          | — |   |
| Net  cash used in investing activities                                                          |   | (49,381                      | )          | (1,578 | ) |
| **Cash  flow from financing activities:**                                                       |   |                         |       |   |   |
| Net  proceeds from (repayments of) short-term debt                                              |   | 4,874                        |       | (1,313 | ) |
| Proceeds  from issuance of long-term debt                                                       |   | 125,000                      |       | — |   |
| Debt  issuance costs                                                                            |   | (4,406                       | )          | — |   |
| Repayments  of long-term debt                                                                   |   | (212                         | )          | (137 | ) |
| Repurchase  of common stock                                                                     |   | (12,497                      | )          | — |   |
| Proceeds  from issuance of common stock, net                                                    |   | 3,248                        |       | 86,423 |   |
| Net  cash provided by financing activities                                                      |   | 116,007                      |       | 84,973 |   |
| Effect  of exchange rate changes on cash                                                        |   | (641                         | )          | — |   |
| Net  change in cash and cash equivalents for the period                                         |   | 122,647                      |       | 100,325 |   |
| Cash  and cash equivalents at beginning of period                                               |   | 159,736                      |       | 11,386 |   |
| **Cash  and cash equivalents at end of period**                                                 |   | $                            | 282,383    |   | $ | 111,711 |   |
| **Supplemental  disclosures of cash flow information:**                                         |   |                         |       |   |   |
| Interest  paid                                                                                  |   | $                            | 374        |   | $ | 304 |   |
| Income  taxes paid                                                                              |   | $                            | 47,054     |   | $ | 7,831 |   |
| **Supplemental  disclosures of noncash investing and financing activities:**                    |   |                         |       |   |   |
| Issuance  of common stock in connection with acquisition of subsidiary                          |   | $                            | —     |   | $ | 1,199 |   |
| Financing  obligations incurred for the purchase of new equipment                               |   | $                            | 668        |   | $ | 86 |   |
| Warrant  issued in connection with investment advisory services and financing related  services |   |                         |       |   |   |
| Issuance  of common stock in connection with the exercise of warrants                           |   | $                            | —     |   | $ | 995 |   |
| Financing  obligations incurred for insurance policy renewals                                   |   | $                            | 1,691      |   | $ | — |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

5

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**InVision Technologies, Inc.Notes to Condensed ConsolidatedFinancial Statements(Unaudited)**

 

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

 

**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 allof the information and footnotes required by generally accepted accountingprinciples for complete financial statements.  In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurringadjustments) considered necessary for a fair presentation.  Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements of InVision Technologies, Inc. and itssubsidiaries (the “Company”) as of December 31, 2002 and 2001 and for eachof the three years in the period ended December 31, 2002, including thenotes thereto, included in the Company’s Annual Report on Form 10-K filed onMarch 28, 2003.

 

Operating results for thethree and nine-month periods ended September 28, 2003 may not necessarilybe indicative of the results that may be expected for the year endedDecember 31, 2003 or any other future period.

 

**Business Combinations and Goodwilland Other Intangible Assets**

 

On January 1, 2002,the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).  SFAS142 addresses the initial recognition and measurement of intangible assetsacquired outside of a business combination and the accounting for goodwill andother intangible assets subsequent to their acquisition.  SFAS 142provides that intangible assets with finite useful lives be amortized and thatgoodwill and intangible assets with indefinite lives not be amortized, but willrather be tested at least annually for impairment.  Since adopting SFAS142 on January 1, 2002, the Company ceased amortization of the carryingvalue of goodwill of $2.5 million and acquired workforce of $331,000 atJanuary 1, 2002, resulting in a reduction in annual amortization expenseof $426,000.  The net carrying amount of acquired workforce was also reclassifiedto goodwill.  In the fourth quarter of 2002, the Company performed theannual impairment test required by the standard and recorded a $2.1 millionimpairment of goodwill relating to the Inovec reporting unit.  The Company will perform its 2003 annualimpairment test in the fourth quarter of 2003.

 

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

 

On January 1, 2003,the Company adopted SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (“SFAS 146”), which addresses accounting for restructuringand similar costs.  SFAS 146 supersedes previous accounting guidance,principally Emerging Issues Task Force (“EITF”) Issue No. 94-3(“EITF 94-3”).  SFAS 146 requires that the liability for costs associatedwith an exit or disposal activity be recognized when the liability isincurred.  Under EITF 94-3, a liability for exit costs was recognizedat the date of the Company’s commitment to an exit plan.  SFAS 146also establishes that the liability should initially be measured and recordedat fair value.  Accordingly, SFAS 146 may affect the timing of recognizingfuture restructuring costs as well as the amounts recognized.  There wasno effect on the Company’s financial statements from the adoption of SFAS 146.

 

**Accounting for Stock-BasedCompensation**

 

In December 2002,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure – anAmendment of FASB Statement 123” (“SFAS 148”), which provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, SFAS 148amends the disclosure requirements of SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”) to require prominent

 

6

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disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results.  The amended disclosure requirementsof SFAS 148 are effective for years ending after December 15, 2002.

 

The Company grants stockoptions for a fixed number of shares to employees with an exercise price equalto the fair value of the shares at the date of grant. The Company accounts foremployee stock-based compensation in accordance with Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB 25”). The Company accounts for stock-based awards to non-employeesin accordance with SFAS 123 and EITF Issue No. 96-18, “Accounting forEquity Instruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services.”

 

Had compensation cost foroptions granted and shares issued in 2003 and 2002 under the Company’s stockoption plans (the “Equity Plans”) and employee stock purchase plans (the“Purchase Plans”) been determined based on the fair value at the grant andissue dates, as prescribed in SFAS 123, the Company’s net income and proforma net income per share would have been as follows (in thousands, except pershare data):

 
|                                                                                 |   | **Three  months ended** |   | **Nine  months ended** |   |
|--------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                 |   | **Sept. 28,  2003**     |   | **Sept. 29,  2002**    |   | **Sept. 28,  2003** |   | **Sept. 29,  2002** |   |
| Net  income:                                                                         |   | $                       | 9,276  |                   | $      | 21,473 |   | $ | 50,658 |   | $ | 33,898 |   |
| As  reported                                                                         |   |                    |   |                   |   |   |   |   |   |
| add:  stock compensation as reported, net of tax effects                             |   | $                       | 56     |                   | $      | 20 |   | $ | 120 |   | $ | 60 |   |
| less:  stock compensation determined using the fair value method, net of tax effects |   | $                       | (2,249 | )                      | $      | (1,725 | ) | $ | (6,335 | ) | $ | (4,307 | ) |
| Pro  forma                                                                           |   | $                       | 7,083  |                   | $      | 19,768 |   | $ | 44,443 |   | $ | 29,651 |   |
| Pro  forma net income per share:                                                     |   |                    |   |                   |   |   |   |   |   |
| Basic:                                                                               |   |                    |   |                   |   |   |   |   |   |
| As  reported                                                                         |   | $                       | 0.54   |                   | $      | 1.28 |   | $ | 2.95 |   | $ | 2.16 |   |
| Pro  forma                                                                           |   | $                       | 0.41   |                   | $      | 1.18 |   | $ | 2.59 |   | $ | 1.89 |   |
| Diluted:                                                                             |   |                    |   |                   |   |   |   |   |   |
| As reported                                                                          |   | $                       | 0.50   |                   | $      | 1.17 |   | $ | 2.75 |   | $ | 1.93 |   |
| Pro  forma                                                                           |   | $                       | 0.38   |                   | $      | 1.09 |   | $ | 2.41 |   | $ | 1.71 |   |

 

Under the intrinsic valuemethod, when the exercise price of the Company’s employee stock options equalsor exceeds the market price of the underlying stock on the date of grant, nocompensation expense is recognized.  The pro forma information regardingthe results of operations and net income per share above is determined as ifthe Company had accounted for its employee stock options using the fair valuemethod. Under this method, the fair value of each option granted is estimatedon the date of grant using the Black-Scholes option pricing model.

 

Option valuation modelssuch as Black-Scholes were developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions, including the expected life of the option. In management’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of the Company’s employee stock options because theCompany’s employee stock options have characteristics significantly differentfrom those of traded options and because changes in the subjective assumptionsrequired by these models can materially affect the fair value estimates.

 

7

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The fair value of eachoption grant and share granted is estimated on the date of grant using thefollowing assumptions used for grants during the applicable period:

 
|                                   |   | **2003**  |   | **2002**  |   |
|----------------------------------------|--------|-----------|--------|-----------|--------|
| Option Grants:                         |   |      |   |      |   |
| Average  risk free rate of return      |   | 2.31-3.00 | %      | 3.50-4.39 | %      |
| Weighted  average expected option life |   | 4.1 years |   | 4.0 years |   |
| Volatility  rate                       |   | 74        | %      | 83        | %      |
| Dividend  yield                        |   | 0         | %      | 0         | %      |

 
|                                  |   | **2003**   |   | **2002**   | ** ** |
|---------------------------------------|--------|------------|--------|------------|------------|
| Shares  Granted                       |   |       |   |       |       |
| Average  risk free rate of return     |   | 1.15-1.19  | %      | 1.25-1.65  | %          |
| Weighted  average expected share life |   | 3.0 months |   | 3.0 months |       |
| Volatility  rate                      |   | 17-30      | %      | 31-33      | %          |
| Dividend  yield                       |   | 0          | %      | 0          | %          |

 

**Accounting and Disclosure Requirementsfor Guarantees**

 

In December 2002,the Company adopted FASB Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirement for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” (“FIN 45”).  FIN 45 requires that, upon issuanceof a guarantee, the guarantor must recognize a liability for the fair value ofthe obligation it assumes under that guarantee.  The provisions forinitial recognition and measurement are effective on a prospective basis forguarantees that are issued or modified after December 31, 2002,irrespective of a guarantor’s year-end.

 

**Accrued Warranty**

 

Estimated warranty costsare recorded on product revenues and adjusted periodically based on historicaland anticipated experience. The Company accrues the estimated cost of productwarranties at the time revenues are recognized. Although the Company engages inextensive product quality programs and processes, including actively monitoringand evaluating the quality of component suppliers, the warranty obligation isaffected by actual warranty costs, including usage of material and labor andservice delivery costs incurred in correcting a product failure.

 

Information regarding thechanges in the Company’s warranty liabilities was as follows for the ninemonths ended September 28, 2003:

 
| **Balance at  Dec. 31,  2002** |   | **Accruals  for  warranties issued** | ** ** | **Reduction  for  payments made** | ** ** | **Increase  resulting  from Yxlon acquisition  on March 31, 2003** | ** ** | **Changes in  accruals related  to pre-existing  warranties** | ** ** | **Balance at  Sept. 28,  2003** | ** ** |
|--------------------------------|--------|--------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------|------------|
|                           |   |                                 |       |                              |       |                                                                    |       |                                                          |       |                            |       |
| $                              | 19,890 |                                 | $          | 16,693                            |       | $                                                                       | (20,001    | )                                                             | $          | 925                             |       | $ | 334 |   | $ | 17,841 |   |
|                                |        |                                      |            |                                   |            |                                                                         |            |                                                               |            |                                 |            |  |  |  |  |  |  |

 

**Revenue Arrangements with MultipleDeliverables**

 

In November 2002,the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements withMultiple Deliverables” (“EITF 00-21”). EITF 00-21 addresses certain aspects ofthe accounting by a vendor for arrangements under which the vendor will performmultiple revenue generating activities.  EITF 00-21 is effective forfiscal periods beginning after June 15, 2003.  There was no impactfrom the adoption of EITF 00-21 on the Company’s results of operations orfinancial position.

 

8

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**Derivative Instruments and HedgingActivities**

 

The Company is exposed toforeign currency exchange rate risk inherent in its sales commitments,anticipated sales, anticipated purchases and assets and liabilities denominatedin currencies other than the U.S. dollar.  The Company utilizes foreignexchange forward contracts to limit its exposure to foreign currency ratefluctuation.  The maturity of foreign exchange forward contracts as ofSeptember 28, 2003 is consistent with the contractual or expected timingof the transactions being hedged, principally receipt of customerpayments.  These foreign exchange forward contracts all mature withintwelve months.  The Company does not enter into market risk sensitiveinstruments for trading purposes.  During the nine months endedSeptember 28, 2003, the Company’s derivatives consisted only of foreignexchange forward contracts.  The Company had aggregate foreign exchangeforward contracts with notional amounts of $23.7 million at September 28,2003. The fair value of these instruments, included in the consolidated balancesheets, represented a net liability of $605,000 at September 28, 2003.

 

In May 2002, theCompany began applying hedge accounting as defined by SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) anddesignated certain foreign exchange forward contracts as cash flow hedges offoreign exchange risk for international sales contracts.  As ofSeptember 28, 2003, the Company has recorded $1,677,000 of othercomprehensive loss, net of income taxes of $1,240,000, representing the netchange in the fair value of the foreign exchange forward contracts that weredesignated as and qualified for hedge accounting.  The amounts deferred inother comprehensive loss are reclassified to earnings upon the collection ofthe hedged contract.  As of September 28, 2003, the Companyanticipates reclassifying the full amount included within other comprehensiveloss to earnings within the next twelve months.  During the nine monthsended September 28, 2003, the Company also recorded $21,000 as foreigncurrency transaction loss related to ineffectiveness under hedgeaccounting.  For the nine-month period ended September 28, 2003,primarily all of the changes in the fair value of forward contracts notdesignated for hedge accounting were offset by the measurement of associatedaccounts receivable.

 

In April 2003, theFASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities” (“SFAS 149”).  SFAS No. 149 amends and clarifiesthe accounting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS 133. SFAS No. 149 is generally effective for contracts entered into or modifiedafter June 30, 2003 and for hedging relationships designated afterJune 30, 2003. There was no impact from the adoption of SFAS No. 149 onthe Company’s operations and financial condition.

 

In May 2003, theFASB issued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity” (“SFAS 150”).  SFAS No.150 requires that certain financial instruments, which under previous guidancewere accounted for as equity, must now be accounted for as liabilities. Thefinancial instruments affected include mandatorily redeemable stock, certainfinancial instruments that require or may require the issuer to buy back someof its shares in exchange for cash or other assets and certain obligations thatcan be settled with shares of stock. SFAS No. 150 is effective for interimperiods beginning after June 15, 2003. The Company does not expect theadoption of SFAS No. 150 to have a material effect on its financial condition.

 

**2.****                                      BusinessCombinations**

 

In accordance with SFASNo. 141, “Business Combinations,” the Company allocates the purchase price ofits acquisitions to the tangible assets, liabilities and intangible assetsacquired, as well as in-process research and development, based on theirestimated fair values.  The excess purchase price over those fair valuesis recorded as goodwill.  The fair value assigned to intangible assetsacquired is based on valuations prepared by independent third party appraisalfirms using estimates and assumptions provided by management.  Inaccordance with SFAS 142, goodwill and purchased intangibles with indefinitelives acquired after June 30, 2001 are not amortized but will be reviewedperiodically for impairment.  Purchased intangibles with finite lives willbe amortized on a straight-line basis over their estimated useful lives.

 

9

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**Yxlon International Holding GmbH**

 

On March 31, 2003,the Company completed its acquisition of Yxlon International Holding GmbH(“Yxlon”), a company based in Hamburg, Germany.  Yxlon develops,manufactures, markets and supports X-ray based non-destructive testing (“NDT”)systems for a wide range of industrial applications, and systems that use X-raybased diffraction (“XRD”) technology for explosives detection.  TheCompany acquired Yxlon for €38.6 million in cash, or $41.7 million, andincurred additional acquisition costs of $2.1 million for a total purchaseprice of $43.8 million.  The Company would be required to make anadditional payment of €7.5 million if Yxlon’s XRD system is certified forexplosives detection by the Transportation Security Administration (“TSA”) byDecember 31, 2003 or €5.0 million if Yxlon’s XRD system is thereaftercertified for explosives detection by the TSA by June 30, 2004.  Ifthe XRD system is certified for explosives detection by the TSA, the Companywould record the additional consideration as intangible assets.

 

An independent valuationto determine the allocation of the fair value of the net assets acquired wascompleted in September 2003.  The total purchase price ofapproximately $43.8 million has been allocated as follows (in thousands):

 
| Cash and cash equivalents                 |   | $       | 1,946  |   |
|-------------------------------------------|--------|---------|--------|--------|
| Current assets                            |   | 29,101  |   |
| Other  non-current assets                 |   | 1,726   |   |
| Amortizable  intangible assets:           |   |    |   |
| Developed  and core technology            |   | 8,700   |   |
| Other                                     |   | 1,480   |   |
| Intangible  assets with indefinite lives: |   |    |   |
| Goodwill                                  |   | 18,253  |   |
| Trademark                                 |   | 2,780   |   |
| Current  liabilities                      |   | (22,866 | )      |
| Other  non-current liabilities            |   | (1,644  | )      |
| In-process  research and development      |   | 4,300   |   |
| Total  purchase price                     |   | $       | 43,776 |   |

 

***AmortizableIntangible Assets***

 

Of the total purchaseprice, approximately $10.2 million has been allocated to amortizable intangibleassets, including maintenance contracts and renewals, contract backlog, directcustomer relationships, supplier agreements and developed and coretechnology.  The maintenance contracts and renewals represent a valueassigned to the revenue stream estimated from existing maintenance contracts asof the acquisition date with an assumed renewal rate.  Contract backlogrepresents the gross contract backlog to be recognized over the twelve-monthperiod following the close of the acquisition.  Direct customerrelationships represent the sale of products and services by Yxlon’s internalsales and marketing force.  Supplier agreements represent the value inmaterial supplier agreements where Yxlon receives below market rates oninventory component purchases.   The Company expects to amortize thefair value of these assets on a straight-line basis over estimated useful livesranging from twelve months to six years. Expected future amortization expenses for the intangible assets are asfollows:

 
| **(in thousands)**                         |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   |
|--------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|
| Expected intangibles amortization expenses |   | $        | 1,479  |     | $      | 1,612    |   | $        | 1,477  |     | $      | 1,387          |   | $ | 1,359 |   | $ | 2,867 |   |
|                                            |        |          |        |          |        |          |        |          |        |          |        |                |        |  |  |  |  |  |  |

 

Developed and coretechnology, which consists of products that have reached technologicalfeasibility, includes Yxlon’s XRD system and NDT system products.  TheCompany expects to amortize the fair value of the developed and core technologyon a straight-line basis over an estimated useful life of seven years.

 

10

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***Intangible AssetsWith Indefinite Lives***

 

The estimated fair valueof intangible assets with indefinite lives was $18.3 million for goodwill and$2.8 million for the Yxlon trade name.  These intangible assets will notbe amortized because the assets have indefinite useful lives based on manyfactors and considerations, including the length of time that the Yxlon namehas been in use, the Yxlon brand awareness and market position and the plans forcontinued use of the Yxlon brand within a portion of the Company’s overallproduct portfolio.

 

***In-Process Researchand Development***

 

Of the total purchaseprice, $4.3 million has been allocated to in-process research and development(“IPR&D”) and was expensed in the second quarter of fiscal 2003. Projects that qualify as IPR&D represent those that have not yet reachedtechnological viability.  Technological viability is defined as beingequivalent to a beta-phase working prototype in which there is lower remainingrisk relating to the development.

 

The value assigned toIPR&D was determined by considering the importance of each project to theoverall development plan, estimating costs to develop the purchased IPR&Dinto commercially viable products, estimating the resulting net cash flows fromthe projects when completed and discounting the net cash flows to their presentvalue.  The revenue estimates used to value the purchased IPR&D werebased on estimates of the relevant market sizes and growth factors, expectedtrends in technology and the nature and expected timing of new productintroductions by Yxlon.

 

The rates utilized todiscount the net cash flows to their present values are based on Yxlon’sweighted average cost of capital.  The weighted average cost of capitalwas adjusted to reflect the difficulties and uncertainties in completing eachproject and thereby achieving technological feasibility, the percentage ofcompletion of each project, anticipated market acceptance and penetration,market growth rates and risks related to the impact of potential changes infuture target markets.

 

***Pro Forma Results(Unaudited)***

 

The unaudited pro formafinancial information presented below combine the actual results of operationsof the Company and the historical results of operations of Yxlon for therespective periods as if the acquisition of Yxlon had occurred at the beginningof each of the periods presented.  Adjustments of $5.0 million, $285,000,$5.3 million and $5.9 million have been made to the combined results ofoperations for the three and nine-month periods ended September 28, 2003and the three and nine-month periods ended September 29, 2002,respectively, reflecting amortization of purchased intangibles, net of tax,timing of acquisition-related in-process research and development expenserecognition, and bank settlement fees for debt as a result of acquisition, netof tax, as if the acquisition had occurred at the beginning of each of theperiods presented.  The unaudited pro forma financial information is notintended to represent or be indicative of the consolidated results ofoperations or financial condition of the Company that would have been reportedhad the acquisition been completed as of the dates presented, and should not betaken as representative of the future consolidated results of operations orfinancial condition of the Company.

 
|                   |   | **Three Months Ended**                       |       | **Nine Months Ended** |       |
|------------------------|--------|----------------------------------------------|------------|-----------------------|------------|
|                   |   | **Sept. 28  2003**                           |       | **Sept. 29  2002**    | ** ** | **Sept. 28  2003** | ** ** | **Sept. 29  2002** | ** ** |
|                   |   | **(in thousands, except per share amounts)** | ** ** |
| Revenue                |   | $                                            | 86,118     |                  | $          | 135,078 |   | $ | 356,913 |   | $ | 262,545 |   |
| Net  income            |   | 4,270                                        |       | 14,500                |       | 50,881 |   | 24,058 |   |
| Net  income per share: |   |                                         |       |                  |       |   |   |   |   |
| Basic                  |   | $                                            | 0.25       |                  | $          | 0.87 |   | $ | 2.96 |   | $ | 1.54 |   |
| Diluted                |   | $                                            | 0.23       |                  | $          | 0.79 |   | $ | 2.76 |   | $ | 1.37 |   |

 

11

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**Hattinger Pruf- und Entwicklungs-GmbH**

 

Effective August 1,2003, Yxlon International X-Ray GmbH, a wholly owned subsidiary of the Company,acquired Hattinger Pruf- und Entwicklungs- GmbH (“Hapeg”), a privateengineering and systems company that provides industrial testing and evaluationsolutions utilizing computed tomography, for approximately €2.9 million or $3.4million.  The acquisition was accountedfor using the purchase method of accounting. The excess purchase price over the fair value of the underlying netassets of $2.3 million was allocated to goodwill and other intangible assetsand property based upon preliminary estimates of fair values.  The Company does not believe that the finalpurchase price allocation will differ significantly from the preliminarypurchase price allocation recorded at August 1, 2003.  Estimated amortization expense of $42,000was recorded during the third quarter of 2003. The unaudited pro forma results were not provided as they were notdeemed to be material.

 

**3.****              Comprehensive Income**

 

The components ofcomprehensive income are as follows (in thousands):

 
|                                                              |   | **Three  Months Ended**      |       | **Nine  Months Ended**       |       |
|-------------------------------------------------------------------|--------|------------------------------|------------|------------------------------|------------|
|                                                              |   | **September 28,  2003** |       | **September 29,  2002** | ** ** | **September 28,  2003** | ** ** | **September 29,  2002** | ** ** |
|                                                              |   |                         | ** ** |                         | ** ** |   | ** ** |   | ** ** |
| Net  income                                                       |   | $                            | 9,276      |                         | $          | 21,473 |   | $ | 50,658 |   | $ | 33,898 |   |
| Derivatives  classified as cash flow hedges (net of taxes):       |   |                         |       |                         |       |   |   |   |   |
| Net  increase (decrease) in foreign exchange forward contracts    |   | 304                          |       | 926                          |       | 107 |   | (985 | ) |
| Net  increase in cumulative translation adjustment (net of taxes) |   | 48                           |       | —                       |       | 577 |   | — |   |
| Comprehensive  income                                             |   | $                            | 9,628      |                         | $          | 22,399 |   | $ | 51,342 |   | $ | 32,913 |   |

 

**4.****              Net Income Per Share**

 

Basic net income pershare is computed by dividing net income by the weighted-average shares ofcommon stock outstanding for the period.  Diluted net income per sharereflects the weighted-average shares of common stock outstanding plus thepotential effect of dilutive securities or contracts which are convertible toshares of common stock such as options, warrants, convertible debt andpreferred stock (using the treasury stock method) and shares issuable in futureperiods, except in cases where the effect would be anti-dilutive.

 

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

 
|                                                        |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |       |
|-------------------------------------------------------------|--------|------------------------------|--------|------------------------------|------------|
|                                                        |   | **September 28,  2003** |   | **September 29,  2002** |       | **September 28,  2003** |   | **September 29,  2002** |   |
|                                                        |   | **Income**                   |   | **Shares**                   | ** ** | **Per  Share  Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** |
| Basic net income per share                                  |   | $                            | 9,276  |                         | 17,269     |   | $ | 0.54 |   | $ | 21,473 |   | 16,740 |   | $ | 1.28 |   | $ | 50,658 |   | 17,182 |   | $ | 2.95 |   | $ | 33,898 |   | 15,671 |   | $ | 2.16 |   |
| Effect of dilutive securities:                              |   |                         |   |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Options and warrants                                        |   | —                       |   | 1,181                        |       | (0.04 | ) | — |   | 1,690 |   | (0.11 | ) | — |   | 1,233 |   | (0.20 | ) | — |   | 1,880 |   | (0.23 | ) |
| Stock payable in connection with acquisition of  subsidiary |   | —                       |   | —                       |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 10 |   | — |   |
| Diluted net income per share                                |   | $                            | 9,276  |                         | 18,450     |   | $ | 0.50 |   | $ | 21,473 |   | 18,430 |   | $ | 1.17 |   | $ | 50,658 |   | 18,415 |   | $ | 2.75 |   | $ | 33,898 |   | 17,561 |   | $ | 1.93 |   |

 

12

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**5.****              Segment Information**

 

The Company determinesits segments based on how its Chief Executive Officer and its Chief OperatingOfficer assess performance and allocate resources.  Through the firstquarter of 2003, the Company presented segment information based on threereportable segments:  EDS, Quantum and Wood.  As a result of theacquisition of Yxlon, the Company now has two reportable segments, EDS andNDT.  The “EDS” segment is comprised of the business unit that is engagedin the development, manufacturing, marketing and support of explosivesdetection systems based on advanced computed tomography technology.  The“NDT” segment is comprised of the Yxlon business unit that is engaged in thedevelopment, manufacturing, marketing and support of non-destructive testingsystems for a wide range of industrial applications.  Other segments,including Quantum, Wood and XRD, were aggregated to form an “All Other”category as they did not meet the threshold for a reportable segment.

 

Segment financial datafor the three and nine-month periods ended September 29, 2002 has beenrestated to reflect the change in reportable segments.  As of the second quarter of 2003, areportable segment line item also has been changed from net income (loss) toincome (loss) from operations. Financial information by segment is as follows(in thousands):

 
|                                        |   | **EDS** |    | **NDT** |   | **All Other** |   | **Consolidating  Eliminations** |   | **Total** |   |
|---------------------------------------------|--------|---------|---------|---------|--------|---------------|--------|---------------------------------|--------|-----------|--------|
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| **Third  quarter 2003**                     |   |    |    |    |   |          |   |                            |   |      |   |
| Revenues:                                   |   |    |    |    |   |          |   |                            |   |      |   |
| Product  revenues                           |   | $       | 48,467  |    | $      | 14,955        |   | $                               | 5,859  |      | $      | — |   | $ | 69,281 |   |
| Service  revenues                           |   | 10,098  |    | 3,082   |   | 565           |   | —                          |   | 13,745    |   |
| Contract  research and development revenues |   | —  |    | —  |   | 3,092         |   | —                          |   | 3,092     |   |
| Intercompany  revenues                      |   | 3       |    | —  |   | 16            |   | (19                             | )      | —    |   |
| Total  revenues                             |   | $       | 58,568  |    | $      | 18,037        |   | $                               | 9,532  |      | $      | (19 | ) | $ | 86,118 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| Income  (loss) from operations              |   | $       | 16,443  |    | $      | 185           |   | $                               | (479   | )         | $      | — |   | $ | 16,149 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| **September 28,  2003**                |   |    |    |    |   |          |   |                            |   |      |   |
| Total  assets                               |   | $       | 443,398 |    | $      | 48,911        |   | $                               | 21,296 |      | $      | (7,367 | ) | $ | 506,238 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| **Third  quarter 2002**                     |   |    |    |    |   |          |   |                            |   |      |   |
| Revenues:                                   |   |    |    |    |   |          |   |                            |   |      |   |
| Product  revenues                           |   | $       | 109,574 |    | $      | —        |   | $                               | 1,585  |      | $      | — |   | $ | 111,159 |   |
| Service  revenues                           |   | 3,059   |    | —  |   | 508           |   | —                          |   | 3,567     |   |
| Contract  research and development revenues |   | —  |    | —  |   | 2,334         |   | —                          |   | 2,334     |   |
| Intercompany  revenues                      |   | 19      |    | —  |   | 1,119         |   | (1,138                          | )      | —    |   |
| Total  revenues                             |   | $       | 112,652 |    | $      | —        |   | $                               | 5,546  |      | $      | (1,138 | ) | $ | 117,060 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| Income  (loss) from operations              |   | $       | 35,553  |    | $      | —        |   | $                               | (169   | )         | $      | — |   | $ | 35,384 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| **December 31,  2002**                 |   |    |    |    |   |          |   |                            |   |      |   |
| Total  assets                               |   | $       | 421,344 |    | $      | —        |   | $                               | 10,777 |      | $      | (14,334 | ) | $ | 417,787 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |   |   |   |   |   |
| **Nine  months 2003**                       |   |    |    |    |   |          |   |                            |   |      |   |
| Revenues:                                   |   |    |    |    |   |          |   |                            |   |      |   |
| Product  revenues                           |   | $       | 263,382 |    | $      | 24,273        |   | $                               | 9,435  |      | $      | — |   | $ | 297,090 |   |
| Service  revenues                           |   | 27,179  |    | 5,550   |   | 1,438         |   | —                          |   | 34,167    |   |
| Contract  research and development revenues |   | —  |    | —  |   | 9,456         |   | —                          |   | 9,456     |   |
| Intercompany  revenues                      |   | 29      |    | —  |   | 1,302         |   | (1,331                          | )      | —    |   |
| Total  revenues                             |   | $       | 290,590 |    | $      | 29,823        |   | $                               | 21,631 |      | $      | (1,331 | ) | $ | 340,713 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| Income  (loss) from operations              |   | $       | 93,411  |    | $      | (716          | )      | $                               | (6,112 | )         | $      | — |   | $ | 86,583 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| **Nine  months 2002**                       |   |    |    |    |   |          |   |                            |   |      |   |
| Revenues:                                   |   |    |    |    |   |          |   |                            |   |      |   |
| Product  revenues                           |   | $       | 193,367 |    | $      | —        |   | $                               | 5,888  |      | $      | — |   | $ | 199,255 |   |
| Service  revenues                           |   | 8,972   |    | —  |   | 1,484         |   | —                          |   | 10,456    |   |
| Contract  research and development revenues |   | 0       |    | —  |   | 8,973         |   | —                          |   | 8,973     |   |
| Intercompany  revenues                      |   | 299     |    | —  |   | 1,614         |   | (1,913                          | )      | —    |   |
| Total  revenues                             |   | $       | 202,638 |    | $      | —        |   | $                               | 17,959 |      | $      | (1,913 | ) | $ | 218,684 |   |
|                                        |   |    |    |    |   |          |   |                            |   |      |   |
| Income  (loss) from operations              |   | $       | 58,196  |    | $      | —        |   | $                               | (1,443 | )         | $      | — |   | $ | 56,753 |   |

 

 

13

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Substantially all of theCompany’s long-lived assets are located in the United States.

 

**6.****              Inventories**

 

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

 
|                                   |   | **September 28,  2003** |   | **December 31,  2002** |   |
|----------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
| Inventories:                           |   |                         |   |                        |   |
| Raw  material and purchased components |   | $                            | 24,595 |                        | $      | 22,696 |   |
| Field  service spare parts             |   | 28,095                       |   | 16,145                      |   |
| Work-in-process                        |   | 10,152                       |   | 21,927                      |   |
| Finished  goods                        |   | 13,541                       |   | 3,996                       |   |
| Total                                  |   | $                            | 76,383 |                        | $      | 64,764 |   |

 

**7.****              Accrued Liabilities**

 

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

 
|                                |   | **September 28,  2003** |   | **December 31,  2002** | ** ** |
|-------------------------------------|--------|------------------------------|--------|-----------------------------|------------|
| Accrued  liabilities:               |   |                         |   |                        |       |
| Warranty  and other reserves        |   | $                            | 17,841 |                        | $          | 19,890 |   |
| Accrued  employee compensation      |   | 10,155                       |   | 7,540                       |       |
| Income  taxes                       |   | 4,567                        |   | 17,919                      |       |
| Foreign  exchange forward contracts |   | 651                          |   | 4,948                       |       |
| Material  cost reduction accrual    |   | 6,441                        |   | 8,259                       |       |
| Other                               |   | 9,536                        |   | 6,808                       |       |
| Total                               |   | $                            | 49,191 |                        | $          | 65,364 |   |

 

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**8.****              Litigation**

 

InVision and itssubsidiary, Quantum Magnetics, together with many other entities, were named asdefendants in a number of lawsuits in approximately 100 products liabilitylawsuits by individual plaintiffs seeking damages for wrongful death relatingto the terrorist acts of September 11, 2001.  The litigation in connection with the terrorist acts ofSeptember 11, 2001 have been consolidated in In re: September 11Litigation, 21 MC 97 (AKH); Lopez, et al v. United Airlines,et al., 1:02-cv-458, United States District Court for the Southern Districtof New York.  The Company anticipatesthat additional lawsuits relating to the terrorist acts of September 11,2001 will name it as a defendant.  Todate, the Company has been served with 14 of these complaints.  All of the served complaints have beenplaced on the court’s suspense docket, and no action is permitted or requiredin these cases until December 23, 2003. Each of the served complaints alleges that the defendants breached aduty to airplane passengers and others by failing to properly screen passengersand carry-on baggage for dangerous weapons. The Company believes that the plaintiffs’ claims lack merit, especiallyin light of the fact that the Company did not, as of September 11, 2001,have any passenger or carry-on baggage screening equipment at securitycheckpoints in any of the airports from which the hijacked airplanesdeparted.  The Company intends tovigorously defend these lawsuits.

 

The Company is involvedin routine civil litigation arising in the ordinary course of business. Management believes that collectively these proceedings will not have amaterial effect on the Company’s business, financial condition or results ofoperations.

 

**9.****              FinancingArrangements**

 

**Convertible Debt Financing**

 

In September 2003,the Company completed a private offering of $125.0 million aggregate principalamount of its 3% convertible senior notes due 2023. The notes are convertibleinto the Company’s common stock, under certain circumstances, at an initialconversion rate of 31.25 shares per $1,000 principal amount of notes, subjectto adjustment. At the initial conversion rate, the notes will be convertibleinto common stock at a conversion price of $32.00 per share.  The notes will be redeemable for cash at theCompany’s option beginning on October 1, 2008. Holders of the notes havethe option to require the Company to purchase the notes in cash, in whole or inpart, on October 1 in each of 2008, 2013 and 2018. The holders of the noteswill also have the ability to require the Company to purchase the notes in theevent that the Company undergoes a change in control. In each such case, theredemption or purchase price would be at 100% of the principal amount of thenotes, plus accrued and unpaid interest to, but excluding, the redemption orpurchase date, as the case may be.

 

**Short-Term Financing**

 

As of July 19, 2003,one of the Company’s two lines of credit agreements with Silicon Valley Bankexpired.  Therefore, the Companycurrently has one line of credit agreement with Silicon Valley Bank thatprovided for maximum borrowings in an amount up to $25.0 million, which willexpire in July 2004.

 

As of September 28,2003, Yxlon had a balance of $6.6 million of draws against its lines of creditwith its German banks.

 

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**Item 2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Cautions about Forward-Looking Statements**

 

Throughout thisForm 10-Q, we make “forward-looking” statements, or statements aboutevents or circumstances that have not yet occurred. In some cases, we identifythese statements by forward-looking words such as “may,” “will,” “should,”“plans,” “believes,” “predicts,” “intends” or “continue,” and other similarterms. These forward-looking statements involve risks and uncertainties, andour actual results could differ materially. We cannot guarantee future resultsor that current expectations will be accurate, and we will not updateinformation in this Form 10-Q if any forward-looking statement later turnsout to be inaccurate. Important factors that could cause our results to differare discussed under the section ”Risk Factors.” Readers should read thisItem 2 in conjunction with the condensed consolidated financial statementsand related notes in Part I, Item 1 of this Form 10-Q, as well as“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and the consolidated financial statements and related notes in ourForm 10-K for the fiscal year ended December 31, 2002. We encouragereaders to read these sections carefully.

 

## **Overview**

## ** **

We are the leadingprovider of Transportation Security Administration, or TSA (formerly FederalAviation Administration, or FAA) certified explosives detection systems, orEDS, used at airports for screening checked passenger baggage.

 

In September 2003,we completed a private offering of $125 million aggregate principal amount ofour 3% convertible senior notes due 2023. The notes are convertible into ourcommon stock, under certain circumstances, at an initial conversion rate of31.25 shares per $1,000 principal amount of notes, subject to adjustment. Atthe initial conversion rate, the notes will be convertible into common stock ata conversion price of $32.00 per share. The notes will be redeemable for cash at our option beginning onOctober 1, 2008. Holders of the notes have the option to require us topurchase the notes in cash, in whole or in part, on October 1 in each of2008, 2013 and 2018. The holders of the notes will also have the ability torequire us to purchase the notes in the event that we undergo a change incontrol. In each such case, the redemption or purchase price would be at 100%of the principal amount of the notes, plus accrued and unpaid interest to, butexcluding, the redemption or purchase date, as the case may be.

 

On March 31, 2003,we completed the acquisition of Yxlon International Holding GmbH, or Yxlon, for$41.7 million in cash, calculated at the then effective conversion rate for theeuro, and incurred additional acquisition costs of $2.1 million for a totalpurchase price of $43.8 million.  Yxlon develops, manufactures, marketsand supports X-ray based non-destructive testing, or NDT, systems for a wide rangeof industrial applications, and systems that use X-ray based diffraction, orXRD, technology for explosives detection.  We would make an additionalpayment of €7.5 million if Yxlon’s XRD system is certified for explosivesdetection by the TSA by December 31, 2003 or €5.0 million if Yxlon’s XRDsystem is thereafter certified for explosives detection by the TSA byJune 30, 2004.  On August 1,2003, we completed the acquisition of Hattinger Pruf- und Entwicklungs- GmbH,or Hapeg, an engineering and systems company that provides industrial testingand evaluation solutions utilizing computed tomography for €2.9 million or $3.4million in cash, calculated at the then effective conversion rate for the euro.

 

Our goodwill andintangible assets increased by $34.2 million from $1.6 million atDecember 31, 2002 to $35.8 million at September 28, 2003, primarilyas a result of $31.2 million of goodwill and intangible assets acquiredpursuant to our acquisition of Yxlon, partially offset by amortization ofexisting intangible assets.  Based on an independent valuation, theintangible assets we acquired included $8.7 million of developed and coretechnology, $2.8 million of trademarks, $18.3 million of goodwill and $1.5million of other intangible assets.

 

We determine our segmentsbased on how our Chief Executive Officer and Chief Operating Officer assessperformance and allocate resources.  Through the first quarter of 2003, wepresented segment information based on three reportable segments:  EDS,Quantum and Wood.  As a result of the acquisition of Yxlon, we now havetwo reportable segments, EDS and NDT.  The “EDS” segment is comprised ofthe business unit that is engaged in the development, manufacturing, marketingand support of explosives detection systems based on advanced computedtomography technology.  The “NDT” segment is comprised of the Yxlonbusiness unit that is engaged in the

 

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development, manufacturing, marketing and support of non-destructivetesting systems for a wide range of industrial applications.  Othersegments including Quantum, Wood and XRD were aggregated to form an “All Other”category as they did not meet the threshold for a reportable segment.  SeeNote 5 of the condensed consolidated financial statements for additionalinformation about our reportable segments.

 

Our revenues areprimarily comprised of:

 

•                  EDSproduct revenues, which include revenues from sales of CTX systems, accessoriesand related installation and configuration, and EDS service revenues, whichinclude revenues from maintenance contracts related to product support,integration and other services, including those complex integrations andconfigurations that are separate from product revenues; and

 

•                  NDTproduct revenues, which include revenues from the design, assembly andinstallation of X-ray systems and associated components for industrial NDT, andNDT service revenues, which include revenues from maintenance contracts relatedto product support.

 

We market our productsand services directly through internal sales personnel and indirectly throughauthorized agents, distributors and system integrators.  In the UnitedStates, we market our products and services primarily through direct salespersonnel.  Internationally, we use a direct sales force and authorizedrepresentatives to sell our products.  International sales represented26.1% of total revenues in the first nine months of 2003 and 16.5% of totalrevenues in the first nine months of 2002.

 

*EDS*.  In anygiven fiscal quarter or year, our EDS product revenues are derived from ordersof multiple units of our products from a limited number of customers.  Forexample, in the third quarter of 2003 four customers accounted for all of ourEDS products sold during the quarter, in the first nine months of 2003 15customers accounted for all of our EDS products sold during the period, and forthe fiscal year 2002 ten customers accounted for all of our EDS products soldduring the year.  The number of our customers does not vary widely fromperiod to period.  Therefore, a cancellation or delay of an order from acustomer could have a significant negative impact on our operations in a givenperiod.  Including revenues from the Siemens subcontract to providemaintenance service for TSA-owned EDS systems, EDS sales to the FAA and,following the formation of the TSA, to the TSA, accounted for 80% of our EDSrevenues in the nine months ended September 28, 2003 and 85.4% of our EDSrevenues in the year ended December 31, 2002.  There were no otherEDS customers who accounted for more than 10% of total revenues in the firstnine months of 2003 or the year ended December 31, 2002.

 

We typically bill ourcustomers in three stages, as generally provided in our contracts with ourcustomers:

 

•                  amountsto cover the bill of materials when materials are received from suppliers,typically 30% to 40% of the total system price;

 

•                  anadditional amount upon factory acceptance or shipment ranging from 30% to 60%;and

 

•                  thebalance upon installation and site acceptance, ranging from 5% to 30%.

 

These payment termsgenerally provide the necessary working capital for acquisition of materialsand funding inventory during the manufacturing cycle.  We anticipate thatpotential future orders from the TSA will continue to provide payment termswhich provide the necessary working capital for us and our suppliers, even ifproduction volumes were to rapidly increase.  If future orders from theTSA contain different payment terms, a major increase in production rates mayrequire substantial additional working capital.

 

Payment terms for TSAinvoices are net 30 days, while terms for international invoices vary fromamounts due upon receipt of invoice to 160 days.

 

*NDT*.  Our NDTproduct and service revenues are primarily derived from sales of X-ray basedNDT products primarily to the automotive and aerospace industries.  Therewere no NDT customers who accounted for more than 10% of total revenues sincethe acquisition of Yxlon on March 31, 2003.

 

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**Results of Operations**

 

The following table setsforth certain income and expenditure items from our consolidated statements ofoperations expressed as a percentage of total revenues for the periodsindicated.

 
|                                         |   | **Three Months Ended**       |   | **Nine Months Ended**        |       |
|----------------------------------------------|--------|------------------------------|--------|------------------------------|------------|
|                                         |   | **September 28,  2003** |   | **September 29,  2002** | ** ** | **September 28,  2003** | ** ** | **September 29,  2002** | ** ** |
| Revenues:                                    |   |                         |   |                         |       |   |   |   |   |
| Product  revenues                            |   | 80.4                         | %      | 95.0                         | %          | 87.2 | % | 91.1 | % |
| Service  revenues                            |   | 16.0                         |   | 3.0                          |       | 10.0 |   | 4.8 |   |
| Contract  research and development revenues  |   | 3.6                          |   | 2.0                          |       | 2.8 |   | 4.1 |   |
| Total  revenues                              |   | 100.0                        |   | 100.0                        |       | 100.0 |   | 100.0 |   |
| Cost  of revenues:                           |   |                         |   |                         |       |   |   |   |   |
| Product  costs                               |   | 49.1                         |   | 53.7                         |       | 50.3 |   | 51.6 |   |
| Service  costs                               |   | 9.7                          |   | 2.2                          |       | 6.0 |   | 3.6 |   |
| Contract  research and development costs     |   | 2.1                          |   | 1.4                          |       | 1.7 |   | 2.8 |   |
| Total  cost of revenues                      |   | 60.9                         |   | 57.3                         |       | 58.0 |   | 58.0 |   |
| Gross  profit                                |   | 39.1                         |   | 42.7                         |       | 42.0 |   | 42.0 |   |
| Operating  expenses:                         |   |                         |   |                         |       |   |   |   |   |
| Research  and development                    |   | 6.1                          |   | 4.9                          |       | 5.9 |   | 6.5 |   |
| Selling,  general and administrative         |   | 14.3                         |   | 7.6                          |       | 9.3 |   | 9.6 |   |
| In process  research and development (Yxlon) |   | —                       |   | —                       |       | 1.3 |   | — |   |
| Total  operating expenses                    |   | 20.4                         |   | 12.5                         |       | 16.5 |   | 16.1 |   |
| Income  from operations                      |   | 18.7                         |   | 30.2                         |       | 25.5 |   | 25.9 |   |
| Interest  expense                            |   | (0.4                         | )      | (0.1                         | )          | (0.1 | ) | (0.1 | ) |
| Interest  and other income, net              |   | 0.8                          |   | 0.4                          |       | 0.6 |   | 0.2 |   |
| Income  before provision for income taxes    |   | 19.1                         |   | 30.5                         |       | 26.0 |   | 26.0 |   |
| Provision  for income taxes                  |   | 8.4                          |   | 12.2                         |       | 11.0 |   | 10.5 |   |
| Net  income                                  |   | 10.7                         | %      | 18.3                         | %          | 15.0 | % | 15.5 | % |

 

On March 31, 2003,the first day of our second quarter, we acquired Yxlon. Yxlon’s results havebeen included in our results since the acquisition date, and the operatingresults for the NDT segment also have been included only for the second andthird quarters of 2003.

 

**Revenues**

 

EDS product revenues were$48.5 million in the third quarter of 2003, a decrease of 55.8% from $109.6million in the third quarter of 2002.  EDS product revenues were $263.4million in the first nine months of 2003, an increase of 36.2% from $193.4million in the first nine months of 2002.  The revenue decrease in thethird quarter 2003 is primarily due to the fulfillment by the end of the secondquarter of 2003 of several large orders received from the TSA during2002.  The revenue increase year-to-date is mainly due to the relativelylow level of shipments to the TSA during the first three months of 2002 ascompared to the same period in 2003, as the first large TSA delivery order of2002 was not received until late in the first quarter of 2002.

 

EDS service revenues were$10.1 million for the third quarter of 2003, an increase of 230% from $3.1million in the third quarter of 2002.  EDS service revenues were $27.2million for the first nine months of 2003, an increase of 203% from $9.0million in the first nine months of 2002.  The revenue increase in thethird quarter 2003 and the nine-month period results primarily from a largernumber of units installed in the United States, and from services providedunder a contract with Siemens, which was signed in January 2003, toprovide extended hour service for our EDS products owned by the TSA in theUnited States and its territories.  We anticipate that service revenueswill increase in 2003 compared to 2002 due to services provided under theagreement with Siemens and a

 

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larger installed based of EDS coming off of warranty.  As ofSeptember 28, 2003, we had in backlog EDS equipment orders and serviceagreements of $92.8 million, primarily consisting of orders for EDS systems andservices from the TSA and international customers.

 

NDT product revenues were$15.0 million in the third quarter of 2003.  NDT service revenues were$3.1 million in the third quarter of 2003.  As of September 28, 2003,we had in backlog NDT equipment orders and service agreements of $19.5 million,primarily consisting of orders for standard industrial and custom NDTsystems.  NDT product revenues were$24.3 million in the period since the acquisition of Yxlon, and NDT servicerevenues were $5.6 million for the same period.

 

**Gross Profit**

 

Cost of EDS productrevenues primarily consists of purchased materials procured for use in theassembly of our products, as well as manufacturing labor and overhead, contractmanufacturing services, installation, training and warranty.  Cost of EDS servicerevenues primarily consists of direct labor and materials and customer supportoverhead.  In any given period, our gross profit for products and servicesmay be affected by several factors, including product mix, volume of systemsmanufactured in the period, product configuration, location of the installationand complexity of integration into various environments.

 

Gross profit for EDSproducts was $21.2 million in the third quarter of 2003, a decrease of 55.6%from $47.9 million in the third quarter of 2002.  Gross margin percentagesfor EDS products were 43.8% in the third quarter of 2003 and 43.7% in the thirdquarter of 2002.  Gross profit for EDS products was $116.7 million in thefirst nine months of 2003, an increase of 37.4% from $84.9 million in the firstnine months of 2002.  Gross margin percentages for EDS products were 44.3%in the first nine months of 2003 and 43.9% in the first nine months of2002.  The decrease in gross profit for the third quarter was due todecreased sales of our CTX products and the increase in year-to-date period isprimarily due to increased revenues.   Product gross marginpercentages for the third quarter and year-to-date periods remainedapproximately the same primarily as a result of improved manufacturing overheadper unit, offset by decreases in sales price as a result of volume orders fromthe TSA.

 

Gross profit for EDSservices were $4.2 million in the third quarter of 2003, an increase of 471%from $730,000 in the third quarter of 2002. Gross margin percentages for EDSservices were 41.3% in the third quarter of 2003 and 23.9% in the third quarterof 2002.  Gross profit for EDS services were $11.1 million in the firstnine months of 2003, an increase of 517% from $1.8 million in the first ninemonths of 2002. Gross margin percentages for EDS services were 40.8% in thefirst nine months of 2003 and 20% in the first nine months of 2002.  Theincrease in gross profit for EDS services in the third quarter and year-to-dateperiods is primarily due to increased EDS service revenues from the growinginstalled base of domestic systems covered by the Siemens contract, which callsfor extended 24-hour coverage beyond the standard warranty coverage, andservice agreements from international customers.  Gross margin percentagesimproved primarily as the result of service overhead costs being spread over alarger base of installed units.  In addition, in the first nine months of2002, we incurred costs associated with the build-up of our customer supportstaff in anticipation of an increase in EDS services as more units were sold.

 

Cost of NDT productsrevenues primarily consists of purchased materials procured for use in theassembly of our products, as well as manufacturing labor and overhead,installation, training and warranty.  Cost of NDT services revenuesprimarily consists of direct labor and materials and customer supportoverhead.  Gross profit for NDT products was $4.2 million in the thirdquarter of 2003.  Gross margin percentage for NDT products was 27.8% inthe third quarter of 2003.   Gross profit for NDT service was $1.2million in the third quarter of 2003.  Gross margin percentage for NDTservices was 39.7% in the third quarter of 2003.  For the period since the acquisition of Yxlon, gross profit forNDT products was $6.3 million, with a gross margin percentage of 26.0%.  For the period since the acquisition ofYxlon, gross profit for NDT service was $2.0 million, with a gross marginpercentage of 36.5%.

 

### **Researchand Development**

### ** **

Research and developmentexpenses consist primarily of compensation paid to personnel engaged inresearch and development activities, amounts paid for outside services andcosts of materials utilized in the

 

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development of hardware products, including prototype units. Research and development expenditures are partially offset by amountsreimbursed by the TSA and other government agencies and private entities underresearch and development contracts and grants.  These services are providedand reimbursed on a cost basis.

 

Net research anddevelopment expenses for EDS were $2.8 million in the third quarter of 2003, adecrease of 47.2 % from $5.3 million in the third quarter of 2002.  Thenet numbers reflect amounts reimbursed by the TSA of $2.0 million in the thirdquarter of 2003 and $26,000 from FAA and other government agencies in the thirdquarter of 2002.  Net research and development expenses for EDS as apercentage of EDS revenues were 4.8% in the third quarter of 2003 and 4.7% inthe third quarter of 2002.  Net research and development expenses for EDSwere $14.7 million in the first nine months of 2003, an increase of 24.7% from$11.8 million in the first nine months of 2002.  The net numbers reflectamounts reimbursed by the FAA and other government agencies of $2.0 million inthe first nine months of 2003 and $566,000 in the first nine months of2002.  Net research and development expenses for EDS as a percentage ofEDS revenues were 5.1% in the first nine months of 2003 and 5.8% in the firstnine months of 2002.  The decrease in research and development expensesfor EDS for the third quarter was due to the receipt of $2.0 million ofgovernment funding for a research project. The increase in year-to-date periods was primarily due to increasedspending on several initiatives to support our growth partially offset by thereceipt of $2.0 million of government funding for a research project. With the goal of 100% checked baggage screening in U.S. airports, we expectthat our EDS machines will be operated at or near capacity for extendedperiods.  We are investing in sustaining engineering efforts to ensurethat our products achieve high levels of serviceability and reliability whenoperating at capacity.  We are also continuing to develop productenhancements for our existing line of EDS machines.** **In addition, we arecontinuing our development of the ARGUS program, an FAA-sponsored programdesigned to develop a smaller, low-cost EDS product to scan checked baggage insmall airports and low-traffic stations within larger airports.

 

Research and developmentexpenses for NDT were $767,000 in the third quarter of 2003.  Research anddevelopment expenses for NDT as a percentage of NDT revenues were 4.3% in thethird quarter of 2003.  For the periodsince the acquisition of Yxlon, research and development expenses for NDT were$1.4 million, or 4.8% of NDT revenues.

 

### **Selling,General and Administrative**

### ** **

Selling, general andadministrative expenses consist primarily of compensation paid to direct andindirect sales and marketing personnel, administrative personnel, includingdirectors, consultant fees, professional service fees, insurance costs, travel,selling and distribution costs, and other general expenses.

 

Selling, general andadministrative expenses for EDS were $6.1 million in the third quarter of 2003,a decrease of 20.3% from $7.7 million in the third quarter of 2002. Selling, general and administrative expenses for EDS as a percentage of EDSrevenues were 10.5% in the third quarter of 2003 and 6.8% in the third quarterof 2002.  Selling, general and administrative expenses for EDS were $19.7million in the first nine months of 2003, an increase of 17.7% from $16.7million in the first nine months of 2002. Selling, general and administrativeexpenses for EDS as a percentage of EDS revenues were 6.8% in the first ninemonths of 2003 and 8.3% in the first nine months of 2002. The decrease inselling, general and administrative expenses for EDS in absolute dollars forthe third quarter of 2003 compared to the third quarter of 2002 is due to thenon-recurrence of third quarter of 2002 expenses associated with investigationsrelating to potential acquisitions offset somewhat by increases in headcountand employee-related expenses in the third quarter of 2003.  The increase in selling, general andadministrative expenses for EDS in absolute dollars for the year-to-date periodwas primarily due to an increase in headcount and employee-related expenses inthe first nine months of 2003 as compared to the same period a year ago.

 

Selling, general andadministrative expenses for NDT were $4.4 million in the third quarter of2003.  Selling, general and administrative expenses for NDT as apercentage of NDT revenues were 24.5% in the third quarter of 2003.  For the period since the acquisition ofYxlon, selling, general and administrative expenses for NDT were $7.6 million,or 25.6% of NDT revenues.

 

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### **InterestExpense**

### ** **

Interest expense was$343,000 in the third quarter of 2003 and $107,000 in the third quarter of2002. Interest expense resulted primarily from fees associated with our workingcapital lines of credit, equipment term loans, capital leases and financing forinsurance premiums and interest expense associated with long term debt. Interest expense was $488,000 in the first nine months of 2003 and $316,000 inthe first nine months of 2002. Interest expense resulted primarily from feesassociated with our working capital lines of credit, equipment term loans,capital leases and financing for insurance premiums and interest expenseassociated with long term debt.

 

### **Interest and Other Income, Net**

### ** **

Interest and otherincome, net was $667,000 in the third quarter of 2003 and $510,000 in the thirdquarter of 2002. The amount for the third quarter of 2003 consisted primarilyof interest income on cash and cash equivalents of $425,000, and other income,net of $242,000. The amount for the third quarter of 2002 consisted primarilyof interest income on cash and cash equivalents of $832,000, offset by otherexpenses, net of $322,000, including $306,000 in net foreign exchange losses,primarily on outstanding foreign exchange forward contracts atSeptember 29, 2002.

 

Interest and otherincome, net, was $2.0 million in the first nine months of 2003 and $373,000 inthe first nine months of 2002. The amount for the first nine months of 2003consisted primarily of interest income on cash and cash equivalents of$1,263,000, and other income, net of $759,000 including a net $336,000 inforeign exchange gain. The amount for the first nine months of 2002 consistedprimarily of interest income on cash and cash equivalents of $1,354,000, offsetby other expenses, net of $978,000, including $994,000 in net foreign exchangelosses, primarily on outstanding foreign exchange forward contracts atSeptember 29, 2002.

 

**Provision for Income Taxes**

 

The provision for incometaxes was $7.2 million in the third quarter of 2003 and $14.3 million in thethird quarter of 2002.  Our effective tax rate was 43.7% in the thirdquarter of 2003 and 40% in the third quarter of 2002.  The provision forincome taxes was $37.5 million in the first nine months of 2003 and $22.9million in the first nine months of 2002.  Our effective tax rate was42.5% in the first nine months of 2003 and 40.3% in the first nine months of2002.  The increase in the effective tax rates in the third quartercompared to the comparable period in the prior year is due primarily tovaluation reserves recorded against deferred tax assets related to netoperating loss carryforwards of certain Yxlon subsidiaries.  We expect that our effective tax rate willbe reduced to a limited extent in future quarters.  The increase in the first nine months of 2003 versus thecomparable period in the prior year is due to a $4.3 million expense forin-process research and development associated with the acquisition of Yxlon’sX-ray diffraction business, which was not tax deductible.  Our effectivetax rate was different than statutory tax rates primarily due to the in-processresearch and development expense described above, along with certain otherpermanent differences between book and taxable income.  AtDecember 31, 2002, we had federal and state net operating loss carryforwardsof approximately $1.8 million and $321,000 available to reduce future federaland state taxable income, respectively.  Our federal net operating losscarryforwards begin to expire in 2010 and our state net operating losscarryforwards expire in 2011.  The tax benefit of the net operating losscarryforwards may be limited due to the impact of the Tax Reform Act of1986.  Events which may cause the tax benefit to be limited include, butare not limited to, a cumulative stock ownership change of more than 50% over athree-year period and the timing of utilization of various tax benefits carriedforward.

 

### **Liquidityand Capital Resources**

### ** **

At September 28,2003, we had $282.4 million in cash and cash equivalents, compared to $159.7million at December 31, 2002.

 

Net cash provided byoperating activities was $56.7 million in the first nine months of 2003,compared to $16.9 million provided by operating activities in the first ninemonths of 2002.  Cash provided by operating activities in the first ninemonths of 2003 primarily resulted from significant accounts receivablecollections from the TSA resulting in a $90.4 million decrease in accountsreceivable.  Other significant items include net income of $50.7 million,enhanced by the non-cash effects of the $4.3 million of depreciation andamortization, and the $4.3

 

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million in-process research and development expense related to theYxlon acquisition.  Partially offsetting these increases to net cashprovided by operating activities was a $69.1 million decrease in deferredrevenue, primarily due to the shipment of units to the TSA for which depositshad been received in prior periods for long-lead shipments.  A $43.1million decrease in accounts payable and accrued liabilities also contributedto decreasing the net cash provided by operating activities.

 

Cash provided byoperating activities in the first nine months of 2002 primarily resulted from a$72.4 million increase in deferred revenues, consisting primarily oflong-lead deposits on delivery orders from the TSA, a $46.9 millionincrease in accounts payable and accrued liabilities, net income of$33.9 million enhanced by the $5.8 million effect of income taxbenefits from employee stock transactions, and the $2.6 million non-casheffect of depreciation and amortization, partially offset by a$62.5 million increase in accounts receivable, a $55.9 millionincrease in inventories, and a $23.4 million increase in other currentassets, consisting of approximately $16.8 million in prepaid inventorypurchases, approximately $6.2 million of ramp up costs to be recovered from the TSA, and a $4.4 million increase indeferred income taxes.

 

Net cash used ininvesting activities was $49.4 million in the first nine months of 2003, comparedto $1.6 million in the first nine months of 2002.  Net cash used ininvesting activities in the first nine months of 2003 resulted primarily frompayments of $41.8 million, net of cash acquired, in connection with the Yxlonacquisition.  In addition, other net cash uses were $2.6 million inacquisition of capital equipment, a $1.5 million payment for an equityinvestment and product distribution rights in SafeView, Inc., a companydeveloping an advanced personnel screening portal system, and $3.4 million forthe Hapeg acquisition.  Net cash used in investing activities in the firstnine months of 2002 resulted primarily from $3.4 million in purchases ofcapital equipment, offset by proceeds from the sale of short-term investmentsof $2.0 million.

 

Net cash provided byfinancing activities was $116.0 million in the first nine months of 2003,compared to $85.0 million in the first nine months of 2002.  Net cashprovided by financing activities in the first nine months of 2003 primarilyresulted from the issuance of  $125.0million of convertible senior debt (as discussed above in “—Overview”), offsetby related debt issuance costs of $4.4 million and a stock repurchase of $12.5million.  In addition, there was $4.9million in net proceeds from increased short-term borrowings and $3.2 millionin net proceeds from the sale of common stock under our employee stock purchaseplan and exercises of stock options.  Net cash provided by financingactivities in the first nine months of 2002 primarily resulted from $86.4 millionin net proceeds from the sale of common stock to the public and under ouremployee stock purchase plan and exercises of stock options, partially offsetby $1.3 million in repayments of short-term debt, net of proceeds.

 

As of September 28,2003, we had a line of credit agreement for our U.S. operations that providesfor maximum borrowings of $25.0 million.  Borrowings under this agreementbear interest at the bank’s prime rate minus 0.5%, for a rate of 3.5% atSeptember 28, 2003.  This agreement expires in July 2004 andrequires that the EDS segment maintain certain levels of tangible networth.  We may use proceeds of loans under this agreement for generalcorporate purposes.  At September 28, 2003, we had no borrowings outstandingunder this agreement.  However, at September 28, 2003, we hadoutstanding guarantees to customers and foreign creditors to our subsidiaryentities through the issuance of letters of credit for which a reserve of $15.8million is secured by the line of credit, and foreign exchange forwardcontracts for which a 10% reserve of $2.2 million is secured by the line ofcredit.  We had remaining available borrowing capacity under the line ofcredit of $7.0 million at September 28, 2003 based on eligible EDSaccounts receivable and inventories as of that date.

 

As of September 28,2003, we had two primary sources of financing from German banks for our Yxlonsubsidiary.  The first agreement is a line of credit that provides formaximum borrowings in an amount up to €6.6 million or approximately $7.6million at September 28, 2003.  The second agreement is also a lineof credit that provides for maximum borrowings in an amount up to €5.2 millionor approximately $5.9 million at September 28, 2003.  There is currently no expiration date forthese agreements.  Borrowings under these agreements bear interest at5.75%.  During the third quarter of2003, Yxlon borrowed $2.5 million under the lines of credit.  At September 28,2003, we had debt balances of $6.4 million outstanding under theseagreements.  In addition, at September 28, 2003, we had outstandingguarantees to customers through the issuance of letters of credit for which areserve of $6.0 million is secured by the lines of credit.  Therefore, wehad remaining available borrowing capacity under the lines of credit ofapproximately €1.0 million or $1.1 million at September 28, 2003.

 

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We believe that existingcash and cash equivalents, available borrowings under our lines of credit andfunds expected to be generated from operations will be sufficient to financeour working capital and capital expenditure requirements for at least the nexttwelve months.  However, if we fail to meet required financial covenantsin our credit agreement, or our receivables do not support the upper limits ofthe credit agreement, then we may not be able to have access to further fundsunder our credit agreement.  In addition, if we are unable to deliver EDSunits in a timely manner under orders from the TSA or if we fail to adhere tothe terms of the licensing agreement with the TSA, the TSA may cancel itsorders or not place additional orders.  If any of these events occur, ourcapital resources would be significantly impaired.

 

**Contractual Obligations and Commitments**

 

The following tabledepicts our contractual obligations as of September 28, 2003 (inthousands):

 
|                                |   | **Payments Due by Period** |       |
|-------------------------------------|--------|----------------------------|------------|
| **Contractual  Obligations**        |   | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1-3  years** | ** ** | **Thereafter** | ** ** |
| Long-term  debt                     |   | $                          | 125,000    |   | $ | — |   | $ | — |   | $ | 125,000 |   |
| Operating  leases                   |   | 22,669                     |       | 4,617 |   | 7,360 |   | 10,692 |   |
| Short-term  debt                    |   | 7,365                      |       | 7,365 |   | — |   | — |   |
| Capital  lease obligations          |   | 687                        |       | 289 |   | 392 |   | 6 |   |
| Other  long-term liabilities        |   | 683                        |       | — |   | — |   | 683 |   |
| Total  contractual cash obligations |   | $                          | 156,404    |   | $ | 12,271 |   | $ | 7,752 |   | $ | 136,381 |   |

 

### **RiskFactors**

### ** **

***Risks Related to Our Business***

 

**A number of factors that affect our revenues make our futureresults difficult to predict, and therefore we may not meet expectations for aparticular period.**

 

We believe that ourrevenues have the potential to vary significantly from time to time. Forexample, our total revenues were $89.4 million for the second quarter offiscal 2003, $165.2 million for the first quarter of fiscal 2003 and$220.4 million for the fourth quarter of fiscal 2002, and were$439.1 million for fiscal 2002, $74.3 million for fiscal 2001 and$79.1 million for fiscal 2000. We believe that these variations may resultfrom many factors, including:

 

•                  thetiming, size and mix of orders from our major customers, including inparticular, the TSA and agencies of other governments;

 

•                  legislativeor other government actions driven, in part, by the public’s perception of thethreats facing commercial aviation, leading to fluctuations in demand foraviation security products and services;

 

•                  delaysin product shipments caused by the inability of airports to install orintegrate our products in a timely fashion;

 

•                  theavailability and cost of key components;

 

•                  thetiming of completion of acceptance testing for some of our products;

 

•                  theintroduction and acceptance of new products or enhancements to existingproducts offered by us or our competitors;

 

•                  changesin pricing policies by us, our competitors or our suppliers, including possibledecreases in average selling prices of our products caused by customer volumeorders or in response to competitive pressures; and

 

•                  oursales mix to domestic and international customers.

 

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Further, we depend on asmall number of customers for a substantial portion of our revenues. In thepast, the number of orders placed by these customers has changed significantlyfrom period to period, and we expect that this may continue in the future.

 

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

 

Accordingly, we believethat period-to-period comparisons of our results of operations cannot be reliedupon as indicators of future performance. Because of all of the foregoingfactors, our operating results have from time to time in the past been, and mayagain in the future be, different from expectations of public market analystsand investors. Failure to meet market expectations has in the past resulted,and may again in the future result, in fluctuations in the trading price of ourcommon stock.

 

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

 

Substantially all of thecustomers for our EDS products and our other products under development to datehave been public agencies or quasi-public agencies, such as the FAA, the TSAand airport authorities. Public agencies are subject to budgetary processes andexpenditure constraints. In the past, many domestic and foreign governmentagencies have experienced budget deficits that have led to decreased capitalexpenditures in certain areas.

 

The funding of governmentprograms is subject to legislative appropriation. Budgetary allocations for EDSdepend, in part, upon governmental policies, which fluctuate from time to timein response to political and other factors, including the public’s perceptionof the threat of commercial airline bombings. For example, the terroristattacks of September 11, 2001 resulted in the passage of the Aviation andTransportation Security Act of 2001, or Transportation Security Act, mandatinga small surcharge on each airline ticket purchase to fund airline security.This surcharge was suspended from June 1, 2003 to September 30, 2003.We cannot assure investors that the surcharge will not again be suspended orthat the funds generated by these surcharges will be used to purchase our EDSproducts. We cannot assure investors that funds will continue to beappropriated by Congress or allocated by the TSA or other agencies for thepurchase of EDS products.

 

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

 

In addition to theCongressional budgetary process, other legislation could be introduced thatwould impact demand for aviation security products and services. In response tofluctuation in concern on the part of voters about aviation security andcompeting homeland security demands, or for other reasons, the plans fordeployment of EDS to screen baggage could be changed. Budgetary debates anddelays could result in fewer EDS being sold to the TSA and elected officialswho support the EDS program could fail to maintain their offices, any of whichevents could cause a decrease in the demand for our EDS products.

 

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

 

In contracting withpublic agencies, we are subject to public agency contract requirements thatvary from jurisdiction to jurisdiction. Future sales to public agencies willdepend, in part, on our ability to meet public agency contract requirements,certain of which may be onerous or even impossible for us to satisfy.

 

Government contractstypically contain termination provisions unfavorable to us and are subject toaudit and modification by the government at its sole discretion, which subjectus to additional risks. These risks include the ability of the U.S. governmentto unilaterally:

 

•                  suspendor prevent us for a set period of time from receiving new contracts orextending existing contracts based on violations or suspected violations oflaws or regulations;

 

•                  terminateour existing contracts;

 

•                  reducethe scope and value of our existing contracts;

 

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•                  auditand object to our contract-related costs and fees, including allocated indirectcosts;

 

•                  controland potentially prohibit the export of our products; and

 

•                  changecertain terms and conditions in our contracts.

 

The U.S. government canterminate any of its contracts with us either for its convenience or if wedefault by failing to perform in accordance with the contract schedule andterms. Termination for convenience provisions generally enable us to recoveronly our costs incurred or committed, and settlement expenses and profit on thework completed prior to termination. Termination for default provisions do notpermit these recoveries and make us liable for excess costs incurred by theU.S. government in procuring undelivered items from another source. Ourcontracts with foreign governments may contain similar provisions.Consequently, our backlog is not necessarily indicative of future revenues. Thegovernment’s termination of one or more of the contracts for our EDS productsor our other products under development would harm our business.

 

In addition, U.S.government contracts are conditioned upon the continuing availability ofCongressional appropriations. Congress usually appropriates funds annually fora given program on a September 30 fiscal year-end basis, even thoughcontract performance may take years. Consequently, our contracts with the TSAmay only be partially funded at the outset, and additional monies are normallycommitted to the contract by the TSA only as appropriations are made byCongress for future periods. The government’s failure to fully fund one or moreof the contracts for our EDS products or our other products under developmentwould harm our business.

 

Under our new three-yearagreement with the TSA announced on August 12, 2003, the TSA has the rightto purchase system options and accessories, engineering and installationsupport and 550 CTX units, principally our CTX 9000 DSi systems, over the three-yearterm. While the TSA placed an initial $54.8 million delivery order underthe new agreement, the TSA has no obligation to place additional deliveryorders or purchase additional engineering and installation support under thenew agreement. We cannot assure you that the TSA will make any additionaldelivery orders under the new agreement or will not cancel its existing order.The new agreement is subject to all of the limitations and restrictions thatapply to U.S. government contracts, including those described above.

 

Because we contract withthe U.S. government, we are subject to periodic audits and reviews. Based onthe results of its audits, the U.S. government may adjust our contract-relatedcosts and fees, including allocated indirect costs. In the future, governmentaudits and reviews could result in adjustments to our revenues and cause otheradverse effects, particularly to our relationship with the TSA. In addition,under U.S. government purchasing regulations, some of our costs, including mostfinancing costs, amortization of intangible assets, portions of our researchand development costs, and some marketing expenses may not be reimbursable orallowed in our negotiation of fixed-price contracts. Further, because wecontract with the U.S. government, we are subject to an increased risk ofinvestigations, criminal prosecution, civil fraud, whistleblower lawsuits andother legal actions and liabilities to which purely private sector companiesare not.

 

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

 

**Our growth depends on our introduction of new products andservices, which may be costly to develop and may not achieve market acceptance.**

 

As part of our strategyfor growth, we intend to develop products to address additional aviationsecurity opportunities, such as passenger, carry-on baggage and air cargoscreening. We also intend to address homeland security requirements beyondaviation, such as screening at border checkpoints, government offices andtransportation terminals and ports. We will be required to spend significantfunds to develop or acquire technologies and products for these initiatives,and these initiatives may divert our development and management resources awayfrom our core EDS products. In addition, we have acquired, rather thandeveloped internally, some of our technologies in connection with ouracquisitions of companies and businesses, and these technologies may notperform as we expect. The development

 

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of new products may require greater time and financial resources thanwe currently anticipate and, despite significant investments in research anddevelopment, may not yield commercially successful products.

 

The development of ourproducts for explosives and weapons detection is highly complex. Successfulproduct development and market acceptance of any new products and services thatwe develop depend on a number of factors, including:

 

•                  ourtimely completion and introduction of new products;

 

•                  ouraccurate prediction of the demand for homeland security products and thechanging requirements of the homeland security industry, includingcertification or other required performance standards;

 

•                  theavailability of key components of our products;

 

•                  thequality, price and operating performance of our products and those of ourcompetitors;

 

•                  ourcustomer service capabilities and responsiveness; and

 

•                  thesuccess of our relationships with existing and potential customers.

 

Finally, new products foraviation security applications may require certification or approval by theTSA, and we believe that the TSA does not currently have standards for thecertification of aviation security products other than bulk explosivesdetection systems and explosives trace detectors, or ETD. Other products, suchas metal detectors, are subject to TSA testing prior to approval. Market acceptanceof new products may be limited if the TSA has not developed standards forcertification or approval of such products, and even if it does develop suchstandards, we may be unable to obtain any such certification or approval, whichcould materially limit market acceptance of such products. If we fail to timelyintroduce new products or if these products fail to gain market acceptance, ourresults of operations would be harmed.

 

In addition, even ifsuccessful in the United States, new products that we develop may not achievemarket acceptance outside of the United States. Unlike the U.S. government,foreign governments may be unwilling to commit financial resources to purchaseour new products, which would reduce our potential revenues and harm our business.

 

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

 

Key components used inour products have been designed by us to our specifications and are currentlyavailable only from one or a limited number of suppliers. We currently do nothave long-term agreements with any of these suppliers. In addition, some of thesuppliers of the key components used in our products are our competitors, andthey may be motivated not to supply us with the components we need. Ourinability to develop alternative sources for single or sole source components,to find alternative third party manufacturers or sub-assemblers, or to obtainsufficient quantities of these components, could result in delays orinterruptions in product shipments, which could cause current or potentialcustomers to seek other suppliers of our products. In view of the high cost ofmany of these components, we strive to avoid excess supplies. If our suppliersexperience financial, operational, production or quality assurancedifficulties, or our sole source suppliers are acquired or otherwise influencedby our competitors, the supply of components to us would be reduced orinterrupted. In the event that a supplier ceases operations, discontinues aproduct or withholds or interrupts supply for any reason, we may be unable toacquire the product from alternative sources within a reasonable period oftime.

 

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

 

We plan to continue todevelop new models for our family of EDS products, including systems utilizingX-ray based diffraction, or XRD, technology, of our recently acquired subsidiary,Yxlon International Holding GmbH, or Yxlon, and to continue our participationin the ARGUS program, an FAA/TSA-sponsored program designed to develop asmaller, low-cost EDS product. However, we cannot be certain that any new EDSproduct, including systems utilizing Yxlon’s XRD technology or our CTX 1000(ARGUS) system, will be certified by the TSA. The failure to gain certificationfor an EDS product would harm our ability to sell the product, and recognizeassociated revenues.

 

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**Our existing EDS products may fail to obtain re-certificationby the TSA for changes in the EDS systems.**

 

Our existing EDS productscan be required to be re-certified by the TSA. This can happen when a criticalcomponent is changed, or we wish to make other changes to the EDS systems. Whenthis happens, the affected EDS model requires re-certification by the TSA. Thefailure or delay in gaining re-certification for an existing EDS product couldharm our ability to continue to sell the product and recognize associatedrevenues.

 

**Our major customer, the TSA, is a part of the Department ofHomeland Security, a newly created agency that has experienced, and maycontinue to experience, delays in its operations, which may cause delays in ourreceiving orders from the TSA.**

 

The TSA is a relativelynew agency that was created in November 2001 by the TransportationSecurity Act. As a result, it has experienced, and may continue to experience,delays in fulfilling its mandate as a result of delays in establishing thenecessary infrastructure to operate in an efficient manner. This may result indelays in our receiving orders for our EDS products. Further, the TSA is now apart of the Department of Homeland Security, which was created subsequent tothe creation of the TSA and is therefore in an earlier stage of formation,which may further create delays in our receiving orders as this agency isorganized.

 

**Future sales of our EDS products will depend on the abilityof airports to secure funding to build baggage handling systems and tointegrate our EDS products into such systems, which they may not be able to do.**

 

Future sales will depend,in part, on installing our EDS products into airport lobbies or integratingthem into existing baggage handling systems. If an airport is not configuredfor these systems, deployment of our EDS products may require changes in theairport infrastructure, such as reinforced airport lobby floors and baggageplatforms. If our EDS products cannot easily be installed in airport lobbies orintegrated into existing baggage handling systems, we may experience reducedsales of our EDS products or these sales may be delayed. In addition,installations and integrations are currently partially funded by the TSA in theUnited States. Recent legislation established a “letter of intent” programunder which an airport can present a request to the TSA for reimbursement ofcosts incurred by the airport in improving baggage handling systems to increasesecurity. There can be no assurance that the government will continue to fundinstallations, integrations and reimbursements at the current level or at all.If there is a reduction in funding, we may experience reduced sales of our EDSproducts or these sales may be delayed.

 

We believe that asubstantial opportunity exists for our CTX 9000 DSi model to be integrated intobaggage handling systems. If airports determine, in conjunction withgovernmental authorities, that they will be unable or unwilling to modify orfinance such in-line baggage handling systems, this opportunity may be limited.

 

**As a result of the Transportation Security Act, our EDSproducts are undergoing substantially increased usage per day, which couldcause unforeseen problems with their ability to sustain this increased usage.**

 

As required by theTransportation Security Act, as of December 31, 2002, 100% of checkedbaggage must undergo screening. As a result, our EDS products in operation arebeing used more hours per day than before, which places a burden on them notpreviously experienced. This has resulted in an increase in the amount ofmaintenance required to keep them operating, and may result in unforeseenproblems. If this were to occur, our customers could perceive that there arereliability problems with our EDS products, which could reduce the demand forour products. In addition, our CTX 9000 DSi product is a relatively new modelwith which we have limited experience in sustaining extensive usage. As aresult, our CTX 9000 DSi product may experience maintenance needs and increaseddown time beyond that experienced by our CTX 2500 and CTX 5500 DS products.Further, because the CTX 9000 DSi product is designed to be integrated into anairport’s baggage handling system, it has, in addition to the detectionfunction and mechanisms, components that integrate it into the baggage handlingsystem, which also require maintenance and may also contribute to increasedmaintenance needs and down time. If our CTX 9000 DSi product does experienceadditional maintenance needs beyond that of our CTX 2500 and CTX 5500 DSproducts, our customers may not purchase this product in favor of our CTX 2500and CTX 5500 DS products or the products of our competitors.

 

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

 

As part of our growthstrategy, we may expand our business by pursuing selected acquisitions oftechnologies and companies that offer complementary products, services,technologies or market access. Our ability to grow by acquisition depends uponthe availability of acquisition candidates at acceptable prices. We may incurcosts in connection with our pursuit of acquisitions for which we areresponsible regardless of whether the acquisitions are actually consummated.Future acquisitions by us could result in dilutive issuances of equitysecurities, the incurrence of debt and contingent liabilities and expensesrelated to acquired operations and assets, any of which could harm our businessand our operating results. Acquisitions entail numerous risks and we may notrealize the expected benefits of these transactions. These risks include:

 

•                  difficultiesin the assimilation of acquired operations, technologies and products;

 

•                  diversionof management’s attention from other business concerns;

 

•                  lackof experience operating in the geographic market or industry sector of acquiredcompanies;

 

•                  exposureto unanticipated contingent liabilities of acquired companies; and

 

•                  potentialloss of key employees of acquired companies.

 

The process ofintegrating supply and distribution channels, computer and accounting systemsand other aspects of operations, while managing a larger entity, may present asignificant challenge to our management. We may not be able to successfullyintegrate any businesses, products, technologies or personnel that might beacquired in the future. In such case, we would not fully realize theanticipated benefits of a business combination, and the failure of such effortswould harm our business. Maintaining uniform standards, controls, proceduresand policies may be harder than we anticipate and interfere with efficientadministration of the company as a whole.

 

For example, onMarch 31, 2003, we completed the acquisition of Yxlon. Yxlon is active inbusinesses that are new to us and present a challenge to our management. Inorder to successfully integrate Yxlon’s security technologies and products, wemust, among other things, integrate these into our suite of products, both froman engineering and a sales and marketing perspective. As a result, we may takelonger to develop and introduce new products than we anticipate. In addition,Yxlon’s non-destructive testing business is new to us. We do not haveexperience developing, marketing and selling products in the non-destructivetesting business, and we may not be successful competing for customers inindustries with which we are unfamiliar. The difficulties of integration ofYxlon may be further complicated by the geographic distance between our U.S.offices and Yxlon’s headquarters, which are located in Germany. If we are notsuccessful in integrating Yxlon’s security technologies into our product line,or in managing Yxlon’s non-destructive testing business, we may incuradditional expenses or lose revenue opportunities for Yxlon and us, and ourbusiness results may suffer.

 

**Our strategic investments may not provide any of the benefitswe anticipate, and as a result, we may incur economic losses or be required towrite-down these investments.**

 

From time to time, weconsider strategic investments in development-stage companies that we believeprovide strategic opportunities for us, such as our recent investment in SafeView, Inc.,which is developing portal systems for passenger screening. Although we intendthat these investments will provide access to new technologies and emergingmarkets, we cannot assure you that these investments will create opportunitiesfor us to increase our sales. If these companies are unsuccessful in theirproduct development efforts or are unable to obtain additional privatefinancing, we may be required to write-down these investments or we may losesome or all of these investments, which would harm our results.

 

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

 

We are responsible forsupporting the installation of, and providing warranty service for, our EDSproducts. With the rapid increase in the number of units being shipped, we areexpanding our service organization’s capability. EDS products are relativelycomplex machines, which employ high-speed conveyors and sophisticated imaging

 

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technology. If we are unable to hire and train sufficient servicepersonnel supported by an expanded logistical system, the reliability of ourmachines could suffer. If this were to occur, there could be a decrease indemand for our products.

 

**If our EDS products fail to detect explosives, we could beexposed to product liability and related claims for which we may not haveadequate insurance coverage, and we may lose current and potential customers.**

 

Our business exposes usto potential product liability risks, which are inherent in the manufacturing,sale and maintenance of EDS products. Our machines are not designed to detect,and FAA/TSA certification does not require, 100% detection of any and allexplosives contained in scanned baggage. For this reason, or if our productsmalfunction, it is possible that explosive material could pass undetectedthrough our products, which could lead to product liability claims. There arealso many other factors beyond our control that could lead to liability claims,such as the reliability and competence of the customer’s operators and thetraining of the operators.

 

InVision and oursubsidiary, Quantum Magnetics, were named as defendants in a number of lawsuitsrelating to the terrorist acts of September 11, 2001. We anticipate thatadditional lawsuits relating to the terrorist acts of September 11, 2001will name us as defendants. The cost of defending these and other productliability claims brought against us could be significant, and any adverse determinationmay result in liabilities in excess of our insurance coverage. We currentlyhave product liability insurance in the amount of $200.0 million. We alsohave war and terrorism insurance in the amount of $200.0 million,including up to $50.0 million under our product liability insurance.However, since the terrorist acts of September 11, 2001, insurance rateshave increased dramatically, and we cannot be certain that our currentinsurance can be maintained, or additional insurance coverage could be obtained,on acceptable terms, if at all.

 

In addition, the failureof any EDS product to detect explosives, even if due to operator error and notto the mechanical failure of an EDS product, could result in public andcustomer perception that our products do not work effectively, which may causepotential customers to not place orders and current customers to cancel ordersalready placed or to not place additional orders, any of which would harm ourbusiness and financial results.

 

**We substantially depend on large orders from a limited numberof customers. As a result, order cancellations from any of our customers or thefailure of these customers to continue to purchase EDS products could have amaterial negative impact on our business and financial results.**

 

In any given fiscalquarter or year, our revenues are derived from orders of multiple units of ourEDS products from a limited number of customers. Through September 28,2003, substantially all of our orders from U.S. customers have been funded by theFAA and the TSA, which allocate our products to airports in the United States.Including revenues from the Siemens subcontract to provide maintenance servicefor TSA-owned EDS systems, EDS sales to the FAA, and following the formation ofthe TSA, to the TSA, accounted for 79.9% of our EDS revenues in the nine monthsended September 28, 2003 and 85.4% of our EDS revenues in the year endedDecember 31, 2002. In the nine months ended September 28, 2003, 15customers accounted for all of our EDS units sold during the quarter, and inthe year ended December 31, 2002, ten customers accounted for all of ourEDS products sold during the year. The failure of these customers, particularlythe U.S. government, to continue to purchase our EDS products or the cancellationof existing orders would harm our business.

 

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

 

In connection with ordersfor EDS products, the TSA required that we grant the TSA a two-yearroyalty-bearing license, commencing in March 2002, to enable othermanufacturers to build for the TSA EDS products based on our technology used inthese products. With this license, the TSA may purchase EDS products from othermanufacturers rather than us, even if we have the manufacturing capacity tobuild those EDS products. If this happens, the royalty we receive under thelicense may not fully compensate us for the lost business opportunity. Further,since licensed manufacturers will be building substantially the same productsas we build, if we fail to timely deliver EDS products which the TSA hasordered from us, the TSA may not give us the opportunity to cure the failure todeliver, and it may transfer the order from us to a licensed manufacturer. TheTSA has not exercised this license to date.

 

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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 withFederal Acquisition Regulations included in our development contracts with theFAA, the U.S. government has rights to use our proprietary technologies developedafter the award of the development contract and funded by the developmentcontract. The U.S. government may use these rights to produce or have producedfor the U.S. government competing products using CT technology found in ourexisting EDS products as well as our CTX 1000 model, which has not yet beencertified by the TSA. With respect to Quantum, the U.S. government retains thesame rights to the passive magnetic technology found in the quadrupoleresonance, or QR, technology. In the event that the U.S. government were toexercise these rights, our competitive position in supplying the U.S.government with certified CT-based explosives detection systems and/or theQuantum products would be harmed.

 

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

 

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

 

**Our backlog is not necessarily indicative of future revenues.**

 

We measure our backlog ofproduct revenues as orders for systems and upgrades for which contracts orpurchase orders have been signed, but which have not yet been shipped. Wemeasure our backlog of service revenues as orders for maintenance related toproduct support for which contracts have been signed, but maintenance servicehas not yet been performed. We typically ship our products within three totwelve months after receiving an order. However, such shipments may be affectedby delays which occur in the delivery of components to us or our readiness toaccept delivery of components for reasons of site preparation or otherwise. Insome instances, shipments may be made more quickly depending on our ability tobuild machines to order and our customers’ demand for immediate delivery.

 

We measure our backlog ofQuantum government contracts as funded and unfunded awards from governmentagencies for which services have not yet been performed. At September 28,2003, our Quantum government contracts backlog was $16.5 million, $4.9 millionof which was funded.

 

Any failure by us to meetan agreed upon schedule could lead to the cancellation of the relatedorder. Variations in the size, complexity and delivery requirements of thecustomer order may result in substantial fluctuations in backlog from period toperiod. In addition, all orders are subject to cancellation or delay by thecustomer and, accordingly, we cannot assure investors that our backlog willeventually result in revenues. For these reasons, we believe that backlog cannotbe considered a meaningful indicator of our performance on an annual orquarterly basis.

 

**Our international sales subject us to risks that couldmaterially harm our business.**

 

Sales to countries otherthan the United States accounted for 26.1% of our revenues in the nine monthsended September 28, 2003 and 11.7% of our revenues in the year endedDecember 31, 2002. It is part of our growth strategy to increase ourinternational operations. A number of factors related to our international salesand operations could adversely affect our business, including:

 

•                  changesin domestic and foreign regulatory requirements;

 

•                  politicalinstability in the countries where we sell products;

 

•                  possibleforeign currency controls;

 

•                  fluctuationsin currency exchange rates;

 

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•                  ourability to protect and utilize our intellectual property in foreignjurisdictions;

 

•                  tariffs,embargoes or other barriers;

 

•                  difficultiesin staffing and managing foreign operations;

 

•                  difficultiesin obtaining and managing distributors; and

 

•                  potentiallynegative tax consequences.

 

Further, the sale of someof our products outside the United States is subject to compliance with theU.S. International Traffic in Arms Regulations and Export AdministrationRegulations. Our failure to obtain the requisite licenses, meet registrationstandards or comply with other government export regulations, may affect ourability to generate revenues from the sale of our products outside the UnitedStates, which could harm our business. In particular, some of our EDS productsand our landmine detection equipment are deemed regulated military devicessubject to export restrictions under the U.S. Department of State regulations.Consequently, these regulations may make these products more difficult to sellto a number of countries. Compliance with government regulations may alsosubject us to additional fees and costs. The absence of comparable restrictionson competitors in other countries may adversely affect our competitiveposition.

 

**Exchange rate fluctuations could cause a decline in ourfinancial condition and results of operations.**

 

In 2003, the cost ofcertain international currencies has increased due to fluctuations in theexchange rate of the U.S. dollar against the euro. As a result of ourinternational operations and recently acquired Yxlon operations, we generate asignificant portion of our net sales and incur a significant portion of ourexpenses in currencies other than the U.S. dollar, primarily the euro. Futurefluctuations in this exchange rate could adversely affect our results becausewe pay our non-U.S. employees and certain suppliers in local currencies, and,in some cases, our sales contracts are denominated in local currencies. From timeto time, as and when we determine it is appropriate and advisable to do so, wewill seek to mitigate the effect of exchange rate fluctuations through the useof derivative financial instruments. We cannot assure you, however, that wewill continue this practice or be successful in these efforts.

 

Yxlon, which we acquiredon March 31, 2003, generally transacts business in euros. Consequently,its financial condition and results of operations are reported in euros andthen translated into U.S. dollars at the applicable exchange rate for inclusionin our consolidated financial statements. As a result, appreciation of the U.S.dollar against the euro will have a negative impact on our reported revenuesand operating profit while depreciation of the U.S. dollar against the eurowill have a positive effect on reported revenues and operating profit.

 

**We may have warranty claims that exceed our reserves.**

 

Our EDS products aretypically sold with one-year warranties. We have established reserves for theliability associated with product warranties based on historical experiencewith warranty claims. However, our actual warranty costs, including actualmaterial usage or service delivery costs, may exceed our reserves, which couldhave an adverse effect on our operating results.

 

**We may not be selected to provide post-warranty service onour CTX systems, and if we are selected to provide post-warranty services,these services may not be profitable for us.**

 

We offer to our customersthe opportunity to buy a service contract from us, which provides for scheduledmaintenance, repairs and parts once a warranty period on a CTX system hasexpired (which is typically a one-year period). If we are not selected toprovide post-warranty service, this would harm our business. Some of ourpost-warranty service contracts contain fixed pricing terms. If our actualcosts, including actual material usage or service delivery costs, exceed ourrevenues under these service agreements, our operating results could beadversely affected. In January 2003, we entered into an agreement withSiemens pursuant to which Siemens subcontracted to us its CTX serviceobligations to the FAA/TSA. The agreement is retroactive to November 2002.Commencing in January 2003, Siemens has the option, exercisable each year,to extend the agreement for the following year, through 2007. Siemens hasexercised its option for 2003. We cannot assure investors that Siemens willrenew the agreement in subsequent years. In addition, historically, we havesold service contracts on most eligible CTX systems deployed internationally.We may not achieve this level of service contract sales in the future.

 

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

 

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

 

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

 

•                  adverselyimpact our competitive position;

 

•                  requirewrite-downs of obsolete technology;

 

•                  requireus to discontinue production of obsolete products before we can recover any orall of our related research, development and commercialization expenses; or

 

•                  requiresignificant capital expenditures beyond those currently contemplated.

 

We cannot assureinvestors that we will be able to achieve the technological advances to remaincompetitive and profitable, that new products and services will be developedand manufactured on schedule or on a cost-effective basis, thatanticipated markets will exist or develop for new products or services, or thatour existing products and services will not become technologically obsolete.

 

**The EDS industry is highly competitive. Given the anticipatedcontinuing demand for airport security products, competition may increase.**

 

The EDS industry isintensely competitive and we may not compete successfully. As a result ofincreased demand for security systems, additional companies may enter the EDSindustry. Some of our competitors, including L-3 CommunicationsHoldings, Inc. and many of the potential new entrants into the EDSindustry, have financial, technical, production and other resourcessubstantially greater than ours. We believe that some of our competitors haveEDS products undergoing TSA certification. Our failure to compete successfullycould result in lost sales and could hamper our financial results.

 

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

 

We believe that ourfuture success will be due, in part, to the continued services of our seniormanagement team. We do not have long-term employment agreements with any of ourexecutive officers. Losing the services of one or more members of ourmanagement team could negatively affect our business and our expansion efforts.We do not maintain key person life insurance policies for members of ourmanagement. We could be seriously harmed by the loss of any of our executiveofficers. The implementation of our growth strategy will require that werecruit additional members of our senior management team. In addition, in orderto manage our growth, we will need to recruit and retain additional skilledpersonnel, such as advanced engineering professionals. Our failure to recruitqualified employees in a timely manner and retain them could harm our businessand our ability to continue to grow.

 

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

 

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

 

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

 

Our success depends inpart on our ability to protect our intellectual property. Although we attemptto protect our intellectual property in the United States and other countriesthrough various methods such as patents and patent applications, trademarks,copyrights and non-disclosure agreements, there can be no assurance that wewill successfully protect our technology or that competitors will not be ableto develop similar technology independently.

 

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We have two U.S. patentsfor automatic concealed object detection systems using a pre-scan stage as usedin our CTX products. These patents expire in 2010 and 2011. The patents havenot prevented competitors from developing CT-based products which do not use apre-scan stage. The time period for filing foreign counterparts of our two U.S.EDS patents has expired, and we did not seek or obtain patent protection. Theabsence of foreign counterparts to our patents could adversely affect our abilityto prevent a competitor from using technology similar to technology used in ourCTX products. We also have a U.S. patent for a mechanical radiation shield forour CTX 9000 DSi model, which expires in 2021. We rely on this technology toincrease the speed of the baggage inspection process. We have filed otherapplications in the United States and Europe for patents covering otherfeatures contained in our CTX 9000 DSi model. We cannot assure investors 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 investors that anypatents issued to us will not be challenged, invalidated or circumvented orthat the rights granted under these patents will provide a competitiveadvantage to us. Moreover, the laws of some foreign countries do not protectintellectual property rights to the same extent as the laws of the UnitedStates, and we could experience various obstacles and high costs in protectingour intellectual property rights in foreign countries. If we are unable toobtain or maintain these protections, we may not be able to prevent thirdparties from using our intellectual property.

 

We also rely on tradesecrets, proprietary know-how and continuing technological innovation to remaincompetitive. We have taken measures to protect our trade secrets and know-how,including the use of confidentiality agreements with our employees. It ispossible that these agreements may be breached and that the available remediesfor any breach will not be sufficient to compensate us for damages incurred.

 

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

 

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

 

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

 

**We have received significant amounts of funding fromgovernment grants and contracts. We cannot assure investors that we willcontinue to receive this level of funding for future product development.**

 

The U.S. governmentcurrently plays an important role in funding the development of EDS technologyand sponsoring its deployment in U.S. airports. We performed reimbursableresearch and development for EDS products pursuant to FAA and TSA grants andcontracts totaling $886,000 for the year ended December 31, 2002. Wereceived reimbursable research and development for EDS products of $2.0 millionin the nine months ended September 28, 2003. This is a significantreduction from the $8.3 million for reimbursable research and developmentfor EDS products from FAA grants and contracts in the year endedDecember 31, 2001. We are also aware that other competitors and potentialcompetitors in the EDS market have received FAA and TSA development grants. TheU.S. government also currently funds almost all of the development of Quantumproducts, including QR and passive magnetic sensing. We had contract researchand development revenues from the U.S. government for the development ofQuantum products of $9.5 million for the nine months endedSeptember 28, 2003 and of $12.1 million for the year endedDecember 31, 2002. We cannot assure investors that additional research anddevelopment funds from the government will become available in the future orthat we will receive any of these additional funds. If the government fails tocontinue to sponsor our technology, we would have to expend more resources onproduct development, which

 

33

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could adversely affect our business. In addition, any future grants toour competitors may improve their ability to develop and market advanceddetection products and cause our customers to delay any purchase decisions,which could harm our ability to market our products.

 

**The U.S.government may obligate us to give priority to the TSA, which could harm ourrelationships with other customers.**

 

The TSA has beenauthorized by the U.S. Department of Commerce to place a priority rating on EDScontracts, which would obligate us to timely fulfill the TSA’s orders and delayany unrated or lower-rated orders. In addition, as part of any future orders,the TSA may request that we agree to timely fill its orders prior to fulfillingthe needs of any other customers. Accordingly, we may not be able to fulfillorders for our EDS products from non-U.S. government customers during a periodof demand from the U.S. government. This could cause our current and potentialnon-U.S. government customers to seek EDS products from other sources, andcould trigger financial penalties under the agreements with such customers. Wealso may lose our goodwill and relationships with these customers, which couldharm our ability to make sales in the future.

 

**Substantial leverage and debt service obligations mayadversely affect our cash flow.**

 

As a result of theconvertible debt offering that we completed in September 2003, our debtservice obligations increased substantially. There is the possibility that wemay be unable to generate cash sufficient to pay the principal of, interest onand other amounts due in respect of our indebtedness when due. We may also addequipment loans and lease lines to finance capital expenditures and may obtainadditional long-term debt, working capital lines of credit and lease lines.

 

Our substantial leveragecould have significant negative consequences, including:

 

•                  increasingour vulnerability to general adverse economic and industry conditions;

 

•                  limitingour ability to obtain additional financing;

 

•                  requiringthe dedication of a portion of our expected cash flow from operations toservice our indebtedness, thereby reducing the amount of our expected cash flowavailable for other purposes, including capital expenditures;

 

•                  limitingour flexibility in planning for, or reacting to, changes in our business andthe industry in which we compete; and

 

•                  placingus at a possible competitive disadvantage relative to less leveragedcompetitors and competitors that have better access to capital resources.

 

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

 

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

 

The trading price of ourcommon stock has been and may continue to be subject to large fluctuations,which may result in losses to investors. Our stock price may increase ordecrease in response to a number of events and factors, including:

 

•                  thelevel and changing nature of terrorist activity;

 

•                  legislativeand regulatory developments related to anti-terrorism efforts or aviationsecurity;

 

•                  ourquarterly operating results or those of other explosives detection companies;

 

•                  thepublic’s reaction to our press releases, announcements and our filings with theSecurities and Exchange Commission;

 

34

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•                  ourannouncement of an acquisition or strategic investment;

 

•                  changesin earnings estimates or recommendations by research analysts;

 

•                  changesin our relationships with customers; and

 

•                      developmentsaffecting our competitors.

 

The market price of our common stock has fluctuateddramatically since the terrorist attacks of September 11, 2001. Forexample, immediately prior to September 11, 2001, our common stock closedat $3.11 per share. Since that date, our closing stock price has risen to ahigh of $48.29 per share on March 12, 2002. On September 26, 2003,the last trading day of our third quarter of 2003, our common stock closed at$24.40 per share. In addition, the stock market has periodically experiencedsignificant price and volume fluctuations that have particularly affected themarket prices of common stock of technology companies. These changes have oftenbeen unrelated to the operating performance of particular companies. Thesebroad market fluctuations may also negatively affect the market price of ourcommon stock and the notes.

 

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

 

We are a Delawarecorporation and the anti-takeover provisions of Delaware law impose variousimpediments on the ability of a third party to acquire control of us, even if achange in control would be beneficial to our existing stockholders. Ourcertificate of incorporation provides for 5,000,000 shares of preferred stockwhich our board of directors may issue with terms determined by them withoutstockholder approval, a classified board of directors serving staggeredthree-year terms, restrictions on who may call a special meeting of stockholdersand a prohibition on stockholder action by written consent. These provisions ofDelaware law and in our charter documents could impede a merger, takeover orother business combination involving us or discourage a potential acquirer frommaking a tender offer for our common stock, which, under certain circumstances,could reduce the market value of our common stock and the notes.

 

**We may not pay cash dividends.**

 

We have not declared orpaid any cash dividends on our capital stock previously, and we have agreed notto pay cash dividends under our current bank line of credit. Historically, wehave retained earnings, if any, to support the development of our business.Payment of future dividends, if any, will be at the discretion of our board ofdirectors after taking into account various factors, including our financialcondition, operating results and current and anticipated cash needs.

 

**We may become subject to costly and time-consuming classaction litigation following significant changes in our stock price.**

 

In the past, followingperiods of volatility in the market price of a company’s securities, securitiesclass action litigation has often been instituted against such a company. Weresuch litigation to be commenced against us, we would incur substantial costsand there would be diversion of our management’s attention and resources, whichcould materially harm our business, results of operations and financialcondition.

 

## **Item3.  Quantitative andQualitative Disclosures About Market Risk**

 

Our international systemsales and maintenance contracts are generally denominated in U.S.dollars.   In instances where there are significant internationalsystem sales contracts denominated in a foreign currency, we often enter intoforward contracts to mitigate foreign exchange risk.   We do notenter into market risk sensitive instruments for trading purposes.  In thethird quarter of 2003, we entered into foreign exchange forward contracts witha total notional value of approximately $4.6 million to hedge against foreignexchange risk for contracts with international customers denominated in euros,and at September 28, 2003, December 31, 2002 and December 31,2001, we had outstanding contracts to convert euros to dollars with notionalvalues totaling $21.9 million, $34.7 million and $16.9 million, withnegative fair values of approximately $646,000 and $4.9 million and a positivefair value of $47,000, respectively.  The following table depicts thematurities of the outstanding contract amounts (in thousands):

 

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| **Contract Maturity** |   | **Within 3  months** |   | **4-6 months** |   | **7-9 months** |   | **10-12  months** |   | **13 months** |   |
|-----------------------|--------|----------------------|--------|----------------|--------|----------------|--------|-------------------|--------|---------------|--------|
| Amount at 9/28/03     |   | $                    | 13,100 |           | $      | 8,212          |   | $                 | 588    |          | $      | — |   | $ | — |   |
| Amount  at 12/31/02   |   | 13,884               |   | 18,020         |   | 2,653          |   | 99                |   |          |   |
| Amount  at 12/31/01   |   | 5,623                |   | 110            |   | 2,194          |   | 2,179             |   | 6,841         |   |
|                       |        |                      |        |                |        |                |        |                   |        |               |        |  |  |  |  |  |

 

Purchases of rawmaterials and other inventory components are primarily denominated in U.S.dollars and, when purchased in foreign currencies, are generally made on an asneeded basis. We have some advance purchase commitments in foreign currencieswith a few European suppliers. We currently do not hedge against these purchasecommitments, as the foreign exchange rate fluctuations have not had a materialadverse impact on these purchases; however, we will continue to monitor theforeign exchange rates and may enter into forward contracts to mitigate foreignexchange risk as appropriate.

 

Certain costs ofproviding warranty and maintenance services for systems sold to foreigncountries are denominated in local currencies.  To the extent exchangerates fluctuate, it could become more expensive to provide theseservices.  To date, these costs have not been significant; however, weexpect they will increase as our installed base increases.

 

We are exposed to foreigncurrency exchange rate risk inherent in our sales commitments, anticipatedsales, anticipated purchases and assets and liabilities denominated incurrencies other than the U.S. dollar. We transact business primarily in fourcurrencies worldwide, of which the most significant to our operations is theeuro. In some situations, we are a net receiver of foreign currencies andtherefore benefit from a weaker U.S. dollar and are adversely affected by astronger U.S. dollar relative to those foreign currencies in which we transactsignificant amounts of business. We performed a sensitivity analysis as ofSeptember 28, 2003, December 31, 2002 and December 31, 2001using a modeling technique that measures the change in the fair values arising froma hypothetical 10% and 15% adverse movement in the levels of foreign currencyexchange rates relative to the U.S. dollar (that is, strengthening of the U.S.dollar) with all other variables held constant. The analysis covers all of ourforeign exchange forward contracts offset by the underlying exposures. The analysis excludes balances and transactions pertaining to Yxlon. Foreign exchange rate risk is relatively low for Yxlon given that it primarilytransacts business in euros.

 

The cash flow impacts ofour sensitivity analysis as of September 28, 2003 are summarized in thefollowing table (the foreign currency exchange rates used were based on marketrates in effect at September 28, 2003):

 
|                                 |   | **Contract** |   | **Fair Value  as of  September 28,** |   | **Cash flow  impact of change in  exchange rates** |   |
|--------------------------------------|--------|--------------|--------|-------------------------------------------|--------|----------------------------------------------------|--------|
| **(in thousands)**                   |   | **Amount**   |   | **2003**                                  |   | **10% Change**                                     |   | **15% Change** |   |
| Foreign  exchange forward contracts  |   | $            | 21,900 |                                      | $      | (646                                               | )      | $ | 2,261 |   | $ | 3,391 |   |
| Accounts  receivable                 |   | 11,190       |   | 12,524                                    |   | (1,252                                             | )      | (1,879 | ) |
| Firm  orders*                        |   | 17,018       |   | 18,811                                    |   | (1,881                                             | )      | (2,822 | ) |
| Other  working capital balances, net |   | 353          |   | 205                                       |   | (21                                                | )      | (31 | ) |
| Total                                |   |         |   |                                      |   | $                                                  | (893   | ) | $ | (1,341 | ) |
|                                      |        |              |        |                                           |        |                                                    |        |  |  |  |  |  |  |

 

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* Firm orders representorders for which we have received a signed purchase order.

 

The cash flow impact ofchanges in exchange rates at September 28, 2003 is not significantlydifferent from the cash flow impact of changes in exchange rates atDecember 31, 2002.  We do not expect the impact of changes ininterest rates to have a material impact on our operations, cash flow orliquidity.  In addition, the impact of inflation has not been material onour operations, cash flow or liquidity to date.

 

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The cash flow impacts ofthe sensitivity analysis as of December 31, 2002 are summarized in thefollowing table (the foreign currency exchange rates used were based on marketrates in effect at December 31, 2002):

 
| **(in thousands)**                  |   | **Contract  Amount** |           | **Fair Value  as  of Dec. 31,  2002** |           | **Cash flow  impact of change in  exchange rates** |   |
|-------------------------------------|--------|----------------------|----------------|---------------------------------------|----------------|----------------------------------------------------|--------|
|                                |   |                 | **10% Change** |                                  | **15% Change** |                                               |
| Foreign  exchange forward contracts |   | $                    | 34,656         |                                  | $              | (4,948                                             | )      | $ | 3,973 |   | $ | 5,960 |   |
| Accounts  receivable                |   | 13,216               |           | 14,803                                |           | (1,480                                             | )      | (2,220 | ) |
| Firm  orders*                       |   | 24,123               |           | 27,390                                |           | (2,739                                             | )      | (4,109 | ) |
| Net  accounts payable               |   | (835                 | )              | (1,022                                | )              | 102                                                |   | 153 |   |
| Total                               |   |                 |           |                                  |           | $                                                  | (144   | ) | $ | (216 | ) |
|                                     |        |                      |                |                                       |                |                                                    |        |  |  |  |  |  |  |

 

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* Firm orders representorders for which we have received a signed purchase order.

 

The cash flow impact ofchanges in exchange rates at December 31, 2002 is not significantlydifferent from the cash flow impact of changes in exchange rates atDecember 31, 2001.

 

## **Item4.  Controlsand Procedures**

## ** **

The Securities and Exchange Commission defines theterm “disclosure controls and procedures” to mean a company’s controls andother procedures that are designed to ensure that information required to bedisclosed in the reports that it files or submits under the Securities ExchangeAct of 1934 is recorded, processed, summarized and reported, within the timeperiods specified in the Commission’s rules and forms.  Our chief executive officer and our chieffinancial officer, based on their evaluation of the effectiveness of our“disclosure controls and procedures” as of the end of the period covered bythis report, have concluded that our disclosure controls and procedures wereeffective for this purpose.

 

During the period coveredby this report, there have been no changes in our internal control overfinancial reporting that have materially affected or are reasonably likely tomaterially affect our internal control over financial reporting.

 

**PARTII.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

InVision and oursubsidiary, Quantum Magnetics, together with many other entities, were named asdefendants in a number of lawsuits in approximately 100 products liabilitylawsuits by individual plaintiffs seeking damages for wrongful death relatingto the terrorist acts of September 11, 2001.  The litigation in connection with the terrorist acts ofSeptember 11, 2001 have been consolidated in In re: September 11Litigation, 21 MC 97 (AKH); Lopez, et al v. United Airlines, etal., 1:02-cv-458, United States District Court for the Southern District ofNew York.  We anticipate that additionallawsuits relating to the terrorist acts of September 11, 2001 will name usas defendants.  To date, we have beenserved with 14 of these complaints.  Allof the served complaints have been placed on the court’s suspense docket, andno action is permitted or required in these cases until December 23,2003.  Each of the served complaintsalleges that the defendants breached a duty to airplane passengers and othersby failing to properly screen passengers and carry-on baggage for dangerousweapons.  We believe that theplaintiffs’ claims lack merit, especially in light of the fact that we did not,as of September 11, 2001, have any passenger or carry-on baggage screeningequipment at security checkpoints in any of the airports from which thehijacked airplanes departed.  We intendto vigorously defend these lawsuits.

 

We also are involved inlegal proceedings, claims and litigation arising in the ordinary course ofbusiness.  While the outcome of thesematters is currently not determinable, management does not believe that theultimate cost to resolve these matters will have a material adverse effect onour consolidated financial condition, results of operations or cash flows.

 

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### **Item2.  Changesin Securities**

### ** **

(c)          Underthe terms of a Purchase Agreement dated September 16, 2003, we sold $125.0million aggregate principal amount of our 3% convertible senior notes due 2023to Merrill Lynch, Pierce, Fenner & Smith Incorporated.  The issuance and sale of the notes and thesubsequent offering of the notes by the initial purchaser were exempt from theregistration provisions of the Securities Act of 1933, as amended, bySection 4(2) of the Securities Act and Rule 144A promulgated underthe Securities Act.  We sold the notesfor cash.  The aggregate offering pricewas $125.0 million and our net proceeds were approximately$120.5 million.

 

The notes will mature onOctober 23, 2023 and are convertible into our common stock on or beforethe maturity date, under certain circumstances, at an initial conversion rateof 31.25 shares per $1,000 principal amount of notes, subject to adjustment.  At the initial conversion rate, the noteswill be convertible into common stock at a conversion price of $32.00 pershare.  The notes will be redeemable forcash at our option beginning on October 1, 2008.  Holders of the notes have the option to require us to purchasethe notes in cash, in whole or in part, on October 1 in each of 2008, 2013and 2018.  The holders of the notes willalso have the ability to require us to purchase the notes in the event that weundergo a change in control.  In eachsuch case, the redemption or purchase price would be at 100% of the principalamount of the notes, plus accrued and unpaid interest to, but excluding, theredemption or purchase date, as the case may be.

 

**Item 5.  Other Information**

 

Consistent with Section 10A(i)(2) of theSecurities Exchange Act of 1934, as added by Section 202 of theSarbanes-Oxley Act of 2002, we are responsible for listing the non-auditservices approved by our Audit Committee to be performed by Deloitte &Touche LLP, our external auditor. Non-audit services are defined as servicesother than those provided in connection with an audit or a review of ourfinancial statements.  During thequarterly period covered by this filing, the Audit Committee approvedengagements of Deloitte & Touche LLP for the following non-audit services:

 

•                  taxservices, which includes consulting related to (1) the review of federal andstate tax returns; (2) general tax consulting; and (3) sales and use taxconsulting; and

 

•                  audit-relatedservices, which includes consulting related to the (1) audit of the financialstatements of our subsidiary, Yxlon International X-Ray GmbH; and (2) review ofthe reporting package and consolidation of our German subsidiaries.

 

**Item 6.****           Exhibits and Reports on Form 8-K**

 

(a)          Exhibits

 
| 2.1  |   | Share and Purchase Transfer  Agreement dated as of February 21, 2003 among the registrant, Yxlon  Beteiligungs-Verwaltung GmbH, NDT International Holdings A.S, Yxlon  International Holding GmbH, Yxlon International X-Ray GmbH, Joseph  Kosanetzky, Reinhard Bonisch and Botts & Company Ltd. (1) |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1  |   | Amended and Restated  Certificate of Incorporation of the registrant. (2)                                                                                                                                                                                                                                     |
| 3.2  |   | Amendment to Amended  and Restated Certificate of Incorporation of the registrant (3)                                                                                                                                                                                                                         |
| 3.3  |   | Bylaws of the  registrant, as amended. (4)                                                                                                                                                                                                                                                                    |
| 4.1  |   | Reference is made to  Exhibits 3.1 through 3.3.                                                                                                                                                                                                                                                               |
| 4.2  |   | Indenture, dated as of September 19, 2003, between  the registrant and U.S. Bank National Association, as Trustee. (5)                                                                                                                                                                                   |
| 4.3  |   | Registration Rights Agreement, dated as of  September 19, 2003 between the registrant and Merrill Lynch, Pierce,  Fenner & Smith Incorporated. (5)                                                                                                                                                   |
| 4.4  |   | Form of Note for the registrant’s 3% Convertible Senior  Notes due October 1, 2023. (4)                                                                                                                                                                                                             |
| 10.1 |   | Solicitation, Offer and Award dated August 5, 2003,  between the registrant and the TSA (the “Frame Agreement”). (5) *                                                                                                                                                                         |
| 10.2 |   | Delivery Order #1 from the TSA under the Frame Agreement.  (5) *                                                                                                                                                                                                                                              |

 

38

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| 10.3 |   | Amendment of Solicitation/Modification of Contract  between the Company and the TSA (the “Definitized Letter Agreement”). (5) * |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4 |   | Delivery Order #8 from the TSA under the Definitized  Letter Agreement.(5)                                                                |
| 10.5 |   | Amendment to Delivery Order Delivery Order #5 from the  TSA under the Definitized Letter Agreement. (5) *                                 |
| 10.6 |   | Amendment to Delivery Order Delivery Order #3 from the  TSA under the Definitized Letter Agreement. (5) *                                 |
| 10.7 |   | Amendment to Loan  Documents dated as of August 13, 2003 between the registrant and Silicon  Valley Bank.                            |
| 31.1 |   | Section 302  Certification of Chief Executive Officer.                                                                               |
| 31.2 |   | Section 302 Certification  of Chief Financial Officer.                                                                               |
| 32.1 |   | Certificate of Chief  Executive Officer and Chief Financial Officer.                                                                      |

 

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(1)          Filed as an exhibit tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedMarch 30, 2003 and incorporated herein by reference.

 

(2)          Filed as an exhibit tothe registrant’s Registration Statement on Form S-1 (No. 333-05517) andincorporated herein by reference.

 

(3)          Filed as an exhibit tothe registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2001 and incorporated herein by reference.

 

(4)          Filed as an exhibit tothe registrant’s Quarterly Report on Form 10-Q for the quarter ended June 29,2003 and incorporated herein by reference.

 

(5)          Filed as an exhibit tothe registrant’s Registration Statement on Form S-3 (No. 333-110289) andincorporated herein by reference.

 

*                 Confidentialtreatment has been requested for portions of this exhibit.

 

(b)         Report on Form 8-Kfiled during the fiscal quarter ended September 28, 2003:  On July 22, 2003, we filed a currentreport on Form 8-K, pursuant to Item 12 thereof, furnishing a copy ofa press release titled “InVision Technologies Reports Second-Quarter Earnings”and dated July 22, 2003.

 

On September 9,2003, we filed a current report on Form 8-K, pursuant to Item 5 thereof,furnishing a copy of press releases titled “InVision Technologies, Inc.Announces Proposed Private Offering of Convertible Senior Notes” and “InVisionTechnologies, Inc. Announces Pricing of Private Offering of Convertible SeniorNotes,” dated August 12, 2003 and September 16, 2003, respectively.

 

39

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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: November 10,  2003 | /s/ Sergio Magistri                                                                               |   |
|                          | Sergio Magistri, Ph.D.                                                                            |
|                          | President and Chief  Executive Officer*(Authorized  Officer)*                                     |
|                          |                                                                                              |
|                          |                                                                                              |
| Date: November 10,  2003 | /s/ Ross Mulholland                                                                               |   |
|                          | Ross Mulholland                                                                                   |
|                          | Senior Vice President  and Chief Financial Officer*(Principal  Financial and Accounting Officer)* |

 

40

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EXHIBIT INDEX

 

**Exhibit**

 
| 2.1  |   | Share and Purchase  Transfer Agreement dated as of February 21, 2003 among the registrant,  Yxlon Beteiligungs-Verwaltung GmbH, NDT International Holdings A.S, Yxlon  International Holding GmbH, Yxlon International X-Ray GmbH, Joseph  Kosanetzky, Reinhard Bonisch and Botts & Company Ltd. (1) |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1  |   | Amended and Restated  Certificate of Incorporation of the registrant. (2)                                                                                                                                                                                                                                     |
| 3.2  |   | Amendment to Amended  and Restated Certificate of Incorporation of the registrant (3)                                                                                                                                                                                                                         |
| 3.3  |   | Bylaws of the  registrant, as amended. (4)                                                                                                                                                                                                                                                                    |
| 4.1  |   | Reference is made to  Exhibits 3.1 through 3.3.                                                                                                                                                                                                                                                               |
| 4.2  |   | Indenture, dated as of September 19, 2003, between  the registrant and U.S. Bank National Association, as Trustee. (5)                                                                                                                                                                                   |
| 4.3  |   | Registration Rights Agreement, dated as of  September 19, 2003 between the registrant and Merrill Lynch, Pierce,  Fenner & Smith Incorporated. (5)                                                                                                                                                   |
| 4.4  |   | Form of Note for the registrant’s 3% Convertible Senior  Notes due October 1, 2023. (4)                                                                                                                                                                                                             |
| 10.1 |   | Solicitation, Offer and Award dated August 5, 2003,  between the registrant and the TSA (the “Frame Agreement”). (5) *                                                                                                                                                                         |
| 10.2 |   | Delivery Order #1 from the TSA under the Frame Agreement.  (5) *                                                                                                                                                                                                                                              |
| 10.3 |   | Amendment of Solicitation/Modification of Contract  between the Company and the TSA (the “Definitized Letter Agreement”). (5) *                                                                                                                                                                     |
| 10.4 |   | Delivery Order #8 from the TSA under the Definitized  Letter Agreement.(5)                                                                                                                                                                                                                                    |
| 10.5 |   | Amendment to Delivery Order Delivery Order #5 from the  TSA under the Definitized Letter Agreement. (5) *                                                                                                                                                                                                     |
| 10.6 |   | Amendment to Delivery Order Delivery Order #3 from the  TSA under the Definitized Letter Agreement. (5) *                                                                                                                                                                                                     |
| 10.7 |   | Amendment to Loan  Documents dated as of August 13, 2003 between the registrant and Silicon  Valley Bank.                                                                                                                                                                                                |
| 31.1 |   | Section 302  Certification of Chief Executive Officer.                                                                                                                                                                                                                                                   |
| 31.2 |   | Section 302  Certification of Chief Financial Officer.                                                                                                                                                                                                                                                   |
| 32.1 |   | Certificate of Chief  Executive Officer and Chief Financial Officer.                                                                                                                                                                                                                                          |

 

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(1)          Filed as an exhibit tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedMarch 30, 2003 and incorporated herein by reference.

 

(2)          Filed as an exhibit tothe registrant’s Registration Statement on Form S-1 (No. 333-05517) andincorporated herein by reference.

 

(3)          Filed as an exhibit tothe registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2001 and incorporated herein by reference.

 

(4)          Filed as an exhibit tothe registrant’s Quarterly Report on Form 10-Q for the quarter ended June 29,2003 and incorporated herein by reference.

 

(5)          Filed as an exhibit tothe registrant’s Registration Statement on Form S-3 (No. 333-110289) andincorporated herein by reference.

 

*                 Confidentialtreatment has been requested for portions of this exhibit.

 

 

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