**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|
|       | **For the quarterly  period ended June 29, 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          ** |

 

**CommissionFile Number: 0-28236**

 

**INVISIONTECHNOLOGIES, INC.**

(Exact name ofregistrant as specified in its charter)

 

**Delaware**

(State or other jurisdiction of incorporationor organization)

 

**94-3123544**

(I.R.S. Employer Identification No.)

 

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

(Address of principal executive offices,including zip code)

 

**(510)739-2400**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý   No  o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act). Yes  ý   No  o

 

On July 15,2003, there were 17,266,870 shares of the registrant’s common stockoutstanding.

 

 

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**InVisionTechnologies, Inc.**

**Form 10-Q**

**INDEX**

 
| **PART  I.  FINANCIAL INFORMATION** |
|-----------------------------------------------|
|                                          |
| **Item**                                      |   |
|                                          |   |   |
| 1.                                            | Financial Statements |
|                                          |   |   |
|                                          | a. | Condensed Consolidated Balance Sheets –  June 29, 2003 and December 31, 2002 |
|                                          |   |   |
|                                          | b. | Condensed Consolidated Statements of  Operations - Three and six months ended June 29, 2003 and June 30, 2002 |
|                                          |   |   |
|                                          | c. | Condensed Consolidated Statements of Cash  Flows - Six months ended June 29, 2003 and June 30, 2002 |
|                                          |   |   |
|                                          | d. | Notes to Condensed Consolidated Financial  Statements |
|                                          |   |   |
| 2.                                            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                          |   |
| 3.                                            | Quantitative and Qualitative Disclosures  about Market Risk |
|                                          |   |
| 4.                                            | Controls and Procedures |
|                                          |   |
| **PART  II.  OTHER INFORMATION**    |
|                                          |
| **Item**                                      |
|                                          |
| 1.                                            | Legal Proceedings |
|                                          |   |
| 4.                                            | Submission of Matters to a Vote of Security  Holders |
|                                          |   |
| 5.                                            | Other Information |
|                                          |   |
| 6.                                            | Exhibits and Reports on Form 8-K |
|                                          |   |
| Signature  Page                               |
|                                          |   |
| Certification  of Dr. Sergio Magistri         |
|                                          |   |
| Certification  of Ross Mulholland             |

 

InVision, Quantum Magnetics, QScan, Yxlon, CTX, CTX 5500 DS and CTX9000 DSi, among others, are trademarks of InVision Technologies, Inc. or one ofits subsidiaries in the United States and other countries.   InVision, Quantum Magnetics, QScan andYxlon among others, are registered trademarks marks of InVision Technologies,Inc. or one of its subsidiaries in the United States.

----

 

**PART I. FINANCIAL INFORMATION**

 

### **Item 1.  Financial Statements**

 

**InVisionTechnologies, Inc.**

**CondensedConsolidated Balance Sheets**

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

**(Unaudited)**

 
|                                                                                                                                                   |   | **June 29,  2003** |    | **December  31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|-------------------------|--------|
| **Assets**                                                                                                                                             |   |               |    |                    |   |
| Current assets:                                                                                                                                        |   |               |    |                    |   |
| Cash and cash equivalents                                                                                                                              |   | $                  | 162,977 |                    | $      | 159,736 |   |
| Accounts receivable, net                                                                                                                               |   | 64,411             |    | 146,295                 |   |
| Inventories                                                                                                                                            |   | 80,323             |    | 64,764                  |   |
| Deferred income taxes                                                                                                                                  |   | 20,648             |    | 20,889                  |   |
| Other current assets                                                                                                                                   |   | 9,340              |    | 15,811                  |   |
| Total current assets                                                                                                                                   |   | 337,699            |    | 407,495                 |   |
| Property and equipment, net                                                                                                                            |   | 9,750              |    | 7,225                   |   |
| Deferred income taxes                                                                                                                                  |   | 812                |    | 1,050                   |   |
| Intangible assets, net                                                                                                                                 |   | 32,235             |    | 1,603                   |   |
| Other assets                                                                                                                                           |   | 1,816              |    | 414                     |   |
| Total assets                                                                                                                                           |   | $                  | 382,312 |                    | $      | 417,787 |   |
| **Liabilities and stockholders’ equity**                                                                                                          |   |               |    |                    |   |
| Current liabilities:                                                                                                                                   |   |               |    |                    |   |
| Accounts payable                                                                                                                                       |   | $                  | 15,217  |                    | $      | 28,477 |   |
| Accrued liabilities                                                                                                                                    |   | 62,194             |    | 65,364                  |   |
| Deferred revenue                                                                                                                                       |   | 14,828             |    | 86,284                  |   |
| Short-term debt                                                                                                                                        |   | 5,588              |    | 184                     |   |
| Current maturities of long-term obligations                                                                                                            |   | 271                |    | 112                     |   |
| Total current liabilities                                                                                                                              |   | 98,098             |    | 180,421                 |   |
| Long-term obligations                                                                                                                                  |   | 2,303              |    | 653                     |   |
|                                                                                                                                                   |   |               |    |                    |   |
| 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;  17,495,000 and 17,243,000 shares issued; 17,260,000 and 17,008,000 shares  outstanding |   | 17                 |    | 17                      |   |
| Additional paid-in capital                                                                                                                             |   | 169,659            |    | 166,243                 |   |
| Deferred stock compensation expense                                                                                                                    |   | (339               | )       | (406                    | )      |
| Accumulated other comprehensive loss                                                                                                                   |   | (1,450             | )       | (1,783                  | )      |
| Retained earnings                                                                                                                                      |   | 116,218            |    | 74,836                  |   |
| Treasury stock, at cost (235,000 and  235,000 shares)                                                                                                  |   | (2,194             | )       | (2,194                  | )      |
| Total stockholders’ equity                                                                                                                        |   | 281,911            |    | 236,713                 |   |
| Total liabilities and stockholders’ equity                                                                                                        |   | $                  | 382,312 |                    | $      | 417,787 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

1

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**InVision Technologies, Inc.**

**Condensed Consolidated Statements ofOperations**

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

**(Unaudited)**

 
|                                        |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|---------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                        |   | **June 29,  2003**      |   | **June 30,  2002**    |   | **June 29,  2003** |   | **June 30,  2002** |   |
| Revenues:                                   |   |                    |   |                  |   |   |   |   |   |
| Product revenues                            |   | $                       | 74,995 |                  | $      | 62,001 |   | $ | 227,809 |   | $ | 88,096 |   |
| Service revenues                            |   | 11,513                  |   | 3,423                 |   | 20,422 |   | 6,889 |   |
| Contract research and development revenues  |   | 2,919                   |   | 3,002                 |   | 6,364 |   | 6,639 |   |
| Total revenues                              |   | 89,427                  |   | 68,426                |   | 254,595 |   | 101,624 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Cost of revenues:                           |   |                    |   |                  |   |   |   |   |   |
| Product costs                               |   | 44,452                  |   | 35,007                |   | 129,126 |   | 49,924 |   |
| Service costs                               |   | 7,167                   |   | 2,994                 |   | 12,167 |   | 5,308 |   |
| Contract research and development costs     |   | 1,933                   |   | 1,989                 |   | 4,069 |   | 4,532 |   |
| Total cost of revenues                      |   | 53,552                  |   | 39,990                |   | 145,362 |   | 59,764 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Gross profit                                |   | 35,875                  |   | 28,436                |   | 109,233 |   | 41,860 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Operating expenses:                         |   |                    |   |                  |   |   |   |   |   |
| Research and development                    |   | 7,646                   |   | 4,718                 |   | 15,001 |   | 8,030 |   |
| Selling, general and administrative         |   | 10,436                  |   | 6,655                 |   | 19,498 |   | 12,034 |   |
| In-process research and development (Yxlon) |   | 4,300                   |   | —                |   | 4,300 |   | — |   |
| Total operating expenses                    |   | 22,382                  |   | 11,373                |   | 38,799 |   | 20,064 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Income from operations                      |   | 13,493                  |   | 17,063                |   | 70,434 |   | 21,796 |   |
| Interest expense                            |   | (103                    | )      | (116                  | )      | (145 | ) | (210 | ) |
| Interest and other income (expenses), net   |   | 670                     |   | (694                  | )      | 1,355 |   | (564 | ) |
| Income before provision for income taxes    |   | 14,060                  |   | 16,253                |   | 71,644 |   | 21,022 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Provision for income taxes                  |   | 7,085                   |   | 6,647                 |   | 30,262 |   | 8,598 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Net income                                  |   | $                       | 6,975  |                  | $      | 9,606 |   | $ | 41,382 |   | $ | 12,424 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Net income per share:                       |   |                    |   |                  |   |   |   |   |   |
| Basic                                       |   | $                       | 0.41   |                  | $      | 0.58 |   | $ | 2.41 |   | $ | 0.82 |   |
| Diluted                                     |   | $                       | 0.38   |                  | $      | 0.52 |   | $ | 2.25 |   | $ | 0.73 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Weighted average shares outstanding:        |   |                    |   |                  |   |   |   |   |   |
| Basic                                       |   | 17,210                  |   | 16,579                |   | 17,139 |   | 15,132 |   |
| Diluted                                     |   | 18,415                  |   | 18,387                |   | 18,397 |   | 17,124 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

2

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**InVisionTechnologies, Inc.**

**CondensedConsolidated Statements of Cash Flows**

**(Inthousands)**

**(Unaudited)**

 
|                                                                              |   | **Six Months  Ended** |       |
|-----------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                              |   | **June 29,  2003**    |       | **June 30,  2002** |   |
| **Cash flow from operating activities:**                                          |   |                  | ** ** |   | ** ** |
| Net income                                                                        |   | $                     | 41,382     |   | $ | 12,424 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities |   |                  |       |   |   |
| Depreciation and amortization                                                     |   | 2,363                 |       | 1,695 |   |
| Deferred income taxes                                                             |   | (487                  | )          | 55 |   |
| Loss on disposal of fixed assets                                                  |   | 536                   |       | 430 |   |
| Bad debt expense                                                                  |   | 284                   |       | 32 |   |
| Income tax benefit from employee stock  transactions                              |   | 1,193                 |       | 5,088 |   |
| Stock compensation expense                                                        |   | 109                   |       | 572 |   |
| In-process research and development (Yxlon)                                       |   | 4,300                 |       | — |   |
|                                                                              |   |                  |       |   |   |
| Changes in operating assets and  liabilities:                                     |   |                  |       |   |   |
| Accounts receivable                                                               |   | 92,698                |       | (26,530 | ) |
| Inventories                                                                       |   | 4,245                 |       | (38,358 | ) |
| Other current assets                                                              |   | 6,585                 |       | (10,345 | ) |
| Accounts payable                                                                  |   | (21,456               | )          | 23,137 |   |
| Accrued liabilities                                                               |   | (11,760               | )          | 10,207 |   |
| Deferred revenues                                                                 |   | (77,649               | )          | 111,660 |   |
| Other                                                                             |   | 33                    |       | 328 |   |
| Net cash provided by operating activities                                         |   | 42,376                |       | 90,395 |   |
|                                                                              |   |                  |       |   |   |
| **Cash flow from investing activities:**                                          |   |                  |       |   |   |
| Purchases of property and equipment                                               |   | (1,765                | )          | (2,239 | ) |
| Proceeds from short-term investments                                              |   | —                |       | 1,992 |   |
| Purchase of Yxlon subsidiary, net of cash  acquired                               |   | (41,830               | )          | — |   |
| Purchase of other long-term investments, net                                      |   | (1,500                | )          | (183 | ) |
| Net cash used in investing activities                                             |   | (45,095               | )          | (430 | ) |
|                                                                              |   |                  |       |   |   |
| **Cash flow from financing activities:**                                          |   |                  |       |   |   |
| Net proceeds from (repayments of)  short-term debt                                |   | 3,769                 |       | (516 | ) |
| Repayments of long-term debt                                                      |   | (136                  | )          | (99 | ) |
| Proceeds from issuance of common stock, net                                       |   | 2,181                 |       | 86,274 |   |
| Net cash provided by financing activities                                         |   | 5,814                 |       | 85,659 |   |
|                                                                              |   |                  |       |   |   |
| Effect of exchange rate changes on cash                                           |   | 146                   |       | — |   |
| Net change in cash and cash equivalents for  the period                           |   | 3,241                 |       | 175,624 |   |
| Cash and cash equivalents at beginning of  period                                 |   | 159,736               |       | 11,386 |   |
| **Cash and cash equivalents at end of period**                                    |   | $                     | 162,977    |   | $ | 187,010 |   |
|                                                                              |   |                  |       |   |   |
| **Supplemental disclosures of cash flow  information:**                           |   |                  |       |   |   |
| Interest paid                                                                     |   | $                     | 138        |   | $ | 258 |   |
| Income taxes paid                                                                 |   | $                     | 37,153     |   | $ | 2 |   |
|                                                                              |   |                  |       |   |   |
| **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 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

 

3

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**InVisionTechnologies, Inc.**

**Notes to Condensed Consolidated FinancialStatements**

**(Unaudited)**

 

**1.****                                      Summaryof Significant Accounting Policies**

 

**InterimUnaudited Financial Information**

 

The accompanying interim unaudited condensed consolidated****financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America (“generally acceptedaccounting principles”) for interim financial information and in accordancewith the instructions to Form 10-Q and Rule 10-01 of RegulationS-X.  Accordingly, they do not containall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, the accompanying unaudited condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments) considered necessary for a fairpresentation.  These financialstatements should be read in conjunction with the audited consolidatedfinancial statements of InVision Technologies, Inc. and its subsidiaries (the“Company”) as of December 31, 2002 and 2001 and for each of the three years inthe period ended December 31, 2002, including the notes thereto, included inthe Company’s Annual Report on Form 10-K filed on March 28, 2003.

 

Operating results for the three and six-month periods ended June 29,2003 may not necessarily be indicative of the results that may be expected forthe year ended December 31, 2003 or any other future period.

 

**BusinessCombinations and Goodwill and Other Intangible Assets**

 

On January 1, 2002, the Company adopted Statement of FinancialAccounting Standards (“SFAS”) No. 142, “Goodwill and Other IntangibleAssets” (“SFAS 142”).  SFAS 142addresses the initial recognition and measurement of intangible assets acquiredoutside of a business combination and the accounting for goodwill and otherintangible assets subsequent to their acquisition.  SFAS 142 provides that intangible assets with finite useful livesbe amortized and that goodwill and intangible assets with indefinite lives notbe amortized, but will rather be tested at least annually for impairment.  Since adopting SFAS 142 on January 1, 2002,the Company ceased amortization of the carrying value of goodwill of $2.5million and acquired workforce of $331,000 at January 1, 2002, resulting in areduction in annual amortization expense of $426,000.  The net carrying amount of acquired workforce was alsoreclassified to goodwill.  In the fourthquarter of 2002, the Company performed the annual impairment test required bythe standard and recorded a $2.1 million impairment of goodwill relating to theInovec reporting unit.

 

**Accountingfor Costs Associated with Exit or Disposal Activities**

 

On January 1, 2003, the Company adopted SFAS No. 146, “Accounting forCosts Associated with Exit or Disposal Activities” (“SFAS 146”), whichaddresses accounting for restructuring and similar costs.  SFAS 146supersedes previous accounting guidance, principally Emerging Issues Task Force(“EITF”) Issue No. 94-3 (“EITF 94-3”).  SFAS 146 requires that theliability for costs associated with an exit or disposal activity be recognizedwhen the liability is incurred.  Under EITF 94-3, a liability forexit costs was recognized at the date of the Company’s commitment to an exitplan.  SFAS 146 also establishes that the liability should initiallybe measured and recorded at fair value.  Accordingly, SFAS 146 may affectthe timing of recognizing future restructuring costs as well as the amountsrecognized.  There was no effect on theCompany’s financial statements from the adoption of SFAS 146.

 

**Accountingfor Stock-Based Compensation**

 

In December 2002, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition andDisclosure – an Amendment of FASB Statement 123” (“SFAS 148”), which providesalternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation.  Inaddition, SFAS 148 amends the disclosure

 

4

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requirements of SFASNo. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) torequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reported results.  The amended disclosurerequirements of SFAS 148 are effective for years ending after December 15,2002.

 

The Company grants stock options for a fixed number of shares toemployees with an exercise price equal to the fair value of the shares at thedate of grant. The Company accounts for employee stock-based compensation inaccordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”). The Company accounts forstock-based awards to non-employees in accordance with SFAS 123 and EITFIssue No. 96-18, “Accounting for Equity Instruments That Are Issued toOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices.”

 

Had compensation cost for options granted and shares issued in 2003 and2002 under the Company’s stock option plans (the “Equity Plans”) and employeestock purchase plans (the “Purchase Plans”) been determined based on the fairvalue at the grant and issue dates, as prescribed in SFAS 123, the Company’snet income and pro forma net income per share would have been as follows (inthousands, except per share data):

 
|                                                                                       |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|--------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                                                                       |   | **June 29,  2003**      |   | **June 30,  2002**    |   | **June 29,  2003** |   | **June 30,  2002** |   |
| Net income:                                                                                |   |                    |   |                  |   |   |   |   |   |
| As reported                                                                                |   | $                       | 6,975  |                  | $      | 9,606 |   | $ | 41,382 |   | $ | 12,424 |   |
| add:  stock compensation as reported,  net of tax effects                             |   | $                       | 44     |                  | $      | 20 |   | $ | 64 |   | $ | 40 |   |
| less:  stock compensation determined  using the fair value method, net of tax effects |   | (2,209                  | )      | (1,530                | )      | (4,086 | ) | (2,582 | ) |
| Pro forma                                                                                  |   | $                       | 4,810  |                  | $      | 8,096 |   | $ | 37,360 |   | $ | 9,882 |   |
|                                                                                       |   |                    |   |                  |   |   |   |   |   |
| Pro forma net income per share:                                                            |   |                    |   |                  |   |   |   |   |   |
| Basic:                                                                                     |   |                    |   |                  |   |   |   |   |   |
| As reported                                                                                |   | $                       | 0.41   |                  | $      | 0.58 |   | $ | 2.41 |   | $ | 0.82 |   |
| Pro forma                                                                                  |   | $                       | 0.28   |                  | $      | 0.49 |   | $ | 2.18 |   | $ | 0.65 |   |
| Diluted:                                                                                   |   |                    |   |                  |   |   |   |   |   |
| As reported                                                                                |   | $                       | 0.38   |                  | $      | 0.52 |   | $ | 2.25 |   | $ | 0.73 |   |
| Pro forma                                                                                  |   | $                       | 0.26   |                  | $      | 0.44 |   | $ | 2.03 |   | $ | 0.58 |   |

 

Under the intrinsic value method, when the exercise price of theCompany’s employee stock options equals or exceeds the market price of theunderlying stock on the date of grant, no compensation expense isrecognized.  The pro forma informationregarding the results of operations and net loss per share above is determinedas if the Company had accounted for its employee stock options using the fairvalue method. Under this method, the fair value of each option granted isestimated on the date of grant using the Black-Scholes option valuation model.

 

Optionvaluation models such as Black-Scholes were developed for use in estimating thefair value of traded options that have no vesting restrictions and are fullytransferable. In addition, option valuation models require the input of highlysubjective assumptions, including the expected life of the option. Inmanagement’s opinion, the existing models do not necessarily provide a reliablesingle measure of the fair value of the Company’s employee stock optionsbecause the Company’s employee stock options have characteristics significantlydifferent from those of traded options and because changes in the subjective assumptionsrequired by these models can materially affect the fair value estimates.

 

5

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The fair value of each option grant is estimated on the date of grantusing the following assumptions used for grants during the applicable period:

** **
|                                  |   | **2003**  |   | **2002**  |   |
|---------------------------------------|--------|-----------|--------|-----------|--------|
| Option Grants:                        |   |      |   |      |   |
| Average risk free rate of return      |   | 2.26-3.00 | %      | 3.50-4.39 | %      |
| Weighted average expected option life |   | 4.2 years |   | 4.0 years |   |
| Volatility rate                       |   | 74        | %      | 83        | %      |
| Dividend yield                        |   | 0         | %      | 0         | %      |

** **

**Accountingand Disclosure Requirements for Guarantees**

 

In December 2002, the Company adopted FASB Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirement for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (“FIN 45”).  FIN 45requires that, upon issuance of a guarantee, the guarantor must recognize aliability for the fair value of the obligation it assumes under thatguarantee.  The provisions for initial recognition and measurement areeffective on a prospective basis for guarantees that are issued or modifiedafter December 31, 2002, irrespective of a guarantor’s year-end.

 

**AccruedWarranty**

 

Estimated warranty costs are recorded on product revenues and adjustedperiodically based on historical and anticipated experience. The Companyaccrues the estimated cost of product warranties at the time revenues arerecognized. Although the Company engages in extensive product quality programsand processes, including actively monitoring and evaluating the quality ofcomponent suppliers, the warranty obligation is affected by actual warrantycosts, including usage of material and labor and service delivery costsincurred in correcting a product failure.

 

Information regarding the changes in the Company’s warranty liabilitieswas as follows for the six months ended June 29, 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  June 29,  2003** |   |
|--------------------------------|--------|--------------------------------------|--------|-----------------------------------|--------|--------------------------------------------------------------------|---------|---------------------------------------------------------------|--------|--------------------------------|--------|
|                           |   |                                 |   |                              |   |                                                               |    |                                                          |   |                           |   |
| $                              | 19,890 |                                 | $      | 13,204                            |   | $                                                                  | (13,023 | )                                                             | $      | 925                            |   | $ | 726 |   | $ | 21,722 |   |
|                                |        |                                      |        |                                   |        |                                                                    |         |                                                               |        |                                |        |  |  |  |  |  |  |

 

**RevenueArrangements with Multiple Deliverables**

 

In November 2002, the EITF reached a consensus on Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21addresses certain aspects of the accounting by a vendor for arrangements underwhich the vendor will perform multiple revenue generating activities. EITF 00-21 will be effective for fiscal periods beginning after June 15, 2003. The Company has not yet determined the impact of the adoption of EITF 00-21 onthe Company’s results of operations or financial position.

 

**DerivativeInstruments and Hedging Activities**

 

The Company is exposed to foreign currency exchange rate risk inherentin its sales commitments, anticipated sales, anticipated purchases and assetsand liabilities denominated in currencies other than the U.S. dollar.  The Company utilizes foreign exchangeforward contracts to limit its exposure to foreign currency ratefluctuation.  The maturity of foreignexchange forward contracts as of June 29, 2003 is consistent with thecontractual or expected timing of the transactions being hedged, principallyreceipt of customer payments.  These foreign exchange forward contractsall mature within twelve months.  TheCompany does not enter into market risk sensitive instruments for tradingpurposes.  During the six months endedJune 29, 2003, the Company’s derivatives 

 

6

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consisted only of foreignexchange forward contracts.  The Company had aggregate foreign exchangeforward contracts with notional amounts of $26.1 million at June 29, 2003. Thefair value of these instruments, included in the consolidated balance sheets, representeda liability of $621,000 at June 29, 2003.

 

In May 2002, the Company began applying hedge accounting as defined bySFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“SFAS 133”) and designated certain foreign currency forward contractsas cash flow hedges of foreign exchange risk for international salescontracts.  As of June 29, 2003, theCompany has recorded $1,981,000 of other comprehensive loss, net of incometaxes of $1,335,000, representing the net change in the fair value of theforeign exchange forward contracts that were designated as and qualified forhedge accounting.  The amounts deferred in other comprehensive loss arereclassified to earnings upon the recognition of the hedged contract asrevenue.  As of June 29, 2003, the Company anticipates reclassifying thefull amount included within other comprehensive loss to earnings within thenext twelve months.  During the sixmonths ended June 29, 2003, the Company also recorded $57,000 as foreigncurrency transaction loss related to ineffectiveness under hedgeaccounting.  For the six month period ended June 29, 2003, primarily allof the changes in the fair value of forward contracts not designated for hedgeaccounting were offset by the measurement of associated accounts receivable.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement133 on Derivative Instruments and Hedging Activities” (“SFAS 149”).  SFAS No. 149 amends and clarifies theaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS 133.  SFAS No. 149 is generally effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003. The Company is currentlyevaluating the effect that the adoption of SFAS No. 149 will have on itsresults of operations and financial condition.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity”(“SFAS 150”).  SFAS No. 150 requiresthat certain financial instruments, which under previous guidance wereaccounted 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 interim periodsbeginning after June 15, 2003. The Company does not expect the adoption of SFASNo. 150 to have a material effect on its financial condition.

** **

**2.****                                      BusinessCombination**

 

In accordancewith SFAS No. 141, “Business Combinations,” the Company allocates the purchaseprice of its acquisitions to the tangible assets, liabilities and intangibleassets acquired, as well as in-process research and development, based on theirestimated fair values.  The excesspurchase price over those fair values is 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.  In accordance with SFAS 142, goodwill andpurchased intangibles with indefinite lives acquired after June 30, 2001 arenot amortized but will be reviewed periodically for impairment.  Purchased intangibles with finite lives willbe amortized on a straight-line basis over their estimated useful lives.

 

**Yxlon International Holding GmbH**

 

On March 31,2003, the Company completed its acquisition of Yxlon International Holding GmbH(“Yxlon”), a company based in Hamburg, Germany.  Yxlon develops, manufactures, markets and supports X-ray basednon-destructive testing (“NDT”) systems for a wide range of industrialapplications, and systems that use X-ray based diffraction (“XRD”) technologyfor explosives detection.  The Companyacquired Yxlon for €38.6 million in cash, or $41.7 million, and incurredadditional acquisition costs of $2.1 million for a total purchase price of$43.8 million.  The Company would berequired to make an additional payment of €10.0 million if Yxlon’s XRD systemis certified for explosives detection by the Transportation SecurityAdministration (“TSA”) by December 31, 2003. If the XRD system is certified for explosives detection by the TSA, theCompany would record the additional consideration as goodwill.

 

7

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The valuationto determine the allocation of the fair value of the net assets acquired hasnot been completed.  However, based on apreliminary independent valuation, which may change upon receipt of the finalvaluation, the total purchase price of approximately $43.8 million has beenallocated 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 purchase price, approximately $10.2 million has beenallocated to amortizable intangible assets, including maintenance contracts andrenewals, contract backlog, direct customer relationships, supplier agreementsand developed and core technology.  Themaintenance contracts and renewals represent a value assigned to the revenuestream estimated from existing maintenance contracts as of the acquisition datewith an assumed renewal rate.  Contractbacklog represents the gross contract backlog to be recognized over the twelve-monthperiod following the close of the acquisition. Direct customer relationships represent the sale of products andservices by Yxlon’s internal sales and marketing force.  Supplier agreements represent the value inmaterial supplier agreements where Yxlon receives below market rates oninventory component purchases.   TheCompany expects to amortize the fair value of these assets on a straight-linebasis over estimated useful lives ranging from twelve months to six years.

 

Developed and core technology, which consists of products that havereached technological feasibility, includes Yxlon’s XRD system and NDT systemproducts.  The Company expects toamortize the fair value of the developed and core technology on a straight-linebasis over an estimated useful life of seven years.

 

**IntangibleAssets With Indefinite Lives**

 

The estimated fair value of intangible assets with indefinite lives was$18.3 million for goodwill and $2.8 million for the Yxlon trade name.  These intangible assets will not be amortizedbecause the assets have indefinite useful lives based on many factors andconsiderations, including the length of time that the Yxlon name has been inuse, the Yxlon brand awareness and market position and the plans for continueduse of the Yxlon brand within a portion of the Company’s overall productportfolio.

 

**In-ProcessResearch and Development**

 

Of the total purchase price, an estimate of $4.3 million has beenallocated to in-process research and development (“IPR&D”) and was expensedin the second quarter of fiscal 2003. Projects that qualify as IPR&D represent those that have not yetreached technological viability. Technological viability is defined as being equivalent to a beta-phaseworking prototype in which there is lower remaining risk relating to thedevelopment.

 

The value assigned to IPR&D was determined by considering theimportance of each project to the overall development plan, estimating costs todevelop the purchased IPR&D into commercially viable products, estimatingthe resulting net cash flows from the projects when completed and discountingthe net cash flows to their present value. The revenue estimates used to value the purchased IPR&D were basedon estimates of the relevant market

 

8

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sizes and growth factors,expected trends in technology and the nature and expected timing of new productintroductions by Yxlon.

 

The rates utilized to discount the net cash flows to their presentvalues are based on Yxlon’s weighted average cost of capital.  The weighted average cost of capital wasadjusted 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.

 

**ProForma Results**

 

The unauditedpro forma financial information presented below combine the actual results ofoperations of the Company and the historical results of operations of Yxlon forthe respective periods as if the acquisition of Yxlon had occurred at thebeginning of 2002.  Adjustments of $4.4million, $5.0 million, $292,000 and $5.6 million have been made to the combinedresults of operations for the three and six-month periods ended June 29, 2003and the three and six-month periods ended June 30, 2002, respectively,reflecting amortization of purchased intangibles, net of tax, timing ofacquisition-related in-process research and development expense recognition,and bank settlement fees for debt as a result of acquisition, net of tax, as ifthe acquisition had occurred at the beginning of 2002.  The unaudited pro forma financial informationis not intended 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**                       |   | **Six Months  Ended** |   |
|-----------------------|--------|-----------------------------------------------|--------|-----------------------|--------|
|                  |   | **June 29,  2003**                            |   | **June 30,  2002**    |   | **June 29,  2003** |   | **June 30,  2002** |   |
|                  |   | **(in  thousands, except per share amounts)** |   |
|                  |   |                                          |   |
| Revenues              |   | $                                             | 89,427 |                  | $      | 81,724 |   | $ | 270,795 |   | $ | 127,467 |   |
| Net income            |   | 11,344                                        |   | 8,780                 |   | 46,911 |   | 4,530 |   |
| Net income per share: |   |                                          |   |                  |   |   |   |   |   |
| Basic                 |   | $                                             | 0.66   |                  | $      | 0.53 |   | $ | 2.74 |   | $ | 0.30 |   |
| Diluted               |   | $                                             | 0.62   |                  | $      | 0.48 |   | $ | 2.55 |   | $ | 0.26 |   |

 

**3.****                                      ComprehensiveIncome**

 

The componentsof comprehensive income are as follows (in thousands):

 
|                                                             |   | **Three  Months Ended** |       | **Six Months  Ended** |       |
|------------------------------------------------------------------|--------|-------------------------|------------|-----------------------|------------|
|                                                             |   | **June 29,  2003**      |       | **June 30,  2002**    |       | **June 29,  2003** |   | **June 30,  2002** |   |
|                                                             |   |                    | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| Net income                                                       |   | $                       | 6,975      |                  | $          | 9,606 |   | $ | 41,382 |   | $ | 12,424 |   |
| Derivatives classified as cash flow hedges,  net of taxes:       |   |                    |       |                  |       |   |   |   |   |
| Net increase (decrease) in foreign exchange  forward contracts   |   | 189                     |       | (1,911                | )          | (197 | ) | (1,911 | ) |
| Net increase in cumulative translation  adjustment, net of taxes |   | 530                     |       | —                |       | 530 |   | — |   |
| Comprehensive income                                             |   | $                       | 7,694      |                  | $          | 7,695 |   | $ | 41,715 |   | $ | 10,513 |   |

 

**4.****                                      NetIncome Per Share**

 

Basic netincome per share is computed by dividing income available to commonstockholders by the weighted-average shares of common stock outstanding for theperiod.  Diluted net income per sharereflects the weighted-average shares of common stock outstanding plus thepotential effect of dilutive securities or contracts

 

9

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which are convertible to shares of common stock such as options,warrants, convertible debt and preferred stock (using the treasury stockmethod) and shares issuable in future periods, except in cases where the effectwould be anti-dilutive.

 

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

 
|                                                        |               | **Three  Months Ended** |               | **Six Months  Ended** |                   |
|-------------------------------------------------------------|--------------------|-------------------------|--------------------|-----------------------|------------------------|
|                                                        | **June 29,  2003** |                    | **June 30,  2002** |                  | **June 29,  2003**     |   | **June 30,  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                                  |               | $                       | 6,975              |                  | 17,210                 |   | $ | 0.41 |   | $ | 9,606 |   | 16,579 |   | $ | 0.58 |   | $ | 41,382 |   | 17,139 |   | $ | 2.41 |   | $ | 12,424 |   | 15,132 |   | $ | 0.82 |   |
| Effect of dilutive securities:                              |               |                    |               |                  |                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Options and warrants                                        |               | —                  |               | 1,205                 |                   | (0.03 | ) | — |   | 1,808 |   | (0.06 | ) | — |   | 1,258 |   | (0.16 | ) | — |   | 1,977 |   | (0.09 | ) |
| Stock payable in connection with acquisition of  subsidiary |               | —                  |               | —                |                   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 15 |   | — |   |
| Diluted net income per share                                |               | $                       | 6,975              |                  | 18,415                 |   | $ | 0.38 |   | $ | 9,606 |   | 18,387 |   | $ | 0.52 |   | $ | 41,382 |   | 18,397 |   | $ | 2.25 |   | $ | 12,424 |   | 17,124 |   | $ | 0.73 |   |

 

10

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**5.****                                      SegmentInformation**

 

The Company determines its segments based on how its Chief ExecutiveOfficer and its Chief Operating Officer assess performance and allocateresources.  Through the first quarter of2003, the Company presented segment information based on three reportablesegments:  EDS, Quantum and Wood.  As a result of the acquisition of Yxlon, theCompany now has two reportable segments, EDS and NDT.  The “EDS” segment is comprised of the business unit that isengaged in the development, manufacturing, marketing and support of explosivesdetection systems based on advanced computed tomography technology.  The “NDT” segment is comprised of the Yxlonbusiness unit that is engaged in the development, manufacturing, marketing andsupport of non-destructive testing systems for a wide range of industrialapplications.  Other segments includingQuantum, Wood and XRD were aggregated to form an “Other” category as they didnot meet the materiality threshold for a reportable segment.

 

Segment financial data for the three and six-month periods ended June30, 2002 has been restated to reflect the change in reportable segments.Financial information by segment is as follows (in thousands): 

 
|                                          |   | **EDS** |    | **NDT** |   | **Other** |   | **Consolidating  Eliminations** |   | **Total** |   |
|-----------------------------------------------|--------|---------|---------|---------|--------|-----------|--------|---------------------------------|--------|-----------|--------|
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| **Second quarter 2003**                       |   |    |    |    |   |      |   |                            |   |      |   |
| Revenues:                                     |   |    |    |    |   |      |   |                            |   |      |   |
| Product revenues                              |   | $       | 63,791  |    | $      | 9,318     |   | $                               | 1,886  |      | $      | — |   | $ | 74,995 |   |
| Service revenues                              |   | 8,589   |    | 2,468   |   | 456       |   | —                          |   | 11,513    |   |
| Contract research & development  revenues |   | —  |    | —  |   | 2,919     |   | —                          |   | 2,919     |   |
| Intercompany revenues                         |   | 26      |    | —  |   | 749       |   | (775                            | )      | —    |   |
| Total revenues                                |   | $       | 72,406  |    | $      | 11,786    |   | $                               | 6,010  |      | $      | (775 | ) | $ | 89,427 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| Income (loss) from operations                 |   | $       | 19,830  |    | $      | (868      | )      | $                               | (5,469 | )         | $      | — |   | $ | 13,493 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| **June 29, 2003**                             |   |    |    |    |   |      |   |                            |   |      |   |
| Total assets                                  |   | $       | 325,977 |    | $      | 30,064    |   | $                               | 20,510 |      | $      | 5,761 |   | $ | 382,312 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| **Second quarter 2002**                       |   |    |    |    |   |      |   |                            |   |      |   |
| Revenues:                                     |   |    |    |    |   |      |   |                            |   |      |   |
| Product revenues                              |   | $       | 60,615  |    | $      | —    |   | $                               | 1,386  |      | $      | — |   | $ | 62,001 |   |
| Service revenues                              |   | 2,878   |    | —  |   | 545       |   | —                          |   | 3,423     |   |
| Contract research & development  revenues |   | —  |    | —  |   | 3,002     |   | —                          |   | 3,002     |   |
| Intercompany revenues                         |   | 53      |    | —  |   | 479       |   | (532                            | )      | —    |   |
| Total revenues                                |   | $       | 63,546  |    | $      | —    |   | $                               | 5,412  |      | $      | (532 | ) | $ | 68,426 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| Income (loss) from operations                 |   | $       | 17,635  |    | $      | —    |   | $                               | (572   | )         | $      | — |   | $ | 17,063 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| **June 30, 2002**                             |   |    |    |    |   |      |   |                            |   |      |   |
| Total assets                                  |   | $       | 421,344 |    | $      | —    |   | $                               | 10,777 |      | $      | (14,334 | ) | $ | 417,787 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| **Six months 2003**                           |   |    |    |    |   |      |   |                            |   |      |   |
| Revenues:                                     |   |    |    |    |   |      |   |                            |   |      |   |
| Product revenues                              |   | $       | 214,915 |    | $      | 9,318     |   | $                               | 3,576  |      | $      | — |   | $ | 227,809 |   |
| Service revenues                              |   | 17,081  |    | 2,468   |   | 873       |   | —                          |   | 20,422    |   |
| Contract research & development  revenues |   | —  |    | —  |   | 6,364     |   | —                          |   | 6,364     |   |
| Intercompany revenues                         |   | 26      |    | —  |   | 1,286     |   | (1,312                          | )      | —    |   |
| Total revenues                                |   | $       | 232,022 |    | $      | 11,786    |   | $                               | 12,099 |      | $      | (1,312 | ) | $ | 254,595 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| Income (loss) from operations                 |   | $       | 76,968  |    | $      | (868      | )      | $                               | (5,666 | )         | $      | — |   | $ | 70,434 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| **Six months 2002**                           |   |    |    |    |   |      |   |                            |   |      |   |
| Revenues:                                     |   |    |    |    |   |      |   |                            |   |      |   |
| Product revenues                              |   | $       | 83,793  |    | $      | —    |   | $                               | 4,303  |      | $      | — |   | $ | 88,096 |   |
| Service revenues                              |   | 5,913   |    | —  |   | 976       |   | —                          |   | 6,889     |   |
| Contract research & development  revenues |   | 0       |    | —  |   | 6,639     |   | —                          |   | 6,639     |   |
| Intercompany revenues                         |   | 280     |    | —  |   | 495       |   | (775                            | )      | —    |   |
| Total revenues                                |   | $       | 89,986  |    | $      | —    |   | $                               | 12,413 |      | $      | (775 | ) | $ | 101,624 |   |
|                                          |   |    |    |    |   |      |   |                            |   |      |   |
| Income (loss) from operations                 |   | $       | 22,643  |    | $      | —    |   | $                               | (847   | )         | $      | — |   | $ | 21,796 |   |

 

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Substantially all of the Company’s long-lived assets are located in theUnited States.

 

**6.**                                  **Inventories**

 

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

 
|                                  |   | **June 29,  2003** |   | **December  31,  2002** |   |
|---------------------------------------|--------|--------------------|--------|-------------------------|--------|
| Inventories:                          |   |               |   |                    |   |
| Raw material and purchased components |   | $                  | 29,262 |                    | $      | 22,696 |   |
| Field service spare parts             |   | 25,248             |   | 16,145                  |   |
| Work-in-process                       |   | 2,184              |   | 21,927                  |   |
| Finished goods                        |   | 23,629             |   | 3,996                   |   |
| Total                                 |   | $                  | 80,323 |                    | $      | 64,764 |   |

 

**7.**                                      **AccruedLiabilities**

 

The components of accrued liabilities consist of the following (inthousands):

 
|                               |   | **June 29,  2003** |   | **December  31,  2002** |   |
|------------------------------------|--------|--------------------|--------|-------------------------|--------|
| Accrued liabilities:               |   |               |   |                    |   |
| Warranty and other reserves        |   | $                  | 21,722 |                    | $      | 19,890 |   |
| Accrued employee compensation      |   | 11,425             |   | 7,540                   |   |
| Income taxes                       |   | 10,292             |   | 17,919                  |   |
| Foreign exchange forward contracts |   | 621                |   | 4,948                   |   |
| Material cost reduction accrual    |   | 8,767              |   | 8,259                   |   |
| Other                              |   | 9,367              |   | 6,808                   |   |
| Total                              |   | $                  | 62,194 |                    | $      | 65,364 |   |

 

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**8.****                                      Litigation**

 

The Company is involved in routine civil litigation arising in theordinary course of business.  Managementbelieves that collectively these proceedings will not have a material effect onthe Company’s business, financial condition or results of operations.

 

**9.****                                      SubsequentEvent**

 

On August 12, 2003, the Company announced that the TSA ordered new CTX9000 DSi systems for integration into the baggage handling systems of certainairports in the United States. The delivery order for the new systems is valuedat $54.8 million and is an initial order under a new three-year agreement withthe TSA.  The new agreement, including the $54.8 million delivery order,provides the TSA with rights to purchase system options and accessories,engineering and installation support and up to 550 CTX units, principally theCompany's CTX 9000 DSi systems, over the three-year term.  The TSA has noobligation to place additional delivery orders or purchase additionalengineering and installation support under the new agreement.

 

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

** **

**Cautionsabout Forward-Looking Statements**

 

Throughout this Form 10-Q, we make “forward-looking” statements,or statements about events or circumstances that have not yet occurred. In somecases, we identify these statements by forward-looking words such as “may,”“will,” “should,” “plans,” “believes,” “predicts,” “intends” or “continue,” andother similar terms. These forward-looking statements involve risks anduncertainties, and our actual results could differ materially. We cannotguarantee future results or that current expectations will be accurate, and wewill not update information in this Form 10-Q if any forward-lookingstatement later turns out to be inaccurate. Important factors that could causeour results to differ are discussed under the section “Risk Factors.” Readersshould read this Item 2 in conjunction with the condensed consolidatedfinancial statements and related notes in Part I, Item 1 of thisForm 10-Q, as well as “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and the consolidated financial statementsand related notes in our Form 10-K for the fiscal year ended December 31,2002. We encourage readers 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.  On March 31, 2003, we completed theacquisition of Yxlon International Holding GmbH, or Yxlon, for $41.7 million incash, calculated at the then effective conversion rate for the euro, andincurred additional acquisition costs of $2.1 million for a total purchaseprice of $43.8 million.  Yxlon develops,manufactures, markets and supports X-ray based non-destructive testing, or NDT,systems for a wide range of industrial applications, and systems that use X-raybased diffraction, or XRD, technology for explosives detection.  We would make an additional payment of €10.0million if Yxlon’s XRD system is certified for explosives detection by the TSAby December 31, 2003.

 

Our intangibleassets, net increased by $30.6 million from $1.6 million in December 31, 2002to $32.2 million in June 29, 2003, primarily as a result of $31.2 million ofintangible assets acquired pursuant to our acquisition of Yxlon, partiallyoffset by amortization of existing intangible assets.  Based on a preliminary independent valuation, which may changeupon receipt of the final valuation, the intangible assets we acquired included$8.7 million of developed and core technology, $2.8 million of trademarks,$18.3 million of goodwill and $1.5 million of other intangible assets.

 

We determine our segments based on how our Chief Executive Officer andChief Operating Officer assess performance and allocate resources.  Through the first quarter of 2003, we presentedsegment information based on three reportable segments:  EDS, Quantum and Wood.  As a result of the acquisition of Yxlon, wenow have two reportable segments, EDS and NDT. The “EDS” segment is comprised of the business unit that is engaged inthe development, manufacturing, marketing and support of explosives detectionsystems based on advanced computed tomography technology.  The “NDT” segment is comprised of the Yxlonbusiness unit that is engaged in the development, manufacturing, marketing andsupport of non-destructive testing systems for a wide range of industrialapplications.  Other segments includingQuantum, Wood and XRD were aggregated to form an “Other” category as they didnot meet the materiality threshold for a reportable segment.  See Note 5 of the condensed consolidatedfinancial statements for additional information about our reportable segments.

 

Our revenues are primarily comprised of:

 

•                  EDS productrevenues, which include revenues from sales of CTX systems, accessories andrelated installation and configuration, and EDS service revenues, which includerevenues from maintenance contracts related to product support, integration andother services, including those complex integrations and configurations thatare separate from product revenues; and

 

•                  NDT productrevenues, which include revenues from the design, assembly and installation ofX-ray systems and associated components for industrial NDT, and NDT servicerevenues, which include revenues from maintenance contracts related to productsupport.

 

We market our products and services directlythrough internal sales personnel and indirectly through authorized agents,distributors and system integrators.  Inthe United States, we market our products and services primarily through directsales personnel.  Internationally, weuse a direct sales force and authorized representatives to sell ourproducts.  International salesrepresented 22.4% of total revenues in the first six months of 2003 and 25.3%of total revenues in the first six months of 2002.

 

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*EDS*.  In any given fiscal quarter or year, our EDS product revenues arederived from orders of multiple units of our products from a limited number ofcustomers.  For example, in the secondquarter of 2003 eight customers accounted for all of our EDS products soldduring the quarter, in the first six months of 2003 thirteen customersaccounted for all of our EDS products sold during the period, and for thefiscal year 2002 ten customers accounted for all of our EDS products soldduring the year.  The number of ourcustomers does not vary widely from period to period.  Therefore, a cancellation or delay of an order from a customercould have a significant negative impact on our operations in a givenperiod.  Including revenues from theSiemens subcontract to provide maintenance service for TSA-owned EDS systems,EDS sales to the FAA and, following the formation of the TSA, to the TSA,accounted for 79.4% of our EDS revenues in the six months ended June 29, 2003and 85.4% of our EDS revenues in the year ended December 31, 2002.  There were no other EDS customers whoaccounted for more than 10% of total revenues in the first six months of 2003or the year ended December 31, 2002.

 

We typically bill our customers in threestages, as generally provided in our contracts with our customers:

 

•                  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 paymentterms effectively provide the necessary working capital for acquisition ofmaterials and funding inventory during the manufacturing cycle.  We anticipate that potential future ordersfrom the TSA will continue to provide payment terms which provide the necessaryworking capital for us and our suppliers, even if production volumes were torapidly increase.  If future orders fromthe TSA contain different payment terms, a major increase in production ratesmay require substantial additional working capital.

 

Payment terms for TSA invoices are net 30days, while terms for international invoices vary from amounts due upon receiptof invoice to 160 days.

 

*NDT*.  Our NDT product and service revenues areprimarily derived from sales of X-ray based NDT products primarily to theautomotive and aerospace industries. There were no NDT customers who accounted for more than 10% of totalrevenues since the acquisition of Yxlon on March 31, 2003.

 

 

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**Resultsof Operations**

 

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

 
|                                        |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|---------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                        |   | **June 29,  2003**      |   | **June 30,  2002**    |   | **June 29,  2003** |   | **June 30,  2002** |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Revenues:                                   |   |                    |   |                  |   |   |   |   |   |
| Product revenues                            |   | 83.9                    | %      | 90.6                  | %      | 89.5 | % | 86.7 | % |
| Service revenues                            |   | 12.9                    |   | 5.0                   |   | 8.0 |   | 6.8 |   |
| Contract research and development revenues  |   | 3.2                     |   | 4.4                   |   | 2.5 |   | 6.5 |   |
| Total revenues                              |   | 100.0                   |   | 100.0                 |   | 100.0 |   | 100.0 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Cost of revenues:                           |   |                    |   |                  |   |   |   |   |   |
| Product costs                               |   | 49.7                    |   | 51.2                  |   | 50.7 |   | 49.1 |   |
| Service costs                               |   | 8.0                     |   | 4.4                   |   | 4.8 |   | 5.2 |   |
| Contract research and development costs     |   | 2.2                     |   | 2.9                   |   | 1.6 |   | 4.5 |   |
| Total cost of revenues                      |   | 59.9                    |   | 58.5                  |   | 57.1 |   | 58.8 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Gross profit                                |   | 40.1                    |   | 41.5                  |   | 42.9 |   | 41.2 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Operating expenses:                         |   |                    |   |                  |   |   |   |   |   |
| Research and development                    |   | 8.5                     |   | 6.9                   |   | 5.9 |   | 7.9 |   |
| Selling, general and administrative         |   | 11.7                    |   | 9.7                   |   | 7.7 |   | 11.8 |   |
| In-process research and development (Yxlon) |   | 4.8                     |   | —                |   | 1.6 |   | — |   |
| Total operating expenses                    |   | 25.0                    |   | 16.6                  |   | 15.2 |   | 19.7 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Income from operations                      |   | 15.1                    |   | 24.9                  |   | 27.7 |   | 21.5 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Interest expense                            |   | (0.1                    | )      | (0.2                  | )      | (0.1 | ) | (0.2 | ) |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Interest and other income (expenses), net   |   | 0.7                     |   | (1.0                  | )      | 0.5 |   | (0.6 | ) |
| Income before provision for income taxes    |   | 15.7                    |   | 23.7                  |   | 28.1 |   | 20.7 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Provision for income taxes                  |   | 7.9                     |   | 9.7                   |   | 11.9 |   | 8.5 |   |
|                                        |   |                    |   |                  |   |   |   |   |   |
| Net income                                  |   | 7.8                     | %      | 14.0                  | %      | 16.2 | % | 12.2 | % |

 

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

### ** **

### **Revenues**

 

EDS product revenues were $63.8 million inthe second quarter of 2003, an increase of 5.2% from $60.6 million in thesecond quarter of 2002.  EDS productrevenues were $214.9 million in the first six months of 2003, an increase of156.5% from $83.8 million in the first six months of 2002.  The revenue increase in the second quarter2003 reflects continued shipments of CTX 5500 DS and CTX 9000 DSi systems tothe TSA to fulfill the remainder of several large orders received in 2002.  The revenue increase year-to-date is mainlydue to the relatively low level

 

16

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of shipments to the TSA duringthe first three months of 2002 as compared to the same period in 2003, as thefirst large TSA delivery order of 2002 was not received until late in the firstquarter of 2002.

 

EDS service revenues were $8.6 million forthe second quarter of 2003, an increase of 198.4% from $2.9 million in thesecond quarter of 2002.  EDS servicerevenues were $17.1 million for the first six months of 2003, an increase of188.9% from $5.9 million in the first six months of 2002.  The revenue increase in the second quarter2003 and the six-month period results from a contract with Siemens, which wassigned in January 2003, to provide service for our EDS products owned by theTSA in the United States and its territories and from service contracts frominternational customers for which warranty periods expired.  We anticipate that service revenues willincrease in 2003 compared to 2002 due to the agreement with Siemens and alarger installed based of EDS coming off of warranty.  As of June 29, 2003, we had in backlog EDS equipment orders andservice agreements of $70.0 million, primarily consisting of orders for EDSsystems and services from international customers.

 

NDT product revenues were $9.3 million in thesecond quarter of 2003.  NDT servicerevenues were $2.5 million in the second quarter of 2003.  As of June 29, 2003, we had in backlog NDTequipment orders and service agreements of $19.2 million, primarily consistingof orders for standard industrial and custom NDT systems.

 

**GrossProfit**

 

Cost of EDS product revenues primarilyconsists of purchased materials procured for use in the assembly of ourproducts, as well as manufacturing labor and overhead, contract manufacturingservices, installation, training and warranty. Cost of EDS service revenues primarily consists of direct labor andmaterials and customer support overhead. In any given period, our gross profit for products and services may beaffected 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 EDS products was $27.7million in the second quarter of 2003, an increase of 4.2% from $26.6 millionin the second quarter of 2002.  Grossmargin percentages for EDS products were 43.5% in the second quarter of 2003and 43.9% in the second quarter of 2002. Gross profit for EDS products was $95.3 million in the first six monthsof 2003, an increase of 157.4% from $37.0 million in the first six months of2002.  Gross margin percentages for EDSproducts were 44.4% in the first six months of 2003 and 44.2% in the first sixmonths of 2002.  The increase in grossprofit for the second quarter and year-to-date periods is primarily due toincreased revenues.   Product grossmargin percentages for the second quarter and year-to-date periods remainedapproximately the same as a result of improved manufacturing overhead per unit,offset by decreases in sales price as a result of volume orders from the TSA.

 

Gross profit for EDS services were $3.3million in the second quarter of 2003, an increase of 2274% from $137,000 inthe second quarter of 2002. Gross margin percentages for EDS services were37.9% in the second quarter of 2003 and 4.8% in the second quarter of2002.  Gross profit for EDS serviceswere $6.9 million in the first six months of 2003, an increase of 548.6% from$1.1 million in the first six months of 2002. Gross margin percentages for EDSservices were 40.6% in the first six months of 2003 and 18.1% in the first sixmonths of 2002.  The increase in grossprofit for EDS services in the second quarter and year-to-date periods isprimarily due to increased EDS service revenues from the growing installed baseof domestic systems covered by the Siemens contract, which calls for extended24-hour coverage beyond the standard warranty coverage, and service agreementsfrom international customers.  Grossmargin percentages improved primarily as the result of service overhead costsbeing spread over a larger base of installed units.  In addition, in the first six months of 2002, we incurred costsassociated with the build-up of our customer support staff in anticipation ofan increase in EDS services as more units were sold.

 

Cost of NDTproducts revenues primarily consists of purchased materials procured for use inthe assembly of our products, as well as manufacturing labor and overhead,installation, training and warranty. Cost of NDT services revenues primarily consists of direct labor andmaterials and customer support overhead. Gross profit for NDT products was $2.1 million in the second quarter of2003.  Gross margin percentage for NDTproducts was 23.0% in the second quarter of 2003.   Gross profit for NDT service was $803,000 in the second quarterof 2003.  Gross margin percentage forNDT services was 32.5% in the second quarter of 2003.

 

17

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### **Research and Development**

 

Research and development expenses consistprimarily of compensation paid to personnel engaged in research and developmentactivities, amounts paid for outside services and costs of materials utilizedin the development of hardware products, including prototype units.  Research and development expenditures arepartially offset by amounts reimbursed by the FAA and other government agenciesand private entities under research and development contracts and grants.  These services are provided and reimbursedon a cost basis.

 

Net research and development expenses for EDSwere $5.6 million in the second quarter of 2003, an increase of 38.8% from $4.0million in the second quarter of 2002. The net numbers reflect amounts reimbursed by the FAA and othergovernment agencies of $53,000 in the second quarter of 2002.  There were no such reimbursements in thesecond quarter of 2003.  Net researchand development expenses for EDS as a percentage of EDS revenues were 7.7% inthe second quarter of 2003 and 6.4% in the second quarter of 2002.  Net research and development expenses forEDS were $11.9 million in the first six months of 2003, an increase of 84.2%from $6.5 million in the first six months of 2002.  The net numbers reflect amounts reimbursed by the FAA and othergovernment agencies of $540,000 in the first six months of 2002.  There were no such reimbursements in thefirst six months of 2003.  Net researchand development expenses for EDS as a percentage of EDS revenues were 5.1% inthe first six months of 2003 and 7.2% in the first six months of 2002.  The increase in research and developmentexpenses for EDS for the second quarter and year-to-date periods was primarilydue to an increased focus on several initiatives to support our growth.  With the goal of 100% checked baggagescreening in U.S. airports, we expect that our EDS machines will be operated ator near capacity for extended periods. We are investing in sustaining engineering efforts to ensure that ourproducts achieve high levels of serviceability and reliability when operatingat capacity.  We are also continuing todevelop product enhancements for our existing line of EDS machines.** **Inaddition, we are continuing our development of the ARGUS program, anFAA-sponsored program designed to develop a smaller, low-cost EDS product toscan checked baggage in small airports and low-traffic stations within largerairports.

 

Research and development expenses for NDTwere $653,000 in the second quarter of 2003. Research and development expenses for NDT as a percentage of NDTrevenues were 5.5% in the second quarter of 2003.

 

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

 

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

 

Selling, general and administrative expensesfor EDS were $5.6 million in the second quarter of 2003, an increase of 9.3%from $5.1 million in the second quarter of 2002.  Selling, general and administrative expenses for EDS as apercentage of EDS revenues were 7.7% in the second quarter of 2003 and 8.0% inthe second quarter of 2002.  Selling,general and administrative expenses for EDS were $13.5 million in the first sixmonths of 2003, an increase of 50.3% from $9.0 million in the first six monthsof 2002.  Selling, general andadministrative expenses for EDS as a percentage of EDS revenues were 5.8% inthe first six months of 2003 and 10% in the first six months of 2002.  The increase in selling, general andadministrative expenses for EDS in absolute dollars for the second quarter andyear-to-date periods was primarily due to an increase in headcount and employee-relatedexpenses in the second quarter of 2003 as compared to the same period a yearago.

 

Selling, general and administrative expensesfor NDT were $3.2 million in the second quarter of 2003.  Selling, general and administrative expensesfor NDT as a percentage of NDT revenues were 26.9% in the second quarter of2003.

 

### **Interest Expense**

 

Interest expense was $103,000 in the secondquarter of 2003 and $116,000 in the second quarter of 2002. Interest expenseresulted primarily from fees associated with our working capital lines ofcredit, equipment term loans, capital leases and financing for insurancepremiums.  Interest expense was $145,000in the first six months of 2003 and $210,000 in the first six months of 2002.Interest expense resulted primarily from fees associated with our working capitallines of credit, equipment term loans, capital leases and financing forinsurance premiums.

 

18

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

 

Interest and other income, net was $670,000in the second quarter of 2003 and a net expense of $694,000 in the secondquarter of 2002. The amount for the second quarter of 2003 consisted primarilyof interest income on cash, cash equivalents and short-term investments of$400,000, and other income, net of $270,000. The amount for the second quarterof 2002 consisted primarily of interest income on cash, cash equivalents andshort-term investments of $467,000, offset by other expenses, net of $1.2million, including a net $759,000 in foreign exchange losses, primarily on outstandingforeign exchange forward contracts at June 30, 2002.

 

Interest and other income, net, was $1.4million in the first six months of 2003 and a net expense of $564,000 in thefirst six months of 2002. The amount for the first six months of 2003 consistedprimarily of interest income on cash, cash equivalents and short-terminvestments of $838,000, and other income, net of $517,000. The amount for thefirst six months of 2002 consisted primarily of interest income on cash, cashequivalents and short-term investments of $523,000, offset by other expenses,net of $1.1 million, including a net $688,000 in foreign exchange losses,primarily on outstanding foreign exchange forward contracts at June 30, 2002.

 

**Provision for IncomeTaxes**

 

The provision for income taxes was $7.1million in the second quarter of 2003 and $6.6 million in the second quarter of2002.  Our effective tax rate was 50.4%in the second quarter of 2003 and 40.9% in the second quarter of 2002.  The provision for income taxes was $30.3million in the first six months of 2003 and $8.6 million in the first sixmonths of 2002.  Our effective tax ratewas 42.2% in the first six months of 2003 and 40.9% in the first six months of2002.  The increase in the effective taxrates in the second quarter and first six months of 2003 versus the comparableperiods in the prior year is due to a $4.3 million expense for in-processresearch and development associated with the acquisition of Yxlon’s X-raydiffraction business, which was not tax deductible.  Our effective tax rate was different than statutory tax ratesprimarily due to the in-process research and development expense describedabove, along with certain other permanent differences between book and taxableincome.  At December 31, 2002, we hadfederal and state net operating loss carryforwards of approximately $1.8million and $321,000 available to reduce future federal and state taxableincome, respectively.  Our federal net operating loss carryforwards beginto expire in 2010 and our state net operating loss carryforwards expire in2011.  The tax benefit of the net operating loss carryforwards may belimited due to the impact of the Tax Reform Act of 1986.  Events which maycause the tax benefit to be limited include, but are not limited to, a cumulativestock ownership change of more than 50% over a three-year period and the timingof utilization of various tax benefits carried forward.

 

### **Liquidityand Capital Resources**

 

At June 29,2003, we had $163.0 million in cash, cash equivalents and short-term investments,compared to $159.7 million at December 31, 2002.

 

Net cashprovided by operating activities was $42.4 million in the first six months of2003, compared to $90.4 million provided by operating activities in the firstsix months of 2002.  Cash provided byoperating activities in the first six months of 2003 primarily resulted fromsignificant accounts receivable collections from the TSA resulting in a $92.7million decrease in accounts receivable. Other significant items include net income of $41.4 million, enhanced bythe non-cash effects of the $2.4 million of depreciation and amortization, andthe $4.3 million in-process research and development expense related to theYxlon acquisition.  Partially offsettingthese increases to net cash provided by operating activities was a $77.6million decrease in deferred revenue, primarily due to the shipment of units tothe TSA for which deposits had been received in prior periods for long-leadshipments.  A $33.2 million decrease inaccounts payable and accrued liabilities also contributed to decreasing the netcash provided by operating activities.

 

Cash provided by operating activities in the first six months of 2002primarily resulted from a $111.7 million increase in deferred revenues,consisting primarily of long-lead deposits on delivery orders from the TSA, a$33.3 million increase in accounts payable and accrued liabilities, net incomeof $12.4 million enhanced by the $5.1 million non-cash effect of income taxbenefits from employee stock transactions, and the $1.7 million non-cash effectof depreciation and amortization.  Theseamounts were partially offset by a $38.4 million increase in inventories, a$26.5 million increase in accounts receivable, and a $10.3 million increase inother current assets

 

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(consisting of approximately$6.0 million of ramp up costs to be recovered from the TSA, and approximately$3.3 million in prepaid inventory purchases).

 

Net cash used in investing activities was $45.1 million in the firstsix months of 2003, compared to $430,000 in the first six months of 2002.  Net cash used in investing activities in thefirst six months of 2003 resulted primarily from payments of $41.8 million, netof cash acquired for the Yxlon acquisition. In addition, other net cash uses were $1.8 million in acquisition ofcapital equipment and $1.5 million payment for an investment interest andproduct distribution rights in SafeView, Inc., a company developing an advancedpersonnel screening portal system.  Netcash used in investing activities in the first six months of 2002 resulted from$2.2 million in acquisitions of capital equipment, offset primarily by proceedsfrom the sale of short-term investments of $2.0 million.

 

Net cashprovided by financing activities was $5.8 million in the first six months of2003, compared to $85.7 million in the first six months of 2002.  Net cash provided by financing activities inthe first six months of 2003 primarily resulted from $3.8 million in netproceeds from increased short-term borrowings and $2.1 million in net proceedsfrom the sale of common stock under the employee stock purchase plan andexercises of incentive stock options. Net cash provided by financing activities in the first six months of 2002primarily resulted from $86.3 million in net proceeds from the sale of commonstock to the public and under the employee stock purchase plan and exercises ofincentive stock options, partially offset by $516,000 in repayments ofshort-term debt, net of proceeds.

 

As of June 29, 2003, we had two primary sources of financing from U.S.banks.  The first agreement is a line of credit that provides for maximumborrowings in an amount up to $25.0 million.  The second agreement is aline of credit partially guaranteed by the Export-Import Bank of the UnitedStates and provides for maximum borrowings in an amount up to the lowerof:  (a) the sum of 70% to 90% of eligible EDS export accounts receivableplus the lower of: (1) 70% of eligible raw materials and work-in-processinventory designated for export customers, or (2) 60% of outstanding loansunder this agreement, or (b) $10.0 million.  Borrowings under theseagreements bear interest at the bank’s prime rate minus 0.5%, for a rate of3.75% at June 29, 2003.  The first agreement expires in July 2004 andrequires that the EDS segment maintain certain levels of tangible networth.  The second agreement expired onJuly 19, 2003.  We may use proceeds of loans under the firstagreement for general corporate purposes.  At June 29, 2003, we hadno borrowings outstanding under these agreements.  However, at June 29,2003, we had outstanding guarantees to customers and foreign creditors to oursubsidiary entities through the issuance of letters of credit for which apartial reserve of $12.1 million is secured by the lines of credit, and foreignexchange forward contracts for which a 10% reserve of $2.5 million is securedby the lines of credit.  We had remaining available borrowing capacityunder the lines of credit of $20.3 million at June 29, 2003 based on eligibleEDS accounts receivable and inventories as of that date.

 

As of June 29, 2003, we had two primary sources of financing fromGerman banks for our Yxlon subsidiary. The first agreement is a line of credit that provides for maximumborrowings in an amount up to €5.6 million or approximately $6.4 million.  There is currently no expiration date forthis agreement.  The second agreement isalso a line of credit that provides for maximum borrowings in an amount up to €3.7million or approximately $4.2 million, and the agreement will expire onSeptember 15, 2003.  Borrowings underthese agreements bear interest at 5.75%. At June 29, 2003, we had debt balances of $3.8 million outstanding underthese agreements.  However, at June 29,2003, we had outstanding guarantees to customers through the issuance ofletters of credit for which a reserve of $5.1 million is secured by the linesof credit.  Therefore, we had remainingavailable borrowing capacity under the lines of credit of approximately €1.6million or $1.8 million at June 29, 2003.

 

We believethat existing cash and cash equivalents, available borrowings under our linesof credit and funds expected to be generated from operations will be sufficientto finance our working capital and capital expenditure requirements for atleast the next twelve months.  However, if we fail to meet requiredfinancial covenants in our credit agreement, or our receivables do not supportthe upper limits of the credit agreement, then we may not be able to haveaccess to further funds under our credit agreement.  In addition, if weare unable to deliver EDS units in a timely manner under orders from the TSA orif we fail to adhere to the terms of the licensing agreement with the

 

20

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TSA, the TSA may cancel itsorders or not place additional orders. If any of these events occur, our capital resources would besignificantly impaired.

 

**ContractualObligations and Commitments**

** **

The followingtable depicts our contractual obligations as of June 29, 2003 (in thousands):

 
|                               |   | **Payments  Due by Period** |   |
|------------------------------------|--------|-----------------------------|--------|
| **Contractual  Obligations**       |   | **Total**                   |   | **Less than**

**1 year** |   | **1-3**

**years** |   | **Thereafter** |   |
| Operating leases                   |   | $                           | 23,310 |   | $ | 4,535 |   | $ | 10,575 |   | $ | 8,200 |   |
| Short-term debt                    |   | 5,588                       |   | 5,588 |   | — |   | — |   |
| Other long-term liabilities        |   | 1,286                       |   | — |   | — |   | 1,286 |   |
| Capital lease obligations          |   | 764                         |   | 289 |   | 475 |   | — |   |
| Long-term debt                     |   | 13                          |   | 13 |   | — |   | — |   |
| Total contractual cash obligations |   | $                           | 30,961 |   | $ | 10,425 |   | $ | 11,050 |   | $ | 9,486 |   |

 

### **RiskFactors**

 

***Risks Related to OurBusiness***

** **

**Anumber of factors that affect our revenues make our future results difficult topredict, and therefore we may not meet expectations for a particular period.**

 

We believethat our revenues have the potential to vary significantly from time to time.For example, our total revenues were $89.4 million for the second quarter offiscal 2003, $165.2 million for the first quarter of fiscal 2003 and $220.4million for the fourth quarter of fiscal 2002, and were $439.1 million for fiscal2002, $74.3 million for fiscal 2001 and $79.1 million for fiscal 2000. Webelieve that these variations may result from many factors, including:

 
| • |   | the timing, size and mix of orders from our  major customers, including in particular, the TSA and agencies of other  governments;                                                                                           |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | legislative or other government actions  driven, in part, by the public’s perception of the threats facing commercial  aviation, leading to fluctuations in demand for aviation security products  and services;        |
| • |   | delays in product shipments caused by the  inability of airports to install or integrate our products in a timely  fashion;                                                                                                  |
| • |   | the availability and cost of key  components;                                                                                                                                                                                |
| • |   | the introduction and acceptance of new  products or enhancements to existing products offered by us or our  competitors;                                                                                                     |
| • |   | changes in pricing policies by us, our  competitors or our suppliers, including possible decreases in average selling  prices of our products caused by customer volume orders or in response to  competitive pressures; and |
| • |   | our sales mix to domestic and international  customers.                                                                                                                                                                      |

 

Further, wedepend on a small number of customers for a substantial portion of ourrevenues. In the past, the number of orders placed by these customers haschanged significantly from period to period, and we expect that this maycontinue in the future.

 

A significantportion of our quarterly and annual operating expenses is, and will continue tobe, relatively fixed in nature. This means that revenue fluctuations will causeour quarterly 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 believe that period-to-period comparisons of our results of operationscannot be relied upon as indicators of future performance. Because of all ofthe foregoing factors, our operating results have from time to time in the pastbeen, and may again in the future be, different from expectations of publicmarket analysts and investors. Failure to meet market expectations has in thepast resulted, and may again in the future result, in fluctuations in thetrading price of our common stock.

 

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

 

Substantiallyall of the customers for our EDS products and our other products underdevelopment to date have been public agencies or quasi-public agencies, such asthe FAA, the TSA and airport authorities. Public agencies are subject tobudgetary processes and expenditure constraints. In the past, many domestic andforeign government agencies have experienced budget deficits that have led todecreased capital expenditures in certain areas.

 

The funding ofgovernment programs is subject to legislative appropriation. Budgetaryallocations for EDS depend, in part, upon governmental policies, whichfluctuate from time to time in response to political and other factors,including the public’s perception of the threat of commercial airline bombings.For example, the terrorist attacks of September 11, 2001 resulted in thepassage of the Aviation and Transportation Security Act of 2001, or 

 

 

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Transportation Security Act, mandating asmall surcharge on each airline ticket purchase to fund airline security. Thissurcharge was suspended on June 1, 2003, for a period of four months. We cannotassure investors that the surcharge will not again be suspended or that thefunds generated by these surcharges will be used to purchase our EDS products.We cannot assure investors that funds will continue to be appropriated byCongress or allocated by the TSA or other agencies for the purchase of EDSproducts.

 

**Legislativeactions could lead to fluctuations in demand for aviation security products andservices.**

 

In addition tothe Congressional 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.

 

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

 

In contractingwith public agencies, we are subject to public agency contract requirementsthat vary from jurisdiction to jurisdiction. Future sales to public agencieswill depend, in part, on our ability to meet public agency contractrequirements, certain of which may be onerous or even impossible for us tosatisfy.

 

Governmentcontracts typically contain termination provisions unfavorable to us and aresubject to audit and modification by the government at its sole discretion,which subject us to additional risks. These risks include the ability of theU.S. government to unilaterally:

 
| • |   | suspend or prevent us for a set period of  time from receiving new contracts or extending existing contracts based on  violations or suspected violations of laws or regulations; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | terminate our existing contracts;                                                                                                                                                 |
| • |   | reduce the scope and value of our existing  contracts;                                                                                                                            |
| • |   | audit and object to our contract-related  costs and fees, including allocated indirect costs;                                                                                     |
| • |   | control and potentially prohibit the export  of our products; and                                                                                                                 |
| • |   | change certain terms and conditions in our  contracts.                                                                                                                            |

 

The U.S.government can terminate any of its contracts with us either for itsconvenience or if we default by failing to perform in accordance with thecontract schedule and terms. Termination for convenience provisions generallyenable us to recover only our costs incurred or committed, and settlementexpenses and profit on the work completed prior to termination. Termination fordefault provisions do not permit these recoveries and make us liable for excesscosts incurred by the U.S. government in procuring undelivered items fromanother source. Our contracts with foreign governments may contain similarprovisions. Consequently, our backlog is not necessarily indicative of futurerevenues. The government’s termination of one or more of the contracts for ourEDS products or 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 though contractperformance may take years. Consequently, our contracts with the TSA may onlybe partially funded at the outset, and additional monies are normally committedto the contract by the TSA only as appropriations are made by Congress forfuture periods. The government’s failure to fully fund one or more of thecontracts for our EDS products or our other products under development wouldharm our business.

 

Under our newthree-year agreement with the TSA announced on August 12, 2003, the TSA has theright to purchase system options and accessories, engineering and installationsupport and 550 CTX units, principally our CTX 9000 DSi systems, over thethree-year term. While the TSA placed an initial $54.8 million delivery orderunder the 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 

 

 

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additional delivery orders under the newagreement or will not cancel its existing order. The new agreement is subjectto all of the limitations and restrictions that apply to U.S. governmentcontracts, including those described above.

 

Because wecontract with the U.S. government, we are subject to periodic audits andreviews. Based on the results of its audits, the U.S. government may adjust ourcontract-related costs and fees, including allocated indirect costs. In thefuture, government audits and reviews could result in adjustments to ourrevenues and cause other adverse effects, particularly to our relationship withthe TSA. In addition, under U.S. government purchasing regulations, some of ourcosts, including most financing costs, amortization of intangible assets,portions of our research and development costs, and some marketing expenses maynot be reimbursable or allowed in our negotiation of fixed-price contracts.Further, because we contract with the U.S. government, we are subject to anincreased risk of investigations, criminal prosecution, civil fraud,whistleblower lawsuits and other legal actions and liabilities to which purelyprivate sector companies are not.

 

In addition,public agency contracts are frequently awarded only after formal competitivebidding processes, which are often protracted and typically contain provisionsthat permit 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.

 

**Ourgrowth depends on our introduction of new products and services, which may becostly to develop and may not achieve market acceptance.**

 

As part of ourstrategy for growth, we intend to develop products to address additionalaviation security opportunities, such as passenger, carry-on baggage and aircargo screening. We also intend to address homeland security requirementsbeyond aviation, such as screening at border checkpoints, government officesand transportation terminals and ports. We will be required to spendsignificant funds to develop or acquire technologies and products for theseinitiatives, and these initiatives may divert our development and managementresources away from our core EDS products. In addition, we have acquired,rather than developed internally, some of our technologies in connection withour acquisitions of companies and businesses, and these technologies may notperform as we expect. The development of new products may require greater timeand financial resources than we currently anticipate and, despite significantinvestments in research and development, may not yield commercially successfulproducts.

 

Thedevelopment of our products for explosives and weapons detection is highlycomplex. Successful product development and market acceptance of any newproducts and services that we develop depend on a number of factors, including:

 
| • |   | our timely completion and introduction of  new products;                                                                                                                                                  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | our accurate prediction of the demand for  homeland security products and the changing requirements of the homeland  security industry, including certification or other required performance  standards; |
| • |   | the availability of key components of our  products;                                                                                                                                                      |
| • |   | the quality, price and operating performance  of our products and those of our competitors;                                                                                                               |
| • |   | our customer service capabilities and  responsiveness; and                                                                                                                                                |
| • |   | the success of our relationships with  existing and potential customers.                                                                                                                                  |

 

Finally, newproducts for aviation security applications may require certification orapproval by the TSA, and we believe that the TSA does not currently havestandards for the certification of aviation security products other than bulkexplosives detection systems and explosives trace detectors, or ETD. Otherproducts, such as metal detectors, are subject to TSA testing prior toapproval. Market acceptance of new products may be limited if the TSA has notdeveloped standards for certification or approval of such products, and even ifit does develop such standards, we may be unable to obtain any suchcertification or approval, which could materially limit market acceptance ofsuch products. If we fail to timely introduce new products or if these productsfail to gain market acceptance, our results of operations would be harmed.

 

 

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In addition,even if successful in the United States, new products that we develop may notachieve market acceptance outside of the United States. Unlike the U.S.government, foreign governments may be unwilling to commit financial resourcesto purchase our new products, which would reduce our potential revenues andharm our business.

 

**Wedepend upon a limited number of suppliers for components of our products, andif we are unable to obtain parts from these suppliers on a timely basis, thenwe may not be able to deliver our products as required.**

 

Key componentsused in our products have been designed by us to our specifications and arecurrently available only from one or a limited number of suppliers. Wecurrently do not have long-term agreements with any of these suppliers. Inaddition, some of the suppliers of the key components used in our products areour competitors, and they may be motivated not to supply us with the componentswe need. Our inability to develop alternative sources for single or sole sourcecomponents, to find alternative third party manufacturers or sub-assemblers, orto obtain sufficient 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.

 

**Ourfuture EDS products may fail to obtain certification by the TSA.**

 

We plan tocontinue to develop new models for our family of EDS products, includingsystems utilizing X-ray based diffraction, or XRD, technology, of our recentlyacquired subsidiary, Yxlon International Holding GmbH, or Yxlon, and tocontinue our participation in the ARGUS program, an FAA/TSA-sponsored programdesigned to develop a smaller, low-cost EDS product. However, we cannot becertain that any new EDS product, including systems utilizing Yxlon’s XRDtechnology or our CTX 1000 (ARGUS) system, will be certified by the TSA. Thefailure to gain certification for an EDS product would harm our ability to sellthe product, and recognize associated revenues.

 

**Ourexisting EDS products may fail to obtain re-certification by the TSA forchanges in the EDS systems.**

 

Our existingEDS products can be required to be re-certified by the TSA. This can happenwhen a critical component is changed, or we wish to make other changes to theEDS systems. When this happens, the affected EDS model requiresre-certification by the TSA. The failure or delay in gaining re-certificationfor an existing EDS product could harm our ability to continue to sell theproduct and recognize associated revenues.

 

**Ourmajor customer, the TSA, is a part of the Department of Homeland Security, anewly created agency that has experienced, and may continue to experience,delays in its operations, which may cause delays in our receiving orders fromthe TSA.**

 

The TSA is arelatively new 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. For example,Congress is still in the process of organizing subcommittees for the TSA. Thismay result in delays in our receiving orders for our EDS products. Further, theTSA is now a part of the Department of Homeland Security, which was createdsubsequent to the creation of the TSA and is therefore in an earlier stage offormation, which may further create delays in our receiving orders as thisagency is organized.

 

**Futuresales of our EDS products will depend on the ability of airports to securefunding to build baggage handling systems and to integrate our EDS productsinto such systems, which they may not be able to do.**

 

Future saleswill depend, in part, on installing our EDS products into airport lobbies orintegrating them into existing baggage handling systems. If an airport is notconfigured for these systems, deployment of our EDS

 

 

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products may require changes in the airportinfrastructure, such as reinforced airport lobby floors and baggage platforms.If our EDS products cannot easily be installed in airport lobbies or integratedinto existing baggage handling systems, we may experience reduced sales of ourEDS products or these sales may be delayed. In addition, installations andintegrations are currently partially funded by the TSA in the United States.Recent legislation established a ‘‘letter of intent’’ program under which anairport can present a request to the TSA for reimbursement of costs incurred bythe airport in improving baggage handling systems to increase security. Therecan be no assurance that the government will continue to fund installations,integrations and reimbursements at the current level or at all. If there is areduction in funding, we may experience reduced sales of our EDS products orthese sales may be delayed.

 

We believethat a substantial opportunity exists for our CTX 9000 DSi model to beintegrated into baggage handling systems. If airports determine, in conjunctionwith governmental authorities, that they will be unable or unwilling to modifyor finance such in-line baggage handling systems, this opportunity may belimited.

 

**Asa result of the Transportation Security Act, our EDS products are undergoingsubstantially increased usage per day, which could cause unforeseen problemswith their ability to sustain this increased usage.**

 

As required bythe Transportation 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.

 

**Wemay seek to grow by acquisition, which subjects us to substantial risks,including the failure to successfully integrate an acquired business.**

 

As part of ourgrowth strategy, we may expand our business by pursuing selected acquisitionsof technologies 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:

 
| • |   | difficulties in the assimilation of  acquired operations, technologies and products;             |
|--------|--------|--------------------------------------------------------------------------------------------------|
| • |   | diversion of management’s attention from  other business concerns;                          |
| • |   | lack of experience operating in the  geographic market or industry sector of acquired companies; |
| • |   | exposure to unanticipated contingent  liabilities of acquired companies; and                     |
| • |   | potential loss 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 

 

 

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such efforts would harm our business.Maintaining uniform standards, controls, procedures and policies may be harderthan we anticipate and interfere with efficient administration of the companyas a whole.

 

For example,on March 31, 2003, the first day of our second quarter of fiscal 2003, wecompleted the acquisition of Yxlon. Yxlon is active in businesses that are newto us and present a challenge to our management. In order to successfullyintegrate Yxlon’s security technologies and products, we must, among otherthings, integrate these into our suite of products, both from an engineeringand a sales and marketing perspective. As a result, we may take longer todevelop and introduce new products than we anticipate. In addition, Yxlon’snon-destructive testing business is new to us. We do not have experiencedeveloping, marketing and selling products in the non-destructive testingbusiness, and we may not be successful competing for customers in industrieswith which we are unfamiliar. The difficulties of integration of Yxlon may befurther complicated by the geographic distance between our U.S. offices andYxlon’s headquarters, which are located in Germany. If we are not successful inintegrating Yxlon’s security technologies into our product line, or in managingYxlon’s non-destructive testing business, we may incur additional expenses orlose revenue opportunities for Yxlon and us, and our business results maysuffer.

 

**Ourstrategic investments may not provide any of the benefits we anticipate, and asa result, we may incur economic losses or be required to write-down theseinvestments.**

 

From time totime, we consider strategic investments in development-stage companies that webelieve provide strategic opportunities for us, such as our recent investmentin SafeView, Inc., which is developing portal systems for passenger screening.Although we intend that these investments will provide access to newtechnologies and emerging markets, we cannot assure you that these investmentswill create opportunities for us to increase our sales. If these companies areunsuccessful in their product development efforts or are unable to obtainadditional private financing, we may be required to write-down theseinvestments or we may lose some or all of these investments, which would harmour results.

 

**Wemay not be able to grow our service organization quickly enough to support ourEDS products deployed in the field.**

 

We areresponsible for supporting the installation of, and providing warranty servicefor, our EDS products. With the rapid increase in the number of units beingshipped, we are expanding our service organization’s capability. EDS productsare relatively complex machines, which employ high-speed conveyors andsophisticated imaging technology. If we are unable to hire and train sufficientservice personnel supported by an expanded logistical system, the reliabilityof our machines could suffer. If this were to occur, there could be a decreasein demand for our products.

 

**Ifour EDS products fail to detect explosives, we could be exposed to productliability and related claims for which we may not have adequate insurancecoverage, and we may lose current and potential customers.**

 

Our businessexposes us to potential product liability risks, which are inherent in themanufacturing, sale and maintenance of EDS products. Our machines are notdesigned to detect, and FAA/TSA certification does not require, 100% detectionof any and all explosives contained in scanned baggage. For this reason, or ifour products malfunction, it is possible that explosive material could passundetected through our products, which could lead to product liability claims.There are also many other factors beyond our control that could lead toliability claims, such as the reliability and competence of the customer’soperators and the training of the operators.

 

If a productliability claim is brought against us, the cost of defending the claim would besignificant and any adverse determination may result in liabilities in excessof our insurance coverage. We currently have product liability insurance in theamount of $200.0 million. We also have war and terrorism insurance in theamount of $200.0 million, including up to $50.0 million under our productliability insurance. However, since September 11, 2001, insurance rates haveincreased dramatically, and we cannot be certain that our current insurance canbe maintained, or additional insurance coverage could be obtained, onacceptable terms, if at all.

 

In addition,the failure of any EDS product to detect explosives, even if due to operatorerror and not to the mechanical failure of an EDS product, could result inpublic and customer perception that our products do not work 

 

 

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effectively, which may cause potentialcustomers to not place orders and current customers to cancel orders alreadyplaced or to not place additional orders, any of which would harm our businessand financial results.

 

**Wesubstantially depend on large orders from a limited number of customers. As aresult, order cancellations from any of our customers or the failure of thesecustomers to continue to purchase EDS products could have a material negativeimpact on our business and financial results.**

 

In any givenfiscal quarter or year, our revenues are derived from orders of multiple unitsof our EDS products from a limited number of customers. Through June 29, 2003,substantially all of our orders from U.S. customers have been funded by the FAAand 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 79.4% of our EDS revenues in the six monthsended June 29, 2003 and 85.4% of our EDS revenues in the year ended December31, 2002. In the six months ended June 29, 2003, thirteen customers accountedfor all of our EDS units sold during the quarter, and in the year endedDecember 31, 2002, ten customers accounted for all of our EDS products soldduring the year. The failure of these customers, particularly the U.S.government, to continue to purchase our EDS products or the cancellation ofexisting orders would harm our business.

 

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

 

In connectionwith orders for 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.

 

**TheU.S. government’s right to use technology developed by us, but funded by theU.S. government, limits our intellectual property rights.**

 

In accordancewith Federal Acquisition Regulations included in our development contracts withthe FAA, the U.S. government has rights to use our proprietary technologiesdeveloped after 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.

 

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

 

The salescycle of our EDS products is often lengthy due to the protracted approvalprocess that typically accompanies large capital expenditures and the timerequired to manufacture and install our EDS products. Typically, six to twelvemonths may elapse between a new customer’s initial evaluation of our systemsand the execution of a contract. Another three months to a year may elapseprior to shipment of our EDS products as the customer site is prepared and ourEDS products are manufactured. In addition, in the United States, the creationof the TSA and debate on formation of a Department of Homeland Security, aswell as 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.

 

 

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**Ourbacklog is not necessarily indicative of future revenues.**

 

We measure ourbacklog of product revenues as orders for systems and upgrades for whichcontracts or purchase orders have been signed, but which have not yet beenshipped. We measure our backlog of service revenues as orders for maintenancerelated to product support for which contracts have been signed, butmaintenance service has not yet been performed. We typically ship our productswithin three to twelve months after receiving an order. However, such shipmentsmay be affected by delays which occur in the delivery of components to us orour readiness to accept delivery of components for reasons of site preparationor otherwise. In some instances, shipments may be made more quickly dependingon our ability to build machines to order and our customers’ demand forimmediate delivery.

 

We measure ourbacklog of Quantum government contracts as funded and unfunded awards fromgovernment agencies for which services have not yet been performed. At the endof the second quarter of fiscal 2003, our Quantum government contracts backlogwas approximately $18.2 million, approximately $6.1 million of which wasfunded.

 

Any failure byus to meet an agreed upon schedule could lead to the cancellation of therelated order. Variations in the size, complexity and delivery requirements ofthe customer order may result in substantial fluctuations in backlog fromperiod to period. In addition, all orders are subject to cancellation or delayby the customer and, accordingly, we cannot assure investors that our backlogwill eventually result in revenues. For these reasons, we believe that backlogcannot be considered a meaningful indicator of our performance on an annual orquarterly basis.

 

**Ourinternational sales subject us to risks that could materially harm ourbusiness.**

 

Sales tocountries other than the United States accounted for 22.4% of our revenues inthe six months ended June 29, 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 internationalsales and operations could adversely affect our business, including:

 
| • |   | changes in domestic and foreign regulatory  requirements;                               |
|--------|--------|-----------------------------------------------------------------------------------------|
| • |   | political instability in the countries  where we sell products;                         |
| • |   | possible foreign currency controls;                                                     |
| • |   | fluctuations in currency exchange rates;                                                |
| • |   | our ability to protect and utilize our  intellectual property in foreign jurisdictions; |
| • |   | tariffs, embargoes or other barriers;                                                   |
| • |   | difficulties in staffing and managing  foreign operations;                              |
| • |   | difficulties in obtaining and managing  distributors; and                               |
| • |   | potentially negative tax consequences.                                                  |

 

Further, thesale of some of our products outside the United States is subject to compliancewith the U.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, our EDS products and ourlandmine detection equipment are deemed regulated military devices subject toexport 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.

 

 

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**Exchangerate fluctuations could cause a decline in our financial condition and resultsof operations.**

 

In 2003, thecost of certain international currencies has increased due to fluctuations inthe exchange 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. Fromtime to time, as and when we determine it is appropriate and advisable to doso, we will seek to mitigate the effect of exchange rate fluctuations throughthe use of derivative financial instruments. We cannot assure you, however,that we will continue this practice or be successful in these efforts.

 

Yxlon, whichwe acquired on March 31, 2003, generally transacts business in euro.Consequently, its financial condition and results of operations are reported ineuro and then translated into U.S. dollars at the applicable exchange rate forinclusion in our consolidated financial statements. As a result, appreciationof the U.S. dollar against the euro will have a negative impact on our reportedrevenues and operating profit while depreciation of the U.S. dollar against theeuro will have a positive effect on reported revenues and operating profit.

 

**TheU.S. government may obligate us to give priority to the TSA, which could harmour relationships with other customers.**

 

The TSA hasbeen authorized by the U.S. Department of Commerce to place a priority ratingon EDS contracts, which would obligate us to timely fulfill the TSA’s ordersand delay any unrated or lower-rated orders. In addition, as part of any futureorders, the TSA may request that we agree to timely fill its orders prior tofulfilling the needs of any other customers. Accordingly, we may not be able tofulfill orders for our EDS products from non-U.S. government customers during aperiod of demand from the U.S. government. This could cause our current andpotential non-U.S. government customers to seek EDS products from othersources, and could trigger financial penalties under the agreements with suchcustomers. We also may lose our goodwill and relationships with thesecustomers, which could harm our ability to make sales in the future.

 

**Wemay have warranty claims that exceed our reserves.**

 

Our EDSproducts are typically sold with one-year warranties. We have establishedreserves for the liability associated with product warranties based onhistorical experience with warranty claims. However, our actual warranty costs,including actual material usage or service delivery costs, may exceed ourreserves, which could have an adverse effect on our operating results.

 

**Wemay not be selected to provide post-warranty service on our CTX systems, and ifwe are selected to provide post-warranty services, these services may not beprofitable for us.**

 

We offer toour customers the opportunity to buy a service contract from us, which providesfor scheduled maintenance, repairs and parts once a warranty period on a CTXsystem has expired (which is typically a one-year period). If we are notselected to provide post-warranty service, this would harm our business. Someof our post-warranty service contracts contain fixed pricing terms. If ouractual costs, including actual material usage or service delivery costs, exceedour revenues under these service agreements, our operating results could beadversely affected. In January 2003, we entered into an agreement with Siemenspursuant to which Siemens subcontracted to us its CTX service obligations tothe FAA/TSA. The agreement is retroactive to November 2002. Commencing inJanuary 2003, Siemens has the option, exercisable each year, to extend theagreement for the following year, through 2007. Siemens has exercised itsoption for 2003. We cannot assure investors that Siemens will renew theagreement in subsequent years. In addition, historically, we have sold servicecontracts on most eligible CTX systems deployed internationally. We may notachieve this level of service contract sales in the future.

 

 

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

 

The EDSindustry may undergo significant technological development in response toincreased demand for aviation security products. A fundamental shift intechnology in our product markets could harm us, because we derivesubstantially all of our revenues from sales of EDS products and services.

 

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

 
| • |   | adversely impact our competitive position;                                                                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • |   | require write-downs of obsolete technology;                                                                                                                          |
| • |   | require us to discontinue production of  obsolete products before we can recover any or all of our related research,  development and commercialization expenses; or |
| • |   | require significant capital expenditures  beyond those currently contemplated.                                                                                       |

 

We cannotassure investors that we will be able to achieve the technological advances toremain competitive and profitable, that new products and services will bedeveloped and 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.

 

**TheEDS industry is highly competitive. Given the anticipated continuing demand forairport security products, competition may increase.**

 

The EDSindustry is intensely competitive and we may not compete successfully. As aresult of increased demand for security systems, additional companies may enterthe EDS industry. Some of our competitors, including L-3 CommunicationsHoldings, Inc. and many of the potential new entrants into the EDS industry,have financial, technical, production and other resources substantially greaterthan ours. We believe that some of our competitors have EDS products undergoingTSA certification. Our failure to compete successfully could result in lostsales and could hamper our financial results.

 

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

 

We believethat our future success will be due, in part, to the continued services of oursenior management team. We do not have long-term employment agreements with anyof our executive 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.

 

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

 

Our corporateand manufacturing 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.

 

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

 

Our successdepends in part on our ability to protect our intellectual property. Althoughwe attempt to protect our intellectual property in the United States and othercountries through various methods such as patents and patent

 

 

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 applications, trademarks, copyrights and non-disclosureagreements, there can be no assurance that we will successfully protect ourtechnology or that competitors will not be able to develop similar technologyindependently.

 

We have twoU.S. patents for automatic concealed object detection systems using a pre-scanstage as used in our CTX products. These patents expire in 2010 and 2011. Thepatents have not prevented competitors from developing CT-based products whichdo not use a pre-scan stage. The time period for filing foreign counterparts ofour two U.S. EDS patents has expired, and we did not seek or obtain patentprotection. The absence of foreign counterparts to our patents could adverselyaffect our ability to prevent a competitor from using technology similar totechnology used in our CTX products. We also have a U.S. patent for amechanical radiation shield for our CTX 9000 DSi model, which expires in 2021.We rely on this technology to increase the speed of the baggage inspectionprocess. We have filed other applications in the United States and Europe forpatents covering other features contained in our CTX 9000 DSi model. We cannotassure investors that the claims allowed under any patents held by us will besufficiently broad to protect our technology against competition from thirdparties with similar technologies or products. In addition, we cannot assureinvestors that any patents issued to us will not be challenged, invalidated orcircumvented or that the rights granted under these patents will provide acompetitive advantage to us. Moreover, the laws of some foreign countries donot protect intellectual property rights to the same extent as the laws of theUnited States, and we could experience various obstacles and high costs inprotecting our intellectual property rights in foreign countries. If we areunable to obtain or maintain these protections, we may not be able to preventthird parties from using our intellectual property.

 

We also relyon trade secrets, proprietary know-how and continuing technological innovationto remain competitive. We have taken measures to protect our trade secrets andknow-how, including the use of confidentiality agreements with our employees.It is possible that these agreements may be breached and that the availableremedies for any breach will not be sufficient to compensate us for damagesincurred.

 

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

 

Litigation maybe necessary in the future to enforce our patents and other intellectualproperty rights, to protect our trade secrets or to determine the validity andscope of the proprietary rights of others. Any litigation, regardless of theoutcome, could be costly and require significant time and attention of keymembers of our management and technical personnel.

 

Our domesticand international competitors, many of whom have substantially greaterresources and have made substantial investments in competing technologies, mayhave patents that will prevent, limit or interfere with our ability tomanufacture and sell our products. We have not conducted an independent reviewof patents issued to third parties. Because of the perceived market opportunitywe face, companies possessing technology rights that they believe we might beinfringing will now be much more motivated to assert infringement of theirrights. These third parties may assert infringement or invalidity claimsagainst us and litigation may be necessary to defend against these claims. Anadverse outcome in the defense of a patent suit could subject us to significantliabilities to third parties, require disputed rights to be licensed from thirdparties or require us to cease selling our products. Even successful defensesof patent suits can be costly and time-consuming.

 

**Wehave received significant amounts of funding from government grants andcontracts. We cannot assure investors that we will continue to receive thislevel of funding for future product development.**

 

The U.S.government currently plays an important role in funding the development of EDStechnology and 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. We did notreceive any reimbursable research and development for EDS products in the sixmonths ended June 29, 2003. This is a significant reduction from the $8.3million for reimbursable research and development for EDS products from FAAgrants and contracts in the year ended December 31, 2001. We are also awarethat other competitors and potential competitors in the EDS market havereceived FAA and TSA development grants. The U.S. government also currentlyfunds almost all of the development of Quantum products, including QR andpassive magnetic sensing. We had contract research and development revenues fromthe U.S. government for the development of Quantum products of $6.4 million forthe six months ended June 29, 2003 and of $12.1 million for the year endedDecember 31, 2002. We cannot assure investors that additional research anddevelopment funds from the 

 

 

31

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government will become available in thefuture or that we will receive any of these additional funds. If the governmentfails to continue to sponsor our technology, we would have to expend more resourceson product development, which could adversely affect our business. In addition,any future grants to our competitors may improve their ability to develop andmarket advanced detection products and cause our customers to delay anypurchase decisions, which could harm our ability to market our products.

 

***Risks Related toOwnership of Our Common Stock***

 

**Theprice of our common stock, and consequently the trading price of the notes, mayfluctuate significantly.**

 

The tradingprice of our common stock has been and may continue to be subject to largefluctuations. Our stock price may increase or decrease in response to a numberof events and factors, including:

 
| • |   | the level and changing nature of terrorist  activity;                                                                          |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------|
| • |   | legislative and regulatory developments  related to anti-terrorism efforts or aviation security;                               |
| • |   | our quarterly operating results or those of  other explosives detection companies;                                             |
| • |   | the public’s reaction to our press  releases, announcements and our filings with the Securities and Exchange  Commission; |
| • |   | our announcement of an acquisition or  strategic investment;                                                                   |
| • |   | changes in earnings estimates or  recommendations by research analysts;                                                        |
| • |   | changes in our relationships with  customers; and                                                                              |
| • |   | developments affecting our competitors.                                                                                        |

 

The marketprice of our common stock has fluctuated dramatically since the terroristattacks of September 11, 2001. For example, immediately prior toSeptember 11, 2001, our common stock closed at $3.11 per share. Since thatdate, our closing stock price has risen to a high of $48.29 per share onMarch 12, 2002. On June 27, 2003, the last trading day of our secondquarter of 2003, our common stock closed at $24.55 per share. In addition, thestock market has periodically experienced significant price and volumefluctuations that have particularly affected the market prices of common stockof technology companies. These changes have often been unrelated to theoperating performance of particular companies. These broad market fluctuationsmay also negatively affect the market price of our common stock.

 

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

 

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

 

**Wemay not pay cash dividends.**

 

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

 

 

32

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**Wemay become subject to costly and time-consuming class action litigationfollowing significant changes in our stock price.**

 

In the past,following periods of volatility in the market price of a company’s securities,securities class action litigation has often been instituted against such acompany. Were such litigation to be commenced against us, we would incursubstantial costs and there would be diversion of our management’s attentionand resources, which could materially harm our business, results of operationsand financial condition.

 

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

## ** **

Our internationalsystem sales and maintenance contracts are generally denominated in U.S.dollars.   In instances where there aresignificant international system sales contracts denominated in a foreigncurrency, we often enter into forward contracts to mitigate foreign exchangerisk.   We do not enter into market risksensitive instruments for trading purposes. In the second quarter of 2003, we did not enter into any new foreignexchange forward contracts, and at June 29, 2003, December 31, 2002 andDecember 31, 2001, we had outstanding contracts to convert euros to dollars with notional values totaling $25.5million, $34.7 million and $16.9 million, with a negative fair values ofapproximately $536,000, $4.9 million and a positive fair value of $47,000,respectively.  The following tabledepicts the maturities of the outstanding contract amounts (in thousands):

 
| **Contract  Maturity** |   | **Within 3  months** |   | **4-6 months** |   | **7-9 months** |   | **10-12 months** |   | **13 months** |   |
|------------------------|--------|----------------------|--------|----------------|--------|----------------|--------|------------------|--------|---------------|--------|
|                   |   |                 |   |           |   |           |   |             |   |          |   |
| Amount at 6/29/03      |   | $                    | 25,362 |           | $      | 99             |   | $                | — |          | $      | — |   | $ | — |   |
| Amount at 12/31/02     |   | 13,884               |   | 18,020         |   | 2,653          |   | 99               |   |          |   |
| Amount at 12/31/01     |   | 5,623                |   | 110            |   | 2,194          |   | 2,179            |   | 6,841         |   |
|                        |        |                      |        |                |        |                |        |                  |        |               |        |  |  |  |  |  |

 

Purchases of raw materials and other inventory components are primarilydenominated in U.S dollars and, when purchased in foreign currencies, aregenerally made on an as needed basis. We have some advance purchase commitmentsin foreign currencies with a few European suppliers. We currently do not hedgeagainst these purchase commitments, as the foreign exchange rate fluctuationshave not had a material adverse impact on these purchases; however, we willcontinue to monitor the foreign exchange rates and may enter into forwardcontracts to mitigate foreign exchange risk as appropriate.

 

Certain costs of providing warranty and maintenance services forsystems sold to foreign countries are denominated in local currencies.  To the extent exchange rates fluctuate, itcould become more expensive to provide these services.  To date, these costs have not beensignificant; however, we expect they will increase as our installed baseincreases.

 

33

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We are exposed to foreign currency exchange rate risk inherent in oursales commitments, anticipated sales, anticipated purchases and assets andliabilities denominated in currencies other than the U.S. dollar. We transactbusiness primarily in four currencies worldwide, of which the most significantto our operations is the euro. In some situations, we are a net receiver offoreign currencies and therefore benefit from a weaker U.S. dollar and areadversely affected by a stronger U.S. dollar relative to those foreigncurrencies in which we transact significant amounts of business. We performed asensitivity analysis as of June 29, 2003, December 31, 2002 and December 31,2001 using a modeling technique that measures the change in the fair valuesarising from a hypothetical 10% and 15% adverse movement in the levels offoreign currency exchange rates relative to the U.S. dollar (that is,strengthening of the U.S. dollar) with all other variables held constant. Theanalysis covers all of our foreign exchange forward contracts offset by theunderlying exposures.  The analysisexcludes balances and transactions pertaining to Yxlon.  Foreign exchange rate risk is relatively lowfor Yxlon given that it primarily transacts business in euros.

 

The cash flow impacts of our sensitivity analysis as of June 29, 2003are summarized in the following table (the foreign currency exchange rates usedwere based on market rates in effect at June 29, 2003):

 
|                                |   | **Contract  Amount** |   | **Fair Value  as of  June 29, 2003** |   | **Cash flow  impact of change in exchange rates** |   |
|-------------------------------------|--------|----------------------|--------|--------------------------------------|--------|---------------------------------------------------|--------|
| **(in thousands)**                  |   |                 |   | **10% Change**                       |   | **15% Change**                                    |   |
| Foreign exchange forward contracts  |   | $                    | 25,461 |                                 | $      | (536                                              | )      | $ | 2,601 |   | $ | 3,902 |   |
| Accounts receivable                 |   | 12,398               |   | 15,171                               |   | (1,517                                            | )      | (2,276 | ) |
| Firm orders*                        |   | 18,340               |   | 20,842                               |   | (2,084                                            | )      | (3,126 | ) |
| Other working capital balances, net |   | 23                   |   | (175                                 | )      | 18                                                |   | 26 |   |
| total                               |   |                 |   |                                 |   | $                                                 | (982   | ) | $ | (1,474 | ) |
|                                     |        |                      |        |                                      |        |                                                   |        |  |  |  |  |  |  |

 

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* Firm orders represent orders for which we have received a signed purchaseorder.

 

The cash flow impact of changes in exchange rates at June 29, 2003 isnot significantly different from the cash flow impact of changes in exchangerates at December 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.

 

The cash flow impacts of the sensitivity analysis as ofDecember 31, 2002 are summarized in the following table (the foreigncurrency exchange rates used were based on market rates in effect atDecember 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 represent orders for which we have received a signedpurchase order.

 

The cash flow impact of changes in exchange rates at December 31, 2002is not significantly different from the cash flow impact of changes in exchangerates at December 31, 2001.

 

34

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## **Item 4.  Controls and Procedures**

 

Within ninety days prior to the date of this Form 10-Q, we carried outan evaluation, under the supervision and with the participation of Dr. SergioMagistri, our principal executive officer, and Ross Mulholland, our principalfinancial officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures. Based on this evaluation, Dr. Magistri andMr. Mulholland concluded that our disclosure controls and procedures areeffective at recording, processing, summarizing and reporting, within the timeperiods specified in the SEC’s rules and forms, the information included in ourperiodic SEC reports. It should be noted that a control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. Further, thedesign of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people or by management override ofthe control. The design of any system of controls also is based in part uponcertain assumptions about the likelihood of future events, and we cannot assureinvestors that any design will succeed in achieving its stated goals under allpotential future conditions. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

In addition, there have been no significant changes in our internalcontrols or in other factors that could significantly affect those controlssubsequent to the date of their last evaluation.

 

**PART II.  OTHER INFORMATION**

 

**Item 1.****           LegalProceedings**

 

We areinvolved in legal proceedings, claims and litigation arising in the ordinarycourse of business.  While the outcomeof these matters is currently not determinable, management does not believethat the ultimate cost to resolve these matters will have a material adverseeffect on our consolidated financial condition, results of operations or cashflows.

 

**Item 4.****           Submissionof Matters to a Vote of Security Holders**

 

Our 2003 Annual Meeting of Stockholders was held June 12, 2003. Matters voted upon at that meeting were:

 
| (1) |   | The election of three directors to hold office until the 2006 Annual  Meeting of Stockholders; and                                        |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The ratification of the selection of Deloitte & Touche LLP as our  independent auditors for our fiscal year ending December 31, 2003. |

 

Tabulations for each proposal were as follows:

 

Proposal 1.  Election of three directors to hold office until the2006 Annual Meeting of Stockholders

 
| **Director**        |   | **For**    |   | **Withheld** |   |
|---------------------|--------|------------|--------|--------------|--------|
| Dr. Sergio Magistri |   | 13,675,284 |   | 96,585       |   |
|                |   |       |   |         |   |
| David Pillor        |   | 13,681,973 |   | 89,896       |   |
|                |   |       |   |         |   |
| Stephen Blum        |   | 13,576,084 |   | 195,785      |   |

 

Dr. Douglas Boyd, Dr. Bruno Trezza and Mr. Louis Turpen will continuein office as directors until our 2005 Annual Meeting of Stockholders.  Dr. Giovanni Lanzara and Ambassador MorrisD. Busby will continue in office as directors until our 2004 Annual Meeting ofStockholders.

 

35

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Proposal 2.  Ratification of the selection of Deloitte &Touche LLP

 
| **For**    |   | **Against** |   | **Abstain** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| 13,321,865 |   | 418,547     |   | 31,457      |   | —                |   |

 

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

 

Consistent with Section 10A(i)(2) of theSecurities Exchange Act of 1934, as added by Section 202 of the Sarbanes-OxleyAct of 2002, we are responsible for listing the non-audit services approved byour Audit Committee to be performed by Deloitte & Touche LLP, our externalauditor. Non-audit services are defined as services other than those providedin connection with an audit or a review of our financial statements.  During the quarterly period covered by thisfiling, the Audit Committee approved engagements of Deloitte & Touche LLPfor the following non-audit services:

 

•                  tax services,which includes consulting related to (1) federal, state and local tax issues,and (2) international tax issues;

 

•                  consultingservices relating to the review of government contracts; and

 

•                  merger andacquisition services, which includes (1) due diligence services, and (2)consulting related to the structuring of mergers and acquisitions.

 

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

 

(a)                                  Exhibits

 

2.1                                 Share and PurchaseTransfer Agreement dated as of February 21, 2003 among the registrant, YxlonBeteiligungs-Verwaltung GmbH, NDT International Holdings A.S, YxlonInternational Holding GmbH, Yxlon International X-Ray GmbH, Joseph Kosanetzky,Reinhard Bonisch and Botts & Company Ltd. (1)

3.1                                 Amended and RestatedCertificate of Incorporation of the registrant. (2)

3.2                                 Amendment to Amendedand Restated Certificate of Incorporation of the registrant (3)

3.3                                 Bylaws of theregistrant, as amended.

4.1                                 Reference is made toExhibits 3.1 through 3.3.

10.1                           Amendment to Loan Documentsdated as of October 2, 2002 between the registrant and Silicon Valley Bank.

10.2                           Amendment to Loan Documents(Exim Program) dated as of October 2, 2002 between the registrant and SiliconValley Bank.

10.3                           Amendment to Loan Documentsdated as of June 30, 2003 between the registrant and Silicon Valley Bank.

99.1                           Certificate of ChiefExecutive Officer and Chief Financial Officer.

 

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(1)          Filed as an exhibit to the registrant’sQuarterly Report on Form 10-Q for the quarter ended March 30, 2003and incorporated herein by reference.

 

(2)          Filed as an exhibit to the registrant’sRegistration Statement on Form S-1 (No. 333-05517) and incorporated herein byreference.

 

(3)        Filed as an exhibit to the registrant’s AnnualReport on Form 10-K for the year ended December 31, 2001 and incorporatedherein by reference.

 

(b)                                 Reporton Form 8-K filed during the fiscal quarter ended June 29, 2003:  On April 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 Strong First QuarterResults” and dated April 22, 2003.

 

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# **SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                  | **INVISION  TECHNOLOGIES, INC.**                  |
|-----------------------|---------------------------------------------------|
|                  |                                              |
|                  |                                              |
| Date: August 12, 2003 | /s/ Sergio Magistri                               |   |
|                  | Dr. Sergio Magistri                               |
|                  | President and Chief Executive Officer             |
|                  | *(Authorized  Officer)*                           |
|                  |                                              |
|                  |                                              |
| Date: August 12, 2003 | /s/ Ross Mulholland                               |   |
|                  | Ross Mulholland                                   |
|                  | Senior Vice President and Chief Financial Officer |
|                  | *(Principal  Financial and Accounting Officer)*   |

 

37

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# **CERTIFICATION**

 

I, Sergio Magistri, certify that:

 

1.               I have reviewed this quarterly report onForm 10-Q of InVision Technologies, Inc.;

 

2.               Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.               The registrant’s other certifyingofficer and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

(a)          designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b)         evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

(c)          presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifyingofficer and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

(a)          all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b)         any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.               The registrant’s other certifyingofficer and I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date: August 12, 2003

 

 
|   | /s/ Sergio Magistri                   |   |
|--------|---------------------------------------|--------|
|   | Dr. Sergio Magistri                   |
|   | President and Chief Executive Officer |
|   | (Principal Executive Officer)         |

 

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# **CERTIFICAT**ION

 

I, Ross Mulholland, certify that:

 

1.           I have reviewed this quarterly report onForm 10-Q of InVision Technologies, Inc.;

 

2.           Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.           Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.           The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

(a)          designed such disclosure controls and proceduresto ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

(b)         evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

(c)          presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifyingofficer and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

(a)          all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b)         any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.   Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: August 12, 2003

 

 
|   | /s/ Ross Mulholland           |   |
|--------|-------------------------------|--------|
|   | Ross Mulholland               |
|   | Chief Financial Officer       |
|   | (Principal Financial Officer) |

 

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**EXHIBIT INDEX**

 

**Exhibitsand Reports on Form 8-K**

 
| **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.                                                                                                                                                                                                                                                                   |
| 4.1          |   | Reference is made to Exhibits 3.1 through 3.3.                                                                                                                                                                                                                                                          |
| 10.1         |   | Amendment to Loan Documents dated as of October 2, 2002 between the  registrant and Silicon Valley Bank.                                                                                                                                                                                                |
| 10.2         |   | Amendment to Loan Documents (Exim Program) dated as of October 2,  2002 between the registrant and Silicon Valley Bank.                                                                                                                                                                                 |
| 10.3         |   | Amendment to Loan Documents dated as of June 30, 2003 between the  registrant and Silicon Valley Bank.                                                                                                                                                                                                  |
| 99.1         |   | Certificate of Chief Executive Officer and Chief Financial Officer.                                                                                                                                                                                                                                     |

 

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(1)          Filed as an exhibit to the registrant’sQuarterly Report on Form 10-Q for the quarter ended March 30, 2003and incorporated herein by reference.

 

(2)          Filed as an exhibit to the registrant’sRegistration Statement on Form S-1 (No. 333-05517) and incorporated herein byreference.

 

(3)          Filed as an exhibit to the registrant’sAnnual Report on Form 10-K for the year ended December 31, 2001 andincorporated herein by reference.

 

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