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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended DECEMBER 31, 2000

or

For the transition period from                to                .

Commission File Number: 0-20815

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

7151 GATEWAY BOULEVARD, NEWARK, CALIFORNIA 94560
(Address of principal executive offices, including zip code)

(510) 739-2400
(Registrant's telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:
NONE

Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE

   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

   Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / /

   Based on the closing price of $3.00 on March 26, 2001, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $28,264,821. For purposes of this computation, voting stock held by directors and executive officers of the Registrant and stockholders holding 5% or more of the Registrant's outstanding Common Stock has been excluded. Such exclusion is not intended, and shall not be deemed, to be an admission that such directors, executive officers and stockholders are affiliates of the Registrant.

   On March 26, 2001, there were 12,650,281 shares of the Registrant's Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

   Portions of the Registrant's definitive Proxy Statement which will be filed with the Securities and Exchange Commission in connection with the Registrant's Annual Meeting of Stockholders to be held June 21, 2001 are incorporated by reference in Part III, Items 10, 11, 12 and 13 of this report.

INVISION TECHNOLOGIES, INC.
TABLE OF CONTENTS

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PART I.

ITEM 1. BUSINESS

Forward Looking Statements

    This Annual Report on Form 10-K of InVision Technologies, Inc. (the "Company") contains forward-looking statements which involve risks and uncertainties. When used in this Annual Report on Form 10-K, the words "anticipate," "believe," "estimate," and "expect" and similar expressions identify such forward-looking statements. The Company's actual results, performance, or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include:

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risks related to market acceptance of the Company's products;

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fluctuations in the Company's quarterly and annual operating results;

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the loss of orders for the Company's products, or the failure to obtain additional orders;

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loss of any of the Company's major suppliers;

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intense competition;

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reliance on few customers and large orders;

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risks related to the lengthy sales cycles for the Company's products;

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budgeting limitations of the Company's customers and prospective customers;

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risks inherent to the development and production of new products and new applications and the certification of certain of these products;

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risk of certification of competitors' products;

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risk of orders in backlog being canceled; and

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those factors discussed in this Item 1, including under "Business Risks," and in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Annual Report on Form 10-K.

General

    The Company brings to market advanced detection and inspection products by adapting various medical and laboratory technologies for government and commercial uses, such as security, defense and process control.

    The Company is the worldwide leader in explosive detection technology. The Company develops, manufactures, markets and supports explosive detection systems for civil aviation security based on advanced computed tomography ("CT") technology. The Company's products were the first automated explosive detection systems to be certified by the Federal Aviation Administration ("FAA") as meeting its stringent requirements. The Company has sold an aggregate of 231 systems to the FAA, foreign aviation security agencies, and domestic and foreign airports and airlines.

    The Company, through its wholly owned subsidiary Quantum Magnetics, Inc. ("Quantum"), develops for commercialization patented and proprietary technology for inspection, detection and analysis of explosives and other materials. Quantum's products are based on passive magnetic sensing technology and quadrupole resonance ("QR") technology, a form of magnetic resonance. The Company believes that QR technology is more accurate than conventional x-ray bulk detection techniques because QR identifies the explosive itself compared to other techniques that predict the presence of explosives by measuring object density or atomic number. Quantum receives grants from a variety of US government agencies for research and development of military and humanitarian landmine detection, carry-on luggage screening, concealed weapon detection, drug detection, and in-process materials inspection.

    In February 2000, the Company announced the formation of the WoodVision division ("WoodVision") to develop the Company's CT technology to optimize the value and yield of harvested

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timber. Previous studies indicated that CT technology can be applied to see inside a log before it is sawn. The Company believes that a market for a product that does this exists. The Company is conducting field trials, which started in 1999, to develop such a system. In connection with the formation of WoodVision, the Company acquired, as a wholly-owned subsidiary, Inovec, Inc. ("Inovec"), effective as of January 1, 2000. Inovec manufactures, markets and supports advanced optimization equipment for sawmills based on laser scanning and other optimization technologies. Since inception, Inovec has installed over 600 laser scanners and other optimization systems in over 300 sawmills worldwide.

    InVision was incorporated in Delaware in 1990. Its headquarters and principal manufacturing facilities are located in Newark, California. InVision acquired Quantum as a wholly owned subsidiary in 1997. Quantum is a California corporation located in San Diego, California. Inovec is a Delaware corporation, with its headquarters and manufacturing facilities located in Eugene, Oregon.

Industry Segments

    The Company reports its financial information in three segments, based on types of technology and consolidated applications. Financial information for each segment, including revenue, profits and total assets, is reported in Note 10 of the Consolidated Financial Statements in Part IV of this Report.

    EDS.  The "EDS" segment is comprised of the business unit that develops, manufactures, markets and supports explosive detection systems based on CT technology. For the years ended December 31, 2000, 1999 and 1998, the Company had EDS product and service revenues of $54.8 million, $47.6 million and $63.3 million, respectively. At December 31, 2000, the Company had in backlog equipment orders and service agreements of approximately $8.1 million, primarily consisting of service agreements. In the first quarter of 2001, the Company received orders valued at approximately $10.5 million from the FAA and an international customer for multiple explosive detection systems, accessories and service.

    Quantum.  The "Quantum" segment is comprised of the business unit that develops for commercialization technology for inspection, detection and analysis of explosives, primarily landmine detection, and other materials based on quadrupole resonance and passive magnetic sensing. For the years ended December 31, 2000, 1999 and 1998, the Company had government contract revenues of $10.6 million, $10.7 million and $7.2 million, respectively. The Company also had a small amount of product revenue in 2000 and 1999. As of December 31, 2000, the Company had $23.6 million of government research and development contracts in backlog.

    Wood.  The "Wood" segment is comprised of those business units that develop, manufacture, market and support technology to optimize the value and yield of harvested timber based on different types of scanning technologies, including CT technology. The Company conducts the business of this segment through its WoodVision division and its Inovec subsidiary. For the year ended December 31, 2000, Inovec had product and service revenues of $13.4 million. At December 31, 2000, Inovec had in backlog equipment orders and service agreements of approximately $1.8 million. In the first quarter of 2001, the Company received orders valued at approximately $2.2 million for laser-based optimization and scanning sysetms for lumber manufacturing. WoodVision is still developing the CT based log scanner and had no revenues or backlog as of December 31, 2000.

EDS

Products and Services

    Products.  The Company's current EDS products are the CTX 2500™, CTX 5500 DS™ and CTX 9000 DSi™ systems (together, the "CTX Series"). These products are designed, through variation in

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price, size and throughput, to provide a "family" of explosive detection systems for the inspection of checked baggage on commercial flights around the world.

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The CTX 5500 model was introduced in 1998 as an upgraded version of the Company's first EDS product—the CTX 5000 model which was introduced in 1994. The CTX 5500 system is used for all airport applications, including being integrated into the baggage handling system and as a non-integrated standalone machine.



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The CTX 9000 model, introduced in 1999, is designed to be significantly faster (higher throughput) and easier to integrate into airports' baggage handling systems than other CT based explosive detection systems. The CTX 9000 system has software specifically refined to respond to the needs of airport operations. It also has a larger belt-size and aperture, and a compact x-ray shielding method, compared to other CT based explosive detection systems.



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The CTX 2500 model, also introduced in 1999, is a less expensive explosive detection system operating at slower throughputs with a smaller footprint than other CT based explosive detection systems. The CTX 2500 system is designed for use in small airports and low-traffic stations within larger airports.

    All three models are certified by the FAA as automated explosive detection systems.

    Service.  In addition to providing generally a one year parts and service warranty with the sale of each system, the Company offers fee-based primary and back-up service contracts to its customers to provide system maintenance, ongoing technical support, documentation, training and, where no new hardware is required, periodic software releases.

    Training.  The Company believes that operator qualification and training in the utilization of the CTX system is important to the detection of explosives. The Company provides operator training and testing as a critical component of each sale and installation. It licenses its training materials to FAA approved customers for a nominal fee. The Company also offers a standalone training console that simulates a CTX system for sale to customers to train operators to use a CTX system without disrupting the operation of a deployed CTX system.

Market

    Market Size.  There are over 1,400 airports worldwide providing scheduled service for an aggregate of approximately 2.5 billion passengers per year. Of these airports, over 550 are located in the United States. A substantial portion of the remainder are located in Europe and the Asia/Pacific region. The market for checked baggage inspection systems depends on both the volume of checked baggage to be inspected and the applicable government regulation of baggage inspection.

    Worldwide Standards.  In the 1970's, in response to hijackings, airports worldwide began to install x-ray systems to screen carry-on baggage for weapons such as guns and knives. Following the December 1988 bombing of Pan American Flight 103 over Lockerbie, Scotland, the European Civil Aviation Commission ("ECAC") mandated a goal for all of its member states to implement 100% checked baggage screening using equipment based on existing technologies. According to ECAC, the vast majority of ECAC member states report themselves as being on course to achieve 100% screening by the target date of December 31, 2002.

    FAA Certification.  In response to airline bombings, in the late 1970's the FAA established a program to develop automated explosive detection capabilities based on existing x-ray technology. In response to the 1988 Lockerbie bombing, the United States enacted the Aviation Security Improvement Act of 1990 (the "Aviation Security Act"). In 1993, as required by the Aviation Security Act, the FAA adopted a certification protocol regarding explosive detection systems for use on checked baggage. The FAA certification process was developed to certify equipment that, alone or as part of an integrated

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system, can detect, under realistic air carrier operating conditions, the amounts, configurations and types of explosive material which would be likely to be used to cause catastrophic damage to commercial aircraft.

    Multi-Level Screening Processes.  Certain airports around the world have sought to augment their detection capabilities by implementing various multi-level screening processes. To date, two distinct processes have become most prevalent: a system first implemented in the United Kingdom (the "Technology Based Multi-Level Approach"); and a system endorsed by the FAA following the advent of certified detection technology (the "CAPPS and Detection Approach").

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The Technology Based Multi Level Approach uses several explosive detection systems operating in series to attempt to increase detection rates while maintaining throughput rates. The effectiveness of the entire detection process depends on technologies with greater emphasis on throughput than detection. Some airports have begun purchasing the more effective certified products to scan luggage identified as suspect by faster but less discriminating systems earlier in the series. In airports using this approach, certified products compete with non-certified products as well as with each other.



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The CAPPS and Detection Approach uses a process of computer-assisted passenger prescreening ("CAPPS") combined with a certified explosive detection system to detect explosives in baggage deemed to be high risk. The "CAPPS" process makes an initial determination of whether a particular passenger represents a high threat based on certain criteria that are believed to be reasonable predictors of risk. Based on this determination, a passenger's baggage may undergo a higher level of investigation, usually with the use of a certified explosive system. This approach requires the purchase of certified technology and limits the competition to sellers of certified technology.

    Effect of Customer Operations.  The Company's newer customers have only limited experience with the operation of the CTX Series in high-volume airport operations. Many of the factors necessary to make the overall baggage scanning system a success, such as the CTX Series' integration with the baggage handling system, are beyond the control of the Company. Also, unsatisfactory performance of operators can lead to reduced effectiveness of the CTX Series. In particular, once the CTX system identifies a threat, the operator must make a determination whether the threat is actual or a false alarm. The failure of the CTX Series to perform successfully in deployments, whether due to the limited experience of a customer, operator error or any other reason, may have an adverse effect on the market's perception of the Company and its products.

    Export Control.  The Company is subject to risks associated with regulations relating to the export of high technology products. In particular, the Company's automated explosive detection systems for aviation security are commodities subject to export control by the U.S. Department of Commerce. They may also be deemed to be defense articles subject to export control by the U.S. Department of State. Exports may be prohibited or limited to a small number of countries.

    Risk of Changing Standards.  There currently is no requirement that U.S. or international airlines or airports deploy FAA-certified explosive detection systems. There is also no requirement that U.S. airlines or airports (or most international airlines or airports) deploy explosive detection systems at all. However, the FAA has the responsibility to set and maintain performance standards for explosive detection systems for all U.S. airlines, both in the U.S. and abroad. Should the FAA increase its certification standards, the Company cannot assure that its products would meet such standards.

Distribution

    Direct and Indirect Sales Personnel.  The Company markets its EDS products both directly through internal sales personnel and indirectly through authorized agents, distributors and systems integrators.

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As of December 31, 2000, the Company employed a total of 21 people including four contractors in sales and marketing. In North America, the Company markets its EDS products primarily through direct sales personnel, which as of December 31, 2000, consisted of three individuals. Internationally, the Company utilizes both a direct sales force and authorized agents to sell its products. As of December 31, 2000, the Company had four direct international sales personnel broadly covering Europe, Asia, the Middle East and Africa and additional authorized representatives representing the Company in specific countries. For sales through its authorized representatives and distributors, the Company generally is directly involved in developing proposal documents and negotiating contract terms.

    Selling Process.  The selling process often involves a team comprised of individuals from sales, marketing, engineering, customer service and support, and senior management. The team frequently engages in a multi-level sales effort directed toward a variety of constituents, including government regulators, the local airport operator or authority, systems and or conveyor integrators, individual airlines and airline operating committees. The Company provides its sales representatives with training, promotional literature, a multi-media presentation, videos and competitive analysis. The sales process includes assisting customers to design baggage handling system configurations, including the use of computer modeling, educating customers on the system and technology, and supporting the implementation and integration process.

    Lengthy Sales Cycle.  The combination of the high average selling prices, the time needed for various agencies to secure funding for systems, and the negotiation and execution of actual contracts leads to a typical sales cycle lasting from six to twelve months, or more, after initial contact with a customer. Often, local government regulators become involved in the sales decision process or provide funds for the purchase. For repeat orders from existing customers, the Company can sometimes expedite the sales cycle by utilizing existing contracts and contract extensions and thereby avoid lengthy procurement processes.

    Customer Support.  The Company believes that customer service and support are critical to its success and has committed significant resources to these functions. The Company provides a high level of customer support to assist in the site planning, installation and integration of the Company's products into its customer's facilities in addition to field service for maintaining the reliability of the Company's products once installed. The Company's service organization includes customer service engineers, product application specialists and technical support engineers. As of December 31, 2000, the Company had 58 individuals employed in customer service and support roles. The Company typically hires and trains its own support staff throughout the world rather than relying on third-party maintenance providers, although a number of third party relationships exist outside the United States.

Customers

    Through December 31, 2000, the Company has shipped 231 CTX Series systems. 146 of these systems were shipped to the FAA and U.S. airlines for installation at the busiest U.S. airports and certain U.S. airlines' foreign locations. For reasons of security, the FAA will not divulge the deployment schedule or locations of these systems. The Company shipped 85 CTX Series systems to international customers for installation at major international airports in Belgium, England, France, Greece, Hong Kong, Israel, Malaysia, The Netherlands, South Korea, Spain and South Africa. In 2000, the Company shipped 32 systems to the FAA and U.S. airlines, and 12 systems to international customers.

    Sales to FAA.  To date, all orders from United States customers have been entirely funded by the FAA. In response to the crash of TWA Flight 800 off Long Island, New York in July 1996, President Clinton announced the formation of the White House Commission on Aviation Safety and Security, chaired by Vice President Gore (the "Gore Commission"), to review airline and airport security and oversee aviation safety. In response to the Gore Commission's conclusions, the U.S. appropriated

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$52.2 million for the FAA to purchase certified explosive detection technology, consisting of the Company's CTX 5000 systems. As a result, the Company had sales to the FAA of the Company's products and services of $30.8 million in fiscal 2000, $37.1 million in fiscal 1999 and $37.9 million in fiscal 1998. The Company's largest sales contract to date, for 105 CTX Series systems, all of which have been shipped, was with the FAA. The FAA signed three new contracts with the Company in March 2000 to purchase up to 60 of each of the Company's CTX 2500, CTX 5500 and CTX 9000 systems. The Company cannot assure that the FAA will obtain funding to purchase or will purchase more than the 11 CTX 9000 systems, 15 CTX 5500 systems and 13 CTX 2500 systems for which the Company has received orders to date.

    Dependence on Few Customers.  In any given fiscal year, the Company's EDS product and service revenues have principally consisted, and the Company believes will continue to consist, of orders of multiple units from a limited number of customers. While the number of individual customers may vary from period to period, the Company is nevertheless dependent upon these multiple orders for a substantial portion of its revenues. The Company cannot assure that it will obtain such multiple orders on a consistent basis. During the year ended December 31, 2000, approximately $43.8 million, or 80.0%, of the Company's EDS product and service revenues were generated from sales to the Company's five largest customers, of which $30.8 million, or 56.1%, of the Company's EDS product and service revenues were generated from sales to the FAA.

    Public Agency Contract and Budget Risks.  Substantially all of the Company's EDS customers to date have been public agencies or quasi-public agencies. In contracting with public agencies, the Company is subject to public agency contract requirements which vary from jurisdiction to jurisdiction and which are subject to budgetary processes and expenditure constraints. Budgetary allocations for explosive detection systems are dependent, in part, upon governmental policies which fluctuate from time to time in response to political and other factors, including the public's perception of the threat of commercial airline bombings. In addition, public agency bidding processes have been and may continue to be protracted, and typically contain provisions that permit cancellation in the event that funds are unavailable to the public agency.

Competition

    Explosive Detection Technologies.  The market for explosive detection systems is intensely competitive and is characterized by continuously developing technology and frequent introductions of new products and features. The Company expects competition to increase as other companies introduce additional and more competitive products and as the Company develops additional capabilities and enhancements for the CTX Series. Several advanced explosive detection technologies have been developed to attempt to address the need for effective explosive detection, including:

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CT technology, which uses a source of x-rays rotating around an object to create multiple two-dimensional images, commonly known as "slices," of the density distribution of the object's cross-section. CT technology compares parameters derived from the analysis of the density images to a database of explosives characteristics. CT is the only technology to base its detection on the density of the object examined.



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Single-view Dual energy x-ray systems, which measure the x-ray absorption properties of a bag's contents at two different x-ray energies using one or two views to determine if any of the contents have the physical characteristics of explosive materials.



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Multi-view x-ray, which is like dual energy x-ray, except that it uses three views in an effort to approximate cross-sectional data. This method gathers more two-dimensional data than conventional single or double view dual energy x-ray systems which gather data from one or two planes. This method gathers less data than CT which uses its multiple slice technology to gather

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thousands of two-dimensional views to reconstruct a full three-dimensional, cross-sectional image of an object.

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QR, which is an electromagnetic field based detection system that examines volume without imaging by using radio frequencies to detect the chemical make-up of an object.



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Trace detection equipment, known as "sniffers," which detect particulate and chemical traces of explosive materials collected by an operator by wiping or vacuuming the bag under inspection.



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Diffraction x-ray systems, which use a single energy source to take hundreds of measurements of the angular scatter patterns of a bag's contents to determine if any of the contents have the chemical characteristics of explosive materials.

    Certified Technologies.  Only explosive detection systems based on CT technology have been certified by the FAA. Competitors have attempted to obtain FAA certification of systems based on non-CT technology in the past without success. Multi-view systems have undergone extensive FAA certification testing. The Company believes that CT based explosive detection technology is the only type of commercially deployed equipment capable of detecting all types of explosives designated by the FAA to be a threat to commercial aviation. The Company believes that even if other technologies can be improved, CT technology will maintain its advantage if the FAA supplements, as it is proposing to do, its current certification testing with additional requirements designed to detect lower quantities of explosives than currently required.

    CT Based Competitor.  In 1994, the Company introduced the first CT based explosive detection system, which was subsequently certified by the FAA. In November 1998 L-3 Communications Corporation ("L-3"), a spin-off of Lockheed Martin Corporation, entered the market with a CT based system that was certified by the FAA. In January 2001, L-3 announced that the FAA had certified a more compact and lower throughput version of its CT based product. The Company believes that its CTX Series is superior to the L-3 products for the following reasons:

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Design for Airport Operation and Integration. The CTX 5500 and CTX 9000 models were developed for high throughput airport operation. The CTX 9000 was designed specifically for ease of integration, including a large aperture with a conveyor belt that is one meter wide which is the standard size of airport baggage handling systems world wide. In addition, the CTX 9000 uses an entirely new type of compact active curtain x-ray shielding that allows the system to assure proper x-ray shielding at high throughput.



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Broader Range of Products. The Company also believes that its family of products provide a broader range of price and performance to more closely meet the needs of airports of various sizes and locations around the world. The Company's CTX 9000 model provides higher throughput and a wider belt and aperture than L-3's fastest model. The Company's CTX 2500 model is more compact than L-3's smallest model.



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Improved Detection Software. The Company has continually improved the detection software used in the CTX Series over a period of ten years, including five years of operational experience in airports worldwide. The Company incorporated improvements derived from customer requirements, operational airport experience and a number of FAA re-certifications of various models.



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Superior Threat Resolution. After an explosive detection system automatically identifies a potential explosive in a piece of baggage, the operator must determine whether the item represents a real threat or a false alarm. The operator relies on a combination of image and data analysis. The Company believes that its CTX Series produces clearer images (by displaying more pixels) and more useful views (both standard x-ray projections and CT slices) of the suspicious object.

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    Dual Energy X-Ray and Multi-View Competitors.  Competitors such as PerkinElmer, Inc. Detection Systems Group (formed by the merger of Vivid Technologies, Inc., and EG&G Astrophysics) ("PerkinElmer") and Heimann Systems GmbH, offer non-certified explosive detection systems using dual energy x-ray technology. PerkinElmer has also introduced a model using multi-view technology using fixed x-ray sources. The Company believes that the CTX Series is superior to the dual energy and multi-view x-ray systems for the following reasons:

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Data Quality and Quantity. CT technology collects data from approximately 500 to 1,000 views to measure the density of each cross-sectional slice of an object. Explosives have well defined density ranges that are generally distinct from those of the contents of checked baggage. Dual energy x-ray systems collect data from one, two or three views of an object to determine the atomic number of materials in the object. However, certain classes of explosives have atomic numbers that are similar to those of many materials commonly found in checked baggage. As a result, the CTX Series can better distinguish between explosives and the benign contents of checked baggage, resulting in higher detection and lower false alarm rates.



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Three Dimensional Data. CT technology renders a three-dimensional map of the characteristics of an object, such as mass and density, regardless of the object's position in the bag and the superposition of other objects. Dual energy x-ray systems render only two-dimensional data regardless of the number of views. As a result, if multiple objects are superimposed over the potential explosive, the dual energy system is less able to calculate the atomic number of the potential explosive, and thus less able to detect the potential explosive. The Company believes that three view, dual energy technology alone will not collect sufficient data to meet or exceed the performance of CT technology.



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Superior Threat Resolution. After an explosive detection system automatically identifies a potential explosive in a piece of baggage, the operator must determine whether the item represents a real threat or a false alarm. The CT Series presents operators with images and threat analysis tools that are unavailable in dual energy systems. The CTX Series simultaneously displays standard x-ray images and CT slice images on separate screens. These images are cross-referenced to give operators a thorough view of a suitcase. The CTX Series also allows operators to take additional slices to provide more data and focus in on the threat. In contrast, dual energy x-ray systems display a single x-ray image of a potential threat and have a limited ability to provide additional information to an operator who suspects that an explosive is present.

    Other Non-CT Competitors.  Other principal competitors in the market for explosive detection systems are Thermedics Detection Inc., Barringer Technologies Inc., and Ion Track Instruments, which use trace detection technology (sniffers). YXLON International X-Ray GmbH has introduced an explosive detection system using x-ray scatter (diffraction) technology. Heimann Systems GmbH has introduced a system that combines x-ray scanning technology with x-ray diffraction technology. Diffraction technology offers the promise of extremely low false alarm rates, but when used alone appears to be too slow, large and expensive for airport application. To date none of these competitors offer a product certified by the FAA. The Company believes that these and other non-CT explosive detection technologies have significant weaknesses that have prevented them from being certified, and also prevented them from being sold in significant quantities for checked baggage inspection.

    Competitive Factors Other than Detection.  The Company believes that it can compete in the EDS market based on many factors that are important in the market, including explosive detection capability and accuracy, product quality and features, customer support, documentation and training. However, other factors are important, such as price, throughput, the ability to handle all sizes of baggage, and the ease of integration into existing baggage handling systems. Certain of the Company's competitors may have an advantage over the Company for the following reasons:

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The CTX Series currently has a top sales price that exceeds $1.0 million, for the CTX 9000 model, compared to substantially lower prices for systems offered by the Company's non-CT competitors.



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The CTX Series has a top throughput rate of approximately 600 bags per hour ("bph") for the CTX 9000 model, compared to 1,000 bph by certain of the Company's non-certified competitors.



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The CTX 2500 and CTX 5500 models have an aperture size that limits the ability of the unit to accept all sizes of baggage, and even the larger gantry of the CTX 9000 model does not necessarily accept all sizes and shapes of checked baggage.



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The CTX Series requires that the baggage remain still while being scanned, making it more challenging to integrate into the continuously moving baggage handling systems found in most airports.

    Manual Methods.  In addition to other explosive detection systems, the Company's products compete against more manual methods of assuring the security of checked baggage. In "100% system-wide bag match" passengers and bags are matched not only at flight origination but also in connection with layovers and connecting flights. Bag match is an explosive deterrent system based on the assumption that a bomber does not want to commit suicide. In "Procedural CAPPS and manual search" computer-assisted passenger prescreening is used to identify passenger bags to be hand searched. In "directed trace and hand search," a conventional x-ray system is used to identify suspicious bags that are then hand searched with the assistance of trace detection. Directed trace and hand search relies on scanning technology that is not currently able to identify all types of explosives even at the "suspicious" level and often requires suitcases to be opened. These manual methods are extremely slow and labor intensive and impose inconveniences on the flying public which make them unpopular. These manual methods can compete with the Company's products depending on the local cost of labor, and the willingness of the airlines' customers to put up with the longer pre-flight check-in requirements necessary to implement these methods on a large scale and to accept the increased invasion of privacy that more frequent hand searches of luggage would entail.

    Risk of Certification of Competing Technologies.  CT based systems are slower and more expensive than uncertified systems based on conventional and dual energy x-ray technology. If competitors develop systems based on dual energy, multi-energy or other non-CT technology to the point where such systems could be certified, the result will be the entry into the market of lower priced, higher throughput explosive detection systems. If so, the Company would lose a significant competitive advantage.

Backlog

    The Company measures its backlog of product and service revenues as orders for systems and upgrades for which contracts or purchase orders have been signed, but which have not yet been shipped; and as orders for maintenance related to product support for which contracts have been signed, but maintenance service has not yet been performed. The Company typically ships its EDS products within three to twelve months after receiving an order. However, such shipments may be affected by delays which occur in the delivery of components to the Company or customers' readiness to accept delivery for reasons of site preparation or otherwise. At December 31, 2000, the Company's EDS product and service revenue backlog was approximately $8.1 million, compared to $19.8 million at December 31, 1999. The Company expects to fill the majority of these orders and complete the majority of these services in 2001. In the first quarter of 2001, the Company received EDS orders valued at approximately $10.5 million from the FAA and an international customer for CTX systems, accessories and service.

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    Any failure of the Company to meet an agreed upon schedule could lead to the cancellation of the related order. Variations in the size, complexity and delivery requirements of the customer order may result in substantial fluctuations in backlog from period to period. The Company believes that it is important for competitive reasons and to better satisfy customer requirements to reduce order lead times and expects that the Company's backlog may decrease on a relative basis over time. In addition, all orders are subject to cancellation or delay by the customer and, accordingly, the Company cannot assure that such backlog will eventually result in revenues. For these reasons, the Company believes that backlog cannot be considered a meaningful indicator of the Company's performance on an annual or quarterly basis.

Quantum

Products and Services

    Products.  The Company develops for commercialization patented and proprietary technology for inspection, detection and analysis of explosives and other materials. The Company's Quantum products are based on passive magnetic sensing technology and quadrupole resonance ("QR") technology, a form of magnetic resonance. The Company's Quantum products, primarily in the prototype stage, include advanced detection systems for such markets as military and humanitarian landmine detection, carry-on luggage screening, concealed weapon detection, drug detection and postal inspection. The Company is also a leading supplier of research and development services in the area of QR technology and passive magnetic sensing to a number of government agencies. In 2000 the Company received grants for approximately $31.3 million in research funding for all products.

    Baggage and Package Screening.  The Company offers fully automatic entry point screening systems based on QR technology, which has a high detection rate for specified explosives combined with one of the lowest false alarm rates for any type of technology. In particular, QR technology has significant detection capabilities to identify components typically found in sheet explosive, which has been the most difficult type of explosive to detect, as well as military plastic explosives. QR directly measures the presence of the specific target material, by identifying the explosive's characteristic signals. The Company's systems can be used alone or to complement existing x-ray screening systems. The Company is developing systems combining the current systems with complementary technologies. The current models available for sale are:

•

QScan™ QR 160 system to screen mail, parcels and personal items at secure facilities and carry-on baggage at airports.



•

QScan™ QR 500 system to screen large items such as mail bags at secure facilities and checked baggage at airports.

    Landmine Detection.  The Company's QR technology is considered to be the most promising landmine detection technology. With funding from the Defense Advanced Research Projects Agency ("DARPA"), the Company developed a cart-based prototype with a tethered, hand-held probe. The probe emits radio frequency magnetic field pulses at the characteristic QR frequency of the explosive. These pulses stimulate coherent signals from the mine that are picked up by a tuned antenna, amplified in a sensitive receiver, and analyzed digitally. Since the QR resonance frequency is highly specific for individual compounds, tests have demonstrated a very high level of detection and a very low incidence of false alarms. This prototype was tested in Bosnia in the summer of 1999. Later in 1999 the prototype successfully demonstrated 100% detection of antipersonnel and antitank landmines during extensive field trials at the Army Combat Engineering School test facility at Fort Leonard Wood, Missouri. This was the first time that plastic, low metal content, TNT landmines had been detected with this level of performance by any system in actual field conditions. The current QR prototype system detects metal, RDX, TNT and Composition B, and is thus able to detect the vast majority of all landmines deployed

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throughout the world. The Company expects future systems to be able to detect tetryl as well. QR has the ability to operate in almost all soil conditions including saturated soils, as well as through water.

    Weapons Detection.  The Company's passive magnetic technology combines high weapons detection probability with a low rate of false alarms. It is capable of real time detection and tracking of concealed weapons. This makes it attractive for screening large numbers of people at entrances to both secure facilities and public buildings. In addition, because it is completely passive and non-intrusive, it diminishes issues involving permission to search. The Company developed the technology with the support of the National Institute of Justice ("NIJ"), and developed four portal systems that were installed at a courthouse in Bannock County, Idaho. In 2000, the Company engineered its concealed weapons detection portal hardware into a manufacturable product, and shipped a number of units as an OEM supplier.

Market, Distribution and Customers

    Baggage and Package Screening.  The market for baggage and package screening systems includes checked baggage inspection for civil aviation, and package inspection at postal facilities and secure facilities. The market for checked baggage explosive detection systems is discussed in "Item 1—Business—Explosive Detection Systems—Market" above. Several units of the Company's QScan products were delivered to the FAA in 1998, the U.S. Navy in 1999 and the FAA in 2000.

    Landmine Detection Market.  According to DARPA, for the last 60 years, a sharply increasing percentage of American soldiers have been killed or wounded by landmines. From World War II to Somalia, the percentage of American casualties caused by landmines has grown from 2.5 percent in World War II to 26 percent in Somalia. Still today, mine detection methods continue to depend primarily on soldiers manually probing the earth. Jane's Mines and Mine Clearance, 3^rd edition, 1998-99, estimates there are up to 60 million landmines buried across four continents, making landmine detection a humanitarian issue as well as a military issue.

    Landmine Detection Customers.  From the commencement of the landmine detection program in April 1997 through December 31, 2000, Quantum received $36.0 million in research and development funding from various U.S. government departments and agencies, including $27.0 million in 2000. The initial funding was from DARPA and the Office of Naval Research to demonstrate the detection and false alarm performance of QR technology. The more recent funding is part of a three year program to develop a vehicle mounted system for the U.S. Army, and a two year program for the Office of Naval Research to develop a man-portable, backpack system for the United States Marine Corps. The Company currently has no customers for landmine detection systems other than the U.S. Government.

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    Export Control.  The Company is subject to risks associated with regulations relating to the export of defense articles. In particular, the Company's landmine detection systems are deemed to be regulated defense articles subject to export control by the U.S. Department of State. Exports may be prohibited or limited to a small number of countries, even for purposes of demonstration and further data collection and development.

    Weapons Detection.  The market for weapons detection systems includes law enforcement and facilities security, including airports, schools, courthouses, prisons, government buildings, banks and corporate headquarters. Four of the Company's concealed weapons detection portals are installed and operating at a courthouse in Bannock County, Idaho.

    Distribution.  The Company seeks government funding through the grant application process. The application process involves a team comprising senior research and development employees and senior management. The Company markets its commercialized products through a marketing manager and a direct sales person, working with research and development employees to prepare and present proposals.

    Public Agency Contract and Budget Risks.  Substantially all of the Company's Quantum customers to date have been public agencies or quasi-public agencies. In contracting with public agencies, the Company is subject to public agency contract requirements which vary from jurisdiction to jurisdiction and which are subject to budgetary processes and expenditure constraints. Budgetary allocations for explosive detection systems are dependent, in part, upon governmental policies which fluctuate from time to time in response to political and other factors. In addition, public agency bidding processes have been and may continue to be protracted, and typically contain provisions that permit cancellation in the event that funds are unavailable to the public agency.

Competition

    Baggage and Package Screening.  The competition for baggage and package screening systems includes conventional x-ray scanners and trace detection systems for carry-on baggage inspection for civil aviation, and package inspection at postal facilities and secure facilities. The competition for checked baggage explosive detection systems is discussed in "Item 1—Business—EDS—Competition" above. The Company's QR technology is more accurate than conventional x-ray bulk detection techniques which predict the explosives presence by measuring object density or atomic number.

    Landmine Detection.  The market for landmine detection is becoming increasingly competitive with the growing interest in military and humanitarian demining. The Company believes that this will continue to prompt the development of new technologies, which will be the basis of competition in the market because there are greater differences between technologies than between companies using the same technology. The current competing technologies include:

•

Conventional landmine detectors use electro-magnetic sensing technology to identify and locate metallic objects. Conventional landmine detectors cannot easily detect landmines that are encased in plastic instead of metal, making detection difficult. A typical battlefield is littered with metallic material including shrapnel from expended ordnance. Conventional landmine detectors identify much of this metallic material as potential landmines, resulting in high false alarm rates. In contrast, QR technology identifies the explosive itself, which results in both high detection rates and low false alarm rates.



•

Ground penetrating radar uses a wide band electromagnetic pulse to produce a map of buried objects, including landmines. These systems use sophisticated algorithms to attempt to distinguish landmines from other buried objects such as rocks and shrapnel. Depending on the effectiveness of the algorithm, these systems can produce high false alarm rates to maintain high detection rates.

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•

Trace detection systems, known as "sniffers," detect particulate and chemical traces of explosive materials by sampling the air, water or soil. Detection performance is limited by the amount of trace molecules that reach the surface to be measured, and how far the molecules have propagated from the location of the landmine. These factors can result in slow detection with low detection rates.

    Weapons Detection.  Many companies manufacture conventional weapons detection systems that use active magnetic technology. These systems emit electro-magnetic radiation and measure variations in the resulting magnetic field. The Company's passive magnetic technology measures variations in the earth's natural magnetic field without emitting additional radiation, so it does not interfere with other equipment, and its operation cannot be detected. The Company's system is also innovative because it displays a video image of the area being scanned with potential weapons highlighted on the image.

Backlog

    The Company measures its backlog of government contracts as awards from government agencies which have been funded, but for which services have not yet been performed. At December 31, 2000, the Company's Quantum government contracts backlog was approximately $23.6 million, compared to approximately $3.2 million at December 31, 1999. The Company expects to fill the December 31, 2000 backlog in 2001 and 2002.

Wood

Products and Services

    WoodVision.  The Company is developing a log scanning system based on CT technology to optimize the value and yield of harvested timber. Development versions were evaluated during ongoing field trials that started in 1999. Where suitable, the log scanner will share components with the Company's EDS products. The Company anticipates features of the log scanner will include the ability to locate hidden defects and undesirable wood properties, and thereby identify high quality logs for sale and indicate sawing solutions to increase the quantity of high value wood products from the log.

    Inovec.  The Company's current Inovec products include the StereoScan™ 3-D log scanner and grade optimizer, YieldMaster™ headrig carriage optimizer, LogMaster™ small log optimizer, TrimMaster™ trim optimizer, CantMaster™ cant optimizer and WaneMaster™ edger optimizer. These systems use laser scanners to measure the size of logs or sawn wood before further sawing. Using proprietary optimizing algorithms, the systems develop cutting solutions to maximize the volume of usable wood, and then control the relative positions of the saw and the wood. In addition to providing generally a one year parts and service warranty, the Company offers fee-based primary and back-up service contracts to its customers.

Market, Customers and Distribution

    WoodVision Market.  The worldwide lumber industry generates revenues of $75 billion per year. Worldwide, there are over 6,000 sawmills. Sawmills will purchase capital equipment to improve yield, efficiency and value. Given the significant payback for sawmills when the value of the lumber is increased by even a small percentage, the Company believes there is a very significant market opportunity for CT based scanners.

    WoodVision Customers.  During the first phase of development the Company expects to sell principally to the planted wood market. Sellers of planted wood will gain a significant competitive advantage by using a CT based system to locate hidden defects and undesirable wood properties such as twist, and thereby identify high quality logs for sale. The Company also expects to further develop systems for sawmills worldwide. Sawmills will gain a significant competitive advantage by using a CT

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based system to locate hidden defects such as knots and cracks and thereby adjust the cutting pattern to increase the quality and quantity of the sawn wood.

    Inovec Customers.  The Company believes that the market for optimization systems will remain competitive as the lumber industry seeks to maximize the value obtained from the current and foreseeable supply of usable timber. Over 600 of the Company's Inovec laser scanners and other optimization systems have been installed in over 300 sawmills worldwide.

    Distribution.  The Company seeks potential customers for its products under development primarily though development and test agreements. The agreements are negotiated by a team of senior research and development employees and senior management. The Company markets its Inovec products both directly through internal sales personnel and indirectly through authorized agents, distributors and systems integrators. As of December 31, 2000, the Company employed a total of seven employees in sales and marketing. For sales through its authorized representatives and distributors, the Company generally is directly involved in developing proposal documents and negotiating contract terms.

    Wood Industry Purchasing.  The Company's Wood revenues will be subject to the ability and willingness of customers in the wood industry to purchase capital equipment to improve productivity, yield and finished product value. The factors that affect the decision to purchase such capital equipment include the demand for wood products, market prices for logs and finished wood products, labor costs, interest rates and other general economic factors. In addition, the revenues related to the Company's CT scanners for the wood industry will be subject to the acceptance of new technology by customers in the wood industry. There are no assurances that market conditions in the wood industry will be favorable for the sale of capital equipment, or that the Company's new products will be accepted by the industry in any particular time, or at all.

Competition

    WoodVision.  The Company's high throughput CT technology creates a three dimensional image of the log, producing a virtual log which is an exact representation of the log's internal structure, including all knots, cracks and grain patterns. Through advanced and proprietary image processing, logs can be graded and optimized for the ideal cutting pattern, therefore allowing the customer to mitigate the impact of previously unseen defects and maximize the value of a log's yield. Competing technologies include:

•

Conventional x-ray scanning produces a two dimensional image of the log, depicting some defects, but not with sufficient location information to generate a complete cutting solution.



•

Multi-view x-ray scanning produces more information than single-view, but still cannot define the position and shape of defects with sufficient precision.



•

Ultrasound scanning produces some three dimensional information, but at a much lower resolution than CT scanning.

    Inovec.  Inovec competes with a number of manufacturers of laser based optimization and scanning systems. The Company believes that it has an advantage because it is focused on scanning and optimization systems compared to many competitors who are focussed on general sawmill equipment and who also offer some scanning or optimization equipment.

Backlog

    The Company measures its backlog of Inovec product and services revenues as orders for systems and upgrades for which contracts or purchase orders have been signed, but which have not yet been shipped, and as orders for maintenance related to product support for which contracts have been

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signed, but maintenance service has not yet been performed. The Company typically ships its Inovec products within three to twelve months after receiving an order. However, such shipments may be affected by delays which occur in the delivery of components to Inovec or customers' readiness to accept delivery for reasons of site preparation or otherwise. At December 31, 2000, the Company's Inovec product and service revenues backlog was approximately $1.8 million. The Company expects to fill these orders and perform these services in 2001. The Company acquired Inovec effective January 1, 2000 and thus had no Inovec backlog at December 31, 1999. In the first quarter of 2001, the Company received orders valued at approximately $2.2 million for Inovec laser based optimization and scanning systems. The Company had no WoodVision backlog at December 31, 2000 and December 31, 1999.

Manufacturing

    In all segments, the Company's manufacturing operations consist primarily of: (1) materials management; (2) assembly, test and quality control of parts and components subassemblies; and (3) final system testing. Using the Company's designs and specifications, subcontractors assemble mechanical and electrical sub-components. The Company performs final assembly and test of systems, including configuration to customers' orders and testing with current release software, prior to shipment. The Company's manufacturing organization has expertise in mechanical, electrical, electronic and software assembly and testing. In addition, because quality and reliability over the life of the Company's products are vital to customer satisfaction and repeat purchases, the Company believes its quality assurance program is a key component of its business strategy.

Suppliers

    The Company outsources certain manufacturing processes, including standard and build-to-print fabricated parts such as mechanical sub-assemblies, sheet metal fabrication, cables and assembled printed circuit boards. The Company generally purchases major contracted assemblies from single source suppliers to ensure high quality, prompt delivery and low cost. The Company reviews its single source procurements on a case by case basis, where feasible, and has qualified second sources for certain contracted assemblies. Although to date the Company has not experienced any significant delays in obtaining any of its single source assemblies, the Company cannot assure that it will not face shortages of one or more of these systems in the future.

Intellectual Property and Proprietary Rights

    Proprietary Technology.  The Company's performance depends in part upon its proprietary technology. In the United States, the Company relies upon patents, copyrights and trade secrets for the protection of the proprietary elements of its products. The Company cannot assure, however, that the Company could enforce such patents, trade secrets or copyrights.

    EDS U.S. Patents.  The Company has two United States patents for automatic concealed object detection systems using a pre-scan stage as used in the CTX Series. These patents expire in the years 2010 and 2011. Outside the United States, the time period for filing foreign counterparts of these patents has expired, and the Company did not seek or obtain patent protection. The patents have not prevented competition from CT based competitors because such system does not use a pre-scan stage. The Company also has a patent application pending covering a number of new features contained in the CTX 9000 model. In accordance with the terms of the Company's development contracts with the FAA, the U.S. Government has rights to use certain of the Company's proprietary technology developed after the award of the Contracts and funded by the contracts. The U.S. Government may use such rights to produce or have produced for the U.S. Government competing products using such technology.

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    EDS Foreign Patents.  Outside the United States, the Company does not have patent protection (except to the extent of licenses held under patents owned by Imatron Inc.) and has relied to date primarily on software copyrights and trade secrets for the protection of its proprietary technology. The absence of foreign counterparts to the Patents could adversely affect the Company's ability to prevent a competitor from using technology similar to technology used in the CTX Series.

    Imatron License.  In connection with the formation of the Company, the Company obtained an exclusive, worldwide, and fully-paid license, as amended, from Imatron, Inc. regarding its patents and know-how related to (a) scanners for the inspection of mail, freight, parcels, baggage and wood products, and (b) compact medical scanners for military field applications. The license allows the Company to develop, manufacture and sell systems based on a different type of CT technology than is currently incorporated in the Company's CTX Series. The Company, in exchange, granted to Imatron an exclusive, worldwide, perpetual and fully paid license under the Company's then existing or future patents and know-how to permit Imatron to utilize such technology in medical scanners other than compact medical scanners for military field applications. The license expires in 2009.

    Quantum Patents.  In the United States, the Company relies on licenses, patents, copyrights and trade secrets held by the Company for the protection of the proprietary elements of its Quantum products. The Company also relies on its ability to obtain research and development contracts in the areas of electromagnetic sensing and detection. In connection with its QR technology, the Company utilizes three key QR patents from the Naval Research Laboratory and has been granted an exclusive license to commercialize the technology, including landmine detection. The license expires in 2009. Additionally, the Company has been granted ten patents related to Quantum technology, with additional patents pending, and has developed a significant amount of know-how in the magnetic sensing and detection areas. These patents and know-how enable field deployable security systems to be designed and cost-effectively manufactured.

    Quantum Licenses.  The Company has also been granted a non-exclusive license by International Business Machines Corporation (IBM). The license covers certain patented and non-patented proprietary software and know-how related to electro-magnetic sensing and detection. The license grant expires in 2009.

    Wood.  The Company has a patent application pending covering a number of new features related to the design and use of the CT based log scanner. The Company has a patent, issued in the US and Canada, for certain technology used in Inovec log cutting optimization systems. The Company cannot assure that the patents would be effective in preventing competition from other CT and laser based scanning and optimizing systems.

    Protection.  The Company generally enters into confidentiality agreements with each of its employees, and on a case-by-case basis enters into similar agreements with distributors, customers, and potential customers. In addition, the Company limits access to distribution of its software, documentation and other proprietary information. The Company cannot assure that these agreements will not be breached, that the Company will have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known to or independently developed by others. The Company cannot assure that the steps taken by the Company to protect its proprietary technology will be adequate or that its competitors will not be able to develop similar, functionally equivalent or superior technology. Although the Company believes that its intellectual property rights are valuable, the Company also believes that product support, and customer relations are of greater competitive significance because of the rapid pace of technological change and evolving customer requirements.

    Dependence on Proprietary Technology.  The Company in the past has received, and from time to time in the future may receive, communications from third parties alleging infringements by the Company or one of its suppliers of patents or other intellectual proprietary rights owned by such third

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parties. The Company cannot assure that any infringement claims (or claims for indemnification resulting from infringement claims against third parties, such as customers) will not be asserted against the Company, resulting in expensive and protracted litigation.

Research and Development

    Importance of Research and Development.  The Company considers research and development to be a vital part of its operating discipline and continues to dedicate substantial resources to research and development. At December 31, 2000 the Company had 132 full-time employees engaged in research and development and product development activities, 47 for EDS, 49 for Quantum and 36 for Wood. The Company was also using the services of sixteen specialized contract employees and consultants in this area. During the years ended December 31, 2000, 1999 and 1998, the Company spent $11.9 million, $11.2 million and $12.9 million, respectively, on research and development activities, of which $0.9 million, $0.7 million and $3.6 million, respectively, were funded by the FAA and other agencies under development contracts and grants. The Company has in backlog grants of $6.7 million for EDS research and development.

    Enhance EDS Technology.  The Company continues to make substantial investments to enhance the performance, functionality and reliability of the CTX Series explosive detection systems, including developments to:

•

reduce false alarms while maintaining throughput rates and certified detection capability, by developing more intelligent algorithms that determine the presence of threats by looking at threat features not considered at present such as detonators and texture;



•

increase threat resolution capabilities by developing an advanced threat resolution operator interface which incorporates artificial intelligence to enhance the ability of the operator by providing clear, easy to understand instructions on how to resolve threats;



•

increase threat resolution by the use of additional sensors to aid the alarm resolution process prior to any operator controlled threat resolution step. These sensors could incorporate either the Company's QR technology, with its increased ability to detect certain types of explosives and its lower false alarm rate, or other externally developed technologies; and



•

improve operator performance by incorporating threat image projection ("TIP") (a system of checking operator performance under actual operating conditions) on the CTX 9000 model (it is already available on the CTX 2500 and CTX 5500 models). The TIP system will be incorporated in the remote field data reporting modules for the CTX Series.

    These and other modifications or updated versions of the CTX Series may require FAA approval to retain certification or may require re-certification testing. The Company cannot assure that any such modifications will be approved or, if required, certified by the FAA.

    Broaden EDS Product Offerings.  The Company is continuing its commitment to its "family" approach to explosive detection by participating in the FAA's ARGUS program. This program is a four-phase competitive research and development program designed to develop a low-cost, automated explosive detection system to scan checked baggage in small airports. The project specifies an explosive detection system that would be smaller and less expensive than the Company's CTX 2500 model. During Phase I of the program, the Company developed an initial system design to meet the FAA's criteria for weight, size, and cost. In 2000, the Company was awarded funding of $7.7 million for Phase II development of a prototype system. Two competitors also received grant awards to develop prototypes. The Company believes that its participation in Phases I and II and its long experience and leading position in the field of certified EDS place it in good stead to receive additional grants under the further phases of the ARGUS program. However, there can be no assurance that the FAA will continue to award ARGUS or other development grants to the Company.

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    Broaden EDS Technology Offerings.  The Company believes that systems combining two or more technologies based on different physical principles will be more robust, more cost effective and more difficult to defeat than single technology systems. For example, combining QR with dual-energy X-ray results in a system with the ability to detect a wider range of explosives than an X-ray alone, with greater reliability, and with images to assist with threat resolution following a QR-generated alarm. The Company is in the early development stage of these combined technologies.

    Competition for FAA Grants.  The U.S. Government currently plays an important role in funding the development of EDS technology and sponsoring its deployment in U.S. airports. Through December 31, 2000, the Company had received $27.8 million from FAA grants and contracts. The Company is also aware that certain other competitors in the EDS market have received FAA development grants. These grants include approximately $14.5 million to the Company's only CT based competitor, and funding to another competitor to develop a new CT system for the ARGUS program. The Company cannot assure that additional research and development funds from the FAA will become available in the future or that the Company will receive any such additional funds.

    Broaden CT based Detection Applications.  The Company believes that its CT detection technology can also be applied to the detection of drugs and agricultural products at ports of entry, and to the detection of contraband entering prisons. The U.S. has deployed approximately 500 conventional x-ray systems at border crossings and other points of entry. There are additional deployments around the world for the purpose of drug interdiction. The Company has determined that its CTX Series explosive detection systems are able to detect illegal drugs and currency. By expanding the software library to specifically include the characteristics of controlled substances, the Company developed a prototype CT based system for drug detection. In late 1999 and early 2000 the Company conducted trials for the United States Customs Service to evaluate the use of a truck-mounted CT based drug detection system. The Company believes that a truck mounted CTX Series system could be sold for aviation security applications.

    Weapons Detection.  The Company is continuing the development of its passive magnetic concealed weapons detection technology, currently developed for portal systems. The Company is exploring portable variations of this technology to detect weapons entering or leaving a specific area. The Company is also developing a wand to screen people for both weapons and explosives.

    Process Control.  In 2000, the Company received a major contract from the U.S. Department of Energy to develop its magnetic resonance technology to improve energy efficiency in process control applications. The Company is developing systems to accurately determine the moisture content of processed materials, including lumber, wood products, paper pulp, food products, and fuels such as coal. Accurate measurements of moisture content are very important, since industrial drying operations consume large quantities of energy, and small improvements in process efficiency result in significant cost and energy savings.

    Uncertainty of Product Development.  The Company's success will depend upon its ability to enhance its existing products, and to develop new products and new applications to meet regulatory and customer requirements and to achieve market acceptance. The enhancement and development of these products will be subject to all of the risks associated with new product development, including unanticipated delays, expenses, technical problems or other difficulties that could result in the abandonment or substantial change in the commercialization of these enhancements or new products. Given the uncertainties inherent with product development and introduction, the Company cannot assure that it will be successful in introducing products or product enhancements, including products that meet FAA certification standards, on a timely basis, if at all, or that the Company will be able to market successfully these products and product enhancements once developed. In addition, if new products and new applications are successfully introduced, the Company cannot assure that it will be

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able to expand quickly enough to meet market demand or that new competitors will not enter the market.

Employees

    As of December 31, 2000, the Company directly employed 335 people, of whom 132 were primarily engaged in research and development activities, 82 in marketing and sales, customer support and field service, 59 in manufacturing, ten in quality and 52 in administration and finance. In addition, The Company utilized the services of 37 full-time consultants and temporary employees in 2000. Management believes that the Company's relationship with its employees is good.

EXECUTIVE OFFICERS OF THE REGISTRANT

    The following sets forth certain information regarding the Company's executive officers:

    Dr. Sergio Magistri has served as President, Chief Executive Officer and Director of InVision since December 1992. From June 1991 to November 1992, he was a Project Manager with AGIE, Switzerland, a manufacturer of high precision tooling equipment, responsible for all aspects of a family of new products for high precision electro-erosion machining with sub-micron precision. From 1988 to June 1991, Dr. Magistri was a consultant to high technology companies. As a consultant, Dr. Magistri was involved in the formation of InVision and the development of its business plan and of its technology. From 1983 to 1988, Dr. Magistri held various positions with Imatron Inc., a CT medical scanner company, including as an Engineering Physicist and Manager of Advanced Reconstruction Systems, and Director of Computer Engineering. Dr. Magistri holds a degree in Electrical Engineering and a doctorate in Biomedical Engineering from the Swiss Institute of Technology, Zurich, Switzerland.

    Donald E. Mattson has served as Senior Vice President and Chief Operating Officer since November 2000. Mr. Mattson previously served as Interim Vice President of Operations at InVision in 1998. In addition to his position at InVision, from 1992 to 2000, Mr. Mattson has been a management consultant, including, among others, interim management assignments as chief executive officer of a computer distribution company, president of a disk drive sub-systems company and vice president of operations of a tape drive manufacturing company. Prior to 1992, Mr. Mattson held senior management positions at Microware Distributors, Inc., Optical Data, Inc., Media Technology Corporation, Verbatim Corporation, Memorex Corporation and Varian Associates. Mr. Mattson holds a bachelor's degree in Industrial Management and Technology and an MBA from the University of California, Berkeley.

    Alfred V. Larrenaga has served as Senior Vice President and Chief Financial Officer since June 1999. Prior to joining InVision, Mr. Larrenaga served as Executive Vice President and CFO of Integrated Packaging Assembly Corporation, an independent semiconductor packaging foundry from 1997 to May 1999. From 1988 to 1997, Mr. Larrenaga was Senior Vice President, CFO and Secretary of Southwall Technologies Inc., a manufacturer of thin film materials. Prior to that, Mr. Larrenaga served as Vice President and CFO of Asyst Technologies Inc., a manufacturer of equipment for the semiconductor industry, and was Controller of the Farinon Division of Harris Corporation. He is a Certified Public Accountant and holds a bachelor's degree in accounting from Santa Clara University.

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    David M. Pillor joined InVision in July 1994 as Vice President, Sales and Marketing. He has served as Senior Vice President, Sales and Marketing since November 1995 and as a director since December 1999. From 1988 to July 1994, Mr. Pillor held various positions including Area Sales Manager, National Sales Manager and Vice President of Sales of Technomed International, a medical products company. Mr. Pillor holds a Bachelor of Science degree in Chemistry from the University of Maryland.

Business Risks

    In addition to the risks discussed above, the Company is subject to the following risks:

    History of Losses; No Assurance of Profitability.  The Company commenced operations in September 1990, remained in the development stage through 1994 and received its first revenues from product sales in the first quarter of 1995. The Company experienced net losses for each year from inception through December 31, 1996. The year ended December 31, 1997 was the Company's first year of profitability. The Company was profitable on an annual basis from 1997 to 1999 but it experienced losses in each of the last two quarters of 1999 and the first two quarters of 2000, and reported a $1.8 million loss for the year ended December 31, 2000. As of December 31, 2000, the Company had an accumulated deficit of approximately $11.0 million. The Company cannot assure that it will return to and maintain profitability. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources."

    Fluctuations in Operating Results.  The Company's past operating results have been, and its future operating results will be, subject to fluctuations resulting from a number of factors. These factors include:

•

the timing and size of orders from, and shipments to, major customers;

•

budgeting and purchasing cycles of its customers;

•

delays in product shipments caused by custom requirements of customers or ability of the customer to accept shipment;

•

the acceptance and timing of enhancements to the Company's products;

•

the introduction and acceptance of new products by the Company or its competitors;

•

changes in pricing policies by the Company, its competitors or suppliers, including possible decreases in average selling prices of the Company's products in response to competitive pressures;

•

the proportion of revenues derived from competitive bid processes;

•

the mix between sales to domestic and international customers;

•

the availability and cost of key components; and

•

fluctuations in general economic conditions.

    The Company also may choose to reduce prices or to increase spending in response to competition or to pursue new market opportunities, all of which may have a material adverse effect on the Company's business, financial condition or results of operations. InVision's systems revenues in any period are derived from sales of multiple CTX Series systems to a limited number of customers and are recognized upon shipment. The high sales price of units in the CTX Series means that minor variations in the number of orders, or in the timing of shipments, substantially affects the Company's quarterly revenues. A significant portion of the Company's quarterly operating expenses are, and will continue to be, relatively fixed in nature. This means that revenue fluctuations will cause the Company's quarterly and annual operating results to vary substantially. Accordingly, the Company believes that period-to-period comparisons of its results of operations are not meaningful and cannot be relied upon as indicators of future performance. Because of all of the foregoing factors, the Company's operating results have from time to time in the past been and may again in the future be below the expectations of public market analysts and investors. This failure to meet market expectation

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has in the past and may again in the future result in a decline in the trading price of the Common Stock.

    International Business.  The Company markets its products to customers outside of the United States and, accordingly, is exposed to the risks of international business operations, including unexpected changes in regulatory requirements, possible foreign currency controls, uncertain ability to protect and utilize its intellectual property in foreign jurisdictions, tariffs or other barriers, difficulties in staffing and managing foreign operations, difficulties in obtaining and managing vendors and distributors, and potentially negative tax consequences. International sales are subject to certain inherent risks including tariffs, embargoes and other trade barriers, staffing and operating foreign sales and service operations and collecting accounts receivable.

    Fluctuation In Exchange Rates.  Fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to customers in a particular country, leading to a reduction in sales or profitability in that country.

    Product Liability Risks; Risk of Failure to Detect Explosives; Availability of Insurance.  The Company's business exposes it to potential product liability risks, which are inherent in the manufacturing and sale of explosive detection systems. There are many factors beyond the control of the Company that could lead to liability claims, such as the reliability of the customer's operators, the training of the operators after the initial installation and training period, and the maintenance of the units by the customers. For these and other reasons, including software and hardware limitations and malfunctions of the CTX Series, the Company cannot assure that the systems will detect all explosives hidden in the luggage scanned. The Company does not believe that it would be liable for any such claims, but the cost of defending any such claims would be significant and any adverse determination may be in excess of the Company's insurance coverage. Moreover, the failure of the CTX Series to detect an explosive would also result in negative publicity which could have a material adverse effect on sales and may cause customers to cancel orders already placed, either of which could have a material adverse effect on the Company's business, financial condition or results of operations. Many of the Company's customers require the Company to maintain insurance at certain levels. The Company currently has product liability insurance in the amount of $150 million. The Company cannot assure that additional insurance coverage, if required by customers or otherwise, could be obtained on acceptable terms, if at all.

    Concentration Of Ownership; Control By Management.  As of December 31, 2000, the Company's principal stockholder, HARAX Holding, S.A. ("HARAX"), held approximately 20% of the Company's common stock, and the present directors and executive officers of the Company and their affiliates, in the aggregate, beneficially owned approximately 14% of the outstanding common stock, in each case including shares issuable pursuant to stock options exercisable within 60 days of December 31, 2000. Consequently, HARAX together with the Company's directors and executive officers, acting in concert, have the ability to significantly affect the election of the Company's directors and have a significant effect on the outcome of corporate actions requiring stockholder approval. In addition, HARAX, acting alone, will have the power to significantly affect matters relating to the Company's affairs and business.

    Anti-Takeover Provisions.  The Company's Restated Certificate of Incorporation contains certain provisions that may discourage bids for the Company. This could limit the price that certain investors might be willing to pay in the future for shares of the Common Stock.

Financial Information about Domestic and Foreign Sales

    Financial information about foreign and domestic sales are stated in the attached Consolidated Financial Statements, Note 2, Summary of Significant Accounting Policies.

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ITEM 2. PROPERTIES

    The Company's principal corporate office and EDS manufacturing facility is located in Newark, California, which consists of approximately 95,000 square feet under a lease which expires in May 2007. The Company has an option to extend the lease for five years. Approximately 16,000 square feet is subleased under an agreement which expires March 31, 2001. Management intends to continue to sublease this space for the foreseeable future. The Company's Quantum office is located in San Diego, California, which consists of approximately 36,000 square feet under a lease which expires May 23, 2002. The Company's Inovec office and manufacturing facility is located in Eugene, Oregon, which consists of approximately 7,500 square feet under a month to month lease and approximately 5,000 square feet in a separate building under a lease which expires at the end of March 2001. The Company is currently negotiating a renewal of this lease. The Company leases an additional approximately 3,850 square foot facility in Eugene, Oregon, for WoodVision and Inovec operations, under a two year lease expiring August 31, 2002. Management believes that these facilities will be sufficient to satisfy its administrative and manufacturing needs for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

    In July 2000, the Company entered into a settlement agreement (the "Settlement Agreement") that settled an action brought on January 7, 1999 by Vivid Technologies, Inc. ("Vivid") in Superior Court of the State of California for the County of San Diego against InVision, Quantum, ESI International, Inc. ("ESI"), Robert Price and Sandra Price (collectively, "Defendants"). Vivid asserted causes of action for (1) misappropriation of trade secrets; (2) inducing breach of contract; (3) interference with contractual relations; (4) statutory unfair competition; (5) common law unfair competition; (6) interference with prospective economic advantage; (7) defamation; and (8) declaratory relief. The complaint was filed by Vivid following efforts by the Company and ESI, a private investigator hired by the Company, to investigate the alleged theft of intellectual property from the Company by a former key employee hired by Vivid and to bring certain evidence to the attention of the Federal Bureau of Investigation and the United States Attorney for the Southern District of California. As part of the Settlement Agreement, Vivid represented that it is no longer pursuing QR technology and agreed not to pursue QR technology for two years from the date of the agreement. Vivid further agreed to file a request for dismissal of the complaint without prejudice which would automatically convert to a dismissal with prejudice on the second anniversary of the Settlement Agreement. Similarly, the Company agreed that their voluntary dismissal of a federal court action (which had been filed but not served) against Vivid based on the alleged theft would also automatically convert to a dismissal with prejudice in two years. Management believes that the terms of the Settlement Agreement will not have a material adverse effect on the Company's business, financial condition or results of operations.

    In addition to the foregoing matter, the Company may be involved, from time to time, in other litigation, including litigation relating to claims arising out of its operations in the normal course of business. The Company is not currently a party to any legal proceedings, the adverse outcome of which, in management's opinion, individually or in aggregate would have a material adverse effect on the Company's business, financial condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    Not applicable.

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PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

    The Company's common stock trades on the Nasdaq National Market under the symbol "INVN." The following table sets forth, for the periods indicated, the high and low bid quotations of the Company common stock as reported on the Nasdaq National Market. These over-the-counter quotations reflect inter-dealer prices, without retail markup, markdown or commission, and may not necessarily represent the sales prices in actual transactions.

    On March 26, 2001, the closing price of the Company's Common Stock on the Nasdaq National Market was $3.00 per share. On March 26, 2001, there were approximately 307 stockholders of record of the Company's Common Stock.

    In May 1998, the Board of Directors of the Company adopted a stock repurchase program, in which management of the Company is authorized to repurchase up to 500,000 shares of the Company's common stock on the open market at prevailing market prices or in negotiated transactions off the market. As of December 31, 1999, the Company had repurchased approximately 200,500 shares of its common stock. The Company has not repurchased any shares since December 1999 and the Com