-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I3TdgJj/9AAT5AT6y5dcTVa85lNCoI18TwLni5XHBP1B8chA7zR+EMFmhukNuML6 qwNuUq9S/UQWdJEZyfkGtg== 0001023813-97-000004.txt : 19971230 0001023813-97-000004.hdr.sgml : 19971230 ACCESSION NUMBER: 0001023813-97-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971229 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: VIVID TECHNOLOGIES INC CENTRAL INDEX KEY: 0001023813 STANDARD INDUSTRIAL CLASSIFICATION: X-RAY APPARATUS & TUBES & RELATED IRRADIATION APPARATUS [3844] STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-28946 FILM NUMBER: 97745109 BUSINESS ADDRESS: STREET 1: BETA PARTNERS LP STREET 2: ONE POST OFFICE SQUARE STE 3800 CITY: BOSTON STATE: MA ZIP: 02109 BUSINESS PHONE: 6174828020 MAIL ADDRESS: STREET 1: 10E COMMERCE WAY CITY: WOBURN STATE: MA ZIP: 01801 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ Commission File Number: 0-28946 Vivid Technologies, Inc. (Exact name of registrant as specified in its charter) Delaware 04-3054475 (State of incorporation) (I.R.S. Employer Identification No.) 10E Commerce Way, Woburn, Massachusetts 01801 (Address of principal executive offices) (Zip Code) (781) 938-7800 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 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 to Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] The aggregate market value of the Registrant's Common Stock, $.01 par value, held by non-affiliates of the registrant as of November 28, 1997 was $123.5 million based on the price of $15.88 on that date on the Nasdaq National Market. As of December 17, 1997, 9,517,601 shares of the Registrant's Common Stock, $.01 par value, were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE (1) Portions of the Company's Proxy Statement involving the election of directors, which is expected to be filed within 120 days after the end of the Company's fiscal year, are incorporated by reference in Part III (Items 10, 11, 12 and 13) of this Report. Part I Item 1. Business Information contained in this Report contains forward-looking statements such as statements of the Company's plans, objectives, expectations and intentions, that can often be identified by the use of forward-looking terminology, such as "may," "will," "expect," "anticipate," "believe," "plan," "intend," "could," "estimates," "is being" or "goal" or other variations of these terms or comparable terminology. Such statements, which include statements relating to the anticipated growth of the market for explosives detection equipment, the Company's ability to develop and market new products and the Company's ability to enter new markets, and other matters are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. The cautionary statements made in this Report should be read as being applicable to all forward- looking statements wherever they appear in this Report. The forward- looking statements contained herein speak only as of the date of this Report. Vivid expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any such statement or reflect any change in Vivid's expectations or any change in events, conditions or circumstances on which any such statement is based. Factors that could cause or contribute to such differences include those discussed in the risk factors set forth in Item 7 below (the "Risk Factors") as well as those discussed elsewhere herein. Vivid Technologies, Inc. ("Vivid" or the "Company") is a leading developer, manufacturer and marketer of automated inspection systems that detect explosives in airline checked baggage. The Company also offers a system that can be used to screen carry-on baggage and enhance building security. The Company's family of advanced explosives detection systems identify targeted materials by analyzing the physical characteristics of each item in a bag or parcel, including the atomic number and mass, using patented composition analysis techniques and proprietary dual energy X-ray technology. These systems automatically (without the use of an operator) isolate and identify targeted materials within a bag or parcel, thereby preventing a suspect bag or parcel from being loaded into an aircraft or entering a building until cleared by operator inspection. The Company's systems can also be used to identify a wide variety of other substances, including drugs and currency. In 1993, the Company's automated systems were successfully deployed in airports as part of an integrated multi-level checked baggage screening approach that is being adopted in many countries throughout the world. As of September 30, 1997, the Company had sold more than 220 systems for installation in airports throughout Europe, Asia and the United States of which over 180 systems had been shipped and installed. Airports at which the Company's systems are deployed include London Heathrow and London Gatwick, Paris Charles de Gaulle, Hong Kong's Chek Lap Kok, Malaysia's Kuala Lumpur, Amsterdam, Zurich, Brussels, Glasgow and Alicante in Spain. The Company was incorporated as a Massachusetts corporation in May 1989 under the name of QDR Security, Inc. The Company changed its name to Vivitech, Inc. in June 1989 and was renamed Vivid Technologies, Inc. in September 1989. In October 1996, the Company changed its state of incorporation to Delaware. Industry Background Markets. There are over 600 commercial airports worldwide providing scheduled service to more than 2.5 billion passengers per year. Of these airports, over 400 are located in the United States, 150 in Europe and 50 in the Asia-Pacific region. Based upon the installations of the Company's systems, the Company believes that one integrated multi-level checked baggage screening system can serve up to approximately one million passengers per year in mid-size and large airports. The capabilities of each integrated multi-level system at each airport, as well as the number of systems required, will vary depending upon a variety of factors, including the explosives detection equipment deployed, the configuration of the airport's baggage handling systems, the nature of the integration of the explosives detection equipment with the airport's baggage handling systems and the profile of the airport's passenger traffic flow. Airports deploying advanced explosives detection equipment, including smaller airports, may choose to implement freestanding systems in addition to or as an alternative to integrated systems. The Company believes that the implementation of effective checked baggage screening will highlight the ineffectiveness of conventional X-ray systems to identify explosives in carry-on baggage. The United Nations International Civil Aviation Organization ("ICAO") requires all 184 member states to inspect 100% of international carry-on baggage for the detection of weapons, and virtually all airports use conventional X-ray systems for this purpose. The Company believes that several thousand of these conventional X-ray systems are installed in airports throughout the world, and that these systems are candidates for replacement with more sophisticated systems. Market Evolution and Government Initiatives. In the 1970s, in response to hijackings, airports worldwide began to install X-ray systems to screen carry-on baggage for weapons such as guns and knives. When combined with walk-through metal detectors, these systems substantially reduced the number of airplane hijackings. The success of these systems in airports also fostered their adoption for use by governmental agencies and private companies. As the threat to civil aviation evolved in the early 1980's from hijackings to bombings, many countries required checked baggage on international flights to be inspected. Most equipment initially deployed for this purpose has been conventional X-ray systems. Although conventional X- ray systems are effective for the detection of weapons made from dense materials with defined shapes, such as guns and knives, they are ineffective in detecting explosive materials that are not as dense and can be molded into virtually any shape. In response to the December 1988 bombing of Pan American Flight 103 over Lockerbie, Scotland, many countries began the installation of systems that could detect plastic and other explosives in airline baggage. Europe, led by the United Kingdom, has been at the forefront of deploying advanced automated explosives detection equipment. The United Kingdom Department of Transport (the "UK DOT") has required the United Kingdom's commercial airports to deploy systems for 100% screening of international checked baggage. The European Civil Aviation Conference ("ECAC"), an organization of 36 member states, has resolved to implement 100% screening of international checked baggage. Several of those countries, including Belgium, France, Netherlands, Spain and Switzerland, have begun to implement checked baggage screening approaches similar to that adopted by the United Kingdom. In the Asia/Pacific region, two major new airports in Malaysia and Hong Kong have purchased integrated systems and plan to commence operations with 100% checked baggage screening in place. Other new airports and terminals in the region, including those in Singapore, South Korea and Thailand, are being designed to include 100% screening of international checked baggage using advanced automated explosives detection systems. These and other countries in the region, including Japan, Philippines, Australia and New Zealand, are also studying the implementation of these systems at existing airports. Following the Pan American Flight 103 bombing, the United States enacted the Aviation Security Improvement Act of 1990 (the "Aviation Security Act"). The Aviation Security Act directed the Federal Aviation Administration (the "FAA") to develop a standard for explosives detection systems and required airports in the United States to deploy systems meeting this standard by 1993. To date, no system has demonstrated that it meets the FAA standard under realistic airport operating conditions, including processing baggage at throughput rates required by airport operators and airlines. As a result, the FAA has not required the installation of automated explosives detection systems, and only a limited number of these systems have been deployed, primarily on a test basis, in the United States. Although ECAC has adopted a standard similar to the FAA standard as a long-term goal, they have allowed and promoted the deployment of effective systems even though overall they do not meet the standards. In response to the crash of TWA Flight 800 off Long Island, New York in July 1996, President Clinton formed 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. The Gore Commission released its initial and final reports in September 1996 and February 1997, respectively, and in October 1996, the United States enacted the Federal Aviation Re-Authorization Act of 1996 (the "Re-Authorization Act") which included an allocation for the purchase of explosives detection systems and other advanced security equipment by air carriers and airport authorities. The Re-Authorization Act requires that, until such time that the FAA determines that the equipment certified by the FAA is commercially available and has successfully completed operational testing, the FAA shall facilitate the deployment of other commercially available explosives detection devices which the FAA determines will enhance aviation security. During 1997, the FAA purchased a variety of state-of-the-art explosives detection devices from several manufacturers, including eight systems from the Company. Implementation of Checked Baggage Systems. Effective screening of checked baggage for explosives and other contraband is a complex task. To accomplish this task while meeting the operational requirements of airports, a screening system must be flexible, accurate, fast, reliable and cost-effective. The screening system must have the ability to effectively identify a wide range of explosives, including plastic explosives that can be molded into virtually any shape. In addition, the system must have an acceptable false alarm rate, rejecting only a limited percentage of explosive- free luggage. The system must also process baggage rapidly and have limited downtime to avoid delays. Costs associated with installation include the cost of modifying the airport's baggage handling system to accommodate the explosives detection equipment and the cost of integrating that equipment with the baggage handling system. A key component of the cost of operation is the staffing associated with operating these systems. Several advanced explosives detection systems have been developed to address these requirements, each with its own inherent advantages and limitations. These systems include dual energy X-ray, trace detection and computed tomography ("CT") systems. Dual energy X-ray systems measure the X-ray absorption properties of a bag's contents at two different X-ray energies to determine if any of the items have the physical characteristics of explosive materials. Trace detection equipment, known as "sniffers," detects particulate and chemical traces of explosive materials collected by manually wiping or vacuuming the bag under inspection. CT systems use hundreds of partial X-ray images, referred to as slices, to analyze the contents of a bag. The FAA first certified a CT-based system in December 1994. However, as recommended by the Gore Commission's final report and as required by the Re-Authorization Act, this system must undergo further testing to resolve whether it can operate under realistic airport operating conditions, including processing baggage at required throughput rates. In 1993, BAA plc ("BAA"), formerly the British Airport Authority and one of the first airport operators to implement 100% checked baggage screening using automated explosives detection equipment, developed a multi-level automated screening approach that integrates the explosives detection equipment directly into the airport baggage handling systems. The multi-level approach, which is being adopted throughout Europe and the Asia-Pacific region, separates the screening process into multiple steps, and permits the use of equipment at each stage that is most suitable for the requirements of that particular stage. Under the multi-level approach, a fully-automated Level 1 explosives detection system is integrated into the existing airport baggage handling system to screen rapidly all baggage without an operator in attendance. Bags rejected by the Level 1 system are subjected to Level 2 inspection. Level 2 inspection equipment allows an operator to review and manipulate images of the contents of the rejected bags provided by a Level 1 system. If the operator rejects the bag, it is forwarded for Level 3 inspection. Level 3 inspection is the slowest and most detailed process. Bags rejected at Level 3 are then opened and inspected by hand in the presence of the passenger. Bags not rejected at any inspection level are conveyed by the baggage handling system for loading into the aircraft. This multi-level approach, when implemented with rapid automated explosives detection equipment, can maintain the processing rates of existing baggage handling systems. The multi-level approach also significantly reduces operating costs by reducing staffing requirements. Level 1 inspection systems, which must inspect all baggage on a conveyor line, are often required to inspect baggage during peak periods at the rate of 900 to 1,500 bags per hour (2.4 to 4.0 seconds per bag) in order to avoid delays in the baggage handling process. Level 2 inspection systems are often required to process baggage at the rate of 180 to 360 bags per hour (10 to 20 seconds per bag). Level 3 systems can be slower to accommodate the greater precision required for the operator to fully inspect the bag in order to avoid the undesirable and expensive final inspection process, which requires the bag to be reunited with the passenger and inspected by hand. As a result of their high throughput rates, dual energy X-ray explosives detection systems have been deployed in all fully integrated Level 1 and most Level 2 installations. Trace Detection, and to a lesser extent CT scanners, have generally been deployed as Level 3 systems. More recently, enhanced versions of dual energy X- ray explosives detection systems have been deployed as Level 3 systems. In addition, trace detection, dual energy X-ray and CT scanners have been deployed as free-standing checked baggage explosives detection systems. Implementation of Carry-on Baggage Systems. There are currently no requirements for the use of automated explosives detection systems to screen carry-on baggage. However, the presence of explosives in carry-on baggage poses a serious threat to civil aviation. A published industry source estimated that approximately one quarter of bombs smuggled on board aircraft were hidden in carry-on baggage. As the global implementation of hold baggage systems continues, regulators are shifting their focus to the detection of explosives in carry-on baggage. The final report of the Gore Commission recommended that the FAA begin conducting feasibility studies with regard to the use of advanced explosives detection equipment for carry-on baggage systems. The FAA performed an initial evaluation of advanced explosives detection equipment for carry-on baggage systems in May and June 1997. Products The Company develops, manufactures and markets a family of advanced automated systems that can detect explosives and other contraband in airline baggage and other parcels. The first market to emerge for these systems has been explosives detection for airline baggage. The Company's product line includes Level 1 and Level 2 integrated automated explosives detection systems for checked baggage, freestanding automated explosives detection systems for Level 3, terminal and baggage hall inspection of checked baggage, and an automated explosives detection system for carry-on baggage, hand baggage and parcels. As of September 30, 1997, the Company had shipped and installed approximately 180 systems for use in airports throughout Europe, the Asia-Pacific region and North America. Each of the Company's automated checked baggage explosives detection systems uses a proprietary instrumentation quality power supply that generates alternating high (150kV) and low (75kV) energy pulses at film safe levels of exposure. The power supply is driven by an X-ray controller that uses both current and source voltage feedback to maintain a stable, repeatable fan shaped X-ray beam. As the X-ray beam passes through the bag and its contents, a portion of the beam is absorbed (referred to as X-ray absorption or attenuation) and a portion is scattered. The beam that passes through the bag without being absorbed or scattered is referred to as the transmitted beam and contains information regarding the X-ray absorption properties of the objects within the bag at each of the two levels of energy generated by the X-ray tube. This information can be used to analyze the atomic number, mass and other physical characteristics of the objects within the bag. The transmitted beam also contains information that can be used to make high quality images of the contents of a bag. The Company's automated checked baggage explosives detection systems incorporate a high resolution detector array that collects high quality data from the transmitted X-ray beam consisting of more than one million pixels of information per bag. The systems then employ the Company's patented composition analysis software algorithms to identify and separate the individual objects within a bag, including objects between other items or within a container. These algorithms also analyze the atomic number, mass and other characteristics of each of those objects to determine whether they match those of a targeted item, such as explosives or other contraband. Additional algorithms detect materials such as lead that could be used to shield an explosive device from this analysis. X-ray absorption analysis techniques are less effective for detecting certain configurations of explosives which only absorb a very small fraction of the transmitted beam. However, these materials tend to scatter X-rays more than other materials. The Company has developed proprietary scatter detection enhancement ("SDE") technology that enhances its systems' ability to detect these configurations. The Company's SDE technology, which includes a combination of additional detector arrays and software, measures and analyzes the scattered X-ray intensity emitted from baggage in both the forward and backward direction. If the scatter levels indicate the possible presence of a suspect material in a bag, the affected area is further analyzed to determine if a threat is present. The Company has incorporated SDE technology in most of its checked baggage inspection products, either as an option or a standard feature, and also offers this technology as an upgrade for existing systems. Both the Company's composition and scatter analysis techniques result in a computer-generated decision regarding the contents of the baggage screened. Any bag that is determined to contain a suspect object will cause the system to reject the bag. In the case of an operator-attended system, such as a Level 2 or Level 3 system, an image of the rejected bag is presented to an operator for detailed inspection. The bag image is presented in high-resolution gray scale, with the suspect object highlighted in color. The system can be programmed to sound an alarm, as well as require the operator to acknowledge the alarm by pressing a designated button to either reject or clear the bag. The Company has integrated its products into a wide range of airport baggage handling systems. These products make use of an effective control software developed by the Company to facilitate communication between the explosives detection system and the airport baggage handling system. If no suspect object is detected by the automated system, a "clear" status is sent to the baggage handling system, allowing the bag to continue directly to the aircraft. If a suspect object is detected, a "reject" message is sent to the baggage handling system, requiring the next level of inspection. The Company has gained broad acceptance of its control software by working closely with many of the major baggage handling systems and control systems contractors. The Company's systems are offered in a variety of configurations depending on the application or installation requirements. Integrated Models. The Company's first integrated products were the VIS Level 1 inspection system and the VDS Level 2 inspection system. The VIS Level 1 system is used to inspect 100% of the baggage on a baggage conveyor line. The system is capable of automatically inspecting up to 1,500 bags per hour without an operator. The VDS Level 2 system is designed to provide an operator with a high quality image in addition to automatically highlighting suspicious objects as an aid to the operator to inspect bags rejected by the automated Level 1 system. The system also allows the operator to view the contents of a bag using various imaging modes and magnifications to determine whether the bag should be cleared or sent to Level 3 for additional investigation. The VIS-W was the Company's first single system alternative to discrete Level 1 and Level 2 systems. The VIS-W combines a VIS Level 1 X-ray system ("VIS mainframe") with a single remote Level 2 operator workstation. The VIS mainframe transmits images of rejected bags to the Level 2 operator workstation. Level 2 inspection is then performed by an operator at a workstation in the same manner as an operator of a discrete Level 2 VDS system, thereby eliminating the need for a separate Level 2 explosives detection system to re-scan all bags rejected at Level 1. The VIS-M, introduced in April 1996, further extends the capability of the workstation concept by allowing several VIS mainframes to be interconnected ("Matrixed") with multiple Level 2 operator workstations. During off-peak periods, workstations can be switched off, thereby significantly reducing staffing requirements and operating costs. The efficiency gained by the additional workstations combined with enhanced baggage control software allows an operator to review images of the contents of a bag while the bag continues en route to the aircraft. This eliminates the need and associated costs of a secondary conveyor system to hold the bags while Level 2 inspection is taking place. These costs can be a significant portion of the total cost of purchase and installation of a multi-level integrated explosives detection approach. The baggage handling systems in the new airports in Malaysia and Hong Kong have been designed to capitalize on the VIS-M's Matrixing capability by interconnecting several of the Company's VIS-M systems with multiple workstations to achieve 100% checked baggage screening. Freestanding Models. The Company's freestanding checked baggage explosives detection systems are intended to be installed in an airport terminal, such as in front of airline check-in counters or in a baggage handling hall. The H-1 inspects bags in the upright position, as they tend to be carried by a passenger. The VDS series of systems, which can be used as freestanding systems, inspect baggage lying flat as they are transported on a conveyor belt. In 1996, the Company introduced a modified version of the operator-attended VDS system to serve as a Level 3 inspection system. Since less than 1% of the bags reach Level 3, additional time is available for bag inspection. This version, the VDS-II, combines the Company's SDE capability with a high-resolution image to enhance detection capability. The system is a low cost alternative to CT scanners for Level 3 inspection. It is also faster and less labor intensive than trace detection systems. This system can be integrated into a baggage handling system or used as a freestanding system in a baggage handling hall or terminal. In 1996, the Company also introduced a modified version of the VDS-II to serve as an inspection system for the inspection of baggage that exceeds the maximum dimensions that can be accommodated by standard baggage handling conveyor lines. The system can be integrated into a baggage handling system or used as a freestanding system in a baggage hall or terminal. Carry-on Model. The Company offers its Model APS system to inspect carry-on baggage, hand baggage and parcels for explosives or contraband material. The system is being evaluated by various governmental agencies. The Model APS is similar in configuration to conventional X-ray systems used to screen for concealed weapons currently installed in airports and government and private facilities. While an operator is required to inspect each bag for weapons, the Model APS automatically alerts the operator to the presence of suspect explosive materials. The Model APS incorporates an advanced proprietary operator interface that allows the operator to view the contents of a bag using various imaging modes and magnifications to determine whether the bag should be cleared or rejected for further inspection. The Company developed the APS system with Gilardoni, S.p.A. ("Gilardoni"), a manufacturer of conventional X-ray weapons screening systems and X-ray based equipment for the medical field. The system combines many of the advanced detection algorithms developed by the Company for its automated checked baggage explosives detection systems with an X-ray main frame using conventional dual energy X-ray technology. The arrangement with Gilardoni greatly reduced the time- to-market of the Company's APS carry-on baggage inspection system. In July 1997, the first sale of an APS system was completed to the Public Intelligence Department in Riyadh, Saudi Arabia. In November 1997, the Company received an order for seven Model APS systems for the new Terminal One at JFK International Airport in New York. This will be the first terminal in the world to screen all carry-on baggage for explosives. Other Products and Applications The Company believes that installations of advanced automated explosives detection systems at airports will accelerate the adoption of this technology for other security applications, including the protection of government and private facilities, and the screening of mail. The Company is also exploring opportunities with various governmental authorities and agencies in the United States and internationally to use its equipment for the detection of illicit drugs and the illegal export of currency. Further, the Company believes that its technology can expand the traditional role of X-ray technology in process control applications by providing enhanced or new value-added functions such as material analysis, segregation and sorting of materials, and quality control. See "Risk Factors - Developing Market; Uncertainty of Market Acceptance" and "- Uncertainty of Product Development." Products Under Development The Company's product development efforts are focused on developing new products for the explosives and contraband detection system market and further enhancing the functionality, reliability and performance of its existing product line. The Company is developing an explosives detection system, based upon the Company's current technology, to meet FAA certification requirements. This development effort is being funded in part by a two year $3.4 million research grant from the FAA awarded in May 1997. This grant is subject to termination by the government at any time. There can be no assurance that the Company will be able to develop a system that will meet FAA certification requirements on a timely basis, if at all, or that if developed, the system will be commercially successful. See "Risk Factors - Dependence on Government Regulation" and " - Uncertainty of Product Development." Marketing and Sales The company sells and markets its products through its direct sales force as well as independent sales representatives and distributors in certain foreign countries, including Spain, France, Hong Kong, Japan and Malaysia. As of September 30, 1997, the Company had an 11 person marketing and sales staff. Two members of this staff are located in the United Kingdom, one in Switzerland and one in Kuala Lumpur. The Company also has a director of business development for the United States based in New Jersey with a primary focus on the non-aviation applications for the Company's systems. The remainder of the marketing and sales staff is headquartered at the Company's offices in Woburn, Massachusetts. In the United States, the Company is working actively with the FAA, other government agencies, airlines, airport operators and congressional committees to promote the efficacy and cost- effectiveness of its products for deployment in United States airports. The Company is also working with United States and foreign governmental agencies to promote its products for non-aviation applications. In addition, the Company markets its products through participation in trade shows, publication of articles and advertising in trade journals, participation in industry forums and standard setting organizations, and distribution of sales literature. The Company benefits from customer referrals and the use of certain customer installations as demonstration sites for its systems. In fiscal 1995, 1996 and 1997, international sales accounted for approximately 91%, 95% and 97%, respectively, of the Company's revenues. All of these foreign sales were to the United Kingdom, other European countries and the Asia-Pacific region. See "Risk Factors - Reliance on International Sales" and "Note 6 in Notes to Consolidated Financial Statements." The selling process for the Company's products often involves a team comprised of individuals from sales and marketing, engineering, operations and senior management. This team frequently engages in a multi-level sales effort directed toward a variety of constituents which may include government regulators, the local airport operator or authority, systems integrators and airlines. The Company's sales effort with certain of its customers has extended over several years. Potential customers frequently require the Company's products to be tested against various performance standards and competitive products. The Company maintains demonstration units for this purpose and intends to increase its investment in demonstration units in order to accelerate the introduction of its products to new customers. Delays in anticipated purchase orders by the Company's customers and potential customers could have a material adverse effect on the Company's business. See "Risk Factors - Lengthy Sales Cycle." The Company has entered into an arrangement with Gilardoni for the manufacture and sale of the Model APS carry-on baggage explosives detection system. Under this arrangement, the Company has the exclusive right to manufacture and sell this system in the United States, the United Kingdom, certain other European countries and Mexico. In addition, the Company has agreed not to sell any competitive X-ray-based system within its territory unless manufactured by Gilardoni or the Company. The Company intends to pursue strategic alliances, acquisitions and licenses of complementary technologies to further enhance its growth. See "Risk Factors - Management of Growth." In fiscal 1995, 1996 and 1997, sales to BAA accounted for approximately 76%, 79% and 39%, respectively, of the Company's revenues. Additionally, in fiscal 1997 Airport Authority Hong Kong and Toyo Kanetsu K.K., the baggage-handling contractor for Malaysia's Kuala Lumpur International Airport, accounted for 19% and 27%, respectively, of the Company's revenues. See "Risk Factors - Customer Concentration." Customer Service and Support The Company provides a high level of customer support to assist in the installation and integration of the Company's products into its customers' facilities and to assist in maintaining the reliability of the Company's products once installed. The Company offers a number of customer support services, including applications support, training, system preventative and corrective maintenance, and upgrades. The Company generally provides one year parts warranty and offers primary and back-up service contracts to its customers. The Company's customer support staff currently includes five support engineers at its headquarters in Massachusetts, five support engineers operating out of the Company's offices in the United Kingdom and two support engineers in the Asia-Pacific region. Regulation The explosives detection systems manufactured and marketed by the Company for use in airports are subject to regulation by the FAA, corresponding foreign governmental authorities and ICAO, the United Nations organization for establishing standard practices for the aviation industry on a worldwide basis. Sales of the Company's explosives detection systems for use in airports have been and will continue to be dependent upon governmental initiatives to require or support the screening of baggage with advanced explosives detection systems. Substantially all of such systems have been installed at airports in countries in which the applicable governmental or regulatory authority overseeing the operations of the airport has mandated such screening. Such mandates are influenced by many factors outside of the control of the Company, including political and budgetary concerns of governments, airlines and airports. See "Risk Factors - Dependence on Government Regulation." The FAA currently requires all carry-on baggage and international checked baggage to be inspected by hand search or with conventional X-ray equipment. United States airlines operating at airports outside of the United States are required to meet FAA security requirements in addition to the requirements of the local authorities. The FAA permits the use of the Company's systems by United States airlines at foreign airports as an alternative to conventional X-ray equipment. Under the Aviation Security Act, the FAA was required to develop a standard for explosives detection systems and to certify equipment that met this standard under realistic airport operating conditions. The Aviation Security Act also required the deployment of certified equipment within the United States by 1993. To date, no system has demonstrated that it meets the FAA standard under realistic airport operating conditions. As a result, the FAA has not required the installation of automated explosives detection systems, and only a limited number of these systems have been deployed, primarily on a test basis, in the United States. The FAA first certified a CT-based system in December 1994. However, as recommended by the Gore Commission's final report and as required by the Re-Authorization Act, this system must undergo further testing to resolve whether it can operate under realistic airport operating conditions, including processing baggage at required throughput rates. The Company's systems do not meet FAA certification standards and there can be no assurance that any of the Company's systems will ever meet this or any other United States certification standard. Although ECAC has adopted a standard similar to the FAA standard as a long-term goal, they have allowed and promoted the deployment of effective systems even though overall they do not meet the standards. In response to the crash of TWA Flight 800, President Clinton formed the Gore Commission to review airline and airport security and oversee aviation safety. The Gore Commission released its initial and final reports in September 1996 and February 1997, respectively, and in October 1996, the United States enacted the Re-Authorization Act which included an allocation for the purchase of explosives detection systems and other advanced security equipment by air carriers and airport authorities. The FAA has ordered initial quantities of the CT-based system, trace detection systems and dual energy X-ray based systems, including eight systems from the Company. The deployment of these systems will allow the U.S. airlines, which are the main users of the equipment, to gain experience with the various technologies enabling them to determine which systems work best in busy U.S. airport environments. The UK DOT has mandated 100% screening of international checked baggage in the United Kingdom. Similarly, the other ECAC member states have resolved to implement 100% screening of international checked baggage. The Company's Level 1, Level 2 and Level 3 systems, as well as the Company's SDE technology, have been allowed for use by the UK DOT. In most other ECAC member states, the Company's systems either must be tested and approved or procured by governmental authorities overseeing the operation of airports within the country. In addition to the United Kingdom, the Company's systems have been purchased or approved for use in airports in many European countries including Belgium, France, The Netherlands, Spain and Switzerland. Governmental authorities overseeing the construction of new airports in the Asia-Pacific region are defining requirements for the use of advanced explosives detection systems to achieve 100% screening of international checked baggage at those airports. As a result, the Company's systems are also being evaluated by the applicable regulatory authorities in countries in the Asia-Pacific region for purchases at new airports and have been installed for use at the new airports being constructed in Malaysia and Hong Kong. There can be no assurance that the Company's systems will be purchased for installation in any of the other new airports or terminals under construction or proposed for construction in that region. ICAO has adopted various recommendations and requirements for screening of checked and carry-on baggage. Currently, ICAO requires the screening of all international carry-on bags and recommends the screening of international checked baggage. This requirement and recommendation relates only to the screening of baggage and does not require any specific technology to be used. There can be no assurance that additional countries will mandate the implementation of effective explosives screening or airline baggage, or that, if mandated, the Company's systems will meet the certification or other requirements of the applicable governmental authority. Even if the Company's systems meet the applicable requirements, there can be no assurance that the Company would be able to market its systems effectively. Research and Development The Company's research and development efforts are focused on developing new products for the explosives and contraband detection system market and further enhancing the functionality, reliability and performance of its existing product line. The Company's research and development personnel also are involved in establishing protocols, monitoring and interpreting and submitting test data to the FAA and other domestic and foreign regulatory agencies to obtain the requisite certifications, clearances and approvals for its products. At September 30, 1997, the Company had 34 employees engaged in research and development and engineering, including 13 employees engaged in software development. During fiscal 1995, 1996 and 1997, the Company's research and development expenses were approximately $3.7 million, $3.5 million and $4.4 million, respectively. In addition, during each of these years certain of the Company's research and development expenses related to work performed under the Company's FAA research and development grants were included under costs of goods sold. Intellectual Property The Company relies upon trade secrets and patents to protect its technology. Due to the rapid technological change that characterizes the explosives detection system industry, the Company believes that the improvement of existing technology, reliance upon trade secrets and unpatented proprietary know-how and the development of new products are generally as important as patent protection in establishing and maintaining a competitive advantage. Nevertheless, the Company has obtained patents and will continue to make efforts to obtain patents, when available, in connection with its product development program. The Company has obtained three patents and has pending three patent applications in the United States (two of which have been allowed but have not yet been issued). In addition, for certain foreign countries the Company has pending patent applications that correspond to the subject matter of certain United States patents and patent applications. Two of the Company's United States patents relate to applications of its dual X-ray technology and the Company's software algorithms used to implement the Company's screening analysis techniques. The Company's third patent relates to the Company's SDE technology. These patents have expiration dates ranging from 2011 to 2015. There can be no assurance that any of the Company's unallowed patent applications will be granted, that any patent or patent application will provide significant protection for the Company's products or technology, be of commercial benefit to the Company, or that its validity will not be challenged. Moreover, there can be no assurance that foreign intellectual property laws will protect the Company's intellectual property rights. In the absence of significant patent protection, the Company may be vulnerable to competitors who attempt to copy or use the Company's products, processes or technology. See "Risk Factors - Limited Protection of Intellectual Property Rights; Patent Litigation." The Company has an exclusive perpetual license to use certain patents and technology developed by Hologic, Inc. ("Hologic") for the development, manufacture and sale of X-ray screening security systems for explosives, drugs, currency and other contraband (subject to termination by either party for certain defined defaults). The Company also has a nonexclusive license to use this technology for the development, manufacture and sale of X-ray-based products for process control applications in the food and beverage industries. Hologic and the Company have also granted to the other a non- exclusive, royalty-free license to use any unpatented technology developed by the other in connection with such party's research and development activities. In addition, Hologic and the Company have the right to obtain from the other an exclusive license, on commercially reasonable terms to be negotiated, for any patented new developments. See "Risk Factors - Limited Protection of Intellectual Property Rights; Patent Litigation." The Company also licenses certain other technologies used in its products, often on an exclusive or semi-exclusive basis, for a defined field of use. These licenses involve eight United States patents and certain foreign patents relating to X-ray and complimentary technology. The United States patents have expiration dates ranging from 2002 to 2007. The Company's arrangement with Gilardoni relating to the Company's Model APS automated explosives detection system for screening of carry-on baggage contains cross licenses of intellectual property rights associated with each party's technology incorporated into the system. This license expires in 1999, subject to certain early termination and extension options. The Company was involved in patent litigation with EG&G Astrophysics Research Corporation ("EG&G"), in which each party claimed that the other was infringing certain patents held by the other. On November 6, 1996, the Company and EG&G signed a settlement agreement pursuant to which, among other things, each party agreed not to sue the other for patent infringement for nonmedical uses of X- ray technology covered by each other's existing patents or by patent applications which claim priority from such patents or, for products existing as of September 12, 1996, covered by patents that may be issued pursuant to existing patent applications. As a result, each party will have broad rights to use the other's existing X-ray technology for an unlimited period of time. There can be no assurance that EG&G will not use the Company's technology in a manner that would materially and adversely affect the Company's business and financial condition. The Company is also involved in certain patent litigation with American Science and Engineering, Inc. ("AS&E"), whereby the Company was seeking a declaratory judgement that it is not infringing any AS&E patent. In connection with this litigation, AS&E filed a counterclaim alleging that the Company is infringing one or more of eight AS&E patents. In October 1996, the court dismissed AS&E's infringement counterclaims, but allowed AS&E to raise more specific infringement counterclaims upon asserting factual support for such claims. In December 1996, AS&E filed a motion for leave to file an amended counterclaim asserting that the Company was violating one AS&E patent. The court subsequently dismissed AS&E's motion, but again allowed AS&E to raise more specific infringement counterclaims upon AS&E's asserting factual support for such claims. In February 1997, AS&E filed a further memorandum in support of its motion for leave to file an amended counterclaim. In April 1997, the Court denied AS&E's motion and dismissed its counterclaim without granting leave to file an amended counterclaim. See "Risk Factors - Limited Protection of Intellectual Property Rights; Patent Litigation" and "Item 3. Legal Proceedings." Competition The markets for the Company's products are highly competitive. Certain of the Company's competitors have substantially greater manufacturing, marketing and financial resources than the Company. Other major corporations have announced their intention to enter the security screening market. Competitors may develop superior products or products of similar quality for sale at the same or lower prices. Moreover, there can be no assurance that the Company's products will not be rendered obsolete by new industry standards or changing technology. There can be no assurance that the Company will be able to compete successfully with existing or new competitors. See "Risk Factors - Rapid Technological Change." While certain of the Company's competitors currently market automated checked baggage explosives detection products that use dual energy X-ray technology, the Company believes that it is able to compete favorably with these products based upon the overall cost effectiveness of the Company's systems as measured by a combination of factors including effective automated explosives detection, throughput, low cost of operation, installation and integration, price, reliability, and their proven operation in a variety of airports. The Company's systems also compete with systems employing other technologies including CT scanner technology and trace detection technology. A product based upon CT scanner technology currently detects a wider range of explosives than does the Company's systems. In 1994, the FAA first certified this CT-based system. However, as recommended by the Gore Commission's final report and as required by the Re-Authorization Act, this system must undergo further testing to resolve whether it can operate under realistic airport operating conditions. This system operates at a significantly lower throughput rate and significantly higher expense than the Company's systems. As a result, there have only been limited permanent installations of CT systems in airports, typically as either Level 2 or Level 3 systems. A new CT-based system currently is in development by another company that is purported to have a higher throughput than the FAA certified CT system. Products based upon trace detection technology have throughput rates lower than those based on dual energy X-ray or CT technology and generally have been installed as Level 3 systems. The Company's new Model APS system, which is intended to detect explosives in carry-on bags and personal effects at airports and other installations, has recently been evaluated by various government agencies. These systems will compete against conventional X-ray systems, which are lower in price, as well as advanced explosives detection systems being adapted by its competitors for this use. The Model APS system will compete on the basis of price, detection capabilities, ease of use, expense of operation and reliability. Manufacturing The Company's manufacturing operations consist primarily of assembly, test, burn-in and quality control. The Company has adopted stringent quality assurance procedures that include standard design practices, component selection procedures, vendor control procedures, and comprehensive reliability testing and analysis. As a result of these efforts, the Company has received ISO 9001 certification. The Company's manufacturing facility is currently producing approximately eight of the Company's checked baggage systems per month and has the capability to accommodate production of over 20 checked baggage systems per month. Should market conditions warrant, the Company may choose to establish overseas manufacturing operations. The Company purchases a major portion of the parts and peripheral components for its products, and manufactures certain subsystems, such as the high voltage power supply, from raw materials. Most parts and materials are readily available from several supply sources. During fiscal 1997, the Company entered into a joint marketing and royalty agreement with Gilardoni for the APS system. Currently, the Company is purchasing the mainframe and other components of the Model APS from Gilardoni. However, the Company intends to begin full manufacturing of the Model APS at its U.S. facility beginning in March 1998. Backlog Backlog for the Company's products as of September 30, 1996 and 1997 totaled approximately $7.5 million and $15 million, respectively. Backlog consists of purchase orders for which a customer has scheduled delivery within the next twelve months. In certain circumstances, orders included in backlog may be canceled or rescheduled by customers without significant penalty. Backlog as of any particular date should not be relied upon as indicative of the Company's revenues for any future period. Employees As of September 30, 1997, the Company had 109 full-time employees, including 30 in manufacturing operations and quality assurance, 34 in research, development and engineering, 26 in marketing, sales and customer support, 15 in finance and administration and four in data management. None of the Company's employees is represented by a union. The Company considers its employee relations to be good. Executive Officers of the Registrant The executive officers of the Company and their ages are as follows: Name Age Position S. David Ellenbogen 59 Chairman of the Board and Chief Executive Officer Dr. Jay A. Stein 55 Senior Vice President, Technical Director and Director Stephen A. Reber 45 President and Chief Operating Officer William J. Frain 31 Chief Financial Officer and Treasurer James J. Aldo 46 Vice President of Marketing and Sales Daniel J. Silva 45 Vice President of Operations S. David Ellenbogen, a co-founder of the Company, has served as its Chief Executive Officer and a director since its organization in June 1989 and served as its President from June 1989 until February 1997. Mr. Ellenbogen was also a co-founder of Hologic, a developer, manufacturer and seller of X-ray and other bone densitometers, served as its President from October 1985 until May 1994, and is currently its Chairman of the Board and Chief Executive Officer. Prior to founding Hologic, Mr. Ellenbogen served as President, Treasurer and a director of Diagnostic Technology, Inc. ("DTI"), which he co-founded in 1981. DTI, which developed an X-ray product for digital angiography, was acquired in 1982 by Advanced Technology Laboratories, Inc. ("ATL"), a wholly-owned subsidiary of Squibb Corporation. Mr. Ellenbogen was involved in the management of the digital angiography group of ATL from 1982 to 1985. Mr. Ellenbogen is employed by Hologic and performs part-time management services for the Company pursuant to a management agreement between the Company and Hologic. See "Item 13. Certain Relationships and Related Transactions." Dr. Jay A. Stein, a co-founder of the Company and Hologic, has served as Senior Vice President, Technical Director and a director for both companies since their organization. Dr. Stein co-founded DTI with Mr. Ellenbogen in 1981, served as Vice President and Technical Director of DTI and was Technical Director of the digital angiography group of its successor, ATL, from 1982 to 1985. Dr. Stein received a Ph.D. in Physics from The Massachusetts Institute of Technology. He is the principal author of fifteen patents pertaining to X-ray technology. Dr. Stein is employed by Hologic and performs part-time management services for the Company pursuant to a management agreement between the Company and Hologic. See "Item 13. Certain Relationships and Related Transactions." Stephen A. Reber has served as the Company's President and Chief Operating Officer since February 1997. Prior to joining the Company, Mr. Reber served as President of the MacBeth division of Kollmorgen Corporation, a color instrumentation and process control producer, from February 1994 to February 1997. Prior to joining Kollmorgen, Mr. Reber served in various capacities at Perkin-Elmer Corporation, an analytical instrument producer, including as General Manager, Process Instrumentation from 1991 to 1993 and as General Manager, Aftermarket Products Instrument Group from 1988 to 1991. Mr. Reber received BS and MS degrees in chemical engineering from The Massachusetts Institute of Technology and an MBA from Harvard Business School. William J. Frain, a Certified Public Accountant, has served as Chief Financial Officer and Treasurer since October 1996. Prior to that, Mr. Frain served as Controller from August 1993 until October 1996. Prior to joining the Company, Mr. Frain served as an auditor at Arthur Andersen LLP from September 1988 to August 1993. James J. Aldo has served as Vice President of Marketing and Sales since July 1993. Prior to that, Mr. Aldo served as Director of Sales and Marketing since joining the Company in July 1989. Prior to joining the Company, Mr. Aldo held positions in marketing, sales, engineering and field service management at AS&E and served as Eastern Regional Manager at Tegal, Inc., a subsidiary of Motorola, Inc., a manufacturer of capital equipment for the semiconductor industry. Daniel J. Silva has served as Vice President of Operations since April 1994. Prior to that, Mr. Silva served as the Company's Director of Operations from June 1992 to April 1994. Mr. Silva was hired as an Operations Manager in June 1991. Prior to joining the Company, Mr. Silva held positions in manufacturing, project management and program management at AS&E. Significant Employees Certain key employees of the Company who are not also executive officers or directors are as follows: Name Age Position Kristoph D. Krug 44 Chief Technical Officer Jeremy M. Attree 38 Director of Operations, Europe Kristoph D. Krug joined the Company in July 1989 as a Project Engineer, was promoted to Director of Research and Development Engineering in 1992 and became Chief Technical Officer in January 1997. Mr. Krug is the author of two of the Company's patents for X- ray screening. Prior to joining the Company, Mr. Krug was Engineering Manager at Teradyne, Inc., a manufacturer of automated test equipment. Jeremy M. Attree has served as Director of Operations, Europe since joining the Company in October 1993. From September 1991 to October 1993, Mr. Attree served as Marketing Manager for EA Technology Ltd, a primary research and development center for the electricity industry in the United Kingdom. Prior to joining EA Technology, Mr. Attree served as Marketing Director and Development Manager for Schlumberger Industries, Security Division, where he was engaged primarily in the development of new products in the airport security field. Item 2. Properties The Company leases its administrative headquarters and manufacturing facility located in Woburn, Massachusetts. The facility consists of approximately 43,000 square feet, including 21,000 square feet dedicated to the Company's manufacturing operations. The Company also leases 3,600 square feet of office and manufacturing space in San Diego, California for a research and development facility. The Company also has two offices in the United Kingdom, leasing approximately 1,000 square feet of space for sales and service. In addition, the Company has sales offices located in Moudon, Switzerland and New Jersey, USA and a sales and customer support office in Kuala Lumpur, Malaysia. The Company believes that its facilities will be adequate for its needs for the foreseeable future and that suitable additional space will be available at commercially reasonable prices as needed. Should market conditions warrant, the Company may expand its presence in Europe and the Asia- Pacific region by establishing a manufacturing operation or expanding its sales and support offices in one or more of those regions. Item 3. Legal Proceedings In May 1996, the Company commenced an action in the United States District Court for the District of Massachusetts against AS&E seeking a declaration that the Company does not infringe AS&E patents related to back scattered X-rays. This followed AS&E's allegations of infringement to third parties. No discovery has been taken to date. Following a court decision in July 1997 construing the claims of the AS&E patent, which decision the Company considers favorable, in September 1997 the Company filed a motion for summary judgment of non-infringement. AS&E has not yet filed its papers in opposition to the Company's motion but is seeking discovery. If granted, the Company's motion will resolve all issues remaining in the case in favor of the Company. Earlier, in April 1997, the Court dismissed AS&E's proposed counterclaim seeking to allege patent infringement, so that the only remaining issue in the case is the Company's request for declaration of non-infringement of two claims of a single AS&E patent. Item 4. Submission of Matters to a Vote of Security Holders None. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Market Information - The Company's Common Stock is quoted on the Nasdaq National Market under the symbol "VVID." The following table sets forth the quarterly high and low sales prices per share of Common Stock since the Company's initial public offering on December 11, 1996, as reported by the Nasdaq National Market. Fiscal Year Ended September 30, 1997 High Low First Quarter 12 3/4 10 Second Quarter 24 1/2 11 7/8 Third Quarter 19 3/4 13 1/4 Fourth Quarter 18 3/8 14 1/4 Number of Holders - As of December 17, 1997, there were approximately 176 holders of record of the Company's Common Stock, including multiple beneficial holders at depositaries, banks and brokers listed as a single holder in the street name of each respective depositary, bank or broker. Dividend Policy - The Company has never declared or paid cash dividends on its capital stock and does not plan to pay any cash dividends in the foreseeable future. The Company's current policy is to retain all of its earnings to finance future growth. The Company's bank line of credit prohibits the payment of cash dividends without prior bank approval. Recent Sales of Unregistered Securities - The following information is furnished with regard to all securities issued by the Registrant within fiscal 1997 which were not registered under the Securities Act. From October 1, 1996 through April 3, 1997, options to purchase a total of 130,850 shares of Common Stock granted under the Registrant's 1989 Combination Stock Option Plan were exercised at exercise prices ranging from $0.10 to $1.00 per share, at an aggregate purchase price of $45,825. The securities issued in such transactions were not registered under the Securities Act, as amended, in reliance upon the exemptions from registration set forth in Section 3(b) and 4(2) of the Securities Act, relating to sales by an issuer not involving any public offering. None of the foregoing transactions, either individually or in the aggregate, involved a public offering. Use of Proceeds of Initial Public Offering - On December 10, 1996, the Securities and Exchange Commission declared effective the Company's Registration Statement on Form S-1, Commission file number 333-14311, relating to the initial public offering of the Company's Common Stock, $.01 par value. The offering commenced on December 11, 1996 and all shares covered by the Registration Statement were sold. The managing underwriters for the offering were Lehman Brothers Inc., Cowen & Company and Needham & Company. The following sets forth certain information regarding the offering and the Companys' application of the net proceeds therefrom through September 30, 1997: INFORMATION RELATING TO THE OFFERING Number of shares registered 2,300,000 Number of shares sold by the Company 2,300,000 Aggregate price of the offering amount registered and sold $27,600,000 Offering Expenses: Underwriting discounts and commissions $1,932,000 Finders' fees -- Expenses paid to or for underwriters -- Other expenses $45,000 Total expenses $2,777,000 (1) Net offering proceeds $24,823,000 ------------------------- (1) No such expenses were paid directly or indirectly to directors, officers, general partners of the Company or their associates; to persons owning ten percent or more of any class of equity securities of the Company, or to affiliates of the Company. USE OF PROCEEDS Category Amount Construction of plant, building and facilities $22,600 Purchase and installation of machinery and equipment $450,000 Purchase of real estate -- Acquisition of other businesses -- Repayment of indebtedness -- Redemption of redeemable preferred stock (1) $5,780,650 Working capital $10,919,089 Temporary investments, net $6,432,405 Notes, drafts, bills of exchange or bankers' acceptances which mature not later than one year from the date of issuance Long-term investments $1,218,856 Investment-grade commercial paper, with an average maturity period of 15 months Total investments $7,651,261 Total $24,823,000 ----------------------- (1)Of this amount, approximately $900,000 was paid to Beta Partners Limited Partnership. Frank Kenny, a director of the Company, is a general partner of this partnership. No other proceeds of the offering were paid directly or indirectly to directors, officers, general partners of the Company or their associates; to persons owning ten percent or more of any class of equity securities of the Company; or to affiliates of the Company. Item 6. Selected Financial Data The following table contains certain selected consolidated financial data of the Company and is qualified in its entirety by the more detailed Consolidated Financial Statements included herein. This data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements appearing elsewhere herein. Year ended September 30, 1993 1994 1995 1996 1997 (Dollars in thousands, except per share data) Consolidated Statement of Operations Data: Revenues $ 2,854 $13,801 $14,437 $15,578 $31,702 Cost of revenues 1,921 6,762 6,129 6,899 13,203 Gross margin 933 7,039 8,308 8,679 18,499 Operating expenses: Research and development 1,139 2,296 3,653 3,462 4,390 Selling and marketing 317 716 1,077 1,395 3,556 General and administrative 221 916 1,120 1,515 2,929 Litigation expenses -- 199 309 1,150 427 Total operating expenses 1,677 4,127 6,159 7,522 11,302 Income (loss) from operations (744) 2,912 2,149 1,157 7,197 Interest and other income (expense), net (115) (2) (45) 8 862 Income (loss) before income taxes (859) 2,910 2,104 1,165 8,059 Provision for income taxes -- 100 90 -- 2,193 Net income (loss) $ (859) $ 2,810 $ 2,014 $ 1,165 $ 5,866 Net income (loss) per common and common equivalent share $ (0.15) $ 0.39 $ 0.28 $ 0.15 $ 0.60 Weighted average number of common and common equivalent shares outstanding 5,815 7,198 7,275 7,869 9,838 (Dollars in thousands) September 30, 1993 1994 1995 1996 1997 Consolidated Balance Sheet Data: Working capital $ (338) $ 2,054 $ 3,968 $ (1,037) $ 29,297 Total assets 1,509 6,365 7,740 11,963 37,457 Redeemable preferred stock, including current portion 5,781 5,781 5,781 5,781 -- Stockholders' equity (deficit) (5,887) (3,065) (1,045) 177 31,711 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with "Item 1. Business," "Item 6. Selected Financial Data," the Company's Consolidated Financial Statements and Notes thereto and the information described under the caption "Risk Factors" below. Overview The Company was founded in 1989 to develop, manufacture and market automated explosives detection systems following the bombing of Pan American Flight 103 over Lockerbie, Scotland. Following its organization, the Company undertook extensive research and development, introducing its first free standing automated explosives detection system, the H-1, in 1991, and its first integrated automated explosives detection systems for Level 1 and Level 2 screening, the VIS and VDS, in 1993. The Company commenced commercial shipments of its VIS and VDS systems in January 1994. As of September 30, 1997, the Company had shipped and installed more than 180 systems for use in airports throughout Europe, and in the Asia/Pacific region. In 1997 the Company introduced the Model APS, a freestanding system to screen carry-on baggage for explosives and weapons. The Model APS can also be used in the non-aviation market to screen baggage at public, private and government facilities. The first unit was sold in June 1997 to the Public Intelligence Department in Riyadh, Saudi Arabia for the protection of VIP's. In November 1997, the Company received an order for seven Model APS systems for the new Terminal One at JFK International Airport in New York. This will be the first terminal in the world to screen all carry-on baggage for explosives. The Company's sales are primarily to owners and operators of airports, including foreign governments and regulatory authorities. The Company's revenues are derived primarily from product sales. The Company recognizes revenue from product sales upon shipment to the customer, provided that no significant Company obligations remain outstanding and collection of the related receivable is deemed probable by management. The Company accrues for anticipated warranty and installation costs upon shipment. The Company's revenues also include government research and development grants and revenues from service, the sale of spare parts and training, which have comprised less than 10% of revenues in the periods presented. The Company recognizes revenues under its development grants as services are rendered. In May 1997, the Company received a two-year, $3.5 million research and development grant from the FAA to fund, in part, the development of a cost effective, high speed explosive detection system, based upon the Company's current proprietary technology, that is intended to meet FAA certification requirements. The Company commenced work under this grant in the third quarter of fiscal 1997. The grant is subject to termination by the government at any time. In fiscal 1995, 1996, and 1997 the Company recognized $1.4 million, $0.7 million, and $0.8 million respectively, in development revenue from FAA grants. The Company has an exclusive perpetual license to use certain patent rights and technology developed by Hologic for the development, manufacture and sale of X-ray screening security systems for explosives, drugs, currency and other contraband (subject to termination by either party for certain defined defaults). The Company also has a nonexclusive license to use these patents and technology for the development, manufacture and sale of X-ray based products which may be used for process control applications in the food and beverage industries. See "Risk Factors-Limited Protection of Intellectual Property Rights; Patent Litigation" and "Item 13. Certain Relationships and Related Transactions." The Company's cost of revenues includes a royalty payable with respect to product sales and other revenues derived from the license with Hologic. Under the terms of this exclusive agreement, this royalty was reduced from 5% to 3% of revenues derived from such license in January 1997 upon the Company reaching $50 million in cumulative revenues subject to the exclusive license. Upon the Company reaching $200 million of cumulative revenues subject to this exclusive license, the royalty will be eliminated entirely. As of September 30, 1997, the Company had reached approximately $79 million in cumulative revenues. See "Item 1. Business-Intellectual Property" and "Item 13. Certain Relationships and Related Transactions." In fiscal 1995, 1996 and 1997, sales to BAA accounted for approximately 76%, 79% and 39%, respectively, of revenues. Additionally, in fiscal 1997 Airport Authority Hong Kong and Toyo Kanetsu K.K., the baggage-handling contractor for Malaysia's Kuala Lumpur International Airport, accounted for 19% and 27% of the Company's revenues. The Company expects that its revenues from these customers will decrease and will become increasingly dependent upon sales of upgrades, replacement equipment and services. The failure of the Company to obtain orders from customers other than these customers would have a material adverse effect on the Company's business and financial condition. See "Risk Factors-Customer Concentration." Substantially all of the Company's revenues have been generated by sales to customers outside the United States. The Company's foreign sales have occurred principally in the United Kingdom, other Western European countries and more recently in the Asia/Pacific region. In fiscal 1997, the Company received orders for 26 and 23 systems at the Kuala Lumpur International Airport in Malaysia and Chek Lap Kok Airport in Hong Kong, respectively, the first two airports in the Asia/Pacific region that are adopting the integrated automated explosives detection approach. The Company shipped all 26 systems to Kuala Lumpur in fiscal 1997, and received a repeat order for three systems to be used at Level 3 to be delivered in fiscal 1998. As of September 30, 1997, the Company had shipped 16 of the 23 systems to Hong Kong. The Company has sales and service offices in the United Kingdom and Malaysia to support its European and Asia/Pacific operations, respectively, and has expanded its presence in Europe and the Middle East. The Company expects international sales to remain an important component of its business. The Company's export sales generally have been denominated in United States dollars. However, during fiscal 1997 approximately 25% of the Company's revenues were denominated in foreign currencies. The Company on occasion has hedged its foreign currency exposure by entering into forward foreign exchange contracts to hedge against foreign currency fluctuations. There can be no assurance that these hedging efforts will be successful. See "Risk Factors-Reliance on International Sales." Results of Operations For the periods indicated, the following table sets forth the percentage of revenues represented by the respective line items in the Company's consolidated statement of operations: Year Ended September 30, 1995 1996 1997 Revenues 100% 100% 100% Cost of revenues 42 44 42 Gross margin 58 56 58 Operating expenses: Research and development 25 22 14 Selling and marketing 8 9 11 General and administrative 8 10 9 Litigation expenses 2 8 1 Total operating expenses 43 49 35 Income from operations 15 7 23 Interest and other income, net -- -- 3 Income before income taxes 15 7 26 Provision for income taxes 1 -- 7 Net income 14% 7% 19% Fiscal Year Ended September 30, 1997 Compared to Fiscal Year Ended September 30, 1996 Revenues. Revenues increased by approximately 104% to $31.7 million in fiscal 1997, from $15.6 million in fiscal 1996. This increase in revenues primarily was the result of an increase in product sales. The increase in product sales was primarily attributable to the total number of product shipments to Europe as well as the commencement of shipments to Chek Lap Kok Airport in Hong Kong and shipments to Kuala Lumpur International Airport in Malaysia, partially offset by slightly lower average selling prices of the Company's products. During fiscal 1997, the Company shipped and installed 76 units compared to 30 units in fiscal 1996. Gross Margin. Gross margin increased to 58% of revenues in fiscal 1997 compared to 56% of revenues in fiscal 1996. The increase in gross margin in fiscal 1997 was primarily attributable to the decrease, commencing in January 1997, in royalties due to Hologic for the exclusive license of certain patents and technology from 5% to 3%, as well as decreased costs attributable to improved manufacturing efficiencies recognized during the year. These decreases were partially offset by lower average selling prices. During the second half of fiscal 1996, the Company's product sales consisted primarily of sales of the newly introduced VIS-M and VDS-II as well as SDE upgrades. During fiscal 1997, the Company was able to reduce certain component costs and achieve other manufacturing efficiencies in the design of the VIS-M and VDS-II, which substantially offset lower average selling prices. The Company also had a significant increase in sales of upgrades, parts and maintenance in fiscal 1997. During the third quarter of fiscal 1997 the Company began recognizing revenue under the $3.5 million FAA research grant. This grant did not have a material impact on gross margins during fiscal 1997. Research and Development Expenses. Research and development expenses increased by approximately 27% to $4.4 million (14% of revenues) in fiscal 1997 from $3.5 million (22% of revenues) in fiscal 1996. The increase in research and development expenses in fiscal 1997 was primarily due to the addition of engineering personnel and outside consultants working on the development of new products and enhancements to existing products, including enhancements to the Model APS system for carry-on baggage and the VIS- M (Matrix configuration). Certain expenses in connection with the development of the Company's next generation system have been included in costs of goods sold in connection with the most recent FAA research and development grant. As a percentage of revenues, research and development expenses declined in the current year, reflecting increased revenues in fiscal 1997. Selling and Marketing Expenses. Selling and marketing expenses increased approximately 155% to $3.6 million (11% of revenues) in fiscal 1997 from $1.4 million (9% of revenues) in fiscal 1996. The increase in selling and marketing expenses in fiscal 1997 primarily was due to additional sales and support personnel, as a result of the expansion of operations in Europe and the establishment of operations in the Asia/Pacific region, the payment of commissions to sales representatives in the Asia/Pacific region, and to a lesser extent an increase in advertising, consulting, trade shows and related travel costs. The Company anticipates that it will continue to expand its selling and marketing efforts in fiscal 1998 in anticipation of continued growth. General and Administrative Expenses. General and administrative expenses increased approximately 93% to $2.9 million (9% of revenues) in fiscal 1997 from $1.5 million (10% of revenues) in fiscal 1996. The increase in general and administrative expenses in fiscal 1997 was primarily attributable to an increase in personnel and related costs (including non-recurring costs related to relocation fees) as well as additional overhead costs as the headcount for the Company increased approximately 42%. The Company anticipates that general and administrative costs will continue to increase in anticipation of continued growth in fiscal 1998. Litigation Expenses. The Company incurred $427,000 and $1.2 million of litigation expenses in fiscal 1997 and 1996, respectively, primarily in connection with the Company's patent litigation with EG&G and to a lesser extent AS&E. On November 6, 1996, the Company entered into an agreement with EG&G to settle EG&G's patent infringement claim against the Company. The litigation expenses in fiscal 1997 also include expenses incurred in connection with the Company's litigation with AS&E. In May 1996, the Company commenced an action in the United States District Court for the District of Massachusetts against AS&E seeking a declaration that the Company does not infringe AS&E patents related to back scattered X-rays. This followed AS&E's allegations of infringement to third parties. No discovery has been taken to date. Following a court decision in July 1997 construing the claims of the AS&E patent, which decision the Company considers favorable, in September 1997 the Company filed a motion for summary judgment of non-infringement. AS&E has not yet filed its papers in opposition to the Company's motion but is seeking discovery. If granted, the Company's motion will resolve all issues remaining in the case in favor of the Company. Earlier, in April 1997, the Court dismissed AS&E's proposed counterclaim seeking to allege patent infringement, so that the only remaining issue in the case is the Company's request for declaration of non-infringement of two claims of a single AS&E patent. As a result of the Company's settlement with EG&G in November, and the recent court rulings against AS&E, the Company expects litigation expenses to decline in fiscal 1998. Interest Income. The Company recognized net interest income of approximately $813,000 in fiscal 1997 compared to net interest income of $8,000 in fiscal 1996. The increase in fiscal 1997 was primarily attributable to higher average cash balances resulting from the receipt of proceeds from the Company's initial public offering. Provision for Income Taxes. The Company's effective tax rate for fiscal 1997 was 27% compared to no provision for income taxes in fiscal 1996. The Company's effective tax rate in fiscal 1997 was lower than the statutory tax rates primarily due to the use of tax credits and the tax benefits associated with the Company's foreign sales corporation. The provision for income taxes in fiscal 1996 was a result of the Company's recognition of a deferred tax asset, which reflected management's determination, in accordance with the Financial Accounting Standards Board's Statement of Financial Accounting Standards ("SFAS") No. 109, that it was more likely than not that this deferred tax asset would be utilized. Fiscal Year Ended September 30, 1996 Compared to Fiscal Year Ended September 30, 1995 Revenues. Revenues increased by approximately 8% to $15.6 million in fiscal 1996, from $14.4 million in fiscal 1995. This increase was the result of an increase in product sales which was partially offset by a decrease in revenue associated with the Company's 1995 FAA development grant. The increase in product sales was primarily attributable to an increase in unit sales, which was partially offset by lower average selling prices. Gross Margin. Gross margin decreased to 56% of revenues in fiscal 1996 compared to 58% of revenues in fiscal 1995. The decrease in gross margin was primarily attributable to the Company's change in product mix, lower average selling prices, and a reduction in revenues associated with the Company's 1995 FAA grant which were partially offset by manufacturing efficiencies. During fiscal 1995 and the first half of fiscal 1996, the Company's product sales consisted primarily of sales of the VIS-W. During the second half of fiscal 1996, product sales shifted to the newly introduced VIS-M, VDS-II, and SDE upgrades, each of which has a lower average selling price than the VIS-W. The Company was able to reduce certain component costs and achieve other manufacturing efficiencies in the design of the VIS-M and VDS-II, which substantially offset these lower selling prices. In addition, the Company's work under its FAA grant was completed in the third quarter of fiscal 1996. The effect of this grant increased the Company's gross margin by approximately 2% in the first three quarters of fiscal 1996. Research and Development Expenses. Research and development expenses decreased by approximately 5% to $3.5 million (22% of revenues) in fiscal 1996 from $3.7 million (25% of revenues) in fiscal 1995. The decrease was primarily attributable to expenditures in fiscal 1995 related to the Company's development of its VIS-M product, which was substantially completed by the first quarter of fiscal 1996. Selling and Marketing Expenses. Selling and marketing expenses increased by approximately 29% to $1.4 million (9% of revenues) in fiscal 1996 from $1.1 million (8% of revenues) in fiscal 1995. The increase was primarily attributable to additional sales and support personnel, and to an increase in advertising, consulting and trade show costs. General and Administrative Expenses. General and administrative expenses increased by approximately 35% to $1.5 million (10% of revenues) in fiscal 1996 from $1.1 million (8% of revenues) in fiscal 1995. The increase was primarily attributable to an increase in personnel and additional overhead costs related to the Company's move to a new facility in March 1996. Litigation Expenses. The Company incurred $1.2 million and $0.3 million of litigation expenses in fiscal 1996 and 1995, respectively, primarily in connection with the Company's patent litigation with EG&G. On November 6, 1996, the Company entered into an agreement with EG&G to settle this litigation. The litigation expenses in fiscal 1996 also included expenses incurred in connection with the Company's litigation with AS&E. See "Risk Factors-Limited Protection of Intellectual Property Rights; Patent Litigation," "Item 1. Business-Intellectual Property" and "Item 3. Legal Proceedings." Interest Income (Expense), Net. The Company recognized net interest income of $8,000 in fiscal 1996 and net interest expense of $45,000 in fiscal 1995. The change in interest income (expense), net was primarily attributable to reduced average borrowings by the Company under its bank working capital line of credit. Provision for Income Taxes. The Company recorded no provision for income taxes in fiscal 1996 compared to an effective tax rate of 4% in fiscal 1995. The provision for income taxes in fiscal 1996 reflected the Company's recognition of a deferred tax asset. If the Company had not recognized this deferred tax asset, the Company's effective tax rate in fiscal 1996 would have been 16%. Liquidity and Capital Resources Since inception, the Company has funded its operations and capital expenditures through internally generated cash flow, proceeds from sales of securities and the availability of a working capital line of credit. In December 1996 and January 1997, the Company received total net proceeds of approximately $24.8 million from the initial public offering of its Common Stock, of which $5.8 million was used to redeem all of the Company's outstanding shares of Series A Preferred Stock and Series C Preferred Stock. See "Item 5. Market for Registrant's Common Equity and Related Stockholder Matters" and "Item 13. Certain Relationships and Related Transactions." At September 30, 1997, the Company had working capital of $29.3 million, including approximately $18.0 million in cash and cash equivalents and short-term investments. In addition, the Company had $1.2 million of long-term investments, none of which have maturities of less than 18 months. The Company also has a $5.0 million bank line of credit which expires in February 1998. The Company's bank line of credit bears interest at the bank's prime rate (8.5% as of September 30, 1997). The line of credit is secured by substantially all of the Company's assets and contains certain financial and other covenants. At September 30, 1997, the Company had no amounts outstanding under this line of credit. During the fiscal year ended September 30, 1997, the Company's net cash used in operating activities was approximately $1.9 million. During that period, net income and depreciation and amortization expenses totaling $6.3 million, were offset by a $5.8 million increase in accounts receivable, a $1.5 million increase in inventories, a $1.0 million decrease in accrued expenses. The increase in inventories and accounts receivable were primarily attributable to the Company's increased product sales. As of November 30, 1997, the Company received payments of approximately $6.4 million against the outstanding receivable balance at September 30, 1997. During the fiscal year ended September 30, 1997, the Company's net cash used in investing activities was approximately $8.1 million, primarily reflecting the net purchase of approximately $7.7 million of short-term investments. Cash used in investing activities also included capital expenditures for fiscal 1997 of approximately $540,000. While the Company does not have any significant commitments for capital expenditures, the Company anticipates that it will continue to purchase equipment to support its anticipated growth. During the fiscal year ended September 30, 1997, net cash provided by financing activities was $19.9 million, primarily attributable to the receipt of net proceeds of approximately $24.8 million from the initial public offering of the Company's common stock and approximately $800,000 of proceeds from the exercise of stock options. The Company used approximately $5.8 million of the net proceeds of the offering to redeem all of its outstanding shares of mandatorily redeemable non-convertible preferred stock. The Company does not currently have any significant capital commitments and believes that existing sources of liquidity, including the net proceeds of its initial public offering, funds expected to be generated from operations and its line of credit will provide adequate cash to fund the Company's anticipated operational and other cash needs through at least the next twelve months. However, for a brief discussion of the factors that could adversely affect the Company's financial position and results of operations, see "Risk Factors." Recent Accounting Pronouncements In March 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share," which established new standards for calculating and presenting earnings per share. The Company will adopt this new standard in its fiscal 1998 financial statements, which will require the reporting of diluted earnings per share and basic earnings per share, as defined. SFAS No. 128 is effective for periods ending after December 15, 1997, and early adoption is not permitted. When adopted, the statement will require restatement of prior years' earnings per share. For the years ended September 30, 1995, 1996 and 1997, diluted earnings per share would have been $0.28, $0.15 and $0.60, respectively. Basic earnings per share would have been $1.11, $0.64 and $0.78, respectively, for the same periods. Risk Factors This Report contains forward-looking statements that involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations and intentions. The cautionary statements made in this Report should be read as being applicable to all forward- looking statements wherever they appear in this Report. The Company's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this Report. Customer Concentration. In fiscal 1995, 1996 and 1997, sales to BAA accounted for approximately 76%, 79% and 39%, respectively, of the Company's revenues. Additionally, in fiscal 1997 Airport Authority Hong Kong and Toyo Kanetsu K.K., the baggage-handling contractor for Malaysia's Kuala Lumpur International Airport, accounted for 19% and 27%, respectively, of the Company's revenues. Each of these customers is nearing completion of deployment of checked baggage explosives detection systems at their respective airports. As a result, the Company expects that its revenues from these customers will decrease and will become increasingly dependent upon sales of upgrades, replacement equipment and services. The inability of the Company to obtain orders from customers other than these would have a material adverse effect on the Company's business and financial condition. Dependence on Government Regulation. The Company's sales of its explosives detection systems for use in airports has been and will continue to be dependent upon governmental initiatives to require or support the screening of baggage with advanced explosives detection systems. Substantially all of such systems have been installed at airports in countries in which the applicable governmental or regulatory authority overseeing the operations of the airport has mandated such screening. Such mandates are influenced by many factors outside of the control of the Company, including political and budgetary concerns of governments, airlines and airports. In the United States, the Aviation Security Act of 1990 directed the FAA to develop a standard for explosives detection systems and required airports in the United States to deploy systems meeting this standard by 1993. The standard adopted by the FAA is more comprehensive than standards adopted in most other countries. The FAA first certified a computed tomography ("CT") system in December 1994. However, as recommended by the Gore Commission's final report, issued in February 1997, and as required by the Federal Aviation Re-Authorization Act of 1996 (the "Re-Authorization Act"), this system must undergo further testing to resolve whether it can operate under realistic airport operating conditions, including processing baggage at required throughput rates. To date, no system has demonstrated that it meets the FAA standard under realistic airport operating conditions. As a result, only a limited number of these systems have been deployed, primarily on a test basis, in the United States. The Company's systems do not meet the FAA certification standard. There can be no assurance that any of the Company's systems will ever meet this or any other United States certification standard. Moreover, there can be no assurance that additional countries will mandate the implementation of effective explosives screening of airline baggage, or that, if mandated, the Company's systems will meet the certification or other requirements of the applicable governmental authority. See "Item 1. Business-Regulation." In October 1996, the United States enacted the Re-Authorization Act, which included an allocation for the purchase of explosives detection systems and other advanced security equipment by air carriers and airport authorities. Utilizing this allocation, the FAA has ordered initial quantities of the CT-based system, trace detection systems and dual energy X-ray based systems, including eight systems from the Company. Deployment of these various systems is not scheduled for completion until mid-1998. There can be no assurance that the FAA will order additional systems from the Company. See "Item 1. Business-Industry Background." Developing Market; Uncertainty of Market Acceptance. The explosives detection system market is at a relatively early stage of development. Acceptance of explosives detection systems on a broad basis will be dependent upon the acceptance and adoption of explosives detection systems by airlines and airports throughout the world, the expansion of applications for explosives detection technology, government initiatives to support the expansion of this market, the performance and price of the Company's and its competitors' products, customer reaction to those products and continued cost and performance improvements in explosives detection technology. There can be no assurance that the explosives detection market will develop further or that the Company will be successful in marketing its products effectively and obtaining broader market acceptance for its products. Failure to do so would have a material adverse effect on the Company's business and financial condition. Further, if one of the Company's or a competitor's systems were to fail to detect explosives and such failure resulted in an airline bombing, the ability of the Company to market its products could be materially adversely affected. See "Item 1. Business-Industry Background." Significant Fluctuations and Unpredictability of Operating Results. Significant annual and quarterly fluctuations in the Company's results of operations may be caused by several factors, including the overall demand for explosives detection systems, market acceptance of the Company's products, the timing of regulatory approvals for the Company's system and government initiatives to promote the use of explosives detection systems such as those manufactured and sold by the Company. Other factors that may cause fluctuations in operating results include the timing of the announcement, introduction and delivery of new products and product enhancements by the Company and its competitors, variations in the Company's product mix and component costs, timing of customer orders, adjustments of delivery schedules to accommodate customers programs, the availability of materials and labor necessary to produce the Company's products, the availability of components from suppliers, the timing and level of expenditures in anticipation of future sales, and pricing and other competitive conditions. Customers may also cancel or reschedule shipments and production difficulties could delay shipments. Relatively few system sales to relatively few customers comprise a significant portion of the Company's revenues in each quarter. Therefore, small variations in the number of systems sold could have a significant effect on the Company's results of operations. The Company believes that period to period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Lengthy Sales Cycle. As a result of the significant capital and other commitments required to install and integrate the Company's products into an airport baggage handling system, foreign regulatory approval requirements, and the developing nature of the explosives detection market, the Company has experienced extended sales cycles with its customers. The Company's sales efforts with certain existing and potential customers have extended over several years. Customers may initially purchase one or a few units for extensive testing and evaluation before making a decision regarding volume purchases and, in certain circumstances, the Company may provide a potential customer with a demonstration unit for regulatory testing and evaluation free of charge. Delays in anticipated purchase orders could have a material adverse effect on the Company's business and financial condition. See "Risk Factors-Significant Fluctuations and Unpredictability of Operating Results" and "Item 1. Business-Marketing and Sales." Reliance on International Sales. In fiscal 1995, 1996 and 1997, international sales accounted for approximately 91%, 95% and 97%, respectively, of the Company's revenues. The Company anticipates that international sales will continue to account for a significant percentage of the Company's revenues. Risks associated with international sales include, among other things, international regulatory requirements and policy changes, political and economic instability, possible foreign currency controls, intellectual property protection, currency exchange rate fluctuations, tariffs or other barriers, staffing and management of foreign operations, inventory management, accounts receivable collection and the management of distributors or representatives. In particular, recent economic instability in the Asia/Pacific region may delay or reduce airport capital projects in that region which could have a material adverse effect on the Company's business. In addition, most foreign countries have their own regulatory approval requirements for sales of the Company's products. As a result, the Company's introduction of new products into international markets can be costly and time consuming, and there can be no assurance that the Company will be able to obtain the required regulatory approvals on a timely basis, if at all. Furthermore, the Company's international sales have been denominated primarily in United States dollars. The Company anticipates that its international sales may increasingly be denominated in foreign currencies. The Company on occasion has hedged its foreign currency exposure by entering into forward foreign exchange contracts to hedge against foreign currency fluctuations. There can be no assurance that these hedging efforts will be successful or that other risks associated with international sales and operations will not have a material adverse effect on the Company's business and financial condition. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 1. Business-Marketing and Sales." Uncertainty of Product Development. The Company's success will depend upon its ability to enhance its existing products, and to develop new products 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, there can be no assurance that the Company 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. Rapid Technological Change. The market for the Company's products is characterized by rapid technological change and evolving industry requirements. The Company believes that its future success will depend in large part upon its ability to enhance its existing products and to successfully develop new products that meet regulatory and customer requirements and gain market acceptance. There can be no assurance that the Company's products will not be rendered obsolete by new industry standards or changing technology. Competition. The markets for the Company's products are highly competitive. The Company's systems compete against dual energy X-ray as well as other competing technologies, including CT and trace detection. Certain of the Company's competitors have substantially greater manufacturing, marketing and financial resources than the Company. In addition, other major corporations have recently announced their intention to enter the security screening market and currently have systems in development. One of the Company's competitors has developed a product based upon CT scanner technology that was certified by the FAA. However, as recommended by the Gore Commission's final report and as required by the Re-Authorization Act, this system must undergo further testing to resolve whether it can operate under realistic airport operating conditions. The Company is aware of a new CT-based system currently in development by another company that is purported to have a higher throughput than the FAA certified CT system. None of the Company's products have been certified by the FAA. Competitors may develop superior products or products of similar quality for sale at the same or lower prices. Other technical innovations may impair the Company's ability to market its products. There can be no assurance that the Company will be able to compete successfully with existing or new competitors. See "Item 1. Business-Competition." Limited Protection of Intellectual Property Rights; Patent Litigation. The Company's success depends significantly upon proprietary technology. The Company relies on a combination of patent, copyright, trademark and trade secret laws, non-disclosure agreements and other contractual provisions to establish, maintain and protect its proprietary rights, all of which afford only limited protection. The Company has obtained three patents and has pending three patent applications in the United States (two of which have been allowed but have not yet been issued). In addition, for certain foreign countries the Company has pending patent applications that correspond to the subject matter of certain United States patents and patent applications. There can be no assurance that any of the Company's unallowed patent applications will be granted, that any patent or patent application will provide significant protection for the Company's products and technology, or that the Company's current or future products, processes or technology will not be challenged under patents held by competitors or potential competitors. Moreover, there can be no assurance that foreign intellectual property laws will protect the Company's intellectual property rights. In the absence of significant patent protection, the Company may be vulnerable to competitors who attempt to copy the Company's products, processes or technology. The Company has an exclusive perpetual license to use certain patent rights and technology developed by Hologic for the development, manufacture and sale of X-ray screening security systems for explosives, drugs, currency and other contraband (subject to termination by either party for certain defined defaults). The Company also has a nonexclusive license to use this technology for the development, manufacture and sale of X-ray-based products for process control applications in the food and beverage industries. If the Company desires to develop products for other applications, it must either use alternative technology or obtain an additional license from Hologic. There can be no assurance that the Company would be able to develop or license alternative technology for any additional applications, or that the Company would be able to license Hologic's technology for these applications on favorable terms, if at all. In addition, there can be no assurance that Hologic will not develop or license its technology to others for applications competitive with those that may be developed by the Company outside of areas for which the Company has an exclusive license. See "Item 13. Certain Relationships and Related Transactions." The Company was involved in patent litigation with EG&G Astrophysics Research Corporation ("EG&G"), in which each party claimed that the other was infringing certain patents held by the other. On November 6, 1996, the Company and EG&G signed a settlement agreement pursuant to which, among other things, each party agreed not to sue the other for patent infringement for nonmedical uses of X- ray technology covered by each other's existing patents or by patent applications which claim priority from such patents, or, for products existing as of September 12, 1996, covered by patents that may be issued pursuant to existing patent applications. As a result, each party will have broad rights to use the other's existing X-ray technology for an unlimited period of time. There can be no assurance that EG&G will not use the Company's technology in a manner that would materially and adversely affect the Company's business and financial condition. See "Item 1. Business-Intellectual Property." In May 1996, the Company commenced an action in the United States District Court for the District of Massachusetts against AS&E seeking a declaration that the Company does not infringe AS&E patents related to back scattered X-rays. This followed AS&E's allegations of infringement to third parties. No discovery has been taken to date. Following a court decision in July 1997 construing the claims of the AS&E patent, which decision the Company considers favorable, in September 1997 the Company filed a motion for summary judgment of non- infringement. AS&E has not yet filed its papers in opposition to the Company's motion but is seeking discovery. If granted, the Company's motion will resolve all issues remaining in the case in favor of the Company. Earlier, in April 1997, the Court dismissed AS&E's proposed counterclaim seeking to allege patent infringement, so that the only remaining issue in the case is the Company's request for declaration of non-infringement of two claims of a single AS&E patent. Although the Company does not believe that it is infringing any valid patent of AS&E, there can be no assurance that AS&E will not make a new counterclaim in which it raises more specific infringement allegations. Failure of the Company to prevail in this litigation could have a material adverse effect on the Company's business and financial condition. See "Item 1. Business-Intellectual Property" and "Item 3. Legal Proceedings." Management of Growth. The Company has undergone a period of growth, and any continued expansion may significantly strain the Company's management, financial and other resources. Due to the level of technical and marketing expertise necessary to support its existing and new customers, the Company must attract and retain highly qualified and well-trained personnel. There are a limited number of persons with the requisite skills to serve in these positions, and it may become increasingly difficult for the Company to hire such personnel. The Company's expansion may also significantly strain the Company's management, manufacturing, financial and other resources. There can be no assurance that the Company's systems, procedures, and controls will be adequate to support the Company's operations or that the Company will be able to successfully integrate its new personnel. Failure to manage the Company's growth properly could have a material adverse effect on the Company's business and financial condition. See "Item 1. Business-Executive Officers of the Registrant." Risks Associated with Possible Acquisitions. The Company intends to pursue potential acquisitions of businesses, products and technologies that could complement or expand the Company's business. There can be no assurance that the Company will be able to identify any appropriate acquisition candidate. If the Company identifies an acquisition candidate, there can be no assurance that the Company would be able to successfully negotiate the terms of any such acquisition, finance such acquisition or integrate such acquired business, products or technologies into the Company's existing business and products. Furthermore, the negotiation of potential acquisitions as well as the integration of an acquired business could cause diversion of management's time and resources, and require the Company to use working capital to consummate a potential acquisition. There can be no assurance that a given acquisition, whether or not consummated, would not have a material adverse effect on the Company's business or financial condition. If the Company consummates one or more significant acquisitions in which consideration consists of Common Stock, stockholders of the Company could suffer significant dilution of their interests in the Company. See "Risk Factors-Management of Growth." Potential for Product Liability Claims. The Company's business involves the risk of product liability claims inherent to the explosives detection industry. There are many factors beyond the control of the Company that could result in the failure of the Company's products to detect explosives, such as the reliability of a customer's operators, the ongoing training of such operators and the maintenance of the Company's products by its customers. For these and other reasons, there can be no assurance that the Company's products will detect all explosives concealed in screened bags. The failure to detect an explosive could give rise to product liability claims and result in negative publicity that could have a material adverse effect on the Company's business and financial condition. The Company currently maintains aviation product liability insurance with an aggregate coverage limit of $150 million per year, subject to certain deductibles and exclusions. There can be no assurance that this insurance will be sufficient to protect the Company from product liability claims, or that product liability insurance will continue to be available to the Company at a reasonable cost, if at all. Concentration of Ownership; Control by Management. As of December 17, 1997, the Company's executive officers, directors and their affiliates and members of their immediate families beneficially owned approximately 18% of the outstanding shares of Common Stock, excluding shares issuable upon exercise of options and warrants. As a result, these stockholders, if acting together, will be able to exert substantial influence over actions requiring stockholder approval, including the election of directors, amendments to the Company's Restated Certificate of Incorporation, mergers, sales of assets or other business acquisitions or dispositions. Antitakeover 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. Item 8. Financial Statements and Supplementary Data The consolidated Financial Statements and Supplementary Data of the Company are listed under Part IV, Item 14, in this Report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant The information required by this Item 10 is hereby incorporated by reference to the text appearing under Part I, Item 1 - Business under the caption "Executive Officers of the Registrant" in this Report, and by reference to the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year. Item 11. Executive Compensation The information required by this Item 11 is hereby incorporated by reference to the information under the heading "Executive Compensation" in the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this Item 12 is hereby incorporated by reference to the information under the heading "Securities Beneficially Owned by Directors, Officers and Principal Stockholders" in the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year. Item 13. Certain Relationships and Related Transactions The information required by this Item 13 is hereby incorporated by reference to the information under the heading "Certain Transactions," if any, in the Company's definitive proxy statement to be filed by the Company within 120 days after the close of its fiscal year. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed as part of this report: (1) Financial Statements Page Report of Independent Public Accountants F-1 Consolidated Balance Sheets as of September 30, 1996 and 1997 F-2 Consolidated Statements of Operations for the years ended September 30, 1995, 1996 and 1997 F-3 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended September 30, 1995, 1996 and 1997 F-4 Consolidated Statements of Cash Flows for the years ended September 30, 1995, 1996 and 1997 F-5 Notes to Consolidated Financial Statements F-6 (2) Financial Statement Schedules Supplemental schedules are not provided because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto. (3) Listing of Exhibits Exhibit Reference No. 2.01 Merger Agreement between the Company A** and the Company's Massachusetts predecessor 3.01 Restated Certificate of Incorporation A** 3.02 By-laws of the Company A** 4.01 Specimen Certificate for shares of A** the Company's Common Stock 4.02 Description of Capital Stock A** (contained in the Restated Certificate of Incorporation of the Company, filed as Exhibit 3.01) 4.03 Description of Registration Rights A** (contained in Exhibits 10.05, 10.11 and 10.13) 10.01 Contract for the Manufacture, Supply, A** Installation and Commissioning of Hold Baggage Screening Equipment between the Company and BAA plc. 10.02 Distribution and Development A** Agreement between the Company and Gilardoni S.p.A. 10.02a Memorandum of Understanding between Filed herewith Gilardoni S.p.A. and the Company 10.03 First Amended and Restated Line of A** Credit Loan and Security Agreement between the Company and BayBank, N.A. and corresponding Note of the Company in favor of BayBank, N.A. 10.04 Form of Warrant to purchase Common A** Stock issued to certain investors. 10.05 Warrant to purchase Common Stock A** issued to Dominion Fund II, L.P. 10.06 1989 Combination Stock Option Plan of A** the Company* 10.07 1996 Non-Employee Director Stock A** Option Plan of the Company* 10.08 1996 Equity Incentive Plan of the A** Company* 10.09 Facility lease between the Company A** and Cummings Properties Management, Inc. 10.10 Form of Indemnification Agreement for A** directors and officers of the Company 10.11 Series A and Series B Preferred Stock A** Purchase Agreement 10.12 Series C and Series D Preferred Stock A** Purchase Agreement 10.13 Conversion Agreement between the A** Company and certain investors 10.14 Amended Shareholder Agreement among A** the Company's Massachusetts predecessor, S. David Ellenbogen, Jay A. Stein and certain investors 10.15 Management Services Agreement between A** the Company and Hologic, Inc. 10.16 License and Technology Agreement A** between Company and Hologic, Inc., together with First Amendment to such License and Technology Agreement 10.17 Description of Bonus Plan A** 10.18 Demand Line of Credit Loan and Filed herewith Security Agreement between the Company and BankBoston, N.A. and corresponding Note of the Company in favor of BankBoston, N.A. 11.01 Statement re: Computation of Per Filed herewith Share Earnings 21.01 Subsidiaries of the Company A** 23.01 Consent of Arthur Andersen LLP Filed herewith 27.01 Financial Data Schedule Filed herewith ____________________ A Incorporated by reference to the Company's registration statement on Form S-1 (Registration No. 333-14311). The number set forth herein is the number of the Exhibit in said registration statement. * Management contract or compensatory plan or arrangement. ** In accordance with Rule 12b-32 under the Securities Exchange Act of 1934, as amended, reference is made to the documents previously filed with the Securities and Exchange Commission, which documents are hereby incorporated by reference. (b) REPORTS ON FORM 8-K The Company did not file any current reports on Form 8-K during the quarter ended September 30, 1997. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VIVID TECHNOLOGIES, INC. Dated: December 29, 1997 By: /s/ Stephen A. Reber Stephen A. Reber President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. Signature Title Date /s/ S. David Ellenbogen Director and Chief December 29, 1997 S. David Ellenbogen Executive Officer /s/ William J. Frain Chief Financial Officer December 29, 1997 William J. Frain and Treasurer /s/ Jay A. Stein Director December 29, 1997 Jay A. Stein Director L. Paul Bremer III Director Frank Kenny /s/ Glenn P. Muir Director December 29, 1997 Glenn P. Muir /s/ Gerald Segel Director December 29, 1997 Gerald Segel Report of Independent Public Accountants To Vivid Technologies, Inc.: We have audited the accompanying consolidated balance sheets of Vivid Technologies, Inc. (a Delaware corporation) and subsidiaries as of September 30, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vivid Technologies, Inc. and subsidiaries as of September 30, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Boston, Massachusetts October 27, 1997 VIVID TECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets September 30, 1996 1997 Assets Current Assets: Cash and cash equivalents $1,661,724 $11,571,630 Short-term investments -- 6,432,405 Accounts receivable 3,720,478 9,493,519 Inventories 4,741,658 6,195,096 Deferred tax asset 181,000 606,790 Other current assets 444,902 742,729 Total current assets 10,749,762 35,042,169 Property and Equipment, at cost: Machinery and equipment 1,681,659 2,166,867 Equipment under capital leases 198,580 198,580 Leasehold improvements 143,776 165,995 Furniture and fixtures 58,855 84,462 2,082,870 2,615,904 Less-Accumulated depreciation and amortization 1,097,717 1,531,709 985,153 1,084,195 Other Assets, net 228,077 1,330,233 $11,962,992 $37,456,597 Liabilities and Stockholders' Equity Current Liabilities: Obligation under capital leases $ 36,888 $ 4,366 Accounts payable 1,493,874 1,566,831 Accrued expenses 3,432,914 2,418,431 Currently redeemable Series A preferred stock 2,343,750 -- Currently redeemable Series C preferred stock 3,436,900 -- Customer deposits 1,042,085 1,755,788 Total current liabilities 11,786,411 5,745,416 Commitments and Contingencies (Notes 9 and 11) Stockholders' Equity: Preferred stock, $.01 par value- Authorized-1,000,000 shares Issued and outstanding-None -- -- Convertible preferred stock, $.01 par value- Series B- Authorized-250,000 shares in 1996 Issued and outstanding-250,000 shares in 1996; none in 1997 2,500 -- Series D- Authorized-254,585 shares in 1996 Issued and outstanding-254,585 shares in 1996; none in 1997 2,546 -- Common stock, $.01 par value- Authorized-30,000,000 shares Issued and outstanding-1,740,520 shares in 1996; 9,496,684 shares in 1997 17,405 94,967 Capital in excess of par value 594,279 26,190,785 Retained earnings (deficit) (440,149) 5,425,429 Total stockholders' equity 176,581 31,711,181 $11,962,992 $37,456,597 The accompanying notes are an integral part of these consolidated financial statements. VIVID TECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Statements of Operations Year Ended September 30, 1995 1996 1997 Revenues $14,437,220 $15,578,326 $31,702,188 Cost of Revenues (includes approximately $929,000, $775,000 and $988,000, respectively, of royalties to and purchases from Hologic; see Note 7) 6,128,986 6,899,433 13,202,925 Gross margin 8,308,234 8,678,893 18,499,263 Operating Expenses (includes approximately $530,000, $325,000 and $112,000, respectively, of management service expenses from Hologic; see Note 7): Research and development 3,653,041 3,461,555 4,390,446 Selling and marketing 1,077,235 1,394,880 3,556,006 General and administrative 1,120,292 1,515,420 2,928,658 Litigation expenses 308,482 1,149,889 427,000 Total operating expenses 6,159,050 7,521,744 11,302,110 Income from Operations 2,149,184 1,157,149 7,197,153 Interest Income 53,378 60,616 814,966 Interest Expense (98,487) (53,001) (2,040) Other Income, net -- -- 48,834 Income before income taxes 2,104,075 1,164,764 8,058,913 Provision for Income Taxes 90,000 -- 2,193,335 Net income $2,014,075 $1,164,764 $5,865,578 Net Income per Common and Common Equivalent Share $ .28 $ .15 $ .60 Weighted Average Number of Common and Common Equivalent Shares Outstanding 7,275,138 7,868,853 9,838,300 The accompanying notes are an integral part of these consolidated financial statements. VIVID TECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (Deficit)
Series B Series D Convertible Convertible Preferred Stock Preferred Stock Common Stock Capital in Retained Number $.01 Number $.01 Number $.01 Excess of Par Earnings of Shares Par Value of Shares Par Value of Shares Par Value Value (Deficit) Total Balance, September 30, 1994 250,000 $ 2,500 254,585 $ 2,546 1,647,600 $ 16,476 $532,238 $(3,618,988) $(3,065,228) Exercise of stock options -- -- -- -- 26,750 267 6,308 -- 6,575 Net income -- -- -- -- -- -- -- 2,014,075 2,014,075 Balance, September 30, 1995 250,000 2,500 254,585 2,546 1,674,350 16,743 538,546 (1,604,913) (1,044,578) Issuance of common stock for services -- -- -- -- 15,000 150 44,850 -- 45,000 Exercise of stock options -- -- -- -- 51,170 512 10,883 -- 11,395 Net income -- -- -- -- -- -- -- 1,164,764 1,164,764 Balance, September 30, 1996 250,000 2,500 254,585 2,546 1,740,520 17,405 594,279 (440,149) 176,581 Exercise of stock options, including tax benefit of $659,194 -- -- -- -- 333,800 3,338 809,231 -- 812,569 Exercise of stock purchase warrants -- -- -- -- 76,514 765 32,195 -- 32,960 Conversion of preferred stock into common stock (250,000) (2,500) (254,585) (2,546) 5,045,850 50,459 (45,413) -- -- Sale of common stock, net of issuance costs of approximately $2,777,000 -- -- -- -- 2,300,000 23,000 24,800,493 -- 24,823,493 Net income -- -- -- -- -- -- -- 5,865,578 5,865,578 Balance, September 30, 1997 -- $ -- -- $ -- 9,496,684 $ 94,967 $26,190,785 $ 5,425,429 $31,711,181
The accompanying notes are an integral part of these consolidated financial statements. VIVID TECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year Ended September 30, 1995 1996 1997 Cash Flows from Operating Activities: Net income $2,014,075 $1,164,764 $5,865,578 Adjustments to reconcile net income to net cash provided by (used in) operating activities- Depreciation and amortization 276,838 344,894 441,072 Issuance of common stock for services -- 45,000 -- Changes in assets and liabilities- Accounts receivable (331,765) (2,552,354) (5,773,041) Inventories (241,116) (1,557,190) (1,453,438) Deferred tax asset -- (181,000) (425,790) Other current assets (23,546) (387,520) (297,827) Accounts payable (504,129) 767,303 72,957 Accrued expenses 535,331 1,156,031 (1,014,483) Customer deposits (677,390) 1,042,085 713,703 Net cash provided by (used in) operating activities 1,048,298 (157,987) (1,871,269) Cash Flows from Investing Activities: Purchase of property and equipment, net (383,670) (427,053) (533,034) Purchases of investments -- -- (11,650,261) Maturity of investments 500,000 -- 3,999,000 Decrease (increase) in other assets 4,063 (37,581) 109,620 Net cash provided by (used in) investing activities 120,393 (464,634) (8,074,675) Cash Flows from Financing Activities: Net proceeds from sale of common stock -- -- 24,823,493 Proceeds from exercise of stock purchase warrants -- -- 32,960 Redemption of Series A and Series C preferred stock -- -- (5,780,650) Proceeds from exercise of stock options (including tax benefit) 6,575 11,395 812,569 Payments on capital lease obligations -- (161,962) (32,522) Deferred financing costs -- (127,000) -- Net cash provided by (used in) financing activities 6,575 (277,567) 19,855,850 Net Increase (Decrease) in Cash and Cash Equivalents 1,175,266 (900,188) 9,909,906 Cash and Cash Equivalents, beginning of year 1,386,646 2,561,912 1,661,724 Cash and Cash Equivalents, end of year $2,561,912 $1,661,724 $11,571,630 Supplemental Disclosure of Cash Flow Information: Cash paid during the year for- Interest $ 98,487 $ 53,001 $ 2,040 Income taxes $ 74,000 $ 351,000 $ 1,772,500 Supplemental Disclosure of Noncash Investing and Financing Activities: Assets acquired under capital leases $ -- $ 198,850 $ -- Conversion of Series B and D preferred stock into common stock $ -- $ -- $ 5,045,850 The accompanying notes are an integral part of these consolidated financial statements. VIVID TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Operations and Significant Accounting Policies Vivid Technologies, Inc. (the Company) is a leading developer, manufacturer and marketer of automated inspection systems that detect plastic and other explosives in airline baggage. The accompanying consolidated financial statements reflect the application of the accounting policies as described below. (a)Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Vivid Technologies UK Ltd., Vivid Foreign Sales Corporation and Vivid Securities Corporation. All material intercompany transactions and balances have been eliminated in consolidation. (b)Revenue Recognition The Company recognizes product revenue upon shipment. The Company's product sales are not conditioned upon satisfactory installation by the Company. Installation is typically performed by the customer or a systems integrator of the airport's baggage handling system. However, the Company has typically assisted the systems integrator and accrues for estimated installation costs, in addition to estimated warranty costs, at the time of shipment. During fiscal 1995, 1996 and 1997, the Company recognized revenue of approximately $1,355,000, $716,000 and $821,000, respectively, under two separate research and development grants from an agency of the U.S. government to pursue certain explosives detection research. The Company recognizes revenue under these grants as services are rendered, provided that the government has appropriated sufficient funds for the work. The Company retains rights to all technological discoveries and products resulting from these efforts. Customer deposits represent amounts received from customers in advance of a shipment. (c)Cash and Cash Equivalents and Investments The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Included in cash equivalents at September 30, 1997 are funds held in money market accounts, certificates of deposit, municipal bonds and repurchase agreements with overnight maturities. Cash equivalents at September 30, 1996 included repurchase agreements with overnight maturities. The Company accounts for investments in accordance with Statement of Financial Accounting Standards (SFAS) Opinion No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under this standard, investments that the Company has the positive intent and ability to hold to maturity are reported at amortized cost, which approximates fair market value, and are classified as held-to-maturity. The investments that the Company has deemed held-to-maturity include certificates of deposit, municipal bonds and commercial paper, which total approximately $13,672,000 and have an average original maturity of six months at September 30, 1997. The Company did not classify any investments as held-to-maturity at September 30, 1996. Investments purchased to be held for indefinite periods of time and not intended at the time of purchase to be held until maturity are classified as available-for-sale and reported at fair market value. Unrealized gains (losses) on available-for-sale securities were not material in 1996 and 1997. The investments that the Company has deemed available- for-sale include repurchase agreements with overnight maturities and money market funds totaling approximately $1,210,000 and $4,699,000 at September 30, 1996 and 1997, respectively. Investments with maturities of greater than three months but less than one year are classified as short- term investments. Investments with maturities of greater than one year have been classified as long-term. As of September 30, 1997, the Company had long-term investments of approximately $1,219,000 included in other assets, consisting of investment-grade commercial paper, with an average maturity period of 15 months. (d)Concentration of Credit Risk and Significant Customers SFAS No. 105, Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. Financial instruments that subject the Company to credit risk consist primarily of cash and cash equivalents, investments and trade accounts receivable. The Company places its investments in financial institutions. The Company has not experienced any material losses on these investments to date. The Company has not experienced any material losses related to receivables from individual customers or groups of customers in the baggage security and inspection industry. The Company has entered into a forward foreign exchange contract to hedge a receivable denominated in a foreign currency. At September 30, 1997, the Company had approximately $5,393,000 of forward exchange contracts against specific balances denominated in Hong Kong dollars which mature through February 2, 1998. The unrealized gain (loss) was not material in 1997. The Company received greater than 10% of total revenues from the following customers during the years ended September 30, 1995, 1996 and 1997. Percentage of Total Revenues Customer Customer Customer A B C Year ended September 30, 1995 76% -- -- Year ended September 30, 1996 79% -- -- Year ended September30, 1997 39% 19% 27% The Company had accounts receivable balances greater than 10% of total accounts receivable from the following customers as of September 30, 1996 and 1997: Percentage of Total Accounts Receivable Customer Customer Customer Customer A B C D As of September 30, 1996 94% -- -- -- As of September 30, 1997 -- 61% 12% 15% Subsequent to September 30, 1997, the Company received payments aggregating approximately $6,437,000 against the accounts receivable balances due as of that date. (e)Disclosure of Fair Value of Financial Instruments The Company's financial instruments consist mainly of cash and cash equivalents, investments, accounts receivable and accounts payable. The carrying amounts of the Company's cash and cash equivalents, investments, accounts receivable and accounts payable approximate fair value due to the short-term nature of these instruments. (f) Translation of Foreign Currencies The accounts of the Company's foreign subsidiary are translated in accordance with SFAS No. 52, Foreign Currency Translation. In translating the accounts of the foreign subsidiary into U.S. dollars, assets and liabilities are translated at the rate of exchange in effect at year-end, while stockholders' equity is translated at historical rates. Revenue and expense accounts are translated using the weighted average exchange rate in effect during the year. Foreign currency translation gains or losses for Vivid Technologies UK Ltd. are included in the accompanying consolidated statements of operations since the functional currency for this subsidiary is the U.S. dollar. The Company had sales of approximately $8,044,000 denominated in foreign currencies during 1997. The Company recognized a loss of approximately $47,000 related to such foreign currency transactions in 1997 which is included in other income, net in the accompanying consolidated statements of operations. (g)Inventories Inventories are stated at the lower of cost (first-in, first- out) or market and consist of the following: September 30, 1996 1997 Raw materials $3,336,696 $3,175,211 Work-in-process 858,983 1,743,746 Finished goods 545,979 1,276,139 $4,741,658 $6,195,096 Finished goods and work-in-process inventories consist of direct materials, labor and overhead. (h)Depreciation and Amortization The Company provides for depreciation and amortization by charges to operations using straight-line and declining- balance methods, which allocate the cost of property and equipment over their estimated useful lives, as follows: Assets Estimated Classification Useful Life Machinery and equipment 5 years Equipment under capital leases Life of lease Leasehold improvements Life of lease Furniture and fixtures 7 years (i)Other Assets Other assets consist primarily of long-term investments, deposits and patent costs. Patent costs are being amortized over 10 years using the straight-line method. At September 30, 1996, other assets also included deferred financing costs associated with the Company's initial public offering. The Company periodically assesses the realizability of intangible assets, including patent costs, in accordance with SFAS No. 121, Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of. The Company has not recorded any impairment of its intangible assets to date. (j)Net Income per Common and Common Equivalent Share Net income per common and common equivalent share is computed by dividing net income by the weighted average number of common and common equivalent shares outstanding during the period, assuming the automatic conversion of all then outstanding shares of convertible preferred stock into 5,045,850 shares of common stock. Pursuant to the requirements of the Securities and Exchange Commission Staff Accounting Bulletin No. 83, common stock issued and stock options granted during the period from December 1995 to December 1996 have been included in the calculation of weighted average number of common shares outstanding for all periods prior to December 1996. Fair market value for the purpose of the calculation was assumed to be $13.00. Common stock equivalents issued in earlier and subsequent periods have been included when the effect would be dilutive. Fully diluted net income per common and common equivalent share has not been separately presented, as the amounts would not be materially different from net income per common and common equivalent share as presented. In March 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings Per Share, which established new standards for calculating and presenting earnings per share. The Company will adopt this new standard in its fiscal 1998 financial statements, which will require the reporting of diluted earnings per share and basic earnings per share, as defined. SFAS No. 128 is effective for periods ending after December 15, 1997, and early adoption is not permitted. When adopted, the statement will require restatement of prior years' earnings per share. For the years ended September 30, 1995, 1996 and 1997, diluted earnings per share would have been $0.28, $0.15 and $0.60, respectively. Basic earnings per share would have been $1.11, $0.64 and $0.78, respectively, for the same periods. (k)Management Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (l)Research and Development and Software Development Costs Research and development costs have been charged to operations as incurred. SFAS No. 86, Accounting for the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed, requires the capitalization of certain computer software development costs incurred after technological feasibility is established. The Company believes that once technological feasibility of a software product has been established, the additional development costs incurred to bring the product to a commercially acceptable level are not significant. (2) Income Taxes The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes, the objective of which is to recognize the amount of current and deferred income taxes at the date of the financial statements as a result of all differences in the tax basis and financial statement carrying amount of assets and liabilities as measured by enacted tax laws. The approximate income tax effect of each type of temporary difference and carryforward is as follows: September 30, 1996 1997 Research and development credit carryforwards $69,000 $32,000 Nondeductible accruals 97,000 27,000 Nondeductible reserves 278,000 543,000 Unamortized start-up costs 24,000 -- Other temporary differences 53,000 4,790 Valuation allowance (340,000) -- Net deferred tax asset $181,000 $606,790 Under SFAS No. 109, the Company recognizes a deferred tax asset for the future benefit of its temporary differences if it concludes that it is more likely than not that the deferred tax asset will be realized. The reduction in the valuation allowance from September 30, 1996 to September 30, 1997 is due to management's belief that it is more likely than not that the majority of the deferred tax assets will be realized. A reconciliation of the federal statutory rate to the Company's effective tax rate is as follows: September 30, 1995 1996 1997 Income tax provision at federal statutory rate 34.0% 34.0% 34.0% Increase (decrease) in tax resulting from- State tax provision, net of federal benefit 6.3 8.1 3.2 Foreign sales corporation benefit -- (7.5) (5.0) Foreign net operating losses not benefited -- 4.1 -- Net operating loss carryforwards utilized (31.2) -- -- Reduction in valuation allowance -- (15.5) (1.2) Research and development tax credit utilized (6.8) (24.1) (3.8) Alternative minimum taxes 2.0 -- -- Other -- 0.9 (0.2) Effective tax rate 4.3% --% 27.0% The provision for income taxes in the accompanying consolidated statements of income consists of the following: September 30, 1995 1996 1997 Federal- Current $ 90,000 $179,000 $2,173,335 Deferred -- (179,000) (224,000) 90,000 -- 1,949,335 State- Current -- 2,000 271,000 Deferred -- (2,000) (27,000) -- -- 244,000 $ 90,000 $ -- $2,193,335 (3) Line of Credit The Company has a secured demand line of credit with a bank for $5,000,000. Borrowings under the line are available through February 28, 1998 and bear interest at one of several interest rates, including the bank's prime rate (8.5% at September 30, 1997) and a LIBOR index rate. There were no amounts outstanding under this line at September 30, 1996 and 1997. The line of credit is collateralized by substantially all assets of the Company. (4) Redeemable Preferred Stock The Company had previously authorized 578,065 shares of redeemable preferred stock, par value $.01 per share, of which 234,375 shares and 343,690 shares had been designated as Series A and Series C redeemable preferred stock, respectively. In connection with the Company's initial public offering, the Company redeemed all outstanding shares of Series A and Series C redeemable preferred stock for approximately $5,781,000, which represents a redemption value of $10.00 per share. (5) Stockholders' Equity (a) Preferred Stock In December 1996, the Company's Board of Directors authorized the issuance of up to 1,000,000 shares of undesignated $.01 par value preferred stock, the rights and privileges of which are to be determined by the Company's Board of Directors. The Series A, B, C and D preferred stock are no longer authorized. There are no preferred shares outstanding as of September 30, 1997. (b) Common Stock In October 1996, the Company approved the Restated Certificate of Incorporation, which includes an increase in the authorized shares of common stock to 30,000,000. The Company has reserved the following number of common shares as of September 30, 1997: Exercise of stock purchase warrants 323,210 Exercise of stock options 1,565,680 1,888,890 In July 1996, the Company issued 15,000 shares of common stock to a customer at no cost in lieu of fees on certain sales of the Company's products for which the customer provided substantial assistance through access to the customer's facilities and liaison activities. The Company recorded a $45,000 charge to selling and marketing expenses for the issuance of these shares during fiscal 1996. (c)Initial Public Offering During fiscal 1997, the Company completed its initial public offering of 2,300,000 shares of the Company's common stock at $12.00 per share. The Company received net proceeds of approximately $24,823,000 after deducting the underwriters' commission and issuance costs. In December 1996, the Company used approximately $5,781,000 of the net proceeds to redeem all of its outstanding shares of redeemable Series A and Series C preferred stock. In connection with the initial public offering, all of the Company's Series B and Series D preferred stock was converted into an aggregate of 5,045,850 shares of common stock. (d)Stock Plans 1989 Combination Stock Option Plan The Company's 1989 Combination Stock Option Plan (the 1989 Plan) provides for the grant to key employees incentive stock options to purchase shares of the Company's common stock at a price not less than fair market value as determined by the Board of Directors, or nonqualified options at a price specified by the Board of Directors. Under the 1989 Plan, the Company has reserved shares for the granting of options to purchase up to 1,250,000 shares of the Company's common stock. The 1996 Equity Incentive Plan In October 1996, the Company approved the 1996 Equity Incentive Plan (the Equity Plan) for which the Company reserved shares for the granting of options or other equity awards to purchase up to 750,000 shares of the Company's common stock. The 1996 Nonemployee Director Stock Option Plan In October 1996, the Company approved the 1996 Nonemployee Director Stock Option Plan (the Director Plan) for which the Company has reserved shares for the granting of options to purchase up to 125,000 shares of the Company's common stock. As of September 30, 1997, there were 676,980 options available for future grants under all plans. A summary of stock option activity under all plans is as follows: Weighted Average Price per Exercise Shares Share Price Outstanding, September 30, 1994 712,250 $.10-1.00 $ .39 Granted 119,250 1.00 1.00 Exercised (26,750) .10- .50 .25 Terminated (47,330) .50-1.00 .81 Outstanding, September 30, 1995 757,420 .10-1.00 .46 Granted 157,750 1.00-3.00 2.22 Exercised (51,170) .10-1.00 .85 Terminated (7,100) .50-1.00 .87 Outstanding, September 30, 1996 856,900 .10-3.00 .78 Granted 386,050 9.50-17.00 14.27 Exercised (333,800) .10-3.00 .46 Terminated (20,450) .50-3.00 1.15 Outstanding, September 30, 1997 888,700 $.10-$17.00 $6.75 Exercisable, September 30, 1997 264,540 $.10-$9.50 $ .65 The range of exercise prices for options outstanding and options exercisable at September 30, 1997 are as follows:
Weighted Average Options Outstanding Options Exercisable Range of Remaining Contractual Weighted Average Weighted Average Exercise Price Life (in years) Number Exercise Price Number Exercise Price $0.10 - $1.00 5.4 418,850 $ 0.57 248,000 $ 0.42 $3.00 - $9.50 8.9 108,300 $ 4.47 16,540 $ 4.08 $10.75 - $15.50 9.4 131,300 $11.68 -- -- $15.88 - $17.00 9.5 230,250 $16.25 -- -- Total 7.47 888,700 $ 6.75 264,540 $ 0.65
The Company accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation, which established a fair-value-based method of accounting for stock-based compensation plans. The Company has adopted the disclosure-only alternative under SFAS No. 123 which requires disclosure of the pro forma effects on net income and earnings per share as if SFAS No. 123 had been adopted, as well as certain other information. The Company has computed the pro forma disclosures required under SFAS No. 123 for all stock options and warrants granted to employees of the Company in fiscal 1996 and 1997 using the Black Scholes option pricing model prescribed by SFAS No. 123. The assumptions used to calculate the SFAS No. 123 pro forma disclosure and the weighted average information for 1996 and 1997 are as follows: Year Ended September 30, 1996 1997 Risk-free interest rate 6.04 6.01 Expected dividend yield -- -- Expected lives (in years) 4.7 4.9 Expected volatility 53% 52% Weighted-average grant date fair value of options granted during the year $1.10 $7.16 The pro forma effect of applying SFAS No. 123 for all options and warrants granted to employees of the Company in 1996 and 1997 would be as follows: Year Ended September 30, 1996 1997 Net income as reported $1,164,764 $5,865,578 Pro forma net income $1,125,371 $5,104,357 Net income per common and common equivalent share, as reported $0.15 $0.60 Pro forma net income per common and common equivalent share $0.14 $0.52 The resulting pro forma compensation expense may not be representative of the amount to be expected in future years as the pro forma expense may vary based on the number of options granted. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, options pricing models require the input of highly subjective assumptions, including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. (e) Series B and D Convertible Preferred Stock The Company had previously authorized 504,585 shares of convertible preferred stock, par value $.01 per share, of which 250,000 shares and 254,585 shares had been designated as Series B and Series D convertible preferred stock, respectively. In connection with the Company's initial public offering, all shares of Series B and Series D convertible preferred stock were converted into an aggregate 5,045,850 shares of common stock. (f)Stock Purchase Warrants In conjunction with a $400,000 promissory note issued in fiscal 1992 and repaid in fiscal 1993, the Company sold a warrant, at nominal value, to purchase 42,667 shares of the Company's common stock at $1.50 per share. The warrant was to expire in December 2001. This stock purchase warrant was exercised during fiscal 1997, resulting in a net issuance of 39,789 shares of common stock. In conjunction with the issuance of certain convertible notes issued in fiscal 1993, the Company sold, at nominal value, warrants to purchase 361,002 shares of the Company's common stock for $1.50 per share. The warrants expire in December 2001. During fiscal 1997, warrants to purchase 37,792 shares were exercised resulting in the net issuance of 36,725 shares of common stock. (6) Geographical Sales Data Export sales as a percentage of the Company's total revenues are as follows: September 30, 1995 1996 1997 Europe 90.6% 95.0% 51.5% Asia -- 0.3 45.7 Other -- 0.1 0.2 Total 90.6% 95.4% 97.4% Substantially all of the Company's assets are located in the United States. (7) Related Party Transactions (a)Management Services Agreement The Company has an agreement with Hologic, Inc. (Hologic), an affiliated company, whereby Hologic provides management, administrative and support services. In addition, the Company subleased its facilities from Hologic under a sublease agreement, which was terminated in February 1996, for approximately $15,000 per month. The Company paid Hologic for all direct costs incurred, as well as a portion of Hologic's overhead costs, as defined, representing a pro rata portion of costs attributable to the Company. Expenses charged to operations under these agreements were approximately $530,000, $325,000 and $112,000 in fiscal 1995, 1996 and 1997, respectively. The Company also made purchases of approximately $210,000 from Hologic in fiscal 1995. The Company had no purchases from Hologic in 1996 or 1997. Approximately $34,000 and $20,000 had not been paid as of September 30, 1996 and 1997, respectively, under the management services agreement. (b)License and Technology Agreement The Company has an agreement with Hologic whereby the Company has a perpetual, exclusive, worldwide license to utilize certain of Hologic's technology and patents for the purpose of developing the Company's X-ray screening security systems for explosives, drugs, currency and other contraband (the Exclusive License). In September 1996, this license was amended to grant the Company a nonexclusive license to utilize these patents and technology for certain new product development for other applications (the Nonexclusive License). Royalty payments to Hologic under the Exclusive License are 5% of revenues, as defined, on the first $50 million in sales; thereafter, payments are 3% on revenues up to $200 million, with no royalty payments on aggregate revenues in excess of $200 million. During 1997, the Company reduced its royalty payments to 3% under the Exclusive License upon achievement of cumulative revenues in excess of $50 million. Royalty payments under the Nonexclusive License are 3% on sales up to $200 million, with no royalty payments on aggregate revenues in excess of $200 million. The agreement terminates by mutual agreement of the two parties or upon certain other defined circumstances. During fiscal 1995, 1996, and 1997, the Company incurred royalty expenses under the Exclusive License of approximately $719,000, $775,000 and $988,000, respectively, of which approximately $624,000 and $753,000 had not been paid as of September 30, 1996 and 1997, respectively. To date, the Company has not incurred any royalty expenses under the Nonexclusive License. (8) Profit-Sharing 401(k) Plan The Company has a qualified profit-sharing plan covering substantially all of its employees. Contributions to the plan are at the discretion of the Company's Board of Directors. The Company has recorded approximately $65,000, $65,000 and $74,000 as a provision for the profit-sharing contribution for fiscal 1995, 1996 and 1997, respectively. (9) Commitments and Contingencies (a)Operating Leases In March 1996, the Company moved into a new facility. The Company is renting the facility under an operating lease which expires in February 2001. The Company's future minimum lease payments under all operating leases as of September 30, 1997 are approximately as follows: Year Amount 1998 $ 389,000 1999 389,000 2000 389,000 2001 162,000 $1,329,000 Rent expense charged to operations for the year ended September 30, 1995 and the first five months of fiscal 1996 was approximately $15,000 per month as a part of the management services agreement with Hologic. Rent expense charged to operations since the Company moved operating facilities through September 30, 1996 and for fiscal 1997 were approximately $227,000 and $438,000, respectively. (b)Capital Leases The Company leases certain equipment under capital leases which expire through June 1999. (c)Patent Infringement Claims In October 1994, EG&G filed a patent infringement claim against the Company in the United States District Court for the District of Massachusetts, alleging that certain of the Company's products infringed a patent held by EG&G. EG&G sought damages and expenses from the Company and sought to enjoin the Company from selling products that allegedly infringed the EG&G patent. In December 1994, the Company filed an answer denying any infringement and counterclaims seeking to invalidate the EG&G patent and alleging that EG&G infringed three patents owned or licensed by the Company. On November 6, 1996, the Company and EG&G entered into a settlement agreement relating to this litigation. Amounts incurred related to the claim, including the settlement, are included in litigation expenses in the accompanying statements of operations. In May 1996, the Company commenced an action in the United States District Court for the District of Massachusetts against AS&E seeking a declaration that the Company does not infringe AS&E patents related to back scattered X-rays. This followed AS&E's allegations of infringement to third parties. No discovery has been taken to date. Following a court decision in July 1997 construing the claims of the AS&E patent, which decision the Company considers favorable, in September 1997 the Company filed a motion for summary judgment of non-infringement. AS&E has not yet filed its papers in opposition to the Company's motion but is seeking discovery. If granted, the Company's motion will resolve all issues remaining in the case in favor of the Company. Earlier, in April 1997, the Court dismissed AS&E's proposed counterclaim seeking to allege patent infringement, so that the only remaining issue in the case is the Company's request for declaration of non-infringement of two claims of a single AS&E patent. (d)Patent License Agreement During fiscal 1996, the Company entered into a patent license agreement for the exclusive license of certain explosives detection technology. Under this agreement, the Company is required to pay aggregate royalties of up to $1,000,000 based on net sales, as defined. During fiscal 1996 and 1997, the Company incurred approximately $28,000 and $97,000, respectively, of royalty expense related to this agreement. (e)Joint Development and Royalty Agreement During fiscal 1997, the Company entered into a joint development and royalty agreement for the development of certain explosives detection technology. Under the terms of the agreement, the Company is required to pay a royalty of $3,000 per unit sold of the developed product for the first 167 units. No royalty expenses were incurred for the year ended September 30, 1997. (10) Accrued Expenses Accrued expenses in the accompanying consolidated balance sheets consist of the following: September 30, 1996 1997 Payroll and payroll-related $513,967 $601,959 Accrued warranty 773,000 798,000 Accrued royalties 651,424 789,684 Accrued legal 1,291,877 75,954 Other 202,646 152,834 $3,432,914 $2,418,431 (11) Subsequent Event Subsequent to year-end, the Company entered into an exclusive technology license agreement. Under the agreement, the Company paid $1,250,000 for the exclusive right to manufacture, use or sell the licensed technology for a three-year period, with a nonexclusive right for the remainder of the life of the patents. The Company will have the option to extend the exclusive rights beyond three years. Upon the ultimate commercialization of the technology, the Company will also be required to pay royalties on sales of products incorporating the licensed technology, as defined. EX-10 2 MEMORANDUM OF UNDERSTANDING BETWEEN GILARDONI AND THE COMPANY Exhibit 10.02a Memorandum of Understanding between Gilardoni S.p.A. Vivid Technologies, Inc. as of March 26, 1997 1. Prepaid Royalty Payment to Gilardoni: A non-refundable payment of $501,000 USD paid to Gilardoni. Vivid to allocate for their financing over the first 167 units and pay Gilardoni per the following schedule. a) $150,000 upon signing and receipt of manufacturing documentation for FEP Platform (except monobloc and inverter). b) $150,000 upon completion of acceptance testing of initial two systems delivered to Vivid. Acceptance criteria to be agreed to by April 10, 1997 and testing to be complete by June 1, 1997. c) $201,000 upon first product shipped by Vivid with both parties making every reasonable effort to complete by January 1, 1998. 2. Ongoing Royalty Payments: a) A royalty payment of $3,000 will be paid to Gilardoni for each of the first 167 units, per item 1. b) Royalty payments made to Gilardoni decrease to $2,000 per unit on the 168th unit and for the life of the product. c) A royalty payment of $3,000 will be paid to Vivid for each CDS Console product and software that Gilardoni uses in manufacturing its products. 3. Pricing: a) FEP Platform transfer price not to exceed $29,500 which includes $3,000 profit. b) Price for the initial 100 Monoblock/Inverter Board sets is $6,250 per set. c) Price of the Monoblock/Inverter Board set reduces to $5,250 from the 101st set. d) Vivid always receives most favored pricing. e) Gilardoni will manufacture and test (integration) the Joint System for Vivid at a transfer price to be developed on the cost plus fee basis used to determine the transfer pricing for the FEP Platform. f) Vivid to purchase the initial eight FEP Platforms at $32,000 by 7 April, 1997 for delivery (shipment from Mandello) as follows: 2 units on April 10th, 3 units on May 30th and 3 units on June 15th. Funds advanced by Vivid on behalf of Gilardoni for the development of the A/D Printed Circuit Board will be deducted from the invoice for the shipment of the first FEP Platform. Standard payment terms to apply. g) The CDC Console cost will not exceed $6,100. And a transfer price will be developed on the cost plus fee basis used to determine the transfer pricing for the FEP Platform. Vivid will supply all manufacturing drawings to Gilardoni. 4. Territories: a) Gilardoni receives exclusive rights for the Joint Products for Italy, Cyprus, Bulgaria, Tunis, Brazil, Argentina, Libya, and Iran. Gilardoni receives exclusive rights for Vivid Products for Italy. b) Rights for the territories of Greece and Romania for Joint System to be upon mutual acceptance at a later date. c) Vivid receives exclusive rights for the Joint Products and FEP Products in North America. d) All other territories are exclusive to Vivid for the Joint System and non-exclusive for FEP Products unless mutually agreed otherwise. 5. Performance improvements and cost reductions developed by one party will be made available to the other party, prior to the development being offered to a third party, at reasonable charges to be negotiated on a case by case basis. 6. For the life of the FEP Platform, the sole manufacturing source for the Monobloc (and inverter) will be Gilardoni. 7. Vivid will evaluate Gilardoni as an alternative supplier of monoblocs, x-ray tubes and generators for Vivid products. 8. Vivid to propose new discount for Vivid Products. 9. The above mentioned costs exclude packaging and shipping. 10. The final agreement subject to legal review (and a contract) and Board of Directors approval by each parties. 11. The final agreement is subject to Vivid finalizing an agreement with the University of Alabama regarding the Barnes patents. 12. The term of the Agreement is for 3 years, with a 1 year notice of termination. This includes an automatic renewal. For Gilardoni S.p.A.: For Vivid Technologies, Inc. /s/ Richard P. Bisson /s/ Stephen A. Reber Richard P. Bisson Stephen A. Reber Managing Director President March 26, 1997 26 March, 1997 Date Date EX-10 3 DEMAND LINE OF CREDIT LOAN AND SECURITY AGREEMENT BETWEEN THE COMPANY AND BANKBOSTON, N.A. Exhibit 10.18 DEMAND LINE OF CREDIT LOAN AND SECURITY AGREEMENT THIS DEMAND LINE OF CREDIT LOAN AND SECURITY AGREEMENT, dated May 30, 1997, by and between VIVID TECHNOLOGIES, INC., a Delaware corporation duly qualified in Massachusetts and with a principal place of business in Woburn, Massachusetts (the "Borrower") and BANKBOSTON, N.A., a national banking association with its head office in Boston, Massachusetts (the "Lender"), successor by merger with BAYBANK, N.A. W I T N E S S E T H: BACKGROUND. The Borrower has requested the Lender to lend it up to $5,000,000.00 on a revolving loan basis (the "Loan"). The Lender is willing to accommodate the Borrower's requests upon the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the premises herein contained, and each intending to be legally bound hereby, the parties agree as follows: ARTICLE 1. DEFINITIONS As used herein: 1.01 "Accounts," "Chattel Paper," "Contracts," "Documents," "Equipment," "Fixtures," "General Intangibles," "Goods," "Instruments," and "Inventory" shall have the same respective meanings as are given to those terms in the Uniform Commercial Code as presently adopted and in effect in the Commonwealth of Massachusetts. 1.02 "Advance(s)" means the Lender's Loan advances to the Borrower under this Agreement to reimburse the Borrower for amounts paid or to be paid by the Borrower for Goods. 1.03 "Affiliate" means, as to any Person, each other Person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or under common control with, such Person or is a related entity (including, but not limited to, partnerships, joint ventures, joint stock companies, corporations) to the Borrower. 1.04 "Agreement" means this Demand Line of Credit Loan and Security Agreement, as the same may from time to time be amended or supplemented. 1.05 "Availability Date" means February 28, 1998. The Availability Date may be extended by the Lender at its sole discretion. 1.06 "Borrowing Availability" means the amount which is equal at any given time to the total of (1) the Borrowing Base, less (2) the aggregate amount of all Advances then outstanding together with interest at the Rate, as defined in Section 2.05 hereof. 1.07 "Borrowing Base" means a maximum credit availability of $5,000,000.00, pursuant to the Loan. At no time shall the Borrowing Base exceed $5,000,000.00. 1.08 "Business Day" means any day other than a Saturday, Sunday, or other day on which commercial banks in Boston, Massachusetts are authorized or required to close pursuant to Massachusetts or Federal laws; if the day relates to a LIBOR Loan, LIBOR Interest Period or notice with respect to a LIBOR Loan, "Business Day" shall mean a day on which dealings in U. S. Dollar deposits are also carried on in the London interbank market and banks are open for business in London on which the Federal Reserve Bank of New York is open for business. 1.09 "Closing" has the meaning given to such term in Section 3.01. 1.10 "Collateral" has the meaning given to such term in Section 4.01. 1.11 "Collateral Documents" means the UCC Financing Statements specified in Section 3.01(C) and the documents, whether deliverable at or after the Closing, required under Article 4.0. 1.12 "Current Assets" means, at any time, all assets that should in accordance with GAAP, be classified as current assets on a balance sheet of the Borrower and its Subsidiary. 1.13 "Current Liabilities" means, at any time, all Indebtedness that should, in accordance with GAAP, be classified as current liabilities on a consolidated balance of the Borrower and its Subsidiary. 1.14 "Current Ratio" means, at any time, Current Assets divided by Current Liabilities. 1.15 "Event of Default" has the meaning provided in Section 7.01. 1.16 "Financial Statements" means (1) the consolidated balance sheet of the Borrower and its Subsidiary as of September 30, 1996, and consolidated statements of income, stockholders' equity, and changes in financial position, and notes thereto, of the Borrower for the year ended on such date, certified as to the year ended September 30, 1996 by a CPA acceptable to Lender; and (2) as to the first quarter of the 1997 fiscal year ended December 31, 1996, the consolidated balance sheet of the Borrower and its Subsidiary and consolidated statements of income, stockholders' equity, and changes in financial position, and notes thereto, of the Borrower prepared and certified by the treasurer to present fairly the consolidated financial position and results of operations of the Borrower at such dates and for such periods in accordance with GAAP. 1.17 "GAAP" means generally accepted accounting principles applied consistently with such changes or modifications thereto as may be approved in writing by the Lender. 1.18 "Indebtedness" means, as to the Borrower or any Subsidiary, all items of indebtedness, obligation or liability whether matured or unmatured, liquidated or unliquidated, direct or contingent, joint or several, including, but without limitation: (A) All indebtedness guarantied, directly or indirectly, in any manner, or endorsed (other than for collection or deposit in the ordinary course of business) or discounted with recourse; (B) All indebtedness in effect guarantied, directly or indirectly, through agreements, contingent or otherwise: (1) to purchase such indebtedness; or (2) to purchase, sell, or lease (as lessee or lessor) property, products, materials, or supplies or to purchase or sell services, primarily for the purpose of enabling the debtor to make payment of such indebtedness or to insure the owner of the indebtedness against loss; or (3) to supply funds to, or in any other manner invest in, the debtor; (C) All indebtedness secured by (or for which the holder of such indebtedness has a right, contingent or otherwise, to be secured by) any mortgage, deed of trust, pledge, lien, security interest, or other charge or encumbrance upon property owned or acquired subject thereto, whether or not the liabilities secured thereby have been assumed; and (D) All indebtedness incurred as the lessee of Goods or services under leases that, in accordance with GAAP, should not be reflected on the lessee's balance sheet. 1.19 "Intellectual Property" means trademarks, service marks, trade names, trade styles, logos, goodwill, trade secrets, patents, copyrights and licenses acquired under any statutory, common law or registration process in any state or nation at any time, or under any agreement executed with any person or entity at any time. The term "license" refers not only to rights granted by agreement from the owner of patents, trademarks, service marks and the like, but also to rights granted by a franchiser under a franchise or similar agreement. The foregoing enumeration is not intended as a limitation of the meaning of the word "license". A complete list of all of the Borrower's Intellectual Property registrations, claims, filings, or pending applications for any of the foregoing, wherever registered, claimed or filed showing the place of filing, the registration, claim, filing or application number and date is attached hereto as Exhibit 1.19. 1.20 "Landlord's Consent and Waiver" means that certain Landlord's Consent and Waiver, a copy of which is attached hereto as Exhibit 1.20, executed by the Borrower and to be duly recorded or filed for the benefit of the Lender, as from time to time supplemented or amended. 1.21 "Laws" means all ordinances, statutes, rules, regulations, orders, injunctions, writs, or decrees of any government or political subdivision or agency thereof, or of any court or similar entity established by any thereof. 1.22 "LIBOR" means the London Interbank Offered Rate. 1.23 "LIBOR Interest Period" means, with respect to any LIBOR Loan, the period commencing on the date such loan is made and ending, as the Borrower may select pursuant to Section 2.05 of this Agreement, 7, 30, 60, 90 or 180 days thereafter; provided, however, that: (a) no LIBOR Interest Period may extend beyond the Availability Date; (b) if a LIBOR Interest Period would end on a day that is not a Business Day, such LIBOR Interest Period shall be extended to the next Business Day unless such Business Day would fall in the next calendar month, in which event such LIBOR Interest Period shall end on the immediately preceding Business Day. 1.24 "LIBOR Loan" means any Advance for which the Borrower makes a Rate Selection of a LIBOR Rate. 1.25 "LIBOR Rate" means the rate of interest determined by the Lender to be the prevailing rate per annum at which deposits in U.S. dollars are offered to the Lender in the interbank Eurodollar market in which it regularly participates on or about 10:00 A.M. (Boston time) at least three (3) Business Days before the effective date of the Rate Selection as set forth in Section 2.05 in an amount approximately equal to the principal amount of the Advance to which the selected LIBOR Interest Period is to apply for a period of time approximately equal to such LIBOR Interest Period. 1.26 "Letter of Credit" means any irrevocable letter of credit payable in the United States or at the issuing bank, subject to Uniform Customs and Practice for Documentary Credits (1993 Revisions) (UCP 500) issued for the benefit of Borrower. 1.27 "Net Sales" means for the applicable period, all proceeds from the sale of goods and services by the Borrower in the ordinary course of the Borrower's business, net of fees, commissions, freight charges and other allowances, adjustments, credits, or similar charges. 1.28 "Note" means the promissory note referred to in Section 2.03. 1.29 "Obligations" is intended to be used in its most comprehensive sense and means all the obligations of the Borrower to the Lender of every kind and description, whether direct or indirect, absolute or contingent, primary or secondary, joint or several, due or to become due, now existing or hereafter arising or acquired and whether by way of loan, discount, letter of credit, lease or otherwise, including without limitation, the following obligations: (A) To pay the principal of, and interest on, the Note in accordance with the terms thereof and to satisfy all other liabilities to the Lender, whether hereunder or otherwise, whether now existing or hereafter incurred, matured or unmatured, direct or contingent, joint or several, including any extensions, modifications, renewals thereof and substitutions therefor; (B) To repay to the Lender all amounts advanced by the Lender hereunder or otherwise on behalf of the Borrower, including, but without limitation, advances for principal or interest payments to prior secured parties, mortgagees, or lienors, or for taxes, levies, insurance, rent, or repairs to, or maintenance or storage of, any of the Collateral; (C) To perform and observe all covenants, agreements and undertakings of the Borrower pursuant to the terms and conditions of this Agreement, the Collateral Documents or any other agreement or instrument now or hereafter delivered to the Lender by the Borrower; and (D) To reimburse the Lender, on demand, for all of the Lender's expenses and costs, including without limitation the reasonable fees and expenses of its counsel, in connection with the preparation, administration, amendment, modification, or enforcement of this Agreement and the documents required hereunder, including, without limitation, any proceeding brought, or threatened, to enforce payment or performance of any of the obligations referred to in the foregoing paragraphs (A), (B) and (C). 1.30 "Operating Account" means the account opened by Borrower at the offices of the Lender, Account #31233852, used for the purposes of disbursement and repayment of the Loan as set out in Sections 2.01 and 2.06. 1.31 "Permitted Liens" means: (A) Liens for taxes, assessments, or similar charges, incurred in the ordinary course of business, that are not yet due and payable; (B) Pledges or deposits made in the ordinary course of business to secure payment of worker's compensation, or to participate in any fund in connection with worker's compensation, unemployment insurance, old-age pensions, or other social security programs; (C) Liens of mechanics, materialmen, warehousemen, carriers, or other like liens, securing obligations incurred in the ordinary course of business that are not yet due and payable; (D) Good faith pledges or deposits made in the ordinary course of business to secure performance of bids, tenders, contracts (other than for the repayment of borrowed money) or leases, not in excess of ten percent (10%) of the aggregate amount due thereunder, or to secure statutory obligations, or surety, appeal, indemnity, performance, or other similar bonds required in the ordinary course of business; (E) Encumbrances consisting of zoning restrictions, easements, or other restrictions on the use of real property, none of which materially impairs the use of such property by the Borrower in the operation of its business, and none of which is violated in any material respect by existing or proposed structures or land use; (F) Liens in favor of the Lender, including, but not limited to the Lender's first priority security interest on a certain telephone system as more particularly described on Exhibit 1.31, attached hereto and made a part hereof; (G) Existing liens set forth or described on Exhibit 1.31, attached hereto and made a part hereof; (H) Purchase money security interests granted to secure not more than seventy-five per cent (75%) of the purchase price of assets, the purchase of which does not violate this Agreement or any instrument required hereunder; and (I) The following, if the validity or amount thereof is being contested in good faith by appropriate and lawful proceedings, so long as levy and execution thereon have been stayed and continue to be stayed and they do not, in the aggregate, materially detract from the value of the property of the Borrower or any Subsidiary, or materially impair the use thereof in the operation of its business: (1) Claims or liens for taxes, assessments, or charges due and payable and subject to interest or penalty; (2) Claims, liens and encumbrances upon, and defects of title to, real or personal property, including any attachment of personal or real property or other legal process prior to adjudication of a dispute on the merits; (3) Claims or liens of mechanics, materialmen, warehousemen, carriers, or other like liens; and (4) Adverse judgments on appeal. 1.32 "Person" means any individual, corporation, partnership, association, joint-stock company, trust, unincorporated organization, joint venture, court, or government or political subdivision or agency thereof. 1.33 "Prime Rate Loan" means any Advance for which the Borrower makes a Rate Selection of the Prime Rate. 1.34 "Records" means correspondence, memoranda, tapes, disks, diskettes, papers, books and other documents, or transcribed information of any type, whether expressed in ordinary or machine- readable language. 1.35 "Stockholders' Equity" means, at any time the aggregate of Subordinated Indebtedness, plus the sum of the following accounts set forth on a consolidated balance sheet of the Borrower and its Subsidiary prepared in accordance with GAAP: (A) the par or stated value of all outstanding capital stock; (B) capital surplus; and (C) retained earnings. 1.36 "Subordinated Indebtedness" means all Indebtedness incurred at any time by the Borrower or any Subsidiary, the repayment of which is subordinated to the Loan in form and manner satisfactory to the Lender and includes, without limitation, any notes, bonds, debentures, or other debts of Borrower to its officers, directors or stockholders. All existing Subordinated Indebtedness is so specified in Exhibit 1.36. 1.37 "Subsidiary" means any Affiliate that is directly, or indirectly through one or more intermediaries, controlled by the Borrower or not less than 50% of the voting capital stock of which is owned, directly or through one or more intermediaries, by the Borrower. 1.38 "Tangible Net Worth" means, at any time, Stockholders' Equity, less the sum of: (A) Any surplus resulting from any write-up of assets subsequent to December 31, 1996; (B) The value of goodwill, including any amounts, however designated on a consolidated balance sheet of the Borrower and its Subsidiary, representing the excess of the purchase price paid for assets or stock acquired over the value assigned thereto on the books of the Borrower; (C) The value of Patents, trademarks, trade names, copyrights and licenses; (D) Any amount at which shares of capital stock of the Borrower appear as an asset on the Borrower's balance sheet; (E) Loans and advances to stockholders, directors, officers, or employees; (F) Deferred expenses; and (G) Any other amount in respect of an intangible that should be classified as an asset on a consolidated balance sheet of the Borrower and its Subsidiary in accordance with GAAP. 1.39 "Total Liabilities" means, at any time, all Indebtedness that should, in accordance with GAAP, be classified as liabilities on a consolidated balance of the Borrower and its Subsidiary. 1.40 Accounting. Accounting terms used and not otherwise defined in this Agreement have the meanings determined by, and all calculations with respect to accounting or financial matters unless otherwise provided herein shall be computed in accordance with, GAAP. ARTICLE 2. THE LOAN 2.01 Disbursement of the Loan. Advances shall only be made upon the written request of the Borrower. The Borrower may make requests for Advances by facsimile transmissions to the Lender. The Lender will credit the proceeds of the Loan to the Operating Account. 2.02 General Terms. Subject to the terms hereof, the Lender will lend the Borrower, from time to time until the Availability Date or until such time as the Lender makes demand on the Note, whichever occurs first, such sums in integral multiples of $10,000.00 as the Borrower may request by written notice to the Lender as set forth herein, but which sums shall not exceed, in the aggregate principal amount at any one time outstanding, Five Million and 00/100 Dollars ($5,000,000.00). The Borrower may borrow, repay and reborrow hereunder, from the date of this Agreement until the Availability Date or such time as the Lender makes demand on the Note, whichever occurs first. 2.03 The Note. The Loan shall be evidenced by a note in the form attached hereto as Exhibit 2.03, payable on demand, but in any event due and payable on the first Business Day after the Availability Date. 2.04 The Facility Fee. In consideration of the Loan, from and after the date of this Agreement up to and including the Availability Date, the Borrower shall pay the Lender a facility fee of one-quarter of one percent (0.25%) on the average daily Borrowing Availability during each fiscal quarter or portion thereof. The facility fee shall be payable, without demand, on the last day of each fiscal quarter commencing June 30, 1997. The Borrower shall make payment of the facility fee by wire transfer, certified check or by authorizing the Lender to withdraw readily available funds from the Operating Account. 2.05 Interest Rate and Payments of Interest. (A) Except as otherwise provided in Section 2.05(B), interest on the principal balance of the Loan from time to time outstanding until the Availability Date or demand, whichever first occurs, shall be determined as follows: (1) The Borrower shall have the right to select any of the interest rates (the "Rate") set forth below to be used in computing the rate of interest to be paid with respect to each Advance. Such rate shall be selected in advance by the Borrower by written notice to the Lender, specifying the date and amount of the requested Advance, the rate selected, the effective date of such selection, and in the case of a LIBOR Loan, the LIBOR Interest Period (the "Rate Selection"). The Borrower may not designate more than one Rate Selection for incremental portions of an Advance. The Rate Selection must be received by the Lender not less than three (3) Business Days prior to the effective date of the Rate Selection. Each Rate Selection shall be irrevocable. The Borrower shall have the option to elect a new Rate Selection for a LIBOR Loan by giving written notice of such election to the Lender received no later than 10:00 a.m. (Boston time) on that date which is three (3) Business Days before the end of the then applicable LIBOR Interest Period. If the Borrower does not provide the Lender in writing with a new Rate Selection within the applicable time limits specified herein, the Borrower shall be deemed to have elected to convert such LIBOR Loan into a Prime Rate Loan as of the last day of the then current LIBOR Interest Period. Notwithstanding the foregoing, the Borrower may not select a LIBOR Interest Period that would end, but for the provisions of the definition of LIBOR Interest Period, after the Availability Date. Pursuant to the foregoing paragraph, the Borrower shall select from the following rates of interest: (a) A floating rate equal to the Prime Rate in effect from time to time as such rate shall change from time to time. As used herein, "Prime Rate" means the rate of interest published internally and so designated by the Lender from time to time. Each time the Prime Rate shall change, the interest rate shall change contemporaneously with such change in the Prime Rate. (b) A rate equal to the LIBOR 7-day index rate plus two and one-quarter percent (2.25%). (c) A rate equal to the LIBOR 30-day index rate plus two and one-quarter percent (2.25%). (d) A rate equal to the LIBOR 60-day index rate plus two and one-quarter percent (2.25%). (e) A rate equal to the LIBOR 90-day index rate plus two and one-quarter percent (2.25%). (f) A rate equal to the LIBOR 180-day index rate plus two and one-quarter percent (2.25%). Each Advance subject to a Rate Selection under clause (a) above shall be subject to repayment at the Borrower's option at any time in whole or in part in increments of $10,000 plus accrued interest to the prepayment date without penalty. If the Borrower prepays all or any portion of an Advance made hereunder to which a LIBOR Rate applies prior to the last day of the LIBOR Interest Period selected for such Advance, the Borrower shall, immediately upon the Lender's request, pay as a prepayment fee an amount calculated by the Lender which reimburses the Lender for any loss incurred by the Lender upon reinvestment of the balance of the Advance at a rate less than the LIBOR Rate, plus any administrative costs incurred by the Lender in connection therewith. The prepayment fee shall be paid to the Lender in immediately available funds. The prepayment fee is not intended as a penalty, but is to compensate the Lender for the favorable credit terms and other financial accommodations extended to the Borrower by the Lender. (2) After the occurrence of an Event of Default, the Availability Date or demand, if any, interest shall be paid at a Rate equal to four percent (4%) above the Prime Rate in effect from time to time after the first to occur of an Event of Default, the Availability Date, or demand. (B) It is the intention of the parties hereto to conform strictly to applicable usury laws as in effect, from time to time, during the term of the Loan. Accordingly, if any transaction or transactions contemplated hereby would be usurious under applicable law (including the laws of the United States of America, or of any other jurisdiction whose laws may be applicable), then, in that event, notwithstanding anything to the contrary in this Agreement or any other agreement entered into in connection with this Agreement, it is agreed as follows: (1) the provisions of this Section 2.05(B) shall govern and control; (2) the aggregate of all interest under applicable law that is contracted for, charged, or received under this Agreement or under any of the other aforesaid agreements or otherwise in connection with this Agreement shall under no circumstances exceed the maximum amount of interest allowed by applicable law, and any excess shall be promptly credited to the Borrower by the Lender (or, if such consideration shall have been paid in full, such excess shall be promptly refunded to the Borrower by the Lender); (3) neither the Borrower nor any person or entity now or hereafter liable in connection with this Agreement shall be obligated to pay the amount of such interest to the extent that it is in excess of the maximum interest permitted by the applicable usury laws; and (4) the effective rate of interest shall be ipso facto reduced to the Highest Lawful Rate hereinafter defined. All sums paid, or agreed to be paid, to the Lender for the use, forbearance, and detention of the indebtedness of the Borrower to the Lender shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full term of the Note until payment is made in full so that the actual rate of interest does not exceed the Highest Lawful Rate in effect at any particular time during the full term thereof. The maximum lawful interest rate, if any, referred to in this Section 2.05(B) that may accrue pursuant to this Agreement is referred to herein as the "Highest Lawful Rate". If at any time the Rate exceeds the Highest Lawful Rate, the rate of interest to accrue pursuant to this Agreement shall be limited, notwithstanding anything to the contrary in this Agreement, to the Highest Lawful Rate, but any subsequent reductions in the Prime Rate shall not reduce the interest to accrue pursuant to this Agreement below the Highest Lawful Rate until the total amount of interest accrued pursuant to this Agreement equals the amount of interest that would have accrued if a varying rate per annum equal to the Rate had at all times been in effect. If the total amount of interest paid or accrued pursuant to this Agreement under the foregoing provisions is less than the total amount of interest that would have accrued if a varying rate per annum equal to the Rate had at all times been in effect, then the Borrower agrees to pay to the Lender an amount equal to the difference between (a) the lesser of (i) the amount of interest that would have accrued if the Highest Lawful Rate had at all times been in effect, or (ii) the amount of interest that would have accrued if a varying rate per annum equal to the Rate had at all times been in effect, and (b) the amount of interest accrued in accordance with the other provisions of this Agreement. 2.06 Payment to the Lender. Interest, computed as specified in Section 2.05 above, shall be calculated on the basis of a 360-day year, counting the actual number of days elapsed, and shall be payable in arrears as follows: Interest on any Advance or portion thereof for which the Borrower selected a rate based on the Prime Rate shall be payable on the last day of each month. Interest on any Advance or portion thereof for which the Borrower selects a rate based on an LIBOR Interest Period shall be payable on the last day of the applicable LIBOR Interest Period. An account shall be maintained on the books of the Lender which shall be designated as Borrower's "Loan Account," in which account a record will be kept of all loans made by the Lender to the Borrower under or pursuant to the Note and all payments thereon. All payments due thereunder will first be credited to accrued but unpaid interest and the balance to principal, except that if an Event of Default continues beyond any applicable grace period or a demand is made for payment, the Lender may apply amounts thereafter received to principal and/or interest in whatever order it deems appropriate. If more than one interest rate is applicable, such payments will be applied as aforesaid and pro rata in relation to the increments of principal to which such rates apply. The Lender shall send the Borrower statements of all amounts paid or due hereunder, which statements shall be considered correct and conclusively binding on the Borrower unless the Borrower notifies the Lender to the contrary within thirty (30) days of its receipt of any statement that it deems to be incorrect. Alternatively, at its sole discretion, the Lender may charge any other deposit account of the Borrower or demand payment against the statements. Nothing in this Section 2.06 shall operate to alter the demand nature of the Loan or otherwise to reduce, diminish or impair the Lender's cumulative rights and remedies. ARTICLE 3. CONDITIONS PRECEDENT The obligation of the Lender to make the Loan is subject to the following conditions precedent: 3.01 Documents Required for the Closing. The Borrower shall have delivered to the Lender, prior to the initial Advance (the "Closing"), the following: (A) The Note duly executed by the Borrower, in the form attached hereto as Exhibit 2.03; (B) The Financial Statements; (C) The UCC Financing Statements and other instruments required by Article 4.0; (D) The fully executed Landlord's Consent and Waiver, in the form attached hereto as Exhibit 1.20; (E) A copy, certified as of the date of the Closing, of resolutions of the board of directors of the Borrower, authorizing the execution, delivery, and performance of this Agreement, the Note, the Collateral Documents, and each other document to be delivered pursuant hereto or in connection herewith; (F) A copy, certified as of the date of the Closing, of the Borrower's bylaws; (G) A certificate of the corporate secretary or assistant secretary of the Borrower, dated the date of the Closing, as to the incumbency and signatures of the officers of the Borrower signing this Agreement, the Note, the Collateral Documents, and each other document to be delivered pursuant hereto; (H) A copy, certified as of the most recent date practicable by the Secretary of the State of Delaware, of the Certificate of Incorporation of the Borrower, and all amendments thereto, together with a certificate (dated the date of the Closing) of the corporate secretary or assistant secretary of the Borrower to the effect that such Certificate of Incorporation has not been further amended since the date of the aforesaid certification of the Secretary of the State of Delaware; (I) Certificates of legal existence (long form) and good standing dated as of the most recent date practicable, issued by the Secretary of the State of Delaware and Secretary of the Commonwealth of Massachusetts as to the legal existence and good standing of the Borrower, together with a certificate (dated the date of the Closing) of the corporate secretary or assistant secretary of the Borrower to the effect that nothing has occurred since issuance of the Certificates of Legal Existence and Good Standing that would prevent either the Secretary of the State of Delaware of the Secretary of the Commonwealth of Massachusetts from issuing updated Certificates; (J) Certificates, as of the most recent dates practicable, of the Secretary of the State of Delaware and the Secretary of the Commonwealth of Massachusetts and of the secretary of state of each other state in which the Borrower is qualified as a foreign corporation and, if applicable, of the department of revenue or taxation of each of the foregoing states, as to the good standing of the Borrower, together with a certificate (dated the date of the Closing) of the corporate secretary or assistant secretary of the Borrower to the effect that nothing has occurred since issuance of the Certificates of Good Standing that would prevent the respective Departments of Revenue from issuing updated Certificates; (K) A certificate, dated the date of the Closing, signed by the president or a vice president of the Borrower and to the effect that: (1) The representations and warranties set forth in Section 5.01 are true as of the date of the Closing; and (2) No Event of Default hereunder, and no event which, with the giving of notice or passage of time or both, would become such an Event of Default, has occurred as of such date; (L) Copies of all documents evidencing the terms and conditions of any debt specified as Subordinated Indebtedness on Exhibit 1.36 and fully executed Subordination Agreements with respect to such Subordinated Indebtedness in form and substance satisfactory to Lender; and (M) A certificate of insurance as required by Section 6.01(D). 3.02 Documents Required for Advances. At the time of, and as a condition to, any Advance subsequent to the Closing, the Lender may require the Borrower to deliver to the Lender a certificate, dated the date on which any such Advance is to be made, signed by the president or a vice president of the Borrower, and to the effect that (1) As of the date thereof, no Event of Default has occurred and is continuing, and no event has occurred and is continuing that, but for the giving of notice or passage of time or both, would be an Event of Default; (2) No material adverse change has occurred in the business prospects, financial condition, or results of operations of the Borrower or any Subsidiary since the date of the Financial Statements; and (3) Each of the representations and warranties contained in Section 5.01 is true and correct in all respects as if made on and as of the date of such disbursement. 3.03 Certain Events. At the time of, and as a condition to, the Closing and each Advance to be made by the Lender at or subsequent to the Closing: (A) No Event of Default shall have occurred and be continuing, and no event shall have occurred and be continuing that, with the giving of notice or passage of time or both, would be an Event of Default; (B) No material adverse change shall have occurred in the business prospects, financial condition, or results of operations of the Borrower or any Subsidiary since the dates of the Financial Statements; and (C) All of the Collateral Documents shall have remained in full force and effect. 3.04 Legal Matters. At the time of the Closing and each subsequent Advance, all legal matters incidental thereto shall be satisfactory to Bowditch & Dewey, LLP, legal counsel to the Lender. ARTICLE 4. COLLATERAL SECURITY 4.01 Composition of the Collateral. The property in which a security interest is granted pursuant to the provisions of Sections 4.02 and 4.03 is herein collectively called the "Collateral". The Collateral, together with all other property of the Borrower of any kind held by the Lender, shall stand as one general, continuing collateral security for all Obligations and may be retained by the Lender until all Obligations have been satisfied in full. 4.02 Rights in Property Held by the Lender. As security for the prompt satisfaction of all Obligations, the Borrower hereby assigns, transfers, and sets over to the Lender all of its right, title, and interest in and to, and grants the Lender a lien on and a security interest in, all amounts that may be owing, from time to time, by the Lender to the Borrower in any capacity, including, but without limitation, any balance or share belonging to the Borrower, or any deposit or other account with the Lender, which lien and security interest shall be independent of, and in addition to, any right of set-off that the Lender has under Section 8.07 or otherwise. 4.03 Rights in Property Held Either by the Borrower or by the Lender. As further security for the prompt satisfaction of all of the Obligations, the Borrower hereby assigns to the Lender all of its right, title and interest in and to, and grants the Lender a lien upon and a continuing security interest in, all of the following, wherever located, whether now owned or hereafter acquired, together with all replacements therefor, accessions thereto, and proceeds (including, but without limitation, insurance proceeds) and products thereof: (A) All Inventory with the sole exception of the two fully working prototype systems located at the Borrower's facility at 10E Commerce Way, Woburn, Massachusetts, and further described as follows: Horizontal System Prototype Vertical System Prototype Part # 10004-10001 Part # 10004-10001 VR Model: H1 Model: VDS-1 Serial #: P002 Serial #: V001 (B) All Accounts, including but not limited to, Contracts, accounts receivable, contract rights, and Chattel Paper, regardless of whether or not they constitute proceeds or products of other Collateral; (C) All General Intangibles, regardless of whether or not they constitute proceeds or products of other Collateral, including, without limitation, all the Borrower's rights (which the Lender may exercise or not as it in its sole discretion may determine) to acquire or obtain Goods and/or services with respect to the manufacture, processing, storage, sale, shipment, delivery or instal lation of any of the Borrower's Inventory or other Collateral; (D) All products of and accessions to any of the Collateral; (E) All liens, guaranties, securities, rights, remedies and privileges pertaining to any of the Collateral, including the right of stoppage in transit; (F) All obligations owing to the Borrower of every kind and nature, and all choses in action; (G) All tax refunds of every kind and nature to which the Borrower is now or hereafter may become entitled no matter however arising, including, without limitation, loss carryback refunds; (H) All Intellectual Property, goodwill, trade secrets, computer programs, customer lists, trade names, trademarks, copyrights and patents; (I) All Chattel Paper, Documents and Instruments (whether negotiable or non-negotiable, and regardless of their being attached to Chattel Paper); (J) All Equipment, including without limitation machinery, furniture, motor vehicles, Fixtures and all other Goods used in the conduct of the business of the Borrower; (K) All proceeds of Collateral of every kind and nature and in whatever form, including, without limitation, both cash and non-cash proceeds resulting or arising from the rendering of services by the Borrower or the sale or other disposition by the Borrower of the Inventory or other Collateral; (L) All books, Records, computer disks, diskettes, electronic data and other information relating to the conduct of the Borrower's business including, without in any way limiting the generality of the foregoing, those relating to its Accounts; and (M) All deposit accounts maintained by the Borrower with any bank, trust company, investment firm or fund, or any similar institution or organization. 4.04 Priority of Liens. The foregoing liens shall be first and prior liens except for Permitted Liens. 4.05 UCC Financing Statements. (A) The Borrower will: (1) Execute such UCC financing statements (including amendments thereto and continuation statements thereof) in form satisfactory to the Lender as the Lender, from time to time, may specify; (2) Pay, or reimburse the Lender for paying, all costs and taxes of filing or recording the same in such public offices as the Lender may designate; and (3) Take such other steps as the Lender, from time to time, may direct, including the noting of the Lender's lien on the Collateral and on any certificates of title therefor, all to perfect to the satisfaction of the Lender the Lender's interest in the Collateral. (B) In addition to the foregoing, and not in limitation thereof: (1) A carbon, photographic, or other reproduction of this Agreement shall be sufficient as a UCC financing statement and may be filed in any appropriate office in lieu thereof; and (2) To the extent lawful, the Borrower hereby appoints the Lender as its attorney-in-fact (without requiring the Lender to act as such) to execute any UCC financing statement in the name of the Borrower, and to perform all other acts that the Lender deems appropriate to perfect and continue its security interest in, and to protect and preserve, the Collateral. 4.06 Mortgagees', Landlords', and Warehousemen's Waivers. The Borrower will, within twenty (20) days after any request of the Lender, cause any mortgagee of real estate owned by the Borrower, any landlord of premises leased by the Borrower, and any warehouseman or other bailee on whose premises any of the Collateral may be located to execute and deliver to the Lender instruments, in form and substance satisfactory to the Lender, by which such mortgagee, landlord or warehouseman or other bailee waives its rights, if any, in and to all Goods composing a part of the Collateral. ARTICLE 5. REPRESENTATIONS AND WARRANTIES 5.01 Original. To induce the Lender to enter into this Agreement, the Borrower represents and warrants to the Lender as follows: (A) The Borrower is a corporation duly organized, validly existing, and in good standing under the Laws of the State of Delaware and is duly qualified to do business in the Commonwealth of Massachusetts; the Borrower has no Subsidiaries other than the Subsidiary named in Exhibit 5.01(A); each Subsidiary is a corporation duly organized, validly existing, and in good standing under the Laws of its jurisdiction of incorporation, all as set forth in Exhibit 5.01(A); the Borrower and Subsidiary have the lawful power to own their properties and to engage in the businesses they conduct, and each is duly qualified and in good standing as a foreign corporation in the jurisdictions wherein the nature of the business transacted by it or property owned by it makes such qualification necessary; the states in which the Borrower and the Subsidiary are qualified to do business are set forth in Exhibit 5.01(A) or otherwise disclosed to the Lender in writing; the percentage of the Borrower's ownership of the outstanding stock of the Subsidiary is as listed in Exhibit 5.01(A); the addresses of all places of business of the Borrower and its Subsidiary are as set forth in Exhibit 5.01(A) or otherwise disclosed to the Lender in writing; neither the Borrower nor the Subsidiary has changed its name, been the surviving corporation in a merger, acquired any business, or changed its principal executive office within five (5) years and one (1) month prior to the date hereof except as set forth in Exhibit 5.01(A); and all of the authorized, issued, and outstanding shares of capital stock of each Subsidiary are owned by the Borrower; (B) Neither the Borrower nor any Subsidiary is directly or indirectly controlled by, or acting on behalf of, any Person which is an "Investment Company", within the meaning of the Investment Company Act of 1940, as amended; (C) Neither the Borrower nor any Subsidiary is in default with respect to any of its existing Indebtedness, and the making and performance of this Agreement, the Note, and the Collateral Documents will not (immediately or with the passage of time, the giving of notice, or both): (1) violate the Certificate of Incorporation or by-laws of the Borrower or any Subsidiary, or violate any Laws or result in a default under any contract, agreement, or instrument to which the Borrower or any Subsidiary is a party or by which the Borrower or any Subsidiary or its property is bound; or (2) result in the creation or imposition of any security interest in, or lien or encumbrance upon, any of the assets of the Borrower or any Subsidiary except in favor of the Lender; (D) The Borrower has the power and authority to enter into and perform this Agreement, the Note, and the Collateral Documents, and to incur the obligations herein and therein provided for, and has taken all actions necessary to authorize the execution, delivery, and performance of this Agreement, the Note, and the Collateral Documents; (E) This Agreement, the Note, and the Collateral Documents are, or when delivered will be, valid, binding, and enforceable in accordance with their respective terms; (F) Except as disclosed in Exhibit 5.01(F) hereto, there is no pending order, notice, claim, litigation, proceeding, or investigation against or affecting the Borrower or any Subsidiary, whether or not covered by insurance, that would in the aggregate involve the payment of $10,000.00 or more or would otherwise materially or adversely affect the financial condition or business prospects of the Borrower or any Subsidiary if adversely determined; (G) The Borrower and its Subsidiary have good and marketable title to all of their assets, none of which is subject to any security interest, encumbrance or lien, or claim of any third Person except for Permitted Liens; (H) The Financial Statements, including any schedules and notes pertaining thereto, have been prepared in accordance with GAAP, and fully and fairly present the financial condition of the Borrower and its Subsidiary at the dates thereof and the results of operations for the periods covered thereby, and there have been no material adverse changes in the consolidated financial condition or business of the Borrower and its Subsidiary from September 30, 1996, to the date hereof; (I) As of the date hereof, the Borrower and its Subsidiary have no material Indebtedness of any nature, including, but without limitation, liabilities for taxes and any interest or penalties relating thereto except to the extent reflected (in a footnote or otherwise) and reserved against in the consolidated balance sheet dated September 30, 1996 included in the Financial Statements or as disclosed in, or permitted by, this Agreement; and the Borrower does not know or have reasonable ground to know of any basis for the assertion against it or any Subsidiary of any claim or litigation related to such Indebtedness as of the date of the Closing except as disclosed on Exhibit 5.01(F) or otherwise disclosed to the Lender in writing; (J) Except as otherwise permitted herein, the Borrower has filed all federal, state, and local tax returns and other reports required by any applicable Laws to have been filed prior to the date hereof, has paid or caused to be paid all taxes, assessments, and other governmental charges that are due and payable prior to the date hereof, and has made adequate provision for the payment of such taxes, assessments, or other charges accruing but not yet payable; the Borrower has no knowledge of any deficiency or additional assessment in a materially important amount in connection with any taxes, assessments, or charges not provided for on its books; (K) Except to the extent that the failure to comply would not materially interfere with the conduct of the business of the Borrower or any Subsidiary, the Borrower and its Subsidiary have each complied with all applicable Laws with respect to (1) any restrictions, specifications, or other requirements pertaining to products that it manufactures or sells or to the services it performs; (2) the conduct of its business; and (3) the use, maintenance, and operation of the real and personal properties owned or leased by it in the conduct of its business; (L) No representation or warranty by or with respect to the Borrower or any Subsidiary contained herein or in any certificate or other document furnished by the Borrower or any Subsidiary pursuant hereto contains any untrue statement of a material fact or omits to state a material fact necessary to make such representation or warranty not misleading in light of the circumstances under which it was made; (M) Each consent, approval or authorization of, or filing, registration or qualification with, any Person required to be obtained or effected by the Borrower, any Subsidiary, or any guarantor in connection with the execution and delivery of this Agreement, the Note, and the Collateral Documents or the undertaking or performance of any obligation hereunder or thereunder has been duly obtained or effected; (N) There is no Indebtedness of the Borrower or any Subsidiary: (1) for money borrowed, or (2) under any security agreement, mortgage or agreement covering the lease by the Borrower or any Subsidiary as lessee of real or personal property except as reflected in the Financial Statements or as described in Exhibit 5.01(N); (O) Except as described in Exhibit 5.01(O), attached hereto, or otherwise disclosed to the Lender in writing, (a) neither the Borrower nor any Subsidiary has any material leases, contracts, or commitments of any kind (including, without limitation, employment agreements; collective bargaining agreements; powers of attorney; distribution arrangements; licenses, patents, copyrights, trademarks, service marks or license agreements; contracts for future purchase or delivery of Goods or rendering of services; bonuses, pension, and retirement plans; or accrued vacation pay, insurance, and welfare agreements); (b) to the best of Borrower's knowledge, all parties to all such material leases, contracts, and other commitments to which the Borrower or any Subsidiary is a party have complied with the provisions of such leases, contracts, and other commitments; and (c) to the best of Borrower's knowledge, no party is in default under any term thereof and no event has occurred which, but for the giving of notice or the passage of time, or both, would constitute a default; (P) The Borrower has not made any agreement or taken any action which may cause anyone to become entitled to a commission or finder's fee as a result of or in connection with the making of the Loan; (Q) The Borrower's consolidated federal tax returns for all years of operation, including the year ended September 30, 1996, have been filed with the Internal Revenue Service and have not been challenged; (R) Any Employee Pension Benefit Plans, as defined in the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), of the Borrower and each Subsidiary meet, as of the date hereof, the minimum funding standards of 29 U.S.C.A. 1082 (Section 302 of ERISA), and no Reportable Event or Prohibited Transaction, as defined in ERISA, has occurred with respect to any Employee Benefit Plans, as defined in ERISA, of the Borrower or any Subsidiary; (S) The liens and security interests created pursuant to Sections 4.02 and 4.03 are and will be at the Closing in all cases first and prior liens except for Permitted Liens; (T) Except as shown on Exhibit 1.19, Borrower has no patent claims, trademark or copyright registrations or other filings or applications protecting its Intellectual Property in any jurisdiction; and (U) The Borrower is in full compliance with all of its tenant obligations under that certain Commercial Lease dated December 19, 1995 between the Borrower and Cummings Properties Management, Inc.; the Landlord's Consent and Waiver dated as of April 4, 1996 among the Borrower, Cummings Properties Management, Inc. and the Lender is in full force and effect; and the Borrower knows of no default under the Commercial Lease. 5.02 Survival. All of the representations and warranties set forth in Section 5.01 shall survive until all Obligations are satisfied in full and there remain no outstanding commitments hereunder. ARTICLE 6. COVENANTS OF THE BORROWER 6.01 Affirmative Covenants. The Borrower does hereby covenant and agree with the Lender that, so long as any of the Obligations remain unsatisfied or any commitments hereunder remain outstanding, it will comply, or if appropriate cause its Subsidiary to comply, at all times with the following affirmative covenants: (A) The Borrower will use the proceeds of the Loan for working capital purposes and will furnish the Lender such evidence as it may reasonably require with respect to such use; (B) The Borrower will furnish the Lender: (1) As soon as available, but in any event within thirty (30) days after the close of each month in each fiscal year: (a) a statement of stockholders' equity and a statement of changes in financial position of the Borrower for such month; (b) an income statement of the Borrower for such month; and (c) a balance sheet of the Borrower as of the end of such month--all in reasonable detail, subject to normal year-end audit adjustments and certified by the Borrower's president or chief financial officer to have been prepared in accordance with GAAP; (2) As soon as available, but in any event within one hundred twenty (120) days after the close of each fiscal year: (a) a consolidated statement of stockholders' equity and a consolidated statement of changes in financial position of the Borrower and its Subsidiary for such fiscal year; (b) consolidated and consolidating income statements of the Borrower and its Subsidiary for such fiscal year; and (c) consolidated and consolidating balance sheets of the Borrower and its Subsidiary as of the end of such fiscal year--all such statements to be in reasonable detail, including all supporting schedules and comments; the consolidated statements and balance sheets to be audited by Arthur Andersen or another independent certified public accountant selected by Borrower and acceptable to the Lender, and certified by such accountants to have been prepared in accordance with GAAP and to present fairly the consolidated financial position and results of operations of the Borrower and its Subsidiary; in addition, the Borrower will obtain from such independent certified public accountants and deliver to the Lender, within one hundred twenty (120) days after the close of each fiscal year, their written statement that in making the examination necessary to their certification they have obtained no knowledge of any Event of Default by the Borrower, or disclosing all Events of Default of which they have obtained knowledge (it being understood and agreed by the Lender that in making their examination, such accountants shall not be required to go beyond the bounds of generally accepted auditing procedures for the purpose of certifying financial statements); the Lender shall have the right, from time to time to discuss the affairs of the Borrower directly with such independent certified public accountants after notice to the Borrower and opportunity of the Borrower to be represented at any such discussions; (3) Contemporaneously with each monthly and year-end financial report required by the foregoing paragraphs (1) and (2), a certificate of the president or chief financial officer of the Borrower stating that he has individually reviewed the provisions of this Agreement and that a review of the activities of the Borrower during such year or monthly period, as the case may be, has been made by him or under his supervision, with a view to determining whether the Borrower has fulfilled all its obligations under this Agreement, and that, to the best of his knowledge, the Borrower has observed and performed each undertaking contained in this Agreement and is not in default in the observance or performance of any of the provisions hereof or, if the Borrower shall be so in default, specifying all such defaults and events of which he may have knowledge; (4) Promptly after the sending or making available or filing of the same, copies of all reports, proxy statements, and financial statements that the Borrower or any successor Person sends or makes available to its stockholders and all registration statements and reports that the Borrower or any successor Person files with the Securities and Exchange Commission; (5) Within thirty (30) days after the end of each calendar month, in such form and detail as shall be satisfactory to the Lender, an aging, as of the end of such month, of Accounts of the Borrower certified by the president or controller of the Borrower to be complete and correct; (6) As soon as available, but in any event within one hundred twenty (120) days after the close of each fiscal year: financial and operating projections for the next fiscal year--all such projections to contain such detail and to be in such form as the Lender may request, and to include all supporting schedules and comments, and to be certified by the president or controller of the Borrower to be complete; (7) Upon the Lender's request, from time to time, copies of any or all agreements, contracts, or commitments referred to in Section 5.01(O) hereof; (C) The Borrower will maintain its Inventory, Equipment, real estate, and other properties in good condition and repair (normal wear and tear excepted), and will pay and discharge or cause to be paid and discharged, when due, the cost of repairs to, or maintenance of, the same, and will pay or cause to be paid in a timely manner all rental or mortgage payments due on such real estate. The Borrower hereby agrees that, in the event it fails to pay or cause to be paid any such payment, it will promptly notify the Lender thereof, and the Lender may, in its discretion, do so and on demand be reimbursed therefor by the Borrower; (D) The Borrower and its Subsidiary will maintain, or cause to be maintained, public liability insurance (subject to a maximum of $10,000.00 in deductibles for each entity) and fire and extended coverage insurance on all assets that are of a character usually insured by corporations engaged in the same or similar businesses, all in form and amount sufficient to indemnify the Borrower or Subsidiary for 100% of the appraised value of any such asset lost or damaged (subject to any deductible customary in the Borrower's or Subsidiary's industry) or in an amount consistent with the amount of insurance generally carried on comparable assets within the industry and with such insurers as may be satisfactory to the Lender. The Borrower and its Subsidiary will cause all such insurance policies to contain a standard mortgage clause and to be payable to the Lender as its interest may appear, to deliver the policies of insurance to the Lender, and, in the case of all policies of insurance carried for the benefit of the Borrower or any Subsidiary by any lessee, sublessee, subtenant, or other party having rights to occupy or use the mortgage property or any part thereof or interest therein under any lease, sublease, or other agreement (whether oral, written, or otherwise evidenced), to cause all such policies to be payable to the Lender as its interest may appear. Such policies shall contain a provision whereby they cannot be cancelled except after ten (10) days' written notice to the Lender. The Borrower will furnish to the Lender such evidence of insurance as the Lender may require. The Borrower hereby agrees that, in the event it or any Subsidiary fails to pay or cause to be paid the premium on any such insurance when due, the Lender, in its discretion, may do so and be reimbursed by the Borrower therefor. The Borrower and each Subsidiary hereby assign to the Lender any returned or unearned premiums that may be due the Borrower or any Subsidiary upon cancellation by the insurer of any such policy for any reason whatsoever and direct any such insurer to pay the Lender any amounts so due. Provided, however, that the Lender will pay to the Borrower or the appropriate Subsidiary any such returned or unearned premiums within five (5) days after the receipt thereof if there has not occurred and be continuing an Event of Default hereunder. The Lender is hereby appointed the attorney-in-fact of the Borrower and each Subsidiary (without requiring the Lender to act as such) to endorse any check which may be payable to the Borrower or any Subsidiary to collect any premiums or the proceeds of such insurance (other than proceeds of public liability insurance), and any amount so collected may be applied by the Lender toward satisfaction of any of the Obligations if an Event of Default has occurred and is continuing. If the Lender receives any proceeds from insurance in the absence of an Event of Default, it shall remit such proceeds to the Borrower or such Subsidiary within three (3) Business Days after the Lender's receipt of such proceeds; (E) The Borrower and its Subsidiary will each pay or cause to be paid when due, all taxes, assessments, and charges or levies imposed upon it or on any of its property or which it is required to withhold and pay except where contested in good faith by appropriate proceedings with adequate reserves therefor having been set aside on its books; provided, however, that the Borrower and each Subsidiary shall pay or cause to be paid all such taxes, assessments, charges or levies forthwith whenever foreclosure on any lien that may have attached (or security therefor) appears imminent; (F) The Borrower shall permit the representatives of the Lender to make reasonable physical inspections at any time during normal business hours of the Collateral and of the Borrower's facilities, activities, books and Records, and cause its officers and employees to give full cooperation and assistance in connection therewith, so that Lender can determine whether the Borrower has maintained the Borrowing Base at no less than the principal amount of the Loan outstanding; the cost of such inspections shall be paid for by Borrower as an additional amount due under the Loan; (G) The Borrower and its Subsidiary will each take all necessary steps to preserve its corporate existence and franchises and comply with all present and future Laws applicable to it in the operation of its business, and all material agreements to which it is subject; (H) The Borrower and its Subsidiary will each collect its Accounts and sell its Inventory only in the ordinary course of business; (I) The Borrower and its Subsidiary will each keep accurate and complete Records of its Accounts, Inventory, and Equipment consistent with sound business practices; (J) The Borrower and its Subsidiary will each give prompt notice to the Lender of (1) any litigation or proceeding in which it is a party if an adverse decision therein would require it to pay more than $10,000.00 or deliver assets the value of which exceeds such sum (whether or not the claim is considered to be covered by insurance); and (2) the institution of any other suit or proceeding involving it that might materially and adversely affect its operations, financial condition, property, or business prospects; (K) Within ten (10) days after the filing thereof, the Borrower will furnish the Lender with copies of federal income tax returns filed by the Borrower. The Borrower will cause the full amount of each federal and other income tax refund (including any interest component thereof) received by the Borrower to be applied as an immediate repayment or partial repayment of the Loan; (L) The Borrower and its Subsidiary will each pay when due (or within applicable grace periods) all of its other Indebtedness due third Persons except when the amount thereof is being contested in good faith by appropriate proceedings and with adequate reserves therefor being set aside on its books; provided, however, that no payment shall be made in respect to Subordinated Indebtedness except in strict compliance with all of the terms of subordination thereof theretofore approved in writing by the Lender. If default be made by the Borrower or any Subsidiary in the payment of any principal (or installment thereof) of, or interest on, any such Indebtedness, the Lender shall have the right, in its discretion, to pay such interest or principal for the account of the Borrower or such Subsidiary and be reimbursed by the Borrower or such Subsidiary therefor; (M) The Borrower and its Subsidiary will each notify the Lender immediately if it becomes aware of the occurrence of any Event of Default or of any fact, condition, or event that only with the giving of notice or passage of time or both, could become an Event of Default or if it becomes aware of any material adverse change in the business prospects, financial condition (including, without limitation, proceedings in bankruptcy, insolvency, reorganization, or the appointment of a receiver or trustee), or results of operations of the Borrower, a Subsidiary, or any guarantor or of the failure of the Borrower or any Subsidiary to observe any of their respective undertakings hereunder or under the Collateral Documents; (N) The Borrower and its Subsidiary will each notify the Lender thirty (30) days in advance of any change in the location of any of its places of business or of the establishment of any new, or the discontinuance of any existing, place of business; (O) The Borrower and its Subsidiary will each (1) fund any of its Employee Pension Benefit Plans in accordance with no less than the minimum funding standards of 29 U.S.C.A. 1082 (Section 302 of ERISA); (2) furnish the Lender, promptly after the filing of the same, with copies of any reports or other statements filed with the United States Department of Labor or the Internal Revenue Service with respect to any such Plan; and (3) promptly advise the Lender of the occurrence of any Reportable Event or Prohibited Transaction with respect to any Employee Benefit Plan; (P) With respect to Letters of Credit: (1) The Borrower shall require that each Letter of Credit issued for its benefit shall provide that one of the required documents for the first payment under the Letter of Credit shall be a copy of an assignment of proceeds executed by the Borrower (the beneficiary of the Letter of Credit) in favor of the Lender; said assignment shall be for the full amount of the Letter of Credit and shall provide that all payments under the Letter of Credit shall be made to the Operating Account; (2) The Borrower will take all necessary and advisable steps to ensure that the Letter of Credit will be delivered to the paying or confirming bank and that said paying or confirming bank shall be authorized to retain the Letter of Credit on behalf of the Lender, which is the assignee of the proceeds thereof; (3) In the event that the Borrower is unable to obtain the assignment of the Letter of Credit in accordance with subparagraphs (1) and (2) above, the Borrower shall arrange in writing (with a copy to the Lender) with the account party under the Letter of Credit that the issuer of said Letter of Credit include therein a provision to the effect that payment under said Letter of Credit shall be negotiated only at the Lender's counters or, alternatively, that payment shall be made only to the Operating Account; (Q) The Borrower shall require payment of all Accounts in U.S. Dollars or in such other form or currency as is acceptable to the Lender; (R) So long as any Obligations are outstanding, the Borrower shall maintain its primary depository accounts with the Lender; and (U) The Borrower shall maintain: (1) A Current Ratio, tested at the end of each fiscal quarter, of not less than 1.5:1.0; and (2) A ratio of Total Liabilities to Tangible Net Worth, tested at the end of each fiscal quarter, of not more than 1.0:1.0. 6.02 Negative Covenants. The Borrower does hereby covenant and agree with the Lender that, so long as any of the Obligations remain unsatisfied or any commitments hereunder remain outstanding, it will comply, or if appropriate cause its Subsidiary to comply, at all times with the following negative covenants, unless the Lender shall otherwise have agreed in writing: (A) Neither the Borrower nor any Subsidiary will change its name, enter into any merger, reorganization or recapitalization, or reclassify its capital stock without at least thirty (30) days' advance written notice to the Lender; provided, however, in no event shall any such merger, reorganization or recapitalization reduce or result in the reduction of the Borrower's Net Worth as of March 31, 1997; (B) Neither the Borrower nor any Subsidiary will sell, transfer, lease, or otherwise dispose of all or (except in the ordinary course of business) any material part of its assets; (C) Neither the Borrower nor any Subsidiary will sell, lease, transfer, assign, or otherwise dispose of any of the Collateral except in the ordinary course of business; (D) Neither the Borrower nor any Subsidiary will sell or otherwise dispose of, or for any reason cease operating, any of its divisions, franchises, or lines of business; (E) Neither the Borrower nor any Subsidiary will mortgage, pledge, grant, or permit to exist a security interest in, or a lien upon, any of its assets of any kind, now owned or hereafter acquired, except for Permitted Liens, liens of the Collateral Documents, and existing liens listed on Exhibit 5.01(N) to the extent shown on Exhibit 1.31 to be permitted to exist after the Closing; (F) Neither the Borrower nor any Subsidiary will become liable, directly or indirectly, as guarantor or otherwise for any obligation of any other Person, except for the endorsement of commercial paper for deposit or collection in the ordinary course of business; (G) Neither the Borrower nor any Subsidiary will incur, create, assume, or permit to exist any Indebtedness except: (1) the Loan; (2) existing Indebtedness listed on Exhibit 5.01(N) to the extent shown on Exhibit 1.31 to be permitted to exist after the Closing; (3) trade indebtedness incurred in the ordinary course of business (provided, however, that neither the Borrower nor any Subsidiary may acquire inventory other than for cash or on open account except as expressly approved in writing and in advance by the Lender); (4) contingent Indebtedness permitted by Section 6.02(F); (5) operating lease obligations incurred in the normal course of business under the current lease arrangement; (6) Indebtedness secured by Permitted Liens; and (7) Subordinated Indebtedness; (H) The Borrower shall not declare, pay or set apart any funds for the payment of any dividends (other than dividends payable in shares of the Borrower's stock) on any class of shares of the Borrower's stock, or apply any of its funds, property or assets to, or set apart any funds, property or assets for, the purchase, redemption or other retirement of, or make any other distribution, by reduction of capital or otherwise, in respect of any class of shares of the Borrower's stock, or with respect to any other funds or assets without the prior written consent of the Lender; (I) Neither the Borrower nor any Subsidiary will form any subsidiary, make any investment in (including any assignment of Inventory or other property), or make any loan in the nature of an investment to, any Person, other than investments of the Borrower in the Subsidiary listed on Exhibit 5.01(A); (J) Neither the Borrower nor any Subsidiary will make payments on account of the purchase or lease of consolidated fixed assets that, in the aggregate, in any fiscal year (commencing with the current fiscal year) will exceed the depreciation taken or to be taken with respect to consolidated fixed assets during such year; as used in this paragraph, the term "lease" means a lease reflected on a consolidated balance sheet of the Borrower and its Subsidiary or a lease that should be so reflected under GAAP; (K) Neither the Borrower nor any Subsidiary will purchase or otherwise invest in or hold securities, nonoperating real estate, or other nonoperating assets except: (1) direct obligations of the United States of America, or of a bank with assets of not less than $50,000,000.00 or other investments approved in advance in writing by the Lender; (2) the present investment in any such assets held as of September 30, 1996 and reflected in the Financial Statements; and (3) operating assets that hereafter become nonoperating assets; (L) Neither the Borrower nor any Subsidiary will transfer, purchase or redeem, or permit any subsidiary to transfer or purchase, any shares of the Borrower's capital stock unless such transfer, purchase or redemption is effected solely from the proceeds of and within a reasonable time after the issuance to third parties by the Borrower or its subsidiary of capital stock which is in addition to the capital stock of the Borrower or its subsidiary, as the case may be, outstanding on the date of this Agreement; (M) Neither the Borrower nor any Subsidiary will prepay any Subordinated Indebtedness, Indebtedness for borrowed money except the Obligations, or Indebtedness secured by any of its assets (except the Obligations), or enter into or modify any agreement as a result of which the terms of payment of any of the foregoing Indebtedness are waived or modified; (N) Neither the Borrower nor any Subsidiary will enter into any sale-leaseback transaction; (O) Neither the Borrower nor any Subsidiary will acquire or agree to acquire any stock in, or all or substantially all of the assets of, any Person, without at least thirty (30) days' advance written notice to the Lender; (P) Neither the Borrower nor any Subsidiary will furnish the Lender any certificate or other document that will contain any untrue statement of material fact or that will omit to state a material fact necessary to make it not misleading in light of the circumstances under which it was furnished; (Q) Neither the Borrower nor any Subsidiary will directly or indirectly apply any part of the proceeds of the Loan to the purchasing or carrying of any "margin stock" within the meaning of Regulation U of the Board of Governors of the Federal Reserve System, or any regulations, interpretations, or rulings thereunder; (R) The Borrower shall make no payments of principal, interest, or of any other amounts under any Subordinated Indebtedness until all amounts outstanding under the Loan ("Senior Debt") have been paid in full; in the event of the dissolution or winding up of the Borrower's business affairs, the Subordinated Indebtedness shall at all times be subordinated to the Senior Debt. At such time as there shall exist any Subordinated Indebtedness, the Borrower shall obtain from the subordinated creditor a written undertaking affirming this covenant; (S) During the term of the Loan, the Borrower shall not make any advances to any stockholder, Affiliate or related entity (including but not limited to, partnerships, joint ventures, joint stock companies, corporations, parent companies or subsidiaries) except that the Borrower may use Loan proceeds to fund its wholly owned British subsidiary, Vivid Technologies UK Ltd.; (T) Neither the Borrower nor any Subsidiary shall utilize the Loan for the purpose of servicing any of the Borrower's pre-existing or future indebtedness unrelated to the Loan; and (U) The Borrower shall not incur a net operating loss for any two (2) consecutive fiscal quarters or in any fiscal year. ARTICLE 7. DEFAULT 7.01 Events of Default. The occurrence of any one or more of the following events shall constitute an Event of Default hereunder: (A) The Borrower or any guarantor shall fail to pay when due any of its Obligations to pay money to the Lender; (B) The Borrower or any guarantor or Subsidiary shall fail to observe or perform any of its Obligations other than payment of money to be observed or performed by it hereunder, under any of the Collateral Documents or otherwise, and such failure shall continue for five (5) days after (1) notice of such failure from the Lender; or (2) the Lender is notified of such failure or should have been so notified pursuant to the provisions of Section 6.01(N), whichever is earlier; (C) The Borrower or any Subsidiary shall fail to pay any Indebtedness due any third Persons, and such failure shall continue beyond any applicable grace period, or the Borrower or any Subsidiary shall suffer to exist any other event of default under any agreement binding the Borrower or any Subsidiary; (D) Any financial statement, representation, warranty, or certificate made or furnished by or with respect to the Borrower or any guarantor or Subsidiary to the Lender in connection with this Agreement, or as inducement to the Lender to enter into this Agreement, or in any separate statement or document to be delivered to the Lender hereunder, shall be materially false, incorrect, or incomplete when made; (E) The Borrower or any guarantor or Subsidiary shall admit its inability to pay its debts as they mature or shall make an assignment for the benefit of itself or any of its creditors; (F) Proceedings in bankruptcy, or for reorganization of the Borrower or any Subsidiary, or for the readjustment of any of their respective debts under the Bankruptcy Code, as amended, or any part thereof, or under any other Laws, whether state or federal, for the relief of debtors, now or hereafter existing, shall be commenced against or by the Borrower or any guarantor or Subsidiary and, except with respect to any such proceedings instituted by the Borrower, guarantor or a Subsidiary, shall not be discharged within ninety (90) days of their commencement; (G) A receiver or trustee shall be appointed for the Borrower or any guarantor or Subsidiary or for any substantial part of their respective assets, or any proceedings shall be instituted for the dissolution or the full or partial liquidation of the Borrower or any guarantor or Subsidiary, and except with respect to any such appointments requested or instituted by the Borrower, any guarantor or a Subsidiary, such receiver or trustee shall not be discharged within ninety (90) days of his appointment, and except with respect to any such proceedings instituted by the Borrower, a guarantor or a Subsidiary, such proceedings shall not be discharged within ninety (90) days of their commencement, or the Borrower or any guarantor or Subsidiary shall discontinue business or materially change the nature of its business, or the Collateral becomes, in the reasonable judgment of the Lender, insufficient in value to satisfy the Obligations, or the Lender otherwise reasonably finds itself insecure as to the prompt and punctual payment and discharge of the Obligations; (H) The Borrower or any guarantor or Subsidiary shall suffer final judgments for payment of money aggregating in excess of $10,000.00 and shall not discharge the same within a period of ninety (90) days unless, pending further proceedings, execution has not been commenced or, if commenced, has been effectively stayed; (I) A judgment creditor of the Borrower or any guarantor or Subsidiary shall obtain possession of any of the Collateral by any means, including (without implied limitation) levy, distraint, replevin, or self-help; or (J) Any obligee of Subordinated Indebtedness shall fail to comply with the subordination provisions of the instruments evidencing such Subordinated Indebtedness. 7.02 Acceleration. At its option, and at any time, whether immediately or otherwise, the Lender may, upon the occurrence of any Event of Default, declare all Obligations of the Borrower or guarantor to the Lender immediately due and payable without further action of any kind and without notice, demand or presentment. 7.03 Demand Nature of Obligations. The enumeration of the non-exclusive list of Events of Default in no way modifies the demand nature of the Obligations. The occurrence of any one or more Events of Default may cause the Lender (i) to make demand for payment and performance of all Obligations, (ii) to cease making advances under the Loan, and (iii) to exercise its cumulative rights and remedies. The Borrower acknowledges that in so acting the Lender shall be deemed to be acting in a commercially reasonable manner and in good faith. The Borrower acknowledges that the occurrence of an Event of Default is not a condition or prerequisite to the Lender making demand for payment or performance of any of the Obligations. ARTICLE 8. THE LENDER'S RIGHTS AND REMEDIES 8.01 The Lender's Rights Upon Default. Upon demand on the Note or the occurrence of an Event of Default and at any time thereafter, the Lender, without presentment, demand, notice, protest or advertisement of any kind, will have the rights set forth in this Article. 8.02 Account Debtors. Upon demand on the Note or the occurrence of an Event of Default and at any time thereafter, the Lender may notify account debtors, at the Borrower's expense, that the Collateral has been assigned to the Lender and that payments shall be made directly to the Lender. Upon request of the Lender, the Borrower will notify such account debtors that their accounts must be paid to the Lender. Upon demand on the Note or the occurrence of an Event of Default and at all times thereafter, the Borrower will hold all checks, drafts, cash and other remittances in trust for the Lender and deliver them in kind to the Lender. The Lender shall have full power to collect, compromise, endorse, sell or otherwise deal with the Collateral or proceeds thereof in its own name or in the name of the Borrower. 8.03 Possession and Foreclosure of Collateral. Upon demand or the occurrence of an Event of Default and at any time thereafter, the Lender shall have the following rights and remedies, which rights and remedies are cumulative and not exclusive: (i) to the extent that the Borrower could legally do so, the Lender may enter onto, occupy and use any premises owned by the Borrower or in which the Borrower has any interest; (ii) the Lender may take possession of all or any Collateral; (iii) in the Lender's sole discretion, the Lender may operate and use the Borrower's equipment, complete work in process and sell inventory without being liable to the Borrower on account of any losses, damage or depreciation that may occur as a result thereof (so long as the Lender acts in good faith); and (iv) the Lender may lease or license the Collateral to any Person for such purposes. In any event, the Lender may sell, lease, assign and deliver the whole or any part of the Collateral, at public or private sale, for cash, upon credit or for future delivery, at such prices and upon such terms as the Lender deems advisable. The Lender may sell or lease Collateral alone or in conjunction with other property, real or personal, and allocate the sale proceeds or leases among the items of Collateral sold without the necessity of the Collateral being present at any such sale, or in view of prospective purchasers thereof. If notice of sale is legally required, the Borrower agrees that five (5) days oral notice shall be deemed reasonable. Upon such sale, the Lender may become the purchaser of the whole or any part of the Collateral sold, discharged from all claims and free from any right of redemption. In case of any such sale by the Lender of all or any of the Collateral on credit, or for future delivery, such Collateral so sold may be retained by the Lender until the selling price is paid by the purchaser. The Lender shall incur no liability in case of the failure of the purchaser to take possession and pay for the Collateral so sold. In case of any such failure, the said Collateral may be resold. Any Collateral remaining unsold after being offered at public auction may be abandoned or disposed of for no consideration in such manner as the Lender deems appropriate. In any event, at any time and from time to time the Lender may abandon the Collateral or any part thereof. The Borrower agrees immediately upon demand to take possession of any and all abandoned Collateral and to remove it from any location in the possession of or under the control of the Lender. 8.04 Use of Intellectual Property. Upon demand on the Note or the occurrence of an Event of Default and at any time thereafter, the Lender may use all or any part of the Borrower's Intellectual Property which the Borrower now has or may hereafter acquire. The Lender may license such Intellectual Property to third parties, seek registration of such Intellectual Property in any state or nation or prosecute pending applications for patents, copyrights, trademarks, or service marks in the Borrower's name in any state or nation. 8.05 Notification of Default to Third Parties. Upon demand on the Note or the occurrence of an Event of Default and at any time thereafter, the Lender may notify the Borrower's suppliers, account debtors and other third parties of the default and of any and all decisions made and actions taken by the Lender with respect to this Agreement, the Obligations or the Collateral, without liability of any kind. 8.06 Assembly of Collateral. Upon demand on the Note or the occurrence of an Event of Default and at any time thereafter, the Lender may require the Borrower to assemble the Collateral in a single location at a place to be designated by the Lender and make the Collateral at all times secure and available to the Lender. 8.07 Right of Set-Off. Upon demand on the Note or the occurrence of any Event of Default and at any time thereafter, the Lender may, and is hereby authorized by the Borrower, at any time and from time to time, to the fullest extent permitted by applicable Laws, without advance notice to the Borrower (any such notice being expressly waived by the Borrower), set-off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and any other indebtedness at any time owing by the Lender to, or for the credit or the account of, the Borrower against any or all of the Obligations of the Borrower or any guarantor, now or hereafter existing, whether or not such Obligations have matured and irrespective of whether the Lender has exercised any other rights that it has or may have with respect to such Obligations, including without limitation any acceleration rights. The Lender agrees promptly to notify the Borrower after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of the Lender under this Section 8.07 are in addition to the other rights and remedies (including, without limitation, other rights of set-off) which the Lender may have. 8.08 Exercise of Other Remedies. Upon demand on the Note or the occurrence of any Event of Default and at any time thereafter, the Lender may exercise the remedies of a Lender afforded by the Uniform Commercial Code and other applicable law or by the terms of any agreement between the Borrower and the Lender. 8.09 Cumulative Rights and Remedies. All rights and remedies of the Lender, whether provided for herein or in other agreements, instruments or documents or conferred by law, are cumulative and may be exercised alone or simultaneously. ARTICLE 9. ATTORNEY-IN-FACT 9.01 Attorney-In-Fact. Upon demand on the Note or the occurrence of an Event of Default and at all times thereafter, the Borrower hereby irrevocably appoints the Lender, or its designee, as the Borrower's true and lawful attorney-in-fact, with full power as follows: (1) to endorse the name of the Borrower on any assignments, notes, checks, drafts, money orders, or other instruments of payment for Collateral; (2) to sign or endorse the name of the Borrower on any negotiable instrument, invoice, freight or express bill, bill of lading, storage or warehouse receipts, drafts, assignments, verifications and notices in connection with Accounts; (3) to obtain, adjust, settle and cancel, in the Borrower's name, insurance policies as required by Section 6.01(D) and to sign the Borrower's name on settlement checks or drafts; (4) in the Borrower's name, to do any act which this Agreement requires Borrower to do, and, (5) to give notice to the United States Post Office to effect changes of address so that mail addressed to the Borrower may be delivered directly to the Lender. In exercising this power-of-attorney, the Lender shall not be liable to the extent that it acts in good faith. ARTICLE 10. MISCELLANEOUS 10.01 Construction. The provisions of this Agreement shall be in addition to those of any security agreement, note, or other evidence of liability now or hereafter held by the Lender, all of which shall be construed as complementary to each other. To the extent that there appears any conflicts between and among the documents, the order of precedence in their construction shall be (1) the Note, (2) this Agreement and (3) other ancillary agreements and documents presented at Closing. Nothing herein contained shall prevent the Lender from enforcing any or all other security agreements, notes, or other evidences of liability in accordance with their respective terms. 10.02 Further Assurance. From time to time, the Borrower will execute and deliver to the Lender such additional documents and will provide such additional information as the Lender may reasonably require to carry out the terms of this Agreement and be informed of the status and affairs of the Borrower. 10.03 Enforcement and Waiver by the Lender. The Lender shall have the right at all times to enforce the provisions of this Agreement and the Collateral Documents in strict accordance with the terms hereof and thereof, notwithstanding any conduct or custom on the part of the Lender in refraining from so doing at any time or times. The failure of the Lender at any time or times to enforce its rights under such provisions, strictly in accordance with the same, shall not be construed as having created a custom in any way or manner contrary to specific provisions of this Agreement or as having in any way or manner modified or waived the same. All rights and remedies of the Lender are cumulative and concurrent and the exercise of one right or remedy shall not be deemed a waiver or release of any other right or remedy. 10.04 Expenses of the Lender. The Borrower will, on demand, reimburse the Lender for all expenses, including the reasonable fees and expenses of legal counsel for the Lender, incurred by the Lender in connection with the preparation, administration, amendment, modification, or enforcement of this Agreement and the Collateral Documents and the collection or attempted collection of any of the Obligations. 10.05 Notices. Any notices or consents required or permitted by this Agreement shall be in writing and shall be deemed delivered if delivered in person or if sent by certified mail, postage prepaid, return receipt requested, facsimile or telegraph, as follows, unless such address is changed by written notice hereunder: (A) If to the Borrower: Vivid Technologies, Inc. 10E Commerce Way Woburn, Massachusetts 01801 Attention: Stephen A. Reber, President With a copy to: Jeffrey L. Keffer, Esquire Brown, Rudnick, Freed & Gesmer One Financial Center Boston, Massachusetts 02111 (B) If to the Lender: BankBoston, N.A. 7 New England Executive Park Burlington, Massachusetts 01803 Attention: David J. Gerbereux, Vice President and to: Richard A. Sheils, Jr., Esquire Bowditch & Dewey, LLP 311 Main Street Worcester, Massachusetts 01608 10.06 Waiver and Indemnification by the Borrower. To the maximum extent permitted by applicable Laws, the Borrower: (A) Waives (1) protest of all commercial paper at any time held by the Lender on which the Borrower is in any way liable; (2) except as the same may herein be specifically granted, notice of acceleration and of intention to accelerate; and (3) notice and opportunity to be heard, after acceleration in the manner provided in Section 7.02, before exercise by the Lender of the remedies of self- help, set-off, or of other summary procedures permitted by any applicable Laws or by any agreement with the Borrower, and, except where required hereby or by any applicable Laws, notice of any other action taken by the Lender; and (B) Indemnifies the Lender and its officers, attorneys, agents, and employees from all claims for loss or damage caused by any act or omission on the part of any of them except willful misconduct. 10.07 Participation. Notwithstanding any other provision of this Agreement, the Borrower understands that the Lender may at any time enter into participation agreements with one or more participating banks whereby the Lender will allocate certain percentages of its commitment to them. The Borrower acknowledges that, for the convenience of all parties, this Agreement is being entered into with the Lender only and that its obligations under this Agreement are undertaken for the benefit of, and as an inducement to, any such participating bank as well as the Lender, and the Borrower hereby grants to each such participating bank, to the extent of its participation in the Loan, the right to set off deposit accounts maintained by the Borrower with such bank. 10.08 Applicable Law. This Agreement is entered into and performable in the Commonwealth of Massachusetts and shall be subject to and construed and enforced in accordance with the laws of the Commonwealth of Massachusetts. 10.09 Binding Effect, Assignment, and Entire Agreement. This Agreement shall inure to the benefit of, and shall be binding upon, the respective successors and permitted assigns of the parties hereto. The Borrower has no right to assign any of its rights or obligations hereunder without the prior written consent of the Lender. This Agreement, including the Exhibits hereto, all of which are hereby incorporated herein by reference, and the documents executed and delivered pursuant hereto, constitute the entire agreement between the parties and may be amended only by a writing signed on behalf of each party. 10.10 Severability. If any provision of this Agreement shall be held invalid under any applicable Laws, such invalidity shall not affect any other provision of this Agreement that can be given effect without the invalid provision, and, to this end, the provisions hereof are severable. 10.11 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, but all of which together shall constitute but one and the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as a sealed instrument as of the day and year first above written. VIVID TECHNOLOGIES, INC. /s/ James J. Aldo By: Stephen A. Reber Witness Stephen A. Reber President BANKBOSTON, N.A. /s/ Greg Holloway By: /s/ David J. Gerbereux Witness David J. Gerbereux Vice President COMMONWEALTH OF MASSACHUSETTS Middlesex, ss May 30, 1997 Then personally appeared Stephen A. Reber, President of Vivid Technologies, Inc., and acknowledged the foregoing to be the free act and deed of said Vivid Technologies, Inc., before me. /s/ Panagiota Twomey 6/26/97 Notary Public My Commission Expires: January 1, 2004 EXHIBIT 1.19 BORROWER'S INTELLECTUAL PROPERTY 1. Patent No. 5,319,547 for "Device and Method for Inspection of Baggage and Other Objects". 2. Patent No. 5,490,218 for "Device and Method for Inspection of Baggage and Other Objects". EXHIBIT 1.20 FORM OF LANDLORD'S CONSENT AND WAIVER EXHIBIT 1.31 PERMITTED INDEBTEDNESS, PERMITTED LIENS 1. Security interest granted to BAA plc with respect to two working baggage inspection prototype systems, as more fully described as follows: Horizontal System Prototype Vertical System Prototype Part #10004-10001 Part #10004-10001 VR Model: H1 Model: VDS-1 Serial #: P002 Serial #: V001 2. Security interest granted to LDI Corporation with respect to Lease #07433 and certain computer equipment, pursuant to lease dated 7/19/94 between LDI Corporation, as lessor, and Vivid Technologies, Inc., as lessee. 3. Security interest granted to Hewlett-Packard Company with respect to Financing Agreement #414469041 and certain computer hardware and equipment pursuant to lease dated 7/28/95 between Hewlett-Packard Co., as lessor and Vivid Technologies Co., as lessee. EXHIBIT 1.36 EXISTING SUBORDINATED INDEBTEDNESS EXHIBIT 2.03 DEMAND LINE OF CREDIT NOTE $5,000,000.00 Framingham, Massachusetts May 30, 1997 FOR VALUE RECEIVED, VIVID TECHNOLOGIES, INC., a Delaware corporation with its principal place of business at 10E Commerce Way, Woburn, Massachusetts (the "Borrower"), promises to pay to BAYBANK, N.A. (the "Lender"), or order, ON DEMAND, at the Lender's branch office at 7 New England Executive Park, Burlington, Massachusetts, the principal sum of FIVE MILLION AND 00/100 DOLLARS ($5,000,000.00) (or such lesser amount as may have been advanced to the Borrower from time to time hereunder), in lawful money of the United States of America, with interest from the date of advancement thereof on the unpaid balance at the rate and in the manner hereinafter provided. This Note evidences indebtedness for one or more advances to the Borrower's order pursuant to a Demand Line of Credit Loan and Security Agreement dated of even date herewith by and between the Borrower and the Lender, the terms, conditions and provisions of which are incorporated herein by reference, as the same may from time to time be amended (the "Agreement"). No reference to the Agreement nor any provision thereof shall affect or impair the absolute and unconditional obligation of the Borrower to pay the principal of and interest on this Note as herein provided. Capitalized terms not otherwise defined herein shall have the meanings ascribed to them in the Agreement. The unpaid principal balance of this Note from time to time outstanding shall bear interest at the rate per annum selected by the Borrower pursuant to Section 2.05 of the Agreement. Interest shall be computed on the basis of the actual number of days elapsed over a year assumed to have 360 days. Principal and interest hereunder shall be payable in accordance with the applicable provisions of Section 2.06 of the Agreement. All indebtedness evidenced by this Note, if not sooner paid, shall in any event be due and payable on February 28, 1998 (the "Maturity Date"), without further notice or demand. Prepayment of this Note shall be governed by the applicable provisions of Section 2.05 of the Agreement. The Borrower may borrow, repay and reborrow the principal hereunder prior to the Maturity Date in accordance with the terms of the Agreement, provided (i) there has been no occurrence of an Event of Default or (ii) the Lender has not made demand on the Borrower. Each payment made hereunder shall be applied first to interest then due on the unpaid balance of principal and then to principal. Upon expiration of any applicable grace period, overdue payments of principal (whether at stated maturity, by acceleration or otherwise) and, to the extent permitted by law, overdue interest, shall bear interest, compounded monthly and payable on demand in immediately available funds, at a rate per annum equal to four percent (4.00%) above the Prime Rate, fully floating; provided that if such interest exceeds the maximum amount permitted to be paid under applicable law, then such interest shall be reduced to such maximum permitted amount. If a payment of principal or interest due hereunder is not made within ten (10) days of its due date, the Borrower will also pay on demand in addition thereto a late charge equal to five percent (5.00%) of the amount of such payment. The indebtedness evidenced by this Note is secured as set forth in the Agreement. Any deposits or other sums at any time credited by or due from the holder to the Borrower or any endorser or guarantor hereof and any securities or other property of the Borrower or any endorser or guarantor hereof at any time in the possession or custody of the holder may at all times be held and treated as collateral security for the payment of this Note and any and all other liabilities (direct or indirect, absolute or contingent, sole, joint or several, secured or unsecured, due or to become due, now existing or hereafter arising) of any such maker to the holder. Upon the occurrence of an Event of Default, the holder may apply or set-off such deposits or other sums against such liabilities at any time. The Borrower and each guarantor, endorser or other person now or hereafter liable for the payment of any of the indebtedness evidenced by this Note, severally agree, by making, guaranteeing or endorsing this Note or by making any agreement to pay any of the indebtedness evidenced by this Note, to waive presentment for payment, protest and demand, notice of protest, demand and or dishonor and nonpayment of this Note, and consents, on one or more occasions, without notice or further assent (a) to the substitution, exchange or release of the collateral securing this Note or any part thereof at any time, (b) to the acceptance or release by the holder or holders hereof at any time of any additional collateral or security for or other guarantors of this Note, (c) to the modification or amendment, at any time, and from time to time, of this Note, the Agreement, or any instrument securing this Note at the request of any person liable hereon, (d) to the granting by the holder hereof of any extension of the time for payment of this Note or for the performance of the agreements, covenants and conditions contained in this Note, the Agreement, or any other instrument securing this Note, at the request of any person liable hereon, and (e) to any and all forbearances and indulgences whatsoever. Such consent shall not alter or diminish the liability of any person. The Borrower agrees to pay all expenses and costs, including reasonable attorneys' fees and costs of collection, which may be incurred by the holder hereof in connection with the enforcement of any obligations hereunder, including without limitation representation of the holder in any bankruptcy or insolvency proceedings in which the Borrower is a party in interest. IN WITNESS WHEREOF, the Borrower has executed this Note by its duly authorized officer as an instrument under seal as of the day and year first written above. VIVID TECHNOLOGIES, INC. __________________________ By:________________________________ Witness Stephen A. Reber, President __________________________ By: /s/ William J. Frain Witness William J. Frain, Treasurer EXHIBIT 5.01(A) CORPORATE BORROWER AND SUBSIDIARY INFORMATION Vivid Technologies, Inc. (Delaware corporation) 10E Commerce Way Woburn, MA 01801 Vivid Technologies UK, Ltd. (UK company) Murlain House, Union Street Chester, England CH1 1QP Vivid Technologies UK, Ltd. is 100% owned by Vivid Technologies, Inc. EXHIBIT 5.01(F) PENDING LITIGATION NONE EXHIBIT 5.01(N) EXISTING INDEBTEDNESS 1. Obligations to BAA Plc in connection with two baggage inspection systems - Model H1, Serial #P002 and Model VDS-1, Serial #V001. 2. Obligations to LDI Corporation in connection with Lease #07433 and certain computer equipment. 3. Obligations to Hewlett-Packard Company in connection with Financing Agreement #414469041. EXHIBIT 5.01(O) MATERIAL LEASES, CONTRACTS, COMMITMENTS 1. Commercial Lease between Cummings Properties Management, Inc. and Vivid Technologies, Inc. dated December 19, 1995. 2. License and Technology Agreement dated as of June 22, 1989 between Hologic, Inc. and Vivitech, Inc. 3. Management Services Agreement between Hologic, Inc. and Vivitech, Inc. dated as of June 22, 1989. 4. Vivid Technologies, Inc. has a verbal agreement with its subsidiary, Vivid Technologies UK Ltd., pursuant to which Vivid Technologies, Inc. pays for certain administration, marketing, sales and customer support activities performed on behalf of Vivid Technologies, Inc. in Europe. 5. Series A and Series B Preferred Stock Purchase Agreement. 6. Series C and Series D Preferred Stock Purchase Agreement. 7. Purchase Agreement dated as of April 20, 1994 between Vivid Technologies, Inc. and BAA, Plc. EX-11 4 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE Exhibit 11.01 VIVID TECHNOLOGIES, INC. AND SUBSIDIARIES STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE Fiscal Year Ended September 30, 1995 1996 1997 PRIMARY: Net income $ 2,014,075 $ 1,164,764 $ 5,865,578 Weighted average common shares outstanding 1,663,066 1,682,109 8,809,427 Assumed conversion of Series B and Series D convertible preferred stock (1) 5,045,850 5,045,850 -- Common stock and common stock equivalents issued within twelve months of initial public offering (2) 148,419 148,419 -- Common stock equivalents 417,803 992,475 1,028,873 Weighted average number of common and common equivalent shares outstanding 7,275,138 7,868,853 9,838,300 Per share amount $ .28 $ .15 $ .60 (1) During fiscal 1997, the Company sold, through an initial public offering, 2,300,000 shares of its Common Stock at $12.00 per share. All shares of the Company's series B and series D convertible Preferred Stock were automatically converted into 5,045,850 shares of Common Stock at the time of the initial public offering and are assumed to be issued Common Stock as of October 1, 1996 (2) Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, stock, stock options and stock warrants issued at prices below the initial public offering price during the 12-month period immediately preceding the initial filing date of the Company's Registration Statement of its initial public offering have been included as outstanding for all periods presented prior to the initial public offering using the treasury-stock method and the public offering price. EX-23 5 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit 23.01 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statement File No. 333-25049. ARTHUR ANDERSEN LLP EX-27 6 FINANCIAL DATA SCHEDULE FOR 1997 FORM 10-K
5 12-MOS SEP-30-1997 OCT-01-1996 SEP-30-1997 11,571,630 6,432,405 9,493,519 0 6,195,096 35,042,169 2,615,904 1,531,709 37,456,597 5,745,416 0 0 0 94,967 31,616,214 37,456,597 31,702,188 31,702,188 13,202,925 24,505,035 0 0 2,040 8,058,913 2,193,335 5,865,578 0 0 0 5,865,578 .60 .60
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