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Friday, January 2, 1998

InVision Technologies, Inc.
(Nasdaq: INVN)
Phone: 650-578-1930
Website: http://www.invision-tech.com
Price (12/31/97): $7 5/8


HOW DID IT FIND TROUBLE?

Shortly after InVision went public in April 1996, the ill-fated TWA Flight 800 exploded off the coast of Long Island. That tragedy sent the shares of InVision and other makers of bomb detection equipment soaring.

Since then, a White House commission headed by Vice President Gore stirred Congress to dole out $144 million for the deployment of advanced security gear at U.S. airports. Some $52.2 million was allocated for the kind of explosive detection systems (EDS) that InVision makes.

The Federal Aviation Administration (FAA) inked a deal with InVision in December 1996 that has led to a terrific year for the company. Third quarter results showed revenues up 290% to $15.5 million. Excluding one-time acquisition costs, it earned $0.15 per share versus a year earlier loss of $0.05 per share. Results for the first nine months of the year are comparable, with EPS of $0.37 versus a loss of $0.50.

The company shipped 16 of its CTX 5000 explosive detection systems during the third quarter, raising this year's total to 38. While InVision is already delivering 50% gross margins, its new headquarters figures to improve manufacturing efficiencies... if orders keep flowing in.

That uncertainty about future orders, though, has weighed on the shares. The FAA is InVision's biggest customer, but Congress must allocate more money before the agency springs for more systems.

In an October 29 press release, CEO Sergio Magistri said he was "not aware of specific funding for additional EDS purchases in the current 1998 federal budget," but he believed "that federal funds will be made available for follow-on orders from the FAA during the government's fiscal year 1998."

Despite InVision's better-than-expected earnings, the stock fell from $12 3/8 to $10 11/16 on that comment. It has continued to slide because, despite InVision's X-ray specs, there is poor earnings visibility ahead.

BUSINESS DESCRIPTION

InVision develops and manufactures bomb detection systems based on advanced computed tomography (CT or CAT scan) technology acquired from its former parent, Imatron (Nasdaq: IMAT). Its CTX 5000 is currently the only device certified by the FAA for use in inspecting luggage on commercial airline flights.

The CTX 5000 sells for $1 million apiece, making it more expensive than competing systems. It is also up to 70% slower, handling just 300 bags per hour. However, InVision's systems can check luggage from every angle, making them better and more accurate at detecting explosives.

As of September, the company had received orders for 112 units (54 ordered by the FAA), with 66 already shipped to 15 airports in ten countries, including Tel Aviv's Ben Gurion International, London's Heathrow, and New York's JFK. For the first nine months of 1997, five large customers accounted for 86% of revenue. Half of the sales have come from international customers.

In September, the company acquired Quantum Magnetics, a firm known for its quadrupole resonance technology, which can be used to improve InVision's CT systems. Because Quantum's QSCAN-500 can identify hard-to-detect compounds in sheet and plastic explosives, the FAA recently purchased several units to complement airport x-ray systems.

Competitors include Vivid Technologies (Nasdaq: VVID), EG&G Astrophysics, Heimann Systems GmbH, Thermedics Detection (AMEX: TDX), former Double Barringer (Nasdaq: BARR), and Lockheed Martin (NYSE: LMT).

InVision insiders own 12% of the shares and primary investor Harax Holdings controls another 22%. In October, the company moved into a new headquarters in Newark, California, consolidating the operations of three sites.

FINANCIAL FACTS

Income Statement
12-month sales: $42.6 million
12-month income: $4.1 million*
12-month EPS: $0.35*
Profit Margin: 9.6%*
Market Cap: $98 million
(*Includes third quarter acquisition charge amounting to $0.07 per share)

Balance Sheet
Cash & Securities: $18.7 million
Current Assets: $46.1 million
Current Liabilities: $17.1 million
Long-term Debt: $0.3 million

Ratios
Price-to-earnings: 21.8
Price-to-sales: 2.3

HOW COULD YOU HAVE SEEN IT COMING?

Any stock that rockets ahead on hype about possible sales merits skepticism. Even in a case like this one where the sales pan out, an investor should expect volatility, even Trouble.

The recent implosion owes a lot to the simple logic of valuation. Exceptional earnings growth today isn't worth much if sales might slow or even contract in the near future. Companies deserve earnings multiples that discount such uncertainty.

InVision depends on U.S. government spending, a tough spot to be in. Even when money is appropriated, it may not flow as quickly as expected. Plus, since the FAA has provided seed money to develop the industry, it may want to develop some competition, too, before placing more orders.

Also, a company's move to a new headquarters often represents a market top, as executives become overly optimistic about future prospects only to find they've saddled themselves with higher overhead expenses at precisely the time when sales begin to slow. That's a possible scenario here.

WHERE TO FROM HERE?

At the end of September, InVision had an order backlog for 46 CTX 5000 units good for about $47 million in revenues. Its new Quantum subsidiary has also been picking up its first contracts: one with the FAA for 2 to 5 QSCAN-500s (up to $2.3 million total) and another worth $4.5 million to develop new landmine detection equipment for the Defense Advanced Research Projects Agency (DARPA).

Add a total of $11 million in research contracts, then, to the $47 million backlog, and it looks like InVision has enough work to maintain current sales for nearly another year. Its future depends on continued spending by the FAA, new business from international customers, and the development of new markets for its products.

Because of the evaluation process, it usually takes InVision 6 to 12 months to close a deal. Assuming the U.S. government's support for the CTX 5000 has encouraged new international customers to give the scanner a serious inspection, it's about time to see some new orders. The latest contract announced, though, was a follow-on for one unit for London's Gatwick airport.

First Call shows consensus earnings estimates of $0.55 per share for FY97 and $0.85 for FY98. The range of individual estimates is quite wide, but the numbers have recently inched up even as the stock price has fallen. One analyst is projecting 35% annual growth for the company and 18% growth for the industry. Using the lowball $0.72 per share estimate for next year and the industry growth rate gives us a YPEG fair value of $13, suggesting that the stock could nearly double in the next year.

Still, that assumes a level of revenue growth that is far from assured. The stock is more interesting at these levels, but it's hard to get enthusiastic about InVision until its international biz markedly picks up, the FAA makes additional commitments, or, regrettably, there's a new wave of terrorism to encourage both.

-- Louis Corrigan
(TMFSeymor@aol.com)


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