INTEGRAL VISION INC - 10-Q Quarterly Report

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

FORM 10-Q

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly period ended June 30, 2003.

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period
from to .

Commission File Number 0-12728

INTEGRAL VISION, INC.
(Exact name of registrant as specified in its charter)


Michigan (State or other jurisdiction of incorporation or organization)		38-2191935 (I.R.S. Employee Identification Number)

38700 Grand River Avenue, Farmington Hills, Michigan (Address of principal executive offices)		48335 (Zip Code)

Registrant’s telephone number, including area code: (248) 471-2660

Former name, former address and former fiscal year, if changed since last report:
Not Applicable

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 the filing requirements for the past 90 days.


YES	ü	NO

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES NO ü

The number of shares outstanding of the registrant’s Common Stock, no par value, stated value $.20 per share, as of July 31, 2003 was 9,429,901.

TABLE OF CONTENTS


Part I — Financial Information
	Item 1. Financial Statements
		Consolidated Balance Sheets
		Consolidated Statements of Operations
		Consolidated Statement of Stockholders’ Deficit
		Consolidated Statements of Cash Flows
		Notes to Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Disclosure Controls and Procedures
Part II — Other Information
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
Certification of Chief Executive Officer
Certification of Chief Financial Officer
906 Certification
906 Certification

INTEGRAL VISION, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q


			PAGE

Part I — Financial Information
	Item 1. Financial Statements
		Consolidated Balance Sheets		3
		Consolidated Statements of Operations		5
		Consolidated Statement of Stockholders’ Deficit		7
		Consolidated Statements of Cash Flows		8
		Notes to Consolidated Financial Statements		9
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
	Item 3. Quantitative and Qualitative Disclosures about Market Risk			26
	Item 4. Disclosure Controls and Procedures			26
Part II — Other Information
	Item 1. Legal Proceedings			27
	Item 2. Changes in Securities and Use of Proceeds			27
	Item 3. Defaults Upon Senior Securities			27
	Item 4. Submission of Matters to a Vote of Security Holders			28
	Item 5. Other Information			28
	Item 6. Exhibits and Reports on Form 8-K			28
Signatures				30
Certifications				31

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

INTEGRAL VISION, INC. AND SUBSIDIARY
Consolidated Balance Sheets


		June 30,			December 31,
		2003			2002

		(Unaudited)
		(in thousands)
ASSETS
CURRENT ASSETS
	Cash	$	25		$	81
	Accounts receivable, less allowance of $166,000 ($170,000 in 2002)		93			153
	Inventories — Note A		125			328
	Note Receivable — Note G		—			30
	Other current assets		12			51

TOTAL CURRENT ASSETS			255			643
PROPERTY, PLANT AND EQUIPMENT
	Leasehold Improvements		43			43
	Production and engineering equipment		153			153
	Furniture and fixtures		73			73
	Vehicles		18			18
	Computer equipment		205			203

			492			490
	Less accumulated depreciation		(447	)		(431	)

			45			59
OTHER ASSETS
	Capitalized computer software development costs, less accumulated amortization of $7,398,000 ($7,301,000 in 2002) — Note A		419			516
	Patents, less accumulated amortization of $405,000 ($382,000 in 2002) — Note A		68			90

			487			606

		$	787		$	1,308

See notes to consolidated financial statements.

INTEGRAL VISION, INC. AND SUBSIDIARY
Consolidated Balance Sheets — Continued


		June 30,			December 31,
		2003			2002

		(Unaudited)
		(in thousands)
LIABILITIES AND STOCKHOLDERS’ DEFICIT
CURRENT LIABILITIES
	Notes payable — Notes C & G	$	1,092		$	967
	Accounts payable		485			678
	Accrued compensation and related costs — Note G		326			331
	Accrued state income taxes — Note B		201			204
	Accrued interest — Note C		255			170
	Other accrued liabilities		92			95
	Customer deposits		—			204
	Current maturities of long-term debt — Note C		257			—

TOTAL CURRENT LIABILITIES			2,708			2,649
LONG-TERM DEBT, less current maturities and O.I.D. — Note C			1,111			962

TOTAL LIABILITIES			3,819			3,611
STOCKHOLDERS’ DEFICIT
	Common stock, without par value, stated value $.20 per share; 25,000,000 shares authorized; 9,429,901 shares issued and outstanding		1,886			1,886
	Additional paid-in capital		31,497			31,376
	Accumulated deficit		(36,415	)		(35,565	)

Total Stockholders’ Deficit			(3,032	)		(2,303	)

		$	787		$	1,308

See notes to consolidated financial statements.

INTEGRAL VISION, INC. AND SUBSIDIARY
Consolidated Statements of Operations


		Three Months Ended June 30,
		2003			2002

		(Unaudited)
		(In thousands, except per share data)
Net revenues		$	128		$	503
Costs of sales:
	Direct costs of sales		43			256
	Depreciation and amortization		66			89

Total costs of sales			109			345

Gross margin			19			158
Other costs and expenses:
	Marketing		60			160
	General and administrative		221			393
	Engineering and development		174			204

Total other costs and expenses			455			757

Operating loss			(436	)		(599	)
Other income			22			13
Interest expense — Note C			(84	)		(56	)
Foreign currency translation loss — Note L			—			(208	)

Loss from operations before income taxes			(498	)		(850	)
Provision(benefit) for income taxes			—			—

Net loss		$	(498	)	$	(850	)

Basic and diluted earnings per share:
	Net loss	$	(0.05	)	$	(0.09	)

Weighted average number of shares of common stock and common stock equivalents, where applicable			9,430			9,430

See notes to consolidated financial statements.

INTEGRAL VISION, INC. AND SUBSIDIARY
Consolidated Statements of Operations


		Six Months Ended June 30,
		2003			2002

		(Unaudited)
		(In thousands, except per share data)
Net revenues		$	540		$	826
Costs of sales:
	Direct costs of sales		258			472
	Depreciation and amortization		132			183

Total costs of sales			390			655

Gross margin			150			171
Other costs and expenses:
	Marketing		109			346
	General and administrative		429			709
	Engineering and development		356			395

Total other costs and expenses			894			1,450

Operating loss			(744	)		(1,279	)
Other income			48			25
Interest expense — Note C			(154	)		(113	)
Foreign currency translation loss — Note L			—			(208	)

Loss from operations before income taxes			(850	)		(1,575	)
Provision (benefit) for income taxes — Note B			—			(90	)

Net loss		$	(850	)	$	(1,485	)

Basic and diluted earnings per share:
	Net loss	$	(0.09	)	$	(0.16	)

Weighted average number of shares of common stock and common stock equivalents, where applicable			9,430			9,430

See notes to consolidated financial statements.

INTEGRAL VISION, INC. AND SUBSIDIARY
Consolidated Statement of Stockholders’ Deficit


		Number of
		Common
		Shares				Additional		Accumulated
		Outstanding		Common Stock		Paid-In Capital		Deficit			Total

		(in thousands, except number of common shares outstanding)
Balance At December 31, 2002			9,429,901	$	1,886	$	31,376	$	(35,565	)	$	(2,303	)
	Net loss for the period								(850	)		(850	)
	Issuance of warrants						121					121

Balance At June 30, 2003			9,429,901	$	1,886	$	31,497	$	(36,415	)	$	(3,032	)

See notes to consolidated financial statements.

INTEGRAL VISION, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows


				Six Months Ended June 30,
				2003			2002

				(Unaudited)
				(in thousands)
Operating Activities
	Net loss			$	(850	)	$	(1,485	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation			16			97
		Amortization			157			178
		Changes in operating assets and liabilities:
			Accounts receivable		60			48
			Inventories		203			155
			Prepaid and other		69			227
			Accounts payable and other current liabilities		(296	)		(320	)

Net Cash Used In Operating Activities					(641	)		(1,100	)
Investing Activities
	Purchase of property and equipment				(2	)		—
	Other				(1	)		(5	)

Net Cash Used In Investing Activities					(3	)		(5	)
Financing Activities
	Proceeds from sale of Class 2 Notes				405			250
	Repayments on Class 2 Notes				(259	)
	Proceeds from other short term notes				27
	Repayments on short term notes				(75	)
	Proceeds from sale of Class 1 Notes, net of discount				369			493
	Proceeds from sale of warrants				121			97

Net Cash Provided By Financing Activities					588			840

Effect of Exchange Rate Changes on Cash					—			211

Decrease in Cash					(56	)		(54	)
Cash at Beginning of Period					81			125

Cash at End of Period				$	25		$	71

Supplemental cash flow disclosure:
	Interest Paid			$	33		$	31

See notes to consolidated financial statements.

INTEGRAL VISION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 2003
(Unaudited)

Note A — Summary of Significant Accounting Policies

Nature of Business

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its 100% owned subsidiary: Integral Vision LTD, United Kingdom. Upon consolidation, all significant intercompany accounts and transactions are eliminated.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and notes thereto included in Integral Vision’s Annual Report on Form 10-K for the year ended December 31, 2002.

Use of 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. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Translation of Foreign Currencies

The financial statements of Integral Vision LTD are translated into United States dollar equivalents at exchange rates as follows: balance sheet accounts at year-end rates; income statement accounts at average exchange rates for the year. Transaction gains and losses are reflected in net earnings and are not significant.

Reclassifications

Certain amounts have been reclassified in prior periods’ presentations to conform to the current year’s presentation.

Accounts Receivable

Trade accounts receivable primarily represent amounts due from equipment manufacturers and end-users in North America, Asia and Europe. The Company maintains an allowance for the inability of our customers to make required payments. These estimates are based on historical data, the length of time the receivables are past due and other known factors.

Inventories

Inventories are stated at the lower of standard cost, which approximates actual cost determined on a first-in, first-out basis, or market. At June 30, 2003 and December 31, 2002, inventories consisted of the following (net of allowance of $605,000 at June 30, 2003 and $561,000 at December 31, 2002):


	June 30,		December 31,
	2003		2002

	(Unaudited)
	(in thousands)
Raw materials	$	82	$	112
Work in process		43		216

	$	125	$	328

Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating these components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves for obsolete and slow-moving parts ranging from 0% for active parts with sufficient forecasted demand up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.

Impairment of Long-lived Assets

The Company reviews its long-lived assets, including property, equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount of the asset.

Capitalized Computer Software Development Costs

Computer software development costs are capitalized after the establishment of technological feasibility of the related technology. These costs are amortized following general release of products based on current and estimated future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product (not to exceed 5 years). Management continually reviews the net realizable value of capitalized software costs. At the time that a determination is made that capitalized software amounts exceed the estimated net realizable value of amounts capitalized, any amounts in excess of the estimated realizable amounts are written off.

Property and Equipment

Property and equipment is stated on the basis of cost. Expenditures for normal repairs and maintenance are charged to operations as incurred.

Depreciation is computed by the straight-line method based on the estimated useful lives of the assets (buildings-40 years, other property and equipment-3 to 10 years).

Patents

Patents are stated at cost less accumulated amortization and are amortized on a straight-line basis over the estimated useful lives of the assets (not to exceed 5 years).

Revenue Recognition

The Company recognizes revenue in accordance with SOP 97-2, Software Revenue Recognition and Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured.

The Company accounts for certain product sales of its flat panel display inspection systems as multiple-element arrangements. If specific customer acceptance requirements are met, the Company recognizes revenue for a portion of the total contract price due and billable upon shipment, with the remainder recognized when it becomes due (generally upon acceptance). The Company recognizes all other product sales with customer acceptance provisions upon final customer acceptance. The Company recognizes revenue from the sale of spare parts upon shipment. Revenue from service contracts is recognized over the life of the contract. Revenue is reported net of sales commissions.

Concentrations of Credit and Other Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable. A significant portion of the Company’s customers are located in Asia, primarily Japan, Taiwan, and Korea, and in Europe. Therefore, the Company’s sales to these countries may be adversely affected by the overall health of these economies, including the effects of currency exchange rate fluctuations and political risks. The Company generally does not require collateral for most of its trade accounts receivable. For sales to some of its customers in certain geographic regions, the Company requires letters of credit. Substantially all of the Company’s revenue is invoiced in U.S. dollars. For the six months ended June 30, 2003, sales to three of the Company’s customers represented $514,000 of the Company’s total revenue of $540,000 for the period. The Company believes its credit evaluation and monitoring mitigates its credit risk.

Advertising

Advertising costs are expensed as incurred. Advertising costs were approximately $5,000 for the six months ended June 30, 2003 and $63,000 for the comparable 2002 period.

Income Taxes

The Company accounts for income taxes in accordance with FASB Statement No. 109, Accounting for Income Taxes (“FAS 109”), which requires the use of the liability method in accounting for income taxes. Under FAS 109, deferred tax assets and liabilities are measured based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates and laws that will be in effect when differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for net deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize their benefit, or future deductibility is uncertain.

Fair Value Disclosure

The carrying amounts of certain financial instruments such as cash, accounts receivable, notes receivable, accounts payable and long-term debt approximate their fair values. The fair value of the long-term financial instruments is estimated using discounted cash flow analysis and the Company’s current incremental borrowing rates for similar types of arrangements.

Contingencies and Litigation

The Company makes an assessment of the probability of an adverse judgment resulting from current and threatened litigation. The Company accrues the cost of an adverse judgment if, in Management’s estimation, an adverse settlement is probable and Management can reasonably estimate the ultimate cost of such litigation. The Company has made no such accruals at June 30, 2003.

Stock Options and Warrants

The Company has elected to follow APB No. 25 “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has elected to adopt only the disclosure provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.”

Pro forma information regarding net income and earnings per share is required by FAS 123 and has been determined as if the Company had accounted for its employee stock options granted subsequent to September 30, 1995 under the fair value method of FAS 123. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:


	Six Months Ended			Six Months Ended
	June 30, 2003			June 30, 2002

Dividend yield		0.0	%		0.0	%
Expected stock price volatility		1.172			0.833
Risk free interest rate		2.0	%		3.0	%
Expected life of options (years)		7.00			7.40

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The following table presents net income and basic and diluted earnings per common share, had the Company elected to recognize compensation cost based on the fair value at the grant dates for stock option awards, consistent with the method prescribed by SFAS 123, as amended by SFAS 148:


	Three Months Ended June 30,						Six Months Ended June 30,

	2003			2002			2003			2002

				(in thousands, except per share data)
Net loss:
Net loss, as reported	$	(498	)	$	(850	)	$	(850	)	$	(1,485	)
Add: Stock-based compensation expense included in the determination of net loss as reported, net of related tax effects		—			—			—			—
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects		(6	)		(8	)		(6	)		(16	)

Pro forma net loss	$	(504	)	$	(858	)	$	(856	)	$	(1,501	)

Basic and diluted earnings per share:
Basic and diluted — as reported	$	(0.05	)	$	(0.09	)	$	(0.09	)	$	(0.16	)

Basic and diluted — pro forma	$	(0.05	)	$	(0.09	)	$	(0.09	)	$	(0.16	)

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock option plan has 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 such Company options.

The Compensation Committee of the Board of Directors approves option grants. The option price is the market price on the date of the grant, vesting generally occurs after one year and the expiration occurs ten years from the date of the grant. In January 2002, the Compensation Committee of the Company’s Board of Directors resolved to grant 225,000 qualified stock options for the purchase of common shares with an exercise price of $.10 per share. In order to facilitate this grant, Mr. Charles Drake, the Company’s Chairman, agreed to forfeit options on 144,000 shares so that they could be distributed to other key people. In March 2002, 55,000 qualified and 20,000 non-qualified stock options for the purchase of common shares were granted with an exercise price of $.24 per share. In May 2003, 180,000 qualified stock options for the purchase of common shares were granted with an exercise price equal to the market price at the close of trading on the grant dates. Options for the purchase of 115,000 shares of the Company’s common stock were granted with an exercise price of $.15 per share and options on 65,000 shares were granted with an exercise price of $.16 per share. In order to facilitate this grant, Mr. Charles Drake, the Company’s Chairman, agreed to forfeit options on 156,000 shares so that they could be distributed to other key people. These options had an exercise price of $1.07 per share. At June 30, 2003, there were options outstanding to purchase 1,053,000 shares of common stock at prices ranging from $.10 to $9.25 per share.

Under the terms of the Company’s Note and Warrant Purchase agreement, as amended, Integral Vision issues warrants for the purchase of the Company’s common stock in connection with placements of debt under the plan. In March 2003, the holders of Class 1 and Class 2 Notes at December 31, 2002 agreed to a modification to the Note and Warrant Purchase Agreement that extended the due dates, increased the maximum amount of Notes outstanding to $2.5 million, and changed the conversion price on warrants previously issued under the plan to $.25 per share. During the six months ended June 30, 2003, warrants for the purchase of 1,960,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $490,000 of the Class 1 Notes. Mr. Charles J. Drake, the Company’s chairman, purchased $180,000 of these Notes for which he also received warrants for the purchase of 720,000 shares of the Company’s common stock. Additionally, warrants for the purchase of 50,671 shares of the Company’s common stock were issued in connection with payments made on Class 2 Notes. At June 30, 2003, warrants for the purchase of 5,273,812 shares of the Company’s common stock had been issued under the plan with a conversion price of $.25 per share. In total, in connection with note purchases under this plan, Mr. Drake has received warrants for the purchase of 1,770,000 shares of the Company’s common stock. Additionally, Max A. Coon (a director of the Company) and Maxco, Inc. (a 25% owner of the Company) have received warrants for the purchase of the Company’s common stock totaling 270,000 shares and 240,000 shares, respectively. Certain holders of Class 2 Notes at June 30, 2003 have the option to convert their notes to Class 1 Notes which would result in additional warrants for the purchase of 1,220,000 shares of the Company’s common stock. Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes at which time they also received warrants for the purchase of 1,020,000 shares of the Company’s common stock with a conversion price of $.25 per share.

Subsequent to June 30, 2003, warrants for the purchase of 680,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $170,000 of Class 1 Notes. Included in these amounts were $30,000 of Class 1 Notes that were purchased by Mr. Drake, for which he also received warrants for the purchase of 120,000 shares of the Company’s common stock with a conversion price of $.25 per share. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003. If the conversion option is exercised, the note holder would receive warrants for the purchase of 300,000 shares of the Company’s common stock with a conversion price of $.25 per share.

Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million.

In connection with the private placement of $7.0 million of debentures in 1997, which were retired in 1999, the Company issued warrants for the purchase of 1,400,000 Integral Vision common shares at $6.86 per share through June 30, 2004, all of which were outstanding at June 30, 2003. Pursuant to the 1997 Note and Warrant Purchase agreement, these warrants have been re-priced based on subsequent warrant issues. At June 30, 2003, the holders of these warrants had the right to purchase up to 2,139,368 shares of the Company’s common stock at $4.49 per share.

A summary of the outstanding warrants and options at June 30, 2003 is as follows:


	Weighted				Weighted
	Average		Number		Average		Number
	Exercise Price		Outstanding		Remaining Life		Exercisable

			(number of shares in thousands)
1997 Note and Warrant Purchase Agreement	$	4.49		2,139		4.04		2,139
2001 Note and Warrant Purchase Agreement (1)	$	0.25		5,274		2.94		5,274
Qualified ISO Plan	$	6.55		58		0.18		58
1995 Employee Stock Option Plan	$	1.02		498		7.27		378
1999 Employee Stock Option Plan	$	0.23		497		8.67		142

	$	1.41		8,466		3.79		7,991

(1)

Excludes warrants exercisable under outstanding Class 2 Notes. The number of warrants available to holders of Class 2 Notes is dependent on the length of time the principal balance is outstanding and the agreed upon base exercise price.

Comprehensive Income

The Company displays components of accumulated comprehensive income (loss), if any, in the Consolidated Statement of Stockholders’ Deficit. The components of comprehensive income (loss) for the three and six months ended June 30, 2003 and 2002 are as follows:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2003			2002			2003			2002

	(unaudited)						(unaudited)
	(in thousands)						(in thousands)
Net loss	$	(498	)	$	(850	)	$	(850	)	$	(1,485	)
Translation adjustments		—			213			—			211

	$	(498	)	$	(637	)	$	(850	)	$	(1,274	)

Recently Issued Accounting Standards

In December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123.” This Statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. The Company has elected to adopt only the disclosure provisions of FASB Statement No. 123, as amended by FASB Statement No. 148, which are included in the notes to the consolidated financial statements included in this Quarterly Report on Form 10-Q.

In April 2003 the FASB issued SFAS No. 149 which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging

Activities.” This statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of SFAS No. 133, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform to language used in FASB Interpretation No. 45, and amends certain other existing pronouncements. This statement is effective for contracts entered into or modified after June 30, 2003. It is not expected that the provisions of Statement No. 149 will have a material impact on the financial position or results of operations of the Company.

In May 2003 the FASB issued SFAS No. 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. It is not expected that the provisions of Statement No. 150 will have a material impact on the financial position of the Company.

Note B — Sale of Welding Controls Division

On June 30, 1999, the Company completed an agreement to sell substantially all the assets of its Welding Controls division for $25.7 million, net of costs of the sale, for cash, the assumption of certain liabilities, and a subordinated note (WTC note). The Company incurred both Federal and State income tax liabilities as a result of the sale of the assets of it Welding Controls division. The Company paid approximately $90,000 for its 1999 alternative minimum tax liability, which resulted primarily from the gain on the sale of the Welding Controls Division. This amount was refunded to the Company in 2002 (see Note H to consolidated financial statements). Additionally, the Company incurred a Michigan Single Business Tax (SBT) liability of approximately $120,000 for the 1999 tax year as a result of the transaction. At June 30, 2003, this liability was not yet paid in full and was included in accrued state income taxes in the consolidated balance sheet. Including interest and penalties, approximately $201,000 was outstanding at June 30, 2003 for this obligation, which is included in accrued state income taxes in the consolidated balance sheet. The Company is making monthly payments of approximately $6,300 to the taxing authority.

The buyer also assumed a liability to Square D in the amount of $1.8 million in accordance with the purchase agreement. This liability resulted from the settlement of patent litigation in 1994. The settlement required payments of $300,000 per year for ten years. In the event the acquiring company fails to make the required payments, Integral Vision may be obligated for those amounts due.

Note C — Long-Term Debt and Other Financing Arrangements

At December 31, 2002, under the terms of the Company’s Note and Warrant Purchase Agreement, as amended, the Company could issue up to $2.0 million of senior debentures, which consists of Class 1 and Class 2 Notes. Class 2 Notes are working capital notes, are secured by accounts receivable of the Company, and are subordinated to the Class 1 Note holders. There was approximately $215,000 in principal and interest due to the Class 1 Note holders at December 31, 2002. In March 2003, the holders of those Notes agreed to a modification to the Note and Warrant Purchase Agreement that extended the due dates, increased the maximum amount of Notes outstanding to $2.5 million, and changed the conversion price on warrants previously issued under the plan to $.25 per share. The terms of the Class 1 Notes were changed such that all accrued interest will be due on December 31, 2003, which is projected to be approximately $310,000. Additionally, the first principal payments on the Class 1 Notes will be due on March 31, 2004 and the maturity dates extended to February 2007. The principal and interest due on March 31, 2004 is projected to be approximately $187,000. The Class 2 Notes were modified to have a due date, both principal and accrued interest, of September 30, 2003. Principal and interest due on the Class 2 notes on September 30, 2003 is projected to be approximately $475,000. Class 1 Notes issued subsequent to December 31, 2002 have maturities of up to four years, an interest rate of 10%, and the purchasers of the Notes receive warrants for the purchase of the Company’s common stock (see Note A to consolidated financial statements). The value assigned to warrants is included in additional paid-in capital and the discount is amortized over the life of the note. Additionally, the directors will determine the conversion rate at the date of issuance, subject to change in the event additional shares are issued in the future.

During the six months ended June 30, 2003, $490,000 of the Class 1 Notes were placed, $180,000 of which were purchased by the Company’s chairman Charles J Drake. At June 30, 2003, a total of $1,590,000 of the Class 1 Notes had been placed. Mr. Drake has purchased a total of $530,000 of the Company’s Class 1 Notes and Max A. Coon (a director of the Company) has purchased a total of $90,000 of the Company’s Class 1 Notes.

During the six months ended June 30, 2003, $405,000 of the Class 2 Notes were placed. The Company made principal payments of approximately $259,000 to Class 2 Note holders in the six months ended June 30, 2003. The outstanding principal balance on the Class 2 Notes was $657,000 at June 30, 2003. Certain holders of Class 2 Notes at June 30, 2003 have the option to convert their notes to Class 1 Notes. Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes.

Subsequent to June 30, 2003, $170,000 of Class 1 Notes were purchased, $30,000 of which were purchased by the Company’s chairman Charles J Drake. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003.

Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million.

At June 30, 2003, the Company had short-term notes payable to related parties of approximately $435,000. The Company’s notes to related parties included the following: a $139,000 obligation to Maxco, Inc. (a 25% owner of the Company); a $196,000 obligation to Warren, Cameron, Faust & Asciutto, P.C. (the Company’s corporate counsel); a $79,000 obligation to 2161 Limited Partnership (a partnership in which J. Michael Warren of Warren, Cameron, Faust & Asciutto, P.C. is a partner); a $10,000 obligation to Charles J. Drake (the Company’s chairman); and an $11,000 obligation to Mark R. Doede (the Company’s president). These notes have interest rates ranging from 5.5% to 8.0% and are due on demand.

A summary of the Company’s debt obligations is as follows:


		June 30,			December 31,
		2003			2002

		(in thousands)
Long Term Debt:
	Face value Class 1 Notes	$	1,590		$	1,100
	Less Original Issue Discount		(222	)		(138	)
	Less Current Maturities		(257	)		—

Net Long Term Debt		$	1,111		$	962

Short Term Debt:
	Class 2 Notes	$	657		$	511
	Other Short Term Debt		435			456

Total Short Term Debt		$	1,092		$	967

Note D — Operations by Geographic Area

The following presents information by geographic area:


		June 30,
		2003		December 31,
		(unaudited)		2002

		(in thousands)
Identifiable assets:
	United States	$	779	$	1,243
	United Kingdom		8		65

		$	787	$	1,308

Long lived assets:
	United States	$	45	$	59
	United Kingdom		—		—

		$	45	$	59


		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2003			2002			2003			2002

					(unaudited)
					(in thousands)
Net revenues from unaffiliated customers:
	United States	$	128		$	329		$	540		$	399
	Untied Kingdom		—			174			—			427

		$	128		$	503		$	540		$	826

Earnings (loss) from operations before income taxes:
	United States	$	(499	)	$	(438	)	$	(839	)	$	(1,073	)
	United Kingdom		1			(412	)		(11	)		(502	)

		$	(498	)	$	(850	)	$	(850	)	$	(1,575	)

Depreciation and amortization expense:
	United States	$	92		$	126		$	173		$	255
	United Kingdom		—			6			—			20

		$	92		$	132		$	173		$	275

Capital expenditures:
	United States	$	—		$	—		$	2		$	—
	United Kingdom		—			—			—			—

		$	—		$	—		$	2		$	—

Net revenues by geographic area:
	North America*	$	59		$	68		$	469		$	167
	Europe		—			173			1			388
	Asia		69			262			70			271

		$	128		$	503		$	540		$	826

Geographic areas that are considered individually material are listed (more than 10% of net revenues), all others are included in North America and in total are considered immaterial.

Note E — Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share:


		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2003			2002			2003			2002

					(unaudited)
					(in thousands, except per share data)
Numerator for basic and diluted earnings per share – income (loss) available to common stockholders
	Net loss	$	(498	)	$	(850	)	$	(850	)	$	(1,485	)

*there was no effect of dilutive securities see below
Denominator for basic and diluted earnings per share – weighted average shares			9,430			9,430			9,430			9,430

*there was no effect of dilutive securities see below
BASIC AND DILUTED EARNINGS PER SHARE:
	Net loss	$	(0.05	)	$	(0.09	)	$	(0.09	)	$	(0.16	)

Warrants and options outstanding were not included in the computation of diluted earnings per share because the inclusion of these options would have an antidilutive effect. For additional disclosures regarding stock options and warrants see Note A.

Note F — Sale of Optical Disc Inspection Technology

On September 9, 2002, DaTARIUS Technologies Inc., a subsidiary of global test equipment manufacturer DaTARIUS Technologies GmbH, purchased Integral Vision’s assets related to inspection systems for the optical disc industry, including the names “Automatic Inspection Systems” and “AID.” The sale included Integral Visions optical disc scanner products as well as its range of print and identification code products used to inspect the printing stage of disc manufacture. The consideration the Company received for the technology consisted of a non-refundable $100,000 advanced minimum royalty payment in addition to future royalties. The Company expects to receive additional royalties in excess of $100,000 a year for the three years following the sale. Additionally, the Company received $25,000 from the sale of equipment to DaTARIUS. The Company recognized a gain on the transaction of approximately $112,000, which was included in gain(loss) on sales of assets in the third quarter of 2002, primarily attributable to the advanced minimum royalty payment received. The proceeds from the transaction were used primarily to fund current operations. The Company received $21,000 in royalties under the agreement in the six months ended June 30, 2003.

Included with the transaction was a Transition Services Agreement whereby Integral Vision provides assembly and agreed upon technical support services for the product line for up to twelve months after the closing date at an agreed upon rate. Revenue generated under this agreement was $18,000 in the six months ended June 30, 2003 and is not expected to be significant in the future.

The optical disc inspection technology included in the sale accounted for approximately $208,000 and $431,000 of the Company’s net revenue for the three and six months ended June 30, 2002, respectively.

Note G — Related Party Transactions

Mr. Charles Drake, the Company’s chairman, has purchased $530,000 of the Company’s Class 1 Notes through June 30, 2003, all of which were outstanding at June 30, 2003. Additionally, subsequent to June 30, 2003, Mr. Drake purchased an additional $30,000 of the Company’s Class 1 Notes. In connection with the purchases, Mr. Drake received warrants for the purchase of 1,890,000 shares of the Company’s common stock with a conversion price of $0.25 per share. Mr. Drake also advanced the Company $10,000 in the quarter ended June 30, 2003, which is included in notes payable in the consolidated balance sheet.

Mr. Mark Doede, the Company’s President, has advances to the Company of approximately $11,000 at June 30, 2003. This amount is included in notes payable in the consolidated balance sheet. Additionally, Mr. Doede has voluntarily deferred approximately $58,000 of his wages as of June 30, 2003. This amount is included in accrued compensation and related costs in the consolidated balance sheet.

Mr. Arthur Harmala, the Company’s Vice President of Marketing, has voluntarily deferred approximately $19,000 of his wages as of June 30, 2003. This amount is included in accrued compensation and related costs in the consolidated balance sheet.

Maxco, Inc., the Company’s principal shareholder, advanced the Company $138,855 in 2001 to permit the Company to meet its obligations. This loan is evidenced by a written document and provides for interest at the rate of prime plus 0.5%. The Company believes that the terms of this transaction are at least as favorable as it could obtain from outside sources. Additionally, Maxco provides consulting services to the Company. These services include assistance with financial statement preparation, compliance with governmental filing requirements, and assistance with certain financing arrangements. The Company has not recorded any charge for these services as the amount cannot reasonably be determined, however, the Company does expect that a charge for these services will be recorded when the amount is reasonably determinable.

Note H — Income Taxes

In March 2002, Congress enacted what is known as the “Job Creation and Worker Assistance Act of 2002” to provide tax incentives for economic recovery. One of the provisions of the Act was to extend the carryback period for net operating losses incurred in tax years ending in 2001 or 2002 to five years versus the three years previously allowed. Additionally, any net operating losses as computed for alternative minimum tax purposes for tax years ending in 2001 or 2002 can also be carried back five years and can be used to offset up to 100% of alternative minimum taxable income. Previously, alternative minimum tax net operating losses could only be used to offset up to 90% of alternative minimum taxable income. As a result of this Act, the Company was able to carryback its 2001 net operating loss as computed for alternative minimum tax purposes to 1999, which reduced its tax liability in that year to zero. In the quarter ended September 30, 2002, the Company received a refund of taxes previously paid of approximately $90,000.

Note I — Going Concern Matters

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, the Company has incurred losses from operations in the current and prior year six month periods of $850,000 and $1.5 million, respectively. Further, during the years ended December 31, 2002, 2001, 2000, 1999 and 1998, the Company incurred losses from continuing operations of $2.2 million, $8.1 million, $7.1 million, $5.7 million and $11.2 million, respectively. The continuing losses, in addition to working capital deficiencies, recurring reductions in product sales, and cash flow deficiencies, among other factors, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time.

The financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitability. The Company’s anticipated cash provided by operating activities will not be sufficient to support the Company’s cash flow needs over the next twelve months. Additionally, at June 30, 2003, substantially all of the Company’s $485,000 in trade

accounts payable was overdue, of which $83,000 was paid subsequent to June 30, 2003. The Company also has an estimated $421,000 in amounts owed to certain regulatory agencies. The Company is making monthly payments of approximately $6,300 to one of the regulatory agencies. In March 2001, the Company’s board of directors approved the issuance of up to $1.5 million of senior debentures (increased to $2.5 million in March 2003 and further increased to $4.0 million in August 2003), which could provide additional financing to the Company. Additionally, effective May 1, 2002, the Company’s Note and Warrant Purchase Agreement was amended to provide for “Class 2 Notes” and “Class 2 Warrants” which are subordinated to the prior purchasers. Class 2 Notes are working capital notes which are secured by accounts receivable of the Company. At December 31, 2002, there was approximately $215,000 in principal and interest due to the Class 1 Note holders under the terms of the agreement. In March 2003, the holders of those Notes agreed to a modification to the Note and Warrant Purchase Agreement which extended the due dates, increased the maximum amount of Notes outstanding to $2.5 million and changed the conversion price on previously issued warrants to $.25 per share. The terms of the Class 1 Notes were changed such that all accrued interest will be due on December 31, 2003, which is projected to be approximately $310,000. Additionally, the first principal payments on the Class 1 Notes will be due on March 31, 2004 and the maturity dates extended to February 2007. The principal and interest due on March 31, 2004 is projected to be approximately $187,000. The Class 2 Notes were modified to have a due date, both principal and accrued interest, of September 30, 2003. Principal and interest due on the Class 2 notes on September 30, 2003 is projected to be approximately $475,000. Management is projecting a cash shortfall over the next twelve months of approximately $1.4 million. Management plans to seek additional investors of its debentures to cover the anticipated shortfall, which would bring the amount of debentures outstanding to $3.0 million. Additionally, if necessary, Management would attempt to obtain any additional cash needed to enable the Company to continue as a going concern through possible joint ventures and other strategic alliances. Additional financing may or may not be available through banks. There can be no assurance that Management will be able to successfully execute these plans before the Company has exhausted all of its resources. These uncertainties raise substantial doubt about the Company’s ability to continue as a going concern.

Note J — Subsequent Events

Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes at which time they also received warrants for the purchase of 1,020,000 shares of the Company’s common stock with a conversion price of $.25 per share. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003. If the conversion option is exercised, the note holder would receive warrants for the purchase of 300,000 shares of the Company’s common stock with a conversion price of $.25 per share.

Subsequent to June 30, 2003, warrants for the purchase of 680,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $170,000 of Class 1 Notes. Included in these amounts were $30,000 of Class 1 Notes that were purchased by Mr. Drake, for which he also received warrants for the purchase of 120,000 shares of the Company’s common stock with a conversion price of $.25 per share.

Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million.

Note K — Off Balance Sheet Risk

A claim has been made against the Company citing unpaid royalties totaling $107,000. Management is still researching the claim but does not believe that the Company will ultimately be found to be liable to the claimant.

Note L — Foreign Currency Translation Adjustment

In June 2002, Integral Vision, Inc. wrote-off an inter-company receivable due from Integral Vision Ltd., its subsidiary in the United Kingdom. As the consolidated financial statements include the accounts of both entities, upon consolidation, the charge recorded by Integral Vision, Inc., approximately $3.1 million, was eliminated against the gain recorded by Integral Vision Ltd. However, previously unrecognized losses that resulted from foreign currency translation adjustments were recognized in the quarter ended June 30, 2002 and totaled approximately $208,000.

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties. Generally, the words “anticipate”, “expect”, “intend”, “believe” and similar expressions identify forward-looking statements. The information included in this Form 10-Q is as of the filing date with the Securities and Exchange Commission and future events or circumstances could differ significantly from the forward-looking statements included herein. Accordingly, we caution readers not to place undue reliance on such statements.

Overview

Integral Vision, Inc. (or the “Company”) develops, manufactures and markets microprocessor-based process monitoring and control systems for use in industrial manufacturing environments. The principle application for the Company’s products is optical display inspection (“machine vision products”) used to ensure product quality during the manufacturing process. The Company’s product offerings include LCI-Professional, SharpEye and ChromaSee. The Company’s products are generally sold as capital goods. Depending on the application, machine vision systems have an indefinite life. Machine vision applications are more likely to require replacement due to possible technological obsolescence rather than physical wear.

The Company’s location outside the US is in the United Kingdom. This was a sales office with net non-current assets that are not significant. This office was closed at December 31, 2002 following the sale of the Company’s disc inspection product line (see Note F to consolidated financial statements).

LCI Professional — Integral Vision’s LCI-Professional product is used for inspection of LCD Displays as components or final assemblies. Applications include cell phones, car radios, pagers, electronic organizers and hand-held video games. Integral Vision’s display inspection systems are designed to detect two classes of defects: cosmetic and functional. Cosmetic defects do not affect the functionality of the display, but they cause user annoyance and reduce product value. Functional defects are flaws that cause the device to be inoperable or have a significant effect on functionality.

SharpEye — Integral Vision’s SharpEye product provides small Flat Panel Display (FPD) inspection for reflective, emissive and transmissive display technologies. SharpEye is designed for the detection of functional and cosmetic defects in LCOS, OLED, Poly OLED, DMD, EL, HTPS, LTPS, LCD and other emerging display technologies. These technologies are applied to consumer products such as camcorders, rear projection computer monitors, digital still cameras, HDTV, projectors, video headsets and video telephones. The core technology of SharpEye inspection algorithms is the ability to quantize data to the level of a single display pixel. SharpEye can be configured for production inspection or for display evaluation in a laboratory based on the equipment configuration selected.

ChromaSee — Integral Vision’s ChromaSee product, which was introduced in 2003, provides luminance, color matching and defect inspections for FPD displays. Defect detection includes functional (e.g. failed pixels, icons) and cosmetic (e.g. scratches) defects. ChromaSee integrates with production equipment to allow inline or offline testing. A configuration interface (Task Sequencer) uses a familiar “Tree View” representation of the inspection sequence flow. For deployment into production, the operator’s interface provides essential views of results, images and statistics for production floor personnel.

Lifetime Tester — Integral Vision’s Lifetime Tester product, which was introduced in 2003, evaluates changes in display luminance, color and other performance characteristics over time. The Lifetime Tester facilitates the process of comparing different display manufacturing processes and formulas by evaluating large numbers of samples side by side to determine their life characteristics. This allows design and process engineers to efficiently evaluate the effectiveness of proposed design and process changes off line prior to implementation.

Results of Operations

Three Months Ended June 30, 2003 Compared with Three Months Ended June 30, 2002

Net revenues decreased $375,000 (74.6%) to $128,000 in the second quarter of 2003 from $503,000 in the second quarter of 2002. The decrease in net revenue was partially attributable to the fact that sales of the Company’s flat panel display inspection products totaled $73,000 in the second quarter of 2003 compared to $187,000 in the comparable 2002 period. Additionally, the second quarter of 2002 included $208,000 of revenue from sales of the Company’s disc identification/print inspection (CDiD/CDiP) products, a product line that the Company sold in early September 2002 (see Note F to consolidated financial statements). The Company’s revenue from service activities decreased to $11,000 in the second quarter of 2003 compared to $71,000 in the comparable 2002 period.

Costs of sales decreased $236,000 (68.4%) to $109,000 (85.2% of sales) in the second quarter of 2003 compared to $345,000 (68.6% of sales) in the second quarter of 2002. In the 2003 period compared to the 2002 period there was a $120,000 decrease in material costs, a $23,000 decrease in depreciation and amortization expense, and a $93,000 decrease in other costs primarily related to the Company’s service activities. Depreciation expense decreased primarily due to the fact that a substantial portion of the Company’s property, plant and equipment was fully depreciated by December 31, 2002. Amortization expense decreased primarily due to the fact that the Company sold certain of its patents related to its disc identification/print inspection (CDiD/CDiP) products in September 2002 (see Note F to consolidated financial statements). Additionally, in September 2002, Management determined that capitalized patent costs exceeded the estimated net realizable value of amounts capitalized and a write-down was necessary. In the quarter ended September 30, 2002, $74,000 of additional amortization was included in costs of sales as a result of this determination. The decrease in costs related to the Company’s service activities is primarily related to the sale of the Company’s disc inspection product line, which eliminated the need for a service department in the UK. Following the sale, the Company closed its office in the United Kingdom and substantially reduced the service department in the US in the fourth quarter of 2002. In total, costs related to the Company’s service activities decreased $51,000 in the second quarter of 2003 from the comparable 2002 levels.

Marketing costs decreased $100,000 (62.5%) to $60,000 in the second quarter of 2003 compared to $160,000 in the second quarter of 2002. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $17,000 in marketing costs in the 2002 period. The remainder of the decrease in the second quarter of 2003 compared to the second quarter of 2002 was attributable to the US and was primarily attributable to workforce reductions, reduced advertising costs, and general overhead reductions. Employee related costs in the marketing division were $40,000 lower in the 2003 period. Advertising costs were $28,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $15,000 lower in the 2003 period.

General and administrative costs decreased $172,000 (43.8%) to $221,000 in the second quarter of 2003 compared to $393,000 in the second quarter of 2002. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $122,000 in general and administrative costs in the 2002 period. The remainder of the decrease in the second quarter of 2003 compared to the second quarter of 2002 was attributable to the US and was primarily attributable to reduced professional fees and general overhead reductions. Professional fees were $19,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $31,000 lower in the 2003 period.

Engineering and development expenditures decreased $30,000 (14.7%) to $174,000 in the second quarter of 2003 compared to $204,000 in the second quarter of 2002. Employee related costs in the engineering and development division increased $7,000 in the 2003 period compared to the second quarter of 2002. General overhead costs, primarily related to facilities and communications allocated to this department, were $37,000 lower in the 2003 period.

Other income in the second quarter of 2003 primarily consists of royalty income received in connection with the DaTARIUS Technologies transaction (see Note F to consolidated financial statements). Other income in the second quarter of 2002 primarily consists of gains on miscellaneous sales of fixed assets.

Interest expense increased $28,000 to $84,000 in the second quarter of 2003 compared to $56,000 in the second quarter of 2002. The increase is primarily attributable to the interest on Class 1 and Class 2 Notes that were placed subsequent to June 30, 2002 (see Note C to consolidated financial statements).

In June 2002, Integral Vision, Inc. wrote-off an inter-company receivable due from Integral Vision Ltd., its subsidiary in the United Kingdom. As the consolidated financial statements include the accounts of both entities, upon consolidation, the charge recorded by Integral Vision, Inc., approximately $3.1 million, was eliminated against the gain recorded by Integral Vision Ltd. However, previously unrecognized losses that resulted from foreign currency translation adjustments were recognized in the quarter ended June 30, 2002 and totaled approximately $208,000.

Six Months Ended June 30, 2003 Compared with Six Months Ended June 30, 2002

Net revenues decreased $286,000 (34.6%) to $540,000 in the 2003 period compared to $826,000 in the 2002 comparable period. The 2002 period included $431,000 of revenue from sales of the Company’s disc identification/print inspection (CDiD/CDiP) products, a product line that the Company sold in early September 2002 (see Note F to consolidated financial statements). The Company’s revenue from service activities decreased to $13,000 in the 2003 period compared to $164,000 in the comparable 2002 period. The decrease in net revenue was partially offset by an increase in sales of the Company’s flat panel display inspection products, which totaled $471,000 in the 2003 period compared to $187,000 in the comparable 2002 period.

Costs of sales decreased $265,000 (40.5%) to $390,000 (72.2% of sales) in the 2003 period compared to $655,000 (79.3% of sales) in the 2002 comparable period. In the 2003 period compared to the 2002 period there was a $84,000 decrease in material costs, a $51,000 decrease in depreciation and amortization expense, and a $130,000 decrease in other costs primarily related to the Company’s service activities. Depreciation expense decreased primarily due to the fact that a substantial portion of the Company’s property, plant and equipment was fully depreciated by December 31, 2002. Amortization expense decreased primarily due to the fact that the Company sold certain of its patents related to its disc identification/print inspection (CDiD/CDiP) products in September 2002 (see Note F to consolidated financial statements). Additionally, in September 2002, Management determined that capitalized patent costs exceeded the estimated net realizable value of amounts capitalized and a write-down was necessary. In the quarter ended September 30, 2002, $74,000 of additional amortization was included in costs of sales as a result of this determination. The decrease in costs related to the Company’s service activities is primarily related to the sale of the Company’s disc inspection product line, which eliminated the need for a service department in the UK. Following the sale, the Company closed its office in the United Kingdom and substantially reduced the service department in the US in the fourth quarter of 2002. In total, costs related to the Company’s service activities decreased $108,000 in the 2003 period from the comparable 2002 levels.

Marketing costs decreased $237,000 (68.5%) to $109,000 in the 2003 period compared to $346,000 in the 2002 comparable period. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $53,000 in marketing costs in the 2002 period. The remainder of the decrease in the 2003 period compared to the 2002 period was attributable to the US and was primarily attributable to workforce reductions, reduced advertising costs, and general overhead reductions. Employee related costs in the marketing division were $87,000 lower in the 2003 period. Advertising costs were $53,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $44,000 lower in the 2003 period.

General and administrative costs decreased $280,000 (39.5%) to $429,000 in the 2003 period compared to $709,000 in the 2002 comparable period. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $155,000 in general and administrative costs in the 2002 period. The remainder of the decrease in the 2003 period compared to the 2002 period was attributable to the US and was primarily attributable to workforce reductions, reduced professional fees and general overhead reductions. Employee related costs in the general and administrative division were $15,000 lower in the 2003 period. Professional fees were $40,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $70,000 lower in the 2003 period.

Engineering and development expenditures decreased $39,000 (9.9%) to $356,000 in the 2003 period compared to $395,000 in the 2002 comparable period. Employee related costs in the engineering and development division increased $37,000 in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $76,000 lower in the 2003 period.

Other income in the 2003 period includes $18,000 for engineering fees and $21,000 of royalty income received in connection with the DaTARIUS Technologies transaction (see Note F to consolidated financial statements). Other income in the 2002 period primarily consists of gains on miscellaneous sales of fixed assets.

Interest expense increased $41,000 to $154,000 in the 2003 period compared to $113,000 in the 2002 period. The increase is primarily attributable to the interest on Class 1 and Class 2 Notes that were placed subsequent to June 30, 2002 (see Note C to consolidated financial statements).

In June 2002, Integral Vision, Inc. wrote-off an inter-company receivable due from Integral Vision Ltd., its subsidiary in the United Kingdom. As the consolidated financial statements include the accounts of both entities, upon consolidation, the charge recorded by Integral Vision, Inc., approximately $3.1 million, was eliminated against the gain recorded by Integral Vision Ltd. However, previously unrecognized losses that resulted from foreign currency translation adjustments were recognized in the quarter ended June 30, 2002 and totaled approximately $208,000.

In March 2002, Congress enacted what is known as the “Job Creation and Worker Assistance Act of 2002” to provide tax incentives for economic recovery. One of the provisions of the Act was to extend the carryback period for net operating losses incurred in tax years ending in 2001 or 2002 to five years versus the three years previously allowed. Additionally, any net operating losses as computed for alternative minimum tax purposes for tax years ending in 2001 or 2002 can also be carried back five years and can be used to offset up to 100% of alternative minimum taxable income. Previously, alternative minimum tax net operating losses could only be used to offset up to 90% of alternative minimum taxable income. As a result of this Act, the Company was able to carryback its 2001 net operating loss as computed for alternative minimum tax purposes to 1999, which reduced its tax liability in that year to zero. In the quarter ended September 30, 2002, the Company received a refund of taxes previously paid of approximately $90,000.

Liquidity and Capital Resources

Operating activities for the six months ended June 30, 2003 used cash of approximately $641,000 primarily due to the Company’s loss from operations of $850,000. Decreases in accounts receivable, inventories, and other assets were offset by a decrease in accounts payable.

The Company investing activities included primarily the purchase of approximately $2,000 of equipment in 2003.

The Company’s financing activities included the receipt of $490,000 from the sale of the Company’s Class 1 Notes and $405,000 from the sale of the Company’s Class 2 Notes. The Company made principal payments of approximately $259,000 on its Class 2 Notes in the period. The Company repaid a $70,000 short-term advance from Max A. Coon, an officer of the Company and repaid approximately $5,000 on a short-term advance from Mark Doede, the Company’s president. The Company received a short-term advances of approximately $17,000 from Mark Doede, the Company’s president, and $10,000 from Charles Drake, the Company’s chairman.

The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitability. The Company’s anticipated cash provided by operating activities will not be sufficient to support the Company’s cash flow needs over the next twelve months. Additionally, at June 30, 2003, substantially all of the Company’s $485,000 in trade accounts payable was overdue, of which $83,000 was paid subsequent to June 30, 2003. The Company also has an estimated $421,000 in amounts owed to certain regulatory agencies. The Company is making monthly payments of approximately $6,300 to one of the regulatory agencies. In March 2001, the Company’s board of directors approved the issuance of up to $1.5 million of senior debentures (increased to $2.5 million in March 2003 and further increased to $4.0 million in August 2003), which could provide additional financing to the Company. Additionally, effective May 1, 2002, the Company’s Note and Warrant Purchase Agreement was amended to provide for “Class 2 Notes” and “Class 2 Warrants” which are subordinated to the prior purchasers. Class 2 Notes are working capital notes which are secured by accounts receivable of the Company. At December 31, 2002, there was approximately $215,000 in principal and interest due to the Class 1 Note holders under the terms of the agreement. In March 2003, the holders of those Notes agreed to a modification to the Note and Warrant Purchase Agreement which extended the due dates,

increased the maximum amount of Notes outstanding to $2.5 million and changed the conversion price on previously issued warrants to $.25 per share. The terms of the Class 1 Notes were changed such that all accrued interest will be due on December 31, 2003, which is projected to be approximately $310,000. Additionally, the first principal payments on the Class 1 Notes will be due on March 31, 2004 and the maturity dates extended to February 2007. The principal and interest due on March 31, 2004 is projected to be approximately $187,000. The Class 2 Notes were modified to have a due date, both principal and accrued interest, of September 30, 2003. Principal and interest due on the Class 2 notes on September 30, 2003 is projected to be approximately $475,000. Management is projecting a cash shortfall over the next twelve months of approximately $1.4 million. Management plans to seek additional investors of its debentures to cover the anticipated shortfall, which would bring the amount of debentures outstanding to $3.0 million. Additionally, if necessary, Management would attempt to obtain any additional cash needed to enable the Company to continue as a going concern through possible joint ventures and other strategic alliances. Additional financing may or may not be available through banks. There can be no assurance that Management will be able to successfully execute these plans before the Company has exhausted all of its resources. These uncertainties raise substantial doubt about the Company’s ability to continue as a going concern.

Management’s Discussion of Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Management to make estimates and judgments 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. The accounting policies discussed below are considered by management to be the most important to an understanding of our financial statements, because their application places the most significant demands on management’s judgment and estimates about the effect of matters that are inherently uncertain. Our assumptions and estimates were based on the facts and circumstances known at June 30, 2003, future events rarely develop exactly as forecast, and the best estimates routinely require adjustment. These policies are also discussed in Note A of the Notes to Consolidated Financial Statements included in this Quarterly Form 10-Q.

Revenue Recognition

The Company recognizes revenue in accordance with SOP 97-2, Software Revenue Recognition and Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured.

The Company accounts for certain product sales of its flat panel display inspection systems as multiple-element arrangements. If specific customer acceptance requirements are met, the Company recognizes revenue for a portion of the total contract price due and billable upon shipment, with the remainder recognized when it becomes due (generally upon acceptance). The Company recognizes all other product sales with customer acceptance provisions upon final customer acceptance. The Company recognizes revenue from the sale of spare parts upon shipment. Revenue from service contracts is recognized over the life of the contract. Revenue is reported net of sales commissions.

Inventories

Inventories are stated at the lower of standard cost, which approximates actual cost determined on a first-in, first-out basis, or market. Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating these components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves for obsolete and slow-moving parts ranging from 0% for active parts with sufficient forecasted demand up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.

Impairment of Long-lived Assets

The Company reviews its long-lived assets, including property, equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount of the asset.

Contingencies and Litigation

The Company makes an assessment of the probability of an adverse judgment resulting from current and threatened litigation. The Company accrues the cost of an adverse judgment if, in Management’s estimation, an adverse settlement is probable and Management can reasonably estimate the ultimate cost of such litigation. The Company has made no such accruals at June 30, 2003.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risk stemming from changes in foreign exchange rates, interest rates and prices of inventory purchased for assembly into finished products. Changes in these factors could cause fluctuations in earnings and cash flows. In the normal course of business, exposure to interest rates is managed by fixing the interest rates on the Company’s long-term debt whenever possible. The Company does not generally enter into long-term purchase contracts but instead purchases inventory to fill specific sales contracts thereby minimizing risks with respect to inventory price fluctuations.

Foreign Exchange Rates — The Company’s location outside the US is in the United Kingdom. This is a sales office with net non-current assets that are not significant. This office was closed at December 31, 2002 due to the sales of the Company’s packaging and disc inspection product lines. On a consolidated basis the Company denominates sales in the following currencies:

v US Dollars
v Pound Sterling
v Euros
v Yen

In management’s opinion, as the currencies of Western Europe and the UK are generally stable, there is no significant exposure to losses due to currency fluctuations. However, because the Yen has not been stable over the past several years, the Company does enter into forward sales contracts equal to the future amount of Yen to be received at the time the order is accepted. These hedging transactions are on an order by order basis and at no time are they speculative in nature. At June 30, 2003, the Company had no open positions.

Item 4. Disclosure Controls and Procedures

An evaluation as of the end of the period covered by this report was carried out under the supervision and with the participation of the Registrant’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures were adequate to ensure that information required to be disclosed by the Registrant in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 2. Changes in Securities and Use of Proceeds

(c) Under the terms of the Company’s Note and Warrant Purchase agreement, as amended, Integral Vision issues warrants for the purchase of the Company’s common stock in connection with placements of debt under the plan. In March 2003, the holders of Class 1 and Class 2 Notes at December 31, 2002 agreed to a modification to the Note and Warrant Purchase Agreement that extended the due dates, increased the maximum amount of Notes outstanding to $2.5 million, and changed the conversion price on warrants previously issued under the plan to $.25 per share. In the quarter ended June 30, 2003, warrants for the purchase of 400,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $100,000 of the Class 1 Notes. Additionally, warrants for the purchase of 50,671 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the repayment of $105,000 of the Class 2 Notes. Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes at which time they received warrants for the purchase of 1,020,000 shares of the Company’s common stock with a conversion price of $.25 per share. Also subsequent to June 30, 2003, warrants for the purchase of 680,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $170,000 of Class 1 Notes. Included in these amounts were $30,000 of Class 1 Notes that were purchased by Mr. Drake, for which he also received warrants for the purchase of 120,000 shares of the Company’s common stock with a conversion price of $.25 per share. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003. If the conversion option is exercised, the note holder would receive warrants for the purchase of 300,000 shares of the Company’s common stock with a conversion price of $.25 per share. Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million. As of August 14, 2003, the purchasers of Class 1 or Class 2 Notes have received warrants for the purchase of 6,981,291 shares of the Company’s common stock with a conversion price of $.25 per share. In total, in connection with Note purchases under this plan, Mr. Drake has received warrants for the purchase of 1,890,000 shares of the Company’s common stock. Additionally, Max A. Coon (a director of the Company) and Maxco, Inc. (a 25% owner of the Company) have received warrants for the purchase of the Company’s common stock totaling 270,000 shares and 240,000 shares, respectively. The cash received in connection with this plan has been used to fund working capital needs.

Effective May 1, 2002, the Note and Warrant Purchase Agreement was amended to provide for “Class 2 Notes” and “Class 2 Warrants” which will be subordinated to the prior purchasers. Class 2 Notes are working capital notes which will be secured by accounts receivable of the Company. The number of Class 2 Warrants to be obtained will be based on the length of time the related Class 2 Note is outstanding. As of August 14, 2003, $1,312,000 of the Class 2 Notes had been placed, of which $437,000 were still outstanding. The holders of the remaining $437,000 will also receive warrants when their notes are paid off, the amount of which will be determined at the pay off date.

The notes and warrants were sold in private transactions exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. There have been fifteen purchasers, some of whom have purchased on more than one occasion. Of these, four of the purchasers are related entities or insiders of the Company. Five of the purchasers is a client, or relative of the principal, of one State of California registered investment advisor. To the best of the Company’s knowledge, all of the purchasers are either “accredited investors” as that term is defined in Regulation D under the Securities Act of 1933 or, either alone or with their purchaser representative, have such knowledge and experience in financial and business matters that they are capable of evaluating the merits and risks of the investment.

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

The annual meeting of shareholders was held on May 28, 2003. The matters voted upon were the election of directors, an amendment to the articles of incorporation and other business, which may come before the meeting (of which there was none). The results of votes were as follows:

1) Election of directors:


	For		Withheld

Craig A. Black		8,782,956		181,868
Max A. Coon		8,779,456		185,368
Charles J. Drake		8,778,256		186,568
Samuel O. Mallory		8,776,256		188,568
Vincent Shunsky		8,779,956		184,858
William B. Wallace		8,788,776		176,048

2) Amendment to Articles of Incorporation

The Company is authorized to amend its articles of incorporation to increase the number of shares of common stock which it is authorized to issue from 20,000,000 to 25,000,000.


For	Against		Abstain

8,663,959		269,905		30,960

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits


Exhibit
Number		Description of Document

3.1		Articles of Incorporation, as amended (filed as Exhibit 3.1 to the registrant’s Form 10-K for the year ended December 31, 1995, SEC file 0-12728, and incorporated herein by reference).
3.2		Bylaws of the Registrant, as amended (filed as Exhibit 3.2 to the registrant’s Form 10-K for the year ended December 31, 1994, SEC file 0-12728, and incorporated herein by reference).
4.1		Note and Warrant Purchase Agreement (filed as Exhibit 4.1 to the registrant’s Form 8-K dated July 15, 1997, SEC file 0-12728, and incorporated herein by reference).
4.3		Form of Integral Vision, Inc. Common Stock Purchase Warrant Certificate (filed as Exhibit 4.3 to registrant’s Form 8-K dated July 15, 1997, SEC file 0-12728, and incorporated herein by reference).
4.4		Note and Warrant Purchase Agreement dated March 29, 2001 including Form of Integral Vision, Inc. 15% Senior Subordinated Secured Note and Integral Vision, Inc. Common Stock Purchase Warrant Certificate (filed as Exhibit 4.4 to registrant’s Form 10-K for the year ended December 31, 2000, SEC file 0-12728, and incorporated herein by reference).
4.5		Form of amended Note and Warrant Purchase Agreement including Form of Integral Vision, Inc. 10% Secured Note and Integral Vision, Inc. Common Stock Purchase Warrant Certificate (filed as Exhibit 4.5 to registrant’s Form 10-Q for the quarter ended June 30, 2001, SEC file 0-12728, and incorporated herein by reference).


Exhibit
Number		Description of Document

4.6		Form of Second Amended Note and Warrant Purchase Agreement including Form of Integral Vision, Inc. Class 2 Note and Integral Vision, Inc. Class 2 Common Stock Purchase Warrant Certificate (filed as Exhibit 4.6 to registrant’s Form 10-Q for the quarter ended March 31, 2002, SEC file 0-12728, and incorporated herein by reference).
4.7		Consent to Modifications dated March 17, 2003 modifying the terms of the Second Amended Note and Warrant Purchase Agreement (filed as Exhibit 4.7 to registrant’s Form 10-K for the year ended December 31, 2002, SEC file 0-12728, and incorporated herein by reference).
10.1		Incentive Stock Option Plan of the Registrant as amended (filed as Exhibit 10.4 to the registrant’s Form S-1 Registration Statement effective July 2, 1985, SEC File 2-98085, and incorporated herein by reference).
10.2		Second Incentive Stock Option Plan (filed as Exhibit 10.2 to the registrant’s Form 10-K for the year ended December 31, 1992, SEC File 0-12728, and incorporated herein by reference).
10.3		Non-qualified Stock Option Plan (filed as Exhibit 10.3 to the registrant’s Form 10-K for the year ended December 31, 1992, SEC File 0-12728, and incorporated herein by reference).
10.4		Amendment to Integral Vision, Inc. Incentive Stock Option Plan dated May 10, 1993 (filed as Exhibit 10.3 to the registrant’s Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).
10.5		Integral Vision, Inc. Employee Stock Option Plan (filed as Exhibit 10.5 to the registrant’s Form 10-Q for the quarter ended September 30, 1995, SEC file 0-12728, and incorporated herein by reference).
10.6		Form of Confidentiality and Non-Compete Agreement Between the Registrant and its Employees (filed as Exhibit 10.4 to the registrant’s Form 10-K for the year ended December 31, 1992, SEC File 0-12728, and incorporated herein by reference).
10.7		Integral Vision, Inc. 1999 Employee Stock Option Plan (filed as Exhibit 10.5 to the registrant’s Form 10-Q for the quarter ended June 30, 1999, and incorporated herein by reference).
10.8*		Patent License Agreement dated October 4, 1995 by and between Integral Vision, Inc. and Square D Company (filed as Exhibit 10.24 to the registrant’s Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).
10.9		Asset Sale Purchase Agreement between the registrant and n.v. DIMACO, s.a. (filed as exhibit 10.12 to the registrant’s Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference).
10.10		Asset Sale Purchase Agreement between the registrant and DaTARIUS Technologies, Inc. (filed as exhibit 10.13 to the registrant’s Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference).
16		Letter regarding change in certifying accountant (filed as exhibit 16 to the registrant’s Form 10-K for the year ended December 31, 2002, SEC file 0-12728, and incorporated herein by reference).
31.1		Certification of Chief Executive Officer of Periodic Report pursuant to Rule 13a-15(e) or Rule 15d-15(e).
31.2		Certification of Chief Financial Officer of Periodic Report pursuant to Rule 13a-15(e) or Rule 15d-15(e).
32.1		Certification by Chief Executive Officer of Periodic Report Pursuant to 18 U.S.C. Section 1350.
32.2		Certification by Chief Financial Officer of Periodic Report Pursuant to 18 U.S.C. Section 1350.

• The Company has been granted confidential treatment with respect to certain portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

(b) There were no reports on Form 8-K filed in the quarter ended June 30, 2003

SIGNATURES

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


		INTEGRAL VISION, INC.

Date:	August 14, 2003	/S/ CHARLES J. DRAKE Charles J. Drake Chairman of the Board and Chief Executive Officer

Date:	August 14, 2003	/S/ MARK R. DOEDE Mark R. Doede President, Chief Operating Officer, and Chief Financial Officer

10-Q EXHIBIT INDEX


EXHIBIT NO.		DESCRIPTION

EX-31.1		Certification of Chief Executive Officer pursuant to Section 302.

EX-31.2		Certification of Chief Financial Officer pursuant to Section 302.

EX-32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

EX-32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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	x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly period ended June 30, 2003.

	o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from to .

		Integral Vision, Inc. (or the “Company”) develops, manufactures and markets microprocessor-based process monitoring and control systems for use in industrial manufacturing environments. The principle application for the Company’s products is optical display inspection (“machine vision products”) used to ensure product quality during the manufacturing process. The Company’s product offerings include LCI-Professional, SharpEye and ChromaSee. The Company’s products are generally sold as capital goods. Depending on the application, machine vision systems have an indefinite life. Machine vision applications are more likely to require replacement due to possible technological obsolescence rather than physical wear.

		The Company’s location outside the US is in the United Kingdom. This was a sales office with net non-current assets that are not significant. This office was closed at December 31, 2002 following the sale of the Company’s disc inspection product line (see Note F to consolidated financial statements).

		Property and equipment is stated on the basis of cost. Expenditures for normal repairs and maintenance are charged to operations as incurred.

		Depreciation is computed by the straight-line method based on the estimated useful lives of the assets (buildings-40 years, other property and equipment-3 to 10 years).

		The Company recognizes revenue in accordance with SOP 97-2, Software Revenue Recognition and Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured.

		The Company accounts for certain product sales of its flat panel display inspection systems as multiple-element arrangements. If specific customer acceptance requirements are met, the Company recognizes revenue for a portion of the total contract price due and billable upon shipment, with the remainder recognized when it becomes due (generally upon acceptance). The Company recognizes all other product sales with customer acceptance provisions upon final customer acceptance. The Company recognizes revenue from the sale of spare parts upon shipment. Revenue from service contracts is recognized over the life of the contract. Revenue is reported net of sales commissions.

		The Company has elected to follow APB No. 25 “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has elected to adopt only the disclosure provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.”

		Pro forma information regarding net income and earnings per share is required by FAS 123 and has been determined as if the Company had accounted for its employee stock options granted subsequent to September 30, 1995 under the fair value method of FAS 123. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

		The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock option plan has 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 such Company options.

		The Compensation Committee of the Board of Directors approves option grants. The option price is the market price on the date of the grant, vesting generally occurs after one year and the expiration occurs ten years from the date of the grant. In January 2002, the Compensation Committee of the Company’s Board of Directors resolved to grant 225,000 qualified stock options for the purchase of common shares with an exercise price of $.10 per share. In order to facilitate this grant, Mr. Charles Drake, the Company’s Chairman, agreed to forfeit options on 144,000 shares so that they could be distributed to other key people. In March 2002, 55,000 qualified and 20,000 non-qualified stock options for the purchase of common shares were granted with an exercise price of $.24 per share. In May 2003, 180,000 qualified stock options for the purchase of common shares were granted with an exercise price equal to the market price at the close of trading on the grant dates. Options for the purchase of 115,000 shares of the Company’s common stock were granted with an exercise price of $.15 per share and options on 65,000 shares were granted with an exercise price of $.16 per share. In order to facilitate this grant, Mr. Charles Drake, the Company’s Chairman, agreed to forfeit options on 156,000 shares so that they could be distributed to other key people. These options had an exercise price of $1.07 per share. At June 30, 2003, there were options outstanding to purchase 1,053,000 shares of common stock at prices ranging from $.10 to $9.25 per share.

		Under the terms of the Company’s Note and Warrant Purchase agreement, as amended, Integral Vision issues warrants for the purchase of the Company’s common stock in connection with placements of debt under the plan. In March 2003, the holders of Class 1 and Class 2 Notes at December 31, 2002 agreed to a modification to the Note and Warrant Purchase Agreement that extended the due dates, increased the maximum amount of Notes outstanding to $2.5 million, and changed the conversion price on warrants previously issued under the plan to $.25 per share. During the six months ended June 30, 2003, warrants for the purchase of 1,960,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $490,000 of the Class 1 Notes. Mr. Charles J. Drake, the Company’s chairman, purchased $180,000 of these Notes for which he also received warrants for the purchase of 720,000 shares of the Company’s common stock. Additionally, warrants for the purchase of 50,671 shares of the Company’s common stock were issued in connection with payments made on Class 2 Notes. At June 30, 2003, warrants for the purchase of 5,273,812 shares of the Company’s common stock had been issued under the plan with a conversion price of $.25 per share. In total, in connection with note purchases under this plan, Mr. Drake has received warrants for the purchase of 1,770,000 shares of the Company’s common stock. Additionally, Max A. Coon (a director of the Company) and Maxco, Inc. (a 25% owner of the Company) have received warrants for the purchase of the Company’s common stock totaling 270,000 shares and 240,000 shares, respectively. Certain holders of Class 2 Notes at June 30, 2003 have the option to convert their notes to Class 1 Notes which would result in additional warrants for the purchase of 1,220,000 shares of the Company’s common stock. Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes at which time they also received warrants for the purchase of 1,020,000 shares of the Company’s common stock with a conversion price of $.25 per share.

		Subsequent to June 30, 2003, warrants for the purchase of 680,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $170,000 of Class 1 Notes. Included in these amounts were $30,000 of Class 1 Notes that were purchased by Mr. Drake, for which he also received warrants for the purchase of 120,000 shares of the Company’s common stock with a conversion price of $.25 per share. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003. If the conversion option is exercised, the note holder would receive warrants for the purchase of 300,000 shares of the Company’s common stock with a conversion price of $.25 per share.

		Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million.

		In connection with the private placement of $7.0 million of debentures in 1997, which were retired in 1999, the Company issued warrants for the purchase of 1,400,000 Integral Vision common shares at $6.86 per share through June 30, 2004, all of which were outstanding at June 30, 2003. Pursuant to the 1997 Note and Warrant Purchase agreement, these warrants have been re-priced based on subsequent warrant issues. At June 30, 2003, the holders of these warrants had the right to purchase up to 2,139,368 shares of the Company’s common stock at $4.49 per share.

		A summary of the outstanding warrants and options at June 30, 2003 is as follows:

		In December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123.” This Statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. The Company has elected to adopt only the disclosure provisions of FASB Statement No. 123, as amended by FASB Statement No. 148, which are included in the notes to the consolidated financial statements included in this Quarterly Report on Form 10-Q.

		In April 2003 the FASB issued SFAS No. 149 which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging

		Activities.” This statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of SFAS No. 133, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform to language used in FASB Interpretation No. 45, and amends certain other existing pronouncements. This statement is effective for contracts entered into or modified after June 30, 2003. It is not expected that the provisions of Statement No. 149 will have a material impact on the financial position or results of operations of the Company.

		In May 2003 the FASB issued SFAS No. 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. It is not expected that the provisions of Statement No. 150 will have a material impact on the financial position of the Company.

		On June 30, 1999, the Company completed an agreement to sell substantially all the assets of its Welding Controls division for $25.7 million, net of costs of the sale, for cash, the assumption of certain liabilities, and a subordinated note (WTC note). The Company incurred both Federal and State income tax liabilities as a result of the sale of the assets of it Welding Controls division. The Company paid approximately $90,000 for its 1999 alternative minimum tax liability, which resulted primarily from the gain on the sale of the Welding Controls Division. This amount was refunded to the Company in 2002 (see Note H to consolidated financial statements). Additionally, the Company incurred a Michigan Single Business Tax (SBT) liability of approximately $120,000 for the 1999 tax year as a result of the transaction. At June 30, 2003, this liability was not yet paid in full and was included in accrued state income taxes in the consolidated balance sheet. Including interest and penalties, approximately $201,000 was outstanding at June 30, 2003 for this obligation, which is included in accrued state income taxes in the consolidated balance sheet. The Company is making monthly payments of approximately $6,300 to the taxing authority.

		The buyer also assumed a liability to Square D in the amount of $1.8 million in accordance with the purchase agreement. This liability resulted from the settlement of patent litigation in 1994. The settlement required payments of $300,000 per year for ten years. In the event the acquiring company fails to make the required payments, Integral Vision may be obligated for those amounts due.

		During the six months ended June 30, 2003, $490,000 of the Class 1 Notes were placed, $180,000 of which were purchased by the Company’s chairman Charles J Drake. At June 30, 2003, a total of $1,590,000 of the Class 1 Notes had been placed. Mr. Drake has purchased a total of $530,000 of the Company’s Class 1 Notes and Max A. Coon (a director of the Company) has purchased a total of $90,000 of the Company’s Class 1 Notes.

		During the six months ended June 30, 2003, $405,000 of the Class 2 Notes were placed. The Company made principal payments of approximately $259,000 to Class 2 Note holders in the six months ended June 30, 2003. The outstanding principal balance on the Class 2 Notes was $657,000 at June 30, 2003. Certain holders of Class 2 Notes at June 30, 2003 have the option to convert their notes to Class 1 Notes. Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes.

		Subsequent to June 30, 2003, $170,000 of Class 1 Notes were purchased, $30,000 of which were purchased by the Company’s chairman Charles J Drake. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003.

		Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million.

		At June 30, 2003, the Company had short-term notes payable to related parties of approximately $435,000. The Company’s notes to related parties included the following: a $139,000 obligation to Maxco, Inc. (a 25% owner of the Company); a $196,000 obligation to Warren, Cameron, Faust & Asciutto, P.C. (the Company’s corporate counsel); a $79,000 obligation to 2161 Limited Partnership (a partnership in which J. Michael Warren of Warren, Cameron, Faust & Asciutto, P.C. is a partner); a $10,000 obligation to Charles J. Drake (the Company’s chairman); and an $11,000 obligation to Mark R. Doede (the Company’s president). These notes have interest rates ranging from 5.5% to 8.0% and are due on demand.

		A summary of the Company’s debt obligations is as follows:

		On September 9, 2002, DaTARIUS Technologies Inc., a subsidiary of global test equipment manufacturer DaTARIUS Technologies GmbH, purchased Integral Vision’s assets related to inspection systems for the optical disc industry, including the names “Automatic Inspection Systems” and “AID.” The sale included Integral Visions optical disc scanner products as well as its range of print and identification code products used to inspect the printing stage of disc manufacture. The consideration the Company received for the technology consisted of a non-refundable $100,000 advanced minimum royalty payment in addition to future royalties. The Company expects to receive additional royalties in excess of $100,000 a year for the three years following the sale. Additionally, the Company received $25,000 from the sale of equipment to DaTARIUS. The Company recognized a gain on the transaction of approximately $112,000, which was included in gain(loss) on sales of assets in the third quarter of 2002, primarily attributable to the advanced minimum royalty payment received. The proceeds from the transaction were used primarily to fund current operations. The Company received $21,000 in royalties under the agreement in the six months ended June 30, 2003.

		Included with the transaction was a Transition Services Agreement whereby Integral Vision provides assembly and agreed upon technical support services for the product line for up to twelve months after the closing date at an agreed upon rate. Revenue generated under this agreement was $18,000 in the six months ended June 30, 2003 and is not expected to be significant in the future.

		The optical disc inspection technology included in the sale accounted for approximately $208,000 and $431,000 of the Company’s net revenue for the three and six months ended June 30, 2002, respectively.

		Mr. Charles Drake, the Company’s chairman, has purchased $530,000 of the Company’s Class 1 Notes through June 30, 2003, all of which were outstanding at June 30, 2003. Additionally, subsequent to June 30, 2003, Mr. Drake purchased an additional $30,000 of the Company’s Class 1 Notes. In connection with the purchases, Mr. Drake received warrants for the purchase of 1,890,000 shares of the Company’s common stock with a conversion price of $0.25 per share. Mr. Drake also advanced the Company $10,000 in the quarter ended June 30, 2003, which is included in notes payable in the consolidated balance sheet.

		Mr. Mark Doede, the Company’s President, has advances to the Company of approximately $11,000 at June 30, 2003. This amount is included in notes payable in the consolidated balance sheet. Additionally, Mr. Doede has voluntarily deferred approximately $58,000 of his wages as of June 30, 2003. This amount is included in accrued compensation and related costs in the consolidated balance sheet.

		Mr. Arthur Harmala, the Company’s Vice President of Marketing, has voluntarily deferred approximately $19,000 of his wages as of June 30, 2003. This amount is included in accrued compensation and related costs in the consolidated balance sheet.

		Maxco, Inc., the Company’s principal shareholder, advanced the Company $138,855 in 2001 to permit the Company to meet its obligations. This loan is evidenced by a written document and provides for interest at the rate of prime plus 0.5%. The Company believes that the terms of this transaction are at least as favorable as it could obtain from outside sources. Additionally, Maxco provides consulting services to the Company. These services include assistance with financial statement preparation, compliance with governmental filing requirements, and assistance with certain financing arrangements. The Company has not recorded any charge for these services as the amount cannot reasonably be determined, however, the Company does expect that a charge for these services will be recorded when the amount is reasonably determinable.

		The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, the Company has incurred losses from operations in the current and prior year six month periods of $850,000 and $1.5 million, respectively. Further, during the years ended December 31, 2002, 2001, 2000, 1999 and 1998, the Company incurred losses from continuing operations of $2.2 million, $8.1 million, $7.1 million, $5.7 million and $11.2 million, respectively. The continuing losses, in addition to working capital deficiencies, recurring reductions in product sales, and cash flow deficiencies, among other factors, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time.

		The financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitability. The Company’s anticipated cash provided by operating activities will not be sufficient to support the Company’s cash flow needs over the next twelve months. Additionally, at June 30, 2003, substantially all of the Company’s $485,000 in trade

		Integral Vision, Inc. (or the “Company”) develops, manufactures and markets microprocessor-based process monitoring and control systems for use in industrial manufacturing environments. The principle application for the Company’s products is optical display inspection (“machine vision products”) used to ensure product quality during the manufacturing process. The Company’s product offerings include LCI-Professional, SharpEye and ChromaSee. The Company’s products are generally sold as capital goods. Depending on the application, machine vision systems have an indefinite life. Machine vision applications are more likely to require replacement due to possible technological obsolescence rather than physical wear.

		The Company’s location outside the US is in the United Kingdom. This was a sales office with net non-current assets that are not significant. This office was closed at December 31, 2002 following the sale of the Company’s disc inspection product line (see Note F to consolidated financial statements).

		LCI Professional — Integral Vision’s LCI-Professional product is used for inspection of LCD Displays as components or final assemblies. Applications include cell phones, car radios, pagers, electronic organizers and hand-held video games. Integral Vision’s display inspection systems are designed to detect two classes of defects: cosmetic and functional. Cosmetic defects do not affect the functionality of the display, but they cause user annoyance and reduce product value. Functional defects are flaws that cause the device to be inoperable or have a significant effect on functionality.

		SharpEye — Integral Vision’s SharpEye product provides small Flat Panel Display (FPD) inspection for reflective, emissive and transmissive display technologies. SharpEye is designed for the detection of functional and cosmetic defects in LCOS, OLED, Poly OLED, DMD, EL, HTPS, LTPS, LCD and other emerging display technologies. These technologies are applied to consumer products such as camcorders, rear projection computer monitors, digital still cameras, HDTV, projectors, video headsets and video telephones. The core technology of SharpEye inspection algorithms is the ability to quantize data to the level of a single display pixel. SharpEye can be configured for production inspection or for display evaluation in a laboratory based on the equipment configuration selected.

		ChromaSee — Integral Vision’s ChromaSee product, which was introduced in 2003, provides luminance, color matching and defect inspections for FPD displays. Defect detection includes functional (e.g. failed pixels, icons) and cosmetic (e.g. scratches) defects. ChromaSee integrates with production equipment to allow inline or offline testing. A configuration interface (Task Sequencer) uses a familiar “Tree View” representation of the inspection sequence flow. For deployment into production, the operator’s interface provides essential views of results, images and statistics for production floor personnel.

		Lifetime Tester — Integral Vision’s Lifetime Tester product, which was introduced in 2003, evaluates changes in display luminance, color and other performance characteristics over time. The Lifetime Tester facilitates the process of comparing different display manufacturing processes and formulas by evaluating large numbers of samples side by side to determine their life characteristics. This allows design and process engineers to efficiently evaluate the effectiveness of proposed design and process changes off line prior to implementation.

		Three Months Ended June 30, 2003 Compared with Three Months Ended June 30, 2002

		Net revenues decreased $375,000 (74.6%) to $128,000 in the second quarter of 2003 from $503,000 in the second quarter of 2002. The decrease in net revenue was partially attributable to the fact that sales of the Company’s flat panel display inspection products totaled $73,000 in the second quarter of 2003 compared to $187,000 in the comparable 2002 period. Additionally, the second quarter of 2002 included $208,000 of revenue from sales of the Company’s disc identification/print inspection (CDiD/CDiP) products, a product line that the Company sold in early September 2002 (see Note F to consolidated financial statements). The Company’s revenue from service activities decreased to $11,000 in the second quarter of 2003 compared to $71,000 in the comparable 2002 period.

		Costs of sales decreased $236,000 (68.4%) to $109,000 (85.2% of sales) in the second quarter of 2003 compared to $345,000 (68.6% of sales) in the second quarter of 2002. In the 2003 period compared to the 2002 period there was a $120,000 decrease in material costs, a $23,000 decrease in depreciation and amortization expense, and a $93,000 decrease in other costs primarily related to the Company’s service activities. Depreciation expense decreased primarily due to the fact that a substantial portion of the Company’s property, plant and equipment was fully depreciated by December 31, 2002. Amortization expense decreased primarily due to the fact that the Company sold certain of its patents related to its disc identification/print inspection (CDiD/CDiP) products in September 2002 (see Note F to consolidated financial statements). Additionally, in September 2002, Management determined that capitalized patent costs exceeded the estimated net realizable value of amounts capitalized and a write-down was necessary. In the quarter ended September 30, 2002, $74,000 of additional amortization was included in costs of sales as a result of this determination. The decrease in costs related to the Company’s service activities is primarily related to the sale of the Company’s disc inspection product line, which eliminated the need for a service department in the UK. Following the sale, the Company closed its office in the United Kingdom and substantially reduced the service department in the US in the fourth quarter of 2002. In total, costs related to the Company’s service activities decreased $51,000 in the second quarter of 2003 from the comparable 2002 levels.

		Marketing costs decreased $100,000 (62.5%) to $60,000 in the second quarter of 2003 compared to $160,000 in the second quarter of 2002. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $17,000 in marketing costs in the 2002 period. The remainder of the decrease in the second quarter of 2003 compared to the second quarter of 2002 was attributable to the US and was primarily attributable to workforce reductions, reduced advertising costs, and general overhead reductions. Employee related costs in the marketing division were $40,000 lower in the 2003 period. Advertising costs were $28,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $15,000 lower in the 2003 period.

		General and administrative costs decreased $172,000 (43.8%) to $221,000 in the second quarter of 2003 compared to $393,000 in the second quarter of 2002. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $122,000 in general and administrative costs in the 2002 period. The remainder of the decrease in the second quarter of 2003 compared to the second quarter of 2002 was attributable to the US and was primarily attributable to reduced professional fees and general overhead reductions. Professional fees were $19,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $31,000 lower in the 2003 period.

		Engineering and development expenditures decreased $30,000 (14.7%) to $174,000 in the second quarter of 2003 compared to $204,000 in the second quarter of 2002. Employee related costs in the engineering and development division increased $7,000 in the 2003 period compared to the second quarter of 2002. General overhead costs, primarily related to facilities and communications allocated to this department, were $37,000 lower in the 2003 period.

		Other income in the second quarter of 2003 primarily consists of royalty income received in connection with the DaTARIUS Technologies transaction (see Note F to consolidated financial statements). Other income in the second quarter of 2002 primarily consists of gains on miscellaneous sales of fixed assets.

		Interest expense increased $28,000 to $84,000 in the second quarter of 2003 compared to $56,000 in the second quarter of 2002. The increase is primarily attributable to the interest on Class 1 and Class 2 Notes that were placed subsequent to June 30, 2002 (see Note C to consolidated financial statements).

		In June 2002, Integral Vision, Inc. wrote-off an inter-company receivable due from Integral Vision Ltd., its subsidiary in the United Kingdom. As the consolidated financial statements include the accounts of both entities, upon consolidation, the charge recorded by Integral Vision, Inc., approximately $3.1 million, was eliminated against the gain recorded by Integral Vision Ltd. However, previously unrecognized losses that resulted from foreign currency translation adjustments were recognized in the quarter ended June 30, 2002 and totaled approximately $208,000.

		Six Months Ended June 30, 2003 Compared with Six Months Ended June 30, 2002

		Net revenues decreased $286,000 (34.6%) to $540,000 in the 2003 period compared to $826,000 in the 2002 comparable period. The 2002 period included $431,000 of revenue from sales of the Company’s disc identification/print inspection (CDiD/CDiP) products, a product line that the Company sold in early September 2002 (see Note F to consolidated financial statements). The Company’s revenue from service activities decreased to $13,000 in the 2003 period compared to $164,000 in the comparable 2002 period. The decrease in net revenue was partially offset by an increase in sales of the Company’s flat panel display inspection products, which totaled $471,000 in the 2003 period compared to $187,000 in the comparable 2002 period.

		Costs of sales decreased $265,000 (40.5%) to $390,000 (72.2% of sales) in the 2003 period compared to $655,000 (79.3% of sales) in the 2002 comparable period. In the 2003 period compared to the 2002 period there was a $84,000 decrease in material costs, a $51,000 decrease in depreciation and amortization expense, and a $130,000 decrease in other costs primarily related to the Company’s service activities. Depreciation expense decreased primarily due to the fact that a substantial portion of the Company’s property, plant and equipment was fully depreciated by December 31, 2002. Amortization expense decreased primarily due to the fact that the Company sold certain of its patents related to its disc identification/print inspection (CDiD/CDiP) products in September 2002 (see Note F to consolidated financial statements). Additionally, in September 2002, Management determined that capitalized patent costs exceeded the estimated net realizable value of amounts capitalized and a write-down was necessary. In the quarter ended September 30, 2002, $74,000 of additional amortization was included in costs of sales as a result of this determination. The decrease in costs related to the Company’s service activities is primarily related to the sale of the Company’s disc inspection product line, which eliminated the need for a service department in the UK. Following the sale, the Company closed its office in the United Kingdom and substantially reduced the service department in the US in the fourth quarter of 2002. In total, costs related to the Company’s service activities decreased $108,000 in the 2003 period from the comparable 2002 levels.

		Marketing costs decreased $237,000 (68.5%) to $109,000 in the 2003 period compared to $346,000 in the 2002 comparable period. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $53,000 in marketing costs in the 2002 period. The remainder of the decrease in the 2003 period compared to the 2002 period was attributable to the US and was primarily attributable to workforce reductions, reduced advertising costs, and general overhead reductions. Employee related costs in the marketing division were $87,000 lower in the 2003 period. Advertising costs were $53,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $44,000 lower in the 2003 period.

		General and administrative costs decreased $280,000 (39.5%) to $429,000 in the 2003 period compared to $709,000 in the 2002 comparable period. The Company’s office in the UK, which was closed in the fourth quarter of 2002, generated $155,000 in general and administrative costs in the 2002 period. The remainder of the decrease in the 2003 period compared to the 2002 period was attributable to the US and was primarily attributable to workforce reductions, reduced professional fees and general overhead reductions. Employee related costs in the general and administrative division were $15,000 lower in the 2003 period. Professional fees were $40,000 lower in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $70,000 lower in the 2003 period.

		Engineering and development expenditures decreased $39,000 (9.9%) to $356,000 in the 2003 period compared to $395,000 in the 2002 comparable period. Employee related costs in the engineering and development division increased $37,000 in the 2003 period. General overhead costs, primarily related to facilities and communications allocated to this department, were $76,000 lower in the 2003 period.

		Other income in the 2003 period includes $18,000 for engineering fees and $21,000 of royalty income received in connection with the DaTARIUS Technologies transaction (see Note F to consolidated financial statements). Other income in the 2002 period primarily consists of gains on miscellaneous sales of fixed assets.

		Interest expense increased $41,000 to $154,000 in the 2003 period compared to $113,000 in the 2002 period. The increase is primarily attributable to the interest on Class 1 and Class 2 Notes that were placed subsequent to June 30, 2002 (see Note C to consolidated financial statements).

		In June 2002, Integral Vision, Inc. wrote-off an inter-company receivable due from Integral Vision Ltd., its subsidiary in the United Kingdom. As the consolidated financial statements include the accounts of both entities, upon consolidation, the charge recorded by Integral Vision, Inc., approximately $3.1 million, was eliminated against the gain recorded by Integral Vision Ltd. However, previously unrecognized losses that resulted from foreign currency translation adjustments were recognized in the quarter ended June 30, 2002 and totaled approximately $208,000.

		In March 2002, Congress enacted what is known as the “Job Creation and Worker Assistance Act of 2002” to provide tax incentives for economic recovery. One of the provisions of the Act was to extend the carryback period for net operating losses incurred in tax years ending in 2001 or 2002 to five years versus the three years previously allowed. Additionally, any net operating losses as computed for alternative minimum tax purposes for tax years ending in 2001 or 2002 can also be carried back five years and can be used to offset up to 100% of alternative minimum taxable income. Previously, alternative minimum tax net operating losses could only be used to offset up to 90% of alternative minimum taxable income. As a result of this Act, the Company was able to carryback its 2001 net operating loss as computed for alternative minimum tax purposes to 1999, which reduced its tax liability in that year to zero. In the quarter ended September 30, 2002, the Company received a refund of taxes previously paid of approximately $90,000.

		Operating activities for the six months ended June 30, 2003 used cash of approximately $641,000 primarily due to the Company’s loss from operations of $850,000. Decreases in accounts receivable, inventories, and other assets were offset by a decrease in accounts payable.

		The Company investing activities included primarily the purchase of approximately $2,000 of equipment in 2003.

		The Company’s financing activities included the receipt of $490,000 from the sale of the Company’s Class 1 Notes and $405,000 from the sale of the Company’s Class 2 Notes. The Company made principal payments of approximately $259,000 on its Class 2 Notes in the period. The Company repaid a $70,000 short-term advance from Max A. Coon, an officer of the Company and repaid approximately $5,000 on a short-term advance from Mark Doede, the Company’s president. The Company received a short-term advances of approximately $17,000 from Mark Doede, the Company’s president, and $10,000 from Charles Drake, the Company’s chairman.

		The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitability. The Company’s anticipated cash provided by operating activities will not be sufficient to support the Company’s cash flow needs over the next twelve months. Additionally, at June 30, 2003, substantially all of the Company’s $485,000 in trade accounts payable was overdue, of which $83,000 was paid subsequent to June 30, 2003. The Company also has an estimated $421,000 in amounts owed to certain regulatory agencies. The Company is making monthly payments of approximately $6,300 to one of the regulatory agencies. In March 2001, the Company’s board of directors approved the issuance of up to $1.5 million of senior debentures (increased to $2.5 million in March 2003 and further increased to $4.0 million in August 2003), which could provide additional financing to the Company. Additionally, effective May 1, 2002, the Company’s Note and Warrant Purchase Agreement was amended to provide for “Class 2 Notes” and “Class 2 Warrants” which are subordinated to the prior purchasers. Class 2 Notes are working capital notes which are secured by accounts receivable of the Company. At December 31, 2002, there was approximately $215,000 in principal and interest due to the Class 1 Note holders under the terms of the agreement. In March 2003, the holders of those Notes agreed to a modification to the Note and Warrant Purchase Agreement which extended the due dates,

		The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Management to make estimates and judgments 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. The accounting policies discussed below are considered by management to be the most important to an understanding of our financial statements, because their application places the most significant demands on management’s judgment and estimates about the effect of matters that are inherently uncertain. Our assumptions and estimates were based on the facts and circumstances known at June 30, 2003, future events rarely develop exactly as forecast, and the best estimates routinely require adjustment. These policies are also discussed in Note A of the Notes to Consolidated Financial Statements included in this Quarterly Form 10-Q.

		*Revenue Recognition*

		The Company recognizes revenue in accordance with SOP 97-2, Software Revenue Recognition and Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured.

		The Company accounts for certain product sales of its flat panel display inspection systems as multiple-element arrangements. If specific customer acceptance requirements are met, the Company recognizes revenue for a portion of the total contract price due and billable upon shipment, with the remainder recognized when it becomes due (generally upon acceptance). The Company recognizes all other product sales with customer acceptance provisions upon final customer acceptance. The Company recognizes revenue from the sale of spare parts upon shipment. Revenue from service contracts is recognized over the life of the contract. Revenue is reported net of sales commissions.

		*Inventories*

		Inventories are stated at the lower of standard cost, which approximates actual cost determined on a first-in, first-out basis, or market. Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating these components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves for obsolete and slow-moving parts ranging from 0% for active parts with sufficient forecasted demand up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.

		*Impairment of Long-lived Assets*

		The Company reviews its long-lived assets, including property, equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount of the asset.

		*Contingencies and Litigation*

		The Company makes an assessment of the probability of an adverse judgment resulting from current and threatened litigation. The Company accrues the cost of an adverse judgment if, in Management’s estimation, an adverse settlement is probable and Management can reasonably estimate the ultimate cost of such litigation. The Company has made no such accruals at June 30, 2003.

		The Company is exposed to market risk stemming from changes in foreign exchange rates, interest rates and prices of inventory purchased for assembly into finished products. Changes in these factors could cause fluctuations in earnings and cash flows. In the normal course of business, exposure to interest rates is managed by fixing the interest rates on the Company’s long-term debt whenever possible. The Company does not generally enter into long-term purchase contracts but instead purchases inventory to fill specific sales contracts thereby minimizing risks with respect to inventory price fluctuations.

		Foreign Exchange Rates — The Company’s location outside the US is in the United Kingdom. This is a sales office with net non-current assets that are not significant. This office was closed at December 31, 2002 due to the sales of the Company’s packaging and disc inspection product lines. On a consolidated basis the Company denominates sales in the following currencies:

(c)		Under the terms of the Company’s Note and Warrant Purchase agreement, as amended, Integral Vision issues warrants for the purchase of the Company’s common stock in connection with placements of debt under the plan. In March 2003, the holders of Class 1 and Class 2 Notes at December 31, 2002 agreed to a modification to the Note and Warrant Purchase Agreement that extended the due dates, increased the maximum amount of Notes outstanding to $2.5 million, and changed the conversion price on warrants previously issued under the plan to $.25 per share. In the quarter ended June 30, 2003, warrants for the purchase of 400,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $100,000 of the Class 1 Notes. Additionally, warrants for the purchase of 50,671 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the repayment of $105,000 of the Class 2 Notes. Subsequent to June 30, 2003, holders of $255,000 worth of Class 2 Notes exercised their conversion option and converted their notes to Class 1 Notes at which time they received warrants for the purchase of 1,020,000 shares of the Company’s common stock with a conversion price of $.25 per share. Also subsequent to June 30, 2003, warrants for the purchase of 680,000 shares of the Company’s common stock with a conversion price of $.25 per share were issued in connection with the placement of $170,000 of Class 1 Notes. Included in these amounts were $30,000 of Class 1 Notes that were purchased by Mr. Drake, for which he also received warrants for the purchase of 120,000 shares of the Company’s common stock with a conversion price of $.25 per share. An additional $75,000 of Class 2 Notes were also placed subsequent to June 30, 2003, which have a conversion option which would allow the note holder to convert the Class 2 Note to a Class 1 Note on or before September 26, 2003. If the conversion option is exercised, the note holder would receive warrants for the purchase of 300,000 shares of the Company’s common stock with a conversion price of $.25 per share. Subsequent to June 30, 2003, the Board of Directors increased the amount of Notes that could be outstanding to $4.0 million. As of August 14, 2003, the purchasers of Class 1 or Class 2 Notes have received warrants for the purchase of 6,981,291 shares of the Company’s common stock with a conversion price of $.25 per share. In total, in connection with Note purchases under this plan, Mr. Drake has received warrants for the purchase of 1,890,000 shares of the Company’s common stock. Additionally, Max A. Coon (a director of the Company) and Maxco, Inc. (a 25% owner of the Company) have received warrants for the purchase of the Company’s common stock totaling 270,000 shares and 240,000 shares, respectively. The cash received in connection with this plan has been used to fund working capital needs.

		Effective May 1, 2002, the Note and Warrant Purchase Agreement was amended to provide for “Class 2 Notes” and “Class 2 Warrants” which will be subordinated to the prior purchasers. Class 2 Notes are working capital notes which will be secured by accounts receivable of the Company. The number of Class 2 Warrants to be obtained will be based on the length of time the related Class 2 Note is outstanding. As of August 14, 2003, $1,312,000 of the Class 2 Notes had been placed, of which $437,000 were still outstanding. The holders of the remaining $437,000 will also receive warrants when their notes are paid off, the amount of which will be determined at the pay off date.

		The notes and warrants were sold in private transactions exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. There have been fifteen purchasers, some of whom have purchased on more than one occasion. Of these, four of the purchasers are related entities or insiders of the Company. Five of the purchasers is a client, or relative of the principal, of one State of California registered investment advisor. To the best of the Company’s knowledge, all of the purchasers are either “accredited investors” as that term is defined in Regulation D under the Securities Act of 1933 or, either alone or with their purchaser representative, have such knowledge and experience in financial and business matters that they are capable of evaluating the merits and risks of the investment.

	2)		Amendment to Articles of Incorporation

			The Company is authorized to amend its articles of incorporation to increase the number of shares of common stock which it is authorized to issue from 20,000,000 to 25,000,000.