**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 December 31, 2007**                                                    |
|   |                                                                                                     |   |   |   |
|   | **OR**                                                                                                   |
|   |                                                                                                     |   |   |   |
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom              to              **

 

**Commission File Number 1-6549**

 

**AmericanScience and Engineering, Inc.**

(Exact name of Registrant as specified in its charter)

 

| **Massachusetts**

(State or other jurisdiction of

incorporation or organization) | ** ** | **04-2240991**

(I.R.S. Employer

Identification No.) |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------|

 

| **829 Middlesex Turnpike**

**Billerica, Massachusetts**

(Address of principal executive offices) | ** ** | **01821**

(Zip Code) |
|----------------------------------------------------------------------------------------------------|------------|-----------------------|

 

**(978) 262-8700**

 (Registrant’s telephone number,including area code)

 

(Former name, former address and former fiscal year, if changed sincelast report)

 

        Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.    Yes x  No o

 

        Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act(Check one):

 

Large accelerated filer o                Acceleratedfiler x                Non-acceleratedfiler o

 

        Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Securities Exchange Act of 1934).    Yes o No x

 

        Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date

 

| **Class of  Common Stock** | ** ** | **Outstanding  at**

**February 5,  2008** |
|---------------------------------|------------|-------------------------------------------------|
| $.662⁄3 par value           |       | 9,081,413                                       |

 

 

----

 

 

**AmericanScience and Engineering, Inc. and Subsidiary**

 

**Index**

** **
| **Part 1—Financial  Information**                                                                                                            | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Item 1**—**Financial Statements                                                                                                                   | 3          |
| Unaudited  Condensed Consolidated Balance Sheets—December 31, 2007 and  March 31, 2007                                                  | 3          |
| Unaudited  Condensed Consolidated Statements of Operations—For the Three and Nine Months  Ended December 31, 2007 and December 31, 2006 | 4          |
| Unaudited  Condensed Consolidated Statements of Cash Flows—For the Nine Months Ended  December 31, 2007 and December 31, 2006           | 5          |
| Notes to  Unaudited Condensed Consolidated Financial Statements                                                                                        | 6          |
| Item 2**—**Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                            | 12         |
| Item 3**—**Quantitative and Qualitative Disclosure  About Market Risk                                                                             | 13         |
| Item 4**—**Controls and Procedures                                                                                                                | 14         |
| **Part II—Other  Information**                                                                                                               | 15         |
| Item 1**—**Legal Proceedings                                                                                                                      | 15         |
| Item 2**—**Unregistered Sales of Equity Securities  and Use of Proceeds                                                                           | 15         |
| Item 6**—**Exhibits                                                                                                                               | 15         |
| **Signatures**                                                                                                                                         | 16         |

 

2

----

 

 

**PART I—FINANCIAL INFORMATION**

 

**Item 1—Financial Statements**

 

**American Science and Engineering, Inc. andSubsidiary**

** Condensed Consolidated Balance Sheets**

** (Unaudited)**

** **
| ** **                                                                                                                                                                            | ** ** | **December 31, 2007** | ** ** | **March 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------|------------|
| **Dollars in thousands**                                                                                                                                                              | ** ** | ** **                 | ** ** | ** **              | ** ** |
| ** **                                                                                                                                                                            | ** ** | ** **                 | ** ** | ** **              | ** ** |
| **Assets**                                                                                                                                                                            | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Current assets:                                                                                                                                                                       |       |                       |       |                    |       |
| Cash and cash equivalents                                                                                                                                                             |       | $                          | 42,378     |                    | $          | 69,650 |   |
| Restricted cash and investments                                                                                                                                                       |       | 319                        |       | 202                     |       |
| Short-term investments                                                                                                                                                                |       | 92,460                     |       | 66,086                  |       |
| Accounts  receivable, net of allowances of $246 and $224 at December 31, 2007 and  March 31, 2007, respectively                                                             |       | 36,317                     |       | 23,366                  |       |
| Unbilled costs and fees                                                                                                                                                               |       | 1,901                      |       | 5,841                   |       |
| Inventories                                                                                                                                                                           |       | 39,548                     |       | 20,140                  |       |
| Note receivable                                                                                                                                                                       |       | —                     |       | 1,443                   |       |
| Prepaid expense and other current assets                                                                                                                                              |       | 5,031                      |       | 5,287                   |       |
| Deferred income taxes                                                                                                                                                                 |       | 4,301                      |       | 3,087                   |       |
| **Total current assets**                                                                                                                                                              |       | 222,255                    |       | 195,102                 |       |
| Building, equipment and leasehold improvements, net                                                                                                                                   |       | 22,254                     |       | 23,054                  |       |
| Restricted cash and investments                                                                                                                                                       |       | 2,204                      |       | 2,599                   |       |
| Deferred income taxes                                                                                                                                                                 |       | 2,579                      |       | 970                     |       |
| Other assets, net                                                                                                                                                                     |       | 4                          |       | —                  |       |
| **Total assets**                                                                                                                                                                      |       | $                          | 249,296    |                    | $          | 221,725 |   |
|                                                                                                                                                                                  |       |                       |       |                    |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                         | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Current liabilities:                                                                                                                                                                  |       |                       |       |                    |       |
| Accounts payable                                                                                                                                                                      |       | $                          | 11,256     |                    | $          | 8,117 |   |
| Accrued salaries and benefits                                                                                                                                                         |       | 2,814                      |       | 7,241                   |       |
| Accrued warranty costs                                                                                                                                                                |       | 1,430                      |       | 1,997                   |       |
| Deferred revenue                                                                                                                                                                      |       | 25,616                     |       | 4,321                   |       |
| Customer deposits                                                                                                                                                                     |       | 9,373                      |       | 11,554                  |       |
| Accrued income taxes                                                                                                                                                                  |       | 1,031                      |       | —                  |       |
| Current portion of lease financing liability                                                                                                                                          |       | 1,130                      |       | 1,263                   |       |
| Warrant liability                                                                                                                                                                     |       | —                     |       | 634                     |       |
| Other current liabilities                                                                                                                                                             |       | 8,010                      |       | 4,290                   |       |
| **Total current liabilities**                                                                                                                                                         |       | 60,660                     |       | 39,417                  |       |
| Lease financing liability, net of current portion                                                                                                                                     |       | 9,825                      |       | 10,379                  |       |
| Other long term liabilities                                                                                                                                                           |       | 3,988                      |       | 4,231                   |       |
| **Total liabilities**                                                                                                                                                                 |       | 74,473                     |       | 54,027                  |       |
|                                                                                                                                                                                  |       |                       |       |                    |       |
| **Stockholders’ equity:**                                                                                                                                                        | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Preferred stock, no par value Authorized—100,000  shares; Issued—none                                                                                                       |       | —                     |       | —                  |       |
| Common stock,  $0.66-2/3 par value Authorized—20,000,000 shares; Issued and Outstanding  9,146,472 shares at December 31, 2007 and 9,186,975 shares at  March 31, 2007 |       | 6,097                      |       | 6,125                   |       |
| Capital in excess of par value                                                                                                                                                        |       | 101,201                    |       | 105,036                 |       |
| Accumulated other comprehensive income                                                                                                                                                |       | 51                         |       | 48                      |       |
| Retained earnings                                                                                                                                                                     |       | 67,474                     |       | 56,489                  |       |
| **Total stockholders’ equity**                                                                                                                                                   |       | 174,823                    |       | 167,698                 |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                   |       | $                          | 249,296    |                    | $          | 221,725 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

 

3

----

 

 

 

**American Science and Engineering, Inc. andSubsidiary**

** Condensed Consolidated Statements ofOperations**

** (Unaudited)**

** **

| ** **                                                     | ** **      | **Three Months Ended**      | ** ** | **Nine Months Ended**      | ** ** |
|----------------------------------------------------------------|-----------------|-----------------------------|------------|----------------------------|------------|
| **Dollars and shares in  thousands, except per share amounts** | ** **      | **December  31, 2007** | ** ** | **December 31, 2006** | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| **Net sales and contract  revenues:**                          | ** **      | ** **                  | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net product sales and contract revenues                        |            | $                           | 26,729     |                       | $          | 33,363 |   | $ | 77,461 |   | $ | 69,514 |   |
| Net service revenues                                           |            | 15,886                      |       | 14,434                     |       | 47,252 |   | 37,753 |   |
| Total net sales and contract revenues                          |            | 42,615                      |       | 47,797                     |       | 124,713 |   | 107,267 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| **Cost of sales and contracts:**                               | ** **      | ** **                  | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of product sales and contracts                            |            | 18,052                      |       | 19,102                     |       | 51,693 |   | 39,078 |   |
| Cost of service revenues                                       |            | 9,379                       |       | 6,757                      |       | 26,357 |   | 19,225 |   |
| Total cost of sales and contracts                              |            | 27,431                      |       | 25,859                     |       | 78,050 |   | 58,303 |   |
| Gross profit                                                   |            | 15,184                      |       | 21,938                     |       | 46,663 |   | 48,964 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| **Expenses:**                                                  | ** **      | ** **                  | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general and administrative expenses                   |            | 7,609                       |       | 7,939                      |       | 19,943 |   | 19,565 |   |
| Research and development costs                                 |            | 3,148                       |       | 1,440                      |       | 8,678 |   | 5,220 |   |
| Total expenses                                                 |            | 10,757                      |       | 9,379                      |       | 28,621 |   | 24,785 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| Operating income                                               |            | 4,427                       |       | 12,559                     |       | 18,042 |   | 24,179 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| **Other income (expense):**                                    | ** **      | ** **                  | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and investment income                                 |            | 1,686                       |       | 1,381                      |       | 5,444 |   | 3,872 |   |
| Interest expense                                               |            | (39                         | )          | (89                        | )          | (119 | ) | (278 | ) |
| Other, net                                                     |            | (182                        | )          | 61                         |       | (398 | ) | 154 |   |
| Change in warrant valuation                                    |            | —                      |       | (224                       | )          | 11 |   | 2,115 |   |
| Total other income (expense)                                   |            | 1,465                       |       | 1,129                      |       | 4,938 |   | 5,863 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| Income before provision for income taxes                       |            | 5,892                       |       | 13,688                     |       | 22,980 |   | 30,042 |   |
| Provision for income taxes                                     |            | 1,890                       |       | 5,616                      |       | 8,291 |   | 11,222 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| Net income                                                     |            | $                           | 4,002      |                       | $          | 8,072 |   | $ | 14,689 |   | $ | 18,820 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |   |   |   |   |
| Income per share                                               |  - Basic   |                        | $          | 0.44                       |       | $ | 0.89 |   | $ | 1.60 |   | $ | 2.07 |   |
|                                                           |  - Diluted |                        | $          | 0.43                       |       | $ | 0.86 |   | $ | 1.56 |   | $ | 1.79 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |   |   |   |   |
| Weighted average shares                              |  - Basic   |                        | 9,136      |                       | 9,100      |   | 9,163 |   | 9,087 |   |
|                                                           |  - Diluted |                        | 9,357      |                       | 9,346      |   | 9,397 |   | 9,340 |   |
|                                                           |            |                        |       |                       |       |   |   |   |   |
| Cash dividends declared per common share                       |            | $                           | 0.20       |                       | $          | — |   | $ | 0.40 |   | $ | — |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

 

4

----

 

**AmericanScience and Engineering, Inc. and Subsidiary**

**Condensed Consolidated Statements ofCash Flows**

**(Unaudited)**

 

**Dollars in thousands**
| ** **                                                                                    | ** ** | **For the Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **Dec. 31, 2007**                       | ** ** | **Dec. 31, 2006** | ** ** |
| **Cash flows from operating activities:**                                                     | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net income                                                                                    |       | $                                                 | 14,689     |   | $ | 18,820 |   |
| Adjustments to reconcile net income to net cash  provided by (used for) operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                                 |       | 3,071                                             |       | 1,666 |   |
| Provisions for contracts, inventory and accounts  receivable reserves                         |       | 77                                                |       | 239 |   |
| Accretion of short term investments                                                           |       | (1,798                                            | )          | (1,264 | ) |
| Deferred income taxes                                                                         |       | (2,823                                            | )          | (679 | ) |
| Change in value of warrants                                                                   |       | (11                                               | )          | (2,115 | ) |
| Stock compensation expense                                                                    |       | 4,141                                             |       | 6,538 |   |
| Changes in assets and liabilities:                                                            |       |                                              |       |   |   |
| Accounts  receivable                                                                          |       | (12,983                                           | )          | (9,402 | ) |
| Unbilled costs  and fees                                                                      |       | 3,940                                             |       | 169 |   |
| Inventories                                                                                   |       | (19,453                                           | )          | (2,099 | ) |
| Prepaid expenses  and other assets                                                            |       | 1,645                                             |       | 884 |   |
| Accounts payable                                                                              |       | 3,139                                             |       | 1,165 |   |
| Accrued income  taxes                                                                         |       | 1,031                                             |       | 1,030 |   |
| Customer deposits                                                                             |       | (2,181                                            | )          | 5,628 |   |
| Deferred revenue                                                                              |       | 21,052                                            |       | 4,233 |   |
| Accrued expenses  and other current liabilities                                               |       | (749                                              | )          | 24 |   |
| Non-current  liabilities                                                                      |       | —                                            |       | (15 | ) |
| Net cash provided by operating activities                                                     |       | 12,787                                            |       | 24,822 |   |
| ** **                                                                                    | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| **Cash flows from investing activities:**                                                     | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Purchases of short-term investments                                                           |       | (125,282                                          | )          | (94,708 | ) |
| Proceeds from maturities of short-term investments                                            |       | 100,725                                           |       | 76,945 |   |
| Purchases of property and equipment                                                           |       | (2,271                                            | )          | (3,379 | ) |
| Net cash used for investing activities                                                        |       | (26,828                                           | )          | (21,142 | ) |
| ** **                                                                                    | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| **Cash flows from financing activities:**                                                     | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Decrease (increase) in restricted cash and  investments                                       |       | 278                                               |       | (1,658 | ) |
| Proceeds from exercise of warrants                                                            |       | 509                                               |       | 835 |   |
| Proceeds from exercise of stock options                                                       |       | 2,939                                             |       | 765 |   |
| Repurchase of shares of common stock                                                          |       | (13,821                                           | )          | — |   |
| Payment of dividends                                                                          |       | (3,704                                            | )          | — |   |
| Proceeds from financing of leasehold improvements                                             |       | 417                                               |       | 2,253 |   |
| Repayment of leasehold financing                                                              |       | (1,054                                            | )          | (581 | ) |
| Reduction of income taxes paid due to the tax  benefit from employee stock option expense     |       | 1,221                                             |       | 479 |   |
| Net cash provided by (used for) financing activities                                          |       | (13,215                                           | )          | 2,093 |   |
|                                                                                          |       |                                              |       |   |   |
| Foreign currency translation effect on cash                                                   |       | (16                                               | )          | 7 |   |
|                                                                                          |       |                                              |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                          |       | (27,272                                           | )          | 5,780 |   |
| Cash and cash equivalents at beginning of period                                              |       | 69,650                                            |       | 50,655 |   |
| Cash and cash equivalents at end of period                                                    |       | $                                                 | 42,378     |   | $ | 56,435 |   |

 

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

 

 

5

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**American Science and Engineering, Inc. andSubsidiary**

** Notes to Unaudited Condensed ConsolidatedFinancial Statements**

 

**1.     General**

 

        Thecondensed consolidated financial statements include the accounts of the Companyand its wholly owned subsidiary. All significant inter-company transactions andbalances have been eliminated.

 

        Theunaudited condensed consolidated financial statements have been preparedpursuant to the rules and regulations of the Securities and ExchangeCommission. Certain information and note disclosures normally included inannual financial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omitted pursuant to those rules andregulations, although the Company believes that the disclosures made areadequate to make the information not misleading. These condensed consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and the notes included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended March 31, 2007.

 

        Theunaudited condensed consolidated financial statements, in the opinion ofmanagement, include all adjustments necessary, consisting solely of normalrecurring adjustments, to present fairly the Company’s financial position,results of operations and cash flows. These quarterly results are notnecessarily indicative of the results to be expected for the entire year.

 

***Nature of Operations***

 

        TheCompany is engaged in the development and manufacture of sophisticated X-rayinspection systems for critical detection and security screening solutions forsale primarily to U.S. and foreign government agencies. The Company has onlyone reporting segment, X-ray screening products.

 

***Significant Accounting Policies***

 

        Revenueson cost reimbursable and long-term fixed price contracts are generally recordedas costs are incurred using the percentage of completion method. For systemsthat are produced in a standard manufacturing operation and have shorter orderto delivery cycles, the Company recognizes sales at the time of shipment of thesystem to the customer and when other revenue recognition criteria (such astransfer of risk) are met.

 

        TheCompany’s Domestic Loan and Security Agreement with Silicon Valley Bank Eastrequires certain cash balances to be restricted as collateral againstoutstanding standby letters of credit; these are separately presented asrestricted cash and investments. (See Note 5)

 

        Theother significant accounting policies followed by the Company and itssubsidiary in preparing its consolidated financial statements are set forth inNote 1 to the consolidated financial statements included in its Form 10-Kfor the year ended March 31, 2007. As discussed in Note 7, theCompany adopted Interpretation No. 48 (“FIN 48”) issued by the FinancialAccounting Standard Board (“FASB”) effective April 1, 2007. The Companyhas made no other changes to its accounting policies during the current year.

 

***Comprehensive Income***

 

Comprehensiveincome is comprised of the following:

 

| ** **                                                          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                                             | ** ** | **Dec. 31,   2007**    | ** ** | **Dec. 31,  2006**         | ** ** | **Dec. 31,   2007** | ** ** | **Dec. 31,  2006** | ** ** |
| Net income                                                          |       | $                                | 4,002      |                            | $          | 8,072 |   | $ | 14,689 |   | $ | 18,820 |   |
| Foreign currency translation adjustments, net of tax                |       | (20                              | )          | (3                              | )          | (12 | ) | 19 |   |
| Unrealized gains and losses from marketable  securities, net of tax |       | 15                               |       | (15                             | )          | 15 |   | 43 |   |
| Comprehensive income                                                |       | $                                | 3,997      |                            | $          | 8,054 |   | $ | 14,692 |   | $ | 18,882 |   |

 

 

 

6

----

 

 

**2.     Accounting for Stock-BasedCompensation**

 

        Stock-basedcompensation costs recognized during the three months ended December 31,2007 and December 31, 2006 amounted to $1,473,000 and $2,289,000,respectively. Total costs recognized during the nine months ended December 31,2007 and December 31, 2006 amounted to $4,141,000 and $6,233,000,respectively. The income tax benefit related to such compensation for the threemonths ended December 31, 2007 and December 31, 2006 wasapproximately $222,000 and $286,000, respectively. The income tax benefitrelated to such compensation for the nine months ended December 31, 2007and December 31, 2006 was approximately $667,000 and $904,000,respectively.

 

 

        The following table summarizesshare-based compensation costs included in the Company’s consolidated statementof income:

 
| ** **                                        | ** ** | **Three months ended**     | ** ** | **Nine Months ended**      | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(In thousands)**                                | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| Cost of revenues                                  |       | $                          | 393        |                       | $          | 1,152 |   | $ | 1,266 |   | $ | 2,666 |   |
| Selling, general and administrative               |       | 1,080                      |       | 1,137                      |       | 2,875 |   | 3,567 |   |
| Total share-based compensation expense before tax |       | $                          | 1,473      |                       | $          | 2,289 |   | $ | 4,141 |   | $ | 6,233 |   |

 

        Thefair value of options at date of grant was estimated with the followingassumptions for grants made during the period presented:

 

| ** **              | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| **Assumptions:**        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Option life             |       | 3 years                         |       | 3 years |   |
| Risk-free interest rate |       | 4.23                            | %          | 4.77 | % |
| Stock volatility        |       | 51                              | %          | 56 | % |
| Dividend yield          |       | 1.3                             | %          | 0 | % |

 

**Stock Option and Other Compensation Plans:**

 

        TheCompany has various stock option and other compensation plans for directors,officers, and employees. The Company had the following stock option plansoutstanding as of December 31, 2007: the 1995 Combination Plan, the 1997Non-Qualified Option Plan, the 1998 Non-Qualified Option Plan, the 1999Combination Plan, the 2000 Combination Plan, the 2002 Combination Plan, the2003 Stock Plan for Non-Employee Directors and the 2005 Equity and IncentivePlan. There are 3,480,000 shares authorized under these plans. Vesting periodsare at the discretion of the Board of Directors and typically range between oneand three years. Total compensation expense relating to these options for thenine months ended December 31, 2007 amounted to $2,884,534.

 

***Stock options***

*** ***

        The following tables summarize stockoption activity during the first nine months of fiscal year 2008:

 

 
| ** **                                | ** ** | **Options Outstanding** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| **Outstanding at March 31, 2007**    |       | 887,573                 |       | $ | 37.43 |   | 7.50 |   |   |   |
| Grants                                    |       | 76,970                  |       | 63.21 |   |   |   | $ | — |   |
| Exercises                                 |       | (121,895                | )          |   |   |   |   |   |   |
| Cancellations                             |       | (8,845                  | )          |   |   |   |   |   |   |
| **Outstanding at December 31, 2007** |       | 833,803                 |       | $ | 41.52 |   | 7.05 |   |   |   |
| **Exercisable at December 31, 2007** |       | 678,763                 |       | $ | 37.85 |   |   |   | $ | 13,382,044 |   |

 

 

 

7

----

 

 

 

        Informationrelated to the stock options outstanding as of December 31, 2007 is asfollows:

 

 

| **Range of Exercise Prices** | ** ** | **Number of Shares** | ** ** | **Weighted-Average  Remaining Contractual Life (years)** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Exercisable  Number of Shares** | ** ** | **Exercisable  Weighted- Average  Exercise Price** | ** ** |
|---------------------------------------------|------------|----------------------|------------|----------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|----------------------------------------------------|------------|
| $6.50 - $20.00                    |       |                 | 173,393    |                                                     | 5.13       |                                 | $          | 11.88                             |       | 173.393                                            |       | $ | 11.88 |   |
| $20.01 - $30.00                   |       |                 | 99,113     |                                                     | 6.64       |                                 | 27.57      |                              | 99,113     |                                               | 27.57      |   |
| $30.01 - $40.00                   |       |                 | 64,532     |                                                     | 6.93       |                                 | 38.93      |                              | 64,532     |                                               | 38.93      |   |
| $40.01 - $50.00                   |       |                 | 126,866    |                                                     | 7.83       |                                 | 45.74      |                              | 92,599     |                                               | 46.05      |   |
| $50.01 - $60.00                   |       |                 | 201,391    |                                                     | 7.58       |                                 | 53.64      |                              | 184,254    |                                               | 53.69      |   |
| $60.01 - $74.72                   |       |                 | 168,508    |                                                     | 8.09       |                                 | 63.54      |                              | 64,872     |                                               | 65.21      |   |
| $6.50 - $74.72                    |       |                 | 833,803    |                                                     | 7.05       |                                 | $          | 41.52                             |       | 678,763                                            |       | $ | 37.85 |   |

 

        Theweighted average fair value of options granted in the nine months ended December 31,2007 was $22.61. As of December 31, 2007, there was $2,003,971 of totalunrecognized compensation cost related to non-vested stock options granted. Theunrecognized compensation will be primarily recognized over a period ofapproximately 3 years. Non-vested common stock options are subject to therisk of forfeiture until the fulfillment of specified conditions.

 

***Restricted Stock and Restricted Stock Units***

 

        Duringfiscal years 2007 and 2008, the Company instituted long term incentive plansfor certain key employees. The plans call for the issuance of restricted stockand options which vest upon the achievement of certain performance based goalsas well as service time incurred. The restricted stock units, once vested, arepaid out in common stock.  In addition,restricted stock and restricted stock units may be granted to other employeeswith vesting periods that range from one to three years. Annually on January 10th,the Board of Directors is granted restricted stock. The stock vests pro-ratabased on service time incurred in the upcoming calendar year. The fair valuesof these restricted stock awards are equal to the market price per share of theCompany’s common stock on the date of grant.

 

Asof December 31, 2007, there was $4,893,067 of total unrecognizedcompensation cost related to non-vested restricted stock and stock unit awardsgranted under the Company’s stock plans. This cost is expected to be recognizedover a 3 year period.  Totalcompensation expense relating to these restricted shares and restricted stockunits for the nine months ended December 31, 2007 amounted to $1,256,533.

 

        Thefollowing table summarizes restricted stock and stock unit awards activityduring the first nine months of fiscal year 2008:

 
| ** **                                | ** ** | **Restricted Stock and Stock Unit Awards** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **Number of Shares**                       | ** ** | **Weighted -Average Grant Date  Fair Value** | ** ** |
| **Outstanding at March 31, 2007**    |       | 49,538                                     |       | $ | 54.52 |   |
| Granted                                   |       | 67,138                                     |       | 62.40 |   |
| Vested                                    |       | (7,855                                     | )          | 57.61 |   |
| Forfeited                                 |       | (2,400                                     | )          | 60.62 |   |
| **Outstanding at December 31, 2007** |       | 106,421                                    |       | $ | 59.13 |   |

 

**Stock Repurchase Program:**

 

        Duringthe first quarter of fiscal 2008, the Board of Directors approved a StockRepurchase Program which authorized the Company to repurchase up to$35 million of shares of its common stock from time to time on the openmarket. During the nine months ended December 31, 2007, a total of 258,748shares were repurchased at an average price of $53.39 per share.

 

**Dividends:**

 

        OnAugust 6, 2007, the Company’s Board of Directors declared a cash dividendof $0.20 per share. The dividend was paid on September 5, 2007 to allshareholders of record at the close of business on August 20, 2007. On November 5,2007, the Company’s Board of Directors declared a cash dividend of $0.20 pershare. The dividend was paid on December 5, 2007 to all shareholders ofrecord at the close of business on November 19, 2007. On February 11, 2008the Company’s Board of Directors declared a quarterly cash dividend of $0.20per share. The dividend will be paid on March 7, 2008 to all shareholders ofrecord at the close of business on February 18, 2008. Future dividends will bedeclared at the discretion of the Board of Directors and will depend upon suchfactors as the Board of Directors deems relevant.

 

 

 

8

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**3.     Inventories**

 

| **(Dollars in thousands)**                                | ** ** | **December 31, 2007** | ** ** | **March 31, 2007** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| Inventories consisted of:                                 |       |                            |       |                         |       |
| Raw materials, completed sub-assemblies, and spare  parts |       | $                               | 17,178     |                         | $          | 11,260 |   |
| Work-in-process                                           |       | 11,821                          |       | 6,681                        |       |
| Finished goods                                            |       | 10,549                          |       | 2,199                        |       |
| Total                                                     |       | $                               | 39,548     |                         | $          | 20,140 |   |

 

**4.     Income per Common and CommonEquivalent Share**

 

        Basicearnings per common share is computed by dividing net income available tocommon stockholders by the weighted average number of shares of common stockoutstanding during the period. Diluted earnings per share include the dilutiveimpact of options, warrants, contingent restricted stock, and restricted stockunits using the average share price of the Company’s common stock for theperiod. For the quarters ended December 31, 2007 and December 31,2006, common stock equivalents of 351,000 and 112,000 respectively, areexcluded from diluted earnings per share, as their effect is anti-dilutive. Forthe nine months ended December 31, 2007 and December 31, 2006, commonstock equivalents of 285,000 and 106,000, respectively, are excluded from dilutedearnings per share, as their effect is anti-dilutive.

 

 
| ** **                                                                                                                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months ended**      | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **(In thousands except per share  amounts)**                                                                                     | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| **Income Per Share**                                                                                                             | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                       | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                                                       | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                                       |       | $                          | 4,002      |                       | $          | 8,072 |   | $ | 14,689 |   | $ | 18,820 |   |
| Weighted average number of common shares  outstanding—basic                                                                 |       | 9,136                      |       | 9,100                      |       | 9,163 |   | 9,087 |   |
| Net income per  share—basic                                                                                                 |       | $                          | 0.44       |                       | $          | 0.89 |   | $ | 1.60 |   | $ | 2.07 |   |
|                                                                                                                             |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| **Diluted:**                                                                                                                     | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                                       |       | $                          | 4,002      |                       | $          | 8,072 |   | $ | 14,689 |   | $ | 18,820 |   |
| Adjustment to net income for change in warrant  valuation                                                                        |       | —                     |       | —                     |       | (11 | ) | (2,115 | ) |
| Adjusted net income                                                                                                              |       | $                          | 4,002      |                       | $          | 8,072 |   | $ | 14,678 |   | $ | 16,705 |   |
|                                                                                                                             |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Weighted average number of common shares outstanding                                                                             |       | 9,136                      |       | 9,100                      |       | 9,163 |   | 9,087 |   |
| Assumed exercise of stock options and warrants, and  restricted stock and restricted stock units using the treasury stock method |       | 220                        |       | 246                        |       | 235 |   | 253 |   |
| Weighted average number of common and potential  common shares outstanding—diluted                                          |       | 9,356                      |       | 9,346                      |       | 9,398 |   | 9,340 |   |
|                                                                                                                             |       |                       |       |                       |       |   |   |   |   |
| Net income per  share—diluted                                                                                               |       | $                          | 0.43       |                       | $          | 0.86 |   | $ | 1.56 |   | $ | 1.79 |   |
|                                                                                                                                  |            |                            |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**5.     Line of Credit**

 

        OnNovember 16, 2006, the Company modified its domestic loan and securityagreement with Silicon Valley Bank East which was scheduled to expire on November 29,2006. The Company increased its domestic facility from $5.0 million to$20.0 million to support the Company’s routine working capital needs. Themaximum amount available for borrowings under the domestic facility is either (a) $20.0 millionminus the amount of all outstanding letters of credit less certain reserves,and minus the outstanding principal balance of any advances (if the Company’sunrestricted cash is greater than or equal to $30.0 million), or (b) thelesser of (i) $20.0 million, or (ii) 85% of eligible domesticaccounts receivable minus the amount of outstanding letters of credit adjustedfor certain reserves and minus the principle balance of any advances (if theCompany’s unrestricted cash is less than $30.0 million for a period of 30consecutive days). The modification of the domestic loan and security agreementextended this credit facility through November 14, 2008.

 

        Thecredit facility bears an interest rate of the greater of 4.0% or the SiliconValley Bank prime rate (7.25% at December 31, 2007). The credit agreementis collateralized by certain assets of the Company and contains certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequires the maintenance of certain financial covenants. As of December 31,2007, the Company was in compliance with these covenants.

 

 

9

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Inthe normal course of business, the Company may provide certain customers andpotential customers with performance guarantees, which are generally backed bystandby letters of credit. In general, the Company would only be liable for theamount of these guarantees in the event of default in the performance of itsobligations, the probability of which is remote in management’s opinion. TheCompany had outstanding $5,993,167 in stand-by letters of credit against thedomestic facility with $14,006,833 remaining available. Of the outstandingletters of credit, $300,000 relates to the Company’s building lease and theremainder is guaranteeing performance on certain international projects. Noamounts have been drawn against these letters of credit. In addition, at December 31,2007, the Company had a restricted cash balance of $2,523,221 related tocertain bank required deposits for outstanding letters of credits, bid bonds,and other bank-related fees.

 

**6.     Warrant Liability**

 

        OnMay 28, 2002, the Company closed on a private placement offering of commonstock and warrants. A total of 1,115,000 shares were sold to accreditedinvestors at a price of $17.64 per share. In addition, warrants to purchase anadditional 295,475 shares of common stock at an exercise price of $23.52 pershare were issued. The warrants were immediately vested and had a five-yearlife expiring in May of 2007.

 

        Dueto certain conversion features of these warrants that provided that the holdercould opt for a cash settlement in certain instances, including a merger, asale of all or substantially all of the Company’s assets, or a tender offer orexchange offer of shares of the Company’s stock, a liability equal to the fairvalue of the warrants at the deal closing date was recorded on the Company’sbalance sheet. This liability was re-measured each quarter and marked tomarket. The “mark to market” change in the warrants valuation of $224,000 wasrecorded as other income (expense) for the three months ended December 31,2006. The “mark to market” change in the warrants valuation of $11,000 and$2,115,000 was recorded as other income (expense) for the nine months ended December 31,2007 and December 31, 2006, respectively. In May of 2007, allremaining warrants were exercised and no liability for these warrants remainsat December 31, 2007.

 

**7.     Income Taxes**

 

        TheCompany accounts for income taxes in accordance with SFAS No. 109, “Accountingfor Income Taxes.” Accordingly, the Company recognizes deferred income taxesbased on the expected future tax consequences of differences between thefinancial statement basis and the tax basis of assets and liabilities,calculated using enacted tax rates in effect for the year in which thedifferences are expected to be reflected in the tax return. The Companyevaluates the need for a valuation allowance against its net deferred taxassets at year end based upon its three year cumulative income and itsprojections of future income, and records a valuation allowance against any netdeferred tax assets if it is more likely than not that they will not berealized.

 

        InJuly 2006, the FASB issued Interpretation No. 48, “Accounting forUncertainty in Income Taxes—an Interpretation of FASB Statement No. 109”(FIN 48). FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an entity’s financial statements in accordance with FASBStatement No. 109, “Accounting for Income Taxes” and prescribes arecognition threshold and measurement attributes for financial statementdisclosure of tax positions taken or expected to be taken on a tax return.Under FIN 48, the impact of an uncertain income tax position on the incometax return must be recognized at the largest amount that is more likely thannot to be sustained upon audit by the relevant taxing authority. An uncertainincome tax position will not be recognized if it has less than a 50% likelihoodof being sustained. Additionally, FIN 48 provides guidance onde-recognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. The Company adopted FIN 48 effective April 1,2007. There were no adjustments required to the reported tax benefits atadoption. Further, the Company does not expect that the amounts of unrecognizedtax benefits will change significantly in the next twelve months. As of April 1,2007, the Company had accrued no interest or penalties related to uncertain taxpositions. The Company’s policy is to recognize interest accrued related tounrecognized tax benefits in interest expense and penalties in operatingexpenses.

 

        TheCompany is currently subject to audit by the Internal Revenue Service andcertain state income tax authorities for the fiscal years ended 2004 through2007.

 

 

10

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**8.     Guarantees**

 

        Certainof the Company’s products carry a one-year warranty, the costs of which areaccrued for at time of shipment or delivery. Accrual rates are based uponhistorical experience over the preceding twelve months and management’sjudgment of future exposure. Warranty experience for the three and nine monthsended December 31, 2007 and December 31, 2006 is as follows:

 
| ** **                                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**            | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|----------------------------------|------------|
| **(In thousands)**                               | ** ** | **December 31, 2007** | ** ** | **December 31,  2006** | ** ** | **December 31, 2007** | ** ** | **December 31,  2006** | ** ** |
| Warranty accrual—beginning of period        |       | $                          | 1,187      |                             | $          | 2,832 |   | $ | 1,997 |   | $ | 3,606 |   |
| Accruals for warranties issued during the period |       | 839                        |       | 790                              |       | 2,239 |   | 1,844 |   |
| Adjustment of preexisting accrual estimates      |       | (273                       | )          | (873                             | )          | (2,020 | ) | (1,854 | ) |
| Warranty costs incurred during the period        |       | (323                       | )          | (276                             | )          | (786 | ) | (1,123 | ) |
| Warranty accrual—end of period              |       | $                          | 1,430      |                             | $          | 2,473 |   | $ | 1,430 |   | $ | 2,473 |   |

 

        Inconjunction with the sale of certain assets and contracts of the Company’s HighEnergy Systems Division in January of 2005, the lease for the Californiaoperations of the High Energy Systems Division was assigned to Accuray, Inc.The Company remains secondarily liable for the remaining lease payments in theevent of default by Accuray, Inc. during the lease term which expires in February 2011.Total remaining lease payments at December 31, 2007 totaled $1,230,000. Noaccrual for this contingent liability has been recorded at December 31,2007 as payment of this liability is considered remote.

 

**9.     Lease Commitments**

 

        InMarch 2005, the Company renewed its lease agreement for its corporateheadquarters and manufacturing facilities in Billerica, Massachusetts. As partof the lease agreement, the Company’s landlord agreed to certain renovations tothe Billerica facility including the construction of additional high baymanufacturing space. The Company was responsible for a portion of theconstruction costs and was deemed to be the owner of the building during theconstruction period under EITF 97-10 “The Effect of Lessee Involvement inAsset Construction”. In January 2007, the Company amended this leaseagreement to expand its lease to include the remaining available space in thebuilding. A total of $7,182,000 was capitalized to record the facility on itsbooks with an offsetting credit to the Lease Financing Liability. In additionthe landlord construction allowances of $6,009,000 were recorded as additionallease financing liability.

 

        Atthe completion of the construction of the initial renovations in February 2006,the lease was reviewed for potential sale-leaseback treatment in accordancewith SFAS No. 98. Based on this review, it was determined that the leasedid not qualify for sale-leaseback treatment in accordance with SFAS No. 98.As a result, building and tenant improvement and associated lease financingliabilities remain on the Company’s books. The Lease Financing Liability isbeing amortized over the lease term based on the payments designated in theagreement and the building and tenant improvement assets are being depreciatedon a straight line basis over the lesser of their useful lives or the leaseterm.

 

 

 

11

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**Item 2—Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**Results of Operations:**

 

        Netrevenues for the quarter ended December 31, 2007 decreased by $5,182,000to $42,615,000 compared to the corresponding period a year ago due primarily toa decrease of $6,634,000 in product revenue. Z Backscatter System revenuedecreased by $12,586,000 as compared to the corresponding period a year agoprimarily attributable to the partial shipment of a large quantity order in theprior fiscal year.  This decrease wasoffset somewhat by an increase of $3,329,000 in CargoSearch system revenues dueto the sale of the Z-Portal system which was introduced in fiscal 2007 andrevenue attributed to the mobile cargo inspection system, an increase of$696,000 in Contract research and development revenues as compared to the priorperiod attributable primarily to one large development project ongoing thisperiod, and an increase of $3,088,000 in ParcelSearch system revenues ascompared to the prior year due to increased volume of shipments of the Geminiparcel screening system. Service revenues for the quarter ended December 31,2007 increased by $1,452,000 to $15,886,000 compared to the correspondingperiod a year ago due primarily to an increase in the number of systems underservice contracts as the warranties on systems sold in prior years expired andwere replaced with service contracts and additional extended warranties soldwith international systems.

 

        Netrevenues for the nine months ended December 31, 2007 increased by $17,446,000to $124,713,000 compared to the corresponding period a year ago. This increaseis somewhat attributable to an increase of $7,947,000 in product sales. Therewas an increase of $16,095,000 in CargoSearch system revenues due to anincrease in the number of contracts ongoing as compared to the prior year inpart due to the increased sales of the OmniView system which was introduced infiscal 2007, an increase of $5,087,000 in Contract research and developmentrevenues as compared to the prior period attributable primarily to one largedevelopment project ongoing this period, and an increase of $4,870,000 inParcelSearch system revenues as compared to the prior year due to increasedvolume of shipments of the Gemini parcel screening system. These productrevenue increases were offset somewhat by a $16,134,000 decrease inZ Backscatter System revenues as compared to the prior year attributableto the shipment of a large quantity order in the prior year. Service revenuesfor the nine months ended December 31, 2007 increased by $9,499,000 to$47,252,000 compared to the corresponding period a year ago due primarily to anincrease in the number of systems under service contracts as the warranties onsystems sold in prior years expired and were replaced with service contractsand additional extended warranties sold with international systems.

 

        Totalcost of sales and contracts for the quarter ended December 31, 2007increased by $1,572,000 to $27,431,000 as compared to the corresponding perioda year ago. Cost of sales and contracts related to product revenues decreasedby $1,050,000 to $18,052,000 as compared to the corresponding period a yearago. Cost of product sales and contract revenues represented 68% of revenuesversus 57% of revenues, for the corresponding period last year. This costincrease is due primarily to the mix of products sold in the period as agreater percentage of revenues were derived from lower margin CargoSearch,ParcelSearch and Contract research and development programs as opposed toZ Backscatter System revenues which yield a higher gross margin. The costof service revenues for the quarter ended December 31, 2007 increased by$2,622,000 to $9,379,000 as compared to the corresponding period a year ago.Cost of service revenues represented 59% of revenues versus 47% for thecorresponding period last year due to an increase in claims against servicecontracts and extended warranties sold with international systems.

 

        Totalcost of sales and contracts for the nine months ended December 31, 2007increased by $19,747,000 to $78,050,000 as compared to the corresponding perioda year ago. Cost of sales and contracts related to product revenues increasedby $12,615,000 to $51,693,000 as compared to the corresponding period a yearago. Cost of product sales and contract revenues represented 67% of revenuesversus 56% of revenues, for the corresponding period last year. This costincrease is due primarily to the mix of products sold in the period as agreater percentage of revenues were derived from lower margin CargoSearch,ParcelSearch and Contract research and development programs as opposed toZ Backscatter System revenues which yield a higher gross margin. The costof service revenues for the nine months ended December 31, 2007 increasedby $7,132,000 to $26,357,000 as compared to the corresponding period a yearago. Cost of service revenues represented 56% of revenues versus 51% for thecorresponding period last year.

 

        Selling,general and administrative expenses for the quarter ended December 31,2007 of $7,609,000 were $330,000 lower than the corresponding period a yearago. Selling, general and administrative expenses represented 18% of revenuesin the current period as compared to 17% for the corresponding period last year.The decrease in cost can be attributed to a $2,365,000 reduction in incentivecompensation accruals and lower marketing related costs of $464,000.  These decreases were somewhat offset by anincrease in salary and benefit costs of $532,000 due to increased headcount anda charge of $1,720,000 due to the write-down of a note receivable  that the Company has deemed uncollectible.

 

        Selling,general and administrative expenses for the nine months ended December 31,2007 of $19,943,000 were $378,000 higher than the corresponding period a yearago. Selling, general and administrative expenses represented 16% of revenuesin the current period as compared to 18% for the corresponding period lastyear. The Company experienced an increase in consulting costs of $447,000,travel-related costs of $294,000, ERP system implementation costs of $224,000,salary and benefit costs of $1,209,000 associated with increased headcount, and$1,720,000 due to the write-down of a note receivable associated that theCompany has deemed uncollectible. These increases were offset somewhat by a$2,669,000 decrease in incentive compensation accruals, lower marketing relatedcosts of $867,000, and a decrease in stock compensation costs of $692,000 ascompared to the prior period.

 

        Companyfunded research and development expenses of $3,148,000 for the quarter ended December 31,2007 increased by $1,708,000 compared to the corresponding period last year.Research and development expenses represented 7% of revenues in the quarterended December 31, 2007 as compared to 3% of revenues in the quarter endedDecember 31, 2006. This increase in expenditures is attributable to theCompany’s hiring of additional engineers to focus on research and developmentactivities.

 

        Companyfunded research and development expenses of $8,678,000 for the nine monthsended December 31, 2007 increased by $3,458,000 compared to thecorresponding period last year. Research and development expenses represented7% of revenues in the nine months ended December 31, 2007 as compared to5% of revenues in the nine months ended December 31, 2006. This increasein expenditures is attributable to the Company’s hiring of additional engineersto focus on research and development activities.

 

        Otherincome was $1,465,000 in income for the quarter ended December 31, 2007 ascompared to $1,129,000 in income for the corresponding period a year ago. Inthe quarter ended December 31, 2007, the Company earned $1,686,000 inincome on investments held as compared to $1,381,000 in the quarter ended December 31,2006 due to increases in the Company’s cash and investment balances. In thequarter ended December 31, 2006, the Company had $224,000 of warrant relatedexpense due to the change in the fair value of the warrant liability. Thewarrants were fully exercised in the first quarter of fiscal 2008, thereforethere was no charge for mark to market adjustments in the quarter ended December 31,2007.

 

        Otherincome was $4,938,000 in income for the nine months ended December 31,2007 as compared to $5,863,000 in income for the corresponding period a yearago. Other income for the nine months ended December 31, 2007 and December 31,2006 included $11,000 and $2,115,000, respectively of warrant income due to thechanges in the fair value of the warrant liability. These warrants were fullyexercised in the first quarter of 2008, therefore the charge in the nine monthsended December 31, 2007 was reduced as compared to the prior period. Inaddition, in the nine months ended December 31, 2007, the Company earned$5,444,000 in income on investments held as compared to $3,872,000 in the ninemonths ended December 31, 2006 due to increases in the Company’s cash andinvestment balances.

 

 

12

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        Asa result of the above, the Company reported pre-tax income of $5,892,000 in thequarter ended December 31, 2007 as compared to pre-tax income of$13,688,000 in the corresponding period a year ago. The Company reportedpre-tax income of $22,980,000 in the nine months ended December 31, 2007as compared to pre-tax income of $30,042,000 in the corresponding period a yearago.

 

        TheCompany’s projected effective tax rate, excluding the income tax effect of thewarrants which is a permanent item, for the nine months ended December 31,2007 decreased to 36% from 40% for the corresponding period a year ago. Thisdecrease is due to changes in permanent tax items, primarily related toincentive stock compensation, increases in certain allowable deductions in thecurrent tax year, and an increase in the percentage of international salesrevenue as compared to the prior period.

 

        TheCompany had net income of $4,002,000 during the quarter ended December 31,2007 as compared to net income of $8,072,000 in the third quarter of fiscal2007. For the nine months ended December 31, 2007, the Company had netincome of $14,689,000 as compared to $18,820,000 for the nine months ended December 31,2006. The significant factors contributing to these results are noted in theabove sections.

 

**Liquidity and Capital Resources:**

 

        Cashand cash equivalents decreased by $27,272,000 to $42,378,000 at December 31,2007 compared to $69,650,000 at March 31, 2007. This decrease in cash andcash equivalents is due to a $19,453,000 increase in inventory balances relatedprimarily to an increase in finished goods inventory, a $12,983,000 increase inaccounts receivable due to the invoicing of certain milestone contracts,$24,557,000 of net purchases of short term investments, $13,821,000 in paymentsmade to repurchase shares under the Company’s share repurchase plan, and$3,704,000 paid in the year in cash dividends to shareholders. These decreasesare offset by the net income earned during the period of $14,689,000 and a$21,052,000 increase in deferred revenue primarily associated with a largegovernment service agreement.

 

        OnNovember 16, 2006, the Company modified its domestic loan and securityagreement with Silicon Valley Bank East which was scheduled to expire on November 29,2006. The Company increased its domestic facility from $5.0 million to$20.0 million to support the Company’s routine working capital needs. Themaximum amount available for borrowings under the domestic facility is either (a) $20.0 millionminus the amount of all outstanding letters of credit less certain reserves,and minus the outstanding principal balance of any advances (if the Company’sunrestricted cash is greater than or equal to $30.0 million), or (b) thelesser of (i) $20.0 million, or (ii) 85% of eligible domesticaccounts receivable minus the amount of outstanding letters of credit adjustedfor certain reserves and minus the principle balance of any advances (if theCompany’s unrestricted cash is less than $30.0 million for a period of 30consecutive days). The modification of the domestic loan and security agreementextended this credit facility through November 14, 2008.

 

        Thecredit facility bears an interest rate of the greater of 4.0% or the SiliconValley Bank prime rate (7.25% at December 31, 2007). The credit agreementis collateralized by certain assets of the Company and contains certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequires the maintenance of certain financial covenants. As of December 31,2007, the Company was in compliance with these covenants.

 

Inthe normal course of business, the Company may provide certain customers andpotential customers with performance guarantees, which are generally backed bystandby letters of credit. In general, the Company would only be liable for theamount of these guarantees in the event of default in the performance of itsobligations, the probability of which is remote in management’s opinion. TheCompany had outstanding $5,993,167 in stand-by letters of credit against thedomestic facility with $14,006,833 remaining available. Of the outstandingletters of credit, $300,000 relates to the Company’s building lease and theremainder is guaranteeing performance on certain international projects. Noamounts have been drawn against these letters of credit. In addition, at December 31,2007, the Company had a restricted cash balance of $2,523,221 related tocertain bank required deposits for outstanding letters of credits, bid bonds,and other bank-related fees.

 

**New Accounting Pronouncements:**

 

        InJuly 2006, the FASB issued Interpretation No. 48, “Accounting forUncertainty in Income Taxes—an Interpretation of FASB Statement No. 109”.FIN 48 clarifies the accounting for uncertainty in income taxes recognizedin an entity’s financial statements in accordance with FASB Statement No. 109,“Accounting for Income Taxes” and prescribes a recognition threshold andmeasurement attributes for financial statement disclosure of tax positionstaken or expected to be taken on a tax return. Under FIN 48, the impact ofan uncertain income tax position on the income tax return must be recognized atthe largest amount that is more likely than not to be sustained upon audit bythe relevant taxing authority. An uncertain income tax position will not berecognized if it has less than a 50% likelihood of being sustained.Additionally, FIN 48 provides guidance on de-recognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition. The Company adopted FIN 48 effective April 1, 2007. Theadoption of FIN 48 did not have a material impact on our condensedconsolidated financial statements.

 

        InFebruary 2007, the FASB issued FASB Statement No. 159 (SFAS No. 159),“The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159gives entities the option, at specified election dates, to measure certainfinancial assets and liabilities at fair value. The election may be applied tofinancial assets and liabilities on an instrument by instrument basis, isirrevocable, and may only be applied to entire instruments. Unrealized gainsand losses on instruments for which the fair value option has been elected willbe reported in earnings at each subsequent reporting date. SFAS No. 159will be effective for the Company beginning April 1, 2008. Adoption ofSFAS No. 159 is currently not expected to have a material impact on theCompany’s consolidated financial position or results of operations.

 

        InSeptember 2006, the FASB issued Statement of Financial AccountingStandards No. 157 “Fair Value Measurements”, (SFAS No. 157). SFAS No. 157defines fair value, establishes a framework for measuring fair value, andexpands disclosure requirements regarding fair value measurement. SFAS No. 157will be effective for the Company beginning April 1, 2008. The Company iscurrently reviewing SFAS No. 157 to determine the impact and materialityof its adoption to the Company.

 

**Item 3—Quantitative and Qualitative Disclosures aboutMarket Risk**

 

        Thecash accounts for the Company’s operations in Singapore, Hong Kong, England,and Abu Dhabi are maintained in Singapore dollars, Hong Kong dollars, poundssterling and dirham, respectively. Foreign currency accounts are marked tomarket at current rates that resulted in immaterial translation adjustments tostockholders’ equity. The gains and losses from foreign currency transactionsare included in the statements of operations for the period and were alsoimmaterial. A hypothetical 10% change in foreign currency rates would not havea material impact on the Company’s results of operations or financial position.

 

        Asof December 31, 2007, the Company held short-term investments consistingof money market funds and U.S. government and government agency bonds. TheCompany’s primary objective with its investment portfolio is to investavailable cash while preserving principal and meeting liquidity needs. Theseinvestments had an average interest rate of approximately 4.71% and are subjectto interest rate risk. As a result of the average maturity and conservativenature of the investment portfolio, a sudden change in interest rates would nothave a material adverse effect on the value of these investments.

 

 

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**Item 4—Controls and Procedures**

 

*a)   *Evaluation ofdisclosure controls and procedures.

 

        Asof the end of the period covered by this report, under the supervision and withthe participation of our management, including our Chief Executive Officer andChief Financial Officer, the Company reviewed and evaluated the effectivenessof the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934 as amended (the “ExchangeAct”). Based upon their evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective to provide reasonable assurance that information required to bedisclosed by the Company in the reports filed and submitted by it under theExchange Act is recorded, processed, summarized and reported within the timeperiod specified in the Securities and Exchange Commission’s rules andforms, and to provide reasonable assurance that information required to bedisclosed by the Company in such reports is accumulated and communicated to theCompany’s management, including its Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

*b)  *Changes ininternal controls.

 

        Therehave been no changes in our internal controls over financial reporting as suchterm is defined in Rule 13a-15(f) and 15d-15(f) of the ExchangeAct during the period covered by this report that have materially affected, orare reasonably likely to materially affect, the Company’s internal controlsover financial reporting.

 

 

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**PART II—OTHER INFORMATION**

 

**Item 1— Legal Proceedings**

 

         On October 3, 2007, the Company commencedlitigation in the United States District Court for the Eastern District ofVirginia against Auto Clear, LLC. and its affiliates Control Screening, LLC,and Scan-Tech Security, LP, for infringement of the Company’s United States PatentNo. 5,313,511, seeking damages and injunctive relief. The District Courtentered a Default in favor of AS&E; however, the Defendants havesubsequently filed a motion to set aside that Default. The parties have filedbriefs on the issue and presently are awaiting consideration by the Court.

 

OnSeptember 4, 2007, the Company received a notice from the United StatesEnvironmental Protection Agency (the “EPA”) that it may potentially be liablefor certain costs related to the proposed clean-up at the Sutton Brook DisposalArea Superfund Site located in Tewksbury, Massachusetts. The Company is one ofapproximately 45 entities identified by the EPA as a Potentially ResponsibleParty (“PRP”) in connection with alleged historical disposal of waste materialsfor the period from 1958 through the mid - 1980s, the time frame underinvestigation by the EPA. The Company has denied liability, and has initiatedparticipation in the global negotiation and settlement processes with the EPAand with other PRPs. Such negotiation processes are ongoing.

 

TheCompany is also subject to various legal proceedings and claims that arise inthe ordinary course of business.  At the present time, it is not possibleto predict the outcome of these matters; however, the Company currentlybelieves that resolving these matters will not have a material adverse impacton its financial condition, results of operations or cash flows.

 

**Item 2—Unregistered Sales of Equity Securities and Useof Proceeds**

 

        Thefollowing table provides information about our purchases during the quarterended December 31, 2007 of equity securities that are registered by uspursuant to Section 12 of the Exchange Act.

 

 

 
| **2007**                         | ** ** | **Total Number  of Shares Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Programs** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| October 1- October  31 |       | 11,439                                |       | $                                 | 59.67      |                                                                                | 11,439     |   |
| November 1-November 30 |       | 129,575                               |       | 49.46                             |       | 129,575                                                                             |       |
| December 1-December 31 |       | 43,874                                |       | 56.96                             |       | 43,874                                                                              |       |
|                             |       |                                  |       |                              |       |                                                                                |       |
| Total                            |       | 184,888                               |       | $                                 | 51.87      |                                                                                | 184,888    |   |

 

 

 

        OnMay 17, 2007, the Board of Directors approved a Stock Repurchase Programwhich authorized the Company to repurchase up to $35 million of shares ofits common stock from time to time on the open market. As of December 31,2007, the maximum dollar value of shares that may yet be purchased under theprogram totaled $21,185,000.

 

**Item 6—Exhibits**

 

 

 
| **(a)** | ** ** | **Exhibits**                                                                                                                                                  |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1    |       | Certification  by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                     |
| 31.2    |       | Certification  by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                     |
| 32.1    |       | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2    |       | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

 

 

        Theinformation required by Exhibit Item 11 (Statement re: Computation ofIncome per Common and Common Equivalent Share) may be found in Footnote No. 4.

 

 

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**SIGNATURES**

 

        Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this Report to be signed on its behalf by the undersigned hereuntoduly authorized.

AMERICAN SCIENCE AND ENGINEERING, INC.

DateFebruary 11, 2008

 
|   |   | /s/ Kenneth J. Galaznik                                  |
|--------|--------|----------------------------------------------------------|
|   |   | Kenneth J. GalaznikChief Financial Officer and Treasurer |

 

*Safe Harbor Statement*

 

        *The foregoing 10-Q contains statements concerning theCompany’s financial performance and business operations, which may beconsidered “forward-looking” under applicable securities laws.*

 

        *The Company wishes to caution readers of this Form 10-Qthat actual results might differ materially from those projected in anyforward-looking statements.*

 

        *Factors which might cause actual results to differmaterially from those projected in the forward-looking statements containedherein include the following: significant reductions or delays in procurementsof the Company’s systems by the United States and other governments; disruptionin the supply of any source component incorporated into AS&E’s products;litigation seeking to restrict the use of intellectual property used by theCompany; potential product liability claims against the Company; globalpolitical trends and events which affect public perception of the threat presentedby drugs, explosives and other contraband; global economic developments and theability of governments and private organizations to fund purchases of theCompany’s products to address such threats; and the potential insufficiency ofCompany resources, including human resources, capital, plant and equipment andmanagement systems, to accommodate any future growth and any future delays infederal funding. These and certain other factors which might cause actualresults to differ materially from those projected are more fully set forth inthe Company’s Annual Report on Form 10-K for the fiscal year ended March 31,2007 under Item 1A “Risk Factors.” Please also refer to our other filingswith the Securities and Exchange Commission.*

 

 

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