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** **

 

** **

**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 September 30,2008**

 

**OR**

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

 

**Forthe transition period from      to**

 

**Commission File Number 1-6549**

 

**American Science and Engineering, Inc.**

(Exact name ofRegistrant as specified in its charter)

 

| **Massachusetts**                                                 | ** ** | **04-2240991**                          |
|-------------------------------------------------------------------|------------|-----------------------------------------|
| (State or other  jurisdiction of   incorporation or organization) |       | (I.R.S. Employer    Identification No.) |
|                                                              |       |                                    |
| **829  Middlesex Turnpike**                                       | ** ** | ** **                              |
| **Billerica,  Massachusetts**                                     | ** ** | **01821**                               |
| (Address of  principal executive offices)                         |       | (Zip Code)                              |

 

**(978)262-8700**

(Registrant’stelephone number, including area code)

 

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.   Yes x     No  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large  accelerated filer o | Accelerated  filer x | Non-accelerated  filer o                        | Smaller  reporting company o |
|----------------------------|---------------------------|-------------------------------------------------|-----------------------------------|
|                       |                      | (Do not check if  a smaller  reporting company) |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934).   Yes o     No x

 

The number of shares ofthe registrant’s common stock, $0.66 2/3 par value, outstanding as of October 31,2008 was 8,788,363.

 

 

 

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Table of Contents

 

**TABLE OF CONTENTS**

 
| **Part I — Financial Information**                                                                                                            |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item  1 — Financial Statements                                                                                                                     | 3      |
| Unaudited Condensed Consolidated Balance  Sheets—September 30, 2008 and March 31, 2008                                                   | 3      |
| Unaudited Condensed Consolidated Statements of  Operations—For the Three and Six Months Ended September 30, 2008 and  September 30, 2007 | 4      |
| Unaudited Condensed Consolidated Statements of Cash  Flows—For the Six Months Ended September 30, 2008 and September 30,  2007           | 5      |
| Notes to Unaudited Condensed Consolidated Financial  Statements                                                                                         | 6      |
| Item 2 — Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                               | 13     |
| Item 3 — Quantitative and Qualitative Disclosure About  Market Risk                                                                                | 15     |
| Item 4 — Controls and Procedures                                                                                                                   | 15     |
| **Part II  — Other Information**                                                                                                              |   |
| Item 1 — Legal Proceedings                                                                                                                         | 15     |
| Item 2 — Purchases of Equity Securities                                                                                                            | 15     |
| Item 4 — Submission of Vote to Shareholders                                                                                                        | 16     |
| Item 5 — Other Information                                                                                                                         | 16     |
| Item 6 — Exhibits                                                                                                                                  | 16     |
| **Signatures**                                                                                                                                          | 16     |

 

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**PART I— FINANCIAL INFORMATION**

**ITEM1 — FINANCIAL STATEMENTS**

 

**AMERICANSCIENCE AND ENGINEERING, INC. AND SUBSIDIARY**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| **Dollars in thousands**                                                                                                                                                         | ** ** | **September  30, 2008** | ** ** | **March 31,  2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| **Assets**                                                                                                                                                                                 | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current assets:                                                                                                                                                                            |       |                    |       |                     |       |
| Cash and cash  equivalents                                                                                                                                                                 |       | $                       | 53,046     |                     | $          | 52,418 |   |
| Restricted cash  and investments                                                                                                                                                           |       | 2,210                   |       | 319                      |       |
| Short-term  investments, at fair value                                                                                                                                                     |       | 50,409                  |       | 72,687                   |       |
| Accounts  receivable, net of allowances of $315 and $230 at September 30, 2008 and  March 31, 2008, respectively                                                                 |       | 38,839                  |       | 27,583                   |       |
| Unbilled costs  and fees                                                                                                                                                                   |       | 2,249                   |       | 6,114                    |       |
| Inventories                                                                                                                                                                                |       | 41,853                  |       | 40,107                   |       |
| Prepaid expenses  and other current assets                                                                                                                                                 |       | 9,094                   |       | 4,815                    |       |
| Deferred income  taxes                                                                                                                                                                     |       | 1,880                   |       | 1,577                    |       |
| **Total  current assets**                                                                                                                                                                  |       | 199,580                 |       | 205,620                  |       |
| Building,  equipment and leasehold improvements, net                                                                                                                                       |       | 20,736                  |       | 22,201                   |       |
| Restricted cash  and investments                                                                                                                                                           |       | 16,401                  |       | 2,204                    |       |
| Deferred income  taxes                                                                                                                                                                     |       | 6,101                   |       | 5,231                    |       |
| Other assets,  net                                                                                                                                                                         |       | 809                     |       | 278                      |       |
| **Total  assets**                                                                                                                                                                          |       | $                       | 243,627    |                     | $          | 235,534 |   |
|                                                                                                                                                                                       |       |                    |       |                     |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                             | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current  liabilities:                                                                                                                                                                      |       |                    |       |                     |       |
| Accounts payable                                                                                                                                                                           |       | $                       | 10,870     |                     | $          | 12,660 |   |
| Accrued salaries  and benefits                                                                                                                                                             |       | 4,604                   |       | 2,935                    |       |
| Accrued warranty  costs                                                                                                                                                                    |       | 2,216                   |       | 1,671                    |       |
| Accrued income  taxes                                                                                                                                                                      |       | 2,823                   |       | —                   |       |
| Deferred revenue                                                                                                                                                                           |       | 18,937                  |       | 23,120                   |       |
| Customer  deposits                                                                                                                                                                         |       | 16,835                  |       | 6,547                    |       |
| Current portion  of lease financing liability                                                                                                                                              |       | 1,142                   |       | 1,134                    |       |
| Other current  liabilities                                                                                                                                                                 |       | 5,469                   |       | 8,097                    |       |
| **Total  current liabilities**                                                                                                                                                             |       | 62,896                  |       | 56,164                   |       |
| Lease financing  liability, net of current portion                                                                                                                                         |       | 8,967                   |       | 9,540                    |       |
| Other long term  liabilities                                                                                                                                                               |       | 5,983                   |       | 3,758                    |       |
| **Total  liabilities**                                                                                                                                                                     |       | 77,846                  |       | 69,462                   |       |
|                                                                                                                                                                                       |       |                    |       |                     |       |
| **Stockholders’  equity:**                                                                                                                                                            | ** ** | ** **              | ** ** | ** **               | ** ** |
| Preferred stock,  no par value, 100,000 shares authorized; no shares issued                                                                                                                |       | —                  |       | —                   |       |
| Common stock,  $0.66 2/3 par value, 20,000,000 shares authorized; 8,821,881 and 8,945,633  shares issued and outstanding at September 30, 2008 and March 31,  2008, respectively |       | 5,880                   |       | 5,963                    |       |
| Capital in  excess of par value                                                                                                                                                            |       | 85,125                  |       | 91,544                   |       |
| Accumulated  other comprehensive income                                                                                                                                                    |       | (216                    | )          | 114                      |       |
| Retained  earnings                                                                                                                                                                         |       | 74,992                  |       | 68,451                   |       |
| **Total  stockholders’ equity**                                                                                                                                                       |       | 165,781                 |       | 166,072                  |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                       |       | $                       | 243,627    |                     | $          | 235,534 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

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

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **Dollars and shares in thousands, except per share amounts**                                                                                                                                                     | ** ** | **Sept. 30,  2008**         | ** ** | **Sept. 30,  2007**       | ** ** | **Sept. 30,  2008** | ** ** | **Sept. 30,  2007** | ** ** |
| ** **                                                                                                                                                                                                                                                | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  sales and contract revenues:**                                                                                                                                                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Net product  sales and contract revenues                                                                                                                                                                                                                  |       | $                                | 38,362     |                           | $          | 21,825 |   | $ | 61,304 |   | $ | 50,732 |   |
| Net service revenues                                                                                                                                                                                                                                      |       | 17,931                           |       | 15,802                         |       | 34,483 |   | 31,366 |   |
| Total net sales  and contract revenues                                                                                                                                                                                                                    |       | 56,293                           |       | 37,627                         |       | 95,787 |   | 82,098 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| **Cost of  sales and contracts:**                                                                                                                                                                                                                         |       |                             |       |                           |       |   |   |   |   |
| Cost of product  sales and contracts                                                                                                                                                                                                                      |       | 22,082                           |       | 14,875                         |       | 37,868 |   | 33,640 |   |
| Cost of service  revenues                                                                                                                                                                                                                                 |       | 11,684                           |       | 8,674                          |       | 20,863 |   | 16,979 |   |
| Total cost of  sales and contracts                                                                                                                                                                                                                        |       | 33,766                           |       | 23,549                         |       | 58,731 |   | 50,619 |   |
| Gross profit                                                                                                                                                                                                                                              |       | 22,527                           |       | 14,078                         |       | 37,056 |   | 31,479 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| **Expenses:**                                                                                                                                                                                                                                             |       |                             |       |                           |       |   |   |   |   |
| Selling, general  and administrative expenses                                                                                                                                                                                                             |       | 7,394                            |       | 5,851                          |       | 15,093 |   | 12,334 |   |
| Research and  development costs                                                                                                                                                                                                                           |       | 4,176                            |       | 2,773                          |       | 7,739 |   | 5,530 |   |
| Total expenses                                                                                                                                                                                                                                            |       | 11,570                           |       | 8,624                          |       | 22,832 |   | 17,864 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Operating income                                                                                                                                                                                                                                          |       | 10,957                           |       | 5,454                          |       | 14,224 |   | 13,615 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| **Other  income (expense):**                                                                                                                                                                                                                              |       |                             |       |                           |       |   |   |   |   |
| Interest and  investment income                                                                                                                                                                                                                           |       | 685                              |       | 1,742                          |       | 1,636 |   | 3,758 |   |
| Interest expense                                                                                                                                                                                                                                          |       | (37                              | )          | (40                            | )          | (74 | ) | (80 | ) |
| Other, net                                                                                                                                                                                                                                                |       | (104                             | )          | (103                           | )          | (83 | ) | (216 | ) |
| Change in  warrant valuation                                                                                                                                                                                                                              |       | —                           |       | —                         |       | — |   | 11 |   |
| Total other  income                                                                                                                                                                                                                                       |       | 544                              |       | 1,599                          |       | 1,479 |   | 3,473 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Income before  provision for income taxes                                                                                                                                                                                                                 |       | 11,501                           |       | 7,053                          |       | 15,703 |   | 17,088 |   |
| Provision for  income taxes                                                                                                                                                                                                                               |       | 4,140                            |       | 2,538                          |       | 5,653 |   | 6,401 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Net income                                                                                                                                                                                                                                                |       | $                                | 7,361      |                           | $          | 4,515 |   | $ | 10,050 |   | $ | 10,687 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Income per  share—Basic                                                                                                                                                                                                                              |       | $                                | 0.85       |                           | $          | 0.49 |   | $ | 1.16 |   | $ | 1.16 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
|                           —Diluted                                                                                 |       | $                                | 0.83       |                           | $          | 0.48 |   | $ | 1.13 |   | $ | 1.13 |   |
|                                                                                                                                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Weighted average  shares—Basic                                                                                                                                                                                                                       |       | 8,650                            |       | 9,194                          |       | 8,682 |   | 9,180 |   |
|                                          —Diluted |       | 8,893                            |       | 9,461                          |       | 8,901 |   | 9,425 |   |
| Cash dividends  declared per common share                                                                                                                                                                                                                 |       | $                                | 0.20       |                           | $          | 0.20 |   | $ | 0.40 |   | $ | 0.20 |   |

 

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

 

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**AMERICANSCIENCE AND ENGINEERING, INC. AND SUBSIDIARY**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                    | ** ** | **For the Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Dollars in thousands**                                                            | ** ** | **September 30,  2008**                     | ** ** | **September 30,  2007** | ** ** |
| **Cash  flows from operating activities:**                                                    | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income                                                                                    |       | $                                                | 10,050     |   | $ | 10,687 |   |
| Adjustments to  reconcile net income to net cash provided by (used for) operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                                                |       | 2,142                                            |       | 2,023 |   |
| Provisions for  contracts, inventory and accounts receivable reserves                         |       | 935                                              |       | 117 |   |
| Amortization of  bond discount                                                                |       | (336                                             | )          | (1,110 | ) |
| Deferred income  taxes                                                                        |       | (1,173                                           | )          | (1,048 | ) |
| Stock based  compensation expense                                                             |       | 2,238                                            |       | 2,668 |   |
| Change in value  of warrants                                                                  |       | —                                           |       | (11 | ) |
| Changes in  assets and liabilities:                                                           |       |                                             |       |   |   |
| Accounts  receivable                                                                          |       | (11,332                                          | )          | 2,461 |   |
| Unbilled costs  and fees                                                                      |       | 3,865                                            |       | (7,226 | ) |
| Inventories                                                                                   |       | (2,605                                           | )          | (15,555 | ) |
| Prepaid expenses  and other assets                                                            |       | (4,810                                           | )          | (839 | ) |
| Accounts payable                                                                              |       | (1,790                                           | )          | 857 |   |
| Accrued income  taxes                                                                         |       | 2,823                                            |       | — |   |
| Customer  deposits                                                                            |       | 10,288                                           |       | (2,566 | ) |
| Deferred revenue                                                                              |       | (1,943                                           | )          | 1,458 |   |
| Accrued expenses  and other current liabilities                                               |       | (56                                              | )          | 58 |   |
| Sale of leased  asset                                                                         |       | 116                                              |       | — |   |
| Non-current liabilities                                                                       |       | (15                                              | )          | — |   |
| Net cash  provided by (used for) operating activities                                         |       | 8,397                                            |       | (8,026 | ) |
|                                                                                          |       |                                             |       |   |   |
| **Cash  flows from investing activities:**                                                    | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Purchases of  short-term investments                                                          |       | (38,943                                          | )          | (82,480 | ) |
| Proceeds from  maturities of short-term investments                                           |       | 61,250                                           |       | 73,025 |   |
| Issuance of note  receivable                                                                  |       | —                                           |       | (250 | ) |
| Purchases of  property and equipment                                                          |       | (793                                             | )          | (1,885 | ) |
| Net cash  provided by (used for) investing activities                                         |       | 21,514                                           |       | (11,590 | ) |
|                                                                                          |       |                                             |       |   |   |
| **Cash  flows from financing activities:**                                                    | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| (Increase)  decrease in restricted cash and investments                                       |       | (16,088                                          | )          | 278 |   |
| Proceeds from  exercise of warrants                                                           |       | —                                           |       | 509 |   |
| Proceeds from  exercise of stock options                                                      |       | 1,967                                            |       | 2,800 |   |
| Repurchase of  shares of common stock                                                         |       | (11,398                                          | )          | (4,225 | ) |
| Payment of  dividends                                                                         |       | (3,509                                           | )          | (1,843 | ) |
| Proceeds from  financing of leasehold improvements                                            |       | —                                           |       | 50 |   |
| Repayment of  lease financing                                                                 |       | (565                                             | )          | (774 | ) |
| Reduction of  income taxes paid due to the tax benefit from employee stock option expense     |       | 331                                              |       | 1,268 |   |
| Net cash used  for financing activities                                                       |       | (29,262                                          | )          | (1,937 | ) |
| Foreign currency  translation effect on cash                                                  |       | (21                                              | )          | 6 |   |
| Net increase  (decrease) in cash and cash equivalents                                         |       | 628                                              |       | (21,547 | ) |
| Cash and cash  equivalents at beginning of period                                             |       | 52,418                                           |       | 69,650 |   |
| Cash and cash  equivalents at end of period                                                   |       | $                                                | 53,046     |   | $ | 48,103 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

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**AMERICAN SCIENCE AND ENGINEERING, INC. ANDSUBSIDIARY**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.  GENERAL**

 

The condensed consolidated financialstatements include the accounts of the Company and its wholly owned subsidiary.All significant intercompany transactions and balances have been eliminated.

 

The unaudited condensed consolidatedfinancial statements have been prepared in accordance with the requirements of Form 10-Qand consequently do not include all disclosures required by Form 10-K.These condensed consolidated financial statements should be read in conjunctionwith the consolidated financial statements and the notes included in theCompany’s Annual Report on Form 10-K for the fiscal year ended March 31,2008.

 

The unaudited condensed consolidatedfinancial statements, in the opinion of management, include all necessaryadjustments, consisting solely of normal recurring adjustments, to presentfairly the Company’s financial position, results of operations and cashflows.  These quarterly results are not necessarily indicative of theresults to be expected for the entire year.

 

**Nature ofOperations**

 

The Company is engaged in the development andmanufacture of sophisticated X-ray inspection systems for critical detectionand security screening solutions for sale primarily to U.S. and foreigngovernment agencies.  The Company has only one reporting segment, X-rayscreening products.

 

**SignificantAccounting Policies**

 

Revenues on cost reimbursable and long-termfixed price contracts are generally recorded as costs are incurred using thepercentage of completion method.  For systems that are produced in astandard manufacturing operation and have shorter order to delivery cycles, theCompany recognizes sales at the time of shipment of the system to the customerand when other revenue recognition criteria (such as transfer of risk) are met.

 

The Company’s Loan and Security Agreementwith Silicon Valley Bank East requires certain cash balances to be restrictedas collateral against outstanding standby letters of credit; these areseparately presented as restricted cash. (See Note 5)

 

The other significant accounting policiesfollowed by the Company and its subsidiary in preparing its consolidatedfinancial statements are set forth in Note 1 to the consolidated financialstatements included in its Form 10-K for the year ended March 31,2008.  The Company has made no changes to these policies during thecurrent year.

 

**ComprehensiveIncome**

 

Comprehensive income is comprised of thefollowing:

 
| ** **                                                          | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands)**                                             | ** ** | **Sept. 30,  2008**         | ** ** | **Sept. 30,  2007**       | ** ** | **Sept. 30,  2008** | ** ** | **Sept. 30,  2007** | ** ** |
| Net income                                                          |       | $                                | 7,361      |                           | $          | 4,515 |   | $ | 10,050 |   | $ | 10,687 |   |
| Foreign currency translation adjustments,  net of tax               |       | (22                              | )          | 5                              |       | (21 | ) | 7 |   |
| Unrealized gains and losses from marketable  securities, net of tax |       | (173                             | )          | 22                             |       | (309 | ) | — |   |
| Comprehensive income                                                |       | $                                | 7,166      |                           | $          | 4,542 |   | $ | 9,720 |   | $ | 10,694 |   |

 

**Stock Repurchase Program**

 

On May 1, 2007, the Company’s Board ofDirectors approved a Stock Repurchase Program which authorized the Company torepurchase up to $35 million of shares of its common stock from time to time onthe open market.   This Stock RepurchaseProgram was completed in the first quarter of fiscal 2009.  On May 13, 2008, the Board of Directorsapproved an additional Stock Repurchase Program which authorized the Company torepurchase up to another $35 million of shares of its common stock from time totime on the open market.   During the sixmonths ended September 30, 2008, a total of 228,127 shares wererepurchased at an average price of $49.96 per share.  As ofSeptember 30, 2008, the maximum dollar value of shares that may yet bepurchased under this program is $33,399,000.

 

**Dividends**

 

Dividends declared and paid on a per share basis were as follows:

 

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| ** **              | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands)** | ** ** | **Sept. 30,  2008**         | ** ** | **Sept. 30,  2007**       | ** ** | **Sept. 30,  2008** | ** ** | **Sept. 30,  2007** | ** ** |
| Dividends declared      |       | $                                | 0.20       |                           | $          | 0.20 |   | $ | 0.40 |   | $ | 0.20 |   |
| Dividends paid          |       | $                                | 0.20       |                           | $          | 0.20 |   | $ | 0.40 |   | $ | 0.20 |   |

 

On November 10, 2008, the Company’sBoard of Directors declared a cash dividend of $0.20 per share. The dividend ispayable on December 4, 2008 to all shareholders of record at the close ofbusiness on November 17, 2008. Future dividends will be declared at thediscretion of the Board of Directors and will depend upon such factors as theBoard of Directors deems relevant.

 

**Concentrations of credit risk**

 

Financial instruments, which potentially subject the Company toconcentrations of credit risk, consist primarily of cash and cash equivalents,investments and accounts and unbilled receivables.  At times, the Company maintains cash balancesin excess of insured limits. The Company maintains its cash and cashequivalents with major financial institutions. The Company’s credit risk is managed by investing its cash in highquality money market funds, commercial paper, investment grade corporate andagency bonds and certificates of deposit.

 

**New Accounting Pronouncements**

 

*SFAS No. 157*

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a commondefinition for fair value to be applied, establishes a framework for measuringfair value in accordance with generally accepted accounting principles, andexpands disclosure about such fair value measurements. The Company adopted therequired provisions of SFAS 157 that became effective in our first quarter offiscal 2009. The adoption of these provisions did not have a material impact onour Consolidated Financial Statements. For further information about theadoption of the required provisions of SFAS 157 see Note 6.

 

In February 2008, the FASB issued FASBStaff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157”(“FSP 157-2”). FSP 157-2 delays the effective date of SFAS 157 for nonfinancialassets and nonfinancial liabilities, except for certain items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). We are currently evaluating the impact ofSFAS 157 on our Consolidated Financial Statements for items within the scope ofFSP 157-2, which will become effective beginning with our first quarter offiscal 2010.

 

*SFAS No. 162*

 

In May 2008, the FASB issued FAS No. 162,The Hierarchy of Generally AcceptedAccounting Principles (FAS 162). FAS 162 identifies the sources ofaccounting principles and the framework for selecting the principles to be usedin the preparation of financial statements of nongovernmental entities that arepresented in conformity with GAAP. FAS 162 is effective 60 days following theSEC’s approval of the Public Company Accounting Oversight Board amendments toAU Section 411, The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principles.The Company does not expect the adoption of FAS 162 to have a material impacton the Company’s financial condition or results of operations.

 

*EITF Issue No. 06-11*

 

In June 2007, the FASB ratified EmergingIssues Task Force Issue No. 06-11, “Accounting for Income Tax Benefits ofDividends on Share-Based Payment Awards” (“EITF 06-11”), which requires incometax benefits from dividends or dividend equivalents that are charged toretained earnings and are paid to employees for equity classified nonvestedshares, nonvested equity share units and outstanding equity share options to berecognized as an increase in additional paid-in capital and to be included inthe pool of excess tax benefits available to absorb potential future taxdeficiencies on share-based payment awards. The adoption of EITF 06-11, whichbecame effective in the first quarter of fiscal 2009, did not have a materialimpact on our Consolidated Financial Statements.

 

 *EITF Issue No. 03-6-1*

 

In June 2008, the FASB issued Staff Position EITF 03-6-1,“Determining Whether Instruments Granted in Share-Based Payment TransactionsAre Participating Securities” (FSP EITF 03-6-1), effective for fiscal yearsbeginning after December 15, 2008.  FSP EITF 03-6-1 clarifies thatunvested share-based awards that contain nonforfeitable rights to dividends ordividend equivalents 

 

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(whether paid or unpaid) are participating securities and must beincluded in the computation of EPS pursuant to the two-class method. We arecurrently evaluating the impact of adopting FSP EITF 03-6-1 on our ConsolidatedFinancial Statements.

 

**2.   ACCOUNTING FOR STOCK-BASEDCOMPENSATION**

 

On April 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123(R) (SFAS 123(R))“Accounting for Stock-Based Compensation”, which requires the measurement andrecognition of all compensation costs for all stock based awards made toemployees and the Board of Directors based upon fair value over the requisiteservice period for awards expected to vest.

 

SFAS 123(R) requires the Company toestimate the fair value of share-based awards on the date of grant using anoption pricing model. The Company adopted SFAS 123(R) using the modifiedprospective transition method which requires the application of the accountingstandard starting April 1, 2006, the first day of the Company’s fiscalyear 2007. Prior period information was not restated to reflect the fair valuemethod of expensing share-based awards.

 

Stock-based compensation costs recognized forthe three month periods ended September 30, 2008 and September 30,2007, included compensation costs for awards granted prior to, but not yetvested as of April 1, 2006 (adoption date), as well as any new grantsissued after April 1, 2006. The Company recognized $1,273,000 and$1,410,000 of share-based compensation costs in the consolidated statements ofincome for the quarter ended September 30, 2008 and September 30,2007, respectively. The Company recognized $2,238,000 and $2,668,000 ofshare-based compensation costs in the consolidated statements of income for thesix months ended September 30, 2008 and September 30, 2007,respectively. The income tax benefit related to this compensation for the threemonths ended September 30, 2008 and September 30, 2007 wasapproximately $451,000 and $220,000, respectively. The income tax benefitrelated to this compensation for the six months ended September 30, 2008and September 30, 2007 was approximately $788,000 and $445,000,respectively.

 

The following table summarizes share-basedcompensation costs included in the Company’s consolidated statement of income:

 
| ** **                                         | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands)**                            | ** ** | **Sept. 30,  2008**         | ** ** | **Sept. 30,  2007**       | ** ** | **Sept. 30,  2008** | ** ** | **Sept. 30,  2007** | ** ** |
| Cost of revenues                                   |       | $                                | 195        |                           | $          | 446 |   | $ | 250 |   | $ | 873 |   |
| Selling, general and administrative                |       | 1,078                            |       | 964                            |       | 1,988 |   | 1,795 |   |
| Total share-based compensation expense  before tax |       | $                                | 1,273      |                           | $          | 1,410 |   | $ | 2,238 |   | $ | 2,668 |   |

 

Upon adoption of SFAS 123(R), in accordancewith Staff Accounting Bulletin No. 107, the Company selected theBlack-Scholes option pricing model as the most appropriate method fordetermining the estimated fair value for the stock awards. The Black-Scholesmethod of valuation requires several assumptions: (1) the expected term ofthe stock award, (2) the expected future stock volatility over theexpected term and (3) a risk-free interest rate. The expected termrepresents the expected period of time the Company believes the options will beoutstanding based on historical information. Estimates of expected future stockprice volatility are based on the historic volatility of the Company’s commonstock and the risk free interest rate is based on the U.S. Zero-Bond rate.

 

There were 45,000 optionsgranted in the three month period ended September 30, 2008.  The fair value of options at date of grantwas estimated with the following assumptions for grants made during the periodpresented:

 
| ** **              | ** ** | **Six months ended**   | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **September 30, 2008** | ** ** | **September 30, 2007** | ** ** |
| **Assumptions:**        | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Option life             |       | 5 years                          |       | 3 years |   |
| Risk-free interest rate |       | 2.9                              | %          | 4.16 | % |
| Stock volatility        |       | 49                               | %          | 51 | % |
| Dividend yield          |       | 1.18                             | %          | 1.3 | % |

 

**Stock Option andOther Compensation Plans**

 

The Company has various stock option andother compensation plans for directors, officers, and employees. The Companyhad the following stock option plans outstanding as of September 30, 2008:the 1995 Combination Plan, the 1997 Non-Qualified Option Plan, the 1998Non-Qualified Option Plan, the 1999 Combination Plan, the 2000 CombinationPlan, the 2002 Combination Plan, the 2003 Stock Plan for Non-Employee Directorsand the 2005 Equity and Incentive Plan. During the quarter ended September 30,2008, the shareholders voted to increase by 250,000 the number of sharesauthorized to be issued under the 2005 Equity and Incentive Plan. Includingthese shares, there are 3,730,000 shares authorized under these plans. As of September 30,2008, 289,636 shares remain available for future issuance under theseplans.  Vesting periods are at thediscretion of the Board of Directors and typically range between one and threeyears. Options under these plans are granted at fair market value and have aterm of five or ten years from the date of grant.

 

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**Stock Options**

 

The following tables summarize stock optionactivity during the first six months of fiscal year 2009:

 
| ** **                                 | ** ** | **Options Outstanding** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Contractual  Life  (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| **Outstanding at March 31, 2008**     |       | 828,063                      |       | $ | 41.70 |   | 6.80 |   |   |   |
| Grants                                     |       | 57,407                       |       | 64.43 |   |   |   | $ | 101,000 |   |
| Exercises                                  |       | (54,394                      | )          | 36.17 |   |   |   |   |   |
| Cancellations                              |       | (3,010                       | )          | 55.77 |   |   |   |   |   |
| **Outstanding at September 30, 2008** |       | 828,066                      |       | $ | 43.59 |   | 5.88 |   |   |   |
| **Exercisable at September 30, 2008** |       | 716,335                      |       | $ | 40.75 |   |   |   | $ | 14,168,000 |   |

 

Information related to the stock optionsoutstanding as of September 30, 2008 is as follows:

 
| **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                        |       | 154,893                    |       | 4.42                                                            |       | $                                         | 11.98      |                                    | 154,893    |                                                   | $          | 11.98 |   |
| $20.01 - $30.00                             |       | 89,463                     |       | 5.88                                                            |       | 27.47                                     |       | 89,463                                  |       | 27.47                                                  |       |
| $30.01 - $40.00                             |       | 60,981                     |       | 6.01                                                            |       | 38.93                                     |       | 60,981                                  |       | 38.93                                                  |       |
| $40.01 - $50.00                             |       | 114,533                    |       | 6.42                                                            |       | 45.63                                     |       | 114,533                                 |       | 45.63                                                  |       |
| $50.01 - $60.00                             |       | 195,589                    |       | 6.67                                                            |       | 53.52                                     |       | 166,260                                 |       | 53.70                                                  |       |
| $60.01 - $74.72                             |       | 212,607                    |       | 5.89                                                            |       | 64.49                                     |       | 130,205                                 |       | 64.12                                                  |       |
| $ 6.50 - $74.72                        |       | 828,066                    |       | 5.88                                                            |       | $                                         | 43.59      |                                    | 716,335    |                                                   | $          | 40.75 |   |

 

As of September 30, 2008, there wasapproximately $1,930,000 of unrecognized compensation costs related to optionsgranted. The unrecognized compensation will be primarily recognized over thenext two years.   Non-vested commonstock options are subject to the risk of forfeiture until the fulfillment ofspecified conditions.

 

**RestrictedStock and Restricted Stock Units**

 

The Company has instituted long termincentive plans for certain key employees. These plans call for the issuance ofrestricted stock which vests upon the achievement of certain performance basedgoals as well as service time incurred. Restricted stock and restricted stock units may also be granted to otheremployees with vesting periods that range from one to three years.  In addition, annually on January 10ththe Board of Directors is granted restricted stock. These restricted stockawards vest on a pro-rata basis on service time incurred in the upcomingcalendar year.  The fair values of theserestricted stock awards are equal to the market price per share of the Company’scommon stock on the date of grant.

 

Nonvested restricted stock and stock unitawards are subject to the risk of forfeiture until the fulfillment of specifiedconditions. As of September 30, 2008 there was $5,221,000 of totalunrecognized compensation cost related to non-vested restricted stock and stockunit awards granted under the Company’s stock plans. This cost is expected tobe recognized over a weighted average two year period.

 

The following table summarizes the status ofthe Company’s non-vested restricted stock awards during the first six months offiscal 2008:

 
| ** **                                 | ** ** | **Non-vested Restricted Stock Awards** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                 | ** ** | **Number of   Shares**                      | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
| **Outstanding at March 31, 2008**     |       | 110,301                                               |       | $ | 58.34 |   |
| Granted                                    |       | 47,120                                                |       | 51.72 |   |
| Vested                                     |       | (5,282                                                | )          | 54.73 |   |
| Forfeited                                  |       | (7,618                                                | )          | 59.40 |   |
| **Outstanding at September 30, 2008** |       | 144,521                                               |       | $ | 56.26 |   |

 

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**3.****              INVENTORIES**

 
| **(Dollars in thousands)**                      | ** ** | **September 30,  2008** | ** ** | **March 31, 2008** | ** ** |
|-----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Inventories consisted of:                                 |       |                         |       |                         |       |
| Raw materials, completed sub-assemblies,  and spare parts |       | $                            | 20,086     |                         | $          | 18,113 |   |
| Work-in-process                                           |       | 14,561                       |       | 12,163                       |       |
| Finished goods                                            |       | 7,206                        |       | 9,831                        |       |
| Total                                                     |       | $                            | 41,853     |                         | $          | 40,107 |   |

 

**4.  INCOME PER COMMON AND COMMON EQUIVALENT SHARE**

 

Basic earnings per common share is computed by dividing net incomeavailable to common stockholders by the weighted average number of shares ofcommon stock outstanding during the period.  Diluted earnings per share includethe dilutive impact of options, warrants, restricted stock and restricted stockunits using the average share price of the Company’s common stock for theperiod. For the quarters ended September 30, 2008 and September 30,2007, common stock equivalents of 269,000 and 152,000 respectively, areexcluded from diluted earnings per share, as their effect is anti-dilutive. Forthe six months ended September 30, 2008 and September 30, 2007,common stock equivalents of 339,000 and 279,000, respectively, are excludedfrom diluted earnings per share, as their effect is anti-dilutive.

 
| ** **                                                                              | ** ** | **Three Months Ended** | ** ** | **Six Months ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands except per share amounts)**                    | ** ** | **Sept. 30,  2008**         | ** ** | **Sept. 30,  2007**       | ** ** | **Sept. 30,  2008** | ** ** | **Sept. 30,  2007** | ** ** |
| **Income Per Share**                                                                    | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                              | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                              |       | $                                | 7,361      |                           | $          | 4,515 |   | $ | 10,050 |   | $ | 10,687 |   |
| Weighted average number of common shares  outstanding —basic                       |       | 8,650                            |       | 9,194                          |       | 8,682 |   | 9,180 |   |
| Net income per share —basic                                                        |       | $                                | 0.85       |                           | $          | 0.49 |   | $ | 1.16 |   | $ | 1.16 |   |
|                                                                                    |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| **Diluted:**                                                                            | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                              |       | $                                | 7,361      |                           | $          | 4,515 |   | $ | 10,050 |   | $ | 10,687 |   |
| Adjustment to net income for change in  warrant valuation                               |       | —                           |       | —-                        |       | — |   | (11 | ) |
| Adjusted net income                                                                     |       | $                                | 7,361      |                           | $          | 4,515 |   | $ | 10,050 |   | $ | 10,676 |   |
| Weighted average number of common shares outstanding                                    |       | 8,650                            |       | 9,194                          |       | 8,682 |   | 9,180 |   |
| Assumed exercise of stock options and  warrants, using the treasury stock method        |       | 243                              |       | 267                            |       | 219 |   | 245 |   |
| Weighted average number of common and  potential common shares outstanding—diluted |       | 8,893                            |       | 9,461                          |       | 8,901 |   | 9,425 |   |
| Net income per share —diluted                                                      |       | $                                | 0.83       |                           | $          | 0.48 |   | $ | 1.13 |   | $ | 1.13 |   |

 

**5.   LINEOF CREDIT**

 

On November 16, 2006, the Companymodified its Loan and Security Agreement with Silicon Valley Bank East toextend the facility through November 2008 and increase the facility from$5.0 million to $20.0 million to support the Company’s routine workingcapital needs.  The maximum amountavailable for borrowings under the domestic facility is (a) if theCompany’s unrestricted cash is greater than or equal to $30.0 million, $20.0million minus the amount of all outstanding letters of credit less certainreserves, and minus the outstanding principal balance of any advances or (b) ifthe Company’s unrestricted cash is less than $30.0 million for a period of 30consecutive days, the lesser of (i) $20.0 million, or (ii) 85% ofeligible domestic accounts receivable minus the amount of outstanding lettersof credits adjusted for certain reserves and minus the principal balance of anyadvances.  The Company is currentlyworking with its bank on a new credit facility to become effective at theexpiration of its current agreement.

 

The credit facility bears an interest rate ofthe greater of 4.0% or the Silicon Valley Bank prime rate (5.00% at September 30,2008). The credit agreement is collateralized by certain assets of the Companyand contains certain restrictions, including limitations on the amount ofdistributions that can be made to stockholders, and the disposition orencumbrances of assets, and requires the maintenance of certain financialcovenants.  As of September 30,2008, the Company was in compliance with these covenants.

 

In the normal course of business, the Companymay provide certain customers and potential customers with performance 

 

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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 ourobligations, the probability of which is remote in management’s opinion.  The Company had outstanding $19,053,000 instand-by letters of credit against the domestic facility with $947,000remaining availability.  The outstandingletters of credit are primarily for guaranteeing performance on certaininternational projects.   No amounts havebeen drawn against these letters of credit. In addition at September 30,2008, the Company had a restricted cash balance of $18,611,000 related tocertain bank required deposits for outstanding letters of credit issued inexcess of amounts available under its loan facility, and other bank-relatedfees.

 

**6.   FAIR VALUE MEASUREMENTS**

 

SFAS 157 defines and establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements.In accordance with SFAS 157, we have categorized our financial assets, based onthe priority of the inputs to the valuation technique, into a three-level fairvalue hierarchy as set forth below. If the inputs used to measure the financialinstruments fall within different levels of the hierarchy, the categorizationis based on the lowest level input that is significant to the fair valuemeasurement of the instrument.

 

Financial assets recorded on the CondensedConsolidated Balance Sheets are categorized based on the inputs to thevaluation techniques as follows:

 

**Level 1** - Financialassets whose values are based on unadjusted quoted prices for identical assetsor liabilities in an active market that the Company has the ability to accessat the measurement date (examples include active exchange-traded equitysecurities, listed derivatives, and most U.S. Government and agencysecurities).  The Company currently doesnot have any Level 1 financial assets or liabilities.

 

**Level 2** - Financialassets whose values are based on quoted prices in markets where trading occursinfrequently or whose values are based on quoted prices of instruments withsimilar attributes in active markets. Level 2 inputs include the following:

 

·                  Quoted pricesfor identical or similar assets or liabilities in non-active markets (examplesinclude corporate and municipal bonds which trade infrequently);

 

·                  Inputs otherthan quoted prices that are observable for substantially the full term of theasset or liability (examples include interest rate and currency swaps); and

 

·                  Inputs that arederived principally from or corroborated by observable market data forsubstantially the full term of the asset or liability (examples include certainsecurities and derivatives).

 

**Level 3** - Financialassets whose values are based on prices or valuation techniques that requireinputs that are both unobservable and significant to the overall fair valuemeasurement. These inputs reflect management’s assumptions about theassumptions a market participant would use in pricing the asset or liability.The Company currently does not have any Level 3 financial assets orliabilities.

 

The following table presents the financialassets and liabilities we measure at fair value on a recurring basis, based onthe fair value hierarchy as of September 30, 2008:

 

*Level 2 – Financial Assets*

* *
| **(In thousands)**    | ** ** | **September 30,  2008** | ** ** |
|----------------------------|------------|------------------------------|------------|
| Government agency bond     |       | $                            | 3,995      |   |
| Certificates of deposit    |       | 3,200                        |       |
| Commercial paper           |       | 19,252                       |       |
| Corporate debentures/bonds |       | 23,962                       |       |
| Short-term investments     |       | $                            | 50,409     |   |

 

**7.   INCOMETAXES**

 

The Company accounts for income taxes inaccordance with SFAS No. 109, “Accounting for Income Taxes.” Accordingly,the Company recognizes deferred income taxes based on the expected future taxconsequences of differences between the financial statement basis and the taxbasis of assets and liabilities, calculated using enacted tax rates in effectfor the year in which the differences are expected to be reflected in the taxreturn. The Company evaluates the need for a valuation allowance against itsnet deferred tax assets at year end based upon its three year cumulative incomeand its projections of future income, and records a valuation allowance againstany net deferred tax assets if it is more likely than not that they will not berealized.

 

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On November 10,2005, the Financial Accounting Standards Board (“FASB”) issued FASB StaffPosition No. FAS 123(R), “Transition Election Related to Accounting for TaxEffects of Share-Based Payment Awards” that allows for a simplified orLong-Haul Method to establish the beginning balance of the additionalpaid-in-capital pool (“APIC pool”) related to the tax effects of employeestock-based compensation, and to determine the subsequent impact on the APICpool and Consolidated Statements of Cash Flows of the tax effects of employeestock-based compensation awards that are outstanding upon adoption of SFAS123(R). The Company has elected to use the Long-Haul Method of calculating theAPIC pool.

 

In June 2006,the FASB issued Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement 109” (“FIN 48”). Thisstatement clarifies the criteria that an individual tax position must satisfyfor some or all of the benefits of that position to be recognized in a company’sfinancial statements. FIN 48 prescribes a recognition threshold of more-likely—than-not,and a measurement attribute for all tax positions taken or expected to be takenon a tax return, in order for those tax positions to be recognized in thefinancial statements. Effective April 1, 2007, the Company adopted theprovisions of FIN 48 and there has been no material effect on the financialstatements. As a result, there was no cumulative effect related to adopting FIN48 and no interest or penalties related to uncertain tax positions was accrued.

 

The Company is currentlyopen to audit under the statute of limitations by the Internal Revenue Serviceand state taxing authorities for the years ending March 31, 2005 through2008.  The Company is under examinationcurrently by the Internal Revenue Service for tax years 2006 and 2007.Management does not believe that the ultimate outcome of this examination willhave a material impact on the Company’s financial position or results ofoperations.  The Company believes that there are no uncertain taxpositions as of September 30, 2008.

 

**8.****              GUARANTEES**

 

Certain of theCompany’s products carry a one-year warranty, the costs of which are accruedfor 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 sixmonths ended September 30, 2008 and September 30, 2007 is as follows:

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands)**                           | ** ** | **Sept. 30, 2008**     | ** ** | **Sept. 30, 2007**   | ** ** | **Sept. 30, 2008** | ** ** | **Sept. 30, 2007** | ** ** |
| Warranty accrual  - beginning of period           |       | $                                | 1,711      |                           | $          | 1,948 |   | $ | 1,671 |   | $ | 1,997 |   |
| Accruals for  warranties issued during the period |       | 1,155                            |       | 667                            |       | 1,664 |   | 1,400 |   |
| Adjustment of  preexisting accrual estimates      |       | (455                             | )          | (1,123                         | )          | (657 | ) | (1,747 | ) |
| Warranty costs  incurred during the period        |       | (195                             | )          | (305                           | )          | (462 | ) | (463 | ) |
| Warranty accrual  — end of period            |       | $                                | 2,216      |                           | $          | 1,187 |   | $ | 2,216 |   | $ | 1,187 |   |

 

In conjunctionwith the sale of certain assets and contracts of the Company’s High EnergySystems 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 September 30, 2008 totaled$955,000.  No accrual for this contingent liability has been recorded at September 30,2008 as payment of this liability is considered remote.

 

**9.   LEASE COMMITMENTS**

 

In March 2005,the Company renewed its lease agreement for its corporate headquarters andmanufacturing facilities in Billerica, Massachusetts.  As part of thelease agreement, the Company’s landlord agreed to certain renovations to theBillerica 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 in AssetConstruction”.  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 onits books with an offsetting credit to the Lease Financing Liability.  Inaddition, amounts paid for construction were capitalized to fixed assets andthe landlord construction allowances of $6,009,000 were recorded as additionalLease Financing Liability.

 

At the completionof the construction of the initial renovations in February 2006, the leasewas reviewed for potential sale-leaseback treatment in accordance with SFAS No. 98. Based on this review, it was determined that the lease did not qualify forsale-leaseback treatment in accordance with SFAS No. 98.  As aresult, building and tenant improvements and associated lease financingliabilities remain on the Company’s books.  The Lease Financing Liabilityis being 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 lessor of their useful lives or the leaseterm.

 

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**ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**Results of Operations**

 

Net revenues forthe second quarter of fiscal 2009 increased by $18,666,000 to $56,293,000compared to the corresponding period a year ago.  This increase isattributable primarily to an increase of $16,537,000 in product sales, of which$13,819,000 relates to increased shipments of Z Backscattersystems.   In addition, there was an increase of $3,103,000 inCargoSearch system revenues due primarily to a comparative increase in thevolume of CargoSearch projects recognized on a percent complete basis from theprior year.  Service revenues increasedby $2,129,000 to $17,931,000 compared to the second quarter of fiscal 2008 dueprimarily to an increase in the volume of international service contracts overthe prior year.

 

Net revenues forthe first six months of fiscal 2009 increased by $13,689,000 to $95,787,000compared to the corresponding period a year ago.  This increase isattributable primarily to an increase of $10,572,000 in product sales, of which$9,030,000 relates to increased shipments of Z Backscatter systems.  In addition, there was an increase of $1,651,000 in ParcelSearch systemrevenues due to a comparative increase in the volume of shipments period overperiod.  Service revenues increased by$3,117,000 to $34,483,000 compared to the first six months of fiscal 2008 dueprimarily to an increase in the volume of service contracts over the prioryear.

 

Total cost ofsales and contracts for the second quarter of fiscal 2009 increased by$10,217,000 to $33,766,000 as compared to the corresponding period a year ago.Cost of sales and contracts related to product revenues increased by $7,207,000to $22,082,000 as compared to the corresponding period a year ago.  Costof product sales and contract revenues represented 58% of revenues versus 68%of revenue, for the corresponding period last year.  The resultantincrease in gross margin percentage is due primarily to the mix of productssold in the period with a greater percentage of revenues derived from highermargin Z Backscatter system shipments and improved margins seen on theParcelSearch related products due to cost reductions efforts expended in thispast fiscal year.   The cost of servicerevenues for the second quarter ended September 30, 2008 increased by$3,010,000 to $11,684,000 as compared to the corresponding period a yearago.  Cost of service revenues represented 65% of revenues versus 55% forthe corresponding period last year.  Thisincrease in costs is due primarily to increased costs for freight and travel toservice systems under fixed price service contracts during the period as wellas the Company entering into some relatively lower margin service contracts insome international markets.

 

Total cost of salesand contracts for the first six months of fiscal 2009 increased by $8,112,000to $58,731,000 as compared to the corresponding period a year ago. Cost ofsales and contracts related to product revenues increased by $4,228,000 to$37,868,000 as compared to the corresponding period a year ago.  Cost ofproduct sales and contract revenues represented 62% of revenues versus 66% ofrevenue, for the corresponding period last year.  The resultant increasein gross margin percentage is due primarily to the mix of products sold in theperiod with a greater percentage of revenues derived from higher margin ZBackscatter system shipments.  The costof service revenues for the first six months of fiscal 2009 increased by $3,884,000to $20,863,000 as compared to the corresponding period a year ago.  Costof service revenues represented 60% of revenues versus 54% for thecorresponding period last year. This increase in costs is due primarily toincreased costs for freight and travel to service systems under fixed price servicecontracts during the period as well as the Company entering into somerelatively lower margin service contracts in some international markets.

 

Selling, generaland administrative expenses for the second quarter of fiscal 2009 increased by$1,543,000 to $7,394,000 as compared to the corresponding period a yearago.  Selling, general and administrative expenses represented 13% ofrevenues in the current period as compared to 16% for the corresponding periodlast year.  The increase in costs was primarily the result of an increasein salaries and benefits associated primarily with increased headcount($312,000), increased incentive and stock compensation expense ($736,000), andincreased legal costs related to ongoing litigation ($531,000).

 

Selling, generaland administrative expenses for the first six months of fiscal 2009 increasedby $2,759,000 to $15,093,000 as compared to the corresponding period a yearago.  Selling, general and administrative expenses represented 16% ofrevenues in the current period as compared to 15% for the corresponding periodlast year.  The increase in costs was primarily the result of an increasein salaries and benefits associated with increased headcount ($559,000),increased incentive and stock compensation expense ($1,029,000), increasedlegal costs related to ongoing litigation ($631,000), increased marketing andtrade-show related costs ($165,000), increased consulting costs ($310,000) andincreased travel related expenditures ($137,000).  These increases were offset somewhat by a$388,000 decrease in ERP system related costs as the Company entered its secondyear post implementation.

 

Company fundedresearch and development expenses for the second quarter of fiscal 2009increased by $1,403,000 to $4,176,000 as compared to the corresponding periodlast year.  Research and development expenses remained consistent at 7% ofrevenues in both periods.  This increase in research and developmentspending was planned and is attributable an increase in the number of researchand development projects being developed and an increase in the number ofengineering resources available to focus on research and develop efforts.

 

Company fundedresearch and development expenses for the first six months of fiscal 2009increased by $2,209,000 to $7,739,000 as compared to the corresponding periodlast year.  Research and development expenses represented 8% of revenuesin the

 

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current period comparedto 7% for the corresponding period last year.  This increase in researchand development spending  was planned andis attributable an increase in the number of research and development projectsbeing developed and an increase in the number of engineering resourcesavailable to focus on research and develop efforts.

 

Other income was$544,000 in income for the second quarter of fiscal 2009 as compared to$1,599,000 in income for the corresponding period a year ago.  Thisdecrease in other income is attributable primarily to a decrease in interestincome attributable to significantly lower interest rates as compared to theprior period and a reduced cash balance available for short term investment.

 

Other income was$1,479,000 in income for the first six months of fiscal 2009 as compared to$3,473,000 in income for the corresponding period a year ago.  Thisdecrease in other income is attributable primarily to a decrease in interestincome attributable to significantly lower interest rates as compared to theprior period and a reduced cash balance available for short term investment.

 

The Companyreported pre-tax income of $11,501,000 in the quarter ended September 30,2008 as compared to pre-tax income of $7,053,000 in the corresponding period ayear ago due to the factors described above. The Company reported pre-taxincome of $15,703,000 in the six months ended September 30, 2008 ascompared to pre-tax income of $17,088,000 in the corresponding period a year agodue to the factors described above.

 

The Company’sprojected effective tax rate for the quarter ended September 30, 2008remained constant at 36% as compared to the prior year.  The Company’s projected effective tax ratefor the six months ended September 30, 2008 decreased to 36% from 37% forthe corresponding period a year ago.  This decrease is due to primarily toan increase in the percentage of international sales revenue as compared to theprior period which reduced the Company’s state tax liability.

 

The Company hadnet income of $7,361,000 for the second quarter of fiscal 2009 as compared tonet income of $4,515,000 for the second quarter of fiscal 2008.  The Company had net income of$10,050,000 for the first six months of fiscal 2009 as compared to net incomeof $10,687,000 for the first six months of fiscal 2008.  The significantfactors contributing to these results are noted in the above sections.

 

**Liquidityand Capital Resources**

 

Cash and cashequivalents increased by $628,000 to $53,046,000 at September 30, 2008compared to $52,418,000 at March 31, 2008. This increase is attributableprimarily to the net income earned for the period adjusted for non-cashdepreciation and stock compensation expense, an increase in customer depositsof $10,288,000 in the period, and proceeds from maturities of short terminvestments of $22,307,000.  These cashinflows were offset by an increase in accounts receivable of $11,332,000related to end of period shipments, an increase in restricted cash of$16,088,000 used to collateralize certain outstanding letters of credit,$11,398,000 used to repurchase outstanding shares of common stock as part ofthe Company’s Stock Repurchase Program, and dividend payments made of$3,509,000.  In addition, cash used forother operating activities included $2,605,000 in inventory increasesattributable to inventory builds to meet orders received, and a $4,810,000increase in prepaid expenses and other assets primarily related to depositsmade with vendors to secure raw material availability and prepaid commissionsand service on certain large international orders.

 

On November 16,2006, the Company modified its Loan and Security Agreement with Silicon ValleyBank East to extend the facility through November 2008 and increase the facilityfrom $5.0 million to $20.0 million to support the Company’s routineworking capital needs.  The maximumamount available for borrowings under the domestic facility is (a) if theCompany’s unrestricted cash is greater than or equal to $30.0 million, $20.0million minus the amount of all outstanding letters of credit less certainreserves, and minus the outstanding principal balance of any advances or (b) ifthe Company’s unrestricted cash is less than $30.0 million for a period of 30consecutive days, the lesser of (i) $20.0 million, or (ii) 85% ofeligible domestic accounts receivable minus the amount of outstanding lettersof credits adjusted for certain reserves and minus the principal balance of anyadvances.  The Company is currentlyworking with its bank on a new credit facility to become effective at theexpiration of its current agreement.

 

The creditfacility bears an interest rate of the greater of 4.0% or the Silicon ValleyBank prime rate (5.00% at September 30, 2008). The credit agreement iscollateralized by certain assets of the Company and contain certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequire the maintenance of certain financial covenants.  As of September 30, 2008, the Companywas in compliance with these covenants.

 

In the normalcourse of business, the Company may provide certain customers and potentialcustomers with performance guarantees, which are generally backed by standbyletters of credit. In general, the Company would only be liable for the amountof these guarantees in the event of default in the performance of ourobligations, the probability of which is remote in management’s opinion.  The Company had outstanding $19,053,000 instand-by letters of credit against the domestic facility with $947,000remaining availability.  The outstandingletters of credit are primarily for guaranteeing performance on certaininternational projects.   No amounts havebeen drawn against these letters of credit. In addition at September 30,2008, the Company had a restricted cash balance of $18,611,000 related tocertain bank required deposits for outstanding letters of credit issued inexcess of amounts available under its loan facility, and other bank-relatedfees.

 

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**ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

The cash accountsfor the Company’s operations in Hong Kong, England, and Abu Dhabi aremaintained in Hong Kong dollars, pounds sterling and dirham, respectively.Foreign currency accounts are marked to market at current rates that resultedin immaterial translation adjustments to stockholders’ equity. The gains andlosses from foreign currency transactions are included in the statements ofoperations for the period and were also immaterial. A hypothetical 10% changein foreign currency rates would not have a material impact on the Company’sresults of operations or financial position.

 

As of September 30,2008, the Company held short-term investments consisting of money market funds,government agency bonds, certificates of deposit, commercial paper and corporatedebentures/bonds. The Company’s primary objective with its investment portfoliois to invest available cash while preserving principal and meeting liquidityneeds. These investments had an average interest rate of approximately 2.535%and are subject to interest rate risk. As a result of the average maturity andconservative nature of the investment portfolio, a sudden change in interestrates would not have a material adverse effect on the value of theseinvestments.

 

**ITEM 4 — CONTROLS AND PROCEDURES**

 

a)  Evaluation of disclosure controls and procedures

 

As of the end ofthe period covered by this report, under the supervision and with theparticipation 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 the ExchangeAct is recorded, processed, summarized and reported within the time periodspecified in the Securities and Exchange Commission’s rules and forms, andto provide reasonable assurance that information required to be disclosed bythe Company in such reports is accumulated and communicated to the Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

 

b)  Changes in internal controls

 

There have been nochanges in our internal controls over financial reporting as such term isdefined in Rule 13a-15(f) and 15d-15(f) of the Exchange Actduring the period covered by this report that have materially affected, or arereasonably likely to materially affect, the Company’s internal controls overfinancial reporting.

 

**PART II — OTHER INFORMATION**

 

**ITEM 1 — LEGAL PROCEEDINGS**

 

On October 3,2007, the Company commenced litigation in the United States District Court forthe Eastern District of Virginia against AutoClear, LLC, and its affiliatesControl Screening, LLC, and Scan-Tech Security, LP, for infringement of theCompany’s United States Patent Nos. 5,313,511 and 6,546,072 (subsequentlyadded), seeking relief, including an injunction. The discovery period has concludedand the case is awaiting trial.

 

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 —PURCHASES OF EQUITY SECURITIES**

 

On May 17, 2007, the Board of Directors approved a Stock RepurchaseProgram which authorized the Company to repurchase up to $35 million of sharesof its common stock from time to time on the open market.  This Repurchase Program was completed duringthe quarter ended June 30, 2008.**  **On May 8, 2008 the****Board of Directors approved another StockRepurchase Program which authorizes the Company to repurchase up to $35 millionof shares of its common stock from time to time on the open market.  As of September 30, 2008, the maximumdollar value of shares that may yet be purchased under this program is$33,399,000.

 

The following table provides information about our purchases during thequarter ended September 30, 2008 of equity securities that are registeredby us pursuant to Section 12 of the Exchange Act.

 

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| **2008**                                   | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of   Shares Purchased   as Part of Publicly  Announced  Programs** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|
| July 1 –  July 31           |       | 7,901                                            |       | $                                                | 49.89      |                                                                                                                      | 7,901      |   |
| August 1 –  August 31       |       | —                                           |       | —                                           |       | —                                                                                                                    |       |
| September 1  – September 30 |       | 4,000                                            |       | 58.95                                            |       | 4,000                                                                                                                     |       |
| **Total**                                  |       | 11,901                                           |       | $                                                | 52.94      |                                                                                                                      | 11,901     |   |

 

**ITEM4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

At the annual meeting ofstockholders of the Company held on September 11, 2008, the stockholdersof the Company (1) elected Denis R. Brown, Roger P. Heinisch, Hamilton W.Helmer, Ernest J. Moniz, Mark Thompson, Carl W. Vogt and Anthony R. Fabiano asdirectors of the Company to hold office for a one-year term and no othernominations were made; (2) voted to increase by 250,000 shares, the numberof shares authorized to be issued under the 2005 Equity and Incentive Plan and (3) ratifiedthe appointment of Vitale, Caturano and Company, Ltd., independent registeredpublic accountants, as our independent auditors for the fiscal year ending March 31,2009. The votes were as follows:

 
| ** ** | ** **                                                                                 | **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** | **Broker  Non-votes** | ** ** |
|------------|--------------------------------------------------------------------------------------------|--------------------|------------|------------------------|------------|-----------------|------------|-----------------------|------------|
|       |                                                                                       |               |       |                   |       |            |       |                  |       |
| (1)        | Election of  Directors:                                                                    |               |       |                   |       |            |       |                  |       |   |
|       |  Denis R. Brown                                                                       |               | 6,069,301  |                   | 2,027,897  |            | —     |                  | —     |   |
|       |  Roger P. Heinisch                                                                    |               | 5,450,082  |                   | 2,647,116  |            | —     |                  | —     |   |
|       |  Hamilton W.  Helmer                                                                  |               | 6,095,976  |                   | 2,001,222  |            | —     |                  | —     |   |
|       |  Ernest J. Moniz                                                                      |               | 6,090,196  |                   | 2,007,002  |            | —     |                  | —     |   |
|       |  Mark Thompson                                                                        |               | 6,096,530  |                   | 2,000,668  |            | —     |                  | —     |   |
|       |  Carl W. Vogt                                                                         |               | 5,447,597  |                   | 2,649,601  |            | —     |                  | —     |   |
|       |  Anthony R.  Fabiano                                                                  |               | 6,104,700  |                   | 1,992,498  |            | —     |                  | —     |   |
| (2)        | Increase in number of  shares authorized to be issued under 2005 Equity and Incentive Plan |               | 4,627,281  |                   | 468,641    |            | 221,042    |                  | 2,780,234  |   |
| (3)        | Ratification of Vitale,  Caturano and Company, Ltd. as independent auditors                |               | 8,049,179  |                   | 35,161     |            | 12,832     |                  | 26         |   |

 

**ITEM 5 — OTHER INFORMATION**

 

**Amendment to 2005 Equity and Incentive Plan**

 

As noted under Item 4 above, at the annual meeting of Stockholders of theCompany held on September 11, 2008, the stockholders of the Company votedto increase the maximum number of shares of the Company’s Common Stockavailable to be issued under the 2005 Equity and Incentive Plan from 750,000 to1,000,000.  The Board of Directorspreviously approved the amendment on July 24, 2008, subject to stockholderapproval.  The American Science andEngineering, Inc. Amended and Restated 2005 Equity and Incentive Plan isattached hereto as Exhibit 10.1 and incorporated herein by reference.

 

**ITEM 6 — EXHIBITS**

 

See the exhibit indexfollowing the signature page to this quarterly report.

 

The information requiredby Exhibit Item 11 (Statement re: Computation of Income per Common andCommon Equivalent Share) may be found in Note 4 to the Unaudited CondensedConsolidated Financial Statements in this quarterly report.

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this Report to be signed on its behalf by the undersigned hereunto dulyauthorized.

 
|                          | AMERICAN SCIENCE AND  ENGINEERING, INC.                       |
|-------------------------------|---------------------------------------------------------------|
|                          |                                                          |
| Date: November 10,  2008 | /s/ Kenneth J. Galaznik                                       |
|                          | Kenneth J. Galaznik                                           |
|                          | Senior Vice President,  Chief Financial Officer and Treasurer |

 

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*Safe Harbor Statement*

 

*Theforegoing 10-Q contains statements concerning the Company’s financialperformance and business operations, which may be considered “forward-looking”under applicable securities laws.*

 

*TheCompany wishes to caution readers of this Form 10-Q that actual resultsmight differ materially from those projected in any forward-lookingstatements.*

 

*Factorswhich might cause actual results to differ materially from those projected inthe forward-looking statements contained herein include the following:significant reductions or delays in procurements of the Company’s systems bythe United States and other governments; disruption in the supply of any sourcecomponent incorporated into the Company’s products; litigation seeking torestrict the use of intellectual property used by the Company; potentialproduct liability claims against the Company; global political trends andevents which affect public perception of the threat presented by drugs,explosives and other contraband; global economic developments and the abilityof governments and private organizations to fund purchases of the Company’sproducts to address such threats; and the potential insufficiency of Companyresources, 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 31,2008 under Item 1A “Risk Factors”.  Please also refer to our other filingswith the Securities and Exchange Commission.*

 

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**EXHIBIT INDEX**

 
| **Exhibit********Number** | ** ** | **Description  of Exhibits**                                                                                                                                  |
|---------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                          |
| 10.1                      |       | American Science and  Engineering, Inc. Amended and Restated Equity and Incentive Plan                                                                   |
|                      |       |                                                                                                                                                          |
| 10.2                      |       | Form of Restricted  Stock Agreement (Performance) under the AS&E 2005 Equity and Incentive  Plan                                                     |
|                      |       |                                                                                                                                                          |
| 10.3                      |       | Form of Incentive  Stock Option Agreement (Performance) under the AS&E 2005 Equity and  Incentive Plan                                               |
|                      |       |                                                                                                                                                          |
| 10.4                      |       | Form of Long-Term  Incentive Plan Agreement - Cash Component                                                                                             |
|                      |       |                                                                                                                                                          |
| 10.5                      |       | Form of Change in  Control and Severance Benefit Agreement between the Company and Named  Executives                                                     |
|                      |       |                                                                                                                                                          |
| 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 |

 

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