**FORM 10-Q**

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

**Forthe quarterly period ended December 31, 2005**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

**Forthe transition period from      to      **

 

**CommissionFile Number 1-6549**

 

**American Science and Engineering, Inc.**

(Exact name of Registrant asspecified 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’s telephone number,including area code)

 

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

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days. Yes ý No o

 

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

 
| Large accelerated filer o |   | Accelerated filer ý |   | Non-accelerated filer o |
|---------------------------|--------|--------------------------|--------|-------------------------|

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Securities Exchange Act of1934). Yes o No ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date

 
| **Class of Common Stock** | ** ** | **Outstanding at  February 2, 2006** |
|--------------------------------|------------|-------------------------------------------|
| $.66 2/3 par  value            |       | 8,179,164                                 |

 

 

----

 

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

**Index**

 
| **Part 1 – Financial Information**                                                                                                       | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Item  1 – Financial Statements                                                                                                                | 3          |
| Unaudited Condensed Consolidated Balance Sheets - December 31,  2005 and March 31, 2005                                                  | 3          |
| Unaudited Condensed Consolidated Statements of Operations - for the  Three and Nine Months Ended December 31, 2005 and December 31, 2004 | 4          |
| Unaudited Condensed Consolidated Statements of Cash Flows - For the  Nine Months Ended December 31, 2005 and December 31, 2004           | 5          |
| Notes to Unaudited Condensed Consolidated Financial Statements                                                                                     | 6          |
| Item 2 – Management’s Discussion and Analysis of Financial Condition  and Results of Operations                                          | 9          |
| Item 3 – Quantitative and Qualitative Disclosure About Market Risk                                                                            | 12         |
| Item 4 - Controls and Procedures                                                                                                                   | 12         |
| **Part II  – Other Information**                                                                                                         | ** ** |
| Item  1 – Legal Proceedings                                                                                                                   | 13         |
| Item 6 –  Exhibits                                                                                                                            | 13         |
| **Signatures**                                                                                                                                     | 13         |

 

2

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**PART I – FINANCIAL INFORMATION**

**Item 1 – Financial Statements**

 

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

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

Dollars in thousands

 
| ** **                                                                                                                                                                              | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| **Assets**                                                                                                                                                                              |       |                        |       |                     |       |
| Current  assets:                                                                                                                                                                        |       |                        |       |                     |       |
| Cash and  cash equivalents                                                                                                                                                              |       | $                           | 41,052     |                     | $          | 15,418 |   |
| Restricted  cash and investments                                                                                                                                                        |       | 162                         |       | 355                      |       |
| Short-term  investments                                                                                                                                                                 |       | 34,265                      |       | 20,590                   |       |
| Accounts  receivable, net of allowances of $361 and $501 at December 31, 2005 and March 31,  2005, respectively                                                               |       | 26,834                      |       | 28,170                   |       |
| Unbilled  costs and fees, net of allowances of $36 and $76 at December 31, 2005  and March 31, 2005, respectively                                                             |       | 2,051                       |       | 691                      |       |
| Note  receivable                                                                                                                                                                        |       | 2,800                       |       | 2,800                    |       |
| Inventories                                                                                                                                                                             |       | 15,670                      |       | 24,941                   |       |
| Deferred tax  assets                                                                                                                                                                    |       | 3,140                       |       | —                   |       |
| Prepaid  expenses and other current assets                                                                                                                                              |       | 5,044                       |       | 1,957                    |       |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Total  current assets**                                                                                                                                                               |       | 131,018                     |       | 94,922                   |       |
| Building,  equipment and leasehold improvements, net                                                                                                                                    |       | 15,305                      |       | 3,329                    |       |
| Deferred tax  asset                                                                                                                                                                     |       | 117                         |       | —                   |       |
| Other  assets, net                                                                                                                                                                      |       | —                      |       | 36                       |       |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Total  assets**                                                                                                                                                                       |       | $                           | 146,440    |                     | $          | 98,287 |   |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                          |       |                        |       |                     |       |
| Current  liabilities:                                                                                                                                                                   |       |                        |       |                     |       |
| Accounts  payable                                                                                                                                                                       |       | $                           | 5,141      |                     | $          | 6,743 |   |
| Accrued  salaries and benefits                                                                                                                                                          |       | 4,676                       |       | 3,158                    |       |
| Accrued  warranty costs                                                                                                                                                                 |       | 3,407                       |       | 2,322                    |       |
| Accrued  income taxes                                                                                                                                                                   |       | —                      |       | 15                       |       |
| Deferred  revenue                                                                                                                                                                       |       | 3,084                       |       | 3,634                    |       |
| Customer  deposits                                                                                                                                                                      |       | 9,457                       |       | 11,132                   |       |
| Current  portion of lease financing liability                                                                                                                                           |       | 728                         |       | —                   |       |
| Other  current liabilities                                                                                                                                                              |       | 2,287                       |       | 2,986                    |       |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Total  current liabilities**                                                                                                                                                          |       | 28,780                      |       | 29,990                   |       |
| Lease  financing liability                                                                                                                                                              |       | 5,695                       |       | —                   |       |
| Warrant  liability                                                                                                                                                                      |       | 6,784                       |       | 6,137                    |       |
| Other  non-current liabilities                                                                                                                                                          |       | 396                         |       | 590                      |       |
| **Total  liabilities**                                                                                                                                                                  |       | 41,655                      |       | 36,717                   |       |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Stockholders’  equity:**                                                                                                                                                         |       |                        |       |                     |       |
| Preferred  stock, no par value Authorized  — 100,000 shares; Issued - none                                                                                                    |       | —                      |       | —                   |       |
| Common  stock, $0.66 2/3 par value Authorized — 20,000,000 shares Issued and  Outstanding 8,639,561 shares at December 31, 2005 and 8,341,480 shares  at  March 31, 2005 |       | 5,759                       |       | 5,560                    |       |
| Capital in  excess of par value                                                                                                                                                         |       | 71,928                      |       | 54,098                   |       |
| Accumulated  other comprehensive income                                                                                                                                                 |       | (35                         | )          | (12                      | )          |
| Unearned  compensation                                                                                                                                                                  |       | (21                         | )          | (169                     | )          |
| Retained  earnings                                                                                                                                                                      |       | 27,154                      |       | 2,093                    |       |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Total  stockholders’ equity**                                                                                                                                                    |       | 104,785                     |       | 61,570                   |       |
|                                                                                                                                                                                    |       |                        |       |                     |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                    |       | $                           | 146,440    |                     | $          | 98,287 |   |

 

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

 

3

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

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 

Dollars and shares in thousands, except per share amounts

 
| ** **                               | ** **    | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------|---------------|-------------------------|------------|-------------------------|------------|
| ** **                               | ** **    | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** |
| Revenues:                                |          |                    |       |                    |       |   |   |   |   |
| Net product  sales and contract revenues |          | $                       | 28,213     |                    | $          | 18,320 |   | $ | 99,705 |   | $ | 47,640 |   |
| Net service  revenues                    |          | 10,327                  |       | 5,160                   |       | 23,138 |   | 13,706 |   |
| Total net  revenues                      |          | 38,540                  |       | 23,480                  |       | 122,843 |   | 61,346 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Cost of  sales and contracts:            |          |                    |       |                    |       |   |   |   |   |
| Cost of  product sales and contracts     |          | 13,544                  |       | 12,090                  |       | 50,352 |   | 32,974 |   |
| Cost of  service revenues                |          | 5,622                   |       | 2,881                   |       | 13,749 |   | 7,728 |   |
| Total cost  of sales and contracts       |          | 19,166                  |       | 14,971                  |       | 64,101 |   | 40,702 |   |
| Gross profit                             |          | 19,374                  |       | 8,509                   |       | 58,742 |   | 20,644 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Expenses:                                |          |                    |       |                    |       |   |   |   |   |
| Selling,  general and administrative     |          | 4,546                   |       | 3,829                   |       | 13,383 |   | 10,550 |   |
| Research and  development                |          | 2,201                   |       | 1,312                   |       | 7,093 |   | 3,779 |   |
| Total  expenses                          |          | 6,747                   |       | 5,141                   |       | 20,476 |   | 14,329 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Operating  income                        |          | 12,627                  |       | 3,368                   |       | 38,266 |   | 6,315 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Other income  (expense):                 |          |                    |       |                    |       |   |   |   |   |
| Interest and  investment income          |          | 704                     |       | 121                     |       | 1,576 |   | 289 |   |
| Other, net                               |          | 14                      |       | (72                     | )          | 39 |   | (77 | ) |
| Change in  warrant valuation             |          | 808                     |       | (1,394                  | )          | (2,109 | ) | (4,580 | ) |
| Total other  income (expense)            |          | 1,526                   |       | (1,345                  | )          | (494 | ) | (4,368 | ) |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Income  before income taxes              |          | 14,153                  |       | 2,023                   |       | 37,772 |   | 1,947 |   |
| Provision  for income taxes              |          | 4,485                   |       | —                  |       | 12,711 |   | 65 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Net income                               |          | $                       | 9,668      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |
| Income per  share                        | —Basic   |                    | $          | 1.12                    |       | $ | 0.25 |   | $ | 2.95 |   | $ | 0.24 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |   |
|                                     | —Diluted |                    | $          | 0.95                    |       | $ | 0.23 |   | $ | 2.77 |   | $ | 0.22 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |   |
| Weighted  average shares                 | —Basic   |                    | 8,601      |                    | 8,082      |   | 8,485 |   | 7,835 |   |
|                                     |          |                    |       |                    |       |   |   |   |   |   |
|                                     | —Diluted |                    | 9,321      |                    | 8,805      |   | 9,062 |   | 8,409 |   |

 

The accompanying notes are anintegral part of these condensed consolidated financial statements.

 

4

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

**Condensed Consolidated Statements of CashFlows**

**(Unaudited**)

 

Dollars in thousands

 
| ** **                                                                                               | ** ** | **For the Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                               | ** ** | **December 31,  2005**   | ** ** | **December 31,  2004** | ** ** |
| Cash flows  from operating activities:                                                                   |       |                          |       |   |   |
| Net income                                                                                               |       | $                             | 25,061     |   | $ | 1,882 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:                       |       |                          |       |   |   |
| Depreciation  and amortization                                                                           |       | 645                           |       | 1,090 |   |
| Provisions  for contract, inventory, and accounts receivable reserves                                    |       | 2,828                         |       | 1,165 |   |
| Realized  gains or losses on short-term investments                                                      |       | —                        |       | (7 | ) |
| Amortization  of bond discount                                                                           |       | (218                          | )          | (21 | ) |
| Deferred  income taxes                                                                                   |       | 5,928                         |       | — |   |
| Reduction of  income taxes paid due to the tax benefit from employee stock option expense                |       | 3,799                         |       | — |   |
| Reversal of  deferred tax asset valuation allowance relating to the utilization of net  operating losses |       | (2,160                        | )          | — |   |
| Stock  compensation in lieu of fees                                                                      |       | 217                           |       | 137 |   |
| Change in  value of warrants                                                                             |       | 2,109                         |       | 4,580 |   |
| Changes in  assets and liabilities:                                                                      |       |                          |       |   |   |
| Accounts  receivable                                                                                     |       | 1,510                         |       | (3,515 | ) |
| Unbilled  costs and fees                                                                                 |       | (1,332                        | )          | 2,303 |   |
| Inventories                                                                                              |       | 6,241                         |       | (10,303 | ) |
| Prepaid  expenses and other assets                                                                       |       | (3,051                        | )          | (550 | ) |
| Accounts  payable                                                                                        |       | (1,602                        | )          | 2,333 |   |
| Customer  deposits                                                                                       |       | (1,675                        | )          | 7,403 |   |
| Deferred  revenue                                                                                        |       | (700                          | )          | (420 | ) |
| Accrued  expenses and other current liabilities                                                          |       | 2,023                         |       | 2,552 |   |
| Non-current  liabilities                                                                                 |       | (44                           | )          | (15 | ) |
| Total  adjustments                                                                                       |       | 14,518                        |       | 6,732 |   |
| Net cash  provided by operating activities                                                               |       | 39,579                        |       | 8,614 |   |
|                                                                                                     |       |                          |       |   |   |
| Cash flows  from investing activities:                                                                   |       |                          |       |   |   |
| Purchases of  short-term investments                                                                     |       | (42,972                       | )          | (17,370 | ) |
| Maturity of  short-term investments                                                                      |       | 29,496                        |       | 2,397 |   |
| Purchases of  property and equipment                                                                     |       | (7,468                        | )          | (2,269 | ) |
| Net cash  used for investing activities                                                                  |       | (20,944                       | )          | (17,242 | ) |
|                                                                                                     |       |                          |       |   |   |
| Cash flows  from financing activities:                                                                   |       |                          |       |   |   |
| Decrease in  restricted cash                                                                             |       | 193                           |       | 205 |   |
| Proceeds  from exercise of warrants                                                                      |       | 1,263                         |       | 1,349 |   |
| Proceeds  from exercise of stock options                                                                 |       | 4,047                         |       | 6,878 |   |
| Proceeds  from short term financing of leasehold improvement                                             |       | 1,500                         |       | — |   |
| Net cash  provided by financing activities                                                               |       | 7,003                         |       | 8,432 |   |
| Effect of  exchange rate changes on cash                                                                 |       | (4                            | )          | — |   |
| Net increase  in cash and cash equivalents                                                               |       | 25,634                        |       | (196 | ) |
| Cash and  cash equivalents at beginning of period                                                        |       | 15,418                        |       | 18,232 |   |
| Cash and  cash equivalents at end of period                                                              |       | $                             | 41,052     |   | $ | 18,036 |   |

 

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

 

5

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

**Notes to Unaudited Condensed ConsolidatedFinancial Statements**

 

1.   General

The condensed consolidated financial statements include the accounts ofthe Company and its wholly owned subsidiary. All significant intercompanytransactions and balances have been eliminated.

 

The unaudited condensed consolidated financial statements have beenprepared in accordance with the requirements of Form 10-Q and consequentlydo not include all disclosures required by Form 10-K. These condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and the notes included in the Company’sAnnual Report on Form 10-K for the year ended March 31, 2005.

 

The unaudited condensed consolidated financial statements, in theopinion of management, include all adjustments necessary, consisting solely ofnormal recurring adjustments, to present fairly the Company’s financialposition, results of operations and cash flows.  These quarterly resultsare not necessarily indicative of the results to be expected for the entireyear.

 

Nature of Operations

The Company is engaged in the development and manufacture ofsophisticated X-ray inspection systems for critical detection and securityscreening solutions for sale primarily to U.S. and foreign governmentagencies.  The Company has only one reporting segment, X-ray screeningproducts.

 

Significant Accounting Policies

Revenues on cost reimbursable and long-term fixed price contracts aregenerally recorded as costs are incurred using the percentage of completionmethod.  For systems that are produced in a standard manufacturingoperation and have shorter order to delivery cycles, the Company recognizessales at the time of shipment of the system to the customer and when otherrevenue recognition criteria (such as transfer of risk) are met.

 

The Company’s Export and Security Agreement with Silicon Valley BankEast requires certain cash balances to be restricted as collateral againstoutstanding standby letters of credit; these are separately presented asrestricted cash. (See Note 4)

 

The other significant accounting policies followed by the Company andits subsidiary in preparing its consolidated financial statements are set forthin Note 1 to the consolidated financial statements included in its Form 10-Kfor the year ended March 31, 2005.  The Company has made no changesto these policies during the current year.

 

Certain amounts in the prior period financial statements have beenreclassified to conform to the current period presentation.

 

Comprehensive Income

 

Comprehensive income is comprised of the following:

 

(In thousands)

 
|                                                    | ** ** | **Three months ended**  | ** ** | **Nine months ended**   | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                              | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** |
| Net income                                              |       | $                       | 9,668      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
| Foreign  currency translation adjustments               |       | (5                      | )          | 12                      |       | (4 | ) | — |   |
| Unrealized  gains and losses from marketable securities |       | —                  |       | (11                     | )          | (19 | ) | (17 | ) |
| Comprehensive  income                                   |       | $                       | 9,663      |                    | $          | 2,024 |   | $ | 25,038 |   | $ | 1,865 |   |

 

Pro Forma Stock-Based Compensation Expense

As permitted by SFAS No. 123, “Accounting for Stock-BasedCompensation”, the Company has elected to continue to apply AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” to account for its stock-based compensation plans. Had compensationcost for awards under the Company’s stock-based compensation plans beendetermined based on the fair value at the grant dates consistent with themethod set forth under SFAS No. 123, the effect on the Company’s netincome and income per share would have been as follows:

 

6

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| ** **                                                                           | ** ** | **Three months ended**  | ** ** | **Nine months ended**   | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **(In thousands except per share amounts)**                                          | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** |
|                                                                                 |       |                    |       |                    |       |   |   |   |   |
| Net income  as reported                                                              |       | $                       | 9,668      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
| Add: Stock  based compensation using intrinsic value for all awards                  |       | 60                      |       | 50                      |       | 217 |   | 137 |   |
| Less: Stock  based compensation using intrinsic and fair value method for all awards |       | (1,607                  | )          | (1,368                  | )          | (6,513 | ) | (2,877 | ) |
| Pro forma  net income (loss) - Basic                                                 |       | $                       | 8,121      |                    | $          | 705 |   | $ | 18,765 |   | $ | (858 | ) |
|                                                                                 |       |                    |       |                    |       |   |   |   |   |
| Net income  as reported                                                              |       | $                       | 9,668      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
| Add: Stock  based compensation using intrinsic value for all awards                  |       | 60                      |       | 50                      |       | 217 |   | 137 |   |
| Less:  Adjustment to net income for change in warrant valuation                      |       | (808                    | )          | —                  |       | — |   | — |   |
| Less: Stock  based compensation using intrinsic and fair value method for all awards |       | (1,607                  | )          | (1,368                  | )          | (6,513 | ) | (2,877 | ) |
| Pro forma  net income (loss) - Diluted                                               |       | $                       | 7,313      |                    | $          | 705 |   | $ | 18,765 |   | $ | (858 | ) |
| Income  (loss) per share — Basic:                                               |       |                    |       |                    |       |   |   |   |   |
| As reported                                                                          |       | $                       | 1.12       |                    | $          | 0.25 |   | $ | 2.95 |   | $ | 0.24 |   |
| Pro forma                                                                            |       | $                       | 0.94       |                    | $          | 0.09 |   | $ | 2.21 |   | $ | (0.11 | ) |
| Income  (loss) per share — Diluted:                                             |       |                    |       |                    |       |   |   |   |   |
| As reported                                                                          |       | $                       | 0.95       |                    | $          | 0.23 |   | $ | 2.77 |   | $ | 0.22 |   |
| Pro forma                                                                            |       | $                       | 0.79       |                    | $          | 0.08 |   | $ | 2.09 |   | $ | (0.11 | ) |

 

The fair value of each option granted was estimated on the grant dateusing the Black-Scholes option pricing model with the following weightedaverage assumptions: risk-free interest rates of 3.38% and 3.25% for fiscal2006 and fiscal 2005, respectively, expected volatility of 52% and 73% forfiscal 2006 and fiscal 2005, respectively, an expected dividend yield of 0% forboth periods and an expected life of 3 years and 5 years for fiscal 2006 andfiscal 2005, respectively.

 

On April 22, 2005, the Company announced that its Board ofDirectors had accelerated the vesting of certain unvested stock optionspreviously awarded to employees.  Optionsto purchase 186,033 shares of common stock were subject to the acceleration.  The acceleration was effective immediately,on a fully vested basis.  Options held bythe Board of Directors, the Chief Executive Officer, the Chief FinancialOfficer, and other employees who participated in other incentive or commissioncompensation plans were excluded from the acceleration.  The Company recorded during the three andnine months ended December 31, 2005, respectively, $0 and $64,000, incompensation expense related to these accelerated options for options exercisedby individuals who terminated employment prior to the original option vestingdate.

 

2.    Inventories

 
| **(Dollars in thousands)**                  | ** ** | **Dec. 31, 2005** | ** ** | **March 31, 2005** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| Inventories  consisted of:                  | ** ** | ** **             | ** ** | ** **              | ** ** |
| Raw  materials and completed sub-assemblies |       | $                      | 5,725      |                    | $          | 12,763 |   |
| Work-in-process                             |       | 6,304                  |       | 5,458                   |       |
| Finished  goods                             |       | 3,641                  |       | 6,720                   |       |
| Total                                       |       | $                      | 15,670     |                    | $          | 24,941 |   |

 

 

3.    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 shareincludes the dilutive impact of options and warrants using the average shareprice of the Company’s common stock for the period. For the quarter ended December 31,2005 and December 31, 2004, common stock equivalents of 56,000 and 31,000,respectively, are excluded from diluted earnings per share, as their effect isanti-dilutive.  For the nine months ended December 31, 2005 and December 31,2004, common stock equivalents of 249,000 and 106,000, respectively, are excludedfrom diluted earnings per share, as their effect is anti-dilutive.

 

7

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| ** **                                                                                | ** ** | **Three months ended**  | ** ** | **Nine months ended**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **(In thousands except per share amounts)**                                               | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** |
| **Earnings  Per Share Basic:**                                                            |       |                    |       |                    |       |   |   |   |   |
| Net income                                                                                |       | $                       | 9,668      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
| Weighted  average number of common shares outstanding – basic                        |       | 8,601                   |       | 8,082                   |       | 8,485 |   | 7,835 |   |
| Net income  per share – basic                                                        |       | $                       | 1.12       |                    | $          | 0.25 |   | $ | 2.95 |   | $ | 0.24 |   |
| **Diluted:**                                                                              |       |                    |       |                    |       |   |   |   |   |
| Net income                                                                                |       | $                       | 9,668      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
| Adjustment  to net income for change in warrant valuation                                 |       | (808                    | )          | —                  |       | — |   | — |   |
| Adjusted net  income                                                                      |       | $                       | 8,860      |                    | $          | 2,023 |   | $ | 25,061 |   | $ | 1,882 |   |
| Weighted  average number of common shares outstanding                                     |       | 8,601                   |       | 8,082                   |       | 8,485 |   | 7,835 |   |
| Assumed  exercise of stock options and/or warrants, using the treasury stock method       |       | 720                     |       | 723                     |       | 577 |   | 574 |   |
| Weighted  average number of common and potential common shares outstanding – diluted |       | 9,321                   |       | 8,805                   |       | 9,062 |   | 8,409 |   |
| Net income  per share - diluted                                                           |       | $                       | 0.95       |                    | $          | 0.23 |   | $ | 2.77 |   | $ | 0.22 |   |

 

**4.****                                      Borrowings**

 

On November 30, 2004, the Company modified its two creditagreements with Silicon Valley Bank East.  The modifications extended thecredit facilities which expired on November 30, 2004 through November 29,2006 and reduced the export loan and security facility, guaranteed by theExport-Import Bank of the United States, from $20.0 million to $10.0million.  The domestic facility is a $5.0 million domestic loan andsecurity agreement to support the Company’s routine working capital needs.Maximum borrowings for this facility are set at the lower of (a) the sumof 80% of eligible domestic accounts receivable plus 10% of finished goodsinventory up to $750,000, or (b) $5.0 million.

 

The credit facilities bear an interest rate of the greater of 4.0% orthe Silicon Valley Bank prime rate (7.25% at December 31, 2005). Thecredit agreements are collateralized by certain assets of the Company andcontain certain restrictions, including limitations on the amount ofdistributions that can be made to stockholders, and the disposition orencumbrances of assets, and require the maintenance of certain financialcovenants.

 

At December 31 2005, there were no borrowings outstanding againstthese credit facilities. The Company had outstanding $932,000 in stand-byletters of credit against the domestic facility and $301,000 in stand-byletters of credit against the export facility. Of the outstanding letters of credit, $300,000 relates to the Company’sbuilding lease and the remainder is guaranteeing performance on certaininternational projects.  No amounts have been drawn against these lettersof credit. In addition, at December 31, 2005, the Company had a restrictedcash balance of $162,000 related to certain bank required deposits related tooutstanding letters of credits, bid bonds, and other bank-related fees.

 

**5.****                                      WarrantLiability**

 

On May 28, 2002, the Company closed on a private placementoffering of common stock and warrants. A total of 1,115,000 shares were sold toaccredited investors at a price of $17.64 per share. In addition, warrants topurchase an additional 295,475 shares of common stock at an exercise price of$23.52 per share were issued.  The warrants were immediately vested andhave a five-year life expiring in May of 2007.

 

At December 31, 2005, 167,700 warrants remainoutstanding.   Due to certain conversion features of these warrantsthat provide that the holder may opt for a cash settlement in certaininstances, including a merger, a sale of all or substantially all of theCompany’s assets, or a tender offer or exchange offer of shares of the Company’sstock, a liability equal to the Black-Scholes valuation of the warrants at thedeal closing date was recorded on the Company’s balance sheet. This liabilityis remeasured each quarter and marked to market.  The “mark to market” change in the warrantsvaluation of $808,000 and $(1,394,000) was recorded as other income (expense)for the three months ended December 31, 2005 and December 31, 2004,respectively.  The “mark to market” change in the warrants valuation of$(2,109,000) and $(4,580,000) was recorded as other expense for the nine monthsended December 31, 2005 and December 31, 2004, respectively. The liability of $6,784,000 and $6,137,000 representing the fair market valueof outstanding warrants at period end is recorded as a non-current liability atDecember 31, 2005 and March 31, 2005, respectively. The fair marketvalue of the warrants was determined using the Black-Scholes pricing model withan assumed volatility of 55% and 73% at December 31, 2005 and March 31,2005, respectively, an interest rate of 3.125% and 3.25% at December 31,2005 and March 31, 2005, respectively and a life equal to the remainingterm of the warrants at each period end.

 

**6.****                                      IncomeTaxes**

 

At March 31, 2005, the Company had gross deferred tax assets of$9,740,000.  The Company had applied a full valuation allowance againstits deferred tax assets at March 31, 2005 based upon its evaluation ofthree year cumulative historical results and its projection of future taxableincome and had determined that it was more likely than not that its deferredtax asset would not be realized.

 

In the first quarter of fiscal 2006, the Company reevaluated itsvaluation allowance for deferred tax assets and determined that a full

 

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release of valuation allowances was appropriate based upon periodearnings, the Company’s updated forecasted earnings for fiscal 2006, salesbacklog and other factors.  The release of the valuation allowance, as itrelates to tax expenses, has been included in determining the Company’s annualeffective tax rate for fiscal 2006.  In connection with this release, theCompany also recorded a corresponding entry to paid in capital totaling$7,025,000 for the tax benefit from the utilization of the net operating losscarry-forwards resulting from the exercise of certain employee stock options.

 

**7.****                                      Guarantees**

 

Certain of the Company’s parcel and cargo products carry a one-yearwarranty, the costs of which are accrued for at time of shipment ordelivery.  Accrual rates are based upon historical experience over thepreceding twelve months and management’s judgment of future exposure. Warranty experience for the three and nine months ended December 31, 2005and December 31, 2004 is as follows:

 
| ** **                                        | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **(In thousands)**                                | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** |
| Warranty  accrual - beginning of period           |       | $                       | 3,751      |                    | $          | 1,243 |   | $ | 2,322 |   | $ | 699 |   |
| Accruals for  warranties issued during the period |       | 186                     |       | 1,214                   |       | 2,327 |   | 2,262 |   |
| Warranty  costs incurred during the period        |       | (530                    | )          | (517                    | )          | (1,242 | ) | (1,021 | ) |
| Warranty  accrual – end of period            |       | $                       | 3,407      |                    | $          | 1,940 |   | $ | 3,407 |   | $ | 1,940 |   |

 

In conjunction with the sale of certain assets and contracts of theCompany’s High Energy Systems Division in January of 2005, the lease forthe California operations of the High Energy Systems Division was assigned toAccuray, Inc.  The Company remains secondarily liable for theremaining lease payments in the event of default by Accuray, Inc. duringthe lease term which expires in February 2011. Total remaining leasepayments at December 31, 2005 totaled $1,877,000.  No accrual forthis contingent liability has been recorded at December 31, 2005 aspayment of this liability is considered remote.

 

**8.****                                      LeaseCommitments**

 

In March 2005, the Company renewed its lease agreement for itscorporate headquarters and manufacturing facilities in Billerica,Massachusetts.  As part of the lease agreement, the Company’s landlordagreed to certain renovations to the Billerica facility including theconstruction of additional high bay manufacturing space.  The Company isresponsible for a portion of the construction costs and was deemed to be theowner of the building during the construction period under EITF 97-10 “TheEffect of Lessee Involvement in Asset Construction”.  During the ninemonths ended December 31, 2005, upon commencement of the constructionproject, the Company capitalized $5,153,000 to record the building facility onits books with an offsetting credit to the Leasehold financing liability. In addition, amounts paid for construction were recorded as construction in progressand the landlord construction contributions of $1,500,000 in the period wererecorded as additional leasehold financing liability.  In connection withthe construction, the Company entered into a construction contract with a totalcommitment of $6,534,000 of which $2,653,000 remains outstanding at December 31,2005.

 

Upon completion of construction, the lease may qualify forsale-leaseback treatment in accordance with SFAS No. 98.  For leasesthat qualify, the deemed landlord financing liability and the associatedconstruction-in-progress and capitalized building costs will be removed and thedifference will be reclassified to prepaid or deferred rent and amortized overthe lease term as rent expense.  If the lease does not qualify for sale-leasebacktreatment in accordance with SFAS No. 98, the deemed landlord financingliability will be amortized over the lease term based on the paymentsdesignated in the agreement and the building and improvement assets will bedepreciated on a straight line basis over their useful lives.

 

**Item 2 – Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

Results of Operations

 

Net revenues for the third quarter of fiscal 2006 increased by$15,060,000 to $38,540,000 compared to the corresponding period a yearago.  This increase is attributable primarily to an increase of $9,893,000in product sales due to increased shipments of Z Backscatter systems which experiencedan increase in revenue of $11,439,000 over the corresponding period a year ago.  In addition, there was an increase of $1,358,000 in CargoSearch system revenuesdue to work performed on one large CargoSearch project during thequarter. These increases were partially offset by a $1,687,000 decrease insales from the High Energy Systems group due to the sale of certain assets andcontracts of the High Energy Systems division in the fourth quarter of fiscal2005.  Service revenues increased by $5,167,000 to $10,327,000 compared tothe third quarter of fiscal 2005 due primarily to the increased volume ofservice contracts related to increased system deliveries over the past 12-18months.

 

Net revenues for the nine months ended December 31, 2005 increasedby $61,497,000 to $122,843,000 compared to the corresponding period a year ago. This increase is attributable primarily to an increase of $52,065,000 inproduct sales due to increased shipments of Z Backscatter systems whichcomprised $47,920,000 of this increase.  In addition, there was anincrease of $7,599,000 in CargoSearch system revenues with increased activityon system projects ongoing during the period and a $2,301,000 increase in sales

 

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of after-market parts.  These increases were partially offset by a$4,414,000 decrease in sales from the High Energy Systems group due to the saleof certain assets and contracts of the High Energy Systems division in thefourth quarter of fiscal 2005.  Service revenues increased by $9,432,000to $23,138,000 in the nine months ended December 31, 2005 compared to thenine months ended December 31, 2004 due primarily to the increased volumeof service contracts related to systems sold over the past 12-18 months.

 

Total cost of sales and contracts for the third quarter of fiscal 2006increased by $4,195,000 to $19,166,000 as compared to the corresponding perioda year ago. Cost of sales and contracts related to product revenues increasedby $1,454,000 to $13,544,000 as compared to the corresponding period a yearago.  Cost of product sales and contract revenues represented 48% ofrevenues versus 66% of revenue for the corresponding period last year. This improvement in gross margin is due primarily to the mix of products soldin the period, improved absorption of fixed overhead costs due to thesignificant volume increases, and the reduction of direct costs of certainproducts through improved supplier agreements and a reduction of internal laborcosts per system due to operating efficiencies.  Some of the product grossmargin improvement was offset by an increase in reserves for excess andobsolete inventory ($425,000) in the quarter due to changes in the Company’sprojected mix of product usage.  Cost of services revenues for the thirdquarter ended December 31, 2005 increased by $2,741,000 to $5,622,000 ascompared to the corresponding period a year ago.  Cost of service revenuesrepresented 54% of revenues versus 56% for the corresponding period lastyear.  This margin improvement is due primarily to comparatively lowercosts incurred on certain service contracts during the period.

 

Total cost of sales and contracts for the nine months ended December 31,2005 increased by $23,399,000 to $64,101,000 as compared to the correspondingperiod a year ago. Cost of sales and contracts related to product revenuesincreased by $17,378,000 to $50,352,000 as compared to the corresponding perioda year ago.  Cost of product sales and contract revenues represented 51%of revenues versus 69% of revenue for the corresponding period last year. This improvement in gross margin is due primarily to the mix of products soldin the period, improved absorption of fixed overhead costs due to thesignificant volume increases, and the reduction of direct costs of certainproducts through improved supplier agreements and a reduction of internal laborcosts per system due to operating efficiencies.   Some of the productgross margin improvement was offset by an increase in reserves for excess andobsolete inventory ($2,137,000) in the first nine months of fiscal 2006 due tochanges in the Company’s projected mix of product usage.  Cost of servicesrevenues for the nine months ended December 31, 2005 increased by$6,021,000 to $13,749,000 as compared to the corresponding period a yearago.  Cost of service revenues represented 59% of revenues versus 56% forthe corresponding period last year.  This margin decline is due primarilyto comparatively higher costs incurred on certain service contracts during theperiod.

 

Selling, general and administrative expenses for the third quarter offiscal 2006 of $4,546,000 were $717,000 higher than the corresponding period ayear ago.  Selling, general and administrative expenses represented 12% ofrevenues in the current period as compared to 16% for the corresponding periodlast year.  The increase in costs are attributable primarily to increasesin corporate insurance premiums ($284,000), increased legal and audit relatedcosts ($399,000), and increased marketing and travel related costs ($209,000)due to increased sales activity. These increases were offset somewhat by a$181,000 reduction in expenses related to the High Energy Systems divisionwhose assets were sold in the fourth quarter of fiscal 2005 and remainingoperations consolidated with the Company’s corporate headquarters.

 

Selling, general and administrative expenses for the nine months ended December 31,2005 of $13,383,000 were $2,833,000 higher than the corresponding period a yearago.  Selling, general and administrative expenses represented 11% ofrevenues in the current period as compared to 17% for the corresponding periodlast year.  The increase in costs are attributable primarily to increasedincentive and payroll costs ($1,345,000), marketing and travel related costs($700,000) due to increased sales activity, increased legal expenditures($533,000) related to ongoing litigation, increased corporate insurancepremiums ($489,000) and costs related to the Company’s software implementationproject ($154,000).  These increases were offset by a $599,000 reductionin expenses related to the High Energy Systems division whose assets were soldin the fourth quarter of fiscal 2005 and remaining operations consolidated withthe Company’s corporate headquarters.

 

Company funded research and development expenses of $2,201,000 for thethird quarter of fiscal 2006 increased by $889,000 compared to thecorresponding period last year. Research and development expenses remainedconstant at 6% of revenues in both periods reported. These expendituresincreased primarily due to three product development programs ongoing duringthe quarter.

 

Company funded research and development expenses of $7,093,000 for thenine months ended December 31, 2005 increased by $3,314,000 compared tothe corresponding period last year. Research and development expensesrepresented 6% of revenues in both periods reported.  These expenditures increased primarily due tothree product development programs ongoing during the fiscal year.

 

Other income (expense) was $1,526,000 in income for the third quarterof fiscal 2006 as compared to $1,345,000 in expense for the correspondingperiod a year ago.   At December 31, 2005, other income(expense) included warrants which were “marked to market” using Black-Scholesand the change in the valuation of the warrants of $808,000 was recorded asother income in the quarter. During the three months ended December 31,2004, this mark to market adjustment generated $1,394,000 in otherexpense.  In addition, in the quarter ended December 31, 2005, theCompany earned $704,000 in income on investments held as compared to $121,000in the quarter ended December 31, 2004 due to increases in the Company’scash and investments balances over the prior year.

 

Other income (expense) was $494,000 in expense for the first ninemonths of fiscal 2006 as compared to $4,368,000 in expense for thecorresponding period a year ago.   At December 31, 2005, otherincome (expense) included warrants which were “marked to market” usingBlack-Scholes and the change in the valuation of the warrants of $2,109,000 wasrecorded as other expense in the nine

 

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months ended December 31, 2005. During the nine months ended December 31, 2004, this mark to marketadjustment generated $4,580,000 in other expense.  In addition, inthe nine months ended December 31, 2005, the Company earned $1,576,000 inincome on investments held as compared to $289,000 in the nine months ended December 31,2004 due to increases in the Company’s cash and investments balances over theprior year.

 

The Company reported pre-tax income of $14,153,000 in the quarter endedDecember 31, 2005 as compared to pre-tax income of $2,023,000 in thecorresponding period a year ago due to the factors described above. For thenine months ended December 31, 2005, the Company reported pre-tax incomeof $37,772,000 as compared to a pre-tax income of $1,947,000 for thecorresponding period a year ago attributable to the factors described above.

 

At March 31, 2005, the Company had gross deferred tax assets of$9,740,000.  The Company had applied a full valuation allowance againstits deferred tax assets at March 31, 2005 based upon its evaluation ofthree year cumulative historical results and its projection of future taxableincome and had determined that it was more likely than not that its deferredtax asset would not be realized.  In thefirst quarter of fiscal 2006, the Company reevaluated its valuation allowancefor deferred tax assets and has determined that a full release of valuationallowance was appropriate based upon period earnings, the Company’s updatedforecasted earnings for fiscal 2006, sales backlog and other factors.  Therelease of the valuation allowance has been included in determining the Company’sannual effective tax rate for fiscal 2006.  In connection with thisrelease, the Company recorded a corresponding entry to paid in capital totaling$7,025,000 for net operating loss carry-forwards resulting from the exercise ofcertain employee stock options.

 

The Company’s effective tax rate for the nine months ended December 31,2005  was 33.6% calculated by adjustingthe Company’s statutory tax rate by the valuation allowance release, permanenttax differences, and other general and business credits.  In the nine months ended December 31,2004, the Company had no effective tax rate due to its net operating losscarryovers as well as other unused general and business credits which requiredvaluation reserves.

 

The Company had net income of $9,668,000 during the third quarter offiscal 2006 as compared to net income of $2,023,000 in the third quarter offiscal 2005.  The Company had net income of $25,061,000 for the ninemonths ended December 31, 2005 as compared to net income of $1,882,000 forthe nine months ended December 31, 2004.  The significant factorscontributing to these results are noted in the above sections.

 

Liquidity and Capital Resources

 

Cash and cash equivalents increased by $25,634,000 to $41,052,000 at December 31,2005 compared to $15,418,000 at March 31, 2005. This increase in cash andcash equivalents is due to cash provided by operations generated primarily fromprofits earned during the period, a decrease in outstanding accounts receivabledue to increased collections and decreased inventory balances attributable tothe increased shipments during the period.  In addition, the Companyreceived $5,310,000 upon exercise of outstanding stock options and warrants and$1,500,000 advance payment received from the landlord for leaseholdimprovements.   These increases were offset somewhat by net purchasesof short term investments of $13,476,000 during the period and $7,468,000 incapital expenditures related primarily to the Company’s ongoing ERP systemimplementation, the construction of certain systems to be used for marketingdemonstration purposes, and construction related costs on a building expansionproject which commenced during the current fiscal year.

 

On November 30, 2004, the Company modified its two creditagreements with Silicon Valley Bank East.  The modifications extended thecredit facilities which expired on November 30, 2004 through November 29,2006 and reduced the export loan and security facility, guaranteed by theExport-Import Bank of the United States, from $20.0 million to $10.0million.  The domestic facility is a $5.0 million domestic loan andsecurity agreement to support the Company’s routine working capital needs.Maximum borrowings for this facility are set at the lower of (a) the sumof 80% of eligible domestic accounts receivable plus 10% of finished goods inventoryup to $750,000, or (b) $5 million.

 

The credit facilities bear an interest rate of the greater of 4.0% orthe Silicon Valley Bank prime rate (7.25% at December 31, 2005). Thecredit agreements are collateralized by certain assets of the Company andcontain certain restrictions, including limitations on the amount ofdistributions that can be made to stockholders, and the disposition orencumbrances of assets, and require the maintenance of certain financialcovenants.

 

At December 31, 2005, there were no borrowings outstanding againstthese credit facilities The Company had outstanding $932,000 in stand-byletters of credit against the domestic facility and $301,000 in stand-byletters of credit against the export facility. Of the outstanding letters of credit, $300,000 relates to the Company’sbuilding lease and the remainder is guaranteeing performance on certaininternational projects.  No amounts have been drawn against these lettersof credit. In addition, at December 31, 2005, the Company had a restrictedcash balance of $162,000 related to certain bank required deposits related tooutstanding letters of credits, bid bonds, and other bank-related fees.

 

**New Accounting Pronouncements:**

 

In December 2004, the FASB issued SFAS No. 123(R), “Share-BasedPayment” (SFAS 123(R)) which establishes accounting standards for alltransactions in which an entity exchanges its equity instruments for goods andservices. SFAS 123(R) revises SFAS

 

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No. 123, “Accounting for Stock-Based Compensation”, supercedesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” and amends Financial Accounting Standard No. 95, “Statementof Cash Flows”. SFAS No. 123(R) generally requires the Company to measurethe cost of employee services received in exchange for an award of equityinstruments based on the fair value of the award on the date of the grant. Thestandard requires the fair value on the grant date to be estimated using eitheran option-pricing model which is consistent with the terms of the award or amarket observed price, if such a price exists. The resulting cost must berecognized over the period during which an employee is required to provideservice in exchange for the award, which is usually the vesting period. In April 2005,the SEC deferred the effective date for SFAS 123(R) to the beginning of thefirst fiscal year that begins after June 15, 2005. The Company expects toadopt SFAS 123(R) on the effective date, and expects the adoption to havea material impact on its results of operations, financial position and cashflows.

 

In December 2004, the FASB issued SFAS No.151, “Inventory Costs*,*” which amends part of ARB 43, “InventoryPricing,” concerning the treatment of certain types of inventory costs. Theprovisions of ARB No. 43 provided that certain inventory-related costs,such as double freight and re-handling, might be “so abnormal” that they shouldbe charged against current earnings rather than be included in the cost ofinventory. As amended by SFAS No. 151, the “so-abnormal” criterion hasbeen eliminated. Thus, all such abnormal costs are required to be treated ascurrent-period charges under all circumstances. In addition, fixed productionoverhead should be allocated based on the normal capacity of the productionfacilities, with unallocated overhead charged to expense when incurred. SFAS151 is required to be adopted for fiscal years beginning after June 15,2005. The Company does not believe its adoption will have a material impact onits results of operations, financial position and cash flows.

 

In December 2004, the FASB issued a FASB Staff Position (FSP)109-1 Application of FASB 109 to the Tax Deduction on Qualified ProductionActivities provided by the American Jobs Creation Act of 2004. The new actprovides for a special tax deduction on qualified production activities incomethat effectively reduces the Company’s tax rate. The FASB has decided thatthese amounts should be recorded as a special deduction, and recorded in theyear earned. The Company does not believe that the adoption of this FSPstatement will have a material impact on the Company’s consolidated financialstatements.

 

**Item 3 - Quantitative and QualitativeDisclosures about Market Risk**

 

The cash accounts for the Company’s operations in Singapore, Hong Kong,England, and Abu Dhabi are maintained in Singapore dollars, Hong Kong dollars,pounds sterling and dirhams, respectively. Foreign currency accounts are markedto market at current rates that resulted in immaterial translation adjustmentsto stockholders’ equity. The gains and losses from foreign currencytransactions are included in the statements of operations for the period andwere also immaterial. A hypothetical 10% change in foreign currency rates wouldnot have a material impact on the Company’s results of operations or financialposition.

 

As of December 31, 2005, the Company held short-term investmentsconsisting of money market funds and U.S. government and government agencybonds. The Company’s primary objective with its investment portfolio is toinvest available cash while preserving principal and meeting liquidity needs.These investments had an average interest rate of approximately 4.30% and aresubject 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.

 

In fiscal 2003, the Company issued 295,475 warrants in connection witha private placement offering of common stock.  As of December 31,2005, 167,700 of these warrants remain outstanding.  These warrants can beexchanged for cash under certain circumstances including a merger, sale ortender offer of the Company, and as such a liability equal to Black-Scholesvalue of the warrants is recorded on the balance sheet. Changes in the fairvalue of the warrants are recorded as other income (expense). The Black-Scholesvalue of these warrants can fluctuate significantly based on the current fairmarket value of the Company’s common stock. A 10% change in the fair marketvalue of the Company’s common stock, holding other assumptions constant, wouldhave approximately a $1,015,000 positive or negative impact on earnings.

 

**Item 4 - Controls and Procedures**

 

a)                                      Evaluationof disclosure controls and procedures.

 

As of the end of the period covered by this report, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, the Company reviewed andevaluated the effectiveness of the Company’s disclosure controls and procedurespursuant to Rule 13a-15(e) and 15d-15(e) of the SecuritiesExchange Act of 1934 as amended (the “Exchange Act”). Based upon theirevaluation, our Chief Executive Officer and our Chief Financial Officerconcluded that our disclosure controls and procedures were effective to providereasonable assurance that information required to be disclosed by the Companyin the reports filed and submitted by it under the Exchange Act is recorded,processed, summarized and reported within the time period specified in theSecurities and Exchange Commission’s rules and forms, and to providereasonable assurance that information required to be disclosed by the Companyin such reports is accumulated and communicated to the Company’s management,including its Chief Executive Officer and Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosure.

 

b)                                     Changesin internal controls

 

There have been no changes in our internal controls over financialreporting as such term is defined in Rule 13a-15(f) and 15d-15(f) of

 

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the Securities Exchange Act of 1934 during the period covered by this reportthat have materially affected, or are reasonably likely to materially affect,the Company’s internal controls over financial reporting.

 

**PART II – OTHER INFORMATION**

 

**Item 1 – Legal Proceedings**

 

In February 2004, L-3 Communications, Inc. (“L-3”) filed alawsuit against the Company in the United States District Court for theDistrict of Massachusetts in Boston, seeking declaratory judgments ofnon-infringement and/or invalidity of two of the Company’s patents—UnitedStates Patent No. 6,292,533 and No. 5,903,623. The Company answeredL-3’s underlying complaint, vigorously opposing the plaintiff’snon-infringement and invalidity claims, and subsequently engaged in substantialdiscovery. In November 2005, the Company filed a motion to dismiss thecase.  Pending the court’s ruling, the parties have suspended discovery asto the underlying claims.

 

The Company is also subject to various legal proceedings and claimsthat arise in the ordinary course of business.  At the present time, it isnot possible to predict the outcome of these matters; however, the Companycurrently believes that resolving these matters will not have a materialadverse impact on its financial condition, results of operations or cash flows.

 

**Item6 - Exhibits**

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

 

The information required by Exhibit Item 11 (Statement re:Computation of Income per Common and Common Equivalent Share) may be found inFootnote No. 3.

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this Report to be signed on its behalf by theundersigned hereunto duly authorized.

 
|                       | AMERICAN SCIENCE AND ENGINEERING, INC. |
|----------------------------|----------------------------------------|
|                       |                                   |
|                       |                                   |
| Date February 9, 2006 | /s/ Kenneth J. Galaznik                |   |
|                       | Kenneth J. Galaznik                    |
|                       | Chief Financial Officer and Treasurer  |

 

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*Safe Harbor Statement*

 

*The foregoing 10-Q contains statementsconcerning the Company’s financial performance and business operations, whichmay be considered “forward-looking” under applicable securities laws.*

 

*The Company wishes to caution readers of thisForm 10-Q that actual results might differ materially from those projectedin any forward-looking statements.*

 

*Factors which might cause actual results todiffer materially from those projected in the forward-looking statementscontained herein include the following: significant reductions or delays inprocurements of the Company’s systems by the United States and othergovernments; disruption in the supply of any source component incorporated intoAS&E’s products; litigation seeking to restrict the use of intellectualproperty used by the Company; potential product liability claims against theCompany; global political trends and events which affect public perception ofthe threat presented by drugs, explosives and other contraband; global economicdevelopments and the ability of governments and private organizations to fundpurchases of the Company’s products to address such threats; and the potentialinsufficiency of Company resources, including human resources, capital, plantand equipment and management systems, to accommodate any future growth and anyfuture delays in federal funding. These and certain other factors which mightcause actual results to differ materially from those projected are more fullyset forth under the caption “Forward-Looking Information and Factors AffectingFuture Performance” in the Company’s Registration Statement on Form 10-K.*

 

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