**FORM 10-Q**

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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

**OF THE SECURITIESEXCHANGE ACT OF 1934**

**Forthe quarterly period ended December 31, 2006**

**OR**

**o TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe transition period from      to**

**CommissionFile Number 1-6549**

**American Science and Engineering, Inc.**

(Exact name ofRegistrant as specified in its charter)

 

| **Massachusetts**                         |   | **04-2240991**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
|  incorporation or organization)      |   | 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 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 bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x  No o

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

| Large accelerated  filero |   | Accelerated  filerx |   | Non-accelerated  filero |
|-----------------------------------|--------|-----------------------------|--------|---------------------------------|

 

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

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date

|                                 |   | **Outstanding  at**   |
|---------------------------------|--------|-----------------------|
| **Class of  Common Stock** |   | **February  5, 2006** |
| $.66 2/3 par  value             |   | 9,177,475             |

 

 

 

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**AmericanScience and Engineering, Inc. and SubsidiaryIndex**
| **Part 1 — Financial  Information**                                                                                             |   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1 — Financial Statements                                                                                                        |   |   |
| Unaudited  Condensed Consolidated Balance Sheets — December 31, 2006 and March 31, 2006                                              |   |   |
| Unaudited  Condensed Consolidated Statements of Operations - For the Three and Nine  Months Ended December 31, 2006 and December 31, 2005 |   |   |
| Unaudited  Condensed Consolidated Statements of Cash Flows - For the Nine Months Ended  December 31, 2006 and December 31, 2005           |   |   |
| Notes to  Unaudited Condensed Consolidated Financial Statements                                                                           |   |   |
| Item 2 —  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                |   |   |
| Item 3 —  Quantitative and Qualitative Disclosure About Market Risk                                                                  |   |   |
| Item 4 - Controls and  Procedures                                                                                                         |   |   |
| **Part II — Other  Information**                                                                                                |   |   |
| Item  1 — Legal Proceedings                                                                                                          |   |   |
| Item 6  - Exhibits                                                                                                                        |   |   |
| **Signatures**                                                                                                                            |   |   |

 

 

2

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**PART I— FINANCIAL INFORMATIONItem 1 — Financial Statements**

**American Science andEngineering, Inc. and SubsidiaryCondensed Consolidated Balance Sheets(Unaudited)**
| **Dollars in thousands**                                                                                                                                         | ** ** | **December 31, 2006** | ** ** | **March 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| **Assets**                                                                                                                                                                 | ** ** | ** **                      | ** ** | ** **                   | ** ** |
| Current assets:                                                                                                                                                            |       |                            |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                 |       | $                               | 56,435     |                         | $          | 50,655 |   |
| Restricted cash and  investments                                                                                                                                           |       | 1,756                           |       | 98                           |       |
| Short-term investments                                                                                                                                                     |       | 62,199                          |       | 43,117                       |       |
| Accounts receivable,  net of allowances of $387 and $345 at December 31, 2006 and March 31, 2006,  respectively                                                            |       | 35,226                          |       | 25,868                       |       |
| Unbilled costs and  fees, net of allowances of $36 and $36 at December 31, 2006 and March 31,  2006, respectively                                                          |       | 3,888                           |       | 4,057                        |       |
| Inventories                                                                                                                                                                |       | 18,790                          |       | 16,886                       |       |
| Prepaid expense and  other current assets                                                                                                                                  |       | 6,227                           |       | 9,862                        |       |
| Deferred income taxes                                                                                                                                                      |       | 3,613                           |       | 3,381                        |       |
| **Total current assets**                                                                                                                                                   |       | 188,134                         |       | 153,924                      |       |
| Building, equipment and  leasehold improvements, net                                                                                                                       |       | 20,430                          |       | 18,717                       |       |
| Deferred income taxes                                                                                                                                                      |       | 1,195                           |       | 748                          |       |
| Other assets, net                                                                                                                                                          |       | 497                             |       | —                       |       |
| **Total assets**                                                                                                                                                           |       | $                               | 210,256    |                         | $          | 173,389 |   |
|                                                                                                                                                                       |       |                            |       |                         |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                              | ** ** | ** **                      | ** ** | ** **                   | ** ** |
| Current liabilities:                                                                                                                                                       |       |                            |       |                         |       |
| Accounts payable                                                                                                                                                           |       | $                               | 7,824      |                         | $          | 6,659 |   |
| Accrued salaries and  benefits                                                                                                                                             |       | 6,026                           |       | 6,554                        |       |
| Accrued warranty costs                                                                                                                                                     |       | 2,473                           |       | 3,606                        |       |
| Accrued income taxes                                                                                                                                                       |       | 1,030                           |       | —                       |       |
| Deferred revenue                                                                                                                                                           |       | 3,877                           |       | 3,331                        |       |
| Customer deposits                                                                                                                                                          |       | 11,731                          |       | 6,103                        |       |
| Current portion of  lease financing liability                                                                                                                              |       | 809                             |       | 787                          |       |
| Warrant liability                                                                                                                                                          |       | 790                             |       | —                       |       |
| Other current  liabilities                                                                                                                                                 |       | 3,045                           |       | 1,853                        |       |
| **Total current liabilities**                                                                                                                                              |       | 37,605                          |       | 28,893                       |       |
| Lease financing  liability, net of current portion                                                                                                                         |       | 9,027                           |       | 9,630                        |       |
| Warrant liability                                                                                                                                                          |       | —                          |       | 4,038                        |       |
| Deferred revenue                                                                                                                                                           |       | 4,265                           |       | 578                          |       |
| Other long term  liabilities                                                                                                                                               |       | 37                              |       | 52                           |       |
| **Total liabilities**                                                                                                                                                      |       | 50,934                          |       | 43,191                       |       |
|                                                                                                                                                                       |       |                            |       |                         |       |
| **Stockholders’ equity:**                                                                                                                                             | ** ** | ** **                      | ** ** | ** **                   | ** ** |
| Preferred stock, no par  value Authorized  — 100,000 shares; Issued - none                                                                                       |       | —                          |       | —                       |       |
| Common stock, $0.66 2/3  par value Authorized —20,000,000 shares Issued and Outstanding 9,170,292  shares at December 31, 2006 and 9,070,679 shares at March 31, 2006 |       | 6,113                           |       | 6,047                        |       |
| Capital in excess of  par value                                                                                                                                            |       | 102,464                         |       | 94,061                       |       |
| Accumulated other  comprehensive income                                                                                                                                    |       | 46                              |       | (16                          | )          |
| Unearned compensation                                                                                                                                                      |       | —                          |       | (1,773                       | )          |
| Retained earnings                                                                                                                                                          |       | 50,699                          |       | 31,879                       |       |
| **Total stockholders’ equity**                                                                                                                                        |       | 159,322                         |       | 130,198                      |       |
|                                                                                                                                                                       |       |                            |       |                         |       |
| **Total liabilities and stockholders’ equity**                                                                                                                        |       | $                               | 210,256    |                         | $          | 173,389 |   |

 

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

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** **

**American Science andEngineering, Inc. and SubsidiaryCondensed Consolidated Statements of Operations(Unaudited)**
| ** **                                                                                            | ** **    | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------|---------------|----------------------------------|------------|---------------------------------|------------|
| **Dollars and shares in thousands, except per share amounts** | ** **    | **Dec. 31,   2006**    | ** ** | **Dec. 31,  2005**         | ** ** | **Dec. 31,   2006** | ** ** | **Dec. 31,  2005** | ** ** |
| ** **                                                                                            | ** **    | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                                                             |          |                             |       |                            |       |   |   |   |   |
| Net product  sales and contract revenues                                                              |          | $                                | 33,363     |                            | $          | 28,213 |   | $ | 69,514 |   | $ | 99,705 |   |
| Net service  revenues                                                                                 |          | 14,434                           |       | 10,327                          |       | 37,753 |   | 23,138 |   |
| Total net  revenues                                                                                   |          | 47,797                           |       | 38,540                          |       | 107,267 |   | 122,843 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Cost of sales  and contracts:                                                                         |          |                             |       |                            |       |   |   |   |   |
| Cost of product  sales and contracts                                                                  |          | 19,102                           |       | 13,544                          |       | 39,078 |   | 50,352 |   |
| Cost of service  revenues                                                                             |          | 6,757                            |       | 5,622                           |       | 19,225 |   | 13,749 |   |
| Total cost of  sales and contracts                                                                    |          | 25,859                           |       | 19,166                          |       | 58,303 |   | 64,101 |   |
| Gross profit                                                                                          |          | 21,938                           |       | 19,374                          |       | 48,964 |   | 58,742 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Expenses:                                                                                             |          |                             |       |                            |       |   |   |   |   |
| Selling, general  and administrative expenses                                                         |          | 7,939                            |       | 4,546                           |       | 19,565 |   | 13,383 |   |
| Research and  development                                                                             |          | 1,440                            |       | 2,201                           |       | 5,220 |   | 7,093 |   |
| Total expenses                                                                                        |          | 9,379                            |       | 6,747                           |       | 24,785 |   | 20,476 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Operating income                                                                                      |          | 12,559                           |       | 12,627                          |       | 24,179 |   | 38,266 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Other income  (expense):                                                                              |          |                             |       |                            |       |   |   |   |   |
| Interest and  investment income                                                                       |          | 1,381                            |       | 704                             |       | 3,872 |   | 1,576 |   |
| Interest expense                                                                                      |          | (89                              | )          | —                          |       | (278 | ) | — |   |
| Other, net                                                                                            |          | 61                               |       | 14                              |       | 154 |   | 39 |   |
| Change in  warrant valuation                                                                          |          | (224                             | )          | 808                             |       | 2,115 |   | (2,109 | ) |
| Total other  income (expense)                                                                         |          | 1,129                            |       | 1,526                           |       | 5,863 |   | (494 | ) |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Income before  income taxes                                                                           |          | 13,688                           |       | 14,153                          |       | 30,042 |   | 37,772 |   |
| Provision for  income taxes                                                                           |          | 5,616                            |       | 4,485                           |       | 11,222 |   | 12,711 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Net income                                                                                            |          | $                                | 8,072      |                            | $          | 9,668 |   | $ | 18,820 |   | $ | 25,061 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Income per share                                                                                      | —Basic   |                             | $          | 0.89                            |       | $ | 1.12 |   | $ | 2.07 |   | $ | 2.95 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
|                                                                                                  | —Diluted |                             | $          | 0.86                            |       | $ | 0.95 |   | $ | 1.79 |   | $ | 2.77 |   |
|                                                                                                  |          |                             |       |                            |       |   |   |   |   |
| Weighted average  shares                                                                              | —Basic   |                             | 9,100      |                            | 8,601      |   | 9,087 |   | 8,485 |   |
|                                                                                                  | —Diluted |                             | 9,346      |                            | 9,321      |   | 9,340 |   | 9,062 |   |

 

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

4

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** **

**American Science andEngineering, Inc. and SubsidiaryCondensed Consolidated Statements of Cash Flows(Unaudited)**
| ** **                                                                                | ** ** | **For the Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **Dollars in thousands**                                                        | ** ** | **December 31,   2006**                 | ** ** | **December 31,   2005** | ** ** |
| **Cash  flows from operating activities:**                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net income                                                                                |       | $                                                 | 18,820     |   | $ | 25,061 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:        |       |                                              |       |   |   |
|                                                                                      |       |                                              |       |   |   |
| Depreciation and  amortization                                                            |       | 1,666                                             |       | 645 |   |
| Provisions for  contract, inventory and accounts receivable reserves                      |       | 239                                               |       | 2,828 |   |
| Accretion of  short-term investments                                                      |       | (1,264                                            | )          | (218 | ) |
| Deferred income  taxes                                                                    |       | (679                                              | )          | 5,928 |   |
| Reversal of  deferred tax asset valuation allowance relating to net operating losses      |       | —                                            |       | (2,160 | ) |
| Stock based  compensation expense                                                         |       | 6,538                                             |       | 217 |   |
| Change in value  of warrants                                                              |       | (2,115                                            | )          | 2,109 |   |
| Changes in  assets and liabilities:                                                       |       |                                              |       | — |   |
| Accounts receivable                                                                       |       | (9,402                                            | )          | 1,510 |   |
| Unbilled costs and fees                                                                   |       | 169                                               |       | (1,332 | ) |
| Inventories                                                                               |       | (2,099                                            | )          | 6,241 |   |
| Prepaid expenses and other assets                                                         |       | 884                                               |       | (3,051 | ) |
| Accounts payable                                                                          |       | 1,165                                             |       | (1,602 | ) |
| Accrued income taxes                                                                      |       | 1,030                                             |       | — |   |
| Customer deposits                                                                         |       | 5,628                                             |       | (1,675 | ) |
| Deferred revenue                                                                          |       | 4,233                                             |       | (700 | ) |
| Accrued expenses and other current liabilities                                            |       | 24                                                |       | 2,023 |   |
| Non-current liabilities                                                                   |       | (15                                               | )          | (44 | ) |
| Total  adjustments                                                                        |       | 6,002                                             |       | 10,719 |   |
| Net cash  provided by operating activities                                                |       | 24,822                                            |       | 35,780 |   |
|                                                                                      |       |                                              |       |   |   |
| **Cash  flows from investing activities:**                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Purchases of  short-term investments                                                      |       | (94,708                                           | )          | (42,972 | ) |
| Maturity of  short-term investments                                                       |       | 76,945                                            |       | 29,496 |   |
| Purchases of  property and equipment                                                      |       | (3,379                                            | )          | (7,468 | ) |
| Net cash used  for investing activities                                                   |       | (21,142                                           | )          | (20,944 | ) |
|                                                                                      |       |                                              |       |   |   |
| **Cash  flows from financing activities:**                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Decrease  (increase) in restricted cash                                                   |       | (1,658                                            | )          | 193 |   |
| Proceeds from  exercise of warrants                                                       |       | 835                                               |       | 1,263 |   |
| Proceeds from  exercise of stock options                                                  |       | 765                                               |       | 4,047 |   |
| Proceeds from  financing of leasehold improvements                                        |       | 2,253                                             |       | 1,500 |   |
| Repayment of  lease financing                                                             |       | (581                                              | )          | — |   |
| Reduction of  income taxes paid due to the tax benefit from employee stock option expense |       | 479                                               |       | 3,799 |   |
| Net cash  provided by financing activities                                                |       | 2,093                                             |       | 10,802 |   |
| Foreign currency  translation effect on cash                                              |       | 7                                                 |       | (4 | ) |
| Net increase in  cash and cash equivalents                                                |       | 5,780                                             |       | 25,634 |   |
| Cash and cash  equivalents at beginning of period                                         |       | 50,655                                            |       | 15,418 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                                 | 56,435     |   | $ | 41,052 |   |

 

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

 

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** **

**American Science andEngineering, Inc. and SubsidiaryNotes to Unaudited Condensed Consolidated Financial Statements**

**1.****                                      General**

The condensedconsolidated financial statements include the accounts of the Company and itswholly owned subsidiary. All significant intercompany transactions and balanceshave been eliminated.

The unaudited condensedconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andnote disclosures normally included in annual financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to those rules and regulations, although the Company believesthat the disclosures made are adequate to make the information not misleading.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 endedMarch 31, 2006.

The unaudited condensedconsolidated financial statements, in the opinion of management, include alladjustments necessary, consisting solely of normal recurring adjustments, topresent fairly 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 of Operations

The Company is engaged inthe development and manufacture of sophisticated X-ray inspection systems forcritical detection and security screening solutions for sale primarily to U.S.and foreign government agencies.  The Company has only one reportingsegment, X-ray screening products.

Significant AccountingPolicies

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

The Company’s Export andSecurity Agreement with Silicon Valley Bank East requires certain cash balancesto be restricted as collateral against outstanding standby letters of credit;these are separately presented as restricted cash. (See Note 5)

The other significantaccounting policies followed by the Company and its subsidiary in preparing itsconsolidated financial statements are set forth in Note 1 to the consolidatedfinancial statements included in its Form 10-K for the year endedMarch 31, 2006.  The Company has made no changes to these policiesduring the current year.

Certain amounts in theprior period financial statements have been reclassified to conform to thecurrent period presentation.

Comprehensive Income

Comprehensive income iscomprised of the following:

  
| ** **                                                          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                                             | ** ** | **Dec. 31,   2006**    | ** ** | **Dec. 31,  2005**         | ** ** | **Dec. 31,   2006** | ** ** | **Dec. 31,  2005** | ** ** |
| Net income                                                          |       | $                                | 8,072      |                            | $          | 9,668 |   | $ | 18,820 |   | $ | 25,061 |   |
| Foreign currency  translation adjustments, net of tax               |       | (3                               | )          | (5                              | )          | 19 |   | (4 | ) |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Unrealized gains  and losses from marketable securities, net of tax |       | (15                              | )          | —                          |       | 43 |   | (19 | ) |
| Comprehensive  income                                               |       | $                                | 8,054      |                            | $          | 9,663 |   | $ | 18,882 |   | $ | 25,038 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |

 

 **2.            Accounting forStock-Based Compensation**

On April 1, 2006, theCompany adopted Statement of Financial Accounting Standards No. 123(R) (SFAS123(R)) “Accounting for Stock-Based Compensation”, which requires themeasurement and recognition of all compensation costs for all stock basedawards made to employees and the Board of Directors based upon fair value overthe requisite service period for awards expected to vest. Prior to adoption,the Company accounted for stock options under the intrinsic value method set inaccordance with Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees,” and related interpretations, and provided therequired pro forma disclosures prescribed by SFAS No. 123, “Accounting forShare-based Compensation”, as amended.

6

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SFAS 123(R) requires theCompany to estimate the fair value of share-based awards on the date of grantusing an option pricing model. The Company adopted SFAS 123(R) using themodified prospective transition method which requires the application of theaccounting standard starting April 1, 2006, the first day of the Company’sfiscal year 2007. Prior period information will not be restated to reflect thefair value method of expensing share-based awards.

Stock- based compensationcosts recognized for the three and nine month periods ended December 31, 2006,includes compensation costs for awards granted prior to, but not yet vested asof April 1, 2006 (adoption date), as well as any new grants issued after April1, 2006. The Company recognized $2,289,000 and $6,233,000 of the share-basedcompensation costs in the consolidated statements of income for the three andnine months ended December 31, 2006, respectively. At December 31, 2006, atotal $305,000 of compensation costs were capitalized to inventory as suchcosts qualified for capitalization. These costs are recognized in the incomestatement when the inventory is disposed of or consumed. The income tax benefitrelated to such compensation for the three and nine months ended December 31,2006 was approximately $286,000 and $904,000, respectively.

The following tablesummarizes share-based compensation costs included in the Company’sconsolidated statement of income:
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                            | ** ** | **December 31, 2006**  | ** ** | **December 31, 2006** | ** ** |
| Cost of revenues                                   |       | $                                | 1,152      |                            | $          | 2,666 |   |
| Selling, general  and administrative               |       | 1,137                            |       | 3,567                           |       |
| Total share-based  compensation expense before tax |       | $                                | 2,289      |                            | $          | 6,233 |   |

 

The Company hadpreviously adopted the provisions of SFAS No. 123, “Accounting forShare-based Compensation,” as amended by SFAS No. 148, “Accounting forShare-based Compensation—Transition and Disclosure,” through disclosure only.The following table illustrates the effect on net income and earnings per sharefor the three and nine months ended December 31, 2005 as if the Companyhad applied the fair value recognition provisions of SFAS No. 123 toshare-based employee awards.
| **(In thousands except per share amounts)**   | ** ** | **Three months ended  Dec. 31, 2005** | ** ** | **Nine months ended  Dec. 31, 2005** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Net income                                                             |       |                                                      |       |                                                     |       |
| As reported                                                            |       | $                                                         | 9,668      |                                                     | $          | 25,061 |   |
| Add: Stock based  compensation included in net income as reported      |       | 60                                                        |       | 217                                                      |       |
| Less: Stock  based compensation using fair value method for all awards |       | (1,607                                                    | )          | (6,513                                                   | )          |
| Pro forma net  income — Basic                                     |       | $                                                         | 8,121      |                                                     | $          | 18,765 |   |
|                                                                   |       |                                                      |       |                                                     |       |
| Net income                                                             |       |                                                      |       |                                                     |       |
| As reported                                                            |       | $                                                         | 9,668      |                                                     | 25,061     |   |
| Add: Stock based  compensation included in net income as reported      |       | 60                                                        |       | 217                                                      |       |
| Less: Stock  based compensation using fair value method for all awards |       | (1,607                                                    | )          | (6,513                                                   | )          |
| Less: Stock  based compensation for change in warrant valuation        |       | (808                                                      | )          | —                                                   |       |
| Pro forma net  income — Diluted                                   |       | $                                                         | 7,313      |                                                     | $          | 18,765 |   |
|                                                                   |       |                                                      |       |                                                     |       |
| Income per share  — Basic                                         |       |                                                      |       |                                                     |       |
| As reported                                                            |       | $                                                         | 1.12       |                                                     | $          | 2.95 |   |
| Pro forma                                                              |       | $                                                         | 0.94       |                                                     | $          | 2.21 |   |
| Income per share  — Diluted:                                      |       |                                                      |       |                                                     |       |
| As reported                                                            |       | $                                                         | 0.95       |                                                     | $          | 2.77 |   |
| Pro forma                                                              |       | $                                                         | 0.79       |                                                     | $          | 2.09 |   |

 

Upon adoption of SFAS123(R), in accordance with Staff Accounting Bulletin No. 107, the Companyselected the Black-Scholes option pricing model as the most appropriate methodfor determining the estimated fair value for the stock awards. TheBlack-Scholes method of valuation requires several assumptions: (1) theexpected term of the stock award, (2) the expected future stock volatility overthe expected term and (3) risk-free interest rate. The expected term representsthe 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. Thefair value of options at date of grant was estimated with the followingassumptions:

7

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| ** **               | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
| **Assumptions:**         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Option life              |       | 3 years                         |       | 3 years |   |
| Risk-free  interest rate |       | 4.77                            | %          | 3.38 | % |
| Stock volatility         |       | 56                              | %          | 52 | % |
| Dividend yield           |       | 0                               | %          | 0 | % |

 

**Stock Option and OtherCompensation Plans:**

The Company has variousstock option and other compensation plans for directors, officers, andemployees. The Company had the following stock option plans outstanding as ofDecember 31, 2006: the 1995 Combination Plan, the 1996 Plan for Non-EmployeeDirectors, the 1997 Non-Qualified Option Plan, the 1998 Non-Qualified OptionPlan, the 1999 Combination Plan, the 2000 Combination Plan, the 2002Combination Plan, the 2003 Stock Plan for Non-Employee Directors and the 2005Equity and Incentive Plan. There are 3,780,000 shares authorized under theseplans. Vesting periods are at the discretion of the Board of Directors andtypically range between one and three years. Options under these plans aregranted at fair market value and have a term of five or ten years from the dateof grant.

***Stockoptions***

Thefollowing tables summarize stock option activity during the first nine monthsof fiscal year 2007:

 
| ** **                            | ** ** | **Options Outstanding** | ** ** |
|---------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted   Average  Contractual   Life  (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| **Outstanding  at March 31, 2006**    |       | 878,470                      |       | $ | 36.79 |   |   |   |   |   |
| Grants                                |       | 60,670                       |       |   |   |   |   |   |   |
| Exercises                             |       | (21,380                      | )          |   |   |   |   | $ | 585,000 |   |
| Cancellations                         |       | (13,637                      | )          |   |   |   |   |   |   |
| **Outstanding  at December 31, 2006** |       | 904,123                      |       | $ | 37.36 |   | 7.68 |   |   |   |
| **Exercisable  at December 31, 2006** |       | 583,736                      |       | $ | 33.71 |   |   |   | $ | 15,411,000 |   |

 

Information related tothe stock options outstanding as of December 31, 2006 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                              |       | 252,920                        |       | 6.06                                                                        |       | $                                               | 11.77      |                                          | 210,920    |                                                                   | $          | 11.52 |   |
| $20.01 - $30.00                             |       | 112,400                        |       | 7.52                                                                        |       | 27.19                                           |       | 103,350                                       |       | 27.76                                                                  |       |
| $30.01 - $40.00                             |       | 73,041                         |       | 7.94                                                                        |       | 38.95                                           |       | 39,208                                        |       | 38.85                                                                  |       |
| $40.01 - $50.00                             |       | 139,199                        |       | 8.77                                                                        |       | 45.83                                           |       | 16,667                                        |       | 44.46                                                                  |       |
| $50.01 - $60.00                             |       | 230,163                        |       | 8.32                                                                        |       | 53.63                                           |       | 163,191                                       |       | 53.70                                                                  |       |
| $60.01 - $83.02                             |       | 96,400                         |       | 8.85                                                                        |       | 64.04                                           |       | 50,400                                        |       | 66.45                                                                  |       |
| $6.50 - $83.02                              |       | 904,123                        |       | 7.68                                                                        |       | $                                               | 37.36      |                                          | 583,736    |                                                                   | $          | 33.71 |   |

The weighted average fair value of options granted in the nine monthsended December 31, 2006 was $20.09. As of December 31, 2006, there was$4,353,000 of total unrecognized compensation cost related to nonvested stockoptions granted and outstanding; that cost is expected to be recognized over a3 year period. Nonvested common stock options are subject to the risk offorfeiture until the fulfillment of specified conditions.

***RestrictedStock and Restricted Stock Units***

During fiscal 2006, theCompany instituted a long term incentive plan for certain key employees. Theplan calls for the issuance of restricted stock and options which vest upon theachievement of certain performance based goals as well as service timeincurred. Restricted stock and restricted stock units granted to otheremployees have vesting periods that range from one to three years. Annually onJanuary 10th the Board of Directors is granted restrictedstock. The stock vests pro-rata based on service time incurred in 

8

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the upcoming calendaryear. The fair values of these restricted stock awards are equal to the marketprice per share of the Company’s common stock on the date of grant.

Nonvested restrictedstock and stock unit awards are subject to the risk of forfeiture until thefulfillment of specified conditions. As of December 31, 2006, there was$2,243,000 of total unrecognized compensation cost related to nonvestedrestricted stock and stock unit awards granted under the Company’s stock plans.This cost is expected to be recognized over a 3 year period.

The following tablesummarizes the status of the Company’s nonvested restricted stock and stockunit awards since March 31, 2006:

 

|                                       | ** ** | **Nonvested   Restricted Stock   and Stock Unit Awards** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **Number of   Shares**                                                       | ** ** | **Weighted Average   Grant Date   Fair Value** | ** ** |
| **Outstanding  at March 31,2006**     |       | 23,125                                                                                 |       | $ | 54.92 |   |
| Granted                               |       | 42,894                                                                                 |       | 52.40 |   |
| Vested                                |       | (2,560                                                                                 | )          |   |   |
| Forfeited                             |       | —                                                                                 |       |   |   |
| **Outstanding at December 31,  2006** |       | 63,459                                                                                 |       | $ | 54.70 |   |

 

**3.             Inventories**

|  (Dollars in thousands)                    | ** ** | **December 31, 2006** | ** ** | **March 31, 2006** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| Inventories  consisted of:                                |       |                            |       |                         |       |
| Raw materials,  completed sub-assemblies, and spare parts |       | $                               | 10,171     |                         | $          | 6,856 |   |
| Work-in-process                                           |       | 7,164                           |       | 6,325                        |       |
| Finished goods                                            |       | 1,455                           |       | 3,705                        |       |
| Total                                                     |       | $                               | 18,790     |                         | $          | 16,886 |   |

 

**4.****                                      Incomeper Common and Common Equivalent Share**

Basic earnings per commonshare is computed by dividing net income available to common stockholders bythe weighted average number of shares of common stock outstanding during theperiod.  Diluted earnings per share include the dilutive impact of optionsand warrants using the average share price of the Company’s common stock forthe period. For the quarters ended December 31, 2006 and December 31, 2005,common stock equivalents of 112,000 and 56,000, respectively, are excluded fromdiluted earnings per share, as their effect is anti-dilutive.  For the nine months endedDecember 31, 2006 and December 31, 2005, common stock equivalents of 106,000and 249,000, respectively, are excluded from diluted earnings per share, astheir effect is anti-dilutive.

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands except per share amounts)**                      | ** ** | **Dec. 31,   2006**    | ** ** | **Dec. 31,  2005**         | ** ** | **Dec. 31,   2006** | ** ** | **Dec. 31,  2005** | ** ** |
| **Income  Per Share**                                                                     | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                |       | $                                | 8,072      |                            | $          | 9,668 |   | $ | 18,820 |   | $ | 25,061 |   |
| Weighted average  number of common shares outstanding — basic                        |       | 9,100                            |       | 8,601                           |       | 9,087 |   | 8,485 |   |
| Net income per  share — basic                                                        |       | $                                | 0.89       |                            | $          | 1.12 |   | $ | 2.07 |   | $ | 2.95 |   |
| **Diluted:**                                                                              | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                |       | $                                | 8,072      |                            | $          | 9,668 |   | $ | 18,820 |   | $ | 25,061 |   |
| Adjustment to  net income for change in warrant valuation                                 |       | —                           |       | (808                            | )          | (2,115 | ) | — |   |
| Adjusted net  income                                                                      |       | $                                | 8,072      |                            | $          | 8,860 |   | $ | 16,705 |   | $ | 25,061 |   |
| Weighted average  number of common shares outstanding                                     |       | 9,100                            |       | 8,601                           |       | 9,087 |   | 8,485 |   |
| Assumed exercise  of stock options and warrants, using the treasury stock method          |       | 246                              |       | 720                             |       | 253 |   | 577 |   |
| Weighted average  number of common and potential common shares outstanding — diluted |       | 9,346                            |       | 9,321                           |       | 9,340 |   | 9,062 |   |
| Net income per share — diluted                                                       |       | $                                | 0.86       |                            | $          | 0.95 |   | $ | 1.79 |   | $ | 2.77 |   |

 

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**5.             Borrowings**

On November 16, 2006, theCompany modified its domestic loan and security agreement with Silicon ValleyBank East which was scheduled to expire on November 29, 2006. The Companyincreased this domestic facility from $5.0 million to $20.0 million tosupport the Company’s routine working capital needs. The Company’s $10.0million export loan and security facility, guaranteed by the Export-Import Bankof the United States, expired as of November 29, 2006 and was notrenewed. Maximum amount available for borrowings under the domesticfacility is (a) if the Company’s unrestricted cash is greater than or equal to$30 million, is $20.0 million minus the amount of all outstanding Letters ofcredit less certain reserves, and minus the outstanding principle balance ofany advances or (b) if the Company’s unrestricted cash is less than $30.0million for a period of 30 consecutive days, the lesser of (i) the $20.0million, or ii) 85% of eligible domestic accounts receivable minus the amountof outstanding letters of credits adjusted for certain reserves and minus theprinciple balance of any advances. The modification of the domestic loan andsecurity agreement extended this credit facility through November 14,2008.

The credit facilitiesbear an interest rate of the greater of 4.0% or the Silicon Valley Bank primerate (8.25% at December 31, 2006). The credit agreements are collateralized bycertain assets of the Company and contain certain restrictions, includinglimitations on the amount of distributions that can be made to stockholders,and the disposition or encumbrances of assets, and require the maintenance ofcertain financial covenants.

At December 31, 2006,there were no borrowings outstanding against these credit facilities. TheCompany had outstanding $18,298,000 in stand-by letters of credit against itscredit facility.  Of the outstanding letters of credit, $13,750,000relates to a performance bond on an ongoing international project, $300,000relates to the Company’s building lease and the remainder is guaranteeingperformance on certain international projects.  No amounts have been drawnagainst these letters of credit. In addition, at December 31, 2006, the Companyhad a restricted cash balance of $1,756,000 relating to certain bank requireddeposits related to outstanding letters of credit, bid bonds, and other bank-relatedfees.

**6.             Warrant Liability**

On May 28, 2002, theCompany closed on a private placement offering of common stock and warrants. Atotal of 1,115,000 shares were sold to accredited investors at a price of$17.64 per share. In addition, warrants to purchase an additional 295,475shares of common stock at an exercise price of $23.52 per share wereissued.  The warrants were immediately vested and have a five-year lifeexpiring in May of 2007.

At December 31, 2006,21,625 warrants remain outstanding.   Due to certain conversionfeatures of these warrants that provide that the holder may opt for a cashsettlement in certain instances, including a merger, a sale of all orsubstantially all of the Company’s assets, or a tender offer or exchange offerof shares of the Company’s stock, a liability equal to the fair value of thewarrants at the deal closing date was recorded on the Company’s balance sheet.This liability is remeasured each quarter and marked to market.  The “markto market” change in the warrants valuation of $(224,000) and $808,000 wasrecorded as other income (expense) for the three months ended December 31, 2006and December 31, 2005, respectively. The “mark to market” change in thewarrants valuation of $2,115,000 and $(2,109,000) was recorded as other income(expense) for the nine months ended December 31, 2006 and December 31, 2005,respectively.  The liability of $790,000 and $4,038,000 representing thefair market value of outstanding warrants at period end is recorded as acurrent liability at December 31, 2006 and as a non-current liability as ofMarch 31, 2006, respectively. The fair market value of the warrants wasdetermined using the Black-Scholes pricing model with an assumed volatility of65% and 49% at December 31, 2006 and March 31, 2006, respectively, an interestrate of 5.0% and 4.60% at December 31, 2006 and March 31, 2006, respectivelyand a life equal to the remaining term of the warrants at each period end. Thevolatility assumption increased during the period as the remaining life of thewarrants has decreased and the Company has experienced comparatively high stockvolatility over a period equal to the remaining life.

**7.             Income Taxes**

The Company accounts forincome taxes in accordance with SFAS No. 109, “Accounting for IncomeTaxes.” Accordingly, the Company recognizes deferred income taxes based on theexpected future tax consequences of differences between the financial statementbasis and the tax basis of assets and liabilities, calculated using enacted taxrates in effect for the year in which the differences are expected to bereflected in the tax return. The Company evaluates the need for a valuationallowance against its net deferred tax assets at year end based upon its threeyear cumulative income and its projections of future income, and records avaluation allowance against any net deferred tax assets if it is more likelythan not that they will not be realized.

On November 10, 2005, theFinancial Accounting Standards board (“FASB”) issued FASB Staff Position No. FAS123(R) “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards” that allows for a simplified or Long-Haul Method toestablish the beginning balance of the additional paid-in-capital pool (“APICpool”) related to the tax effects of employee stock-based compensation, and todetermine the subsequent impact on the APIC pool and Consolidated Statements ofCash Flows of the tax effects of employee stock-based compensation awards thatare outstanding upon adoptions of SFAS 123(R). The Company has elected to usethe Long-Haul Method of calculating the APIC pool.

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**8.             Guarantees**

Certain of the Company’sproducts carry a one-year warranty, the costs of which are accrued for at timeof shipment or delivery.  Accrual rates are based upon historicalexperience over the preceding twelve months and management’s judgment of futureexposure.  Warranty experience for the three and nine months endedDecember 31, 2006 and December 31, 2005 is as follows:

 

|                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                           | ** ** | **Dec. 31,   2006**    | ** ** | **Dec. 31,  2005**         | ** ** | **Dec. 31,   2006** | ** ** | **Dec. 31,  2005** | ** ** |
| Warranty accrual  — beginning of period      |       | $                                | 2,832      |                            | $          | 3,751 |   | $ | 3,606 |   | $ | 2,322 |   |
| Accruals for  warranties issued during the period |       | 790                              |       | 622                             |       | 1,844 |   | 3,121 |   |
| Adjustment of  preexisting accrual estimates      |       | (873                             | )          | (436                            | )          | (1,854 | ) | (794 | ) |
| Warranty costs  incurred during the period        |       | (276                             | )          | (530                            | )          | (1,123 | ) | (1,242 | ) |
| Warranty accrual — end  of period            |       | $                                | 2,473      |                            | $          | 3,407 |   | $ | 2,473 |   | $ | 3,407 |   |

 

In conjunction with thesale of certain assets and contracts of the Company’s High Energy SystemsDivision in January of 2005, the lease for the California operations ofthe High Energy Systems Division was assigned to Accuray, Inc.  TheCompany remains secondarily liable for the remaining lease payments in theevent of default by Accuray, Inc. during the lease term which expires inFebruary 2011. Total remaining lease payments at December 31, 2006 totaled$1,569,000.  No accrual for this contingent liability has been recorded atDecember 31, 2006 as payment of this liability is considered remote.

**9.             Lease Commitments**

In March 2005, theCompany renewed its lease agreement for its corporate headquarters andmanufacturing facilities in Billerica, Massachusetts. As part of the lease agreement,the Company’s landlord agreed to certain renovations to the Billerica facilityincluding the construction of additional high bay manufacturing space. TheCompany was responsible for a portion of the construction costs and was deemedto be the owner of the building during the construction period under EITF97-10, “The Effect of Lessee Involvement in Asset Construction”. During theyear ended March 31, 2006, the Company capitalized $5,153,000 to recordthe facility on its books with an offsetting credit to the lease financingliability. In addition, amounts paid for construction were recorded asconstruction in progress and the landlord construction allowances of $5,642,000(of which $50,000 was a receivable at December 31, 2006) were recorded as additionallease financing liability.

At the completion of theconstruction in February 2006, the lease was reviewed for potentialsale-leaseback treatment in accordance with SFAS No. 98. Based on thisreview, it was determined that due to certain non-recourse financing provisionswhich constituted continuing involvement, the lease did not qualify forsale-leaseback treatment. As a result, building and tenant improvements andassociated lease financing liabilities remain on the Company’s books. The leasefinancing liability is being amortized over the lease term based on thepayments designated in the agreement and the building and tenant improvementassets are being depreciated on a straight line basis over their useful lives.

**Item2 — Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

Results of Operations

Net revenues for thequarter ended December 31, 2006 increased by $9,257,000 to $47,797,000 comparedto the corresponding period a year ago.  This increase is attributable to anincrease of $5,150,000 in product sales, $4,200,000 of which relates to anincrease in the volume of shipments of Z Backscatter systems.   Inaddition, there was a $1,341,000 increase in CargoSearch system revenues and$1,346,000 increase in contract research and development revenues due primarilyto one project. These increases were offset somewhat by decreases in sales ofaftermarket parts from the prior year due to certain large orders fulfilledlast year. Service revenues increased by $4,107,000 to $14,434,000 compared tothe third quarter of fiscal 2006 due primarily to an increase in the number ofsystems under service contracts as the warranties on systems sold in prioryears expired and were replaced with service contracts and additional extended warrantiessold with international systems.

Net revenues for the ninemonths ended December 31, 2006 decreased by $15,576,000 to $107,267,000compared to the corresponding period a year ago.  This decrease isattributable primarily to a decrease of $30,191,000 in product sales,$18,294,000 which relates to a decrease in the volume of shipments of ZBackscatter systems.   In addition, there was a $5,425,000 decreasein sales of aftermarket parts from the prior year due primarily to a largeorder fulfilled last year, a decrease of $3,605,000 in CargoSearch systemrevenues due primarily to the completion of two large CargoSearch projectswhich were ongoing last fiscal year and a decrease of $3,677,000 inParcelSearch system revenues attributable to lower unit sales in the currentyear. These decreases were offset somewhat by a $933,000 increase in contractresearch and development revenues attributable primarily to one largeengagement entered into in the current year. Service revenues increased by$14,615,000 to $37,753,000 compared to the first nine months of fiscal 2006 dueprimarily to an increase in the number of systems under service contracts asthe warranties on systems sold in prior years expired and were replaced withservice contracts and additional extended warranties sold with internationalsystems.

 

11

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Total cost of sales andcontracts for the quarter ended December 31, 2006 increased by $6,693,000 to$25,859,000 as compared to the corresponding period a year ago. Cost of salesand contracts related to product revenues increased by $5,558,000 to $19,102,000as compared to the corresponding period a year ago.  Cost of product salesand contract revenues represented 57% of revenues versus 48% of revenue, forthe corresponding period last year.  This decrease in gross margin is dueprimarily to $1,152,000 of stock-based compensation recorded as a result ofadopting SFAS 123(R) and a decrease in the volume of shipments of higher marginZ Backscatter systems.  The cost ofservice revenues for the quarter ended December 31, 2006 increased by$1,135,000 to $6,757,000 as compared to the corresponding period a yearago.  Cost of service revenues represented 47% of revenues versus 54% forthe corresponding period last year.  This margin improvement is dueprimarily to increased service contract and extended warranty contract revenuewith comparatively lower material requirements in the current period.

Total cost of sales andcontracts for the nine months ended December 31, 2006 decreased by $5,798,000to $58,303,000 as compared to the corresponding period a year ago. Cost ofsales and contracts related to product revenues decreased by $11,274,000 to$39,078,000 as compared to the corresponding period a year ago.  Cost ofproduct sales and contract revenues represented 56% of revenues versus 51% ofrevenues, for the corresponding period last year.  This decrease in grossmargin is due primarily to $2,666,000 of stock-based compensation recorded as aresult of adopting SFAS 123(R) and the significant decrease in the volume ofshipments of higher margin Z Backscatter systems in the period.  The cost of service revenues for the ninemonths ended December 31, 2006 increased by $5,476,000 to $19,225,000 ascompared to the corresponding period a year ago.  Cost of service revenuesrepresented 51% of revenues versus 59% for the corresponding period lastyear.  This margin improvement is due primarily to increased servicecontract and extended warranty contract revenue with comparatively lowermaterial requirements in the current period.

Selling, general andadministrative expenses for the quarter ended December 31, 2006 of $7,939,000were $3,393,000 higher than the corresponding period a year ago.  Selling,general and administrative expenses represented 17% of revenues in the currentperiod as compared to 12% for the corresponding period last year.  Theincrease in costs was primarily the result of $1,137,000 of stock-basedcompensation expense recorded in accordance with SFAS 123(R), a $1,911,000increase in incentive compensation due to the attainment of certain goals and a$237,000 increase in bid and proposal and other marketing related costs.

Selling, general andadministrative expenses for the nine months ended December 31, 2006 of$19,565,000 were $6,182,000 higher than the corresponding period a yearago.  Selling, general and administrative expenses represented 18% ofrevenues in the current period as compared to 11% for the corresponding periodlast year.  The increase in costs was primarily the result of $3,567,000of stock-based compensation expense recorded in accordance with SFAS 123(R), a$1,463,000 increase in incentive compensation due to the attainment of certaingoals and an $832,000 increase in bid and proposal related costs and othermarketing related costs.

Company funded researchand development expenses of $1,440,000 for the quarter ended December 31, 2006decreased by $761,000 compared to the corresponding period last year.  Research and development expenses represented3% of revenues as compared to 6% for the corresponding period last year.  These expenditures decreased as the Company’sengineering efforts focused on revenue producing programs, product maintenanceduring the quarter.

Company funded researchand development expenses of $5,220,000 for the nine months ended December 31,2006 decreased by $1,873,000 compared to the corresponding period lastyear.  Research and development expensesrepresented 5% of revenues as compared to 6% for the corresponding period lastyear. These expenditures decreased as the Company’s engineering efforts focusedon revenue producing programs, bid and proposal activities and productmaintenance during the period.

Other income was$1,129,000 in income for the quarter ended December 31, 2006 as compared to$1,526,000 in income for the corresponding period a year ago.  Otherincome for the quarter ended December 31, 2006 and December 31, 2005 includes$(224,000) and $808,000, respectively of warrant income (expense) due to thechanges in the warrant liability attributable to stock price volatility overthe remaining warrant life.  In addition, in the quarter ended December31, 2006, the Company earned $1,381,000 in income on investments held ascompared to $704,000 in the quarter ended December 31, 2005 due to increases inthe Company’s cash and investments balances, and an increase in the averageinterest rate when compared to the prior year.

Other income was$5,863,000 in income for the nine months ended December 31, 2006 as compared to$494,000 in expense for the corresponding period a year ago.  Otherincome for the nine months ended December 31, 2006 and December 31, 2005includes $2,115,000 and $(2,109,000), respectively of warrant income (expense)due to the changes in the warrant liability as a result of stock pricevolatility.  In addition, in the nine months ended December 31, 2006, theCompany earned $3,872,000 in income on investments held as compared to$1,576,000 in the nine months ended December 31, 2005 due to increases in theCompany’s cash and investments balances, and an increase in the averageinterest rate when compared to the prior year.

As a result of the above,the Company reported pre-tax income of $13,688,000 in the quarter endedDecember 31, 2006 as compared to pre-tax income of $14,153,000 in thecorresponding period a year ago. The Company reported pre-tax income of$30,042,000 in the nine months ended December 31, 2006 as compared to pre-taxincome of $37,772,000 in the corresponding period a year ago.

The Company’s projectedeffective tax rate, excluding the income tax effect of the warrants which arenot taxable, for fiscal year 2007 increased to 40.2% from 30.8% for the yearended March 31, 2006.  This increase isdue to the Company’s recognition of tax carryforward benefits during fiscal2006 which reduced taxable income as well as changes in other permanent taxitems.

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The Company had netincome of $8,072,000 during the quarter ended December 31, 2006 as compared tonet income of $9,668,000 in the third quarter of fiscal 2006. For the ninemonths ended December 31, 2006, the Company had net income of $18,820,000 ascompared to $25,061,000 for the nine months ended December 31, 2005.   The significant factors contributing tothese results are noted in the above sections.

Liquidity and CapitalResources

Cash and cash equivalentsincreased by $5,780,000 to $56,435,000 at December 31, 2006 compared to$50,655,000 at March 31, 2006.  Thisincrease is attributable primarily to $24,822,000 in cash provided by operatingactivities comprised mainly of $18,820,000 of net income earned during theperiod adjusted for non-cash related items related to stock compensation andwarrants ($4,423,000), and increases in customer deposits ($5,628,000)attributable primarily to one large deposit on an international program anddeferred revenue ($4,233,000) related primarily to one large multi-year serviceagreement invoiced at inception.  Theseincreases are offset somewhat by decreases in cash and cash equivalentsattributable to $17,763,000 of net purchases of short term investments, a$9,402,000 increase in accounts receivable attributable to a large number ofshipments in the third month of the quarter, and $3,379,000 in capitalexpenditures related primarily to the Company’s ongoing ERP systemimplementation and other leasehold improvements.

On November 16, 2006, theCompany modified its domestic loan and security agreement with Silicon ValleyBank East which was scheduled to expire on November 29, 2006.  The Company increased this domestic facilityfrom $5.0 million to $20.0 million to support the Company’s routineworking capital needs.  The Company’s$10.0 million export loan and security facility, guaranteed by theExport-Import Bank of the United States, expired as of November 29, 2006 andwas not renewed. Maximum amount available for borrowings under thedomestic facility is (a) if the Company’s unrestricted cash is greater than orequal to $30 million, is $20.0 million minus the amount of all outstanding Letters of credit less certain reserves,and minus the outstanding principle balance of any advances or (b) if the Company’sunrestricted cash is less than $30.0 million for a period of 30 consecutivedays, the lesser of (i) the $20.0 million, or ii) 85% of eligible domesticaccounts receivable minus  the amount ofoutstanding letters of credits adjusted for certain reserves and minus theprinciple balance of any advances.  Themodification of the domestic loan and security agreement extended this creditfacility through November 14, 2008.

The credit facilitiesbear an interest rate of the greater of 4.0% or the Silicon Valley Bank primerate (8.25% at December 31, 2006). The credit agreements are collateralized bycertain assets of the Company and contain certain restrictions, includinglimitations on the amount of distributions that can be made to stockholders,and the disposition or encumbrances of assets, and require the maintenance ofcertain financial covenants.

At December 31, 2006,there were no borrowings outstanding against these credit facilities. TheCompany had outstanding $18,298,000 in stand-by letters of credit against itscredit facility.  Of the outstanding letters of credit, $13,750,000relates to a performance bond on an ongoing international project, $300,000relates to the Company’s building lease and the remainder is guaranteeingperformance on certain international projects.  No amounts have been drawnagainst these letters of credit. In addition, at December 31, 2006, the Companyhad a restricted cash balance of $1,756,000 relating to certain bank requireddeposits related to outstanding letters of credits, bid bonds, and otherbank-related fees.

**NewAccounting Pronouncements:**

In July 2006, the FASBissued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”(“FIN48”).  FIN 48 is an interpretationof FASB Statement No. 109.  “Accountingfor Income Taxes,” and it seeks to reduce the diversity in practice associatedwith certain aspects of measurement and recognition in accounting for incometaxes.  In addition, FIN 48 requiresexpanded disclosure with respect to the uncertainty in income taxes and isrequired to be adopted for fiscal years beginning after December 15, 2006.  The Company is currently evaluating theimpact, if any, that FIN 48 will have on its consolidated financial statements.

In September 2006, the FASB issued Statement of Financial AccountingStandards No. 157 “Fair Value Measurements”, (“FAS 157”).  FAS 157 defines fair value, establishes aframework for measuring fair value, and expands disclosure requirementsregarding fair value measurement.  FAS157 is effective for the Company beginning April 1, 2008. The Company iscurrently reviewing the Statement to determine the impact and materiality ofits adoption to the Company.

**Item3 - Quantitative and Qualitative Disclosures about Market Risk**

The cash accounts for theCompany’s operations in Singapore, Hong Kong, England, and Abu Dhabi aremaintained in Singapore dollars, Hong Kong dollars, pounds sterling and dirham,respectively. Foreign currency accounts are marked to market at current ratesthat resulted in immaterial translation adjustments to stockholders’ equity.The gains and losses from foreign currency transactions are included in thestatements of operations for the period and were also immaterial. Ahypothetical 10% change in foreign currency rates would not have a materialimpact on the Company’s results of operations or financial position.

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As of December 31, 2006,the Company held short-term investments consisting of money market funds andU.S. government and government agency bonds. The Company’s primary objectivewith its investment portfolio is to invest available cash while preservingprincipal and meeting liquidity needs. These investments had an averageinterest rate of approximately 4.91% and are subject to interest rate risk. Asa result of the average maturity and conservative nature of the investmentportfolio, a sudden change in interest rates would not have a material adverseeffect on the value of these investments.

In fiscal 2003, theCompany issued 295,475 warrants in connection with a private placement offeringof common stock.  As of December 31, 2006, 21,625 of these warrants remainoutstanding.  These warrants can be exchanged for cash under certaincircumstances including a merger, sale or tender offer of the Company, and assuch a liability equal to the fair value of the warrants is recorded on thebalance sheet. Changes in the fair value of the warrants are recorded as otherincome (expense). The Black-Scholes value of these warrants can fluctuatesignificantly based on the current fair market value of the Company’s commonstock. A 10% change in the fair market value of the Company’s common stock,holding other assumptions constant, would have approximately a$128,000 positive or negative impact on earnings.

**Item4 – Controls and Procedures**

a)             Evaluation of disclosure controls and procedures.

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

b)            Changes 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 SecuritiesExchange Act of 1934 during the period covered by this report that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal controls over financial reporting.

**PART II— OTHER INFORMATION**

**Item1– Legal Proceedings**

TheCompany is subject to various legal proceedings and claims that arise in theordinary course of business.  At thepresent time, it is not possible to predict the outcome of these matters;however, the Company currently believes that resolving these matters will nothave a material adverse impact o its financial condition, results of operationsor cash flows.

**Item6 - Exhibits**

 
| (a)         | ** ** | ** ** | ** ** | **Exhibits**                                                                                                                                                  |
|-------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10(d)(xiii) |       |       |       | Third Loan Modification Agreement between Silicon  Valley Bank and American Science and Engineering, Inc. dated November 15,  2006                            |
| 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 requiredby Exhibit Item 11 (Statement re: Computation of Income per Common andCommon Equivalent Share) may be found in Footnote No. 4.

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**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 February 9,  2007 |   | /s/ Kenneth J. Galaznik                |
|                   |   | Kenneth J. Galaznik                    |
|                   |   | Chief Financial Officer and Treasurer  |
|                   |   |                                   |

 

*SafeHarbor 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-looking statements.*

*Factorswhich might cause actual results to differ materially from those projected inthe forward-looking statements contained herein include the following: significantreductions or delays in procurements of the Company’s systems by the UnitedStates and other governments; disruption in the supply of any source componentincorporated into the Company’s products; litigation seeking to restrict theuse of intellectual property used by the Company; potential product liabilityclaims against the Company; global political trends and events which affectpublic perception of the threat presented by drugs, explosives and othercontraband; global economic developments and the ability of governments andprivate organizations to fund purchases of the Company’s products to addresssuch threats; and the potential insufficiency of Company resources, includinghuman resources, capital, plant and equipment and management systems, toaccommodate any future growth and any future delays in federal funding. Theseand certain other factors which might cause actual results to differ materiallyfrom those projected are more fully set forth in the Company’s Annual Report onForm 10-K for the fiscal year ended March 31, 2006 under Item 1A “Risk Factors.”  Please also refer to our other filings withthe Securities and Exchange Commission.*

 

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