**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**ý****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

###### **For the quarterly period ended June 30, 2005**

######  

**OR**

 

**o****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from              to              **

 

**CommissionFile Number 1-6549**

 

**AmericanScience and Engineering, Inc.**

(Exact name of Registrant as specified in itscharter)

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

 
| **(978) 262-8700**                                                                  |
|-------------------------------------------------------------------------------------|
| (Registrant’s telephone  number, including area code)                          |
|                                                                                |   |   |
|                                                                                |   |   |
| (Former name, former  address and former fiscal year, if changed since last report) |

 

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

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes ý  No o

 

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

 
| **Class of  Common Stock** | ** ** | **Outstanding  at  July, 27, 2005** |
|---------------------------------|------------|-------------------------------------|
| $.66 2/3 par value              |       | 8,417,548                           |

 

 

----

 

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

 

**Index**

 
| **Part 1 – Financial Information**                                                                                      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                        | ** ** |
| Item  1– Financial Statements                                                                                                |       |
|                                                                                                                              |       |
| Condensed Consolidated  Balance Sheets – June 30, 2005 and March 31, 2005                                          | 3          |
|                                                                                                                              |       |
| Condensed  Consolidated Statement of Operations – For the Three Months Ended June 30, 2005 and June 30,  2004 | 4          |
|                                                                                                                              |       |
| Condensed  Consolidated Statements of Cash Flows – For the Three Months Ended  June 30, 2005 and June 30, 2004     | 5          |
|                                                                                                                              |       |
| Notes  to Unaudited Condensed Consolidated Financial Statements                                                                   | 6          |
|                                                                                                                              |       |
| Item  2– Management’s Discussion and Analysis of Financial Condition and Results of Operations                     | 9          |
|                                                                                                                              |       |
| Item  3 – Quantitative and Qualitative Disclosures About Market Risk                                                         | 11         |
|                                                                                                                              |       |
| Item 4 –  Controls and Proceduresw                                                                                           | 11         |
|                                                                                                                              |       |
| **Part II – Other  Information**                                                                                        | ** ** |
| ** **                                                                                                                        | ** ** |
| Item 1 – Legal Proceedings                                                                                                   | 11         |
|                                                                                                                              |       |
| Item 6 –  Exhibits                                                                                                           | 12         |
|                                                                                                                              |       |
| **Signatures**                                                                                                                    | 12         |

 

2

----

 

**PART I****– FINANCIAL INFORMATION**

**Item 1 – Financial****Statements**

 

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

**Condensed Consolidated Balance Sheets**

 

Dollars in thousands

 
| ** **                                                                                                                                                                          | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **(unaudited)**         | ** ** | ** **               | ** ** |
| **Assets**                                                                                                                                                                          |       |                    |       |                     |       |
| Current  assets:                                                                                                                                                                    |       |                    |       |                     |       |
| Cash and  cash equivalents                                                                                                                                                          |       | $                       | 22,960     |                     | $          | 15,418 |   |
| Restricted  cash and investments                                                                                                                                                    |       | 982                     |       | 355                      |       |
| Short-term  investments                                                                                                                                                             |       | 22,393                  |       | 20,590                   |       |
| Accounts  receivable, net of allowances of $431 and $501 at June 30, 2005 and March 31,  2005, respectively                                                               |       | 23,022                  |       | 28,170                   |       |
| Unbilled  costs and fees, net of allowances of $76 at June 30, 2005 and March 31,  2005                                                                                   |       | 1,148                   |       | 691                      |       |
| Note  receivable                                                                                                                                                                    |       | 2,800                   |       | 2,800                    |       |
| Inventories                                                                                                                                                                         |       | 21,942                  |       | 24,941                   |       |
| Deferred tax  assets                                                                                                                                                                |       | 2,154                   |       | —                   |       |
| Prepaid  expenses and other current assets                                                                                                                                          |       | 2,299                   |       | 1,957                    |       |
|                                                                                                                                                                                |       |                    |       |                     |       |
| **Total  current assets**                                                                                                                                                           |       | 99,700                  |       | 94,922                   |       |
| Equipment  and leasehold improvements, net                                                                                                                                          |       | 4,109                   |       | 3,329                    |       |
| Deferred tax  asset                                                                                                                                                                 |       | 3,450                   |       | —                   |       |
| Other  assets, net                                                                                                                                                                  |       | —                  |       | 36                       |       |
|                                                                                                                                                                                |       |                    |       |                     |       |
| **Total  assets**                                                                                                                                                                   |       | $                       | 107,259    |                     | $          | 98,287 |   |
| ** **                                                                                                                                                                          |       |                    |       |                     |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                      |       |                    |       |                     |       |
| Current  liabilities:                                                                                                                                                               |       |                    |       |                     |       |
| Accounts  payable                                                                                                                                                                   |       | $                       | 2,831      |                     | $          | 6,743 |   |
| Accrued  salaries and benefits                                                                                                                                                      |       | 1,546                   |       | 3,158                    |       |
| Accrued  warranty costs                                                                                                                                                             |       | 2,768                   |       | 2,322                    |       |
| Accrued  income taxes                                                                                                                                                               |       | 285                     |       | 15                       |       |
| Deferred  revenue                                                                                                                                                                   |       | 2,942                   |       | 3,634                    |       |
| Customer  deposits                                                                                                                                                                  |       | 7,947                   |       | 11,132                   |       |
| Other  current liabilities                                                                                                                                                          |       | 5,188                   |       | 2,986                    |       |
|                                                                                                                                                                                |       |                    |       |                     |       |
| **Total  current liabilities**                                                                                                                                                      |       | 23,507                  |       | 29,990                   |       |
| Warrant  liability                                                                                                                                                                  |       | 4,906                   |       | 6,137                    |       |
| Other  non-current liabilities                                                                                                                                                      |       | 671                     |       | 590                      |       |
| **Total  liabilities**                                                                                                                                                              |       | 29,084                  |       | 36,717                   |       |
|                                                                                                                                                                                |       |                    |       |                     |       |
| **Stockholders’  equity:**                                                                                                                                                     |       |                    |       |                     |       |
| Preferred  stock, no par value Authorized  — 100,000 shares; Issued — none                                                                                           |       | —                  |       | —                   |       |
| Common  stock, $0.66 2/3 par value  Authorized — 20,000,000 shares  Issued and Outstanding 8,412,290 shares at June 30, 2005 and 8,341,480  shares at March 31, 2005 |       | 5,607                   |       | 5,560                    |       |
| Capital in  excess of par value                                                                                                                                                     |       | 63,628                  |       | 54,098                   |       |
| Accumulated  other comprehensive income                                                                                                                                             |       | (19                     | )          | (12                      | )          |
| Unearned  compensation                                                                                                                                                              |       | (131                    | )          | (169                     | )          |
| Retained  earnings                                                                                                                                                                  |       | 9,090                   |       | 2,093                    |       |
|                                                                                                                                                                                |       |                    |       |                     |       |
| **Total  stockholders’ equity**                                                                                                                                                |       | 78,175                  |       | 61,570                   |       |
| ** **                                                                                                                                                                          |       |                    |       |                     |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                |       | $                       | 107,259    |                     | $          | 98,287 |   |

 

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

 

3

----

 

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

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 

Dollars and shares in thousands, except per share amounts

 
| ** **                                       | ** **     | **For the Three Months Ended** | ** ** |
|--------------------------------------------------|----------------|--------------------------------|------------|
| ** **                                       | ** **     | **June 30, 2005**         | ** ** | **June 30, 2004** | ** ** |
|                                             |           |                           |       |   |   |
| **Net  sales and contract revenues:**            |           |                           |       |   |   |
| Net product  sales and contract revenues         |           | $                              | 29,513     |   | $ | 12,822 |   |
| Net service  revenues                            |           | 5,649                          |       | 3,990 |   |
| Total net  revenues and contract revenues        |           | 35,162                         |       | 16,812 |   |
|                                             |           |                           |       |   |   |
| **Cost of  sales and contracts:**                |           |                           |       |   |   |
| Cost of  product sales and contracts             |           | 17,027                         |       | 9,522 |   |
| Cost of  service revenues                        |           | 3,543                          |       | 2,152 |   |
| Total cost  of sales and contracts               |           | 20,570                         |       | 11,674 |   |
| **Gross  profit**                                |           | 14,592                         |       | 5,138 |   |
|                                             |           |                           |       |   |   |
| **Expenses:**                                    |           |                           |       |   |   |
| Selling,  general and administrative             |           | 4,138                          |       | 3,274 |   |
| Research and  development                        |           | 2,422                          |       | 1,455 |   |
| Total  expenses                                  |           | 6,560                          |       | 4,729 |   |
|                                             |           |                           |       |   |   |
| Operating  income                                |           | 8,032                          |       | 409 |   |
|                                             |           |                           |       |   |   |
| **Other  income (expense):**                     |           |                           |       |   |   |
| Interest and  investment income                  |           | 361                            |       | 41 |   |
| Other, net                                       |           | 14                             |       | (71 | ) |
| Change in  warrant valuation                     |           | 533                            |       | (920 | ) |
| Total other  income (expense)                    |           | 908                            |       | (950 | ) |
|                                             |           |                           |       |   |   |
| Income  (loss) before provision for income taxes |           | 8,940                          |       | (541 | ) |
| Provision  for income taxes                      |           | 1,943                          |       | — |   |
|                                             |           |                           |       |   |   |
| Net income  (loss)                               |           | $                              | 6,997      |   | $ | (541 | ) |
|                                             |           |                           |       |   |   |
| Income  (loss) per share                         | – Basic   |                           | $          | 0.84 |   | $ | (0.07 | ) |
|                                             | – Diluted |                           | $          | 0.78 |   | $ | (0.07 | ) |
|                                             |           |                           |       |   |   |
| Weighted  average shares                         | – Basic   |                           | 8,376      |   | 7,558 |   |
|                                             | – Diluted |                           | 8,984      |   | 7,558 |   |

 

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

 

4

----

 

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

**Condensed Consolidated Statements of Cas****h Flows**

**(Unaudited**)

 

Dollars in thousands

 
| ** **                                                                                | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                | ** ** | **June 30, 2005**         | ** ** | **June 30, 2004** | ** ** |
| **Cash  flows from operating activities:**                                                |       |                           |       |   |   |
| Net income  (loss)                                                                        |       | $                              | 6,997      |   | $ | (541 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation  and amortization                                                            |       | 201                            |       | 338 |   |
| Provisions  for inventory and accounts receivable reserves                                |       | 1,126                          |       | 140 |   |
| Realized  gain on short-term investments                                                  |       | —                         |       | (2 | ) |
| Amortization  of bond discount                                                            |       | (109                           | )          | — |   |
| Deferred  income taxes                                                                    |       | (1,167                         | )          | — |   |
| Reduction of  income taxes paid due to the tax benefit from employee stock option expense |       | 251                            |       | — |   |
| Reversal of  deferred tax asset valuation allowance                                       |       | 2,588                          |       | — |   |
| Change in  value of warrants                                                              |       | (534                           | )          | 920 |   |
| Stock  compensation expense                                                               |       | 52                             |       | 38 |   |
| Changes in  assets and liabilities:                                                       |       |                           |       |   |   |
| Accounts  receivable                                                                      |       | 5,216                          |       | 2,625 |   |
| Unbilled  costs and fees                                                                  |       | (457                           | )          | 60 |   |
| Inventories                                                                               |       | 1,805                          |       | (1,294 | ) |
| Prepaid  expenses and other assets                                                        |       | (306                           | )          | (35 | ) |
| Accounts  payable                                                                         |       | (3,912                         | )          | 528 |   |
| Accrued  income taxes                                                                     |       | 270                            |       | 15 |   |
| Customer  deposits                                                                        |       | (3,185                         | )          | (527 | ) |
| Deferred  revenue                                                                         |       | (691                           | )          | (394 | ) |
| Other  current liabilities                                                                |       | 1,152                          |       | (18 | ) |
| Non-current  liabilities                                                                  |       | 80                             |       | (21 | ) |
| Net cash  provided by operating activities                                                |       | 9,377                          |       | 1,832 |   |
|                                                                                      |       |                           |       |   |   |
| **Cash  flows from investing activities:**                                                |       |                           |       |   |   |
| Purchases of  short-term investments                                                      |       | (13,020                        | )          | — |   |
| Maturities  of short-term investments                                                     |       | 11,330                         |       | 926 |   |
| Purchases of  property and equipment                                                      |       | (981                           | )          | (678 | ) |
| Net cash  provided by (used for) investing activities                                     |       | (2,671                         | )          | 248 |   |
|                                                                                      |       |                           |       |   |   |
| **Cash  flows from financing activities:**                                                |       |                           |       |   |   |
| Increase in  restricted cash and investments                                              |       | (627                           | )          | (44 | ) |
| Proceeds  from exercise of warrants                                                       |       | 838                            |       | — |   |
| Proceeds  from exercise of stock options                                                  |       | 636                            |       | 4,006 |   |
| Net cash  provided by financing activities                                                |       | 847                            |       | 3,962 |   |
|                                                                                      |       |                           |       |   |   |
| Foreign  currency translation effect on cash                                              |       | (11                            | )          | (10 | ) |
|                                                                                      |       |                           |       |   |   |
| Net increase  in cash and cash equivalents                                                |       | 7,542                          |       | 6,032 |   |
| Cash and  cash equivalents at beginning of period                                         |       | 15,418                         |       | 18,232 |   |
| Cash and  cash equivalents at end of period                                               |       | $                              | 22,960     |   | $ | 24,264 |   |

 

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

 

5

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

**Notes to Unaudited Condensed Consolidate****d Financial Statements**

 

**1.****              General**

 

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

 

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

 

The consolidated financial statements, in the opinion of management,include all adjustments necessary, consisting solely of normal recurringadjustments, to present fairly the Company’s financial position, results ofoperations and cash flows.  These results are not necessarily indicativeof the results to be expected for the entire year.

 

Nature of Operations

 

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

 

Significant Accounting Policies

 

Revenues on cost reimbursable and long-term fixed price contracts aregenerally recorded as costs are incurred using the percentage of completionmethod.  For systems that are produced in a standard manufacturingoperation and have shorter order to delivery cycles, the Company recognizes salesat the time of shipment of the system to the customer and when other revenuerecognition criteria are met.

 

The Company’s Export and Security Agreement with Silicon Valley BankEast requires certain cash balances to be restricted as collateral againstoutstanding standby letters of credit. (see Note 4)

 

The significant accounting policies followed by the Company and itsSubsidiary in preparing its consolidated financial statements are set forth inNote 1 to the consolidated financial statements included in its Form 10-Kfor the year ended March 31, 2005.

 

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

 

Comprehensive Income

 

Comprehensive income is comprised of the following:

 
| ** **                                              | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|
| **(in thousands)**                                      | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
| Net income  (loss)                                      |       | $                      | 6,997      |   | $ | (541 | ) |
| Foreign  currency translation adjustments               |       | (11                    | )          | (10 | ) |
| Unrealized  gains and losses from marketable securities |       | 4                      |       | — |   |
| Comprehensive  income (loss)                            |       | $                      | 6,990      |   | $ | (551 | ) |

 

Pro Forma Stock-Based Compensation Expense

 

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

 

6

----

 
| ** **                                                                   | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|
| **(in thousands except per share data)**                                     | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
| **Net  income (loss):**                                                      |       |                   |       |   |   |
| As reported                                                                  |       | $                      | 6,997      |   | $ | (541 | ) |
| Add: Stock  based compensation included in net income as reported            |       | 52                     |       | 38 |   |
| Less:   Stock based compensation using fair value method for all awards |       | (3,976                 | )          | (150 | ) |
| Pro forma  net income (loss)                                                 |       | $                      | 3,073      |   | $ | (653 | ) |
| **Income  (loss) per share—Basic:**                                     |       |                   |       |   |   |
| As reported                                                                  |       | $                      | 0.84       |   | $ | (0.07 | ) |
| Pro forma                                                                    |       | $                      | 0.37       |   | $ | (0.09 | ) |
| **Income  (loss) per share—Diluted:**                                   |       |                   |       |   |   |
| As reported                                                                  |       | $                      | 0.78       |   | $ | (0.07 | ) |
| Pro forma                                                                    |       | $                      | 0.34       |   | $ | (0.09 | ) |

 

OnApril 22, 2005, the Company announced that its Board of Directors hadaccelerated the vesting of certain unvested stock options previously awarded toemployees.  Options to purchase 186,033shares of common stock were subject to the acceleration.  The acceleration was effective immediately,on a fully-vested basis.  Options held bythe Board of Directors, Chief Executive Officer, the Chief Financial Officer,and other employees who participated in other incentive or commissioncompensation plans were excluded from the acceleration.  The Company recorded during the quarter endedJune 30, 2005 $14,000 in compensation expense related to these acceleratedoptions.

 

The fair value of each option granted was estimated on the grant dateusing the Black-Scholes option pricing model with the following weightedaverage assumptions: risk-free interest rate of 3.7% for fiscal 2006, 3.8%was used for fiscal 2005, and 5% for fiscal 2004, expected volatility of 72%, 73%,72% and 73% was used for fiscal 2006,  2005, and 2004, respectively, an expecteddividend yield of 0% and an expected life of 3 years in fiscal 2006, 5 years infiscal 2005 and 7 years for fiscal year 2004.

 

**2.****              Inventories**

 

Inventories consisted of:

 
| **(in thousands)**                          | ** ** | **June 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-------------------------|------------|
|                                        |       |                   |       |                    |       |
| Raw materials  and completed sub-assemblies |       | $                      | 8,002      |                    | $          | 12,763 |   |
| Work-in-process                             |       | 8,768                  |       | 5,458                   |       |
| Finished  goods                             |       | 5,172                  |       | 6,720                   |       |
| Total                                       |       | $                      | 21,942     |                    | $          | 24,941 |   |

 

**3.****              Income per Common and Common Equivalent Share**

 

Basic earnings (loss) per common share is computed by dividing netincome (loss) available to common stockholders by the weighted average numberof shares of common stock outstanding during the period.  Diluted earnings(loss) per share include the dilutive impact of options and warrants using theaverage share price of the Company’s common stock for the period. For thequarters ended June 30, 2005 and June 30, 2004, common stockequivalents of 96,626 and 792,633, respectively, are excluded from dilutedearnings per share, as their effect is anti-dilutive.

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------|------------|
| **(in thousands except per share amounts)**                                               | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|                                                                                      |       |                   |       |   |   |
| **Basic  earnings per share**                                                             |       |                   |       |   |   |
| Net income  (loss)                                                                        |       | $                      | 6,997      |   | $ | (541 | ) |
|                                                                                      |       |                   |       |   |   |
| Weighted  average number of common shares outstanding – basic                        |       | 8,376                  |       | 7,558 |   |
|                                                                                      |       |                   |       |   |   |
| Net income  (loss) per share – basic                                                 |       | $                      | 0.84       |   | $ | (0.07 | ) |
|                                                                                      |       |                   |       |   |   |
| **Diluted  earnings per share**                                                           |       |                   |       |   |   |
| Net income  (loss)                                                                        |       | $                      | 6,997      |   | $ | (541 | ) |
|                                                                                      |       |                   |       |   |   |
| Weighted  average number of common shares outstanding – basic                        |       | 8,376                  |       | 7,558 |   |
| Assumed  exercise of stock options and warrants, using the treasury stock method          |       | 608                    |       | — |   |
| Weighted  average number of common and potential common shares outstanding – diluted |       | 8,984                  |       | 7,558 |   |
|                                                                                      |       |                   |       |   |   |
| Net income  (loss) per share – diluted                                               |       | $                      | 0.78       |   | $ | (0.07 | ) |

 

7

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**4.****              Borrowings**

 

OnNovember 30, 2004, the Company modified its two credit agreements withSilicon Valley Bank East.  Themodifications extended the credit facilities which expired on November 30,2004 through November 29, 2006 and reduced the export loan and securityfacility, guaranteed by the Export-Import Bank of the United States, from $20.0million to $10.0 million.  The domesticfacility is a $5.0 million domestic loan and security agreement to supportthe Company’s routine working capital needs. Maximum borrowings for thisfacility are set at the lower of (a) the sum of 80% of eligible domesticaccounts receivable plus 10% of finished goods inventory up to $750,000, or (b) $5 million.

 

Thecredit facilities bear an interest rate of the greater of 4.0% or the SiliconValley Bank prime rate (6.0% at June 30, 2005). The credit agreements arecollateralized by certain assets of the Company and contain certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequire the maintenance of certain financial covenants.

 

AtJune 30, 2005, there were no borrowings outstanding against these creditfacilities. The Company had outstanding $300,000 in stand-by letters of creditagainst the domestic facility related to its building lease and $58,000 instand-by letters of credit against the export facility guaranteeing performanceon an international project.  No amountshave been drawn against these letters of credit. In addition, at June 30,2005, the Company had a restricted cash balance of $982,000 related to certainbank required deposits related to outstanding letters of credits, bid bonds,and other bank-related fees.

 

**5.****              Warrant Liability**

 

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

 

Duringthe quarter ended June 30, 2005, warrants to purchase 35,625 shares ofcommon stock were exercised resulting in total proceeds received of$838,000.  The fair market value of thewarrants at the date of exercise totaled $698,000.  The cash proceeds and the fair value of theliability were recorded as additional paid in capital at June 30, 2005.

 

AtJune 30, 2005,  185,750 warrantsremain outstanding.   Due to certainconversion features of these warrants that provide that the holder may opt fora cash settlement 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 Black-Scholesvaluation of the warrants at the deal closing date was recorded on the Company’sbalance sheet. The “mark to market” change in the warrants valuation of $533,000and ($920,000) was recorded as other income (expense) for the quarters ended June 30,2005 and June 30, 2004, respectively. The liability of $4,906,000 and $6,137,000 representing the fair marketvalue of outstanding warrants at period end is recorded as a non-currentliability at June 30, 2005 and March 31, 2005, respectively. The fairmarket value of the warrants was determined using the Black-Scholes pricingmodel with an assumed volatility of 72% and 73% at June 30, 2005 and March 31,2005, respectively, an interest rate of 3.3% and 3.25% at June 30, 2005and March 31, 2005, respectively and a life equal to the remaining term ofthe warrants at each period end.

 

**6.****              Income Taxes**

 

At March 31, 2005, the Company had gross deferred tax assets of$9,740,000.  The Company had applied afull valuation allowance against its deferred tax assets at March 31, 2005based upon its evaluation of three year cumulative historical results and itsprojection of future taxable income and had determined that it was more likelythan not that its deferred tax asset would not be realized.

 

In the first quarter of fiscal 2006, the Company has reevaluated itsvaluation allowance for deferred tax assets and has determined that a full releaseof valuation allowances is appropriate based upon current period earnings, theCompany’s updated forecasted earnings for fiscal 2006, sales backlog and otherfactors.  The release of the valuationallowance has been included in determining the Company’s annual effective taxrate for fiscal 2006.  In connection withthis release, the Company recorded a corresponding entry to paid in capitaltotaling $7,025,000 for net operating loss carryforwards resulting from theexercise of certain employee stock options.

 

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**7.****              Guarantees**

 

Certain of the Company’s parcel and cargo products carry a one-yearwarranty, the costs of which are accrued for at time of shipment or delivery. Accrual rates are based upon historical experience over the preceding twelvemonths and management’s judgment of future exposure.  Warranty experiencefor the three months ended June 30, 2005 and June 30, 2004 is as follows:

 
| **(in thousands)**                                | ** ** | **Three months  ended June 30,  2005** | ** ** | **Three months  ended June 30,  2004** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Warranty  accrual at beginning of period          |       | $                                           | 2,322      |                                        | $          | 699 |   |
| Accruals for  warranties issued during the period |       | 814                                         |       | 406                                         |       |
| Warranty  costs incurred during period            |       | (368                                        | )          | (205                                        | )          |
| Warranty  accrual at end of period                |       | $                                           | 2,768      |                                        | $          | 900 |   |

 

Inconjunction with the sale of certain assets and contracts of the Company’s HighEnergy Systems Division in January of 2005, the lease for the Californiaoperations of the High Energy Systems Division was assigned to Accuray.  The Company remains secondarily liable forthe remaining lease payments in the event of default by Accuray during thelease term which expires in February 2011. Total remaining lease paymentsat June 30, 2005 totaled $2,011,000. No accrual for this contingent liability has been recorded at June 30,2005 as payment of this liability is considered remote.

 

**Item 2 – Management****’s Discussion and Analysis of Financial Condition andResults of Operations**

 

Results of Operations

 

Net revenues for the first quarter of fiscal 2006 increased by $18,350,000to $35,162,000 compared to the corresponding period a year ago.  This increaseis attributable primarily to an increase of $16,691,000 in product sales due toincreased shipments of Z Backscatter systems which experienced high ordervolume in the latter half of fiscal 2005. In addition, there was an increase in CargoSearch system revenues withincreased activity on two system projects ongoing during the quarter.  ParcelSearch system revenues remainedrelatively flat from the prior year. These increases were offset somewhat by a $1,574,000 decrease in salesfrom the High Energy Systems group due to the sale of certain assets and contractsof the High Energy Systems division in the fourth quarter of fiscal 2005.  Service revenues increased by $1,659,000 to $5,649,000compared to the first quarter of fiscal 2005 due primarily to the increasedvolume of service contracts related to systems sold over the past 12 months.

 

Total cost of sales and contracts for the first quarter of fiscal 2006 increasedby $8,896,000 to $20,570,000 as compared to the corresponding period a yearago. Cost of product sales and contracts increased by $7,505,000 to $17,027,000as compared to the corresponding period a year ago.  Cost of product sales and contract revenuesrepresented 58% of revenues versus 74% of revenue for the corresponding periodlast year.  This improvement in grossmargin is due primarily to improved absorption of fixed overhead costs due tothe significant volume increases, and the reduction of direct costs of certainproducts through improved supplier agreements and a reduction of internal laborcosts per system due to operating efficiencies.   Some of the product gross margin improvementwas offset by an increase in reserves for excess and obsolete inventory ($1,100,000)in the quarter due to changes in the Company’s projected mix of productusage.  Cost of services revenuesincreased by $1,391,000 to $3,543,000 as compared to the corresponding period ayear ago.  Cost of service revenuesrepresented 63% of revenues versus 54% for the corresponding period lastyear.  This margin decline is due primarily to comparatively higher costsincurred on certain service contracts during the period.

 

Selling, general and administrative expenses for the first quarter offiscal 2006 of $4,138,000 were $864,000 higher than the corresponding period ayear ago.  Selling, general and administrative expenses represented 12% ofrevenues in the current period as compared to 19% for the corresponding periodlast year.  The increase in costs are attributable primarily to increasedincentive and payroll costs for sales and marketing  ($397,000), marketing related costs($221,000) due to increased headcount and sales activity, increased legalexpenditures ($204,000) related to outstanding litigation, and costs related tothe Company’s software implementation project ($126,000).  These increases were offset by $290,000related to the High Energy Systems division whose assets were sold in thefourth quarter of fiscal 2005 and remaining operations consolidated with theCompany’s corporate headquarters.

 

Company funded research and development expenses of $2,422,000 for thefirst quarter of fiscal 2006 increased by $967,000 compared to thecorresponding period last year. Research and development expenses represented 7%of revenues in the current period compared to 9% for the corresponding periodlast year**.  ** These expendituresincreased primarily due to one major product development program which wasstarted in the latter half of fiscal 2005.

 

Other income (expense) was $908,000 in income for the first quarter offiscal 2006 as compared to $950,000 in expense for the corresponding period ayear ago.   At June 30, 2005, other income (expense) includedwarrants which were “marked to market” using Black-Scholes and the change inthe valuation of the warrants of $533,000 was recorded as other income in thequarter. During the three months ended June 30, 2004, this mark to marketadjustment generated $920,000 in other expense.  In addition, in the quarter 

 

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endedJune 30, 2005, the Company earned $341,000 in income on investments heldas compared to $41,000 in the quarter ended June 30, 2004.

 

The Company reported pre-tax income of $8,940,000 in the currentquarter as compared to a pre-tax loss of $541,000 in the corresponding period ayear ago. At March 31, 2005, the Company had gross deferred tax assets of$9,740,000.  The Company had applied afull valuation allowance against its deferred tax assets at March 31, 2005based upon its evaluation of three year cumulative historical results and itsprojection of future taxable income and had determined that it was more likelythan not that its deferred tax asset would not be realized.

 

In the first quarter of fiscal 2006, the Company has reevaluated itsvaluation allowance for deferred tax assets and has determined that a full releaseof valuation allowances is appropriate based upon current period earnings, theCompany’s updated forecasted earnings for fiscal 2006, sales backlog and otherfactors.  The release of the valuationallowance has been included in determining the Company’s annual effective taxrate for fiscal 2006.  In connection withthis release, the Company recorded a corresponding entry to paid in capital totaling$7,025,000 for net operating loss carryforwards resulting from the exercise ofcertain employee stock options.

 

The Company had net income of $6,997,000 during the first quarter offiscal 2006 as compared to net loss of $541,000 in the first quarter of fiscal2005.  The significant factors contributing to these results are noted inthe above sections.

 

Liquidity and Capital Resources

 

Cash and cash equivalents increased by $7,542,000 to $22,960,000 at June 30,2005 compared to $15,418,000 at March 31, 2005. This increase in cash andcash equivalents is due to cash provided by operations generated primarily fromprofits earned during the quarter, as well as $1,474,000 received upon exerciseof outstanding stock options and warrants. These increases were offset somewhat by net purchases of short terminvestments of $1,690,000 during the quarter and $981,000 in capitalexpenditures related primarily to the Company’s ongoing ERP systemimplementation.

 

OnNovember 30, 2004, the Company modified its two credit agreements withSilicon Valley Bank East.  Themodifications extended the credit facilities which expired on November 30,2004 through November 29, 2006 and reduced the export loan and securityfacility, guaranteed by the Export-Import Bank of the United States, from $20.0million to $10.0 million.  The domesticfacility is a $5.0 million domestic loan and security agreement to supportthe Company’s routine working capital needs. Maximum borrowings for thisfacility are set at the lower of (a) the sum of 80% of eligible domesticaccounts receivable plus 10% of finished goods inventory up to $750,000, or (b) $5 million.

 

Thecredit facilities bear an interest rate of the greater of 4.0% or the SiliconValley Bank prime rate (6.0% at June 30, 2005). The credit agreements arecollateralized by certain assets of the Company and contain certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequire the maintenance of certain financial covenants. 

 

AtJune 30, 2005, there were no borrowings outstanding against these creditfacilities. The Company had outstanding $300,000 in stand-by letters of creditagainst the domestic facility related to its building lease and $58,000 instand-by letters of credit against the export facility guaranteeing performanceon an international project.  No amountshave been drawn against these letters of credit. In addition, at June 30,2005, the Company had a restricted cash balance of $982,000 related to certainbank required deposits related to outstanding letters of credits, bid bonds,and other bank-related fees.

 

**New Accounting Pronouncements:**

 

InDecember 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”(SFAS 123(R)) which establishes accounting standards for all transactionsin which an entity exchanges its equity instruments for goods and services.SFAS 123(R) revises SFAS No. 123, “Accounting for Stock-BasedCompensation”, supercedes Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” and amends Financial Accounting Standard No. 95,“Statement of Cash Flows”. SFAS No. 123(R) generally requires the Companyto measure the cost of employee services received in exchange for an award ofequity instruments based on the fair value of the award on the date of thegrant. The standard requires the fair value on the grant date to be estimatedusing either an option-pricing model which is consistent with the terms of theaward or a market observed price, if such a price exists. The resulting costmust be recognized over the period during which an employee is required toprovide service in exchange for the award, which is usually the vesting period.In April 2005, the SEC deferred the effective date for SFAS 123(R) to thebeginning of the first fiscal year that begins after June 15, 2005. TheCompany expects to adopt SFAS 123(R) on the effective date, and expectsthe adoption to have a material impact on its results of operations, financialposition and cash flows.

 

InDecember 2004, the FASB issued SFAS No.151, “Inventory Costs*,*” which amends part of ARB 43, “InventoryPricing,” concerning the treatment of certain types of inventory costs. Theprovisions of ARB No. 43 provided that certain inventory-related costs,such as double freight and re-handling, might be “so abnormal” that they shouldbe charged against current earnings rather than be included in the cost ofinventory. As amended by SFAS No. 151, the “so-abnormal” criterion hasbeen eliminated. Thus, all such 

 

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(abnormal)costs are required to be treated as current-period charges under all circumstances.In addition, fixed production overhead should be allocated based on the normalcapacity of the production facilities, with unallocated overhead charged toexpense when incurred. SFAS 151 is required to be adopted for fiscal yearsbeginning after June 15, 2005. The Company does not believe its adoptionwill have a material impact on its results of operations, financial positionand cash flows.

 

InDecember 2004, the FASB issued a FASB Staff Position (FSP) 109-1Application of FASB 109 to the Tax Deduction on Qualified Production Activitiesprovided by the American Jobs Creation Act of 2004. The new act provides for aspecial tax deduction on qualified production activities income thateffectively reduces the Company’s tax rate. The FASB has decided that theseamounts should be recorded as a special deduction, and recorded in the yearearned. The adoption of this FSP statement will not have an impact on theCompany’s consolidated financial statements.

 

**Item 3 - Quantitative****and Qualitative Disclosures About Market Risk**

 

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

 

Asof June 30, 2005, the Company held short-term investments consisting ofmoney market funds and U.S. government and government agency bonds. The Company’sprimary objective with its investment portfolio is to invest available cashwhile preserving principal and meeting liquidity needs. These investments havean average interest rate of approximately 3.34% and are subject to interestrate risk. As a result of the average maturity and conservative nature of theinvestment portfolio, a sudden change in interest rates would not have amaterial adverse effect on the value of these investments.

 

Infiscal 2003, the Company issued 295,475 warrants in connection with a privateplacement offering of common stock.  Asof June 30, 2005, 185,750 of these warrants remain outstanding.  These warrants can be exchanged for cashunder certain circumstances including a merger, sale or tender offer of theCompany, and as such a liability equal to Black-Scholes value of the warrantsis recorded on the balance sheet. Changes in the fair value of the warrants arerecorded as other income (expense). The Black-Scholes value of these warrantscan fluctuate significantly based on the current fair market value of theCompany’s common stock. A 10% change in the fair market value of the Company’scommon stock, holding other assumptions constant, would have approximately a $690,000positive or negative impact on earnings.

 

**Item 4 - Controls****and Procedures**

 

a)                                      Evaluationof disclosure controls and procedures.

 

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

 

b)             Changes in internalcontrols

 

There have been no changes in our internal controls over financialreporting as such term is defined in Rule 13a-15(f) and 15d-15(f) ofthe Securities Exchange Act of 1934 during the period covered by this reportthat have materially affected, or are reasonably likely to materially affect,the Company’s internal controls over financial reporting.

 

**PART II – OTHER INFORMATION**

 

**Item 1 – Legal Proceedings**

 

InFebruary 2004, L-3 Communications, Inc. (“L-3”) filed a lawsuitagainst the Company in the United States District Court for the District ofMassachusetts in Boston, seeking declaratory judgments of non-infringementand/or invalidity of two of the Company’s patents—United States Patent No. 6,292,533and No. 5,903,623. The Company initially filed a motion to dismiss thelitigation for lack 

 

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ofsubject matter jurisdiction, but was denied. The Company subsequently answeredL-3’s underlying complaint, vigorously opposing the plaintiff’s non-infringementand invalidity claims, and recently has been engaging in substantialdiscovery.  In December 2004, theCompany also filed a motion for summary judgment with respect to one of theprinciple claims alleged by the plaintiff.

 

TheCompany is also subject to various legal proceedings and claims that arise inthe ordinary course of business.  At the present 

time, it is not possible to predict the outcome ofthese matters, however,  the Company currently believesthat resolving these matters will not have a material adverse impact on itsfinancial condition, results of operations or cash flows.

 

**Item 6 - Exhibits**

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

 

The information required by Exhibit Item 11 (Statement re:Computation of Income per Common and Common Equivalent Share) may be found inFootnote No. 3 on Page 8.

 

**SIGNATURES**

 

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

 
|                                | AMERICAN SCIENCE AND ENGINEERING, INC. |
|-------------------------------------|----------------------------------------|
|                                |                                   |
|                                |                                   |
| Date  August 9, 2005 | /s/ Kenneth J. Galaznik                |   |
|                                | Kenneth J. Galaznik                    |
|                                | Chief Financial Officer and Treasurer  |

 

 

*Safe Harbor Statement*

 

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

 

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

 

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

 

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