**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**FORM 10-Q**

** **

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**Forthe quarterly period ended September 30, 2005**

** **

**OR**

** **

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**Forthe transition period from              to**

** **

**CommissionFile Number 1-6549**

** **

**American Science and Engineering, Inc.**

(Exact name of Registrant asspecified in its charter)

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

 

**(978)262-8700**

(Registrant’s telephone number,including area code)

 

 

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

 

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

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Securities Exchange Act of1934). Yes ý  No o

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o  No ý

 

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

 
| **Class of Common Stock** | ** ** | **Outstanding at  October, 31, 2005** |
|--------------------------------|------------|---------------------------------------|
| $.66 2/3 par  value            |       | 8,582,114                             |

 

 

----

 

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

 

**Index**

 
| **Part 1 – Financial Information**                                                                                                                  |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                    | ** ** |
| Item  1– Financial Statements                                                                                                                            |       |
|                                                                                                                                                          |       |
| Unaudited Condensed Consolidated Balance Sheets – September 30,  2005 and March 31, 2005                                                       | 3          |
|                                                                                                                                                          |       |
| Unaudited Condensed Consolidated Statement of Operations – For the  Three and Six Months Ended September 30, 2005 and  September 30, 2004 | 4          |
|                                                                                                                                                          |       |
| Unaudited Condensed Consolidated Statements of Cash Flows – For the  Six Months Ended September 30, 2005 and September 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                                                                                      | 12         |
|                                                                                                                                                          |       |
| Item 4 – Controls and Procedures                                                                                                                         | 12         |
|                                                                                                                                                          |       |
| **Part II  – Other Information**                                                                                                                    | 12         |
| ** **                                                                                                                                                    | ** ** |
| Item  1 – Legal Proceedings                                                                                                                              | 12         |
|                                                                                                                                                          |       |
| Item 4 – Submission of Matters to a Vote of Security Holders                                                                                             | 13         |
|                                                                                                                                                          |       |
| Item 6 –  Exhibits                                                                                                                                       | 13         |
|                                                                                                                                                          |       |
| **Signatures**                                                                                                                                                | 13         |

 

2

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**PART I – FINANCIAL INFORMATION**

**Item 1 – Financial Statements**

 

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

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

 
| **Dollars in thousands**                                                                                                   | ** ** | **September 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|
| **Assets**                                                                                                                 |       |                         |       |                     |       |
| Current assets:                                                                                                            |       |                         |       |                     |       |
| Cash and cash equivalents                                                                                                  |       | $                            | 30,240     |                     | $          | 15,418 |   |
| Restricted cash and investments                                                                                            |       | 162                          |       | 355                      |       |
| Short-term investments                                                                                                     |       | 22,274                       |       | 20,590                   |       |
| Accounts receivable, net of allowances of  $426 and $501 at September 30, 2005 and March 31, 2005,  respectively |       | 44,278                       |       | 28,170                   |       |
| Unbilled costs and fees, net of allowances  of $64 at September 30, 2005 and $76 at March 31, 2005               |       | 801                          |       | 691                      |       |
| Note receivable                                                                                                            |       | 2,800                        |       | 2,800                    |       |
| Inventories                                                                                                                |       | 14,851                       |       | 24,941                   |       |
| Deferred tax assets                                                                                                        |       | 3,639                        |       | —                   |       |
| Prepaid expenses and other current assets                                                                                  |       | 1,674                        |       | 1,957                    |       |
|                                                                                                                       |       |                         |       |                     |       |
| **Total current assets**                                                                                                   |       | 120,719                      |       | 94,922                   |       |
| Building, equipment and leasehold  improvements, net                                                                       |       | 11,599                       |       | 3,329                    |       |
| Deferred tax asset                                                                                                         |       | 2,695                        |       | —                   |       |
| Other assets, net                                                                                                          |       | —                       |       | 36                       |       |
|                                                                                                                       |       |                         |       |                     |       |
| **Total assets**                                                                                                           |       | $                            | 135,013    |                     | $          | 98,287 |   |
|                                                                                                                       |       |                         |       |                     |       |
| **Liabilities and Stockholders’ Equity**                                                                              |       |                         |       |                     |       |
| Current liabilities:                                                                                                       |       |                         |       |                     |       |
| Accounts payable                                                                                                           |       | $                            | 4,718      |                     | $          | 6,743 |   |
| Accrued salaries and benefits                                                                                              |       | 4,209                        |       | 3,158                    |       |
| Accrued warranty costs                                                                                                     |       | 3,751                        |       | 2,322                    |       |
| Accrued income taxes                                                                                                       |       | 3,073                        |       | 15                       |       |
| Deferred revenue                                                                                                           |       | 2,366                        |       | 3,634                    |       |
| Customer deposits                                                                                                          |       | 6,672                        |       | 11,132                   |       |
| Current portion of lease financing liability                                                                               |       | 645                          |       | —                   |       |
| Other current liabilities                                                                                                  |       | 3,102                        |       | 2,986                    |       |
|                                                                                                                       |       |                         |       |                     |       |
| **Total current liabilities**                                                                                              |       | 28,536                       |       | 29,990                   |       |
| Lease financing liability                                                                                                  |       | 5,893                        |       | —                   |       |
| Warrant liability                                                                                                          |       | 7,592                        |       | 6,137                    |       |
| Other non-current liabilities                                                                                              |       | 464                          |       | 590                      |       |
| **Total liabilities**                                                                                                      |       | 42,485                       |       | 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 8,579,441 shares at  September 30, 2005 and 8,341,480 shares at March 31, 2005            |       | 5,719                        |       | 5,560                    |       |
| Capital in excess of par value                                                                                             |       | 69,427                       |       | 54,098                   |       |
| Accumulated other comprehensive income                                                                                     |       | (29                          | )          | (12                      | )          |
| Unearned compensation                                                                                                      |       | (75                          | )          | (169                     | )          |
| Retained earnings                                                                                                          |       | 17,486                       |       | 2,093                    |       |
|                                                                                                                       |       |                         |       |                     |       |
| **Total stockholders’ equity**                                                                                        |       | 92,528                       |       | 61,570                   |       |
|                                                                                                                       |       |                         |       |                     |       |
| **Total liabilities and stockholders’ equity**                                                                        |       | $                            | 135,013    |                     | $          | 98,287 |   |

 

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

 

3

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

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **Dollars and shares in  thousands, except per share amounts**                                                                                                                                                                                                                  | ** ** | **Sept. 30,  2005**    | ** ** | **Sept. 30,  2004**  | ** ** | **Sept. 30,  2005** | ** ** | **Sept. 30,  2004** | ** ** |
| ** **                                                                                                                                                                                                                                                                      | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                                                                                                                                                                                                                                       |       |                   |       |                 |       |   |   |   |   |
| Net product sales and contract revenues                                                                                                                                                                                                                                         |       | $                      | 41,979     |                 | $          | 16,498 |   | $ | 71,492 |   | $ | 29,320 |   |
| Net service revenues                                                                                                                                                                                                                                                            |       | 7,162                  |       | 4,556                |       | 12,811 |   | 8,546 |   |
| Total net revenues                                                                                                                                                                                                                                                              |       | 49,141                 |       | 21,054               |       | 84,303 |   | 37,866 |   |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Cost of sales and contracts:                                                                                                                                                                                                                                                    |       |                   |       |                 |       |   |   |   |   |
| Cost of product sales and contracts                                                                                                                                                                                                                                             |       | 19,781                 |       | 11,362               |       | 36,808 |   | 20,884 |   |
| Cost of service revenues                                                                                                                                                                                                                                                        |       | 4,584                  |       | 2,695                |       | 8,127 |   | 4,847 |   |
| Total cost of sales and contracts                                                                                                                                                                                                                                               |       | 24,365                 |       | 14,057               |       | 44,935 |   | 25,731 |   |
| Gross profit                                                                                                                                                                                                                                                                    |       | 24,776                 |       | 6,997                |       | 39,368 |   | 12,135 |   |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Expenses:                                                                                                                                                                                                                                                                       |       |                   |       |                 |       |   |   |   |   |
| Selling, general and administrative  expenses                                                                                                                                                                                                                                   |       | 4,699                  |       | 3,448                |       | 8,837 |   | 6,721 |   |
| Research and development                                                                                                                                                                                                                                                        |       | 2,470                  |       | 1,012                |       | 4,892 |   | 2,467 |   |
| Total expenses                                                                                                                                                                                                                                                                  |       | 7,169                  |       | 4,460                |       | 13,729 |   | 9,188 |   |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Operating income                                                                                                                                                                                                                                                                |       | 17,607                 |       | 2,537                |       | 25,639 |   | 2,947 |   |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Other income (expense):                                                                                                                                                                                                                                                         |       |                   |       |                 |       |   |   |   |   |
| Interest and investment income                                                                                                                                                                                                                                                  |       | 511                    |       | 126                  |       | 872 |   | 167 |   |
| Other, net                                                                                                                                                                                                                                                                      |       | 11                     |       | 67                   |       | 25 |   | (4 | ) |
| Change in warrant valuation                                                                                                                                                                                                                                                     |       | (3,450                 | )          | (2,266               | )          | (2,917 | ) | (3,186 | ) |
| Total other income (expense)                                                                                                                                                                                                                                                    |       | (2,928                 | )          | (2,073               | )          | (2,020 | ) | (3,023 | ) |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Income (loss) before income taxes                                                                                                                                                                                                                                               |       | 14,679                 |       | 464                  |       | 23,619 |   | (76 | ) |
| Provision for income taxes                                                                                                                                                                                                                                                      |       | 6,283                  |       | 65                   |       | 8,226 |   | 65 |   |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Net income (loss)                                                                                                                                                                                                                                                               |       | $                      | 8,396      |                 | $          | 399 |   | $ | 15,393 |   | $ | (141 | ) |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Income (loss) per share      –Basic                                                                                                                                                                                                          |       | $                      | 0.99       |                 | $          | 0.05 |   | $ | 1.83 |   | $ | (0.02 | ) |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
|                                            –Diluted |       | $                      | 0.93       |                 | $          | 0.05 |   | $ | 1.72 |   | $ | (0.02 | ) |
|                                                                                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares   –Basic                                                                                                                                                                                                                            |       | 8,475                  |       | 7,860                |       | 8,425 |   | 7,709 |   |
|                                            –Diluted |       | 9,003                  |       | 8,383                |       | 8,931 |   | 7,709 |   |

 

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

 

4

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

**Condensed Consolidated Statements of CashFlows**

**(Unaudited**)

 
| ** **                                                                                           | ** ** | **For the Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| **Dollars in thousands**                                                                             | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Cash flows from operating activities:                                                                |       |                         |       |   |   |
| Net income (loss)                                                                                    |       | $                            | 15,393     |   | $ | (141 | ) |
| Adjustments to reconcile net (loss) income  to net cash provided by (used for) operating activities: |       |                         |       |   |   |
| Depreciation and amortization                                                                        |       | 405                          |       | 684 |   |
| Provisions for contract, inventory and  accounts receivable reserves                                 |       | 2,168                        |       | 675 |   |
| Realized gains or losses on short-term  investments                                                  |       | —                       |       | 13 |   |
| Amortization of bond discount                                                                        |       | (173                         | )          | (3 | ) |
| Deferred income taxes                                                                                |       | 2,284                        |       | — |   |
| Reduction of income taxes paid due to the  tax benefit from employee stock option expense            |       | 2,277                        |       | — |   |
| Reversal of deferred tax asset valuation  allowance relating to net operating losses                 |       | (1,593                       | )          | — |   |
| Stock compensation in lieu of fees                                                                   |       | 157                          |       | 87 |   |
| Change in value of warrants                                                                          |       | 2,917                        |       | 3,186 |   |
| Changes in assets and liabilities:                                                                   |       |                         |       |   |   |
| Accounts receivable                                                                                  |       | (16,034                      | )          | (1,525 | ) |
| Unbilled costs and fees                                                                              |       | (110                         | )          | 250 |   |
| Inventories                                                                                          |       | 7,848                        |       | (4,854 | ) |
| Prepaid expenses and other assets                                                                    |       | 319                          |       | 348 |   |
| Accounts payable                                                                                     |       | (2,024                       | )          | 1,609 |   |
| Accrued income taxes                                                                                 |       | 3,058                        |       | 65 |   |
| Customer deposits                                                                                    |       | (4,460                       | )          | (516 | ) |
| Deferred revenue                                                                                     |       | (1,357                       | )          | (603 | ) |
| Accrued expenses and other current  liabilities                                                      |       | 2,724                        |       | 447 |   |
| Non-current liabilities                                                                              |       | (37                          | )          | 39 |   |
| Total adjustments                                                                                    |       | (1,631                       | )          | (98 | ) |
| Net cash provided by (used for) operating  activities                                                |       | 13,762                       |       | (239 | ) |
|                                                                                                 |       |                         |       |   |   |
| Cash flows from investing activities:                                                                |       |                         |       |   |   |
| Purchases of short-term investments                                                                  |       | (25,444                      | )          | (5,345 | ) |
| Maturity of short-term investments                                                                   |       | 23,915                       |       | 1,387 |   |
| Purchases of property and equipment                                                                  |       | (3,522                       | )          | (1,297 | ) |
| Net cash used for investing activities                                                               |       | (5,051                       | )          | (5,255 | ) |
|                                                                                                 |       |                         |       |   |   |
| Cash flows from financing activities:                                                                |       |                         |       |   |   |
| Decrease (increase) in restricted cash                                                               |       | 193                          |       | (45 | ) |
| Proceeds from exercise of stock options and  warrants                                                |       | 4,417                        |       | 5,849 |   |
| Proceeds from leasehold improvements  financing                                                      |       | 1,500                        |       | — |   |
| Net cash provided by financing activities                                                            |       | 6,110                        |       | 5,804 |   |
| Foreign currency effect on cash                                                                      |       | 1                            |       | (18 | ) |
| Net increase (decrease) in cash and cash  equivalents                                                |       | 14,822                       |       | 292 |   |
| Cash and cash equivalents at beginning of  period                                                    |       | 15,418                       |       | 18,232 |   |
| Cash and cash equivalents at end of period                                                           |       | $                            | 30,240     |   | $ | 18,524 |   |

 

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

 

5

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

**Notes to Unaudited Condensed ConsolidatedFinancial Statements**

 

**1.              General**

 

The condensed consolidated financial statements include the accounts ofthe Company and its wholly owned Subsidiary. All intercompany transactions andbalances 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 condensed consolidated financial statements, in the opinion ofmanagement, include all adjustments necessary, consisting solely of normalrecurring adjustments, to present fairly the Company’s financial position, resultsof operations and cash flows.  These results are not necessarilyindicative of 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 against outstandingstandby 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** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In thousands)**                                      | ** ** | **Sept. 30,  2005**    | ** ** | **Sept. 30,  2004**  | ** ** | **Sept. 30,  2005** | ** ** | **Sept. 30,  2004** | ** ** |
| Net income (loss)                                       |       | $                      | 8,396      |                 | $          | 399 |   | $ | 15,393 |   | $ | (141 | )  |
| Foreign currency translation adjustments                |       | 12                     |       | (2                   | )          | 1 |   | (12 | ) |
| Unrealized gains and losses from marketable  securities |       | (22                    | )          | (7                   | )          | (18 | ) | (7 | ) |
| Comprehensive income (loss)                             |       | $                      | 8,386      |                 | 390        |   | $ | 15,376 |   | $ | (160 | ) |
|                                                         |            |                        |            |                      |            |  |  |  |  |  |  |  |  |

 

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

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| ** **                                                               | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In thousands except per share  amounts)**                             | ** ** | **Sept. 30,  2005**    | ** ** | **Sept. 30,  2004**  | ** ** | **Sept. 30,  2005** | ** ** | **Sept. 30,  2004** | ** ** |
| Net income (loss)                                                        |       |                   |       |                 |       |   |   |   |   |
| As reported                                                              |       | $                      | 8,396      |                 | $          | 399 |   | $ | 15,393 |   | $ | (141 | ) |
| Add: Stock based compensation included in  net income (loss) as reported |       | 106                    |       | 49                   |       | 157 |   | 87 |   |
| Less: Stock based compensation using fair  value method for all awards   |       | (879                   | )          | (1,358               | )          | (4,904 | ) | (1,508 | ) |
| Pro forma net income (loss)                                              |       | $                      | 7,623      |                 | (910       | ) | $ | 10,646 |   | $ | (1,562 | ) |
| Income (loss) per share –Basic:                                     |       |                   |       |                 |       |   |   |   |   |
| As reported                                                              |       | $                      | 0.99       |                 | $          | 0.05 |   | $ | 1.83 |   | $ | (0.02 | ) |
| Pro forma                                                                |       | $                      | 0.90       |                 | $          | (0.12 | ) | $ | 1.26 |   | $ | (0.20 | ) |
| Income (loss) per share –Diluted:                                   |       |                   |       |                 |       |   |   |   |   |
| As reported                                                              |       | $                      | 0.93       |                 | $          | 0.05 |   | $ | 1.72 |   | $ | (0.02 | ) |
| Pro forma                                                                |       | $                      | 0.85       |                 | $          | (0.12 | ) | $ | 1.20 |   | $ | (0.20 | ) |

 

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 3.4% and 3.8% for fiscal2006 and fiscal 2005, respectively, expected volatility of 62% and 72%for fiscal 2006 and 2005, respectively, an expected dividend yield of 0%for both periods and an expected life of 3 to 5 years and 5 years for fiscalyears 2006 and 2005, respectively.

 

On April 22, 2005, the Company announced that its Board ofDirectors had accelerated the vesting of certain unvested stock optionspreviously awarded to employees.  Options to purchase 186,033 shares ofcommon stock were subject to the acceleration.  The acceleration waseffective immediately, on a fully vested basis.  Options held by the Boardof Directors, the Chief Executive Officer, the Chief Financial Officer, andother employees who participated in other incentive or commission compensationplans were excluded from the acceleration.  The Company recorded duringthe three and six months ended September 30, 2005 respectively $50,000 and$64,000, in compensation expense related to these accelerated options foroptions exercised by individuals who terminated employment prior to theoriginal option vesting date.

 

**2.              Inventories**

 

Inventories consisted of:

 
| **(in thousands)**                         | ** ** | **Sept 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-------------------------|------------|
|                                       |       |                   |       |                    |       |
| Raw materials and completed sub-assemblies |       | $                      | 5,096      |                    | $          | 12,763 |   |
| Work-in-process                            |       | 3,704                  |       | 5,458                   |       |
| Finished goods                             |       | 6,051                  |       | 6,720                   |       |
| Total                                      |       | $                      | 14,851     |                    | $          | 24,941 |   |

 

Inventory balances decreased from year end due to the increasedshipments in the first six months of fiscal 2006.

 

**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 and six months ended September 30, 2005 and September 30,2004, common stock equivalents of 177,000, 304,000, 179,000 and 835,000,respectively, are excluded from diluted earnings per share, as their effect isanti-dilutive.

 
| ** **                                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In thousands except per share  amounts)**                                             | ** ** | **Sept. 30,  2005**    | ** ** | **Sept. 30,  2004**  | ** ** | **Sept. 30,  2005** | ** ** | **Sept. 30,  2004** | ** ** |
| **Income (Loss) Per Share**                                                              |       |                   |       |                 |       |   |   |   |   |
| **Basic:**                                                                               |       |                   |       |                 |       |   |   |   |   |
| Net income (loss)                                                                        |       | $                      | 8,396      |                 | $          | 399 |   | $ | 15,393 |   | $ | (141 | ) |
| Weighted average number of common shares  outstanding –basic                        |       | 8,475                  |       | 7,860                |       | 8,425 |   | 7,709 |   |
| Net income (loss) per share –basic                                                  |       | $                      | 0.99       |                 | $          | 0.05 |   | $ | 1.83 |   | $ | (0.02 | ) |
| **Diluted:**                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net income (loss)                                                                        |       | $                      | 8,396      |                 | $          | 399 |   | $ | 15,393 |   | $ | (141 | ) |
| Weighted average number of common shares  outstanding                                    |       | 8,475                  |       | 7,860                |       | 8,425 |   | 7,709 |   |
| Assumed exercise of stock options and  warrants, using the treasury stock method         |       | 528                    |       | 523                  |       | 506 |   | — |   |
| Weighted average number of common and  potential common shares outstanding –diluted |       | 9,003                  |       | 8,383                |       | 8,931 |   | 7,709 |   |
| Net income (loss) per share –diluted                                                |       | $                      | 0.93       |                 | $          | 0.05 |   | $ | 1.72 |   | $ | (0.02 | ) |

 

7

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**4.              Borrowings**

 

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

 

The credit facilities bear an interest rate of the greater of 4.0% orthe Silicon Valley Bank prime rate (6.75% at September 30, 2005). Thecredit agreements are collateralized by certain assets of the Company andcontain certain restrictions, including limitations on the amount ofdistributions that can be made to stockholders, and the disposition orencumbrances of assets, and require the maintenance of certain financialcovenants.

 

At September 30, 2005, there were no borrowings outstandingagainst these credit facilities. The Company had outstanding $300,000 instand-by letters of credit against the domestic facility related to itsbuilding lease and $58,000 in stand-by letters of credit against the exportfacility guaranteeing performance on an international project.  No amountshave been drawn against these letters of credit. In addition, at September 30,2005, the Company had a restricted cash balance of $162,000 related to certainbank required deposits related to outstanding letters of credits, bid bonds,and other bank-related fees.

 

**5.              Warrant Liability**

 

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

 

During the quarter ended September 30, 2005, warrants to purchase18,050 shares of common stock were exercised resulting in total proceedsreceived of $425,000.  The fair market value of the warrants at the dateof exercise totaled $765,000.  The cash proceeds and the fair value of theliability were recorded as additional paid in capital at September 30,2005.

 

At September 30, 2005, 167,700 warrants remainoutstanding.   Due to certain conversion features of these warrantsthat provide that the holder may opt for a cash settlement in certain instances,including a merger, a sale of all or substantially all of the Company’s assets,or a tender offer or exchange offer of shares of the Company’s stock, aliability equal to the Black-Scholes valuation of the warrants at the dealclosing date was recorded on the Company’s balance sheet. The “mark to market”change in the warrants valuation of $3,450,000 and $2,266,000 was recorded asother expense for the three months ended September 30, 2005 and September 30,2004, respectively.  The “mark to market” change in the warrants valuationof $2,917,000 and $3,187,000 was recorded as other expense for the six monthsended September 30, 2005 and September 30, 2004, respectively. The liability of $7,592,000 and $6,137,000 representing the fair market valueof outstanding warrants at period end is recorded as a non-current liability atSeptember 30, 2005 and March 31, 2005, respectively. The fair marketvalue of the warrants was determined using the Black-Scholes pricing model withan assumed volatility of 72% and 73% at September 30, 2005 and March 31,2005, respectively, an interest rate of 3.125% and 3.25% at September 30,2005 and March 31, 2005, respectively and a life equal to the remainingterm of the 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 a full valuation allowance againstits deferred tax assets at March 31, 2005 based upon its evaluation ofthree year cumulative historical results and its projection of future taxableincome and had determined that it was more likely than not that its deferredtax asset would not be realized.

 

In the first quarter of fiscal 2006, the Company reevaluated itsvaluation allowance for deferred tax assets and determined that a full releaseof valuation allowances was appropriate based upon period earnings, the Company’supdated forecasted earnings for fiscal 2006, sales backlog and otherfactors.  The release of the valuation allowance, as it relates to taxexpenses, has been included in determining the Company’s annual effective taxrate for fiscal 2006.  In connection with this release, the Company alsorecorded a corresponding entry to paid in capital totaling $7,025,000 for netoperating loss carry-forwards resulting from the exercise of certain

 

8

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employee stock options.

 

**7.              Guarantees**

 

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

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In thousands)**                                | ** ** | **Sept. 30,  2005**    | ** ** | **Sept. 30,  2004**  | ** ** | **Sept. 30,  2005** | ** ** | **Sept. 30,  2004** | ** ** |
| Warranty accrual - beginning of period            |       | $                      | 2,768      |                 | $          | 900 |   | $ | 2,322 |   | $ | 699 |   |
| Accruals for warranties issued during the  period |       | 1,327                  |       | 642                  |       | 2,141 |   | 1,048 |   |
| Warranty costs incurred during the period         |       | (344                   | )          | (299                 | )          | (712 | ) | (504 | ) |
| Warranty accrual – end of period             |       | $                      | 3,751      |                 | $          | 1,243 |   | $ | 3,751 |   | $ | 1,243 |   |

 

In conjunction with the sale of certain assets and contracts of theCompany’s High Energy Systems Division in January of 2005, the lease forthe California operations of the High Energy Systems Division was assigned toAccuray, Inc.  The Company remains secondarily liable for theremaining lease payments in the event of default by Accuray, Inc. duringthe lease term which expires in February 2011. Total remaining leasepayments at September 30, 2005 totaled $1,944,000.  No accrual forthis contingent liability has been recorded at September 30, 2005 aspayment of this liability is considered remote.

 

**8.              Lease Commitments**

 

InMarch 2005, the Company renewed its lease agreement for its corporateheadquarters and manufacturing facilities in Billerica, Massachusetts.  As part of the lease agreement, the Company’slandlord agreed to certain renovations to the Billerica facility including theconstruction of additional high bay manufacturing space.  The Company is responsible for a portion ofthe construction costs and was deemed to be the owner of the building duringthe construction period under EITF 97-10 “The Effect of Lessee Involvement inAsset Construction”.  During the quarterended September 30, 2005, upon commencement of the construction project,the Company capitalized $5,153,000 to record the building facility on its bookswith an offsetting credit to the Leasehold financing liability.  In addition, amounts paid for construction wererecorded as construction in progress and the landlord constructioncontributions of $1,500,000 in the period were recorded as additional leaseholdfinancing liability.  In connection withthe construction, the Company has entered into a construction contract with atotal commitment of $6,419,000.

 

Uponcompletion of construction, the lease may qualify for sale-leaseback treatmentin accordance with SFAS No. 98.  Forthese leases, the deemed landlord financing liability and the associatedconstruction-in-progress and capitalized building costs will be removed and thedifference will be reclassified to prepaid or deferred rent and amortized overthe lease term as rent expense.  If thelease does not qualify for sale-leaseback treatment in accordance with SFAS No. 98,the deemed landlord financing liability will be amortized over the lease termbased on the payments designated in the agreement and the building andimprovement assets will be depreciated on a straight line basis over theiruseful lives.

 

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

 

Results of Operations

 

Net revenues for the second quarter of fiscal 2006 increased by$28,087,000 to $49,141,000 compared to the corresponding period a yearago.  This increase is attributable primarily to an increase of$25,481,000 in product sales due to increased shipments of Z Backscattersystems which continued to experience high order volume and comprised$22,743,000 of the total product sale increase.   In addition, there was an increase of$2,820,000 in CargoSearch system revenues due to work performed on one largeCargoSearch project during the quarter and an increase of $1,423,000 inaftermarket part sales. These increases were partially offset by a$1,153,000 decrease in sales from the High Energy Systems group due to the saleof certain assets and contracts of the High Energy Systems division in thefourth quarter of fiscal 2005.  Service revenues increased by $2,606,000to $7,162,000 compared to the first quarter of fiscal 2005 due primarily to theincreased volume of service contracts related to systems sold over the past 12months.

 

Net revenues for the six months ended September 30, 2005 increasedby $46,437,000 to $84,303,000 compared to the corresponding period a yearago.  This increase is attributable primarily to an increase of$42,172,000 in product sales due to increased shipments of Z Backscattersystems which comprised $36,481,000 of this increase.  In addition, therewas an increase of $6,241,000 in CargoSearch system revenues with increasedactivity on system projects ongoing during the period and a $2,205,000 increasein sales of after-market parts.  These increases were partially offset bya $2,727,000 decrease in sales from the High Energy Systems group due to thesale of certain assets and contracts of the High Energy Systems division in thefourth quarter of fiscal 2005.  Service revenues increased by $4,265,000to $12,811,000 compared to the first quarter of fiscal 2005 due primarily tothe increased volume of service contracts related to systems sold over the past12 months.

 

Total cost of sales and contracts for the second quarter of fiscal 2006increased by $10,308,000 to $24,365,000 as compared to the corresponding perioda year ago. Cost of sales and contracts related to product revenues increasedby $8,419,000 to $19,781,000 as

 

9

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compared to the corresponding period a year ago.  Cost of productsales and contract revenues represented 47% of revenues versus 69% of revenuefor the corresponding period last year.  This improvement in gross marginis due primarily to the mix of products sold in the period, improved absorptionof fixed overhead costs due to the significant volume increases, and thereduction of direct costs of certain products through improved supplieragreements and a reduction of internal labor costs per system due to operatingefficiencies.   Some of the product gross margin improvement wasoffset by an increase in reserves for excess and obsolete inventory($1,000,000) in the quarter due to changes in the Company’s projected mix ofproduct usage.  Cost of services revenues increased by $1,889,000 to$4,584,000 as compared to the corresponding period a year ago.  Cost ofservice revenues represented 64% of revenues versus 59% for the correspondingperiod last year.  This margin decline is due primarily to comparativelyhigher costs incurred on certain service contracts during the period.

 

Total cost of sales and contracts for the six months ended September 30,2005 increased by $19,204,000 to $44,935,000 as compared to the correspondingperiod a year ago. Cost of sales and contracts related to product revenuesincreased by $15,924,000 to $36,808,000 as compared to the corresponding perioda year ago.  Cost of product sales and contract revenues represented 51%of revenues versus 71% of revenue for the corresponding period last year. This improvement in gross margin is due primarily to the mix of products soldin the period, improved absorption of fixed overhead costs due to thesignificant volume increases, and the reduction of direct costs of certainproducts through improved supplier agreements and a reduction of internal laborcosts per system due to operating efficiencies.   Some of the productgross margin improvement was offset by an increase in reserves for excess andobsolete inventory ($2,241,000) in the first six months of fiscal 2006 due tochanges in the Company’s projected mix of product usage.  Cost of servicesrevenues increased by $3,280,000 to $8,127,000 as compared to the correspondingperiod a year ago.  Cost of service revenues represented 63% of revenuesversus 57% for the corresponding period last year.  This margin decline isdue primarily to comparatively higher costs incurred on certain servicecontracts during the period.

 

Selling, general and administrative expenses for the second quarter offiscal 2006 of $4,699,000 were $1,251,000 higher than the corresponding perioda year ago.  Selling, general and administrative expenses represented 10%of revenues in the current period as compared to 16% for the correspondingperiod last year.  The increase in costs are attributable primarily toincreased incentive and payroll costs ($707,000), increased marketing andtravel related costs ($282,000) due to increased sales activity, and increasedcorporate insurance costs ($110,000). These increases were offset by a $128,000reduction in expenses related to the High Energy Systems division whose assetswere sold in the fourth quarter of fiscal 2005 and remaining operationsconsolidated with the Company’s corporate headquarters.

 

Selling, general and administrative expenses for the six months ended September 30,2005 of $8,837,000 were $2,116,000 higher than the corresponding period a yearago.  Selling, general and administrative expenses represented 10% ofrevenues in the current period as compared to 18% for the corresponding periodlast year.  The increase in costs are attributable primarily to increasedincentive and payroll costs ($1,238,000), marketing and travel related costs($506,000) due to increased sales activity, increased legal expenditures($249,000) related to ongoing litigation, and costs related to the Company’ssoftware implementation project ($154,000).  These increases were offsetby a $418,000 reduction in expenses related to the High Energy Systems divisionwhose assets were sold in the fourth quarter of fiscal 2005 and remainingoperations consolidated with the Company’s corporate headquarters.

 

Company funded research and development expenses of $2,470,000 for thesecond quarter of fiscal 2006 increased by $1,458,000 compared to thecorresponding period last year. Research and development expenses remainedconstant at 5% of revenues in both periods reported.**  ** Theseexpenditures increased primarily due to three product development programsongoing during the quarter.

 

Company funded research and development expenses of $4,892,000 for thesix months ended September 30, 2005 increased by $2,425,000 compared tothe corresponding period last year. Research and development expensesrepresented 6% of revenues in the current period compared to 7% for thecorresponding period last year.**  ** These expendituresincreased primarily due to three product development programs ongoing duringthe fiscal year.

 

Other income (expense) was $2,928,000 in expense for the second quarterof fiscal 2006 as compared to $2,073,000 in expense for the correspondingperiod a year ago.   At September 30, 2005, other income(expense) included warrants which were “marked to market” using Black-Scholesand the change in the valuation of the warrants of $3,450,000 was recorded asother expense in the quarter. During the three months ended September 30,2004, this mark to market adjustment generated $2,266,000 in otherexpense.  In addition, in the quarter ended September 30, 2005, theCompany earned $511,000 in income on investments held as compared to $126,000in the quarter ended September 30, 2004 due to increases in the Company’scash and investments balances over the prior year.

 

Other income (expense) was $2,020,000 in expense for the first sixmonths of fiscal 2006 as compared to $3,023,000 in expense for thecorresponding period a year ago.   At September 30, 2005, otherincome (expense) included warrants which were “marked to market” usingBlack-Scholes and the change in the valuation of the warrants of $2,917,000 wasrecorded as other expense in the period. During the six months ended September 30,2004, this mark to market adjustment generated $3,186,000 in otherexpense.  In addition, in the six months ended September 30, 2005,the Company earned $872,000 in income on investments held as compared to$167,000 in the six months ended September 30, 2004 due to increases inthe Company’s cash and investments balances over the prior year.

 

The Company reported pre-tax income of $14,679,000 in the quarter endedSeptember 30, 2005 as compared to pre-tax income of

 

10

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$464,000 in the corresponding period a year ago due to the factorsdescribed above. For the six months ended September 30, 2005, the Companyreported pre-tax income of $23,619,000 as compared to a pre-tax loss of $76,000for the corresponding period a year ago attributable to the factors describedabove.   At March 31, 2005, theCompany had gross deferred tax assets of $9,740,000.  The Company hadapplied a full valuation allowance against its deferred tax assets at March 31,2005 based upon its evaluation of three year cumulative historical results andits projection of future taxable income and had determined that it was morelikely than not that its deferred tax asset would not be realized.

 

In the first quarter of fiscal 2006, the Company reevaluated itsvaluation allowance for deferred tax assets and has determined that a fullrelease of valuation allowance was appropriate based upon period earnings, theCompany’s updated forecasted earnings for fiscal 2006, sales backlog and otherfactors.  The release of the valuation allowance has been included indetermining the Company’s annual effective tax rate for fiscal 2006.  Inconnection with this release, the Company recorded a corresponding entry topaid in capital totaling $7,025,000 for net operating loss carry-forwardsresulting from the exercise of certain employee stock options.

 

The Company had net income of $8,396,000 during the second quarter offiscal 2006 as compared to net income of $399,000 in the second quarter offiscal 2005.  The Company had net income of $15,393,000 for the six monthsended September 30, 2005 as compared to a net loss of $141,000 for the sixmonths ended September 30, 2004. The significant factors contributing to these results are noted in theabove sections.

 

Liquidity and Capital Resources

 

Cash and cash equivalents increased by $14,822,000 to $30,240,000 at September 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 and a decrease in inventory balances andcorresponding increase in outstanding accounts receivable attributable to theincreased revenues and shipments during the period.  In addition, the Company received $4,417,000upon exercise of outstanding stock options and warrants and $1,500,000 advancepayment received from the landlord for leasehold improvements.   These increases were offset somewhat by netpurchases of short term investments of $1,531,000 during the period and$3,522,000 in capital expenditures related primarily to the Company’s ongoingERP system implementation, the construction of certain systems to be used formarketing demonstration purposes, and construction related costs on a buildingexpansion project commenced during the quarter ended September 30, 2005.

 

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

 

The credit facilities bear an interest rate of the greater of 4.0% orthe Silicon Valley Bank prime rate (6.75% at September 30, 2005). Thecredit agreements are collateralized by certain assets of the Company andcontain certain restrictions, including limitations on the amount ofdistributions that can be made to stockholders, and the disposition orencumbrances of assets, and require the maintenance of certain financial covenants.

 

At September 30, 2005, there were no borrowings outstandingagainst these credit facilities. The Company had outstanding $300,000 instand-by letters of credit against the domestic facility related to itsbuilding lease and $58,000 in stand-by letters of credit against the exportfacility guaranteeing performance on an international project.  No amountshave been drawn against these letters of credit. In addition, at September 30,2005, the Company had a restricted cash balance of $162,000 related to certainbank required deposits related to outstanding letters of credits, bid bonds,and other bank-related fees.

 

**New Accounting Pronouncements:**

 

In December 2004, the FASB issued SFAS No. 123(R), “Share-BasedPayment” (SFAS 123(R)) which establishes accounting standards for alltransactions in which an entity exchanges its equity instruments for goods andservices. SFAS 123(R) revises SFAS No. 123, “Accounting forStock-Based Compensation”, supercedes Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” and amends Financial AccountingStandard No. 95, “Statement of Cash Flows”. SFAS No. 123(R) generallyrequires the Company to measure the cost of employee services received inexchange for an award of equity instruments based on the fair value of theaward on the date of the grant. The standard requires the fair value on thegrant date to be estimated using either an option-pricing model which isconsistent with the terms of the award or a market observed price, if such aprice exists. The resulting cost must be recognized over the period duringwhich an employee is required to provide service in exchange for the award,which is usually the vesting period. In April 2005, the SEC deferred theeffective date for SFAS 123(R) to the beginning of the first fiscal year thatbegins after June 15, 2005. The Company expects to adopt SFAS 123(R)on the effective date, and expects the adoption to have a material impact onits results of operations, financial position and cash flows.

 

In December 2004, the FASB issued SFAS No.151, “Inventory Costs*,*” which amends part of ARB 43, “InventoryPricing,” concerning the treatment of certain types of inventory costs. Theprovisions of ARB No. 43 provided that certain inventory-related costs, suchas double freight and re-handling, might be “so abnormal” that they should becharged against current earnings rather than

 

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be included in the cost of inventory. As amended by SFAS No. 151,the “so-abnormal” criterion has been eliminated. Thus, all such abnormal costsare 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.

 

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

 

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

 

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

 

As of September 30, 2005, the Company held short-term investmentsconsisting of money market funds and U.S. government and government agencybonds. The Company’s primary objective with its investment portfolio is toinvest available cash while preserving principal and meeting liquidity needs.These investments had an average interest rate of approximately 3.86% and aresubject to interest rate risk. As a result of the average maturity andconservative nature of the investment portfolio, a sudden change in interestrates would not have a material adverse effect on the value of theseinvestments.

 

In fiscal 2003, the Company issued 295,475 warrants in connection witha private placement offering of common stock.  As of September 30,2005, 167,700 of these warrants remain outstanding.  These warrants can beexchanged for cash under certain circumstances including a merger, sale ortender offer of the Company, and as such a liability equal to Black-Scholesvalue of the warrants is recorded on the balance sheet. Changes in the fairvalue of the warrants are recorded as other income (expense). The Black-Scholesvalue of these warrants can fluctuate significantly based on the current fairmarket value of the Company’s common stock. A 10% change in the fair marketvalue of the Company’s common stock, holding other assumptions constant, wouldhave approximately a $1,049,000  positiveor negative impact on earnings.

 

**Item 4 - Controls and Procedures**

 

a)             Evaluation ofdisclosure 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, includingits Chief Executive Officer and Chief Financial Officer, as appropriate toallow 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**

 

In February 2004, L-3 Communications, Inc. (“L-3”) filed alawsuit against the Company in the United States District Court for theDistrict of Massachusetts in Boston, seeking declaratory judgments ofnon-infringement and/or invalidity of two of the Company’s patents—UnitedStates Patent No. 6,292,533 and No. 5,903,623. The Company answeredL-3’s underlying complaint, vigorously opposing the plaintiff’snon-infringement and invalidity claims, and subsequently engaged in substantialdiscovery. In September 2005, the court denied a motion filed by theCompany for summary judgment and granted a related motion that was later filedby L-3 regarding certain of the claims in one of the patents.  The court’s ruling, which is currently thesubject of a motion for reconsideration,

 

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does not address other claims in the case, which remain to beadjudicated.  The parties continue toengage in discovery as to the remaining claims.

 

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

 

**Item 4 - Submission of Matters to a Vote ofSecurity Holders**

** **

At the annual meeting of Stockholders of the Company held on September 15,2005, the stockholders of the Company (1) elected William E. Odom, DenisR. Brown, Roger P. Heinisch, Hamilton W. Helmer, Ernest J. Moniz, Carl W. Vogtand Anthony R. Fabiano as directors of the Company to hold office for aone-year term and no other nominations were made; (2) approved theadoption of the Company’s 2005 Equity and Incentive Plan; and (3) ratifiedthe appointment of PricewaterhouseCoopers LLP as our independent auditors forthe fiscal year ending March 31, 2006.  The votes were as follows:

 
| ** **                                                                    | ** ** | **Votes For** | ** ** | **Votes  Withheld or  Opposed** | ** ** | **Abstentions** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------|------------|---------------------------------|------------|-----------------|------------|
|                                                                          |       |          |       |                            |       |            |       |
| (1) Election of Directors:                                               |       |          |       |                            |       |            |       |
| William E. Odom                                                               |       | 7,708,196     |       | 194,546                         |       | —          |       |
| Denis R. Brown                                                                |       | 7,621,522     |       | 281,220                         |       | —          |       |
| Roger P. Heinisch                                                             |       | 6,230,464     |       | 1,672,278                       |       | —          |       |
| Hamilton W. Helmer                                                            |       | 7,543,473     |       | 359,269                         |       | —          |       |
| Ernest J. Moniz                                                               |       | 7,716,767     |       | 185,975                         |       | —          |       |
| Carl W. Vogt                                                                  |       | 7,616,173     |       | 286,569                         |       | —          |       |
| Anthony R. Fabiano                                                            |       | 7,544,987     |       | 357,755                         |       | —          |       |
|                                                                          |       |          |       |                            |       |            |       |
| (2) Approval of the 2005 Equity and  Incentive Plan                      |       | 2,634,922     |       | 2,105,823                       |       | 69,148          |       |
| (3) Ratification of  PricewaterhouseCoopers LLP as independent auditors. |       | 7,798,298     |       | 53,082                          |       | 51,362          |       |

 

**Item6 - Exhibits**

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

 

The information required by Exhibit Item 11 (Statement re:Computation of Income per Common and Common Equivalent Share) may be found inFootnote No. 3 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 November 9, 2005 | /s/ Kenneth J. Galaznik                |   |
|                       | Kenneth J. Galaznik                    |
|                       | Chief Financial Officer and Treasurer  |

 

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*Safe Harbor Statement*

 

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

 

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

 

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

 

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