Tableof Contents

 

 

 

**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **x**                                                      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**      |
|------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|
|                                                       |       |                                                                                                         |
| **For the quarterly period ended  December 31, 2008** |
|                                                       |       |                                                                                                         |
| **OR**                                                     |
|                                                       |       |                                                                                                         |
| **o**                                                      | ** ** | **T****RANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**Forthe transition period from      to      **

 

**Commission File Number 1-6549**

 

**American Science and Engineering, Inc.**

(Exact name ofRegistrant as specified in its charter)

 

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

 

**(978)262-8700**

(Registrant’stelephone number, including area code)

 

 

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

 

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

 

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

 

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

 

The number of shares ofthe registrant’s common stock, $0.66 2/3 par value, outstanding as of January 31,2009 was 9,106,963.

 

 

 

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**TABLE OF CONTENTS**

 
| **Part I  — Financial Information**                                                                                                          |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item  1 — Financial Statements                                                                                                                    | 3      |
| Unaudited  Condensed Consolidated Balance Sheets—December 31, 2008 and  March 31, 2008                                                  | 3      |
| Unaudited Condensed Consolidated Statements of  Operations—For the Three and Nine Months Ended December 31, 2008 and  December 31, 2007 | 4      |
| Unaudited Condensed Consolidated Statements of Cash  Flows—For the Nine Months Ended December 31, 2008 and December 31,  2007           | 5      |
| Notes to Unaudited Condensed Consolidated Financial Statements                                                                                         | 6      |
| Item  2 — Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                             | 12     |
| Item 3 — Quantitative and Qualitative Disclosure About  Market Risk                                                                               | 15     |
| Item  4 — Controls and Procedures                                                                                                                 | 15     |
| **Part II  — Other Information**                                                                                                             |   |
| Item 1A  —Risk Factors                                                                                                                            | 15     |
| Item  1 — Legal Proceedings                                                                                                                       | 16     |
| Item 2 — Purchases of Equity Securities                                                                                                           | 16     |
| Item 6 —  Exhibits                                                                                                                                | 17     |
| **Signatures**                                                                                                                                         | 17     |

 

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**PART I— FINANCIAL INFORMATION**

**ITEM1 — FINANCIAL STATEMENTS**

** **

**AMERICAN SCIENCE AND ENGINEERING,INC. AND SUBSIDIARYCONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| **Dollars in thousands**                                                                                                                                                             | ** ** | **December 31,  2008** | ** ** | **March 31,  2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| **Assets**                                                                                                                                                                                     | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Current assets:                                                                                                                                                                                |       |                        |       |                     |       |
| Cash and cash  equivalents                                                                                                                                                                     |       | $                           | 83,395     |                     | $          | 52,418 |   |
| Restricted cash  and investments                                                                                                                                                               |       | 59                          |       | 319                      |       |
| Short-term  investments, at fair value                                                                                                                                                         |       | 47,934                      |       | 72,687                   |       |
| Accounts  receivable, net of allowances of $399 and $230 at December 31, 2008 and  March 31, 2008, respectively                                                                      |       | 44,176                      |       | 27,583                   |       |
| Unbilled costs  and fees                                                                                                                                                                       |       | 4,917                       |       | 6,114                    |       |
| Inventories                                                                                                                                                                                    |       | 45,042                      |       | 40,107                   |       |
| Prepaid expenses  and other current assets                                                                                                                                                     |       | 7,889                       |       | 4,815                    |       |
| Deferred income  taxes                                                                                                                                                                         |       | 2,571                       |       | 1,577                    |       |
| **Total  current assets**                                                                                                                                                                      |       | 235,983                     |       | 205,620                  |       |
| Building,  equipment and leasehold improvements, net                                                                                                                                           |       | 20,161                      |       | 22,201                   |       |
| Restricted cash  and investments                                                                                                                                                               |       | —                      |       | 2,204                    |       |
| Deferred income  taxes                                                                                                                                                                         |       | 6,191                       |       | 5,231                    |       |
| Other assets,  net                                                                                                                                                                             |       | 965                         |       | 278                      |       |
| **Total  assets**                                                                                                                                                                              |       | $                           | 263,300    |                     | $          | 235,534 |   |
|                                                                                                                                                                                           |       |                        |       |                     |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                 | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Current  liabilities:                                                                                                                                                                          |       |                        |       |                     |       |
| Accounts payable                                                                                                                                                                               |       | $                           | 13,958     |                     | $          | 12,660 |   |
| Accrued salaries  and benefits                                                                                                                                                                 |       | 8,222                       |       | 2,935                    |       |
| Accrued warranty  costs                                                                                                                                                                        |       | 2,216                       |       | 1,671                    |       |
| Accrued income  taxes                                                                                                                                                                          |       | 2,198                       |       | —                   |       |
| Deferred revenue                                                                                                                                                                               |       | 21,951                      |       | 23,120                   |       |
| Customer  deposits                                                                                                                                                                             |       | 16,249                      |       | 6,547                    |       |
| Current portion  of lease financing liability                                                                                                                                                  |       | 1,146                       |       | 1,134                    |       |
| Other current  liabilities                                                                                                                                                                     |       | 6,976                       |       | 8,097                    |       |
| **Total  current liabilities**                                                                                                                                                                 |       | 72,916                      |       | 56,164                   |       |
| Lease financing  liability, net of current portion                                                                                                                                             |       | 8,679                       |       | 9,540                    |       |
| Other long term  liabilities                                                                                                                                                                   |       | 5,788                       |       | 3,758                    |       |
| **Total  liabilities**                                                                                                                                                                         |       | 87,383                      |       | 69,462                   |       |
|                                                                                                                                                                                           |       |                        |       |                     |       |
| **Stockholders’  equity:**                                                                                                                                                                | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Preferred stock,  no par value, 100,000 shares authorized; no shares issued                                                                                                                    |       | —                      |       | —                   |       |
| Common stock,  $0.66 2/3 par value, 20,000,000 shares authorized;  8,845,497 and 8,945,633 shares issued and  outstanding at December 31, 2008 and March 31, 2008, respectively |       | 5,896                       |       | 5,963                    |       |
| Capital in  excess of par value                                                                                                                                                                |       | 86,716                      |       | 91,544                   |       |
| Accumulated  other comprehensive income                                                                                                                                                        |       | 12                          |       | 114                      |       |
| Retained  earnings                                                                                                                                                                             |       | 83,293                      |       | 68,451                   |       |
| **Total  stockholders’ equity**                                                                                                                                                           |       | 175,917                     |       | 166,072                  |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                           |       | $                           | 263,300    |                     | $          | 235,534 |   |

 

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

 

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**American Science and Engineering, Inc.and SubsidiaryCondensed Consolidated Statements of Operations(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                    | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Dollars and shares in thousands, except per share amounts**                                                                                                                                                         | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007**     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| ** **                                                                                                                                                                                                                                                    | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  sales and contract revenues:**                                                                                                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Net product  sales and contract revenues                                                                                                                                                                                                                      |       | $                                | 45,810     |                            | $          | 26,729 |   | $ | 107,114 |   | $ | 77,461 |   |
| Net service  revenues                                                                                                                                                                                                                                         |       | 19,480                           |       | 15,886                          |       | 53,963 |   | 47,252 |   |
| Total net sales  and contract revenues                                                                                                                                                                                                                        |       | 65,290                           |       | 42,615                          |       | 161,077 |   | 124,713 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| **Cost of  sales and contracts:**                                                                                                                                                                                                                             |       |                             |       |                            |       |   |   |   |   |
| Cost of product  sales and contracts                                                                                                                                                                                                                          |       | 25,616                           |       | 18,052                          |       | 63,484 |   | 51,693 |   |
| Cost of service  revenues                                                                                                                                                                                                                                     |       | 10,914                           |       | 9,379                           |       | 31,777 |   | 26,357 |   |
| Total cost of  sales and contracts                                                                                                                                                                                                                            |       | 36,530                           |       | 27,431                          |       | 95,261 |   | 78,050 |   |
| Gross profit                                                                                                                                                                                                                                                  |       | 28,760                           |       | 15,184                          |       | 65,816 |   | 46,663 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| **Expenses:**                                                                                                                                                                                                                                                 |       |                             |       |                            |       |   |   |   |   |
| Selling, general  and administrative expenses                                                                                                                                                                                                                 |       | 9,132                            |       | 7,609                           |       | 24,225 |   | 19,943 |   |
| Research and  development costs                                                                                                                                                                                                                               |       | 4,815                            |       | 3,148                           |       | 12,554 |   | 8,678 |   |
| Total expenses                                                                                                                                                                                                                                                |       | 13,947                           |       | 10,757                          |       | 36,779 |   | 28,621 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Operating income                                                                                                                                                                                                                                              |       | 14,813                           |       | 4,427                           |       | 29,037 |   | 18,042 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| **Other  income (expense):**                                                                                                                                                                                                                                  |       |                             |       |                            |       |   |   |   |   |
| Interest and  investment income                                                                                                                                                                                                                               |       | 477                              |       | 1,686                           |       | 2,113 |   | 5,444 |   |
| Interest expense                                                                                                                                                                                                                                              |       | (36                              | )          | (39                             | )          | (110 | ) | (119 | ) |
| Other, net                                                                                                                                                                                                                                                    |       | (252                             | )          | (182                            | )          | (335 | ) | (398 | ) |
| Change in  warrant valuation                                                                                                                                                                                                                                  |       | —                           |       | —                          |       | — |   | 11 |   |
| Total other  income                                                                                                                                                                                                                                           |       | 189                              |       | 1,465                           |       | 1,668 |   | 4,938 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Income before  provision for income taxes                                                                                                                                                                                                                     |       | 15,002                           |       | 5,892                           |       | 30,705 |   | 22,980 |   |
| Provision for  income taxes                                                                                                                                                                                                                                   |       | 4,943                            |       | 1,890                           |       | 10,596 |   | 8,291 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Net income                                                                                                                                                                                                                                                    |       | $                                | 10,059     |                            | $          | 4,002 |   | $ | 20,109 |   | $ | 14,689 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Income per  share—Basic                                                                                                                                                                                                                                  |       | $                                | 1.16       |                            | $          | 0.44 |   | $ | 2.32 |   | $ | 1.60 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
|                            —Diluted                                                                               |       | $                                | 1.13       |                            | $          | 0.43 |   | $ | 2.26 |   | $ | 1.56 |   |
|                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares—Basic                                                                                                                                                                                                                           |       | 8,670                            |       | 9,136                           |       | 8,679 |   | 9,163 |   |
|                                         —Diluted |       | 8,940                            |       | 9,357                           |       | 8,917 |   | 9,397 |   |
| Cash dividends declared  per common share                                                                                                                                                                                                                     |       | $                                | 0.20       |                            | $          | 0.20 |   | $ | 0.60 |   | $ | 0.40 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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**AMERICAN SCIENCE AND ENGINEERING,INC. AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

 
| ** **                                                                                | ** ** | **For the nine months ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **Dollars in thousands**                                                        | ** ** | **December 31,  2008**                       | ** ** | **December 31,  2007** | ** ** |
| **Cash  flows from operating activities:**                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net income                                                                                |       | $                                                 | 20,109     |   | $ | 14,689 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:        |       |                                              |       |   |   |
| Depreciation and  amortization                                                            |       | 3,194                                             |       | 3,071 |   |
| Provisions for  contracts, inventory and accounts receivable reserves                     |       | 1,874                                             |       | 77 |   |
| Amortization of  bond discount                                                            |       | (401                                              | )          | (1,798 | ) |
| Deferred income  taxes                                                                    |       | (1,954                                            | )          | (2,823 | ) |
| Stock based  compensation expense                                                         |       | 3,126                                             |       | 4,141 |   |
| Change in value  of warrants                                                              |       | —                                            |       | (11 | ) |
| Changes in  assets and liabilities:                                                       |       |                                              |       |   |   |
| Accounts  receivable                                                                      |       | (16,754                                           | )          | (12,983 | ) |
| Unbilled costs  and fees                                                                  |       | 1,197                                             |       | 3,940 |   |
| Inventories                                                                               |       | (6,648                                            | )          | (19,453 | ) |
| Prepaid expenses  and other assets                                                        |       | (3,761                                            | )          | 1,645 |   |
| Accounts payable                                                                          |       | 1,298                                             |       | 3,139 |   |
| Accrued income  taxes                                                                     |       | 2,198                                             |       | 1,031 |   |
| Customer  deposits                                                                        |       | 9,702                                             |       | (2,181 | ) |
| Deferred revenue                                                                          |       | 881                                               |       | 21,052 |   |
| Accrued expenses  and other current liabilities                                           |       | 5,289                                             |       | (749 | ) |
| Sale of leased  asset                                                                     |       | 116                                               |       | — |   |
| Non-current  liabilities                                                                  |       | (20                                               | )          | — |   |
| Net cash  provided by operating activities                                                |       | 19,446                                            |       | 12,787 |   |
|                                                                                      |       |                                              |       |   |   |
| **Cash  flows from investing activities:**                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Purchases of  short-term investments                                                      |       | (50,500                                           | )          | (125,282 | ) |
| Proceeds from  maturities of short-term investments                                       |       | 75,650                                            |       | 100,725 |   |
| Purchases of  property and equipment                                                      |       | (1,270                                            | )          | (2,271 | ) |
| Net cash  provided by (used for) investing activities                                     |       | 23,880                                            |       | (26,828 | ) |
|                                                                                      |       |                                              |       |   |   |
| **Cash  flows from financing activities:**                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Decrease in  restricted cash and investments                                              |       | 2,464                                             |       | 278 |   |
| Proceeds from  exercise of warrants                                                       |       | —                                            |       | 509 |   |
| Proceeds from  exercise of stock options                                                  |       | 4,602                                             |       | 2,939 |   |
| Repurchase of  shares of common stock                                                     |       | (14,382                                           | )          | (13,821 | ) |
| Payment of  dividends                                                                     |       | (5,267                                            | )          | (3,704 | ) |
| Proceeds from  financing of leasehold improvements                                        |       | —                                            |       | 417 |   |
| Repayment of  lease financing                                                             |       | (849                                              | )          | (1,054 | ) |
| Reduction of  income taxes paid due to the tax benefit from employee stock option expense |       | 1,181                                             |       | 1,221 |   |
| Net cash used  for financing activities                                                   |       | (12,251                                           | )          | (13,215 | ) |
| Foreign currency  translation effect on cash                                              |       | (98                                               | )          | (16 | ) |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 30,977                                            |       | (27,272 | ) |
| Cash and cash  equivalents at beginning of period                                         |       | 52,418                                            |       | 69,650 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                                 | 83,395     |   | $ | 42,378 |   |

 

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

 

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**AMERICANSCIENCE AND ENGINEERING, INC. AND SUBSIDIARYNOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.   GENERAL**

** **

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

 

The unauditedcondensed consolidated financial statements have been prepared in accordancewith the requirements of Form 10-Q and consequently do not include alldisclosures required by Form 10-K. These condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements and the notes included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended March 31, 2008.

 

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

 

**Nature of Operations**

** **

The Company isengaged in the development and manufacture of sophisticated X-ray inspectionsystems for critical detection and security screening solutions for saleprimarily to U.S. and foreign government agencies.  The Company has onlyone reporting segment, X-ray screening products.

 

**Significant Accounting Policies**

** **

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

 

The Company’s Loanand Security Agreement with Silicon Valley Bank East requires certain cashbalances to be restricted as collateral against outstanding standby letters ofcredit; these are separately presented as restricted cash. (See Note 5.)

 

The othersignificant accounting policies followed by the Company and its subsidiary inpreparing its consolidated financial statements are set forth in Note 1 to theconsolidated financial statements included in its Form 10-K for the yearended March 31, 2008.  The Company has made no changes to thesepolicies during the current year.

 

**Comprehensive Income**

** **

Comprehensiveincome is comprised of the following:

 
| ** **                                                          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                                             | ** ** | **December  31, 2008**      | ** ** | **December  31, 2007**     | ** ** | **December  31, 2008** | ** ** | **December  31, 2007** | ** ** |
| Net income                                                          |       | $                                | 10,059     |                            | $          | 4,002 |   | $ | 20,109 |   | $ | 14,689 |   |
| Foreign currency  translation adjustments, net of tax               |       | (74                              | )          | (20                             | )          | (95 | ) | (12 | ) |
| Unrealized gains  and losses from marketable securities, net of tax |       | 303                              |       | 15                              |       | (6 | ) | 15 |   |
| Comprehensive  income                                               |       | $                                | 10,288     |                            | $          | 3,997 |   | $ | 20,008 |   | $ | 14,692 |   |

 

**StockRepurchase Program**

 

On May 1,2007, the Company’s Board of Directors approved a Stock Repurchase Programwhich authorized the Company to repurchase up to $35 million in shares of itscommon stock from time to time on the open market.   This Stock Repurchase Program was completedin the first quarter of fiscal 2009.  On May 13,2008, the Board of Directors approved an additional Stock Repurchase Programwhich authorized the Company to repurchase up to another $35 million in sharesof its common stock from time to time on the open market.   During the nine months ended December 31,2008, a total of 281,027 shares were repurchased at an average price of $51.18per share under the two programs.  As of December 31, 2008, the maximumdollar value of shares that may yet be purchased under the remaining program is$30,412,000.

 

**Dividends**

 

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

 

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| ** **          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **          | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007**     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| Dividends  declared |       | $                                | 0.20       |                            | $          | 0.20 |   | $ | 0.60 |   | $ | 0.40 |   |
| Dividends paid      |       | $                                | 0.20       |                            | $          | 0.20 |   | $ | 0.60 |   | $ | 0.40 |   |

 

On February 9, 2009, the Company’s Board ofDirectors declared a cash dividend of $0.20 per share. The dividend is payableon March 5, 2009 to all shareholders of record at the close of business onFebruary 16, 2009. Future dividends will be declared at the discretion ofthe Board of Directors and will depend upon such factors as the Board ofDirectors deems relevant.

 

**Concentrationsof credit risk**

 

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprimarily of cash and cash equivalents, investments and accounts and unbilledreceivables.  At times, the Companymaintains cash balances in excess of insured limits. The Company maintains itscash and cash equivalents with major financial institutions.  The Company’s credit risk is managed byinvesting its cash in high quality money market funds, commercial paper,investment grade corporate and agency bonds, treasury bills and certificates ofdeposit.

 

**NewAccounting Pronouncements**

 

*SFAS No. 157*

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS157 establishes a common definition for fair value to be applied, establishes aframework for measuring fair value in accordance with generally acceptedaccounting principles, and expands disclosure about such fair valuemeasurements. The Company adopted the required provisions of SFAS 157 thatbecame effective in our first quarter of fiscal 2009. The adoption of theseprovisions did not have a material impact on our Consolidated FinancialStatements. For further information about the adoption of the requiredprovisions of SFAS 157 see Note 6.

 

In February 2008,the FASB issued FASB Staff Position No. 157-2, “Effective Date of FASBStatement No. 157” (“FSP 157-2”). FSP 157-2 delays the effective date ofSFAS 157 for nonfinancial assets and nonfinancial liabilities, except forcertain items that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually). We are currentlyevaluating the impact of SFAS 157 on our Consolidated Financial Statements foritems within the scope of FSP 157-2, which will become effective beginning withour first quarter of fiscal 2010.

 

*SFAS No. 162*

 

In May 2008,the FASB issued FAS No. 162, “TheHierarchy of Generally Accepted Accounting Principles” (“FAS 162”). FAS162 identifies the sources of accounting principles and the framework forselecting the principles to be used in the preparation of financial statementsof nongovernmental entities that are presented in conformity with GAAP. FAS 162is effective 60 days following the SEC’s approval of the Public CompanyAccounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in ConformityWith Generally Accepted Accounting Principles”. The Company does notexpect the adoption of FAS 162 to have a material impact on the Company’sfinancial condition or results of operations.

 

*EITFIssue No. 06-11*

 

In June 2007,the FASB ratified Emerging Issues Task Force Issue No. 06-11, “Accountingfor Income Tax Benefits of Dividends on Share-Based Payment Awards” (“EITF06-11”), which requires income tax benefits from dividends or dividendequivalents that are charged to retained earnings and are paid to employees forequity classified nonvested shares, nonvested equity share units andoutstanding equity share options to be recognized as an increase in additionalpaid-in capital and to be included in the pool of excess tax benefits availableto absorb potential future tax deficiencies on share-based payment awards. Theadoption of EITF 06-11, which became effective in the first quarter of fiscal2009, did not have a material impact on our Consolidated Financial Statements.

 

*EITF IssueNo. 03-6-1*

 

In June 2008,the FASB issued Staff Position EITF 03-6-1, “Determining Whether InstrumentsGranted in Share-Based Payment Transactions Are Participating Securities” (“FSPEITF 03-6-1”), effective for fiscal years beginning after December 15,2008.  FSP EITF 03-6-1 clarifies that unvested share-based awards thatcontain nonforfeitable rights to dividends or dividend equivalents (whetherpaid or unpaid) are participating securities and must be included in thecomputation of EPS pursuant to the two-class

 

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method. We arecurrently evaluating the impact of adopting FSP EITF 03-6-1 on our ConsolidatedFinancial Statements which will become effective beginning with our firstquarter of fiscal 2010.

 

**2.  ACCOUNTING FOR STOCK-BASED COMPENSATION**

 

On April 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(R) “Accountingfor Stock-Based Compensation” (“SFAS 123(R)”), which requires the measurementand recognition of all compensation costs for all stock based awards made toemployees and members of the Board of Directors based upon fair value over therequisite service period for awards expected to vest.

 

SFAS 123(R) requiresthe Company to estimate the fair value of share-based awards on the date ofgrant using an option pricing model. The Company adopted SFAS 123(R) usingthe modified prospective transition method which requires the application ofthe accounting standard starting April 1, 2006, the first day of theCompany’s fiscal year 2007. Prior period information was not restated toreflect the fair value method of expensing share-based awards.

 

Stock-basedcompensation costs recognized for the three month periods ended December 31,2008 and December 31, 2007, included compensation costs for awards grantedprior to, but not yet vested as of April 1, 2006 (adoption date), as wellas any new grants issued after April 1, 2006. The Company recognized$888,000 and $1,473,000 of share-based compensation costs in the consolidatedstatements of income for the quarters ended December 31, 2008 and December 31,2007, respectively. The Company recognized $3,126,000 and $4,141,000 ofshare-based compensation costs in the consolidated statements of income for thenine months ended December 31, 2008 and December 31, 2007,respectively. The income tax benefit related to this compensation for the threemonths ended December 31, 2008 and December 31, 2007 wasapproximately $273,000 and $222,000, respectively. The income tax benefitrelated to this compensation for the nine months ended December 31, 2008and December 31, 2007 was approximately $1,061,000 and $667,000,respectively.

 

The following tablesummarizes share-based compensation costs included in the Company’sconsolidated statement of income:

 
| ** **                                         | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                            | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007**     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| Cost of revenues                                   |       | $                                | 198        |                            | 393        |   | $ | 448 |   | $ | 1,266 |   |
| Selling, general  and administrative               |       | 690                              |       | 1,080                           |       | 2,678 |   | 2,875 |   |
| Total  share-based compensation expense before tax |       | $                                | 888        |                            | $          | 1,473 |   | $ | 3,126 |   | $ | 4,141 |   |
|                                                    |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

Upon adoption ofSFAS 123(R), in accordance with Staff Accounting Bulletin No. 107, theCompany selected the Black-Scholes option pricing model as the most appropriatemethod for determining the estimated fair value for the stock awards. TheBlack-Scholes method of valuation requires several assumptions: (1) theexpected term of the stock award, (2) the expected future stock volatilityover the expected term and (3) a risk-free interest rate. The expectedterm represents the expected period of time the Company believes the optionswill be outstanding based on historical information. Estimates of expectedfuture stock price volatility are based on the historic volatility of theCompany’s common stock and the risk free interest rate is based on the U.S.Zero-Bond rate.  There were 6,784 optionsgranted in the three month period ended December 31, 2008.  The fair value of options at date of grantwas estimated with the following assumptions for grants made during the periodpresented:

 
| ** **               | ** ** | **Nine months ended** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
| **Assumptions:**         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Option life              |       | 5 years                         |       | 3 years |   |
| Risk-free  interest rate |       | 3.0                             | %          | 4.23 | % |
| Stock volatility         |       | 49                              | %          | 51 | % |
| Dividend yield           |       | 1.25                            | %          | 1.3 | % |

 

**Stock Option and Other Compensation Plans**

 

The Company hasvarious stock option and other compensation plans for directors, officers, andemployees. The Company had the following stock option plans outstanding as of December 31,2008: the 1995 Combination Plan, the 1997 Non-Qualified Option Plan, the 1998Non-Qualified Option Plan, the 1999 Combination Plan, the 2000 Combination Plan,the 2002 Combination Plan, the 2003 Stock Plan for Non-Employee Directors andthe 2005 Equity and Incentive Plan. During the quarter ended September 30,2008, the shareholders voted to increase by 250,000 the number of sharesauthorized to be issued under the 2005 Equity and Incentive Plan. Includingthese shares, there are 3,730,000 shares authorized under these plans. As of December 31,2008, 300,434 shares remain available for future issuance under theseplans.  Vesting periods are at thediscretion of the Board of Directors and typically range between one and threeyears. Options under these plans are granted at fair market value and have aterm of five or ten years from the date of grant.

 

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**Stock Options**

 

The followingtables summarize stock option activity during the first nine months of fiscalyear 2009:

 
| ** **                                 | ** ** | **Options Outstanding** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Contractual  Life  (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| **Outstanding  at March 31, 2008**    |       | 828,063                      |       | $ | 41.70 |   | 6.80 |   |   |   |
| Grants                                     |       | 64,191                       |       | 64.13 |   |   |   | $ | 631,000 |   |
| Exercises                                  |       | (134,243                     | )          | 34.28 |   |   |   |   |   |
| Cancellations                              |       | (21,247                      | )          | 56.58 |   |   |   |   |   |
| **Outstanding  at December 31, 2008** |       | 736,764                      |       | $ | 44.57 |   | 5.71 |   |   |   |
| **Exercisable  at December 31, 2008** |       | 645,511                      |       | $ | 42.00 |   |   |   | $ | 20,629,000 |   |

 

Informationrelated to the stock options outstanding as of December 31, 2008 is asfollows:

 
| **Range of Exercise Prices** | ** **                | **Number of**

**Shares** | ** ** | **Weighted-Average  Remaining  Contractual  Life (years)** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Exercisable  Number of  Shares** | ** ** | **Exercisable  Weighted-Average  Exercise Price** | ** ** |
|---------------------------------------------|---------------------------|--------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------------------|------------|
| $                                           |   6.50 - $20.00 |                           | 130,945    |                                                            | 4.13       |                                      | $          | 12.25                                   |       | 130,945                                                |       | $ | 12.25 |   |
| $                                           | 20.01 - $30.00            |                           | 74,184     |                                                            | 5.59       |                                      | 28.16      |                                    | 74,184     |                                                   | 28.16      |   |
| $                                           | 30.01 - $40.00            |                           | 54,606     |                                                            | 5.92       |                                      | 39.07      |                                    | 54,606     |                                                   | 39.07      |   |
| $                                           | 40.01 - $50.00            |                           | 98,533     |                                                            | 6.67       |                                      | 45.47      |                                    | 98,533     |                                                   | 45.47      |   |
| $                                           | 50.01 - $60.00            |                           | 174,460    |                                                            | 6.03       |                                      | 53.53      |                                    | 154,980    |                                                   | 53.71      |   |
| $                                           | 60.01 - $74.72            |                           | 204,036    |                                                            | 5.99       |                                      | 64.67      |                                    | 132,263    |                                                   | 64.14      |   |
| $                                           |   6.50 - $74.72 |                           | 736,764    |                                                            | 5.71       |                                      | $          | 44.57                                   |       | 645,511                                                |       | $ | 42.00 |   |

 

As of December 31,2008, there was approximately $1,512,000 of unrecognized compensation costsrelated to options granted. The unrecognized compensation will be primarilyrecognized over the next two years.  Non-vested common stock options are subject to the risk offorfeiture until the fulfillment of specified conditions.

 

**Restricted Stock and Restricted Stock Units**

 

The Company hasinstituted long term incentive plans for certain key employees. These planscall for the issuance of restricted stock which vests upon the achievement ofcertain performance based goals as well as service time incurred.  Restricted stock and restricted stock unitsmay also be granted to other employees with vesting periods that range from oneto three years.  In addition,  members of the Board of Directors are grantedrestricted stock annually on January 10th. These restricted stock awards vest on apro-rata basis on service time incurred in the upcoming calendar year.  The fair values of these restricted stockawards are equal to the market price per share of the Company’s common stock onthe date of grant.

 

Nonvestedrestricted stock and stock unit awards are subject to the risk of forfeitureuntil the fulfillment of specified conditions. As of December 31, 2008there was $4,187,000 of total unrecognized compensation cost related tonon-vested restricted stock and stock unit awards granted under the Company’sstock plans. This cost is expected to be recognized over a weighted average twoyear period.

 

The followingtable summarizes the status of the Company’s non-vested restricted stock awardsduring the first nine months of fiscal 2009:

 
| ** **                                 | ** ** | **Non-vested Restricted Stock Awards** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                 | ** ** | **Number of  Shares**                            | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
| **Outstanding  at March 31, 2008**    |       | 110,301                                               |       | $ | 58.34 |   |
| Granted                                    |       | 49,388                                                |       | 52.32 |   |
| Vested                                     |       | (7,919                                                | )          | 55.53 |   |
| Forfeited                                  |       | (16,679                                               | )          | 57.64 |   |
| **Outstanding  at December 31, 2008** |       | 135,091                                               |       | $ | 56.39 |   |

 

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** **

**3.****              INVENTORIES**

** **
| **(Dollars in thousands)**                      | ** ** | **December 31,  2008** | ** ** | **March 31,  2008** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Inventories consisted  of:                                |       |                        |       |                     |       |
| Raw materials,  completed sub-assemblies, and spare parts |       | $                           | 20,881     |                     | $          | 18,113 |   |
| Work-in-process                                           |       | 15,442                      |       | 12,163                   |       |
| Finished goods                                            |       | 8,719                       |       | 9,831                    |       |
| Total                                                     |       | $                           | 45,042     |                     | $          | 40,107 |   |

 

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

 

Basic earnings per commonshare is computed by dividing net income available to common stockholders bythe weighted average number of shares of common stock outstanding during theperiod.  Diluted earnings per share include the dilutive impact of options,warrants, restricted stock and restricted stock units using the average shareprice of the Company’s common stock for the period. For the quarters ended December 31,2008 and December 31, 2007, common stock equivalents of 100,000 and351,000 respectively, are excluded from diluted earnings per share, as theireffect is anti-dilutive. For the nine months ended December 31, 2008 and December 31,2007, common stock equivalents of 266,000 and 285,000, respectively, areexcluded from diluted earnings per share, as their effect is anti-dilutive.

 
| ** **                                                                              | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands except per share amounts)**                    | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007**     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| **Income  Per Share**                                                                   | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                              | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                              | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                              |       | $                                | 10,059     |                            | $          | 4,002 |   | $ | 20,109 |   | $ | 14,689 |   |
| Weighted average  number of common shares outstanding —basic                       |       | 8,670                            |       | 9,136                           |       | 8,679 |   | 9,163 |   |
| Net income per  share —basic                                                       |       | $                                | 1.16       |                            | $          | 0.44 |   | $ | 2.32 |   | $ | 1.60 |   |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| **Diluted:**                                                                            | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                              |       | $                                | 10,059     |                            | $          | 4,002 |   | $ | 20,109 |   | $ | 14,689 |   |
| Adjustment to  net income for change in warrant valuation                               |       | —                           |       | —                          |       | — |   | (11 | ) |
| Adjusted net  income                                                                    |       | $                                | 10,059     |                            | $          | 4,002 |   | $ | 20,109 |   | $ | 14,678 |   |
| Weighted average  number of common shares outstanding                                   |       | 8,670                            |       | 9,136                           |       | 8,679 |   | 9,163 |   |
| Assumed exercise  of stock options and warrants, using the treasury stock               |       | 270                              |       | 221                             |       | 237 |   | 234 |   |
| Weighted average  number of common and potential common shares outstanding—diluted |       | 8,940                            |       | 9,357                           |       | 8,917 |   | 9,397 |   |
| Net income per  share —diluted                                                     |       | $                                | 1.13       |                            | $          | 0.43 |   | $ | 2.26 |   | $ | 1.56 |   |

 

**5.   LINE OF CREDIT**

 

On November 14,2008, the Company modified its Loan and Security Agreement with Silicon ValleyBank East to extend the facility through November 13, 2009 and to increasethe facility from $20.0 million to $40.0 million to support the Company’sroutine letters of credit and working capital needs.  If the Company maintains a cash andinvestments balance of $60 million or greater, then the maximum amountavailable for borrowings under the facility is $40.0 million minus the amountof all outstanding letters of credit less certain reserves, and minus theoutstanding principal balance of any advances. If the Company’s cash and investment balance falls below $60 million fora period of 30 consecutive days, then the maximum amount available forborrowings under the facility is the lesser of (i) $40.0 million, or (ii) 80%of eligible domestic accounts receivable minus the amount of outstandingletters of credits adjusted for certain reserves and minus the principalbalance of any advances.

 

The creditfacility bears an interest rate of the greater of 4.0% or the Silicon ValleyBank prime rate (4.00% at December 31, 2008). The credit agreement iscollateralized by certain assets of the Company and contains certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequires the maintenance of certain financial covenants.  As of December 31, 2008, the Company wasin compliance with these covenants.

 

In the normalcourse of business, the Company may provide certain customers and potentialcustomers with performance guarantees, which are generally backed by standbyletters of credit. In general, the Company would only be liable for the amountof these guarantees in the event of default in the performance of ourobligations, the probability of which is remote in management’s opinion.  The Company had outstanding $35,497,000 instandby letters of credit against the Loan and Security Agreement with 

 

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$4,503,000remaining availability.  The outstandingletters of credit are primarily for guaranteeing performance on certaininternational projects.   No amounts havebeen drawn against these letters of credit. In addition, at December 31,2008, the Company had a restricted cash balance of $59,000 related to certainbank required deposits for outstanding letters of credit issued and otherbank-related fees.

 

**6.  FAIR VALUE MEASUREMENTS**

 

SFAS 157 definesand establishes a framework for measuring fair value and expands disclosuresabout fair value measurements. In accordance with SFAS 157, we have categorizedour financial assets, based on the priority of the inputs to the valuationtechnique, into a three-level fair value hierarchy as set forth below. If theinputs used to measure the financial instruments fall within different levelsof the hierarchy, the categorization is based on the lowest level input that issignificant to the fair value measurement of the instrument.

 

Financial assetsrecorded on the Condensed Consolidated Balance Sheets are categorized based onthe inputs to the valuation techniques as follows:

 

**Level 1**- Financial assets whose values are based on unadjusted quoted prices foridentical assets or liabilities in an active market that the Company has theability to access at the measurement date (examples include activeexchange-traded equity securities, listed derivatives, and most U.S. Governmentand agency securities).

 

**Level 2**- Financial assets whose values are based on quoted prices in markets wheretrading occurs infrequently or whose values are based on quoted prices ofinstruments with similar attributes in active markets.  Level 2 inputs include the following:

 
| · | Quoted prices for  identical or similar assets or liabilities in non-active markets (examples  include corporate and municipal bonds which trade infrequently);                                        |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                   |
| · | Inputs other than  quoted prices that are observable for substantially the full term of the  asset or liability (examples include interest rate and currency swaps); and                               |
|   |                                                                                                                                                                                                   |
| · | Inputs that are derived  principally from or corroborated by observable market data for substantially  the full term of the asset or liability (examples include certain securities  and derivatives). |

** **

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

 

The followingtable presents the financial assets and liabilities we measure at fair value ona recurring basis, based on the fair value hierarchy as of December 31,2008:

 
| **(In thousands)**                                       | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|
| **Level 1  – Financial Assets**                          |       |                        |       |
| U.S. Treasury  bills                                          |       | $                           | 3,993      |   |
| **Level 2  – Financial Assets**                          |       |                        |       |
| Government  agency bond                                       |       | 4,051                       |       |
| Certificates of  deposit                                      |       | 3,200                       |       |
| Commercial paper                                              |       | 16,169                      |       |
| Corporate  debentures/bonds                                   |       | 20,521                      |       |
| Total Level 2  Financial Assets – Short-term investments |       | 43,941                      |       |
| Total Short-term  investments                                 |       | $                           | 47,934     |   |

 

**7.   INCOME TAXES**

 

The Companyaccounts for income taxes in accordance with SFAS No. 109, “Accounting forIncome Taxes.” Accordingly, the Company recognizes deferred income taxes basedon the expected future tax consequences of differences between the financialstatement basis and the tax basis of assets and liabilities, calculated usingenacted tax rates in effect for the year in which the differences are expectedto be reflected in the tax return. The Company evaluates the need for avaluation allowance against its net deferred tax assets at year end based uponits three year cumulative income and its projections of future income, andrecords a valuation allowance against any net deferred tax assets if it is morelikely than not that they will not be realized.

 

On November 10,2005, the Financial Accounting Standards Board (“FASB”) issued FASB StaffPosition No. FAS 123(R), “Transition Election Related to Accounting forTax Effects of Share-Based Payment Awards” that allows for a simplified orLong-Haul Method to establish the beginning balance of the additionalpaid-in-capital pool (“APIC pool”) related to the tax effects of 

 

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employee stock-basedcompensation, and to determine the subsequent impact on the APIC pool andConsolidated Statements of Cash Flows of the tax effects of employeestock-based compensation awards that are outstanding upon adoption of SFAS123(R). The Company has elected to use the Long-Haul Method of calculating theAPIC pool.

 

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

 

The Company is currentlyopen to audit under the statute of limitations by the Internal Revenue Serviceand state taxing authorities for the fiscal years ending March 31, 2005through 2008.  The Company is underexamination currently by the Internal Revenue Service for tax years 2006 and2007. Management does not believe that the ultimate outcome of this examinationwill have a material impact on the Company’s financial position or results ofoperations.  The Company believes that there are no uncertain taxpositions as of December 31, 2008.

 

**8.     GUARANTEES**

 

Certain of the Company’s products carry a one-yearwarranty, the costs of which are accrued for at time of shipment ordelivery.  Accrual rates are based upon historical experience over thepreceding twelve months and management’s judgment of future exposure. Warranty experience for the three and nine months ended December 31, 2008and December 31, 2007 is as follows:

 
| ** **                                        | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                           | ** ** | **December 31,  2008**      | ** ** | **December 31,  2007**     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| Warranty accrual  — beginning of period      |       | $                                | 2,216      |                            | $          | 1,187 |   | $ | 1,671 |   | $ | 1,997 |   |
| Accruals for  warranties issued during the period |       | 538                              |       | 839                             |       | 2,202 |   | 2,239 |   |
| Adjustment of  preexisting accrual estimates      |       | (140                             | )          | (273                            | )          | (797 | ) | (2,020 | ) |
| Warranty costs  incurred during the period        |       | (398                             | )          | (323                            | )          | (860 | ) | (786 | ) |
| Warranty accrual  — end of period            |       | $                                | 2,216      |                            | $          | 1,430 |   | $ | 2,216 |   | $ | 1,430 |   |

 

In conjunctionwith the sale of certain assets and contracts of the Company’s High EnergySystems Division in January of 2005, the lease for the Californiaoperations of the High Energy Systems Division was assigned to Accuray, Inc. The Company remains secondarily liable for the remaining lease payments in theevent of default by Accuray, Inc. during the lease term which expires in February 2011.Total remaining lease payments at December 31, 2008 totaled$862,000.  No accrual for this contingent liability has been recorded at December 31,2008 as payment of this liability is considered remote.

 

**9.   LEASE COMMITMENTS**

 

In March 2005,the Company renewed its lease agreement for its corporate headquarters andmanufacturing facilities in Billerica, Massachusetts.  As part of thelease agreement, the Company’s landlord agreed to certain renovations to theBillerica facility including the construction of additional high baymanufacturing space.  The Company was responsible for a portion of theconstruction costs and was deemed to be the owner of the building during theconstruction period under EITF 97-10 “The Effect of Lessee Involvement in AssetConstruction”.  In January 2007, the Company amended this leaseagreement to expand its lease to include the remaining available space in thebuilding.  A total of $7,182,000 was capitalized to record the facility onits books with an offsetting credit to the lease financing liability.  Inaddition, amounts paid for construction were capitalized to fixed assets andthe landlord construction allowances of $6,009,000 were recorded as additionallease liability.

 

At the completionof the construction of the initial renovations in February 2006, the leasewas reviewed for potential sale-leaseback treatment in accordance with SFAS No. 98. Based on this review, it was determined that the lease did not qualify forsale-leaseback treatment in accordance with SFAS No. 98.  As aresult, building and tenant improvements and associated lease financingliabilities remain on the Company’s books.  The lease financing liabilityis being amortized over the lease term based on the payments designated in theagreement and the building and tenant improvement assets are being depreciatedon a straight line basis over the lessor of their useful lives or the leaseterm.

 

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

 

**Results of Operations**

 

        Net revenues for the third quarter ended December 31,2008 increased by $22,675,000 to $65,290,000 compared to the

 

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corresponding period ayear ago.  This increase is attributable primarily to an increase of$19,081,000 in product sales, of which $10,179,000 relates to increasedshipments of Z Backscatter systems.   In addition, there was anincrease of $5,424,000 in CargoSearch system revenues due primarily to acomparative increase in the volume of CargoSearch projects recognized on apercent complete basis from the prior year. In addition, aftermarket parts sales increased by $3,800,000 to$4,677,000 compared to the corresponding period a year ago.  Service revenues increased by $3,594,000 to$19,480,000 compared to the third quarter of fiscal 2008 due primarily to anincrease in the volume of international service contracts over the prior year.

 

Net revenues forthe nine months ended December 31, 2008 increased by $36,364,000 to$161,077,000 compared to the corresponding period a year ago.  Thisincrease is attributable primarily to an increase of $29,653,000 in productsales, of which $19,209,000 relates to increased shipments of Z Backscattersystems.   In addition, there was an increase of $5,098,000 inCargoSearch system revenues due to a comparative increase in the volume ofshipments period over period. In addition, aftermarket parts sales increased by$4,484,000 to $8,216,000 compared to the corresponding period a year ago.  Service revenues increased by $6,711,000 to$53,963,000 compared to the first nine months of fiscal 2008 due primarily toan increase in the volume of service contracts over the prior year.

 

Total cost ofsales and contracts for the third quarter ended December 31, 2008increased by $9,099,000 to $36,530,000 as compared to the corresponding perioda year ago. Cost of sales and contracts related to product revenues increasedby $7,564,000 to $25,616,000 as compared to the corresponding period a yearago.  Cost of product sales and contract revenues represented 56% ofrevenues versus 68% of revenues for the corresponding period last year. The resultant increase in gross margin percentage is due primarily to the mixof products sold in the period with a greater percentage of revenues derivedfrom higher margin Z Backscatter system shipments and improved margins seen onboth the ParcelSearch and CargoSearch related products due to manufacturingefficiencies and cost reductions efforts expended in this past fiscalyear.  The cost of service revenues forthe third quarter ended December 31, 2008 increased by $1,535,000 to$10,914,000 as compared to the corresponding period a year ago.  Cost ofservice revenues represented 56% of revenues versus 59% for the correspondingperiod last year.  The margin improvementseen over the prior year is due primarily to labor costs reducing as apercentage of revenues as the Company has been able to service a number of thenew service contracts received with its existing field service engineerworkforce.

 

Total cost ofsales and contracts for the nine months ended December 31, 2008 increasedby $17,211,000 to $95,261,000 as compared to the corresponding period a yearago. Cost of sales and contracts related to product revenues increased by$11,791,000 to $63,484,000 as compared to the corresponding period a yearago.  Cost of product sales and contract revenues represented 59% ofrevenues versus 67% of revenues for the corresponding period last year. The resultant increase in gross margin percentage is due primarily to the mixof products sold in the period with a greater percentage of revenues derivedfrom higher margin Z Backscatter system shipments as well as improved marginson CargoSearch systems.  The cost ofservice revenues for the nine months ended December 31, 2008 increased by$5,420,000 to $31,777,000 as compared to the corresponding period a yearago.  Cost of service revenues represented 59% of revenues versus 56% forthe corresponding period last year. This increase in costs is due primarily toincreased costs for freight and travel to service systems under fixed priceservice contracts during the period as well as the Company entering into somerelatively lower margin service contracts in some international markets.

 

Selling, generaland administrative expenses for the third quarter ended December 31, 2008increased by $1,523,000 to $9,132,000 as compared to the corresponding period ayear ago.  Selling, general and administrative expenses represented 14% ofrevenues in the current period as compared to 18% for the corresponding periodlast year.  The increase in costs was primarily the result of an increasein incentive and stock compensation expense ($2,014,000) as the Companyachieved certain performance based incentive compensation goals, an increase incompensation related costs due to the accrual of certain severance payments($245,000), increased sales and marketing related consulting costs ($142,000),and increased legal costs related to ongoing litigation ($656,000).  These increases were offset by a decrease inother administrative expenses as the Company in the third quarter of fiscal2008 wrote down an uncollectible note receivable in the amount of $1,720,000.

 

Selling, generaland administrative expenses for the first nine months of fiscal 2009 increasedby $4,282,000 to $24,225,000 as compared to the corresponding period a yearago.  Selling, general and administrative expenses represented 15% ofrevenues in the current period as compared to 16% for the corresponding periodlast year.  The increase in costs was primarily the result of an increasein incentive and stock compensation expense ($3,044,000) as the Companyachieved certain performance based incentive compensation goals, an increase incompensation related costs due to increased headcount ($528,000), increasedsales and marketing related consulting costs ($414,000), increased marketingand trade show related costs ($574,000), and increased legal costs related toongoing litigation ($1,288,000).  Theseincreases were offset by a decrease in other administrative expenses as theCompany in the third quarter of fiscal 2008 wrote down an uncollectible notereceivable in the amount of $1,720,000.

 

Company fundedresearch and development expenses for the third quarter of fiscal 2009increased by $1,667,000 to $4,815,000 as compared to the corresponding periodlast year.  Research and development expenses remained consistent at 7% ofrevenues in both periods.  This overall increase in research anddevelopment spending was planned and is attributable to an increase in thenumber of research and development projects ongoing and an increase in thenumber of engineering resources available to focus on research and developmentefforts.

 

Company fundedresearch and development expenses for the first nine months of fiscal 2009increased by $3,876,000 to 

 

 

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$12,554,000 as comparedto the corresponding period last year.  Research and development expensesrepresented 8% of revenues in the current period as compared to 7% for thecorresponding period last year.  This increase in research and developmentspending was planned and is attributable to an increase in the number ofresearch and development projects ongoing and an increase in the number ofengineering resources available to focus on research and development efforts.

 

Other income was$189,000 in income for the third quarter of fiscal 2009 as compared to$1,465,000 in income for the corresponding period a year ago.  Thisdecrease in other income is attributable primarily to the decrease in interestand investment income caused by significantly lower interest rates andinvestment returns as compared to the prior period.

 

Other income was$1,668,000 in income for the first nine months of fiscal 2009 as compared to$4,938,000 in income for the corresponding period a year ago.  Thisdecrease in other income is attributable primarily to a decrease in interestand investment income caused by significantly lower interest rates andinvestment returns as compared to the prior period.

 

The Companyreported pre-tax income of $15,002,000 in the quarter ended December 31,2008 as compared to pre-tax income of $5,892,000 in the corresponding period ayear ago due to the factors described above. The Company reported pre-taxincome of $30,705,000 in the nine months ended December 31, 2008 ascompared to pre-tax income of $22,980,000 in the corresponding period a yearago due to the factors described above.

 

The Company’s effectivetax rate for the quarter ended December 31, 2008 was 33% as compared to32% for the corresponding period last year. The Company’s effective tax rate for the nine months ended December 31,2008 decreased to 34.5% from 36% for the corresponding period a year ago. This decrease is due primarily to an increase in the amount of stock optionexercises in the period for which the Company receives a tax deduction, thereinstatement in the current quarter by the Internal Revenue Service of theresearch and development tax credit, and the continued shift in revenues fromdomestic to international which reduces the Company’s state income taxliabilities.

 

The Company hadnet income of $10,059,000 for the third quarter of fiscal 2009 as compared tonet income of $4,002,000 for the third quarter of fiscal 2008.  TheCompany had net income of $20,109,000 for the first nine months of fiscal 2009as compared to net income of $14,689,000 for the first nine months of fiscal2008.  The significant factors contributing to these results are noted inthe above sections.

 

**Liquidityand Capital Resources**

 

Cash and cashequivalents increased by $30,977,000 to $83,395,000 at December 31, 2008compared to $52,418,000 at March 31, 2008. This increase is attributableprimarily to the net income earned for the period adjusted for non-cashdepreciation and stock compensation expense, an increase in customer depositsof $9,702,000 in the period, an increase in accrued expenses of $5,289,000,proceeds received from stock option exercises of $4,602,000, a decrease inrestricted cash of $2,464,000, and net proceeds from maturities of short terminvestments of $25,150,000.  These cashinflows were offset by an increase in accounts receivable of $16,754,000 relatedto end of period shipments, $14,382,000 used to repurchase outstanding sharesof common stock as part of the Company’s Stock Repurchase Program, and dividendpayments made of $5,267,000.  Inaddition, cash provided by other operating activities included $6,648,000 ininventory increases attributable to inventory builds to meet orders received,and a $3,761,000 increase in prepaid expenses and other assets primarilyrelated to deposits made with vendors to secure raw material availability andprepaid commissions and service on certain large international orders.

 

On November 14,2008, the Company modified its Loan and Security Agreement with Silicon ValleyBank East to extend the facility through November 13, 2009 and to increasethe facility from $20.0 million to $40.0 million to support the Company’sroutine letters of credit and working capital needs.  If the Company maintains a cash andinvestments balance of $60 million or greater, then the maximum amountavailable for borrowings under the facility is $40.0 million minus the amountof all outstanding letters of credit less certain reserves, and minus theoutstanding principal balance of any advances. If the Company’s cash and investment balance falls below $60 million fora period of 30 consecutive days, then the maximum amount available forborrowings under the facility is the lesser of (i) $40.0 million, or (ii) 80%of eligible domestic accounts receivable minus the amount of outstandingletters of credits adjusted for certain reserves and minus the principalbalance of any advances.

 

The creditfacility bears an interest rate of the greater of 4.0% or the Silicon ValleyBank prime rate (4.00% at December 31, 2008). The credit agreement iscollateralized by certain assets of the Company and contains certainrestrictions, including limitations on the amount of distributions that can bemade to stockholders, and the disposition or encumbrances of assets, andrequires the maintenance of certain financial covenants.  As of December 31, 2008, the Company wasin compliance with these covenants.

 

In the normalcourse of business, the Company may provide certain customers and potentialcustomers with performance guarantees, which are generally backed by standbyletters of credit. In general, the Company would only be liable for the amountof these guarantees in the event of default in the performance of ourobligations, the probability of which is remote in management’s opinion.  The Company had outstanding $35,497,000 instandby letters of credit against the Loan and Security Agreement with$4,503,000 remaining availability.  Theoutstanding letters of credit are primarily for guaranteeing performance oncertain international projects.   Noamounts have been drawn against these letters of credit. In addition at December 31,2008, the Company had a restricted cash balance of $59,000 related to certainbank required deposits for outstanding letters of credit issued and other 

 

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bank-related fees.

 

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

 

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

 

As of December 31,2008, the Company held short-term investments consisting of money market funds,government agency bonds, U.S. treasury bills, certificates of deposit,commercial paper and corporate debentures/bonds. The Company’s primaryobjective with its investment portfolio is to invest available cash whilepreserving principal and meeting liquidity needs. These investments had anaverage interest rate of approximately 1.56% and are subject to interest raterisk. 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.

 

**ITEM 4 — CONTROLS AND PROCEDURES**

 

a)  Evaluation of disclosure controls and procedures

 

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

 

b)  Changes in internal controls

 

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

 

**PART II — OTHER INFORMATION**

 

**ITEM1A — RISK FACTORS**

 

**Safe Harbor Statement**

 

This Quarterly Report on Form 10-Q contains statements concerningthe Company’s financial performance and business operations, which may beconsidered “forward-looking” under applicable securities laws. The Companywishes to caution readers of this 10-Q that actual results might differmaterially from those projected in any forward-looking statements.

 

Factors which might cause actual results to differ materially fromthose projected in the forward-looking statements contained herein include thefollowing: significant reductions or delays in procurements of the Company’ssystems by the United States and other governments; disruption in the supply ofany source component incorporated into the Company’s products; litigationseeking to restrict the use of intellectual property used by the Company;potential product liability claims against the Company; global political trendsand events which affect public perception of the threat presented by drugs,explosives and other contraband; global economic developments and the abilityof governments and private organizations to fund purchases of the Company’sproducts to address such threats; and the potential insufficiency of Companyresources, including human resources, capital, plant and equipment andmanagement systems, to accommodate any future growth and any future delays infederal funding. These and certain other factors which might cause actualresults to differ materially from those projected are more fully set forthbelow and under “Risk Factors” section of the Company’s Annual Report on Form 10-K for the fiscal yearended March 31, 2008.  Please also refer to our other filings withthe Securities and Exchange Commission.

 

Other than asdescribed in the risk factors below, there have been no material changes to therisk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-Kfor the year ended March 31, 2008, as filed with the SEC on June 13,2008.

 

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**The Company’s results ofoperations are affected by the overall economy and governmental spending.**

 

The Company’sresults of operations may be materially adversely affected by the conditions inthe global economy and the impact of those conditions on U.S. and foreigngovernment spending. The current global financial crisis, which began lastyear, has deteriorated further and has caused extreme volatility anddisruptions in the capital and credit markets, including a significantreduction in the availability of capital resources to many businessenterprises. U.S. and foreign economies have experienced and continue toexperience significant declines in employment, spending, household wealth andlending.  Businesses have faced and maycontinue to face weakened demand for their products and services, difficultyobtaining access to financing, increased funding costs, and barriers toexpanding operations. U.S. and foreign government spending for programs involvingproducts such as the Company’s may be reduced or delayed, now or in the future,due to reduced tax revenues and other spending imperatives, including financialinstitution support and economic stimulus programs.  Economic and market conditions may continueto worsen and could negatively impact the Company’s results of operations.

 

**TheCompany’s business is dependent upon governmental policies and appropriations.**

 

The Company’slargest customers are government agencies and demand for its products is dependentupon national priorities and governmental initiatives, including security anddefense-related programs. These priorities and initiatives are subject tochange from time to time in response to the economic and political environment,including changes in Presidential administrations and Congressionalleadership.   The Company is also exposed to the U.S. budget approvaland appropriation decisions and processes which are driven by numerous factors,including geo-political events and macroeconomic conditions, and are beyond ourcontrol. While the overall level of U.S. security and defense spending hasincreased in recent years for numerous reasons, including increases in fundingof operations in Iraq and Afghanistan and the U.S. Department of Defense’s militarytransformation initiatives, we can give no assurance that such spending willcontinue to grow, or not be reduced, under the current administration andCongressional leadership.  Significantchanges in security and defense spending could have long-term consequences forour size and structure. In addition, changes in government priorities andrequirements could impact the funding, or the timing of funding, of ourprograms which could negatively impact our results of operations and financialcondition.

 

**Potential funding for securityprograms under the U.S. economic stimulus legislation may not offset overalldecreases in security and defense funding.**

 

The U.S. economic stimulus legislation introduced byboth the U.S. House of Representatives and the U.S. Senate in January 2009may provide for increases in federal funding for security relatedprojects.  The version of the AmericanRecovery and Reinvestment Act of 2009 passed by the House of Representatives onJanuary 28, 2009 contained funding to the U.S. Department of HomelandSecurity, including funding to the Transportation Security Administration for thepurchase and installation of explosive detection systems and emergingcheckpoint technologies and funding to Customs and Border Protection for detectiontechnology to be deployed at sea ports of entry.  If passed by Congress and approved byPresident Obama, this additional funding could favorably impact demand for theCompany’s products in the U.S. and potentially offset, to some extent, theimpact of potential decreases in U.S. funding for security and defense-relatedprograms, including operations in Afghanistan and Iraq and the U.S. Departmentof Defense’s military transformation initiatives.  If this additional security-related fundingis not approved, however, demand for the Company’s products could be materiallyand negatively impacted in the U.S., which could have a material adverse effecton the Company’s business, financial condition and results of operations. Inaddition, even if additional security-related funding is approved, there can beno assurance that its impact would be sufficient to offset potential reduceddemand for the Company’s products resulting potential decreases in U.S. fundingfor security and defense-related programs.

 

**ITEM 1 — LEGAL PROCEEDINGS**

 

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

 

TheCompany is also subject to various legal proceedings and claims that arise inthe ordinary course of business.  At the present time, it is not possibleto predict the outcome of these matters; however, the Company currentlybelieves that resolving these matters will not have a material adverse impacton its financial condition, results of operations or cash flows.

 

**ITEM 2 —PURCHASES OF EQUITY SECURITIES**

 

On May 17, 2007, the Board of Directors approved a Stock RepurchaseProgram which authorized the Company to repurchase up to $35 million of sharesof its common stock from time to time on the open market.  This Repurchase Program was completed duringthe quarter ended June 30, 2008.** **On May 8, 2008 the****Board of Directors approved another StockRepurchase Program which authorizes the Company to repurchase up to $35 millionof shares of its common stock from time to time on the open market.  As of December 31, 2008, the maximumdollar value of shares that may yet be purchased under this program is$30,412,000.

 

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The following table provides information about our purchases during thequarter ended December 31, 2008 of equity securities that are registeredby us pursuant to Section 12 of the Exchange Act.

 
| **2008**                                 | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced  Programs** | ** ** |
|------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| October 1 –  October 31   |       | 50,900                                           |       | $                                                | 56.28      |                                                                                                          | 50,900     |   |
| November 1 –  November 30 |       | 2,000                                            |       | 59.92                                            |       | 2,000                                                                                                         |       |
| December 1 –  December 31 |       | —                                           |       | —                                           |       | —                                                                                                        |       |
| **Total**                                |       | 52,900                                           |       | $                                                | 56.42      |                                                                                                          | 52,900     |   |

 

**ITEM 6 — EXHIBITS**

 

See the exhibit indexfollowing the signature page to this Quarterly Report on Form 10-Q.

 

The information requiredby Exhibit Item 11 (Statement re: Computation of Income per Common andCommon Equivalent Share) may be found in Note 4 to the Unaudited CondensedConsolidated Financial Statements in this Quarterly Report on Form 10-Q.

 

 

**SIGNATURES**

 

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

 
|                         | AMERICAN SCIENCE AND  ENGINEERING, INC.                       |
|------------------------------|---------------------------------------------------------------|
|                         |                                                          |
| Date: February 9,  2009 | /s/ Kenneth J. Galaznik                                       |
|                         | Kenneth J. Galaznik                                           |
|                         | Senior Vice President,  Chief Financial Officer and Treasurer |

 

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**EXHIBIT INDEX**

 
| **Exhibit********Number** | ** ** | **Description  of 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 |

 

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