**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K/A**

 

**(AmendmentNo. 1)**

 

| **ý**                                        | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|---------------------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                                        | ** **                                                                                      |
| **For the fiscal year ended March 31, 2004** |

 

| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|-----------------------------------------------------------------------------------------------------|

 

**Commission file number 1-6549**

 

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**AMERICANSCIENCE AND ENGINEERING, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **Massachusetts**                                                | **04-2240991**                     |
|------------------------------------------------------------------|------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) | (IRS  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)

 

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| **Title of each class**            | ** ** | **Name of each exchange on which registered** |
|------------------------------------|------------|-----------------------------------------------|
|                               |       |                                          |
| Common Stock  ($.66 2/3 par value) |       | American  Stock Exchange                      |

 

Securitiesregistered pursuant to Section 12(g) of the Act: None

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý  No o

 

Indicate bycheck mark whether the Registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act of 1934) Yes ý  No o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K/A or anyamendment to this Form 10-K/A. o

 

The aggregatemarket value of voting stock held by non-affiliates of the registrant on June 1,2004 was $134,836,946.

 

7,551,344shares of Registrant’s Common Stock were outstanding on June 1, 2004.

 

 

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**DOCUMENTS INCORPORATED BY REFERENCE**

 

**Theregistrant intends to file a definitive Proxy Statement pursuant toRegulation 14A within 120 days of the end of the fiscal year ended March 31,2004. Portions of such Proxy Statement are incorporated by reference inPart III.**

 

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**ExplanatoryNote: **This AmendmentNo. 1 on Form 10-K/A amends our Annual Report on Form 10-K filed with theSecurities and Exchange Commission on June 14, 2004 (the “Original Form 10-K) solelyin order to amend and correct Item 9A. As a result of the amendment of Item 9A,the Section 302 and Section 906 certifications filed as Exhibits inItem 15 have been re-executed as of the date of this Amendment No. 1 on Form10-K/A. Except for the aforementioned amendments, this Amendment No. 1 speaksas of the original filing date of the Original Form 10-K and does not modify orupdate disclosures in the Original Form 10-K, including the nature andcharacter of such disclosures, to reflect events occurring, or itemsdiscovered, after the original filing date of the Original Form 10-K.  Accordingly, this Amendment No. 1 should beread in conjunction with the Company’s filings made with the Securities andExchange Commission subsequent to the original filing date of the Original Form10-K, including any amendments to those filings.

 

**AmericanScience & Engineering, Inc.**

**FORM10-K/A**

**FORTHE PERIOD ENDED MARCH 31, 2004**

 

**TABLE OF CONTENTS**

 
| **PART I**    |                                                                                             |
|---------------|--------------------------------------------------------------------------------------------------|
| ITEM 1.       | Business                                                                                         |   |
| ITEM 2.       | Properties                                                                                       |   |
| ITEM 3.       | Legal Proceedings                                                                                |   |
| ITEM 4.       | Submission of  Matters to a Vote of Security Holders                                             |   |
| **PART II**   |                                                                                             |
| ITEM 5.       | Market for  the Company’s Common Equity and Related Stockholder Matters                     |   |
| ITEM 6.       | Selected Financial Data                                                                          |   |
| ITEM 7.       | Management’s Discussion  and Analysis of Financial Condition and Results of Operations |   |
| ITEM 7A.      | Quantitative  and Qualitative Disclosures about Market Risk                                      |   |
| ITEM 8.       | Financial  Statements and Supplementary Data                                                     |   |
| ITEM 9.       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure            |   |
| ITEM 9A.      | Controls and Procedures                                                                          |   |
| **PART III**  |                                                                                             |
| ITEM 10.      | Directors and  Executives Officers of the Company                                                |   |
| ITEM 11.      | Executive Compensation                                                                           |   |
| ITEM 12.      | Security Ownership  of Certain Beneficial Owners and Management                                  |   |
| ITEM 13.      | Certain  Relationships and Related Transactions                                                  |   |
| ITEM 14.      | Principal Accountant  Fees and Services                                                          |   |
| **PART IV**   |                                                                                             |
| ITEM 15.      | Financial  Statement Schedules and Exhibits and Reports on Form 8-K                         |   |
| SIGNATURES    |                                                                                             |   |
| EXHIBIT INDEX |                                                                                             |   |

 

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**PART I**

 

**ITEM 1. BUSINESS**

 

AmericanScience and Engineering, Inc., a Massachusetts corporation formed in 1958(together with its subsidiary, the “Company” or “AS&E”), develops,manufactures, markets, sells, provides maintenance and warranty services, aswell as research, engineering, and training services with respect to X-rayinspection and other inspection solutions.

 

The Company’ssophisticated X-ray inspection products are used for critical detection andsecurity applications by seaport and border authorities, federal facilities, militarybases, airports and corporations in the United States and around the globe.These security applications include X-ray inspection and screening systems forcombating terrorism, drug and weapon smuggling, trade fraud, and illegalimmigration.

 

The Company’sobjective is to distinguish itself from its competitors through technicalinnovations and a superior approach to detection. The Company’s patentedZ® Backscatter and Shaped EnergyTM technologies detect plastic explosives,plastic weapons, illegal drugs, and other contraband, even when concealed incomplex backgrounds by terrorists and smugglers. In addition, AS&E’s newRadioactive Threat Detection (RTD) technology detects dirty bombs and nucleardevices while Z® Backscatter and transmission images are simultaneouslyproduced.

 

Historically,the Company has focused its product development and marketing efforts on twobroad markets: (i) the protection of high-risk government personnel andfacilities; and (ii) the inspection and clearance of cargo, trucks andcars at seaports, borders and airports. These markets are driven by domesticand global trends in terrorism; the continued global proliferation of drug andpeople smuggling, and the continuing increase in global trade which createsgreater incentives and opportunities to evade duties or perpetrate trade fraudutilizing false cargo shipping manifests.

 

Beginning withthe terrorist attacks on September 11, 2001, and continuing with theproliferation of global terrorism, as well as the potential threat of terrorismposed by the war in Iraq, homeland security and force protection concerns havebecome of paramount importance in the United States and around the world. TheCompany believes that homeland defense, force protection and military securityinitiatives will continue to provide new revenue opportunities with increasedgrowth in the seaports and borders, federal and military facilities, force protection,and corporate security markets.

 

***High Energy Systems Division***  In 1998 the Company established the HighEnergy Systems division (“HES”). HES, located in Mountain View, California,develops and manufactures linear accelerators for a variety of applications andproducts, including a proprietary high-energy linear accelerator for theCompany’s Shaped Energy technology. The linear accelerators generate high-energyX-rays by accelerating electrons from energy of approximately 20 KeV to energyof several MeV using microwave fields created in an evacuated acceleratingstructure. The accelerated electrons either strike a heavy metal target togenerate high energy X-rays, or are extracted in air to produce a propagatinghigh-energy electron beam for various applications. The applications for HES’slinear accelerators include dense cargo screening, medical, scientific,military, electron beam curing, and non-destructive testing.

 

**Technology**

 

The Company’sproduct line utilizes a variety of technologies including proprietaryZ® Backscatter technology, traditional transmission X-ray, Shaped Energyand the recently introduced Radioactive Threat Detection (RTD).

 

***Z® Backscatter Technology***  All of the Company’s X-ray systems utilizeAS&E’s patented Z® Backscatter technology. Backscattered X-rays referto those X-rays that are directed toward an object and are scattered, ratherthan absorbed by that object. Z® Backscatter captures these scattered X-raysand uses them to create highly readable, photo-like images. A key aspect ofZ® Backscatter is that objects that are organic in content (low atomicnumber or “low Z”), such as drugs, explosives, plastic weapons, or people,scatter X-rays very well. These organic items stand out as bright objects inthe Z® Backscatter images, making them easy to identify in even the mostcomplex X-ray backgrounds. As a result, the Z® Backscatter images showthese potential threats clearly. When used in combination with transmission X-raytechnology, Z® Backscatter adds significant interpretability to atransmission image enabling an inspector to perform a quicker and more thoroughexamination of the object in question.

 

***TransmissionX-ray Technology*** Transmission X-rays are used in combination with Z® Backscatter inmany of the Company’s products. A standard transmission X-ray image resultswhen X-rays are absorbed rather than scattered as they pass through the objectunder examination. When transmission X-rays pass through the parcel, containeror vehicle being scanned, and are viewed on the transmission monitor, theycreate a “shadowgram” image, similar to the result of a medical X-ray exam.Shadowgram images are generally high resolution and result from the X-ray beampenetrating through, and being absorbed by, objects of varying densities. Withtransmission

 

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technology, the more objects or clutter in the path of the beam theless differentiation of those objects is achieved.

 

The best method for X-ray inspection isviewing Z® Backscatter and transmission X-ray images simultaneously,giving inspectors more information about the contents of the parcel orcontainer by differentiating dense objects, such as metal, from low Zmaterials, such as explosives.

 

***ShapedEnergyTM Technology*** This patented technology is specifically designed for use in examiningdensely loaded cargo containers at seaports and border crossings and isavailable in various fixed or modular system configurations. The Shaped Energy(SE) detection system combines the penetration capability of a high-energy X-raysource (3.8 MeV) with the photo-like quality and material discriminationfeatures of the Company’s Z® Backscatter imaging technology.

 

An important characteristic of Shaped Energytechnology is that it allows for optimal penetration while maintaining one ofthe smallest footprints and radiation exclusion zones in the industry.Historically, high-energy X-ray systems were constrained by the necessity forlarge exclusion zones and heavy shielding in order to protect against thehazards of excessive radiation. The Shaped Energy linear accelerator, designedand produced by the Company’s HES division, incorporates an X-ray system designthat eliminates the need for cumbersome shielding and exclusion zones.

 

***RadioactiveThreat Detection Technology***  An AS&E cargo inspection system enhancedwith Radioactive Threat Detection (RTD) can be used to find radioactive threatsin vehicles and cargo containers. RTD is highly sensitive to both gamma raysand neutrons—typically associated with dirty bomb materials (such as Cesium137) or fissile material such as weapons grade plutonium. RTD is particularlyimportant in light of the potential terrorist threat of explosives packagedwith radioactive material that scatters upon deployment, commonly referred toas “dirty bombs.” AS&E’s RTD technology is unique as the X-ray system canperform radioactive material detection while simultaneously producingZ® Backscatter and transmission X-ray images thereby maintaining optimumthroughput.

 

**Products and Systems**

 

The Company’sproducts can be grouped into four different areas including the CargoSearchTMfamily, the ParcelSearchTM family, Backscatter-only products, as well as Serviceand Support. These areas, each with dedicated, accountable leadership that arefocused on continued enhancement of their respective products.

 

***CargoSearchTM Inspection Systems***  The CargoSearch family of systems includeshigh-energy and medium-energy non-intrusive inspection and screening devicesfor the X-ray scanning of trucks, cars, cargo containers, pallets and air cargoprimarily at border crossings, seaports, railroad centers, airports, and cargoand transportation hubs. These systems are designed to combat trade fraud, drugtrafficking, weapons smuggling and terrorism. In addition, the Company recentlyintroduced the Z® Backscatter Van, an effective, low-cost and high-speed X-rayinspection tool for screening vehicles and cargo in crowded environments.AS&E currently has 83 CargoSearch inspection systems deployed in 15countries. The CargoSearch family includes:

 

***Shaped Energy Gantry System,***anX-ray inspection system combining high-energy transmission andZ® Backscatter imaging ideal for ports, borders and high-threatfacilities. With the SE Gantry, detectors move on rails past stationaryvehicles and cargo. The system is bi-directional, allowing for high throughput.The SE Gantry system eliminates the need for a cargo transport system.

 

***Shaped Energy CargoSearchTM System,***afixed site X-ray inspection system combining high-energy transmission andZ® Backscatter imaging ideal for ports, borders and high-threatfacilities. The SE CargoSearch configuration provides the stability of apermanent inspection location, within a very small footprint.

 

***MobileSearchTM System,***atruck-mounted, cargo and vehicle X-ray inspection system that adds flexibility,mobility and the ability to inspect cars (from one or both sides) to the basicCargoSearch concept.

 

***PalletSearchTM System,***whichallows for the inspection of pallets to detect contraband, weapons andexplosives for high security facilities where high confidence inspection is arequirement.

 

***Backscatter-Only Inspection Systems***  An advantage of Z® Backscattertechnology is that it can be used as a standalone technology, or in combinationwith other technologies, including Transmission, Shaped EnergyTM, andRadioactive Threat Detection. Z® Backscatter scanning can be implementedwithout the use of boom-mounted receptors, which allows for rapid drive-byscreening of containers and vehicles in a variety of applications withoutimpeding the flow of commerce.

 

***Z® Backscatter Van (ZBV)***isan extremely mobile X-ray screening system built into a commercially availabledelivery 

 

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van. Itutilizes AS&E’s patented Z® Backscatter X-ray technology to producephoto-like images of the contents of a vehicle or cargo container, highlightingorganic materials such as plastic explosives or other anomalies.

 

***Z® Backscatter Portal,***amulti-view backscatter-only, drive-through inspection system capable ofscanning cars, vans, trucks, and their cargoes for threats and contraband.

 

***ParcelSearchTM Inspection Systems***ParcelSearchsystems are designed for the non-intrusive X-ray scanning of parcels, baggageand mail. They are primarily located in government facilities, airports, andcommercial office buildings, high-security federal facilities (researchfacilities and military bases) and convention centers. There are currently inexcess of 1,990 ParcelSearch systems deployed in over 127 countries. TheParcelSearch family includes:

 

***Model 101VANTM,***aself-contained, conveyer based parcel inspection system housed in a standardvan and designed and built to the rigorous specifications of the U.S. Bureau ofCustoms and Border Protection.

 

***Models 101ZTM, 101ZZTM, 101GTTM and 101XLTM,***conveyor-basedsystems allowing rapid inspection of high volumes of luggage and otherpackages.

 

***Model 66ZplusTM,***acompact system designed to handle small packages, including briefcases, carry-onluggage and mail.

 

In addition,the Company manufactures the **BodySearchTMPersonnel Inspection System**. The BodySearch system offers a fast,safe, and non-intrusive way to screen individuals for weapons, drugs, andillegal contraband concealed under clothing, providing a viable alternative topat or strip searches.

 

***Service and Support****AS*&E’s highly skilled FieldService Engineers (FSEs) provide support services and comprehensive technicaltraining on all X-ray inspection systems worldwide. FSEs are located atAS&E offices in Asia, Europe, the Middle East and North America. Inaddition, Technical Support is provided at headquarters in Billerica. AS&Eprovides comprehensive, cost-effective spare parts solutions customized foreach system.

 

**Intellectual Property**

 

The Companyrelies on a combination of patent, copyright, trademark, contract and tradesecret laws to establish and protect its proprietary rights in its technology.The Company has patents either issued and/or pending in the United States,Germany, Japan, the United Kingdom, China and Egypt and under the Patent CooperationTreaty.

 

In general,the company pursues a policy of obtaining patent protection both in the UnitedStates and in selected foreign countries for subject matter we considerpatentable and important to our business strategy. We have 50 unexpired patentsissued by, and 17 patent applications pending with, the U.S. Patent andTrademark Office, as well as a number of international patents and patentapplications. Of our issued patents, over half have been issued in the lastfive years.

 

Generally,patents issued in the United States are effective for the longer of17 years from the date of issue or 20 years from the earliesteffective filing date of the corresponding patent application if filed prior toJune 8, 1995. The duration of foreign patents varies in accordance withapplicable local law. While the duration of our patents varies, we believe thatthe duration of our patents is adequate relative to the expected lives of ourproducts.

 

The Companybelieves that its patents, proprietary technology, know-how, and trademarksprovide substantial protection for the Company’s competitive position and theCompany intends to aggressively protect its intellectual property assets, bylitigation or other means, as appropriate. Nevertheless, there can be noassurances that the steps taken by the Company in this regard will be adequateto prevent misappropriation or infringement of its technology or that theCompany’s competitors will not independently develop technologies that aresubstantially equivalent or superior to the Company’s technology. Effectiveprotection of intellectual property rights may be limited or unavailable incertain foreign countries. See Item 3: Legal Proceedings below.

 

**Sales and Marketing**

 

The Company’sX-ray products are marketed to private and governmental organizations through asales force that contacts potential customers and responds to public tendersand other expressions of interest. This sales force includes Company personnelbased in the United States and abroad as well as independent representativesunder contracts to sell in foreign countries.

 

Many of theCompany’s systems are built for existing customers and the Company maintains aninventory of common parts and 

 

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sub-assemblies for these systems in order tomeet expected customer delivery requirements and spares requirements.

 

**Customers**

 

The Companyhas a customer list consisting of government and commercial clients from boththe U.S. and abroad. Domestically, the Company’s primary client base iscomprised of agencies of the U.S. Government. International sales, primarily toforeign governments, accounted for approximately 12%, 15%, and 30% of theCompany’s total sales in fiscal 2004, 2003 and 2002, respectively. Theinternational market will continue to remain a high priority for the Company aspart of its long-term growth strategy.

 

During fiscal2004, approximately 77% of the Company’s sales were derived from either(i) contracting directly with the U.S. Government, or (ii) contractingwith contractors working directly with the U.S. Government. A small percentageof the Company’s contracts with the U.S. Government provide the U.S. Governmentwith the standard unilateral right to terminate these contracts forconvenience. To date, the Company has not experienced any material losses asthe result of this contractual provision. The Company is heavily dependent uponsales to agencies of the U.S. Government and reductions or delays inprocurement of the Company’s systems by these agencies may have a materialadverse effect on the Company.

 

Notwithstandingthe longer sales cycles and project financing requirements often associatedwith international sales, the Company continues to focus on these sales as ameans of reducing its dependence on sales to the U.S. Government. The Companymanages its overseas risk in a number of ways, including actively increasingthe number of opportunities it is pursuing at any one time and by working withinternational funding sources to help customers finance and secure funding ofthese projects. The majority of international contracts are bid in U.S.dollars. For those contracts that are bid in other currencies, the Companywould consider engaging in hedging contracts to control foreign exchange risk.There were no hedging activities in fiscal 2004.

 

In fiscal year2004, the Company had sales to two major customers, both agencies of the U.S.Government, which accounted for 19% and 15%, respectively, of total sales. Infiscal year 2003, the Company had sales to one major customer, an agency of theU.S. Government, which accounted for 17% of total sales.

 

**Competition**

 

The Companyhas many competitors in the X-ray product market, including several large andwell-established manufacturers of security X-ray equipment with financial andother resources greater than those of the Company. Certain X-ray securitysystem customers select such systems based largely on price. Other customers,notably the U.S. Government and users in countries with high levels of concernover security, tend to select systems based largely on performance anddetection capability. The Company’s systems offer premium performance and havehistorically been priced higher than many competing systems. The Companybelieves that its patented and proprietary technology gives it a strongcompetitive position in the sale of security systems to customers concernedwith performance and detection. The Company also believes that its strategy ofconcentrating on differentiable products with unique features, includingZ® Backscatter and Shaped Energy, and/or competitive pricing will give ita strong position to increase its sales of X-ray systems. However, a number ofcompanies have developed products that compete with the Company’s X-rayinspection products. (See “Forward-Looking Information and Factors AffectingFuture Performance”).

 

**ISO 9001Certification**

 

In August 2003,the Company announced that its Quality Management System had been registeredunder the updated ISO 9001:2000 Standard of the International Organization forStandardization. The Company had been registered under the previous ISOstandard since March 2001. ISO 9001 is an internationally recognizedquality management and assurance standard. In November 2003, the Companyannounced that its west coast division, HES, had been registered under theupdated ISO 9001:2000 Standard of the International Organization forStandardization. HES had been registered under the previous ISO 9001 standardsince April 2003 and the ISO 13485 standard since August 2002. ISO13485 is the internationally recognized quality management system standard formedical devices.

 

In qualifying,the Company met or exceeded the standards for establishing a quality managementsystem for preventing non-conformity at every level of the product life cycle,from customer order, through development and production, to installation andsupport.

 

The Companybelieves that demonstrating continuous quality improvement is vital forbuilding customer satisfaction and making business processes more efficient inorder to increase its competitive edge.

 

**Raw MaterialAvailability**

 

The Companyhas not experienced during the last year, and does not currently anticipate,any product delivery delays due to raw material shortages. Most procuredmaterial is from U.S. sources. However, the Company is dependent upon certainoverseas providers of 

 

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important components. No rare or exoticmaterials are utilized. Following the events of September 11, demand for X-raysystem subcomponents increased significantly across the security industry. Inresponse, the Company took steps to mitigate sourcing risks by working closelywith its vendors to secure future raw material availability. In some cases, theCompany chooses to stock certain inventory components to assure futureavailability. These efforts also included identifying and qualifying second-sourceproviders for several critical components on all of its product lines.

 

**Regulatory Compliance**

 

The Companycomplies with applicable Health and Human Services regulations outlined underthe “Regulations for the Administration and Enforcement of the RadiationControl for Health and Safety Act of 1968” (21CFR 1020.40), published by theU.S. Department of Health and Human Services. All X-ray products of the Companycomply with all applicable U.S. Government regulatory standards.

 

**Research andDevelopment**

 

The Companyspent approximately $5,535,000 of its own funds for research and developmentduring fiscal 2004, compared to $6,419,000 and $7,136,000 in fiscal 2003 and2002, respectively. The principal focus of fiscal 2004 and 2003 was on researchand development of new products including the Shaped Energy Gantry, theZ® Backscatter Van and Radioactive Threat Detection. In addition fundswere invested to enhance existing products, to develop new applications and forconceptualization of new products.

 

In addition,the Company conducted government-sponsored research primarily focused ontechnologies for the detection of illicit drugs, explosives, and other securityissues. The Company recognized revenues of $444,000, $747,000 and $635,000, infiscal 2004, 2003, and 2002, respectively for these efforts. A significantamount of the Company’s government sponsored research and development work isobtained via contracts or subcontracts that typically provide for a fixed feeor a reimbursement of allowable costs plus a fixed fee. The Company’s contractsin these areas are obtained by submitting research and development proposals tovarious organizations, sometimes in response to requests for such proposals.The Company’s contract research ranges from advances in X-ray systems and imageanalysis to integrated system development for niche security inspectionproblems.

 

**Personnel**

 

As of March 31,2004 the Company had 324 employees as compared to 304 employees at the end ofthe prior year. It is the Company’s policy to have employees sign nondisclosureagreements as a condition of employment. None of the Company’s employees arerepresented by labor unions.

 

**Sales Backlog**

 

The Company’sfirm (under signed contracts) sales backlog was $33,852,000, $38,765,000, and$40,735,000 at March 31, 2004, March 31, 2003 and March 31,2002, respectively.

 

A majority ofthe Company’s contracts with the U.S. Government contain clauses permitting thegovernment to terminate the contract for convenience upon certain terms andconditions, including partial payment to the Company for work performed. Thetotal of such contracts in the backlog was $16,645,000, $17,751,000, and$22,233,000 at March 31, 2004, March 31, 2003 and March 31,2002, respectively. The reduction is attributable to the high sales volume inthe fourth quarter of the current fiscal year and the shipment of certain fixed-sitecargo systems during the year. It is estimated that approximately 82% of the2004 backlog will be filled within the fiscal year ending March 31, 2005.

 

**Financial InformationAbout Foreign and Domestic Operations and Export Sales**

 

Most exportsales are made in U.S. dollars, and many are either secured by irrevocableletters of credit or paid in advance. The following chart provides informationabout the breakdown between domestic and export sales in dollars andpercentages of total sales for the indicated fiscal years. With the exceptionof small amounts of spares inventory and cash accounts maintained at foreignlocations (less than 1% of the Company’s assets), all assets are maintainedwithin the United States.

 

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**NetSales and Contract Revenues**

 
| ** **                                  | ** ** | **Fiscal Year**            | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
|                                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Domestic  (based on customer location)      |       | $                          | 66,848     |   | 88 | % | $ | 52,834 |   | 85 | % | $ | 45,932 |   | 70 | % |
| Export  (based on customer location)        |       | 9,494                      |       | 12 | % | 9,124 |   | 15 | % | 19,464 |   | 30 | % |
| Net Sales  and Contract Revenues            |       | $                          | 76,342     |   | 100 | % | $ | 61,958 |   | 100 | % | $ | 65,396 |   | 100 | % |
|                                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Percent of  Export Revenue by Major Region: |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Middle East  & Africa                   |       | 34.2                       | %          |   |   | 70.6 | % |   |   | 59.0 | % |   |   |
| Europe                                      |       | 29.1                       | %          |   |   | 16.8 | % |   |   | 28.1 | % |   |   |
| Mexico                                      |       | —                     |       |   |   | — |   |   |   | 7.7 | % |   |   |
| Pacific Rim                                 |       | 34.4                       | %          |   |   | 11.7 | % |   |   | 4.4 | % |   |   |
| All Other                                   |       | 2.3                        | %          |   |   | 0.9 | % |   |   | 0.8 | % |   |   |

 

**ITEM 2. PROPERTIES**

 

The Company’sexecutive offices are located in Billerica, MA and its research, manufacturingand warehouse facilities are located in Billerica, MA and Mountain View, CA. InBillerica, the Company occupies 118,300 square feet of space in a 160,000square foot single-story, concrete and brick building owned by an unaffiliatedreal estate limited partnership. The remaining space is currently unoccupiedand is available for lease from the building owner. The Company occupies thespace under a long-term lease with a ten-year initial term that commenced March 1,1995, and an option to extend for an additional ten-year term. In October 1999,the Company leased an additional 56,000 square feet of manufacturing and officespace in an office park near the main office. This lease has a term of fiveyears. The Company is currently evaluating the market for potential new real estatelocations.

 

Located inMountain View, CA, HES leases 24,733 square feet of manufacturing, research anddevelopment, test and office space. The initial term of the lease is sevenyears, with an option to extend for an additional five-year period. The leasecommenced on February 1, 2004.

 

The Company’sfacilities are currently utilized on a one-shift basis. The Company can addadditional capacity by adding second and third shifts if necessary.

 

**ITEM 3. LEGAL PROCEEDINGS**

 

In September 1998,the Company filed suit against EG&G Astrophysics Research Corp. (“EG&G”)in the U.S. District Court for the District of Massachusetts in Boston,alleging that EG&G infringed upon at least two patents owned by the Companyand that EG&G had misappropriated certain trade secrets of the Company.EG&G denied these allegations and filed counterclaims alleging that thepatents-in-suit were not infringed and/or were invalid. In May 2003, theCompany and PerkinElmer, Inc. (the former parent of EG&G) completed asettlement agreement which resolved all of the Company’s claims againstEG&G through June 14, 2002, the date that PerkinElmer sold EG&G toits new corporate parent, L-3 Communications, Inc, (“L-3”). Counterclaims as toany liability through the same date also were released. After completing thissettlement, the litigation continued against EG&G’s successor-in-interest,L-3, concerning any liability accrued after that date. Upon a determinationthat L-3 was not continuing the accused infringement, the Company moved todismiss the case. In February 2004, the District Court entered an orderdismissing the Company’s claims with prejudice and L-3’s counterclaims withoutprejudice. The Company covenanted not to sue L-3 for infringement by anycurrent products of the two above-referenced patents.

 

On or about February 19,2004, L-3 filed a lawsuit against the Company in the United States DistrictCourt for the District of Massachusetts, in Boston, seeking declaratoryjudgments of non-infringement and/or invalidity of two of the Company’spatents—United States Pat. No. 6,292,533 and No. 5,903,623. TheCompany filed a motion to dismiss the litigation for lack of subject matterjurisdiction, but was denied. The Company has answered L-3’s underlyingcomplaint, vigorously opposing the plaintiff’s non-infringement and invalidityclaims.

 

The Company isalso subject to various legal proceedings and claims that arise in the ordinarycourse of business. The Company currently believes that resolving these matterswill not have a material adverse impact on its financial condition or resultsof operations.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

No matter wassubmitted to a vote of the Company’s security holders during the fourth quarterof the fiscal year covered by this report.

 

 

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**PARTII**

 

**ITEM 5. MARKET FOR THE COMPANY’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

The Company’scommon stock is listed on the American Stock Exchange (ticker symbol: ASE). Themarket price range for the Common Stock for the last two fiscal years follows:

 
| **Fiscal Year** | ** ** | **Quarter Ended**       | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------|------------|-------------------------|------------|----------|------------|---------|------------|
|            |       |                    |       |     |       |    |       |
| 2004            |       | March 31, 2004     |       | $        | 16.90      |    | $          | 10.94 |   |
|            |       | December 31, 2003  |       | 14.10    |       | 11.25   |       |
|            |       | September 30, 2003 |       | 11.70    |       | 9.05    |       |
|            |       | June 30, 2003      |       | 10.00    |       | 7.16    |       |
| 2003            |       | March 31, 2003     |       | $        | 13.23      |    | $          | 6.80 |   |
|            |       | December 31, 2002  |       | 14.25    |       | 9.10    |       |
|            |       | September 30, 2002 |       | 15.90    |       | 9.05    |       |
|            |       | June 30, 2002      |       | 23.50    |       | 13.95   |       |

 

As of June 1,2004, there were approximately 939 holders of record of the Company’s CommonStock.

 

No cashdividends have been declared in the two most recent fiscal years and theCompany does not contemplate paying any dividends in the immediate future. TheCompany’s credit facility restricts the payment of dividends (except in sharesof the Company’s stock) without the consent of the bank. See “ManagementsDisclosure and Analysis” describing the dividend limitation.

 

10

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**Equity CompensationPlan Information**

 

The followingtable provides the information about the Company’s common stock that may beissued upon the exercise of options and rights under all existing equitycompensation plans as of March 31, 2004. The Company has the followingstock option plans outstanding as of March 31, 2004: 1984 Stock OptionPlan, the 1993, 1994-1995, 1996 and 2003 Stock Option Plans for Non-employeeDirectors; 1995 Combination Plan; 1997 and 1998 Non-Qualified Option Plan; 1994-95Stock Option Plan for New Employees, a 1999 Combination Plan, a 2000Combination Plan, and a 2002 Combination Plan.

 
| **Plan category**                                                | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights as  of March 31, 2004** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of securities  remaining available for future  issuance under equity  compensation plans as of  March 31, 2004 (excluding  securities reflected in column(a))** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                             |       |                                                                                                                          |       |                                                                                |       |                                                                                                                                                                          |       |
| **Equity  compensation plans approved by security holders:**     |       |                                                                                                                          |       |                                                                                |       |                                                                                                                                                                          |       |
| 1984 Stock  Option Plan                                          |       | 200                                                                                                                           |       | $                                                                                   | 5.44       |                                                                                                                                                                          | —     |   |
| 1993 Plan  for New Non-Employee Directors                        |       | 5,000                                                                                                                         |       | $                                                                                   | 6.38       |                                                                                                                                                                          | —     |   |
| 1995  Combination Plan                                           |       | 145,866                                                                                                                       |       | $                                                                                   | 10.29      |                                                                                                                                                                          | 66         |   |
| 1999  Combination Plan                                           |       | 220,400                                                                                                                       |       | $                                                                                   | 10.71      |                                                                                                                                                                          | 4,234      |   |
| 2000  Combination Plan                                           |       | 166,767                                                                                                                       |       | $                                                                                   | 10.10      |                                                                                                                                                                          | 83,767     |   |
| 2002  Combination Plan                                           |       | 490,135                                                                                                                       |       | $                                                                                   | 10.86      |                                                                                                                                                                          | 230,565    |   |
| 2003 Stock  Plan for Non-Employee Directors                      |       | 42,500                                                                                                                        |       | $                                                                                   | 11.58      |                                                                                                                                                                          | 104,980    |   |
| **Equity  compensation plans not approved by security holders:** |       |                                                                                                                          |       |                                                                                |       |                                                                                                                                                                          |       |
| 1994-1995  Plan for New Employees                                |       | 22,000                                                                                                                        |       | $                                                                                   | 7.25       |                                                                                                                                                                          | —     |   |
| 1994-1995  Plan for Non-Employee Directors                       |       | 28,000                                                                                                                        |       | $                                                                                   | 5.87       |                                                                                                                                                                          | —     |   |
| 1996 Plan  for Non-Employee Directors                            |       | 119,000                                                                                                                       |       | $                                                                                   | 10.52      |                                                                                                                                                                          | 102,833    |   |
| 1997 Non-Qualified  Option Plan                                  |       | 95,700                                                                                                                        |       | $                                                                                   | 10.74      |                                                                                                                                                                          | 25,917     |   |
| 1998 Non-Qualified  Option Plan                                  |       | 145,073                                                                                                                       |       | $                                                                                   | 12.32      |                                                                                                                                                                          | 34,483     |   |
| Total                                                            |       | 1,480,641                                                                                                                     |       | $                                                                                   | 10.66      |                                                                                                                                                                          | 586,845    |   |

 

In addition,the Company has a common stock installment purchase plan under which the Boardof Directors may grant key personnel the right to purchase shares of theCompany’s common stock at fair market value and to pay the purchase price intwelve equal monthly installments. As of March 31, 2004, no shares havebeen reserved or granted under this plan.

 

11

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The Companyhas instituted two common stock purchase plans. The Executive Equity IncentivePlan allows an executive officer of the Company to buy original issue Companycommon stock in any dollar amount up to the gross amount of the annual bonusgranted to the Officer and to receive half the number of shares purchased inrestricted stock which vests after 3 years. If the employee leaves theCompany prior to 3 years, then the shares revert back to the Company. Asof both March 31, 2004 and 2003, 2,251 shares have been reserved andrestricted under this plan. The Reload Option Plan allows any eligible employeedesignated by the Board of Directors to receive new stock options (at anexercise price equal to the fair market value of the common stock on the dateof sale of the stock by the employee) for every share of Company common stocksold or used to exercise stock options. There have been no issuances of stockoptions under the Reload Option Plan.

 

**ITEM 6. SELECTED FINANCIAL DATA**

 

**Thefollowing selected financial data is qualified by reference to, and should beread in conjunction with, the consolidated financial statements, including thenotes thereto, and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” included elsewhere in this Annual Report.**

 
| **Fiscal Year**                       | ** ** | **2004**                                              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                            | ** ** | **(Dollars in thousands, except  per share amounts)** | ** ** |
|                                  |       |                                                  |       |     |       |     |       |     |       |     |       |
| Net sales  and contract revenues      |       | $                                                     | 76,342     |     | $          | 61,958   |       | $        | 65,396     |     | $          | 67,374 |   | $ | 60,896 |   |
| Net income  (loss)                    |       | 1,911                                                 |       | (7,951   | )          | (4,512   | )          | 660      |       | 1,459    |       |
| Income  (loss) per share—diluted |       | 0.26                                                  |       | (1.20    | )          | (0.87    | )          | 0.13     |       | 0.29     |       |
| Total assets                          |       | 55,803                                                |       | 47,316   |       | 50,241   |       | 44,310   |       | 38,205   |       |
| Obligations  under capital leases     |       | —                                                |       | —   |       | —   |       | —   |       | 16       |       |
| Stockholders’  equity            |       | 38,433                                                |       | 32,358   |       | 23,129   |       | 22,634   |       | 21,375   |       |
|                                       |            |                                                       |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

**ITEM7.****                  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations should be read in conjunction with our consolidated financialstatements and notes thereto which appear elsewhere in this Annual Report onForm 10-K/A. The following discussion contains forward-looking statementsand should also be read in conjunction with “Forward Looking Information andFactors Affecting Future Performance” beginning on page 17.**

 

**2004 Compared to 2003**

 

**Overview**

 

AmericanScience and Engineering, Inc. develops and manufactures state-of-the-art X-rayinspection systems for homeland security and other critical defenseapplications. AS&E continues to innovate, create and develop new productsby investing in new ideas through research and development, and evolving itstechnology to meet the needs of an ever-changing world. The Company’s primarytechnologies are as follows: Z® Backscatter technology which is used todetect plastic explosives, illegal drugs, and other contraband even whenartfully concealed in complex backgrounds by terrorists and smugglers; ShapedEnergy X-ray inspection systems which combine the material discriminationfeatures of Z® Backscatter with the penetration capability of high-energyX-rays for dense cargos; and the manufacture of linear accelerators for avariety of applications including medical, scientific, security, electron beamcuring and non-destructive testing.

 

In recentyears, the Company has focused on right-sizing its organization in response tothe changes in the global economy and the demands of the security markets thathave changed dramatically since September 11, 2001. In addition toadjusting its production capacities, the Company has also focused on therecruitment of a senior management team that could continue to enhance theCompany’s operating results, as well as its position in the market place. Theestablishment of this team was completed in the current fiscal year. Inaddition, the Company has expanded the internal and external sales forces,including the addition of the VP of Worldwide Marketing and Sales on the seniormanagement team previously noted, in order to maximize potential benefits fromglobal opportunities.

 

Whilecontinuing to control the resources expended on internally funded research anddevelopment projects, the Company remains committed to its belief that theseprojects are critical to its future operating results and position in themarket. As a result of these efforts, the Company has provided the market placewith new innovative products. In the current year, the Company introduced andshipped the first of its new Z® Backscatter van product line, which hasbeen well received in the market place.

 

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Net sales andcontract revenues for fiscal 2004 increased by 23% to $76,342,000 compared tofiscal 2003 net sales and contract revenues of $61,958,000. The Companyreported net income before taxes of $1,820,000 in fiscal 2004 compared to a netloss before taxes of $5,495,000 in the previous fiscal year. Net income forfiscal 2004 was $1,911,000 ($.26 per share, on a diluted basis) as compared toa net loss of $7,951,000 ($1.20 per share, on a diluted basis) in fiscal 2003.Backlog at March 31, 2004 was $33,852,000, a 13% decrease from the backlogreported at the previous fiscal year end. The reduction is attributable to thehigh sales volume in the fourth quarter of the current fiscal year and theshipment of certain fixed-site cargo systems during the year.

 

*** Resultsof Operations*** Net sales and contract revenues increased by $14,384,000 or 23% infiscal 2004 compared to fiscal 2003. The increase in revenues was due primarilyto an increase of approximately $14,050,000 to $38,841,000 in sales ofCargoSearch systems. This increase is primarily attributable to the sale ofnine more MobileSearch systems in fiscal 2004 than in fiscal 2003, the sale ofthe Company’s first four ZBV’s offset by the completion of significant fixed-sitesystems in the current year that had been ongoing in fiscal 2003. In contrast,ParcelSearch sales decreased by $4,876,000 to $15,959,000 primarily due to thecontinuation of the lower revenues experienced in the third and fourth quarterof fiscal 2003 as compared to the higher levels experienced in the first andsecond quarter of fiscal 2003 which were attributable to the increased demandexperienced following September 11th. Aftermarket fieldservices revenues increased by 53% to $13,894,000 as compared to $9,064,000 infiscal 2003 primarily due to new post-warranty service contracts on installedmachines. The Company recorded $444,000 in contract research and developmentrevenues in fiscal 2004 as compared to $747,000 in fiscal 2003. The Company’sHES division increased revenues by $3,588,000 to $7,203,000 in fiscal 2004 ascompared to $3,615,000 in fiscal 2003 primarily due to increased demand fromits major customer as well as orders received from new customers. Thegeographical mix of revenues in fiscal 2004 remained fairly constant at 88%domestic revenues as compared to 85% domestic revenues in fiscal 2003. Infiscal year 2004, the Company had sales to two major customers which accountedfor 19% and 15%, respectively, of total sales. In fiscal year 2003, the Companyhad sales to one major customer, which accounted for 17% of total sales.

 

Cost of salesand contracts of $56,408,000 in fiscal 2004 increased by $5,399,000 or 11% fromthe previous year. This increase is primarily attributable to the 23% revenueincrease noted above, the recognition of a $2,079,000 loss on contractprograms, offset by the lower cost of goods sold related to the nineMobileSearch units and improved service margins as the company entered intoseveral large service contracts in the current fiscal year as warrantiesexpired and the replacement of certain unprofitable service contracts and timeand material service arrangements. Included in cost of sales and contracts infiscal 2003 is a $3,400,000 provision for inventory obsolescence.

 

Selling,general and administrative expenses of $11,648,000 were $761,000 less than theprevious year and represented 15% of revenues in fiscal 2004 as compared to 20%in fiscal 2003. This reduction from the prior year relates to lower consultingcosts and reduced expanded demonstration expenditures. In fiscal 2003, theCompany had an expanded demonstration tour with a MobileSearch system that wasnot repeated in the current year. These decreases were offset somewhat by theaddition of sales and marketing personnel in the current year as well as theseverance and other costs incurred related to the termination of the Company’sChief Executive Officer.

 

Company fundedresearch and development spending decreased to $5,535,000 in fiscal 2004, a 14%decrease compared to the $6,419,000 spent in fiscal 2003. Research anddevelopment spending was 7% of revenues in fiscal 2004 as compared to 10% ofrevenues in fiscal 2003. In fiscal 2004, the Company continued to work tocontrol its research and development spending while continuing to focus on specificinitiatives such as the Shaped Energy Gantry system, which was completed infiscal 2004, the Z® Backscatter Van, of which the first four units wereshipped in the current year and Radiation Threat Detection technology.

 

Other income(expense) was $931,000 in expense in fiscal 2004 as compared to $2,384,000 inincome in fiscal 2003. In May of 2002, the Company closed on a privateplacement offering of common stock and warrants. A total of 1,115,000 shareswere sold to accredited investors at a price of $17.64 each. Proceeds from thisoffering were used in part to pay off the Company’s line of credit resulting ina decrease in interest expense of $390,000 in fiscal 2003. In addition,warrants to purchase an additional 295,475 shares of common stock at a price of$23.52 were issued. These warrants include certain conversion features thatrequire a “mark to market” adjustment that resulted in an expense of $1,273,000in fiscal 2004 and income of $2,298,000 in fiscal 2003.

 

The Companyreported pre-tax income of $1,820,000 in the current year as compared to a pre-taxloss of $5,495,000 in the previous fiscal year primarily due to the increasedrevenues and expense reductions noted above. In fiscal 2003, the Companyreviewed its deferred tax assets as a whole to determine what would be realizedover the next three to five years in light of historical losses incurred andrecorded a reserve of $2,456,000 against its remaining deferred tax asset. Infiscal 2004, the Company recognized $91,000 of tax benefit related to a taxrefund from prior years.

 

The Companyreported net income of $1,911,000 in fiscal 2004 as compared to a net loss of$7,951,000 in fiscal 2003.

 

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**2003 Compared to 2002**

 

**Overview**

 

***Results of Operations***  Net sales and contract revenues decreased by$3,438,000 or 5% in fiscal year 2003 as compared to fiscal 2002. The decreasein revenues was due primarily to a decrease of approximately $13,170,000 to$24,791,000 in sales of CargoSearch systems and upgrades, as numerous projectsongoing in fiscal 2002 were completed in the current year and new engagementsexperienced significant delays as government agencies (both U.S. and foreign)worked to determine the best solution for security in the post-September 11thenvironment. In addition, a significant project to install a CargoSearch systemin the Middle East was halted during the Iraqi conflict resulting in lower thananticipated fourth quarter revenues. In contrast, ParcelSearch sales increasedby $6,306,000 to $20,835,000 due to an immediate increase in demand following September 11ththat resulted in higher ParcelSearch system sales in the third and fourthquarters of fiscal 2002 and continuing through the second quarter of fiscal2003. The third and fourth quarters of fiscal 2003 showed slightly lowerParcelSearch revenues but still remain higher than the average pre-September 11thlevels. The sale of aftermarket parts remained relatively consistent year overyear at approximately $3.0 million. Aftermarket field services revenuesincreased by 42% to $9,064,000 as compared to $6,387,000 in fiscal 2002 as aresult of new post-warranty service contracts on installed machines. Servicerevenues had previously been less than 10% of total revenues and were notseparately disclosed; however, due to the increase in the current year are nowreflected separately on the Company’s statement of operations. The Companyearned $747,000 in contract research and engineering revenues in fiscal 2003 ascompared to $635,000 in fiscal 2002. The Company’s HES division increasedrevenues to external customers by $711,000 to $3,615,000 in fiscal 2003 ascompared to $2,904,000 in fiscal 2002. There was a shift in the geographicalmix of revenues in fiscal 2003 as domestic revenues increased from 70% of totalrevenues in fiscal 2002 to 85% of total revenues in fiscal 2003. This increaseis due primarily to the domestic focus on homeland defense and security in thewake of the terrorist events of September 11th. One customer,an agency of the U.S. Government, accounted for 17% of revenues during fiscal2003.

 

Cost of salesand contracts of $51,009,000 in fiscal 2003 increased by $1,652,000 or 3% fromthe previous year. Cost of sales and contracts represented 82% of revenuesduring fiscal 2003, compared to 75% in fiscal 2002. This percentage increase inthe cost of sales was due primarily to $3,400,000 in provisions for inventoryobsolescence recorded in fiscal 2003 and, to a lesser extent, excessmanufacturing capacity as a result of the sharp decline in CargoSearch sales.The Company, in response to the events of September 11th andthe anticipated increase in demand for security systems, had committed tosignificant volume purchases of raw materials in late fiscal 2002 and increasedproduction of CargoSearch and ParcelSearch systems. The result was asignificant increase in inventory levels at the end of fiscal 2002. The eventsof September 11th raised considerable interest in the Company’sproducts and in the first quarter of fiscal 2003 the Company signed a three-year$500 million blanket purchase agreement with the U.S. Department ofDefense. This level of interest continued into the second quarter of fiscal2003 as the first orders for three MobileSearch trucks under the blanket purchaseagreement were received as well as contracts for two Shaped Energy CargoSearchsystems. Despite these facts, however, the level and product mix of orders theCompany was projecting in late fiscal 2002 did not materialize to the levelsanticipated. In the third quarter of fiscal 2003 the Company experienced asharp decline in order levels that continued through the fourth quarter andsignificantly impacted the fourth quarter revenues. The Company continued tocomplete a certain number of systems, which were in progress despite the lackof related orders, resulting in an increase in finished goods inventory at theend of fiscal 2003. As a result of these continued order delays and inconjunction with its 2004 budgetary process in the fourth quarter of fiscal2003, the Company reassessed its expected inventory usage and required reservelevels. Based upon this analysis, the Company provided a provision forinventory valued above the lower of its cost or market value or not expected tobe utilized within a reasonable period of time.

 

Selling,general and administrative expenses of $12,409,000 were $344,000 lower than theprevious year and represented 20% of revenues, which was consistent with theprior year. In fiscal 2003, the Company increased its investment in marketingand sales by approximately $600,000 by adding personnel and increasing itsdemo, trade show and road show activities and incurred increases in insuranceand consulting costs of approximately $500,000. Offsetting these costs was a$1.6 million decrease in legal fees as the result of the settlement of apatent litigation matter that had significant legal costs during fiscal 2002.

 

Company fundedresearch and development spending decreased to $6,419,000 in fiscal 2003, a 10%decrease compared to the $7,136,000 in spending in fiscal 2002. Research anddevelopment spending in fiscal 2003 and fiscal 2002 was 10% and 11% ofrevenues, respectively. The Company had invested significantly in research anddevelopment spending in fiscal 2002 in the development of new products andproduct enhancements, most notably its Shaped Energy technology, as well asproduct upgrades to improve manufacturability and to address vendorobsolescence issues. In fiscal 2003, the Company worked to control its researchand development spending focusing on specific initiatives such as the ShapedEnergy Gantry system, the Z® Backscatter Van and Radiation ThreatDetection technology.

 

Other income(expenses) was $2,384,000 in income in fiscal 2003 as compared to $662,000 inexpense in fiscal 2002. In May of 2002, the Company closed on a privateplacement offering of common stock and warrants. A total of 1,115,000 shareswere sold to accredited investors at a price of $17.64 each. Proceeds from thisoffering were used in part to pay off the Company’s line of credit resulting ina decrease in interest expense of $390,000 during the year. In addition,warrants to purchase an additional 295,475 shares of common stock at a price of$23.52 were issued. These warrants included certain conversion features thatrequire “mark to market” adjustment that resulted in a credit to other incomein the year of $2.3 million.

 

The Companyexperienced pre-tax operating losses in the current year as a result of thedecreased revenue, excess capacity and inventory reserves. The Company hasreviewed its deferred tax assets as a whole to determine what would be realizedover the next three to 

 

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five years in light of the historical lossesincurred and has recorded a valuation reserve of $2,456,000 against itsremaining deferred tax asset at March 31, 2003.

 

The Companyrecorded a net loss of $7,951,000 for fiscal year 2003 as compared to a loss of$4,512,000 in the previous year.

 

**Liquidity and CapitalResources**

 

Cash and cashequivalents at year-end increased by $12,647,000 to $18,232,000 at March 31,2004, compared to $5,585,000 at March 31, 2003. Cash flow provided byoperations of $5,491,000 was impacted by the following:

 

•                                          Reportednet income of $1,911,000 adjusted for non-cash items of depreciation andamortization of $1,612,000, provisions for inventory, accounts receivable andwarranty reserves of $1,835,000 and a change in the value of warrants issued of$1,273,000.

 

•                                          Adecrease in inventories of $3,397,000 primarily attributable to the shipment ofMobileSearch inspection units offset somewhat by increases related to the newZBV product.

 

•                                          Anincrease in accounts receivable of $4,299,000 from the prior year due toincreased revenues reported in the fourth quarter of fiscal 2004 and themilestone billings related to certain fixed-price contracts.

 

Net cash of$3.6 million was provided from investing activities in fiscal 2004. Fiscal2004 capital expenditures totaled $.5 million versus $1.2 million forfiscal 2003. Investments in fixed assets were comprised primarily ofinformation technology, and furniture and fixtures. The Company invested$2.3 million in short-term investments during the year, and had maturitiesof $5.0 million on short-term investments. At year-end the Company had$.6 million of restricted cash and investments compared to$1.9 million in the prior year.

 

Net cashprovided by financing activities was $3.5 million. This entire amount wasreceived in proceeds from the exercise of employee stock options. On August 11,2003, the Company entered into two new credit agreements with Silicon ValleyBank East replacing its HSBC Bank USA credit agreements that expired on July 31,2003. The first agreement is a $5.0 million domestic loan and securityagreement to support the Company’s routine working capital needs. Maximumborrowings for this line are set at the lower of (a) the sum of 80% ofeligible domestic accounts receivable plus 10% of finished goods inventory upto $750,000, or; (b) $5 million. The second is a $20.0 millionexport loan and security agreement, guaranteed by the Export-Import Bank of theUnited States to support the Company’s overseas contract, trade finance andworking capital needs.

 

The creditfacilities bear an interest rate of the greater of 4.25% or the Silicon ValleyBank prime rate (4.0% at March 31, 2004) and have an expiration date of November 30,2004. The credit agreements are collateralized by certain assets of the Companyand contain certain restrictions, including limitations on the amount ofdistributions that can be made to stockholders, the disposition or encumbrancesof assets, and require the maintenance of certain financial covenants. As of March 31,2004, the Company was in compliance with these covenants. The Company has begunthe process of renewing these credit facilities with Silicon Valley Bank, butthere can be no assurance that Silicon Valley Bank will renew the creditagreements or that alternative financing can be obtained. Management believes theCompany’s working capital requirements through March 31, 2005 can be metwithout the line of credit.

 

At March 31,2004, there were no borrowings outstanding against these credit facilities. TheCompany had outstanding $526,000 in stand by letters of credit guaranteeingperformance on certain international projects, which have been collateralizedby cash. No amounts have been drawn on these stand by letters of credit.

 

OnMay 28, 2002, the Company closed on a private placement offering of commonstock and warrants. A total of 1,115,000 shares were sold to accreditedinvestors at a price of $17.64 each. Net proceeds to the Company approximated$18.4 million and were used in part to repay $9.3 million outstandingon the line of credit. In addition, warrants to purchase an additional 295,475shares of common stock at a price of $23.52 were issued. These warrants have afive-year life, expiring in May 2007.

 

The Companyleases various office and manufacturing facilities under noncancelableoperating leases. Future minimum rental payments under the Company’s operatingleases, excluding real estate taxes, insurance and operating costs paid by theCompany required over the initial terms of the leases are as follows:

 
| **Year Ending March 31,** | ** ** | **(in thousands)** | ** ** |
|--------------------------------|------------|--------------------|------------|
|                           |       |               |       |
| 2005                           |       | $                  | 1,065      |   |
| 2006                           |       | 316                |       |
| 2007                           |       | 319                |       |
| 2008                           |       | 346                |       |
| 2009                           |       | 376                |       |
|                           |       | $                  | 2,422      |   |

 

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Historically,the Company has funded its operations and capital expenditures with cashgenerated by operations, including deposits from customers on long-termprojects, or from lines of credit available to the Company. The Companycurrently has no debt outstanding and believes that its cash flows fromoperations and cash on hand are sufficient to meet the current and foreseeableoperating requirements of the Company’s business.

 

***Inflation***  The Company does not believe that inflationhas had a material effect on its results of operation. There can be noassurance, however, that the Company’ s business will not be affected by inflationin the future.

 

***Purchase Commitments***  In the normal course of business, the Companyenters into purchase orders with its vendors for the purchase of materials orservices to meet its production needs. At March 31, 2004, the Company had$7,689,000 of open purchase orders which are expected to be fulfilled withinthe next twelve to eighteen months. Certain single source vendors or vendorsproducing custom material require significant lead times from order to deliveryof their material. Should the demand for the Company’s products declinesignificantly, or should there be a significant shift in the mix of productsbeing demanded, the Company may incur cancellation charges, related to thesecommitments, that could be material to the Company’s results of operations. Todate, the Company has not experienced any material losses related tocancellation penalties.

 

**Critical AccountingPolicies**

 

The Companyconsiders certain accounting policies related to revenue recognition,inventories and the related allowance for obsolete and excess inventory,warrant liability, and income taxes to be critical policies due to theestimation processes involved in each.

 

***Revenue Recognition***  The Company derives a portion of its revenuefrom fixed-price contracts, which require the accurate estimation of the cost,and scope of each contract. The fixed-site CargoSearch systems are sold underfixed-price arrangements. Revenue is recognized using percentage of completionaccounting, generally using a total cost method to measure the percent completewith revisions to estimates reflected in the period in which changes becomeknown. If the Company does not accurately estimate the resources required orthe costs to be incurred under the contracts, then future margins may besignificantly and negatively affected or losses on existing contracts may needto be recognized. Any such resulting reductions in margins or contract lossescould be material to the Company’s results of operations.

 

The Companyrecognizes certain CargoSearch system sales and other product revenue,primarily ParcelSearch systems and spare parts, in accordance with SEC StaffAccounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB101”), modified by Emerging Issues Task Force (“EITF”) No. 00-21 and SABNo. 104 which requires that four basic criteria must be met before revenuecan be recognized: (1) persuasive evidence of an arrangement exists;(2) delivery has occurred or services rendered; (3) the fee is fixedand determinable; and (4) collectibility is reasonably assured.Determination of criteria (3) and (4) are based on management’sjudgments regarding the fixed nature of the fee charged for services renderedand products delivered and the collectibility of those fees. Should changes inconditions cause management to determine these criteria are not met for certainfuture transactions, revenue recognized for any reporting period could beadversely affected. In those instances where the Company enters into agreementsinvolving multiple revenue elements, the agreement is divided into separateelements of accounting, the arrangement consideration is allocated to theseelements based on fair value, and revenue recognition is considered separatelyfor each individual element. The Company recognizes field service revenues asservices are performed and generally recognizes revenues under maintenancecontracts on a straight-line basis over the contract period. Revenues receivedin advance of services being rendered are deferred until such services havebeen provided.

 

The Company’sproducts are generally covered by a warranty for a one-year period. The Companyaccrues a warranty reserve for estimated costs to provide warranty services.The Company’s estimate of costs to service its warranty obligations is based onhistorical experience and expectation of future conditions. To the extent theCompany experiences increased warranty claim activity or increased costsassociated with servicing those claims, its warranty accrual will increaseresulting in decreased gross profit.

 

***Inventories and Related Allowance forObsolete and Excess Inventory***  Inventories consist of material, labor andmanufacturing overhead and are recorded at the lower of cost or net realizablevalue. Excessive manufacturing overhead costs attributable to idle facilitiesor abnormal production volumes are excluded from inventory and recorded as anexpense in the period incurred. The Company regularly reviews inventoryquantities on hand and records a provision for excess and obsolete inventory basedprimarily on the estimated forecast of product demand over the next twelve toeighteen months. As demonstrated during 2002 and 2003, demand for products canfluctuate significantly. A significant increase in the demand for the Company’sproducts could result in a short-term increase in inventory balances while asignificant decrease in demand could result in an increase in the amount ofexcess inventory quantities on hand. Additionally, 

 

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estimates of future product demand may proveto be inaccurate, in which case the Company may have understated or overstatedthe provision required for excess and obsolete inventory. In the future, ifinventory were determined to be overvalued, the Company would be required torecognize such costs in its cost of goods sold at the time of suchdetermination. Likewise, if inventory is determined to be undervalued, theCompany may have over-reported costs of goods sold in previous periods andwould be required to recognize such additional operating income at the time ofsale. Therefore, although the Company makes every effort to ensure the accuracyof forecasts of future product demand, any significant unanticipated changes indemand or technological developments could have a significant impact on thevalue of its inventory and reported operating results.

 

***Warrant Liability***  In fiscal 2003, the Company issued 295,475warrants in connection with a private placement offering of common stock. Thesewarrants can be exchanged for cash under certain circumstances including amerger, sale or tender offer of the Company and as such the Company recordedthe fair value of these warrants as a long-term liability on the balance sheet.The fair value of these warrants is adjusted each period with the resultinggain or loss recorded as other income (expense) in the statement of operations.The Black-Scholes method is used to value the warrants and the calculationrequires the use of estimates for stock price volatility and interest rates.The Black-Scholes value of these warrants can fluctuate significantly based onthe current fair market value of the Company’s common stock, changes ininterest rates or changes in the volatility of the Company’s stock price.

 

***Income Taxes***  The Company accounts for income taxes inaccordance with SFAS No. 109, “Accounting for Income Taxes.” Accordingly,the Company recognizes deferred income taxes based on the expected future taxconsequences of differences between the financial statement basis and the taxbasis of assets and liabilities, calculated using enacted tax rates in effectfor the year in which the differences are expected to be reflected in the taxreturn. The Company records a valuation allowance against any net deferred taxassets if it is more likely than not that they will not be realized.

 

**New AccountingPronouncements**

 

In January 2003,the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation ofVariable Interest Entities,” which addresses consolidation by businessenterprises of variable interest entities (VIEs) that either: (1) do nothave sufficient equity investment at risk to permit the entity to finance itsactivities without additional subordinated financial support, or (2) theequity investors lack an essential characteristic of a controlling financialinterest. Throughout 2003, the FASB released numerous proposed and final FSPsregarding FIN 46, which both clarified and modified FIN 46’s provisions. On December 24,2003, the FASB issued revised Interpretation No. 46 (FIN 46-R) which willreplace FIN 46 upon its effective date. The application of FIN 46 to VIEscreated after February 1, 2003, did not result in any entities requiringconsolidation that would not already have required consolidation under thevoting equity interest model. The adoption of this pronouncement did not havean effect on the consolidated financial statements.

 

**Forward-LookingInformation and Factors Affecting Future Performance**

 

Some of the statements contained in thisreport and in the documents incorporated by reference are forward-lookingstatements, within the meaning of the federal securities laws, about ourbusiness and prospects. Our future results may differ materially from our pastresults and from those projected in the forward-looking statements due tovarious uncertainties and risks including but not limited to those set forthbelow, on-time events and other important factors disclosed previously and fromtime to time in our other filings with the SEC. We disclaim any obligation toupdate any forward-looking statements contained herein after the date of thisAnnual Report.

 

**The Company’sreliance on a small number of customers for a large portion of its revenuescould harm its business and prospects.**

 

The Company’s business is heavily dependenton sales to a small number of customers, which include agencies of the UnitedStates government. During fiscal 2004, four customers accounted for 51% of theCompany’s total revenues. During fiscal 2003, four customers accounted for 38%of the Company’s total revenues and during fiscal 2002, five customersaccounted for 62% of the Company’s total revenues. During fiscal 2004 and 2003,the Company’s largest customer, an agency of the U.S. government, accounted forapproximately 19% and 17% of total revenues, respectively. In general, theCompany’s government contracts may be terminated at the government’sdiscretion. The termination of the Company’s relationship with one or more ofits significant customers or the reduction or delay of orders of its systems bythese customers would substantially reduce the Company’s revenues and itsbusiness and prospects may be harmed.

 

**The Company conductsits business worldwide, which exposes it to a number of difficulties incoordinating its international activities and dealing with multiple regulatoryenvironments.**

 

The Company’sinternational business, including sales to foreign governments, accounted forapproximately 12%, 15% and 30% of its net revenues for the fiscal years ended March 31,2004, March 31, 2003 and March 31, 2002, respectively. Althoughfiscal 2004 revenues reflect a domestic focus, the Company anticipates thatinternational sales will account for a significant percentage of its revenuesin the future. As a result of the Company’s worldwide business operations, itis subject to various risks, including:

 

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•                                          internationalregulatory requirements and policy changes;

 

•                                          lengthysales cycles;

 

•                                          longerpayment cycles of foreign customers;

 

•                                          difficultiesin inventory management, accounts receivable collection and the management ofdistributors or representatives;

 

•                                          difficultiesin staffing and managing foreign operations;

 

•                                          geopoliticalinstability;

 

•                                          politicaland economic changes and disruptions;

 

•                                          favoritismtowards local suppliers;

 

•                                          governmentalcurrency controls;

 

•                                          currencyexchange rate fluctuations; and

 

•                                          tariffregulations.

 

Although theCompany’s international sales have been denominated primarily in U.S. dollars,changes in currency exchange rates that increase the relative value of the U.S.dollar may make it more difficult for the Company to compete with foreignmanufacturers on price or otherwise have a material adverse effect on its salesand operating results.

 

**The Homeland Securityfocus has increased financial expectations that may not materialize.**

 

Following the September 11,2001 terrorist attacks, the United States government made it a nationalpriority with the creation of the Department of Homeland Security and otherinitiatives to increase security in airports, high-threat federal facilities,U.S. military bases, and seaports and borders. The efforts of the United Statesgovernment to revamp security in the United States have resulted in increasedinterest in the Company’s X-ray inspection products. However, the Company hasnot at all times experienced an increased level of demand for its products tothe extent such demand might have been anticipated. This phenomenon occurredduring 2002 and 2003 and may continue to occur again in the future. The Companyis uncertain what solutions ultimately will be adopted and implemented by theUnited States government and other international entities to combat terrorismand whether the Company’s products will be a part of the solution. Even if theCompany’s products are considered as part of the security solution, it isunclear what level the Company will be involved and how quickly funding topurchase its products may be made available. The Company may incur non-recoverableexpenditures in anticipation of future demand for its products that may notmaterialize. All of these factors may adversely impact the Company’s operationsand create unpredictability in its revenues and operating results.

 

**The Company’s lengthysales cycle requires it to incur significant expenses with no assurance that itwill generate revenue or recover such expenses.**

 

A substantialportion of the Company’s sales depends upon the decision of governmentalagencies to upgrade or expand security at border crossing inspection sites,existing airports, seaports and other facilities. Accordingly, a portion of theCompany’s product sales is subject to delays associated with the lengthyapproval processes that often accompany such capital expenditures. During theseapproval periods, the Company expends significant financial and managerialresources in anticipation of future orders that may not occur. If the Companyfails to receive an order after expending these resources, it may be unable togenerate sufficient revenue to recover the costs incurred and its business andprospects may be harmed.

 

**The Company’sbusiness is dependent upon governmental policies and appropriations.**

 

The Company’slargest customers are government agencies and demand for its products isdependent upon national priorities and governmental initiatives. Thesepriorities and initiatives are subject to change from time to time in responseto the economic and political environment. The Company is also exposed to theUnited States budget approval and appropriation cycle, which may be subject tosignificant and unpredictable delays. If demand for the Company’s products isreduced because of a change in economic or political conditions or if there aredelays in receiving governmental approvals and appropriations, sales of theCompany’s products may be adversely affected and its business and prospects maybe harmed.

 

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**Changes ingovernmental regulations may reduce demand for the Company’s products orincrease its expenses.**

 

The Companycompetes in markets in which the Company or its customers must comply withfederal, state, local and foreign regulations, such as health and safetyregulations. The Company develops, configures and markets its products to meetits customers’ needs created by these regulations. Any significant change inthese regulations could reduce demand for the Company’s products or increaseits costs to comply with new regulations, both of which may adversely affectits operating results.

 

**The Company’sreliance on only a limited number of suppliers for some key components for itsproducts could harm its business and prospects.**

 

The Companyrelies on only a limited number of suppliers for some key components for itsproducts. The Company’s reliance on limited supply sources reduces its controlover timely delivery, price increases, reliability, and quality of criticalcomponents. Obtaining alternative sources of supply of these key componentscould involve significant delays and other costs, and may not be available to theCompany on reasonable terms, if at all. If the Company changes any of itssuppliers, the potential new supplier would be required to go through aqualification process, creating potential delays or reductions in productshipments. The failure of any supplier to provide quality and timely componentsat an acceptable price, or an interruption of supplies from such a suppliercould result in lost or deferred sales, which would harm the Company’s businessand prospects.

 

**Fluctuations in theCompany’s quarterly operating results may cause its stock price to fluctuate.**

 

Given thenature of the markets in which the Company participates, it cannot reliablypredict future revenue and profitability. A high proportion of the Company’scosts are fixed, due in part to its significant sales, research anddevelopment, and manufacturing costs. As a result of its fixed costs, smalldeclines in revenue could disproportionately affect the Company’s operatingresults and stock price in a quarter. Factors that may affect the Company’squarterly operating results and the market price of its Common Stock include:

 

•                                          demandfor and market acceptance of its X-ray inspection systems;

 

•                                          lengthysales cycles and the effect of large orders;

 

•                                          changesin political agendas or national priorities;

 

•                                          adversechanges in the level of economic activity in regions in which the Company doesbusiness;

 

•                                          politicalunrest in the regions where the Company transacts business;

 

•                                          adversechanges in industries on which the Company is particularly dependent;

 

•                                          competitivepressures resulting in lower selling prices for its products;

 

•                                          changesin the portions of its revenue represented by its various products andcustomers;

 

•                                          delaysor problems in the introduction of new products;

 

•                                          theCompany’s competitors’ announcement or introduction of new products, servicesor technological innovations;

 

•                                          variationsin the Company’s product mix;

 

•                                          thetiming and amount of the Company’s expenditures in anticipation of futuresales;

 

•                                          increasedcosts of raw materials or supplies; and

 

•                                          changesin the volume or timing of product orders.

 

**The Company couldincur substantial costs as a result of product liability claims and adversepublicity if its X-ray inspection systems fail to detect bombs, explosives, weapons,contraband or other threats to personal safety.**

 

If the Company’sX-ray inspection systems fail to detect the presence of bombs, explosives,weapons, contraband or other threats to personal safety, the Company could besubject to product liability claims and negative publicity, which could resultin increased costs, reduced sales, and a decline in the market price of theCompany’s common stock. There are many factors beyond the Company’s control

 

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that could result in the failure of itsproducts to detect the presence of bombs, explosives, weapons, contraband orother threats to personal safety. Examples of these factors include operatorerror or misuse of or malfunction of its equipment. The failure of the Company’ssystems to detect the presence of these dangerous materials may lead topersonal injury, loss of life, and extensive property damage and resultingclaims against the Company.

 

**The Company’sinsurance may be insufficient to protect it from product liability claims.**

 

The Company’sproduct liability and umbrella liability insurance may be insufficient toprotect it from product liability claims. Moreover, there is a risk thatproduct liability insurance will not continue to be available to the Company ata reasonable cost, if at all. If liability claims exceed the Company’s currentor available insurance coverage, its business and prospects may be harmed.Regardless of the adequacy of the Company’s product liability insuranceprotection, any significant claim may have an adverse affect on its industryand market reputation, leading to a substantial decrease in demand for itsproducts and reduced revenues.

 

**The Company may notbe able to fund its research and development activities.**

 

The Company generatesfunds for its research and development activities from operations, privatesources and the government. The Company may be unable to generate the fundsnecessary to support its research and development activities if it does notgenerate sufficient funds from operations, other potential private sources, orthe government. The Company may not successfully compete with other companiesand research institutions for government funding and funding from other privatesources. Additionally, government-funding priorities are subject to frequentchanges. For example, in fiscal 2004 and 2003, the Company recorded $444,000and $747,000, respectively, for government-sponsored research and development.There is no guarantee that the Company will receive funds for government-sponsoredresearch in the future. If the Company is unable to fund its research anddevelopment activities through its operations or from outside sources, theCompany may be unable to continue to innovate or bring its innovations tomarket on a timely or cost effective basis, or its innovations may be surpassedby other competitors or new technologies.

 

**The Company’s successdepends on new product development.**

 

The Company’scontinuing research and development program is designed to develop new productsand to enhance and improve its current products. The Company plans to expendsignificant resources on the development of its new products. The successfuldevelopment of its products and product enhancements is subject to numerousrisks, both known and unknown, including:

 

•                                          unanticipateddelays;

 

•                                          accessto capital;

 

•                                          budgetover-runs;

 

•                                          technicalproblems; and

 

•                                          otherdifficulties that could result in the abandonment or substantial change in thedesign, development and commercialization of new products and productenhancements, including, for example, changes requested or required bygovernmental and regulatory agencies.

 

Given theuncertainties inherent with product development and introduction of X-rayinspection systems, the Company cannot assure that its product developmentefforts will be successful on a timely basis or within budget, if at all. TheCompany’s failure to develop new products and product enhancements on a timelybasis or within budget would harm its business and prospects.

 

**The Company’s successdepends upon its ability to adapt to rapid changes in technology and customerrequirements.**

 

The market forthe Company’s products has been characterized by rapid technological changes,frequent product introductions and evolving industry standards and customerrequirements. The Company believes that these trends will continue into theforeseeable future. The Company’s success will depend, in part, upon itsability to enhance its existing products, successfully develop new productsthat meet changing customer and regulatory requirements and gain marketacceptance. If the Company fails to do so, its products may be renderedobsolete or uncompetitive by new industry standards or changing technology, inwhich case its revenue and operating results would suffer. In developing anynew product, the Company may be required to make a substantial investmentbefore it can determine the commercial viability of the new product. If theCompany fails to accurately foresee its customers’ needs and future activities,it may invest heavily in research and development of products that do not leadto significant revenue.

 

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**The Company may notbe able to compete successfully.**

 

A number ofcompanies have developed products that compete with the Company’s X-rayinspection products. Many of the Company’s competitors are larger and havegreater financial resources than it does. Some of its competitors have moreextensive research, marketing and manufacturing capabilities and greatertechnical and personnel resources than the Company does, and may be betterpositioned to continue to improve their technology in order to compete in anevolving industry. The Company’s failure to compete successfully could decreasedemand for its products or make its products obsolete.

 

In theinspection systems market, competition is based primarily on the followingfactors:

 

•                                          productperformance, functionality and quality;

 

•                                          price;

 

•                                          theoverall costs of the system;

 

•                                          priorcustomer relationships;

 

•                                          technologicalcapabilities of the product;

 

•                                          certificationby government authorities;

 

•                                          localmarket presence; and

 

•                                          breadthof sales and service organization.

 

To remaincompetitive, the Company must develop new products and periodically enhance itsexisting products in a timely manner. The Company anticipates that it may haveto adjust the prices of some of its products to stay competitive. In addition,new competitors may emerge, and entire product lines may be threatened by new technologiesor market trends that reduce the value of these product lines.

 

**The Company’sbusiness could be harmed if it is unable to protect its intellectual property.**

 

The Companyrelies primarily on a combination of trade secrets, patents, copyrights, trademarks,licensing arrangements and confidentiality procedures to protect itstechnology. Despite its precautions, the steps the Company has taken to protectits technology may be inadequate. Existing trade secret, patent, trademark andcopyright laws offer only limited protection. The Company’s patents could beinvalidated or circumvented. The laws of some foreign countries in which theCompany’s products are or may be developed, manufactured or sold may notprotect its products or intellectual property rights to the same extent, as dothe laws of the United States. This may make the possibility of piracy of theCompany’s technology and products more likely. The Company cannot assure thatthe steps it has taken to protect its intellectual property will be adequate toprevent misappropriation of its technology. The Company’s business could beharmed if it is unable to protect its intellectual property.

 

**The Company’sbusiness may be materially and adversely affected by infringement claimsinitiated by the Company or its competitors.**

 

Initiating ordefending against the enforcement of the Company’s intellectual property rightsmay result in significant, protracted, and costly litigation. The Company haspreviously been involved in various litigation involving its intellectualproperty and has been successful in protecting such interests to date. However,the Company is currently involved in civil litigation filed by a competitorseeking a declaratory judgment that the competitor’s product did not infringeupon certain of the Company’s patents. The Company expects intellectualproperty disputes to be an ordinary part of its business for the foreseeablefuture. The Company may initiate claims or litigation against third parties forinfringement of its intellectual property rights, or to establish the validityof its property rights. There can be no assurance that the Company will prevailin any such action. Litigation by or against the Company could result insignificant expense to it and divert the efforts of technical and managementpersonnel, whether or not such litigation results in a favorable outcome forthe Company. In the event of an adverse result in any such litigation, theCompany could be required to pay substantial damages, cease the manufacture,use and sale of infringing products, expend significant resources to developnon-infringing technology, discontinue the use of certain processes, or obtainlicenses for the infringing technology. If a license were required, the Companycannot assure that it would be able to obtain one on commercially reasonableterms, if at all. The Company cannot assure that it will be successful indeveloping non-infringing technology or that the cost or time required todevelop such technology will be reasonable.

 

**The Company’s successdepends on its ability to attract and retain qualified managementprofessionals.**

 

During thefiscal year 2004, the CEO and certain other members of our senior managementteam left the Company. The Company 

 

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subsequently recruited what it believes to bea highly qualified team of executives to join the Company. The Company’s futuresuccess will continue to depend in large measure upon the continuedcontributions of its senior management team and other key personnel. If we loseprofessionals or are unable to attract new talent, we will not be able tomaintain our position in the market or grow our business.

 

**Future sales of theCompany’s common stock by existing stockholders could depress the market priceof the Company’s common stock.**

 

Substantiallyall of the Company’s outstanding shares of common stock are freely tradablewithout restriction or further registration. Affiliates must sell all sharesthey own in compliance with the volume and other requirements of Rule 144,except for the holding period requirements. Nevertheless, sales of substantialamounts of common stock by the Company’s stockholders, or even the potentialfor such sales, may cause the market price of the Company’s common stock to declineand could impair the Company’s ability to raise capital through the sale of theCompany’s equity securities.

 

**Existing externalfinancing may not be available in the future.**

 

The Companymay require additional capital to finance continuing operations. The Companycannot assure that operations will continue to be profitable, that it willgenerate levels of revenues and cash flows sufficient to fund operations, or,if necessary, that the Company will be able to obtain additional financing onsatisfactory terms, if at all. Any existing financing arrangements may not beavailable or sufficient to meet the Company’s cash needs or may not beavailable in the future, or, if available, at a cost that the Company believesis reasonable.

 

**The volatility of theCompany’s stock price could adversely affect an investment in the Company’scommon stock.**

 

The marketprice of the Company’s common stock has been, and may continue to be, highlyvolatile. The Company believes that a variety of factors could cause the priceof the Company’s common stock to fluctuate, perhaps substantially, including:

 

•                                          announcementsof developments related to the Company’s business;

 

•                                          quarterlyfluctuations in the Company’s actual or anticipated operating results and orderlevels;

 

•                                          generalconditions in the worldwide economy;

 

•                                          announcementsof technological innovations;

 

•                                          newproducts or product enhancements by the Company or its competitors;

 

•                                          developmentsin patents or other intellectual property rights and litigation; and

 

•                                          developmentsin the Company’s relationships with its customers and suppliers.

 

In addition,in recent years the stock market in general and the markets for shares of smallcapitalization and “high-tech” companies in particular, have experiencedextreme price fluctuations which have often been unrelated to the operatingperformance of affected companies. Any such fluctuations in the future couldadversely affect the market price of the Company’s common stock.

 

**Provisions in theCompany’s articles of organization and the Company’s shareholder rights planmay have the effect of discouraging advantageous offers for the Company’sbusiness or common stock and limit the price that investors might be willing topay in the future for shares of the Company’s common stock.**

 

Provisions inthe Company’s articles of organization and the Company’s shareholder rightsplan may have the effect of discouraging or preventing a change in control.These provisions could limit the price that certain investors might be willingto pay in the future for shares of the Company’s common stock. Specifically,the Company’s articles of organization authorize its Board of Directors toissue up to 100,000 shares of preferred stock in one or more series, to fixcertain rights, preferences, privileges and restrictions granted to or imposedupon any wholly unissued shares of preferred stock, to fix the number of sharesconstituting any such series, and to fix the designation of any such series,without further vote or action by its shareholders. The terms of any series ofpreferred stock, which may include priority claims to assets and dividends andspecial voting rights, could adversely affect the rights of the holders ofcommon stock and thereby reduce the value of the Company’s common stock. TheCompany has no present plans to issue shares of preferred stock. The Companyhas in place a shareholder rights plan, adopted in 1998, under which itsstockholders are entitled to purchase shares of its preferred stock undercertain circumstances. These circumstances include the purchase of 15% or moreof the outstanding shares of common stock by a person or group, or theannouncement of a tender or exchange offer to acquire 15% or more of theoutstanding common stock. The shareholder rights plan may have the effect ofimpeding or preventing certain types of transactions involving a change 

 

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in control of the Company that could bebeneficial to the stockholders.

 

**Inability to obtainformer auditor’s, Arthur Andersen LLP, consent may limit stockholder’s right ofrecovery under Section 11(a)(4) of the Securities Act of 1933.**

 

Prior to July 18,2002, Arthur Andersen LLP served as the Company’s independent auditors. On March 14,2002 Arthur Andersen was indicted on federal obstruction of justice chargesarising from the government’s investigation of Enron Corporation and on June 15,2002 Arthur Andersen was found guilty. Arthur Andersen informed the SEC that itwould cease practicing before the SEC by August 31, 2002, unless the SECdetermined that another date was appropriate. On July 18, 2002, theCompany dismissed Arthur Andersen and retained PricewaterhouseCoopers as itsindependent auditors for its fiscal year ended March 31, 2004 and March 31,2003. SEC rules require the Company to present historical audited financialstatements in various SEC filings, such as registration statements, along withArthur Andersen’s consent to the Company’s inclusion of Arthur Andersen’s auditreport in those filings. Since the cessation of Arthur Andersen’s practice, theCompany has not be able to obtain the consent of Arthur Andersen, to theinclusion of Arthur Andersen’s audit report in the Company’s relevant currentand future filings. The SEC recently has provided regulatory relief designed toallow companies that file reports with the SEC to dispense with the requirementto file a consent of Arthur Andersen in certain circumstances, butpurchasers of securities sold under the Company’s registration statements,which were not filed with the consent of Arthur Andersen to the inclusion ofArthur Andersen’s audit report will not be able to sue Arthur Andersen pursuantto Section 11(a)(4) of the Securities Act of 1933 and therefore thepurchasers’ right of recovery under that section may be limited as aresult of the lack of the Company’s ability to obtain Arthur Andersen’sconsent.

 

**The Company does notplan to pay dividends on its common stock.**

 

The Companyhas not declared or paid a cash dividend on its common stock in recent years andit does not expect to declare or pay any cash dividends in the foreseeablefuture. The Company intends to retain all earnings, if any, in order to expandits operations. Investors should not rely on dividends from the common stock asa possible source of income.

 

**ITEM 7(A). QUANTITIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

The Company issubject to interest rate risk on its credit facilities which have variableinterest rates tied to the Prime Rate or LIBOR. As of March 31, 2004, theCompany had no variable interest rate debt outstanding. See Note 3 ofNotes to Consolidated Financial Statements for a discussion of our long-termindebtedness.

 

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

 

As of March 31,2004, the Company holds short-term investments consisting of money market fundsand U.S. government and government agency bonds. The Company’s primaryobjective with its investment portfolio is to invest available cash whilepreserving principal and meeting liquidity needs. These investments have anaverage interest rate of approximately .9% 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.

 

In Fiscal2003, the Company issued 295,475 warrants in connection with a privateplacement offering of common stock. These warrants can be exchanged for cashunder certain circumstances including a merger, sale or tender offer of theCompany and as such a liability equal to Black-Scholes value of the warrants isrecorded on the balance sheet. Changes in the fair value of the warrants arerecorded as other income (expense). The Black-Scholes value of these warrantscan fluctuate significantly based on the current fair market value of theCompany’s common stock. A 10% change in the fair market value of the Company’scommon stock, holding other assumptions constant, would have approximately a$340,000 positive or negative, impact on earnings.

 

# **ITEM 8. FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The financialstatements and supplementary financial information listed in the Index toConsolidated Financial Statements and Schedule on page 26 are filedas part of this Annual Report on Form 10-K/A and are incorporated intothis Item by reference.

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Notapplicable.

 

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**ITEM 9A. CONTROLS AND PROCEDURES**

 

a)  Evaluation of disclosure controls andprocedures.

 

As of the endof the 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)and 15d-15(e) of the Securities Exchange Act of 1934 as amended (the “ExchangeAct”).  Based upon their evaluation, ourChief Executive Officer and our Chief Financial Officer concluded that ourdisclosure controls and procedures were effective to provide reasonableassurance that information required to be disclosed by the Company in thereports filed and submitted by it under the Exchange Act is recorded,processed, summarized and reported within the time period specified in theSecurities and Exchange Commission’s rules and forms, and to provide reasonableassurance that information required to be disclosed by the Company in suchreports is accumulated and communicated to the Company’s management, includingits Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

 

b)  Changes in internal controls

 

There havebeen no changes in our internal controls over financial reporting as defined inRule 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934 during thequarter ended March 31, 2004 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART III**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OFTHE COMPANY**

 

Theinformation called for by this item is hereby incorporated by reference fromthe Registrant’s definitive Proxy Statement relating to the 2004 Annual Meetingof Stockholders, which Proxy Statement will be filed with the Securities andExchange Commission on or about July 29, 2004.

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

Theinformation called for by this item is hereby incorporated by reference fromthe Registrant’s definitive Proxy Statement relating to the 2004 Annual Meetingof Stockholders, which Proxy Statement will be filed with the Securities andExchange Commission on or about July 29, 2004.

 

# **ITEM 12. SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

Theinformation called for by this item is hereby incorporated by reference fromthe Registrant’s definitive Proxy Statement relating to the 2004 Annual Meetingof Stockholders, which Proxy Statement will be filed with the Securities andExchange Commission on or about July 29, 2004.

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

Theinformation called for by this item is hereby incorporated by reference fromthe Registrant’s definitive Proxy Statement relating to the 2004 Annual Meetingof Stockholders, which Proxy Statement will be filed with the Securities andExchange Commission on or about July 29, 2004.

 

**ITEM 14. PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

Theinformation called for by this item is hereby incorporated by reference fromthe Registrant’s definitive Proxy Statement relating to the 2004 Annual Meetingof Stockholders, which Proxy Statement will be filed with the Securities andExchange Commission on or about July 29, 2004.

 

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**PARTIV**

 

**ITEM 15. FINANCIAL STATEMENT SCHEDULES ANDEXHIBITS, AND REPORTS ON FORM 8-K**

 

**Financial StatementSchedules and Exhibits**

 

The financialstatements and schedule listed in the Index to Consolidated FinancialStatements and Schedule on page 29 are filed as part of this report, andsuch Index is incorporated in this Item by reference.

 

The exhibitslisted in the Exhibit Index on page 47 are filed as part of this report,and such Index is incorporated in this Item by reference.

 

**Reports onForm 8-K**

 

The Companyfiled a current report on Form 8-K on January 22, 2004, containingone exhibit: the press release issued by the Company on January 22, 2004reporting its earnings for the third quarter.

 

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##  

## **AMERICAN SCIENCE AND ENGINEERING, INC.,AND SUBSIDIARYINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE**

 

(Submitted in answer to Item 8 and Item 15 ofForm 10-K/A, Securities and Exchange Commission)

 
| **CONSOLIDATED FINANCIAL STATEMENTS**                                                                               |   |
|---------------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent Registered Public  Accounting Firm                                                            |   |
| Consolidated Balance Sheets—March 31,  2004 and 2003                                                           |   |
| Consolidated Statements of Operations  For the Years Ended March 31, 2004, 2003, and 2002                      |   |
| Consolidated Statements of  Stockholders’ Equity For the Years Ended March 31, 2004, 2003, and 2002       |   |
| Consolidated Statements of Cash Flows  For the Years Ended March 31, 2004, 2003, and 2002                      |   |
| Notes to Consolidated Financial Statements                                                                          |   |
| **CONSOLIDATED SUPPLEMENTARY FINANCIAL  INFORMATION**                                                               |   |
| Unaudited quarterly consolidated  financial data for the years ended March 31, 2004 and 2003                   |   |
| **FINANCIAL STATEMENT SCHEDULE**                                                                                    |   |
| Report of Independent Registered Public  Accounting Firm on Financial Statement Schedule                            |   |
| Schedule II—Valuation and Qualifying  Accounts and Reserves for the years ended March 31, 2004, 2003, and 2002 |   |

 

Otherschedules have been omitted because of the absence of conditions under whichthey are required or because the required information is given in the financialstatements or notes thereto.

 

26

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**Report of Independent Registered PublicAccounting Firm**

 

To the Board of Directors and

Stockholders of American Science andEngineering, Inc.:

 

In ouropinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, stockholders’ equity and cash flowspresent fairly, in all material respects, the financial position of AmericanScience and Engineering, Inc. and its subsidiary at March 31, 2004and March 31, 2003, and the results of their operations and their cashflows for each of the two years in the period ended March 31, 2004 inconformity with accounting principles generally accepted in the United Statesof America. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits. We conducted our audits of these statements inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion. The financial statementsof the Company for the year ended March 31, 2002 were audited by otherindependent accountants who have ceased operations. Those independentaccountants expressed an unqualified opinion on those financial statements intheir report dated May 31, 2002.

 

 
| /s/ PricewaterhouseCoopers LLP |   |
|--------------------------------|--------|
|                           |
| Boston, MA                     |
| May 19, 2004              |

 

27

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THIS REPORT IS A CONFORMED COPY OF THE REPORTPREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH THE COMPANY’SANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2002 AND HAS NOT BEENREISSUED BY THAT FIRM.

 

**Reportof Independent Public Accountants**

 

To American Science andEngineering, Inc.:

 

We haveaudited the accompanying consolidated balance sheets of American Science andEngineering, Inc. (a Massachusetts corporation) and subsidiaries as ofMarch 31, 2002 and March 31, 2001 and the related consolidatedstatements of operations, stockholders’ investment and cash flows for each ofthe three years in the period ended March 31, 2002. These consolidatedfinancial statements and the schedule referred to below are the responsibilityof the Company’s management. Our responsibility is to express an opinion onthese consolidated financial statements and schedule based on our audits.

 

We conductedour audits in accordance with auditing standards generally accepted in theUnited States. Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofAmerican Science and Engineering, Inc. and subsidiaries as ofMarch 31, 2002 and March 31, 2001 and the results of their operationsand their cash flows for each of the three years in the period endedMarch 31, 2002 in conformity with accounting principles generally acceptedin the United States.

 

Our auditswere made for the purpose of forming an opinion on the basic consolidatedfinancial statements taken as a whole. The schedule listed in the index toconsolidated financial statements and schedule is presented for purposes ofcomplying with the Securities and Exchange Commission’s rules and is not partof the basic consolidated financial statements. This schedule has beensubjected to the auditing procedures applied in the audit of the basicconsolidated financial statements and, in our opinion, fairly states in allmaterial respects the financial data required to be set forth therein inrelation to the basic consolidated financial statements taken as a whole.

 

 
| /s/ Arthur Andersen LLP |   |
|-------------------------|--------|
|                    |
| Boston, Massachusetts   |
| May 31, 2002       |

 

28

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# **AmericanScience and Engineering, Inc. and SubsidiaryConsolidated Balance SheetsMarch 31, 2004 and 2003(Amounts in thousands, except share and per share amounts)**

 
| ** **                                                                                                                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                |       |     |       |     |       |
| **Assets**                                                                                                                                          |       |     |       |     |       |
| Current assets:                                                                                                                                     |       |     |       |     |       |
| Cash and cash equivalents                                                                                                                           |       | $        | 18,232     |     | $          | 5,585 |   |
| Restricted cash and investments                                                                                                                     |       | 585      |       | 1,895    |       |
| Short-term investments                                                                                                                              |       | 1,845    |       | 4,538    |       |
| Accounts receivable, net of allowances of  $250 in 2004 and $246 in 2003                                                                            |       | 14,771   |       | 10,499   |       |
| Unbilled costs and fees, net of allowances  of $394 in 2004 and $437 in 2003                                                                        |       | 4,468    |       | 4,343    |       |
| Inventories                                                                                                                                         |       | 11,390   |       | 15,748   |       |
| Prepaid expenses and other current assets                                                                                                           |       | 1,890    |       | 822      |       |
| **Total current assets**                                                                                                                            |       | 53,181   |       | 43,430   |       |
| Equipment and leasehold improvements, net                                                                                                           |       | 2,585    |       | 3,714    |       |
| Other assets, net                                                                                                                                   |       | 37       |       | 172      |       |
| **Total assets**                                                                                                                                    |       | $        | 55,803     |     | $          | 47,316 |   |
| ** **                                                                                                                                          |       |     |       |     |       |
| **Liabilities & Stockholders’ Equity**                                                                                                     |       |     |       |     |       |
| Current liabilities:                                                                                                                                |       |     |       |     |       |
| Accounts payable                                                                                                                                    |       | $        | 3,690      |     | $          | 5,327 |   |
| Accrued salaries and benefits                                                                                                                       |       | 1,954    |       | 1,476    |       |
| Accrued warranty costs                                                                                                                              |       | 699      |       | 535      |       |
| Deferred revenue                                                                                                                                    |       | 2,020    |       | 1,928    |       |
| Customer deposits                                                                                                                                   |       | 4,419    |       | 2,747    |       |
| Other current liabilities                                                                                                                           |       | 1,875    |       | 1,221    |       |
| **Total current liabilities**                                                                                                                       |       | 14,657   |       | 13,234   |       |
| Warrant liability                                                                                                                                   |       | 2,093    |       | 820      |       |
| Other long term liabilities                                                                                                                         |       | 620      |       | 904      |       |
| **Total liabilities**                                                                                                                               |       | 17,370   |       | 14,958   |       |
| Commitments and contingencies (Notes 2 and  8)                                                                                                      |       |     |       |     |       |
| Stockholders’ equity:                                                                                                                          |       |     |       |     |       |
| Preferred stock, no par value  Authorized—100,000 shares  Issued—None                                                                     |       | —   |       | —   |       |
| Common stock, $0.66 2/3  par value  Authorized—20,000,000 shares  Issued and outstanding 7,415,660 shares in 2004 and 6,871,729 shares in 2003 |       | 4,943    |       | 4,581    |       |
| Capital in excess of par value                                                                                                                      |       | 42,683   |       | 38,780   |       |
| Cumulative translation adjustment                                                                                                                   |       | 14       |       | —   |       |
| Unearned compensation                                                                                                                               |       | (115     | )          | —   |       |
| Accumulated deficit                                                                                                                                 |       | (9,092   | )          | (11,003  | )          |
| **Total stockholders’ equity**                                                                                                                 |       | 38,433   |       | 32,358   |       |
| **Total liabilities and stockholders’ equity**                                                                                                 |       | $        | 55,803     |     | $          | 47,316 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

29

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**American Science andEngineering, Inc. and Subsidiary****Consolidated Statementsof OperationsFor the Years Ended March 31, 2004, 2003, and 2002(Amounts in thousands, except per share amounts)**

 
| ** **                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |     |       |
| **Net sales and contract revenues:**                 |       |     |       |     |       |     |       |
| Net product sales and contract revenues              |       | $        | 62,448     |     | $          | 52,894   |       |   |   |
| Net service revenues                                 |       | 13,894   |       | 9,064    |       |     |       |
| **Total net sales and contract revenues**            |       | 76,342   |       | 61,958   |       | $        | 65,396     |   |
| **Cost of sales and contracts:**                     |       |     |       |     |       |     |       |
| Cost of product sales and contracts                  |       | 47,676   |       | 42,610   |       |     |       |
| Cost of service revenues                             |       | 8,732    |       | 8,399    |       |     |       |
| **Total cost of sales and contracts**                |       | 56,408   |       | 51,009   |       | 49,357   |       |
| **Gross profit**                                     |       | 19,934   |       | 10,949   |       | 16,039   |       |
| **Expenses:**                                        |       |     |       |     |       |     |       |
| Selling, general and administrative                  |       | 11,648   |       | 12,409   |       | 12,753   |       |
| Research and development                             |       | 5,535    |       | 6,419    |       | 7,136    |       |
| **Total expenses**                                   |       | 17,183   |       | 18,828   |       | 19,889   |       |
| **Operating income (loss)**                          |       | 2,751    |       | (7,879   | )          | (3,850   | )          |
| **Other (expense) income:**                          |       |     |       |     |       |     |       |
| Interest income                                      |       | 107      |       | 95       |       | 39       |       |
| Interest expense                                     |       | —   |       | (86      | )          | (476     | )          |
| Other, net                                           |       | (1,038   | )          | 2,375    |       | (225     | )          |
| **Total other (expenses) income**                    |       | (931     | )          | 2,384    |       | (662     | )          |
| **Income (loss) before provision for income  taxes** |       | 1,820    |       | (5,495   | )          | (4,512   | )          |
| **(Benefit) provision for income taxes**             |       | (91      | )          | 2,456    |       | —   |       |
| **Net income (loss)**                                |       | $        | 1,911      |     | $          | (7,951   | )          | $ | (4,512 | ) |
| ** **                                           |       |     |       |     |       |     |       |
| **Income/(loss) per share—Basic**               |       | $        | 0.27       |     | $          | (1.20    | )          | $ | (0.87 | ) |
|                                                 |       |     |       |     |       |     |       |
| **—Diluted**                                    |       | $        | 0.26       |     | $          | (1.20    | )          | $ | (0.87 | ) |
|                                                 |       |     |       |     |       |     |       |
| **Weighted average shares—Basic**               |       | 7,155    |       | 6,627    |       | 5,191    |       |
| ** **                                           |       |     |       |     |       |     |       |
| **—Diluted**                                    |       | 7,345    |       | 6,627    |       | 5,191    |       |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

30

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** **

**American Science and Engineering, Inc. and SubsidiaryConsolidated Statements of Stockholders’ EquityFor the Years Ended March 31, 2004, 2003, and 2002(Amounts in thousands, except share amounts)**

 
| ** **                                                     | ** ** | **Common Stock** | ** ** | ** ** | ** ** | ** **                             | ** ** | ** **                                                       | ** ** | ** **                                                      | ** ** | ** **                                                      | ** ** | ** ** | ** ** |
|----------------------------------------------------------------|------------|------------------|------------|------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|------------|------------|
| ** **                                                     | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Capital in****Excess of  Par Value** | ** ** | **Retained  Earnings********(Accumulated**** ****Deficit)** | ** ** | **Cumulative**** ****Translation**** ****Adjustment** | ** ** | **Note  Receivable  Officer and  Unearned********Compensation** | ** ** | **Total**  | ** ** | **Comprehensive  Income** | ** ** |
|                                                           |       |             |       |       |       |                                   |       |                                                             |       |                                                            |       |                                                            |       |       |       |   |   |
| **Balance, March 31, 2001**                                    |       | 5,012,752        |       | $          | 3,342      |                                   | $          | 18,472                                                           |       | $                                                               | 1,460      |                                                            | $          | —     |       | $ | (640 | ) | $ | 22,634 |   |   |   |
| Net loss                                                       |       | —           |       | —     |       | —                                 |       | (4,512                                                           | )          | —                                                          |       | —                                                          |       | (4,512     | )          |   |   |
| Exercise of stock options                                      |       | 484,116          |       | 323        |       | 3,491                                  |       | —                                                           |       | —                                                          |       | —                                                          |       | 3,814      |       |   |   |
| Repayment of officer note                                      |       | —           |       | —     |       | —                                 |       | —                                                           |       | —                                                          |       | 640                                                             |       | 640        |       |   |   |
| Issuance of stock                                              |       | 52,610           |       | 34         |       | 519                                    |       | —                                                           |       | —                                                          |       | —                                                          |       | 553        |       |   |   |
| **Balance, March 31, 2002**                                    |       | 5,549,478        |       | 3,699      |       | 22,482                                 |       | (3,052                                                           | )          | —                                                          |       | —                                                          |       | 23,129     |       |   |   |
| Net loss                                                       |       | —           |       | —     |       | —                                 |       | (7,951                                                           | )          | —                                                          |       | —                                                          |       | (7,951     | )          |   |   |
| Private placement issuance of stock                            |       | 1,115,000        |       | 743        |       | 14,553                                 |       | —                                                           |       | —                                                          |       | —                                                          |       | 15,296     |       |   |   |
| Exercise of stock options                                      |       | 175,347          |       | 117        |       | 1,355                                  |       | —                                                           |       | —                                                          |       | —                                                          |       | 1,472      |       |   |   |
| Issuance of stock                                              |       | 31,904           |       | 22         |       | 390                                    |       | —                                                           |       | —                                                          |       | —                                                          |       | 412        |       |   |   |
| **Balance, March 31, 2003**                                    |       | 6,871,729        |       | 4,581      |       | 38,780                                 |       | (11,003                                                          | )          | —                                                          |       | —                                                          |       | 32,358     |       |   |   |
| Net income                                                     |       | —           |       | —     |       | —                                 |       | 1,911                                                            |       | —                                                          |       | —                                                          |       | 1,911      |       | $ | 1,911 |   |
| Exercise of stock options                                      |       | 477,619          |       | 318        |       | 3,220                                  |       | —                                                           |       | —                                                          |       | —                                                          |       | 3,538      |       | — |   |
| Issuance of stock under employee and board  compensation plans |       | 53,312           |       | 35         |       | 537                                    |       | —                                                           |       | —                                                          |       | —                                                          |       | 572        |       | — |   |
| Issuance of restricted stock                                   |       | 13,000           |       | 9          |       | 146                                    |       | —                                                           |       | —                                                          |       | (155                                                            | )          | —     |       | — |   |
| Translation adjustment                                         |       | —           |       | —     |       | —                                 |       | —                                                           |       | 14                                                              |       | —                                                          |       | 14         |       | 14 |   |
| Amortization of unearned compensation                          |       | —           |       | —     |       | —                                 |       | —                                                           |       | —                                                          |       | 40                                                              |       | 40         |       | — |   |
| **Balance, March 31, 2004**                                    |       | 7,415,660        |       | $          | 4,943      |                                   | $          | 42,683                                                           |       | $                                                               | (9,092     | )                                                               | $          | 14         |       | $ | (115 | ) | $ | 38,433 |   | $ | 1,925 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

31

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** **

**American Science andEngineering, Inc. and SubsidiaryConsolidated Statements of Cash FlowsFor the Years Ended March 31, 2004, 2003, and 2002(Amounts in thousands)**

 
| ** **                                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Cash flows from operating activities:**                                                            |       |     |       |     |       |     |       |
| Net income (loss)                                                                                    |       | $        | 1,911      |     | $          | (7,951   | )          | $ | (4,512 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used for) operating activities: |       |     |       |     |       |     |       |
| Depreciation and amortization                                                                        |       | 1,612    |       | 2,185    |       | 2,379    |       |
| Provisions for inventory, accounts  receivable and warranty reserves                                 |       | 1,835    |       | 4,501    |       | 607      |       |
| Change in value of warrants issued                                                                   |       | 1,273    |       | (2,298   | )          | —   |       |
| Realized gain on short-term  investments                                                             |       | (51      | )          | —   |       | —   |       |
| Deferred income tax                                                                                  |       | —   |       | 3,298    |       | —   |       |
| Change in assets and liabilities:                                                                    |       |     |       |     |       |     |       |
| Accounts receivable                                                                                  |       | (4,299   | )          | (3,421   | )          | 2,510    |       |
| Unbilled costs and fees                                                                              |       | (125     | )          | 1,113    |       | 3,451    |       |
| Inventories                                                                                          |       | 3,397    |       | 1,650    |       | (7,421   | )          |
| Prepaid expenses, other assets, and  deposits                                                        |       | (966     | )          | (71      | )          | 229      |       |
| Accounts payable                                                                                     |       | (1,637   | )          | (1,230   | )          | (870     | )          |
| Accrued income taxes                                                                                 |       | —   |       | (763     | )          | 325      |       |
| Deferred revenue                                                                                     |       | (135     | )          | 958      |       | 218      |       |
| Customer deposits                                                                                    |       | 1,672    |       | (2,128   | )          | 2,983    |       |
| Accrued expenses and other current  liabilities                                                      |       | 1,176    |       | (570     | )          | (98      | )          |
| Noncurrent liabilities                                                                               |       | (172     | )          | (168     | )          | (61      | )          |
| Total adjustments                                                                                    |       | 3,580    |       | 3,056    |       | 4,252    |       |
| Net cash provided by (used for) operating  activities                                                |       | 5,491    |       | (4,895   | )          | (260     | )          |
| **Cash flows from investing activities:**                                                            |       |     |       |     |       |     |       |
| Decrease (increase) in restricted cash                                                               |       | 1,310    |       | (1,895   | )          | —   |       |
| Maturities of short-term investments                                                                 |       | 5,063    |       | —   |       | —   |       |
| Purchase of short-term instruments                                                                   |       | (2,319   | )          | (4,538   | )          | —   |       |
| Purchase of property and equipment                                                                   |       | (450     | )          | (1,155   | )          | (1,109   | )          |
| Cash provided by (used in) investing  activities                                                     |       | 3,604    |       | (7,588   | )          | (1,109   | )          |
| **Cash flows from financing activities:**                                                            |       |     |       |     |       |     |       |
| Proceeds from (repayment of) line of credit                                                          |       | —   |       | (9,319   | )          | 3,300    |       |
| Proceeds from issuance of common stock and  warrants, net                                            |       | —   |       | 18,415   |       | —   |       |
| Repayment of officer loan                                                                            |       | —   |       | —   |       | 640      |       |
| Proceeds from exercise of stock options                                                              |       | 3,538    |       | 1,381    |       | 3,814    |       |
| Cash provided by financing activities                                                                |       | 3,538    |       | 10,477   |       | 7,754    |       |
| Foreign currency translation effect on cash                                                          |       | 14       |       | —   |       | —   |       |
| **Net increase (decrease) in cash and cash  equivalents**                                            |       | 12,647   |       | (2,006   | )          | 6,385    |       |
| **Cash and cash equivalents at beginning of  year**                                                  |       | 5,585    |       | 7,591    |       | 1,206    |       |
| **Cash and cash equivalents at end of year**                                                         |       | $        | 18,232     |     | $          | 5,585    |       | $ | 7,591 |   |
|                                                                                                 |       |     |       |     |       |     |       |
| **Supplemental disclosures of cash flow  information:**                                              |       |     |       |     |       |     |       |
| Interest paid                                                                                        |       | $        | —     |     | $          | 124      |       | $ | 481 |   |
| Income taxes paid                                                                                    |       | $        | —     |     | $          | —   |       | $ | 15 |   |
| **Non-cash transactions:**                                                                           |       |     |       |     |       |     |       |
| Issuance of stock and warrants in lieu of  fees                                                      |       | $        | 727        |     | $          | 412      |       | $ | 553 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

32

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**American Science andEngineering, Inc. and SubsidiaryNotes to Consolidated Financial StatementsMarch 31, 2004**

 

**1.             Nature of Operations and Summary ofSignificant Accounting Policies**

 

American Science and Engineering, Inc.(the “Company”) is engaged in the development and manufacture of sophisticatedX-ray inspection systems for critical detection and security screeningsolutions for sale primarily to U.S. and foreign government agencies.

 

**Use of Estimates:**  Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

**Principles ofConsolidation:**  The consolidated financial statements includethe accounts of the Company and its wholly owned subsidiary. All significantintercompany balances and transactions have been eliminated in consolidation.

 

**Reclassifications:**  Certainamounts in the prior period financial statements have been reclassified toconform to the current period presentation.

 

**Cash and CashEquivalents:**  The Company considers all investments withoriginal maturities of 90 days or less to be cash equivalents. Cash andcash equivalents are carried at cost, which approximates fair market value atyear-end 2004 and 2003. The Company has repurchase agreements with itsbanks. The repurchase agreements are collateralized by investments principallyconsisting of U.S. Government Agency securities in the amount of at least 100%of such obligation.

 

**Restricted Cash andInvestments:**  The Company’s Export and Security Agreementswith HSBC Bank USA and Silicon Valley Bank require certain cash and investmentbalances to be restricted as collateral against outstanding standby letters ofcredit. The restricted cash amounts with Silicon Valley Bank are in the form ofcertificates of deposits that mature beyond 90 days.

 

**Short-termInvestments:**  Short-term investments consist ofinvestments in money market funds and U.S government and government agencybonds. These investments are classified as available-for-sale andare recorded at their fair market values. The unrealized holding gains orlosses on these securities were immaterial for the year ended March 31,2004.

 

**Inventories:** Inventories consist of material, labor and manufacturing overhead andare recorded at the lower of cost or net realizable value. Excessivemanufacturing overhead costs attributable to idle facilities or abnormalproduction volumes are excluded from inventory and recorded as an expense inthe period incurred.

 

The components of inventories atMarch 31, 2004 and 2003 were as follows (dollars in thousands):

 
| ** **                                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|
| Raw materials, completed subassemblies and  spare parts |       | $        | 7,089      |     | $          | 8,119 |   |
| Work-in-process                                         |       | 4,168    |       | 3,783    |       |
| Finished goods                                          |       | 133      |       | 3,846    |       |
|                                                    |       | $        | 11,390     |     | $          | 15,748 |   |

 

The Company periodically reviews quantitiesof inventory on hand and compares these amounts to expected usage of eachparticular product or product line. The Company records, as a charge to cost ofsales, any amounts required to reduce the carrying value to net realizablevalue.

 

**Equipment andLeasehold Improvements:**  The Company provides fordepreciation and amortization of its fixed assets on a straight-linebasis over estimated useful lives of 2-10 years. Expenditures fornormal maintenance and repairs are charged to expense as incurred. Significantadditions, renewals or betterments that extend the useful lives of the assetsare capitalized at cost. The cost and accumulated depreciation applicable toequipment and leasehold improvements sold, or otherwise disposed of, areremoved from the accounts, and any resulting gain or loss is included in theconsolidated statements of operations.

 

33

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Equipment and leasehold improvementsconsisted of the following at March 31 (in thousands):

 
| ** **                                      | ** ** | **Estimated Useful  Lives**                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|
| Equipment                                       |       | 3-10 years                                  |       | $        | 2,136      |     | $          | 1,948 |   |
| Computer equipment and software                 |       | 2-5 years                                   |       | 6,020    |       | 5,580    |       |
| Tooling                                         |       | 3-7 years                                   |       | 369      |       | 366      |       |
| Leasehold improvements                          |       | Lesser of 10 years or  remaining lease term |       | 2,041    |       | 1,999    |       |
| Furniture and fixtures                          |       | 5-7 years                                   |       | 1,687    |       | 1,682    |       |
| Demo and test equipment                         |       | 3-7 years                                   |       | 2,419    |       | 2,647    |       |
| Motor vehicles                                  |       | 3 years                                     |       | 30       |       | 41       |       |
| Total                                           |       |                                        |       | 14,702   |       | 14,263   |       |
| Less accumulated depreciation and  amortization |       |                                        |       | (12,117  | )          | (10,549  | )          |
| Equipment and leasehold improvements, net       |       |                                        |       | $        | 2,585      |     | $          | 3,714 |   |

 

**Patents and OtherIntangibles:**  Patents and other intangible assets are beingamortized using the straight-line method over the legal lives of thepatents, not to exceed 17 years. The Company’s inability to protect itsintellectual property could have a significant impact on its results ofoperations. Claims against others for patent infringement are not recordeduntil realized.

 

**Revenue Recognition:**  TheCompany recognizes certain CargoSearch system sales and other product revenue,primarily ParcelSearch systems and spare parts, in accordance with SEC StaffAccounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB101”), modified by Emerging Issues Task Force (“EITF”) No. 00-21 andSAB No. 104 which requires that four basic criteria must be met beforerevenue can be recognized: (1) persuasive evidence of an arrangementexists; (2) delivery has occurred or services rendered; (3) the feeis fixed and determinable; and (4) collectibility is reasonably assured.Revenues on cost reimbursable and long-term fixed price contracts aregenerally recorded as costs are incurred using the percentage of completionmethod. These contracts are for custom-built systems or contractengineering projects and the length of these contracts typically range from 9to 24 months from order to delivery and acceptance. Percentages-of-completionare determined by relating the actual costs of work performed to date for eachcontract to its estimated final costs. Revisions in costs and profit estimatesare reflected in the period in which the facts causing the revision becomeknown.

 

Certain contracts require payments from thecustomer upon execution of the agreement that are included in customerdeposits. Individual customer deposits are reduced by the amount of revenuerecognized on the contract until a zero balance is reached. Revenue recognizedin excess of billings or customer deposits under the contracts is included inunbilled costs and fees in the accompanying balance sheet.

 

For all fixed price contracts, if a loss isanticipated on the contract, provision is made in the period in which suchlosses are determined.

 

Under the terms of certain of its costreimbursement contracts, the Company is not permitted to bill customers aspecified portion of the contract value until completion. Such retainages(approximately $179,000 in 2004 and $214,000 in 2003) result from bothcommercial contract retentions and government contract withholdings generallyfor up to 15% of fees, as well as the difference between the actual andprovisional indirect cost billing rates. Retainages are included in theaccompanying consolidated balance sheets as components of unbilled costs andfees.

 

The Company recognizes sales for its systemsthat are produced in a standard manufacturing operation and have shorter orderto deliver cycles at the time of shipment of the system to the customer andwhen other revenue recognition criteria is met. The costs of installation atthe customer’s site are accrued at the time of shipment. Management believesthe customer’s post-delivery acceptance provisions and installation areperfunctory and inconsequential. The Company has never failed to successfullycomplete a system installation. Installation is non-complex and does notrequire specialized skills and the related costs are predictable andinsignificant to the total purchase price. The Company has demonstrated ahistory of customer acceptance subsequent to shipment and installation of thesesystems.

 

Service revenues are accrued on time andmaterials engagements as the services are provided. Service contract revenuesare recognized on a straight-line basis over the length of the contract.Service revenues for fiscal 2004 and 2003 exceeded 10% of total

 

34

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revenues and as such have been separately presented.

 

The Company records billed shipping andhandling fees and billed out-of-pocket expenses as revenue and theassociated costs as cost of goods sold in the accompanying consolidated incomestatement.

 

Included in accounts receivable and unbilledcosts and fees at March 31, 2004 and 2003 are $11,417,374 and $9,957,000,respectively, attributable to both prime and subcontracts with the U.S.Government.

 

**Warranty Costs:**  TheCompany generally provides a one-year parts and labor warranty with thepurchase of domestic equipment, and a one-year parts only warranty withinternational equipment. The anticipated cost for this one-year warrantyis accrued for at the time of the sale and is recorded as accrued warrantycosts and as an expense within cost of goods sold, or is included in contractcosts for contracts accounted for using the percentage of completion method.

 

**Deferred Revenue:**  TheCompany offers to its customers extended warranty and service contracts. Thecoverage period of these contracts will typically range from one to five years,and typically with advance payments that are recorded as Deferred Revenue.Revenue is recognized on a straight-line basis over the life of thecontract.

 

**Impairment of Long-LivedAssets:**  Long-lived assets are reviewed forpossible impairment whenever events or changes in circumstances indicate thatthe carrying amount of such assets may not be recoverable in accordance withSFAS No. 144, Accounting for the Impairment and Disposal of Long-LivedAssets. Impairment is assessed by comparing the estimated undiscounted cashflows over the asset’s remaining life to the carrying amount of the asset. Ifthe estimated cash flows are insufficient to recover the investment animpairment loss is recognized based on the fair value of the asset less anycosts of disposal.

 

**Customer Deposits:**  For mostinternational orders, the Company generally includes, as part of its terms andconditions, an advance deposit with order acceptance. For long-terminternational contracts, the Company will generally include milestone paymentstied to a specific event and/or passage of time. These deposit amounts arerecorded as a liability under Customer Deposits until reduced by revenuerecognized against the specific contract.

 

**Deferred Rent:**  TheCompany has a lease for its office and manufacturing facilities, which includesescalation clauses. Accounting principles generally accepted in the UnitedStates of America require the rental expense to be recorded on a straight-linebasis over the life of the lease, resulting in deferred rent being reflected inthe accompanying consolidated balance sheets.

 

**Research andDevelopment:**  Internally funded research and developmentcosts are expensed as incurred.

 

**Fair Value ofFinancial Instruments:**  The Company’s financialinstruments consist primarily of cash and cash equivalents, short-terminvestments, accounts receivable, unbilled costs and fees, accounts payable,debt and letters of credit. The carrying amounts of these instrumentsapproximate fair value.

 

**Comprehensive IncomePolicy:**  Comprehensive income encompasses all changesin stockholder’s equity (except those arising from transactions with owners)and includes net income, net unrealized gains or losses on available for salesecurities and foreign currency translation adjustments. For the fiscal yearended 2004 comprehensive income includes net income and the cumulativetranslation adjustment of $14,000. The Company’s comprehensive net loss isequal to the Company’s net loss for fiscal 2003 and 2002.

 

**Income Per Common andPotential Common Shares:**  Basic earnings per common shareis computed by dividing net income available to common stockholders by theweighted average number of shares of common stock outstanding during the year.Diluted earnings per share include the dilutive impact of options and warrantsusing the average share price of the Company’s common stock for the period. Forthe years ended March 31, 2004, March 31, 2003 and March 31,2002, respectively, 875,000, 1,146,355, and 854,989 shares attributable to theexercise of outstanding options and warrants are excluded from diluted earningsper share, as their effect is anti-dilutive.

 
| ** **                                                                              | ** ** | **Year Ended**     | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                              | ** ** | **March 31, 2004** | ** ** | **March 31, 2003** | ** ** | **March 31, 2002** | ** ** |
| ** **                                                                              | ** ** | **(in thousands)** | ** ** |
| ** **                                                                              | ** ** | ** **         | ** ** |
| Weighted average number of common shares  outstanding—basic                        |       | 7,155              |       | 6,627 |   | 5,191 |   |
| Assumed exercise of stock options, using  the treasury stock method                     |       | 190                |       | — |   | — |   |
| Weighted average number of common and  potential common shares outstanding—diluted |       | 7,345              |       | 6,627 |   | 5,191 |   |

 

35

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**Income Taxes:**  TheCompany accounts for income taxes in accordance with SFAS No. 109, “Accountingfor Income Taxes.” Accordingly, the Company recognizes deferred income taxesbased on the expected future tax consequences of differences between thefinancial statement basis and the tax basis of assets and liabilities,calculated using enacted tax rates in effect for the year in which thedifferences are expected to be reflected in the tax return. The Company recordsa valuation allowance against any net deferred tax assets if it is more likelythan not that they will not be realized.

 

**Pro Forma Stock-BasedCompensation Expense:**  As permitted by SFAS No. 123, “Accountingfor Stock-Based Compensation,” the Company has elected to continue toapply Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees,” to account for its stock-based compensation plans.Had compensation cost for awards in 2004, 2003 and 2002 under the Company’sstock-based compensation plans been determined based on the fair value atthe grant dates consistent with the method set forth under SFAS No. 123,the effect on the Company’s net income (loss) and income (loss) per share wouldhave been as follows:

 
| ** **                                                             | ** ** | **2004**                                    | ** ** | **2003**   | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|------------|------------|----------|------------|
| ** **                                                             | ** ** | **(In thousands except per share amounts)** | ** ** | ** ** | ** ** |
| ** **                                                             | ** ** | ** **                                  | ** ** | ** ** | ** ** |
| Net income (loss):                                                     |       |                                        |       |       |       |     |       |
| As reported                                                            |       | $                                           | 1,911      |       | $          | (7,951   | )          | $ | (4,512 | ) |
| Less: Stock based compensation using fair  value method for all awards |       | (3,464                                      | )          | (3,689     | )          | (3,351   | )          |
| Pro forma                                                              |       | $                                           | (1,553     | )          | $          | (11,640  | )          | $ | (7,863 | ) |
|                                                                   |       |                                        |       |       |       |     |       |
| Income (loss) per share—Basic:                                    |       |                                        |       |       |       |     |       |
| As reported                                                            |       | $                                           | 0.27       |       | $          | (1.20    | )          | $ | (0.87 | ) |
| Pro forma                                                              |       | $                                           | (0.22      | )          | $          | (1.76    | )          | $ | (1.52 | ) |
| Income (loss) per share—Diluted:                                  |       |                                        |       |       |       |     |       |
| As reported                                                            |       | $                                           | 0.26       |       | $          | (1.20    | )          | $ | (0.87 | ) |
| Pro forma                                                              |       | $                                           | (0.22      | )          | $          | (1.76    | )          | $ | (1.52 | ) |
|                                                                        |            |                                             |            |            |            |          |            |  |  |  |  |

 

The fair value of each option granted wasestimated on the grant date using the Black-Scholes option pricing modelwith the following weighted average assumptions: risk-free interest ratesof 5.0% for fiscal year 2004 and 2003, and 4.53% to 5.13%, for fiscal year2002. The expected volatility of 72%, 73%, and 68% for 2004, 2003, and 2002,respectively, an expected dividend yield of 0% and an expected life of7 years for all three fiscal years.

 

**New AccountingPronouncements:**  In January 2003, the FASB issuedInterpretation No. 46 (“FIN 46”), “Consolidation of Variable InterestEntities,” which addresses consolidation by business enterprises of variableinterest entities (VIEs) that either: (1) do not have sufficient equityinvestment at risk to permit the entity to finance its activities withoutadditional subordinated financial support, or (2) the equity investorslack an essential characteristic of a controlling financial interest.Throughout 2003, the FASB released numerous proposed and final FSPs regardingFIN 46, which both clarified and modified FIN 46’s provisions. OnDecember 24, 2003, the FASB issued revised Interpretation No. 46 (FIN46-R) which will replace FIN 46 upon its effective date. The applicationof FIN 46 to VIEs created after February 1, 2003, did not result in anyentities requiring consolidation that would not already have requiredconsolidation under the voting equity interest model. The adoption of thispronouncement did not have an effect on the consolidated financial statements.

 

**2.             Lease Agreements**

 

The Company leases various office andmanufacturing facilities under non-cancelable operating leases. TheCompany incurred $1,115,000, $1,116,000, and $1,062,000 of rent expense in2004, 2003, and 2002 respectively. The security deposits on these leases amountto $163,000.

 

Future minimum rental payments under theCompany’s operating leases, excluding real estate taxes, insurance andoperating costs paid by the Company required over the initial terms of theleases are as follows:

 
| **Year Ending March 31,** | ** ** | **(in thousands)** | ** ** |
|---------------------------|------------|--------------------|------------|
| ** **                | ** ** | ** **         | ** ** |
| 2005                      |       | $                  | 1,065      |   |
| 2006                      |       | 316                |       |
| 2007                      |       | 319                |       |
| 2008                      |       | 346                |       |
| 2009                      |       | 376                |       |
|                      |       | $                  | 2,422      |   |

 

36

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**3.             Line of Credit**

 

On August 11, 2003, the Company enteredinto two new credit agreements with Silicon Valley Bank East replacing its HSBCBank USA credit agreements that expired on July 31, 2003. The firstagreement is a $5.0 million domestic loan and security agreement to supportthe Company’s routine working capital needs. Maximum borrowings for this lineare set at the lower of (a) the sum of 80% of eligible domestic accountsreceivable plus 10% of finished goods inventory up to $750,000, or;(b) $5 million. The second is a $20.0 million export loan andsecurity agreement, guaranteed by the Export-Import Bank of the UnitedStates to support the Company’s overseas contract, trade finance and workingcapital needs.

 

The credit facilities bear an interest rateof the greater of 4.25% or the Silicon Valley Bank prime rate (4.0% atMarch 31, 2004) and have an expiration date of November 30, 2004. Thecredit agreements are collateralized by certain assets of the Company andcontain certain restrictions, including limitations on the amount of distributionsthat can be made to stockholders, and the disposition or encumbrances ofassets, and require the maintenance of certain financial covenants. As ofMarch 31, 2004, the Company was in compliance with these covenants. TheCompany has begun the process of renewing these credit facilities with SiliconValley Bank East.

 

At March 31, 2004, there were noborrowings outstanding against these credit facilities. The Company hadoutstanding $526,000 in stand by letters of credit guaranteeing performance oncertain international projects, which have been collateralized by cash. Noamounts have been drawn on these stand by letters of credit.

 

**4.             Income Taxes**

 

The provision for (benefit from) income taxesfor the years ended March 31, 2004, 2003 and 2002 consisted of thefollowing:

 
| ** ** | ** ** | **2004**           | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|------------|------------|--------------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | **(in thousands)** | ** ** |
| ** ** | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current:   |       |               |       |       |       |       |       |
| Federal    |       | $                  | —     |       | $          | (840       | )          | $ | — |   |
| State      |       | (123               | )          | (2         | )          | —     |       |
| Foreign    |       | 32                 |       | —     |       | —     |       |
|       |       | (91                | )          | (842       | )          | —     |       |
| Deferred   |       |               |       |       |       |       |       |
| Federal    |       | —             |       | 3,066      |       | —     |       |
| State      |       | —             |       | 232        |       | —     |       |
|       |       | —             |       | 3,298      |       | —     |       |
| Total      |       | $                  | (91        | )          | $          | 2,456      |       | $ | — |   |

 

The difference between the total expectedprovision for (benefit) income taxes computed by applying the statutory federalincome tax rate to income before provision for (benefit from) income taxes andthe recorded provision for (benefit) income taxes for the three years in theperiod ended March 31, follows:

 
| ** **                                                                | ** ** | **2004**           | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                                                                | ** ** | **(in thousands)** | ** ** |
| ** **                                                                | ** ** | ** **         | ** ** |
| Provision (benefit) for income taxes at  statutory rate                   |       | $                  | 619        |     | $          | (1,868   | )          | $ | (1,534 | ) |
| State tax (benefit) provision net of  federal effect                      |       | (90                | )          | 154      |       | 13       |       |
| Permanent tax differences for non-deductible  expenses/non-taxable income |       | 455                |       | (759     | )          | 31       |       |
| Research tax credits                                                      |       | (60                | )          | —   |       | —   |       |
| Effect of ETI exclusion                                                   |       | (85                | )          | —   |       | (86      | )          |
| Expiration of tax credits                                                 |       | —             |       | —   |       | 8        |       |
| Change in valuation allowance                                             |       | (940               | )          | 4,929    |       | 1,282    |       |
| Other                                                                     |       | 10                 |       | —   |       | 286      |       |
|                                                                      |       | $                  | (91        | )        | $          | 2,456    |       | $ | — |   |

 

37

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The significant components of the netdeferred tax asset at March 31, 2004 and 2003 as is follows:

 
| ** **                                        | ** ** | **2004**           | ** ** | **2003**        | ** ** |
|---------------------------------------------------|------------|--------------------|------------|-----------------|------------|
| ** **                                        | ** ** | **Current**        | ** ** | **Non-current** | ** ** | **Current** | ** ** | **Non-current** | ** ** |
| ** **                                        | ** ** | **(in thousands)** | ** ** |
| ** **                                        | ** ** | ** **         | ** ** |
| **Assets:**                                       |       |               |       |            |       |   |   |   |   |
| Net operating loss carry forwards                 |       | $                  | —     |            | $          | 4,890 |   | $ | — |   | $ | 7,086 |   |
| Accounts receivable and unbilled costs and  fees  |       | 437                |       | —          |       | 266 |   | — |   |
| Inventory                                         |       | 958                |       | —          |       | 693 |   | — |   |
| Deferred revenue                                  |       | —             |       | 409             |       | — |   | 584 |   |
| Accrued vacation                                  |       | 328                |       | —          |       | 291 |   | — |   |
| Accrued warranty costs                            |       | 272                |       | —          |       | 208 |   | — |   |
| Research & development and other tax  credits |       | —             |       | 1,987           |       | — |   | 1,813 |   |
| Depreciation                                      |       | —             |       | 664             |       | — |   | 604 |   |
| Other                                             |       | 177                |       | 40              |       | 82 |   | 70 |   |
| Deferred income tax assets                        |       | 2,172              |       | 7,990           |       | 1,540 |   | 10,157 |   |
| Valuation allowance                               |       | (2,172             | )          | (7,990          | )          | (1,540 | ) | (10,157 | ) |
| Net deferred income taxes                         |       | $                  | —     |            | $          | — |   | $ | — |   | $ | — |   |

 

The Company has available general business andother credits of approximately $2.0 million expiring at various timesthrough 2024. As of March 31, 2004, the Company had federal and state netoperating loss carry forwards of approximately $12,800,000 and $8,500,000,respectively expiring at various times from 2005 through 2024.

 

The Company has established a full valuationreserve in accordance with the provisions of SFAS No. 109. The Companycontinually reviews the adequacy of valuation allowances and releases theseallowances when it is determined that is more likely than not that the benefitswill be realized.

 

**5.             Warranty Obligations**

 

The Company’s parcel product line carries aone-year warranty; the costs of which are accrued for at time ofshipment. Accrual rates are based upon historical experience over the precedingtwelve months and the adequacy of the warranty reserve is evaluated monthly.Warranty experience for the years ended March 31, 2004 and 2003 is asfollows:

 
| ** **                                        | ** ** | **2004**           | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|----------|------------|
| ** **                                        | ** ** | **(in thousands)** | ** ** |
|                                              |       |               |       |     |       |
| Warranty accrual beginning of period              |       | $                  | 535        |     | $          | 196 |   |
| Accruals for warranties issued during the  period |       | 847                |       | 672      |       |
| Warranty costs incurred during period             |       | (683               | )          | (333     | )          |
| Balance at end of period                          |       | $                  | 699        |     | $          | 535 |   |

 

38

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**6.             Stockholders’ Equity**

 

**Preferred Stock:**  TheCompany’s articles of organization authorize its Board of Directors to issue upto 100,000 shares of preferred stock in one or more series, to determine andfix certain relative rights and preferences of the shares of any series, to fixthe number of shares constituting any such series, and to fix the designationof any such series, without further vote or action by its shareholders. TheCompany has no present plans to issue shares of preferred stock. In 1998, theCompany designated a series of Preferred Stock as Series A JuniorParticipating Cumulative Preferred Stock (the “Series A Preferred Stock”)to be issued upon the exercise of Rights issued under the Company’sShareholders Rights Plan. Under the Shareholder Rights Plan, adopted in 1998,under which its stockholders are entitled to purchase shares of itsSeries A Preferred Stock under certain circumstances. These circumstancesinclude the purchase of 15% or more of the outstanding shares of common stockby a person or group, or the announcement of a tender or exchange offer toacquire 15% or more of the outstanding common stock.

 

**Common Stock andWarrant Offering:**  On May 28, 2002, the Company closed on aprivate placement offering of common stock and warrants. A total of 1,115,000shares were sold to accredited investors at a price of $17.64 each. Inaddition, warrants to purchase an additional 295,475 shares of common stock ata price of $23.52 were issued. Proceeds to the Company approximated$18.4 million, net of approximately $1.3 million of issuance costs ofwhich $3.1 million was assigned to the warrants issued. The warrants wereimmediately vested and have a five-year life expiring in May of 2007. Dueto certain conversion features of these warrants, that provide that the holdermay opt for a cash settlement in certain instances, including a merger, a saleof all or substantially all of the Company’s assets, or a tender offer orexchange offer of shares of the Company’s stock, a liability equal to the Black-Scholesvaluation of the warrants at the deal closing date was recorded on the Company’sbalance sheet. The “mark to market” change in the warrants value atMarch 31, 2004 of $1,273,000 was recorded as other expense the year endedMarch 31, 2004. The liability of $2,093,000 associated with the warrantsis recorded as a non-current liability on the March 31, 2004 balancesheet. The fair market value of the warrants was determined using the Black-Scholespricing model and an assumed volatility of 72% and 68% to 72% for fiscal year2004 and 2003, respectively, as well as an interest rate of 5% for fiscal year2004 and 2003, and the remaining life of the warrants.

 

**Stock Option andOther Compensation Plans:**  The Company has various stockoption and other compensation plans for directors, officers, and employees. TheCompany has the following stock option plans outstanding as of March 31,2004: the 1984 Stock Option Plan, the 1993, 1994-1995, 1996 and 2003Stock Option Plans for Non-employee Directors; 1995 Combination Plan;1997 and 1998 Non-Qualified Option Plan; 1994-95 Stock Option Planfor New Employees, a 1999 Combination Plan, a 2000 Combination Plan, and a 2002Combination Plan. There were 3,293,000 shares authorized under these plans.Vesting periods on these plans range from immediate vesting to four years.Options under these plans are granted at fair market value and generally becomeexercisable within one to two years of the grant date and terminate ten yearsfrom the date of grant. In addition, the Company has a common stock installmentpurchase plan under which the Board of Directors may grant key personnel theright to purchase shares of the Company’s common stock at fair market value andto pay the purchase price in twelve equal monthly installments. As ofMarch 31, 2004, no shares have been reserved or granted under this plan.

 

The Company has instituted two common stockpurchase plans. The Executive Equity Incentive Plan allows an executive officerof the Company to buy original issue Company common stock in any dollar amountup to the gross amount of the annual bonus granted to the Officer and toreceive half the number of shares purchased in restricted stock which vestsafter 3 years. If the employee leaves the Company prior to 3 years,then the shares revert back to the Company. As of both March 31, 2004 and2003, 2,251 shares have been reserved and restricted under this plan. TheReload Option Plan allows any eligible employee designated by the Board ofDirectors to receive new stock options (at an exercise price equal to the fairmarket value of the common stock on the date of sale of the stock) for everyshare of Company common stock sold or used to exercise stock options. Therehave been no issuances of stock options under the Reload Option Plan.

 

The Company’s 2003 Stock Plan for Non-EmployeeDirectors allows for the granting of restricted stock to non-employeeDirectors. The Company granted 13,000 shares of restricted common stock duringthe year ended March 31, 2004. Stock-based compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as expense over the vesting period which is 1 year. Unearnedcompensation is charged to a separate component of stockholders’ equity andsubsequently amortized as compensation expense over the vesting period.

 

39

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**Stock Option Activity**

 

A summary of the Company’s stock optionactivity is as follows:

 
| ** **                                                                | ** ** | **2004**              | ** ** | **2003**                               | ** ** | **2002**              | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                                                                      |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Options outstanding, beginning of year                                    |       | 2,159,860             |       | $                                      | 10.03      |                  | 1,739,657  |   | $ | 9.50 |   | 2,025,133 |   | $ | 8.78 |   |
| Options granted                                                           |       | 485,685               |       | 11.48                                  |       | 704,100               |       | 11.13 |   | 484,400 |   | 10.04 |   |
| Options exercised                                                         |       | (477,619              | )          | 7.40                                   |       | (175,347              | )          | 8.39 |   | (484,367 | ) | 7.78 |   |
| Options expired                                                           |       | (687,285              | )          | 11.50                                  |       | (108,550              | )          | 9.14 |   | (285,509 | ) | 7.92 |   |
| Options outstanding, end of year                                          |       | 1,480,641             |       | $                                      | 10.66      |                  | 2,159,860  |   | $ | 10.03 |   | 1,739,657 |   | $ | 9.50 |   |
| Options exercisable                                                       |       | 863,360               |       | $                                      | 10.11      |                  | 1,350,246  |   | $ | 9.78 |   | 1,112,392 |   | $ | 9.62 |   |
|                                                                      |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Options available for grant                                               |       | 586,845               |       |                                   |       | 344,615               |       |   |   | 327,615 |   |   |   |
|                                                                      |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Weighted average fair value per share of  options granted during the year |       |                  |       | $                                      | 7.40       |                  |       |   | $ | 7.84 |   |   |   | $ | 8.17 |   |

 

The following summarizes certain data foroptions outstanding and exercisable at March 31, 2004:

 
| ** **                        | ** ** | **Number of  Shares** | ** ** | **Range of  Exercise Prices** | ** **      | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** |
|-----------------------------------|------------|-----------------------|------------|-------------------------------|-----------------|----------------------------------------|------------|-----------------------------------------------------|------------|
|                              |       |                  |       |                          |            |                                   |       |                                                |       |
| Options outstanding, End of year: |       | 161,216               |       | $                             | 3.25—$7.00 |                                   | $          | 6.13                                                |       | 5.3 |   |
|                              |       | 152,700               |       | 7.01—10.25               |            | 7.97                                   |       | 4.8                                                 |       |
|                              |       | 1,117,025             |       | 10.26—14.00              |            | 11.43                                  |       | 7.8                                                 |       |
|                              |       | 48,200                |       | 14.01—17.50              |            | 16.23                                  |       | 5.1                                                 |       |
|                              |       | 1,500                 |       | 17.51—22.00              |            | 19.35                                  |       | 7.8                                                 |       |
|                              |       | 1,480,641             |       |                          |            | $                                      | 10.66      |                                                | 7.2        |   |
|                              |       |                  |       |                          |            |                                   |       |                                                |       |
| Options exercisable:              |       | 148,550               |       | $                             | 3.25—$7.00 |                                   | $          | 6.15                                                |       |   |   |
|                              |       | 124,801               |       | 7.01—10.25               |            | 7.77                                   |       |                                                |       |
|                              |       | 553,976               |       | 10.26—14.00              |            | 11.32                                  |       |                                                |       |
|                              |       | 34,533                |       | 14.01—17.50              |            | 15.79                                  |       |                                                |       |
|                              |       | 1,500                 |       | 17.51—22.00              |            | 19.35                                  |       |                                                |       |
|                              |       | 863,360               |       |                          |            | $                                      | 10.11      |                                                |       |   |

 

On April 15, 1998, the Company announcedthat its Board of Directors adopted a Shareholders’ Rights Plan (the Plan) anddeclared a dividend of one preferred stock purchase right for each outstandingshare of common stock. The dividend was payable to all holders of record ofshares of common stock as of the close of business on April 17, 1998. Therights become exercisable ten days after a person or group acquires 15% or moreof the Company’s common stock and in certain other situations described in thePlan. As of March 31, 2004, no options have been granted or exercisedunder this plan.

 

The Company realizes a tax deduction upon theexercise of non-qualified stock options and disqualifying dispositions ofincentive stock options due to the recognition of compensation expense in thecalculation of its taxable income. The amount of the compensation recognizedfor tax purposes is based on the difference between the market value of thecommon stock and the option price at the date the options are exercised. Thesetax benefits are credited to additional paid-in capital if it isconsidered more likely than not that they will be realized. No tax benefitswere recorded in fiscal 2004 or 2003.

 

**7.             Business Segment Information**

 

In accordance with the provisions of SFASNo. 131 “Disclosures about Segments of an Enterprise and RelatedInformation,” the Company has determined that it has only one operatingsegment, the X-ray product segment. This includes X-ray detectionand imaging products used primarily for the detection of illegal drugs,terrorist explosives, and smuggled goods. The equipment is purchased by

 

40

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sophisticated government and commercialclients who place a premium on the detection of organic material in complexbackgrounds and the ability to see the contents of containers with precision.

 

**Geographical Data:**  All of theCompany’s export sales originate from the U.S. Less than 1% of the Company’sassets are in any foreign country. The following table shows the breakdown ofNet sales and contract revenues to foreign and domestic customers and the majorregions of export activity based upon customer country of domicile.

 
| ** **                                 | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                                 | ** ** | **(dollars in thousands)** | ** ** |
|                                       |       |                       |       |     |       |     |       |   |   |   |   |   |   |
| Domestic (based on customer location)      |       | $                          | 66,848     |     | 88         | %        | $          | 52,834 |   | 85 | % | $ | 45,932 |   | 70 | % |
| Export (based on customer location)        |       | $                          | 9,494      |     | 12         | %        | $          | 9,124 |   | 15 | % | $ | 19,464 |   | 30 | % |
| Net sales and contract revenues            |       | $                          | 76,342     |     | 100        | %        | $          | 61,958 |   | 100 | % | $ | 65,396 |   | 100 | % |
|                                       |       |                       |       |     |       |     |       |   |   |   |   |   |   |
| Percent of Export Revenue by Major Region: |       |                       |       |     |       |     |       |   |   |   |   |   |   |
| Middle East & Africa                   |       | 34.2                       | %          |     |       | 70.6     | %          |   |   | 59.0 | % |   |   |
| Europe                                     |       | 29.1                       | %          |     |       | 16.8     | %          |   |   | 28.1 | % |   |   |
| Mexico                                     |       | —                     |       |     |       | —   |       |   |   | 7.7 | % |   |   |
| Pacific Rim                                |       | 34.4                       | %          |     |       | 11.7     | %          |   |   | 4.4 | % |   |   |
| All Other                                  |       | 2.3                        | %          |     |       | 0.9      | %          |   |   | 0.8 | % |   |   |
|                                            |            |                            |            |          |            |          |            |  |  |  |  |  |  |  |  |  |  |

 

**Major Customers:**  Sales tomajor customers (representing in excess of 10% of consolidated revenues)consisted of X-ray product sales of the following:

 

***Fiscal2004:***  $14,674,000 to one customer and $11,090,000to another customer.

 

***Fiscal2003:***  $10,768,000 to one customer.

 

***Fiscal2002:***  $18,199,000 to one customer.

 

One customer, an agency of the U.S.Government, at March 31, 2004 had an accounts receivable balance(representing in excess of 10% of consolidated accounts receivable) of$2,842,000.

 

Included in unbilled costs and fees is$3,387,000 related to a single customer, which is expected to be billed andcollected within the next 12 months.

 

**8.             Commitments and Contingencies**

 

**DeferredCompensation:**  The Company has an unfunded deferredcompensation plan, originally adopted in 1976 and amended at various times, forcertain retired directors. This plan provides for periodic payments beginningat age 65, the amount of which depends on length of service. The Company paid$14,000 in 2004, $24,000 in 2003, and $16,000 in 2002 under this deferredcompensation plan. As of March 31, 2004 and 2003, $89,369 and $103,156,respectively, is accrued for under this plan.

 

**Litigation:**  InSeptember 1998, the Company filed suit against EG&G AstrophysicsResearch Corp. (“EG&G”) in the U.S. District Court for the District ofMassachusetts in Boston, alleging that EG&G infringed upon at least twopatents owned by the Company and that EG&G had misappropriated certaintrade secrets of the Company. EG&G denied these allegations and filedcounterclaims alleging that the patents-in-suit were not infringedand/or were invalid. In May 2003, the Company and PerkinElmer, Inc.(the former parent of EG&G) completed a settlement agreement which resolvedall of the Company’s claims against EG&G through June 14, 2002, thedate that PerkinElmer sold EG&G to its new corporate parent, L-3Communications, Inc, (“L-3”). Counterclaims as to any liability throughthe same date also were released. After completing this settlement, thelitigation continued against EG&G’s successor-in-interest, L-3,concerning any liability accrued after that date. Upon a determination that L-3was not continuing the accused infringement, the Company moved to dismiss thecase. In February 2004, the District Court entered an order dismissing theCompany’s claims with prejudice and L-3’s counterclaims withoutprejudice. The Company covenanted not to sue L-3 for infringement by anycurrent products of the two above-referenced patents.

 

On or about February 19, 2004, L-3filed a lawsuit against the Company in the United States District Court for theDistrict of Massachusetts, in Boston, seeking declaratory judgments of non-infringementand/or invalidity of two of the Company’s patents—United 

 

41

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States Pat. No. 6,292,533 and No. 5,903,623. The Companyfiled a motion to dismiss the litigation for lack of subject matterjurisdiction, but was denied. The Company has answered L-3’s underlyingcomplaint, vigorously opposing the plaintiff’s non-infringement andinvalidity claims.

 

The Company is also subject to various legalproceedings and claims that arise in the ordinary course of business. TheCompany currently believes that resolving these matters will not have amaterial adverse impact on its financial condition or results of operations.

 

**Purchase Commitments:**  In thenormal course of business, the Company enters into purchase orders with itsvendors for the purchase of materials or services to meet its production needs.At March 31, 2004, the Company had $7,689,000 of open purchase orderswhich are expected to be fulfilled within the next twelve to eighteen months.Certain single source vendors or vendors producing custom material requiresignificant lead times from order to delivery of their material. Should thedemand for the Company’s products decline significantly, or should there be asignificant shift in the mix of products being demanded, the Company may incurcancellation charges, related to these commitments, that could be material tothe Company’s results of operations. To date, the Company has not experiencedany material losses related to cancellation penalties.

 

**EmploymentAgreements:**  The Company has employment agreements withcertain executives that provide for severance payments of up to one years basesalary and the continuation of certain benefits for a period not to exceed oneyear if terminated pursuant to a change in control of the Company.

 

**Retirement Savings Plan:**  TheCompany maintains a 401(k) Retirement Savings Plan for all employees with morethan 500 hours and 6 months of credited service annually. The Plan isfunded by elective employee contributions of up to 15% of their compensation.Under the Plan the Company matches 3% of employee contributions for eachparticipant in the form of Company common stock. Expense under the Plan,consisting of Company contributions and Plan administrative expenses paid bythe Company, totaled $390,426, $420,711, and $393,512, in 2004, 2003 and 2002,respectively.

 

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**American Science andEngineering, Inc. and SubsidiaryUnaudited Quarterly Consolidated Financial DataFor the years ended March 31, 2004 and March 31, 2003**

 
| ** **                      | ** ** | **2004 by quarter**                                  | ** ** | **2003 by quarter** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|---------------------|------------|
| ** **                      | ** ** | **1st(3)**                                           | ** ** | **2nd(3)**          | ** ** | **3rd** | ** ** | **4th(4)** | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th(1)(2)** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands, except per share amounts)** | ** ** |
|                            |       |                                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales and contract revenues |       | $                                                    | 17,388     |                | $          | 18,179 |   | $ | 16,266 |   | $ | 24,509 |   | $ | 14,918 |   | $ | 16,935 |   | $ | 17,220 |   | $ | 12,885 |   |
| Gross profit                    |       | 4,572                                                |       | 4,797               |       | 3,964 |   | 6,601 |   | 3,490 |   | 3,362 |   | 3,878 |   | 219 |   |
| Operating income (loss)         |       | 235                                                  |       | 582                 |       | (530 | ) | 2,464 |   | (1,548 | ) | (2,071 | ) | (519 | ) | (3,741 | ) |
| Net income (loss)               |       | 120                                                  |       | 413                 |       | (422 | ) | 1,800 |   | (909 | ) | (697 | ) | (1,058 | ) | (5,287 | ) |
| Net income per share            |       |                                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| —Basic                     |       | $                                                    | 0.02       |                | $          | 0.06 |   | $ | (0.06 | ) | $ | 0.24 |   | $ | (0.15 | ) | $ | (0.10 | ) | $ | (0.15 | ) | $ | (0.77 | ) |
| —Diluted                   |       | $                                                    | 0.02       |                | $          | 0.06 |   | $ | (0.06 | ) | $ | 0.24 |   | $ | (0.15 | ) | $ | (0.10 | ) | $ | (0.15 | ) | $ | (0.77 | ) |
|                                 |            |                                                      |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  The fourth quarter of 2003 net losses includesvaluation reserves of approximately $2.5 million, recorded againstdeferred tax assets previously recorded in connection with net operating lossesincurred.

 

(2)                                  The fourth quarter of 2003 net losses include$3.2 million, in provisions for inventory obsolescence based on theCompany’s forecast of future sales and the recoverability analysis.

 

(3)                                  The quarterly 10-Q reports for the first andsecond quarters of fiscal 2004 were amended during the current fiscal year.

 

(4)                                  The fourth quarter of 2004 net income includes$.75 million in provisions for inventory obsolescence based on the Company’sforecast of future sales and the recoverability analysis.

 

43

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**Report of IndependentRegistered Public Accounting Firmon Financial Statement Schedule**

 

To the Board of Directors

of American Science andEngineering, Inc.:

 

Our audits of the consolidated financialstatements referred to in our report dated May 19, 2004 appearing in thisAnnual Report on Form 10-K of American Science andEngineering, Inc., also included an audit of the March 31, 2004 and2003 financial statement schedule listed in the index to the consolidatedfinancial statements and schedule of this Form 10-K. In our opinion,this 2004 and 2003 financial statement schedule presents fairly, in allmaterial respects, the information set forth therein when read in conjunctionwith the related consolidated financial statements.

 
| /s/ PricewaterhouseCoopers LLP |       |   |
|--------------------------------|------------|--------|
|                           |       |
| Boston, MA                     |       |
| **May 19, 2004**          | ** ** |

 

44

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**SCHEDULE II**

 

**AMERICAN SCIENCE ANDENGINEERING, INC. AND SUBSIDIARYVALUATION AND QUALIFYING ACCOUNTS AND RESERVESFor the years ended March 31, 2004, March 31, 2003, andMarch 31, 2002**

 

**Description—Allowance for Doubtful Accounts**

 
| ** ** | ** ** | **Balance at  Beginning of  Year** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions  from  Reserves** | ** ** | **Balance at  At End  of Year** | ** ** |
|------------|------------|------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** ** | ** ** | **(Dollars in thousands)**         | ** ** |
|       |       |                               |       |                                |       |                           |       |                            |       |
| 2004       |       | $                                  | 246        |                                | $          | 27                             |       | $                               | 23         |   | $ | 250 |   |
| 2003       |       | $                                  | 111        |                                | $          | 138                            |       | $                               | 3          |   | $ | 246 |   |
| 2002       |       | $                                  | 134        |                                | $          | —                         |       | $                               | 23         |   | $ | 111 |   |

** **

**Description—Allowances for Unbilled Cost and Fees**

 
| ** ** | ** ** | **Balance at  Beginning of  Year** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions  from  Reserves** | ** ** | **Balance  At End of  Year** | ** ** |
|------------|------------|------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** ** | ** ** | **(Dollars in thousands)**         | ** ** |
|       |       |                               |       |                                |       |                           |       |                         |       |
| 2004       |       | $                                  | 437        |                                | $          | —                         |       | $                            | 43         |   | $ | 394 |   |
| 2003       |       | $                                  | 437        |                                | $          | —                         |       | $                            | —     |   | $ | 437 |   |
| 2002       |       | $                                  | 437        |                                | $          | —                         |       | $                            | —     |   | $ | 437 |   |

 

45

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**SIGNATURES**

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the Companyhas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                     | AMERICAN  SCIENCE AND ENGINEERING, INC. |
|--------------------------|-----------------------------------------|
|                     |                                    |   |
| DATED: February 15, 2005 | By:                                     | /s/ Anthony R. Fabiano |   |
|                     |                                    | Anthony R. Fabiano*President and Chief  Executive Officer* |   |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the Company and in the capacities and on thedates indicated:

 
| **Signature**                | ** ** | **Title**                                                                         | ** ** | **Date**              |
|------------------------------|------------|-----------------------------------------------------------------------------------|------------|-----------------------|
|                         |       |                                                                              |       |                  |
| /s/ Anthony R. Fabiano       |       |                                                                              |       |                  |
| Anthony R. Fabiano           | ** ** | Director and  President and Chief Executive Officer (Principal Executive Officer) | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| **/s/  Kenneth J. Galaznik** | ** ** | ** **                                                                        | ** ** | ** **            |
| Kenneth J. Galaznik          |       | Chief Financial Officer and Treasurer  (Principal Financial Officer)              | ** ** | **February 15, 2005** |
|                         |       |                                                                              | ** ** | ** **            |
| /s/ Denis R. Brown           |       |                                                                              | ** ** | ** **            |
| Denis R. Brown               |       | Director                                                                          | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| /s/ Roger P. Heinisch        | ** ** | ** **                                                                        | ** ** | ** **            |
| Roger P. Heinisch            |       | Director                                                                          | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| /s/ Hamilton W. Helmer       | ** ** | ** **                                                                        | ** ** | ** **            |
| Hamilton W. Helmer           |       | Director                                                                          | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| /s/ Donald J. McCarren       | ** ** | ** **                                                                        | ** ** | ** **            |
| Donald J. McCarren           |       | Director                                                                          | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| /s/ Ernest J. Moniz          | ** ** | ** **                                                                        | ** ** | ** **            |
| Ernest J. Moniz              | ** ** | Director                                                                          | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| /s/ William E. Odom          | ** ** | ** **                                                                        | ** ** | ** **            |
| William E. Odom              |       | Chairman of the Board, Director                                                   | ** ** | **February 15, 2005** |
| ** **                   | ** ** | ** **                                                                        | ** ** | ** **            |
| /s/ Carl W. Vogt             | ** ** | ** **                                                                        | ** ** | ** **            |
| Carl W. Vogt                 |       | Director                                                                          | ** ** | **February 15, 2005** |

 

46

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**EXHIBIT INDEX**

** **
| **Exhibit  Number** | ** ** | **Description of Exhibit (and Statement  of Incorporation by Reference, If Applicable)**                                                                                                                                                     | ** ** | **Page Number  (If Filed)** |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|
|                |       |                                                                                                                                                                                                                                         |       |                        |
| (3)(a)              |       | Restated Articles of Organization of the Company (filed  as an Exhibit to Company’s Annual Report on Form 10-K for the year  ended September 30, 1967, and incorporated herein by reference)                                            |       |                        |
| (3)(b)              |       | Articles of Amendment to Restated Articles of  Organization of Company (filed as Exhibit 2(a)(ii)(B) to the Company’s  Registration Statement on Form S-7, No. 2-56452, filed May 25,  1976, and incorporated herein by reference)      |       |                        |
| (3)(c)              |       | Articles of Amendment to Restated Articles  of Organization of Company (filed as Exhibit 12 to the Company’s Annual  Report on Form 10-K for the year ended March 31, 1976, and incorporated  herein by reference)                      |       |                        |
| (3)(d)              |       | By-laws of Company, as amended (filed  as Exhibit 2(a)(iii) to Company’s Registration Statement on Form S-7,  No. 2-56452, filed May 25, 1976, and incorporated herein by reference)                                                    |       |                        |
| (3)(e)              |       | Amended and Restated Bylaws of American  Science & Engineering, Inc. (filed as Exhibit 3.2 to the Company’s  Quarterly Report on Form 10-Q for the quarter ended December 31,2003,  and incorporated herein by reference)           |       |                        |
| (4)                 |       | Shareholders Rights Plan (filed as Exhibit  to the Company’s filing on Form dated, 1992 and incorporated herein by  references)                                                                                                         |       |                        |
| (10)(b)(xii)        |       | 1997 Non-Qualified Stock Option Plan  (filed as Exhibit 99 to the Company’s Registration Statement on Form S-8,  File No. 333-27927, filed on May 28, 1997 and incorporated herein by  reference)                                       |       |                        |
| (10)(b)(xiii)       |       | 1998 Non-Qualified Stock Option Plan  (filed as Exhibit (10) (b) (xiii) to the Annual Report on Form 10-K for  the year ended March 31, 1998, and incorporated herein by reference)                                                          |       |                        |
| (10)(b)(xv)*        |       | Employment Agreement between the Company  and Dr. Joseph Callerame dated May 6, 1998, (filed as Exhibit (10) (b) (xv)  to the Annual Report on Form 10-K for the year ended March 31, 1998,  and incorporated herein by reference)           |       |                        |
| (10)(c)(i)          |       | Lease of Billerica property (filed as  Exhibit 10(c) to the Company’s Annual Report on Form 10-K for the year  ended March 31, 1995 and incorporated herein by reference)                                                               |       |                        |
| (10)(c)(ii)         |       | Amendment to Lease of Billerica property  (filed as to the Company’s Annual Report on Form 10-K for the year  ended March 28, 1997 and incorporated herein by reference)                                                                |       |                        |
| (10)(c)(iii)        |       | Lease of 33 Manning Road, Billerica, MA                                                                                                                                                                                                      |       |                        |
| (10)(c)(iv)         |       | 1999 Combination Stock Option Plan (filed  as Exhibit 99 to the Company’s Registration Statement on Form S-8, File  No. 333-91801, filed on November 30, 1999 and incorporated herein by  reference)                                    |       |                        |
| (10)(c)(v)          |       | 2000 Combination Stock Option Plan (filed  as Exhibit 99 to the Company’s Registration Statement, filed as Exhibit A to  the Definitive Proxy Statement on Schedule 14A filed on August 18, 2000 and  incorporated herein by reference) |       |                        |
| (10)(c)(vi)         |       | 2002 Combination Stock Option Plan (filed  as Exhibit 99.1 to the Company’s Registration Statement on Form S-8,  No. 333-102338, filed on January 3, 2003 and incorporated herein by  reference)                                        |       |                        |
| (10)(c)(viii)       |       | Sub-lease from the Company of 30  Manning Road, Billerica, Massachusetts (filed as Exhibit (10)(c)(viii) to the  Annual Report on Form 10-K for the year ended March 31, 2000, and  incorporated herein by reference).                       |       |                        |
| (10)(c)(ix)*        |       | Employment Agreement between the Company  and Richard Mastronardi dated August, 2000                                                                                                                                                         |       |                        |
| (10)(c)(x)*         |       | Employment Agreement between the Company  and Andrew R. Morrison dated May 30, 2001                                                                                                                                                          |       |                        |
| (10)(c)(xiv)*       |       | Employment Agreement between the Company  and Paul Theodore Owens dated December 12, 2002                                                                                                                                                    |       |                        |

 

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| (10)(c)(xv)   |   | Lease of Mountain View, CA facility for  High Energy Systems Division (filed as Exhibit 10(c)(xv) to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, and  incorporated herein by reference)                                                                                     |   |   |
|---------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| (10)(c)(xvi)* |   | Employment Offer Letter between the Company  and Anthony R. Fabiano dated August 21, 2003 (filed as Exhibit 10(c)(xv) to  the Company’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2003, and incorporated herein by reference)                                                            |   |   |
| (10)(d)(xi)   |   | Loan and Security Agreement between  American Science and Engineering, Inc., and Silicon Valley Bank East dated  August 11, 2003 (filed as Exhibit 10(d)(xi) to the Company’s Quarterly Report  on Form 10-Q For the quarter ended September 30, 2003, and incorporated  herein by reference)                     |   |   |
| (10)(d)(xii)  |   | Export-Import Bank Loan and Security  Agreement between American Science and Engineering, Inc., and Silicon Valley  Bank East dated August 11, 2003 (filed as Exhibit 10(d)(xii) to the Company’s  Quarterly Report on Form 10-Q for the quarter ended September 30, 2003,  and incorporated herein by reference) |   |   |
| (22)          |   | Identification of Company’s subsidiary,  AS&E Radiography, Inc., incorporated in Massachusetts (filed as Exhibit  (22) to Company’s Annual Report on Form 10-K for the year ended March  31, 1988, and incorporated herein by reference)                                                                 |   |   |
| (22.1)        |   | Identification of Company’s subsidiary,  AS&E Global, Inc., incorporated in Massachusetts (filed as Exhibit 22.1  to Company’s Annual Report on Form 10-K for the year ended March 31,  2003, and incorporated herein by reference)                                                                      |   |   |
| (23.1)        |   | Consent of Independent Registered Public  Accounting Firm                                                                                                                                                                                                                                                              |   |   |
| (23.2)        |   | Notice Regarding Arthur Andersen LLP (filed  as Exhibit 23.2 to Company’s Annual Report on Form 10-K for the year  ended March 31, 2003, and incorporated herein by reference)                                                                                                                                    |   |   |
| (31.1)        |   | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a)                                                                                                                                                                                                                                                   |   |   |
| (31.2)        |   | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a)                                                                                                                                                                                                                                                   |   |   |
| (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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*              Contractwith Management

 

The Company’s principal executive offices are located at 829 MiddlesexTurnpike, Billerica, MA 01821; telephone number 978-262-8700;corporate web site www.as-e.com. We make available, free of chargethrough our website, our annual Form 10-K, current reports onForm 10-Q and Form 8-K, and amendments to these reportsfiled or furnished pursuant to Section 13(a) of the Securities ExchangeAct of 1934 as soon as practicable.

 

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