**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

**FORM 10-K**

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

**Forthe fiscal year ended March 31, 2006**

**o**                                  TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Commissionfile number 1-6549**

----

**AMERICAN SCIENCE AND ENGINEERING, INC.**

(Exact name of registrant 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’s telephonenumber, including area code)

Securities registered pursuant to Section 12(b) ofthe Act:

| **Title of each class**               | ** ** | **Name of  each exchange on which registered** |
|---------------------------------------|------------|------------------------------------------------|
| Common Stock ($.662¤3 par value) |       | NASDAQ Stock  Exchange                         |

 

Securities registeredpursuant to Section 12(g) of the Act: None

Indicate by checkmark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act:   Yes o No x

Indicate by checkmark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act:   Yes o No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.   Yes x No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K.   o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer (as defined in Rule 12b-2 of the SecuritiesExchange Act of 1934)

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

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

The aggregate market valueof voting stock held by non-affiliates of the registrant, computed using theclosing sale price of common stock of $65.59 on September 30, 2005, was $589,288,000.

9,108,687 shares of Registrant’s common stock wereoutstanding on May 30, 2006.

**DOCUMENTSINCORPORATED BY REFERENCE**

**The registrant intends tofile a definitive Proxy Statement pursuant to Regulation 14A within 120 days ofthe end of the fiscal year ended March 31, 2006. Portions of such ProxyStatement are incorporated by reference in Part III.**

 

----

**AMERICAN SCIENCEAND ENGINEERING, INC.**

**FORM 10-K**

**FOR THE PERIODENDED MARCH 31, 2006**

**TABLE OF CONTENTS**

 

|               | ** ** | ** **                                                                                                          | ** ** | **Page  Number** |
|---------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|------------------|
|          | ** ** | **PART I**                                                                                                     |       |             |
| ITEM 1.       |       | Business                                                                                                            |       | 3                |
| ITEM 1A.      |       | Risk Factors                                                                                                        |       | 10               |
| ITEM 1B.      |       | Unresolved Staff Comments                                                                                           |       | 17               |
| ITEM 2.       |       | Properties                                                                                                          |       | 17               |
| ITEM  3.      |       | Legal  Proceedings                                                                                                  |       | 17               |
| ITEM 4.       |       | Submission of Matters to a Vote of Security Holders                                                                 |       | 18               |
| ** **    |       | **PART II**                                                                                                    |       |             |
| ITEM 5.       |       | Market for the Company’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       | 18               |
| ITEM 6.       |       | Selected Financial Data                                                                                             |       | 19               |
| ITEM 7.       |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                         |       | 20               |
| ITEM 7A.      |       | Quantitative and Qualitative Disclosures about Market  Risk                                                         |       | 27               |
| ITEM 8.       |       | Financial Statements and Supplementary Data                                                                         |       | 28               |
| ITEM 9.       |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                               |       | 28               |
| ITEM 9A.      |       | Controls and Procedures                                                                                             |       | 29               |
| ITEM  9B.     |       | Other  Information                                                                                                  |       | 29               |
| ** **    |       | **PART III**                                                                                                   |       |             |
| ITEM 10.      |       | Directors and Executive Officers of the Company                                                                     |       | 30               |
| ITEM 11.      |       | Executive Compensation                                                                                              |       | 30               |
| ITEM 12.      |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                     |       | 30               |
| ITEM 13.      |       | Certain Relationships and Related Transactions                                                                      |       | 30               |
| ITEM 14.      |       | Principal Accounting Fees and Services                                                                              |       | 30               |
| ** **    |       | **PART IV**                                                                                                    |       |             |
| ITEM 15.      |       | Exhibits and Financial Statement Schedules                                                                          |       | 30               |
| SIGNATURES    |       | 56                                                                                                                  |
| EXHIBIT INDEX |       | 57                                                                                                                  |

 

2

----

**CAUTIONARYSTATEMENT**

Some of the statementscontained in this report and in the documents incorporated by reference are “forward-looking”statements, as defined in the Private Securities Litigation Reform Act of 1955or by the Securities and Exchange Commission in its rules, regulations, andreleases, about, among other things, our business and prospects. Our futureresults may differ materially from our past results and from those projected inthe forward-looking statements due to various uncertainties and risks includingbut not limited to those set forth below under ITEM 1A. RISK FACTORS, one-timeevents and other important factors disclosed previously and from time to timein our other filings with the SEC. We disclaim any obligation to update anyforward-looking statements contained herein after the date of this AnnualReport.

**PART I**

**ITEM 1. BUSINESS**

American Science and Engineering, Inc., aMassachusetts corporation formed in 1958 (together with its subsidiary, the “Company”or “AS&E”), develops, manufactures, markets, and sells X-ray inspection andother inspection solutions and provides maintenance, warranty, research,engineering, and training services related to these solutions.

The Company’s sophisticated X-ray inspection productsare used for critical detection and security applications by seaport and borderauthorities, military, airport, federal facility and corporate securityproviders in the United States and around the globe. These securityapplications include X-ray inspection and screening systems for combatingterrorism, drug and weapon smuggling, trade fraud, and illegal immigration.

The Company’s objective is to distinguish itself fromits competitors through technical innovations and a superior approach todetection. The Company’s patented Z® BackscatterTM technology detects plasticexplosives, plastic weapons, illegal drugs, and other contraband, even whenconcealed by complex backgrounds. AS&E’s Shaped EnergyTM X-ray technologyprovides the penetration capability of high energy X-rays for dense cargos, withoutthe problems caused by excessive radiation. Radioactive Threat Detection (RTD)technology detects dirty bombs and nuclear devices simultaneous to theproduction of Z Backscatter and transmission images.

Historically, the Company has focused its productdevelopment and marketing efforts on two broad markets: (i) the protectionof high-risk government or military personnel and facilities; and (ii) theinspection and clearance of cargo, trucks and cars at seaports and borders.These markets are driven by domestic and global trends in terrorism, thecontinuing spread of drugs and people smuggling, and the ongoing increase inglobal trade which creates greater incentives for duty evasion and trade fraudutilizing false cargo shipping manifests.

Beginning with theterrorist attacks on September 11, 2001, and continuing with theproliferation of global terrorism, as well as the ongoing threat of terrorismposed by the war in Iraq, homeland security and force protection concerns areof paramount importance in the United States and around the world. The Companybelieves that homeland defense, force protection and military securityinitiatives will continue to provide new revenue opportunities, with additionalgrowth in the seaports and borders, federal and military facilities, andcorporate security markets.

**Technology**

The Company’s products utilize a variety oftechnologies including proprietary Z Backscatter technology, traditionaltransmission X-ray technology, Shaped Energy technology and Radioactive ThreatDetection (RTD).

3

----

***Z BackscatterTechnology***   Most of the Company’s X-raysystems utilize AS&E’s patented Z Backscatter technology.Backscattered X-rays refer to those X-rays that are directed toward an objectand are scattered, rather than absorbed by that object. Z Backscatter detectorscapture these scattered X-rays and use them to create highly readable,photo-like images. A key aspect of Z Backscatter is that objects organic incontent (low atomic number or “low Z”), such as drugs, explosives, plasticweapons, or people, scatter X-rays effectively. These organic items stand outas bright objects in the Z Backscatter images, making them easy to identify ineven the most complex X-ray backgrounds. As a result, the Z Backscatter imagesshow these potential threats clearly. When used in combination withtransmission X-ray technology, Z Backscatter adds significant interpretabilityto a transmission image enabling an inspector to perform a quicker and morethorough examination of the object in question.

***Transmission X-rayTechnology***   Transmission X-rays are used incombination with Z Backscatter in many of the Company’s products. A standardtransmission X-ray image results when X-rays are absorbed by or pass throughthe object under examination. When transmission X-rays pass through the parcel,container or vehicle being scanned, and are viewed on the transmission monitor,they create a “shadowgram” image, similar to the result of a medical X-rayexam. Shadowgram images are generally high resolution and result from the X-raybeam penetrating through objects of varying densities. With transmissiontechnology, the more objects or clutter in the path of the beam, the lessdifferentiation of those objects is achieved.

The combination of proprietary Z Backscatter X-rayimages and transmission X-ray images gives inspectors more information aboutthe contents of the parcel or container by differentiating dense objects, suchas metal, from low Z materials such as explosives.

***Shaped EnergyTechnology***   This patented high energytechnology is specifically designed for use in examining densely loaded cargocontainers at seaports, high threat facilities, and border crossings. ShapedEnergy’s technology “shapes” the X-ray beam by filtering unnecessary lower doseradiation—allowing for high penetration with safe radiation levels. The systemsthat utilize Shaped Energy (SE) technology combine the penetration capabilityof a high-energy X-ray source with the photo-like quality and materialdiscrimination features of the Company’s Z Backscatter imaging technology.

An important characteristic of Shaped Energytechnology is that it allows for optimal penetration while maintaining acompact footprint and radiation exclusion zone. Historically, high-energy X-raysystems were constrained by the necessity for large exclusion zones and heavyshielding in order to protect against the hazards of excessive radiation. TheSE linear accelerator incorporates an X-ray system design that reduces the needfor cumbersome shielding and large exclusion zones.

***Radioactive Threat Detection Technology***   AnAS&E cargo inspection system enhanced with Radioactive Threat Detection(RTD) can be used to find radioactive threats in vehicles and cargo containers.RTD is highly sensitive to both gamma rays and neutrons-typically associatedwith dirty bomb materials (such as Cesium 137) or fissile material, such asweapons grade plutonium. RTD is particularly important in light of thepotential terrorist threat of explosives packaged with radioactive materialthat scatters upon deployment, commonly referred to as “dirty bombs.” AS&E’sZ Backscatter Van (ZBV) and MobileSearch X-ray systems, when equipped with RTD,are unique in their ability to perform radioactive material detection whilesimultaneously producing Z Backscatter and/or transmission X-ray images therebymaintaining optimum throughput.

**Products andSystems**

The Company’s products and services can be groupedinto five different areas including CargoSearchTM Inspection Systems, ZBackscatter Systems, ParcelSearchTM Inspection Systems, Personnel Inspection,and Service and Support.

4

----

**CargoSearchTMInspection Systems**   The CargoSearch family ofsystems includes high-energy and medium-energy non-intrusive inspection andscreening devices. The systems are primarily used for the inspection of trucks,cars, cargo containers, pallets, and air cargo at locations including bordercrossings, seaports, military bases, railroad centers, airports, and cargo andtransportation hubs. The CargoSearch systems are designed to combat tradefraud, drug trafficking, weapons smuggling and terrorism. The CargoSearchfamily includes:

*OmniViewTMGantry System:*   a multi-view, relocatablehigh-energy cargo and vehicle inspection system. This system combines up to 6MeV high-energy transmission inspection plus three Z Backscatter X-ray viewsfor left, right and top-side imaging of cargo. OmniView Gantry provides highpenetration into inspected objects—up to 14 inches (350 mm) of steel—yet thesystem does not require an exterior building or heavy shielding. The OmniViewGantry System’s scanning platform operates by moving on rails past stationaryvehicles and cargo. The system is bi-directional allowing for a high throughputof approximately 35 trucks per hour. OmniView Gantry is ideal for ports,borders, and high-threat facilities.

*ShapedEnergy CargoSearchTM System:*   a fixed sitehigh-energy transmission X-ray inspection system with optional Z Backscatterimaging, ideal for ports, borders and high-threat facilities. The Shaped EnergyCargoSearch configuration provides the stability of a permanent inspectionlocation, within a very small footprint.

*MobileSearchTMSystem:*   a truck-mounted cargo and vehicleX-ray inspection system that adds flexibility, mobility and the ability toinspect cars (from one or both sides) to the basic CargoSearch concept.

*PalletSearchTMSystem:*   a conveyorized X-ray inspectionsystem designed to perform non-intrusive inspection of mixed cargo shipped onlarge pallets or in air cargo containers. The system is especially useful forinspecting large, irregularly shaped containers and cargo.

**ZBackscatter Systems**   Z Backscatter technology canbe used as a stand-alone technology, or in combination with other technologies,including transmission, Shaped Energy, and Radioactive Threat Detection. ZBackscatter-only scanning can be implemented without the use of boom-mounteddetectors, allowing for drive-by screening of containers and vehicles in avariety of applications without impeding the flow of commerce.

*Z**® Backscatter VanTM (ZBV):*   amobile X-ray screening system built into a commercially available delivery van.It utilizes 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. Withone-sided, backscatter-only imaging and the option for Radioactive ThreatDetection (RTD), security officials can use ZBV for screening vehicles, seacontainers, and other cargo for terrorist threats, trade fraud, and contraband,simply by driving past the subjects.

*Z**® PortalTM:*   a multi-view, drive-through inspection system capable ofscanning cars, vans, trucks, and their cargoes for threats and contraband. Therelocatable screening system can be configured with one, two or three ZBackscatter X-ray detectors, allowing for left, right and/or top-side imagingof the vehicle under examination.

*RuggedizedDetection Imaging Module (RDIM):**  *a relocatable Z Backscatter imaging system forscreening vehicles at a security checkpoint or border crossing. Securityofficials can screen vehicles and vehicle-borne cargo containers for terroristthreats and contraband simply by directing vehicles to drive past the system. RDIMemploys AS&E’s patented Z Backscatter technology, which produces photo-likeimages of the contents of a vehicle, providing manifest verificationinformation and highlighting organic materials, such as explosives or drugs.

5

----

**ParcelSearchTMInspection Systems**   ParcelSearch systems aredesigned for the non-intrusive X-ray scanning of parcels, baggage, and mail.They are primarily located in government facilities, airports, commercialoffice buildings, high-security federal facilities (research facilities andmilitary bases) and convention centers. The ParcelSearch family includes:

*Model66ZPlusTM:*   a compact system designed tohandle small packages, including briefcases, carry-on luggage and mail.

*Models101ZTM, 101ZZTM, 101GTTM and 101XLTM:**  *conveyor-based systems allowing rapid inspection ofhigh volumes of luggage and other packages.

*Model101VANTM:*   a self-contained conveyor-basedparcel inspection system housed in a standard van; designed and built to therigorous specifications of U.S. Customs and Border Protection.

**PersonnelInspection****  **Personnelinspection is a crucial part of any threat detection effort. Today, threats cantake the smallest of forms and are often easily hidden on a person. With theadvent of suicide bombings, personnel screening has taken on an even moreimportant role. Personnel screening is also important in the effort tointercept prohibited substances, such as drugs and alcohol.

*SmartCheckTM:*   apersonnel screening system for the effective screening for contraband andthreats hidden under a person’s clothing. SmartCheck simultaneously detectsboth metallic and non-metallic objects, such as guns and knives, plasticexplosives, composite weapons, drugs and other hidden threats and contraband. Itseasily interpreted Z Backscatter image gives the operator an easy-to-readdisplay of where the threat or contraband is hidden, thus eliminating the needfor intrusive and time-consuming pat-downs and strip searches. SmartCheckemploys advanced image processing algorithms to enhance privacy, whilemaintaining a high level of threat detection.

**Service and Support****  **AS&E’s highly skilledField Service Engineers (FSEs) provide support services and comprehensivetechnical training on all of AS&E’s X-ray inspection systems worldwide.FSEs are located at AS&E offices in Asia, Europe, the Middle East and NorthAmerica. In addition, Technical Support is provided at the Company’sheadquarters in Billerica, Massachusetts. AS&E provides comprehensive,cost-effective spare parts solutions customized for each system.

**IntellectualProperty**

The Company relies on a combination of patent,copyright, trademark, contract and trade secret laws to establish and protectits proprietary rights in its technology. The Company has patents either issuedand/or pending in the United States, Germany, Japan, the United Kingdom, China,Austria, France, Ireland, Italy, Switzerland, Australia, Canada, Hong Kong,India, Israel, The Republic of Korea, New Zealand, Mexico, Norway, The RussianFederation, Ukraine, United Arab Emirates, Malaysia, Thailand and Egypt andunder the Gulf Cooperation Council and the Patent Cooperation Treaty.

In general, the Company pursues a policy of obtainingpatent protection both in the United States and in selected foreign countriesfor subject matter we consider patentable and important to our businessstrategy. The Company has 51 unexpired patents issued by, and 48 patentapplications pending with, the U.S. Patent and Trademark Office, as well aswith the respective patent offices of the foreign countries noted above. Overhalf of our issued patents have been issued in the last five years.

Generally, patents issued in the United States areeffective for the longer of 17 years from the date of issue or 20 years fromthe earliest effective filing date of the corresponding patent application iffiled prior to June 8, 1995. The duration of foreign patents varies inaccordance with applicable local law. While the duration of our patents varies,we believe that the duration of our patents is adequate relative to theexpected lives of our products.

6

----

The Company believes thatits patents, proprietary technology, know-how, and trademarks providesubstantial protection for the Company’s competitive position and the Companyintends to aggressively protect its intellectual property assets, by litigationor other means, as appropriate. Nevertheless, there can be no assurances thatthe steps taken by the Company in this regard will be adequate to preventmisappropriation or infringement of its technology or that the Company’scompetitors will not independently develop technologies that are substantiallyequivalent or superior to the Company’s technology. Effective protection ofintellectual property rights may be limited or unavailable in certain foreigncountries. See Item 3: Legal Proceedings below.

**Sales and Marketing**

The Company’s X-ray products are marketed to privateand governmental organizations through a sales force that contacts potentialcustomers and responds to public tenders and other expressions of interest.This sales force includes Company personnel based in the United States andabroad, as well as independent representatives under contracts to sell inforeign countries.

Many of the Company’ssystems are built for existing customers and the Company maintains an inventoryof common parts and sub-assemblies for these systems in order to meet expectedcustomer delivery requirements and spare parts requirements.

**Customers**

The Company has a customer list consisting ofgovernment and commercial clients from both the United States and abroad.Domestically, the Company’s primary client base is comprised of agencies of theU.S. Government. Approximately 77%, 75%, and 77% of the Company’s sales infiscal 2006, 2005 and 2004, respectively, were derived from either (i) contractingdirectly with the U.S. Government, or (ii) contracting with contractorsworking directly with the U.S. Government. Certain of the Company’s contractswith the U.S. Government provide the U.S. Government with the standardunilateral right to terminate these contracts for convenience. To date, theCompany has not experienced any material losses as a result of this contractualprovision. The Company is heavily dependent upon sales to agencies of the U.S.Government and reductions or delays in procurement of the Company’s systems bythese agencies may have a material adverse effect on the Company.

International sales, primarily to foreign governments,accounted for approximately 14%, 15% and 12%, of the Company’s total sales infiscal 2006, 2005 and 2004, respectively, and continue to be a high priorityfor the Company as part of its long-term growth strategy. International salesentail longer sales cycles and project financing requirements; however theCompany continues to focus on these sales as a means of broadening its customerbase and reducing its dependency 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 Companyconsiders the need to engage in hedging contracts to control foreign exchangerisk. There were no hedging activities in fiscal 2006, 2005 or 2004.

In fiscal year 2006, theCompany had sales to two major customers, both agencies of the U.S. Government,which accounted for 30% and 26% of total sales. In fiscal year 2005, theCompany had sales to three major customers, two of which were agencies of theU.S. Government and the third a subcontractor to a U.S. Government agency,which accounted for 17%, 13%, and 13% of total sales. In fiscal year 2004, theCompany had sales to two major customers, both agencies of the U.S. Government,which accounted for 19% and 15% of total sales.

7

----

**Competition**

The Company has manycompetitors 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 security systemcustomers select such systems based largely on price. Other customers, notablythe U.S. Government and users in countries with high levels of concern oversecurity, tend to select systems based largely on performance and detectioncapability. The Company’s systems offer premium performance and havehistorically been priced higher than many competing systems. The Companybelieves that its patented and proprietary technology give 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 products with unique features, including Z Backscatterand Shaped Energy, and/or competitive pricing will give it a strong position toincrease its sales of X-ray systems. However, a number of companies havedeveloped products that compete with the Company’s X-ray inspection products.(See “Forward-Looking Information and Factors Affecting Future Performance”)

**ISO 9001Certification**

In August 2003, the Company announced that itsQuality Management System had been registered under the ISO 9001:2000 Standardof the International Organization for Standardization. The Company had beenregistered under the previous ISO standard since March 2001. ISO 9001 isan internationally recognized quality management and assurance standard.

In qualifying, the Company met or exceeded thestandards for establishing a quality management system for preventingnon-conformity at every level of the product life cycle, from customer order,through development and production, to installation and support.

The Company believes thatdemonstrating continuous quality improvement is vital for building customersatisfaction and making business processes more efficient in order to increaseits competitive edge.

**ComponentAvailability**

The Company has notexperienced during the last year, and does not currently anticipate, anyproduct delivery delays due to component shortages. The majority of procuredcomponents are from U.S. sources. However, the Company is dependent uponcertain overseas providers of important components. No rare or exotic materialsare utilized. Following the events of September 11, 2001, 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 component availability. In some cases, theCompany has chosen to stock certain inventory components to assure futureavailability. These efforts also included identifying and qualifyingsecond-source providers for a number of critical components of its productlines.

**RegulatoryCompliance**

The Company complies withapplicable Health and Human Services regulations outlined under the “Regulationsfor the Administration and Enforcement of the Radiation Control for Health andSafety Act of 1968” (21 CFR 1020.40), published by the U.S. Department ofHealth and Human Services. All X-ray products of the Company comply with allapplicable U.S. Government regulatory standards.

8

----

**Research andDevelopment**

The Company spent approximately $9,601,000 of its ownfunds for research and development during fiscal 2006, compared to $5,727,000and $5,535,000 in fiscal 2005 and 2004, respectively. The fiscal 2006 researchand development efforts were focused on design modifications and enhancementsto existing products, the development of new applications and the developmentof new products.

In addition, the Companyconducted government-sponsored research primarily focused on advances in X-raysystems, image analysis and integrated system development for niche securityinspection problems. The Company recognized revenues of $2,804,000, $2,534,000and $444,000, in fiscal 2006, 2005, and 2004, respectively for these efforts. Asignificant amount of the Company’s government sponsored research anddevelopment contracts provide for a fixed fee or a reimbursement of allowablecosts plus a fixed fee. The Company’s contracts in these areas are obtained bysubmitting research and development proposals to various organizations,sometimes in response to requests for such proposals.

**Personnel**

As of March 31, 2006the Company had 288 employees as compared to 286 employees at March 31,2005. 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’s firm (under signed contracts) salesbacklog was $68,840,000, $72,098,000 and $33,852,000, at March 31, 2006, March 31,2005 and March 31, 2004, respectively.

Certain of the Company’scontracts with the U.S. Government contain clauses permitting the government toterminate the contract for convenience upon certain terms and conditions,including partial payment to the Company for work performed. Total contractswith U.S Government agencies and subcontractors in the backlog were$30,058,000, $48,127,000, and $16,645,000, at March 31, 2006, 2005 and2004, respectively. It is estimated that approximately 72% of the 2006 backlogwill be filled within the fiscal year ending March 31, 2007.

**FinancialInformation about Foreign and Domestic Operations and Export Sales**

Most export sales aretransacted in U.S. dollars, and many are either secured by irrevocable lettersof credit or paid in advance. The following table shows the breakdown of netsales and contract revenues to international and domestic customers and themajor regions of international activity based upon customer’s country ofdomicile. All assets are maintained within the United States with the exceptionof small amounts of spares inventory and cash accounts maintained at foreignlocations (less than 1% of the Company’s assets).

9

----

***Net Sales andContract Revenues***

| ** **                                         | ** ** | **Fiscal Year**                 | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                         | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands)** | ** ** |
| Domestic                                           |       | $                                    | 141,491    |   | 86 | % | $ | 75,376 |   | 85 | % | $ | 66,848 |   | 88 | % |
| International                                      |       | 22,113                               |       | 14 | % | 12,938 |   | 15 | % | 9,494 |   | 12 | % |
| Net Sales and  Contract Revenues                   |       | $                                    | 163,604    |   | 100 | % | $ | 88,314 |   | 100 | % | $ | 76,342 |   | 100 | % |
| Percent of  International Revenue by Major Region: |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Middle East & Africa                      |       | 50.4                                 | %          |   |   | 15.9 | % |   |   | 34.2 | % |   |   |
| Pacific Rim                                        |       | 36.4                                 | %          |   |   | 62.6 | % |   |   | 34.4 | % |   |   |
| Europe                                             |       | 11.4                                 | %          |   |   | 21.5 | % |   |   | 29.1 | % |   |   |
| All Other                                          |       | 1.8                                  | %          |   |   | — | % |   |   | 2.3 | % |   |   |

 

**AvailableInformation**

The Company’s principalexecutive offices are located at 829 Middlesex Turnpike, Billerica, MA 01821;telephone number 978-262-8700; corporate website www.as-e.com. Wemake available, free of charge through our website, our annual Form 10-K,current reports on Form 10-Q and Form 8-K, and amendmentsto these reports filed or furnished pursuant to Section 13(a) of theSecurities Exchange Act of 1934 as soon as practicable. In addition, ourreports, proxy and information statements and other information filed with theSEC are available at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580,Washington, DC 20549 (1-800-SEC-0330), and are also availablefrom the SEC’s website at www.sec.gov.

**ITEM 1A.**        RISKFACTORS

***The Company’s reliance on a small number of customersfor a large portion of its revenues could harm its business and prospects.***

The Company’s business isheavily dependent on sales to a small number of customers, which includeagencies of the United States government. During fiscal 2006, two customersaccounted for 56% of the Company’s total revenues. During fiscal 2005, threecustomers accounted for 43% of the Company’s total revenues and during fiscal2004, two customers accounted for 34% of the Company’s total revenues. Certainof the Company’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 conducts its business worldwide, whichexposes it to a number of difficulties in coordinating its internationalactivities and dealing with multiple regulatory environments.***

The Company’srevenues to international customers, including foreign governments, accountedfor approximately 14%, 15% and 12% of its net revenues for the fiscal yearsended March 31, 2006, March 31, 2005 and March 31, 2004,respectively, and a significant number of domestic customer orders requireshipments to, and services provided in, overseas locations. In addition, theCompany transacts business internationally with a number of its key suppliers.As a result of the Company’s worldwide business operations, it is subject tovarious risks, including:

·       internationalregulatory requirements and policy changes;

·       lengthysales cycles;

10

----

·       longerpayment cycles by 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;

·       interruptionto transportation flow for delivery of parts to us and finished goods to ourcustomers;

·       currencyexchange rate fluctuations; and

·       tariffregulations.

Although the Company’sinternational sales have been denominated primarily in U.S. dollars, changes incurrency exchange rates that increase the relative value of the U.S. dollar maymake it more difficult for the Company to compete with foreign manufacturers onprice or otherwise have a material adverse effect on its sales and operatingresults.

***The Company’s lengthy sales cycle requires it to incursignificant expenses with no assurance that it will generate revenue or recoversuch expenses.***

A substantial portion ofthe Company’s sales depends upon the decision of governmental agencies toupgrade or expand security at border crossing inspection sites, existingairports, seaports and other facilities. Accordingly, a portion of the Company’sproduct sales is subject to delays associated with the lengthy approvalprocesses that often accompany such capital expenditures. During these approvalperiods, the Company expends significant financial and managerial resources inanticipation of future orders that may not occur. If the Company fails toreceive an order after expending these resources, it may be unable to generatesufficient revenue to recover the costs incurred and its business and prospectsmay be harmed.

***The Company’s business is dependent upon governmentalpolicies and appropriations.***

The Company’s largestcustomers are government agencies and demand for its products is dependent uponnational priorities and governmental initiatives. These priorities andinitiatives are subject to change from time to time in response to the economicand political environment. The Company is also exposed to the United Statesbudget approval and appropriation cycle, which may be subject to significantand unpredictable delays. If demand for the Company’s products is reducedbecause of a change in economic or political conditions, or if there are delaysin receiving governmental approvals and appropriations, sales of the Company’sproducts may be adversely affected, and its business and prospects may beharmed.

***Changes in governmental regulations may reduce demandfor the Company’s products or increase its expenses.***

The Company competes inmarkets in which the Company or its customers must comply with federal, state,local and foreign regulations, such as health and safety regulations. TheCompany develops, configures and markets its products to meet its customers’needs created by these regulations. Any significant change in these regulationscould reduce demand for the Company’s products or increase its costs to complywith new regulations, both of which may adversely affect its operating results.

11

----

***The Company’s reliance on only a limited number ofsuppliers for some key components for its products could harm its business andprospects.***

The Company relies on onlya limited number of suppliers for some key components for its products. TheCompany’s reliance on limited supply sources reduces its control over timelydelivery, price increases, reliability, and quality of critical components.Obtaining alternative sources of supply of these key components could involvesignificant delays and other costs, and may not be available to the Company onreasonable terms, if at all. If the Company changes any of its suppliers, thepotential new supplier would be required to go through a qualification process,creating potential delays or reductions in product shipments. The failure ofany supplier to provide quality and timely components at an acceptable price,or an interruption of supplies from such a supplier could result in lost ordeferred sales, which would harm the Company’s business and prospects.

***Fluctuations in the Company’s quarterly operating resultsmay cause its stock price to fluctuate.***

Given the nature ofthe markets in which the Company participates, it cannot reliably predictfuture revenue and profitability. A high proportion of the Company’s costs arefixed, due in part to its significant sales, research and development, andmanufacturing costs. As a result of its fixed costs, small declines in revenuecould disproportionately affect the Company’s operating results and stock pricein a quarter. Factors that may affect the Company’s quarterly operating resultsand 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;

·       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

·       changes in the volume ortiming of product orders.

***The Company could incur substantial costs as a resultof product liability claims and adverse publicity if its X-ray inspectionsystems fail to detect bombs, explosives, weapons, contraband or other threatsto personal safety.***

If the Company’s X-rayinspection systems fail to detect the presence of bombs, explosives, weapons,contraband or other threats to personal safety, the Company could be subject toproduct liability claims and negative publicity, which could result inincreased costs, reduced sales, and a decline in the market price of theCompany’s common stock. There are many factors beyond the Company’s controlthat could result in the failure of its products to detect the presence ofbombs, explosives, weapons, contraband or 

12

----

otherthreats to personal safety. Examples of these factors include operator error ormisuse of or malfunction of its equipment. The failure of the Company’s systemsto detect the presence of these dangerous materials may lead to personalinjury, loss of life, and extensive property damage and may result in potentialclaims against the Company.

***The Company’s insurance may be insufficient to protectit from product liability claims.***

The Company’s productliability and umbrella liability insurance may be insufficient to protect itfrom product liability claims. Moreover, there is a risk that product liabilityinsurance will not continue to be available to the Company at a reasonablecost, if at all. If liability claims exceed the Company’s current or availableinsurance coverage, its business and prospects may be harmed. Regardless of theadequacy of the Company’s product liability insurance protection, anysignificant claim may have an adverse affect on its industry and marketreputation, leading to a substantial decrease in demand for its products andreduced revenues.

***The Company may not be able to fund its research anddevelopment 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 2006 and 2005, the Company recorded $2,804,000and $2,534,000, respectively, for government-sponsored research anddevelopment. There is no guarantee that the Company will receive funds forgovernment-sponsored research in the future. If the Company is unable to fundits research and development activities through its operations or from outsidesources, the Company may be unable to continue to innovate or bring itsinnovations to market on a timely or cost effective basis, or its innovationsmay be surpassed by other competitors or new technologies.

***The Company’s success depends 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 successful developmentof its products and product enhancements is subject to numerous risks, bothknown and unknown, including:

·       unanticipateddelays;

·       accessto capital;

·       budgetoverruns;

·       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 the uncertaintiesinherent with product development and introduction of X-ray inspection systems,the Company cannot assure that its product development efforts will besuccessful on a timely basis or within budget, if at all. The Company’s failureto develop new products and product enhancements on a timely basis or withinbudget would harm its business and prospects.

13

----

***The Company’s success depends upon its ability toadapt to rapid changes in technology and customer requirements.***

The market for the Company’sproducts has been characterized by rapid technological changes, frequentproduct 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.

***The Company may not be able to compete successfully.***

A number of companies have developed products thatcompete with the Company’s X-ray inspection products. Many of the Company’scompetitors are larger and have greater financial resources than it does. Someof its competitors have more extensive research, marketing and manufacturingcapabilities and greater technical and personnel resources than the Companydoes, and may be better positioned to continue to improve their technology inorder to compete in an evolving industry. The Company’s failure to competesuccessfully could decrease demand for its products or make its productsobsolete.

In the inspectionsystems market, competition is based primarily on the following factors:

·        product performance,functionality and quality;

·       price;

·       the overall costs of the system;

·       prior customerrelationships;

·       technological capabilitiesof the product;

·       certification by governmentauthorities;

·       local market presence; and

·       breadth of the sales andservice organization.

To remain competitive, theCompany must develop new products and periodically enhance its existingproducts in a timely manner. The Company anticipates that it may have to adjustthe prices of some of its products to stay competitive. In addition, newcompetitors may emerge, and entire product lines may be threatened by newtechnologies or market trends that reduce the value of these product lines.

***The Company’s business could be harmed if it is unableto protect its intellectual property.***

The Company reliesprimarily 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 

14

----

intellectualproperty will be adequate to prevent misappropriation of its technology. TheCompany’s business could be harmed if it is unable to protect its intellectualproperty.

***The Company’s business may be materially and adverselyaffected by infringement claims initiated by the Company or its competitors.***

Initiating or defendingagainst the enforcement of the Company’s intellectual property rights mayresult in significant, protracted, and costly litigation. The Company haspreviously been involved in various litigations 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 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 success depends on its ability toattract and retain qualified management professionals.***

During the fiscal years2005 and 2004, the CEO and certain other members of our senior management teamleft the Company. The Company subsequently recruited what it believes to be ahighly 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 the Company’s common stock by existingstockholders could depress the market price of the Company’s common stock.***

Substantially all of theCompany’s outstanding shares of common stock are freely tradable withoutrestriction or further registration. Affiliates must sell all shares they ownin compliance with the volume and other requirements of Rule 144, exceptfor the holding period requirements. Nevertheless, sales of substantial amountsof common stock by the Company’s stockholders, or even the potential for suchsales, may cause the market price of the Company’s common stock to decline andcould impair the Company’s ability to raise capital through the sale of theCompany’s equity securities.

***Existing external financing may not be available inthe future.***

The Company may require additional capital to financecontinuing operations. The Company cannot assure that operations will continueto be profitable, that it will generate levels of revenues and cash flowssufficient to fund operations, or, if necessary, that the Company will be ableto obtain additional financing on satisfactory terms, if at all. Any existing financingarrangements may not be available or sufficient to meet the Company’s cashneeds or may not be available in the future, or, if available, at a cost thatthe Company believes is reasonable.

15

----

***The volatility of the Company’s stock price couldadversely affect an investment in the Company’s common stock.***

The market price ofthe Company’s common stock has been, and may continue to be, highly volatile.The Company believes that a variety of factors could cause the price of theCompany’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 recentyears the stock market in general and the markets for shares of smallcapitalization and “high-tech” companies in particular, have experienced extremeprice fluctuations which have often been unrelated to the operating performanceof affected companies. Any such fluctuations in the future could adverselyaffect the market price of the Company’s common stock.

***Provisions in the Company’s articles of organizationand the Company’s shareholder rights plan may have the effect of discouragingadvantageous offers for the Company’s business or common stock, and limit theprice that investors might be willing to pay in the future for shares of theCompany’s common stock.***

Provisions in the Company’sarticles of organization and the Company’s shareholder rights plan may have theeffect of discouraging or preventing a change in control. These provisionscould limit the price that certain investors might be willing to pay in thefuture for shares of the Company’s common stock. Specifically, the Company’sarticles of organization authorize its Board of Directors to issue up to100,000 shares of preferred stock in one or more series, to fix certain rights,preferences, privileges and restrictions granted to or imposed upon any whollyunissued shares of preferred stock, to fix the number of shares constitutingany such series, and to fix the designation of any such series, without furthervote or action by its shareholders. The terms of any series of preferred stock,which may include priority claims to assets and dividends and special votingrights, could adversely affect the rights of the holders of common stock andthereby reduce the value of the Company’s common stock. The Company has nopresent plans to issue shares of preferred stock. The Company has in place ashareholder rights plan, adopted in 1998, under which its stockholders areentitled to purchase shares of its preferred stock under certain circumstances.These circumstances include the purchase of 15% or more of the outstandingshares of common stock by a person or group, or the announcement of a tender orexchange offer to acquire 15% or more of the outstanding common stock. Theshareholder rights plan may have the effect of impeding or preventing certaintypes of transactions involving a change in control of the Company that couldbe beneficial to the stockholders.

***The Company does not plan to pay dividends on itscommon stock.***

The Company has notdeclared or paid a cash dividend on its common stock in recent years, and itdoes not expect to declare or pay any cash dividends in the foreseeable future.The Company intends to retain all earnings, if any, in order to expand itsoperations. Investors should not rely on dividends from the common stock as apossible source of income.

16

----

**ITEM 1B. UNRESOLVEDSTAFF COMMENTS**

There are no materialunresolved written comments that were received from the SEC staff 180 days ormore before the end of our fiscal year relating to our periodic or currentreports under the Securities Exchange Act of 1934.

**ITEM 2. PROPERTIES**

The Company’s executive offices, research,manufacturing and warehouse facilities are located in Billerica, Massachusetts.In December 2004, the Company renewed its lease for this facility andentered into an agreement with the landlord to add an additional 24,974 squarefeet to its leased space and to construct a 26,200 square foot high baymanufacturing space in the back of the premises. The lease provided for atenant allowance for this high bay space and for additional refurbishments inthe building. The balance of construction and renovation costs above thistenant allowance were the responsibility of the Company. The construction andrefurbishments were completed on March 1, 2006 at which time the leasecommenced for a period of 10 years. The Company now occupies 167,000 squarefeet of space in the 187,000 square foot facility owned by an unaffiliated realestate limited partnership. The remaining space is currently unoccupied and isavailable for lease from the building owner.

In October 1999, the Company leased 56,000 squarefeet of manufacturing and office space in an office park near the main officein Billerica Massachusetts. The original lease had a term of five years. TheCompany had extended this lease to February 28, 2006 at which time itconsolidated these operations into the Company’s renovated Billerica facility.

The Company’s former High Energy Systems division hadleased 24,733 square feet of manufacturing, research and development, andoffice space in Mountain View, California. The lease commenced on February 1,2004 and had an initial term of seven years with an option to extend for anadditional five-year period. In January 2005, as part of the asset saleagreement with Accuray, Incorporated, the Company assigned its rights andobligations under this lease to Accuray. The Company is secondarily liable forthe lease payments in the event of default by Accuray.

The Company believes thatits facilities, with its recently completed renovations, and expansion, areadequate and provide sufficient production capacity for its present intendedpurposes. The Company’s facilities are currently utilized primarily on aone-shift basis. The Company is able to add additional capacity by addingsecond and third shifts if necessary.

**ITEM 3. LEGALPROCEEDINGS**

In February 2004, L-3 Communications, Inc.(“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’s patents—UnitedStates Patent No. 6,292,533 and No. 5,903,623. The Company answered L-3’sunderlying complaint, vigorously opposing the plaintiff’s non-infringement andinvalidity claims, and subsequently engaged in substantial discovery. In November 2005,the Company filed a motion to dismiss the case. Pending the court’s ruling, theparties have suspended discovery as to the underlying claims.

The Company is alsosubject to various legal proceedings and claims that arise in the ordinarycourse of business. At the present time, it is not possible to predict theoutcome of these matters; however, the Company currently believes thatresolving these matters will not have a material adverse impact on itsfinancial condition, results of operations or cash flows.

17

----

**ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

No matter was submitted toa vote of the Company’s security holders during the fourth quarter of thefiscal year covered by this report.

**PART II**

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

Our commonstock is traded on the NASDAQ National Market under the symbol ASEI. Prior to October 6,2004, our common stock was traded on the American Stock Exchange. The marketprice range for the common stock for the last two fiscal years as reported onthe NASDAQ National Market or American Stock Exchange, as applicable, is asfollows:

| **Fiscal Year** | ** ** | **Quarter Ended** | ** ** | **High**                 | ** ** | **Low** | ** ** |
|----------------------|------------|------------------------|------------|--------------------------|------------|---------|------------|
|                 | 2006       |                   |       | March 31, 2006      |       | $       | 93.86      |   | $ | 59.83 |   |
|                 |       |                   |       | December 31,  2005  |       | 74.95   |       | 52.33 |   |
|                 |       |                   |       | September 30,  2005 |       | 73.05   |       | 36.50 |   |
|                 |       |                   |       | June 30,  2005      |       | 45.79   |       | 35.95 |   |
|                 | 2005       |                   |       | March 31, 2005      |       | $       | 49.50      |   | $ | 32.40 |   |
|                 |       |                   |       | December 31,  2004  |       | 44.50   |       | 27.60 |   |
|                 |       |                   |       | September 30,  2004 |       | 33.65   |       | 18.15 |   |
|                 |       |                   |       | June 30, 2004       |       | 22.50   |       | 13.05 |   |

 

As of May 30, 2006, there were approximately 828holders of record of the Company’s common stock.

No cash dividends havebeen declared in the two most recent fiscal years and the Company does notcontemplate paying any dividends in the immediate future. The Company’s creditfacility restricts the payment of dividends (except in shares of the Company’sstock) without the consent of the bank.

18

----

**Equity CompensationPlan Information**

Thefollowing table provides information about the Company’s stock option plans andthe common stock that may be issued upon the exercise of options and rightsunder all existing equity compensation plans as of March 31, 2006.

| ** **                                                       | ** ** | **Number of securities to be** | ** ** | ** **                      | ** ** | **Number of securities**                | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                       | ** ** | **issued upon exercise of**         | ** ** | **Weighted-average**            | ** ** | **remaining available for future** | ** ** |
| ** **                                                       | ** ** | **outstanding options**                       | ** ** | **exercise price of** | ** ** | **issuance under equity**               | ** ** |
| ** **                                                       | ** ** | **and rights as of**                | ** ** | **outstanding options**    | ** ** | **compensation plans as of**       | ** ** |
| ** **                                                       | ** ** | **March 31, 2006**                       | ** ** | **and rights**             | ** ** | **March 31, 2006 (excluding**      | ** ** |
| **Plan category**                                           | ** ** | ** **                                         | ** ** | **(a)**                         | ** ** | **(b)**                                           | ** ** | **securities reflected in column(a))** | ** ** |
| **Equity  compensation plans approved by security holders:**     | ** ** |                                               | ** ** | ** **                      |       |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |
| 1995 Combination  Plan                                           |       |                                               | 19,466     | ** **                      |       |                                              | $          | 14.36 | ** ** |   |   | — | ** ** |   |
| 1999 Combination  Plan                                           |       |                                               | 78,667     | ** **                      |       |                                              | $          | 17.95 | ** ** |   |   | — | ** ** |   |
| 2000 Combination  Plan                                           |       |                                               | 91,933     | ** **                      |       |                                              | $          | 30.30 | ** ** |   |   | — | ** ** |   |
| 2002 Combination  Plan                                           |       |                                               | 185,804    | ** **                      |       |                                              | $          | 26.83 | ** ** |   |   | 250 | ** ** |   |
| 2003 Stock Plan  for Non-Employee Directors                      |       |                                               | 118,485    | ** **                      |       |                                              | $          | 40.23 | ** ** |   |   | 2,515 | ** ** |   |
| 2005 Equity and  Incentive Plan                                  |       |                                               | 303,147    | ** **                      |       |                                              | $          | 54.69 | ** ** |   |   | 438,070 | ** ** |   |
| **Equity  compensation plans not approved by security holders:** | ** ** |                                               | ** ** | ** **                      |       |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |
| 1996 Plan for  Non-Employee Directors                            |       |                                               | 7,000      | ** **                      |       |                                              | $          | 13.06 | ** ** |   |   | — | ** ** |   |
| 1997  Non-Qualified Option Plan                                  |       |                                               | 44,811     | ** **                      |       |                                              | $          | 23.25 | ** ** |   |   | — | ** ** |   |
| 1998  Non-Qualified Option Plan                                  |       |                                               | 49,722     | ** **                      |       |                                              | $          | 29.72 | ** ** |   |   | — | ** ** |   |
| Total                                                            |       |                                               | 899,035    | ** **                      |       |                                              | $          | 37.17 | ** ** |   |   | 440,835 | ** ** |   |
|                                                                  |            |                                                    |            |                                 |            |                                                   |            |  |  |  |  |  |  |  |  |  |

 

The Company did notrepurchase any of its securities during fiscal 2006.

**ITEM 6. SELECTEDFINANCIAL 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**                  | ** ** | ** **                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                            | ** ** | **(Dollars in thousands, except per share amounts)** | ** ** |
| Net sales and  contract revenues      |       | $                                                                                  | 163,604    |     | $          | 88,314   |       | $        | 76,342     |     | $          | 61,958   |       | $ | 65,396 |   |
| Net income (loss)                     |       | 29,786                                                                             |       | 11,185   | (1)        | 1,911    |       | (7,951   | )          | (4,512   | )          |
| Income (loss) per  share—diluted |       | 3.27                                                                               |       | 1.31     |       | 0.26     |       | (1.20    | )          | (0.87    | )          |
| Total assets                          |       | 173,389                                                                            |       | 98,287   |       | 55,803   |       | 47,316   |       | 50,241   |       |
| Stockholders’ equity             |       | 130,198                                                                            |       | 61,570   |       | 38,433   |       | 32,358   |       | 23,129   |       |
|                                       |            |                                                                                    |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

----

(1)          Includesa gain of $5,442,000 on the sale of certain assets of the Company’s High EnergySystems division.

19

----

**ITEM7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

This Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with our consolidated financial statements and notesthereto which appear elsewhere in this Annual Report on Form 10-K.The following discussion contains forward-looking statements and should also beread in conjunction with the “Cautionary Statement” included at the beginningof this Annual Report on Form 10-K.

**2006 Compared to2005**

***Overview***   AmericanScience and Engineering, Inc. develops and manufactures state-of-the-artX-ray inspection systems for homeland security and other critical defenseapplications. The Company’s primary technologies are: 1) Z Backscattertechnology which is used to detect plastic explosives, illegal drugs, and othercontraband even when artfully concealed in complex backgrounds; and2) Shaped Energy X-ray inspection systems which combine the materialdiscrimination features of Z Backscatter with the penetration capability ofhigh-energy X-rays for dense cargos.

The Company in fiscal 2006 focused on its core mission—providinginnovative X-ray and other inspection solutions in targeted markets, whiledelivering superior growth in shareholder value over the long term. In itsfocus on innovation, the Company expended its research and developmentresources on the design of modifications to its existing products and thedevelopment of product alternatives to continue to bring leading edge productsto its customers. In focusing on shareholder value, the Company focused onimproving its sales and marketing infrastructure, controlling overhead costsand reducing production costs to improve margins.

Net sales and contract revenues for fiscal 2006increased by 85% to $163,604,000 compared to fiscal 2005 revenues of$88,314,000. The Company reported net income before taxes of $45,769,000 infiscal 2006 compared to a net income before taxes of $11,267,000 in theprevious fiscal year. Net income for fiscal 2006 was $29,786,000 ($3.27 pershare, on a diluted basis) as compared to a net income of $11,185,000 ($1.31per share, on a diluted basis) in fiscal 2005. Backlog at March 31, 2006was $68,840,000, a 5% decrease from the backlog of $72,098,000 reported at theprevious fiscal year end, due primarily to the fulfillment during fiscal 2006of certain orders received in fiscal 2005 and the Company’s enhanced ability tofulfill customer orders more efficiently in 2006.

***Results ofOperations***   Total net sales andcontract revenues of $163,604,000 in fiscal 2006 increased by $75,290,000 or85% from the previous year. Revenues related to product sales and contractsincreased by $59,164,000 or 86% due primarily to increased revenues of approximately$52,408,000 in sales of Z Backscatter Systems. These systems continued toexperience high order volume in fiscal 2006 from the federal governmentcustomer base and experienced increased international demand. Revenues on theCompany’s CargoSearch systems increased $8,401,000 from fiscal 2005 due primarilyto a large follow-on order from one customer. After-market parts revenuesincreased by $3,704,000 to $10,588,000 due primarily to orders received forspares to accompany new system installations. These product revenue increaseswere offset by a $906,000 decrease in ParcelSearch product revenuesattributable to lower unit sales and a decrease in revenues of $4,267,000related to the Company’s former High Energy Systems division which was sold inthe fourth quarter of fiscal 2005. Service revenues increased in fiscal 2006 by$16,124,000 or 83% to $35,528,000 due to increases in service contract revenuesrelated to the increased shipments of systems in 2005 and 2006.

In fiscal 2006, 86% of the Company’s revenues werefrom domestic customers as compared to 85% in fiscal 2005. In fiscal 2006, theCompany had sales to two customers which accounted for 56% of total sales. Infiscal year 2005, the Company had sales to three major customers whichaccounted for 43% of total sales.

20

----

Cost of sales and contracts of $85,406,000 in fiscal2006 increased by $27,580,000 or 48% from the previous year. Cost of productsales and contracts of $65,374,000 increased by $18,300,000 or 39% as comparedto the prior year. Cost of product sales and contracts totaled 51% of revenuesin fiscal 2006 as compared to 68% of revenues in fiscal 2005. This decrease isprimarily attributable to the Company’s efforts in reducing direct productcosts, to production efficiencies associated with higher volume manufacturingand to continued strong sales from the Company’s higher margin products. Thecost of service revenues increased $9,280,000 or 86% from the prior year. Costof service revenues totaled 56% of revenues in fiscal 2006 as compared to 55%of revenues in fiscal 2005.

Selling, general and administrative expenses in fiscal2006 increased by $5,355,000 to $19,642,000 compared to fiscal 2005 andrepresented 12% of revenues in fiscal 2006 as compared to 16% of revenues infiscal 2005. This increase in spending can be attributed to increases in incentivecompensation costs ($2,444,000) related to the bonuses and stock compensationearned during the period, increased salaries and payroll related costs($359,000) as the Company increased its sales and marketing capabilities,increased marketing costs ($722,000), increased insurance related costs ($451,000) attributable to theincreased revenues, increase travel and telephone expenditures ($410,000),increases in expenses related to the Company’s ongoing ERP systemimplementation project ($188,000), increased audit expenditures ($232,000)attributable to the change in auditors during the year and Sarbanes-Oxleycompliance costs, and increased legal expenditures ($625,000) related toongoing litigation expenses and other corporate initiatives. Offsetting theseincreases was a decrease in general and administrative costs of $638,000associated with the Company’s High Energy Systems division which was sold inthe fourth quarter of fiscal 2005.

Company funded research and development spendingincreased by $3,874,000 to $9,601,000 in fiscal 2006, a 68% increase comparedto the $5,727,000 spent in fiscal 2005. Research and development spendingremained constant at 6% of revenues in both fiscal 2006 and fiscal 2005. Infiscal 2006, the Company continued to focus on design modifications to itsexisting products and the development of product alternatives to continue tobring innovative products to its customers.

In January 2005, the Company completed anagreement to sell certain assets, comprised of inventory, fixed assets,intellectual property and certain revenue producing contracts of its HighEnergy Systems Division to Accuray, Incorporated (“Accuray”). The Companyrecognized a gain, net of related expenses, on the sale of these assets of$5,442,000 which was included in income from operations in the year ended March 31,2005. In fiscal 2006 an additional $336,000 in gain was recognized related tothis sale as the Company adjusted certain reserves for warranty exposureestablished at the time of sale due to favorable warranty experience in thecurrent year.

Other income (expense) was $3,522,000 in expense infiscal 2006 as compared to $4,649,000 in expense in fiscal 2005. Interestincome increased by $1,938,000 due to increased funds available for investmentin higher return investment vehicles. This increase in other income was offsetby $6,094,000 related to the fair value mark to market charge associated withoutstanding warrants issued as part of a private placement of common stock in May of2002. During fiscal 2005, this mark to market adjustment resulted in $5,101,000in expense.

The Company reported pre-tax income of $45,769,000 infiscal 2006 as compared to a pre-tax income of $11,267,000 in the previousfiscal year primarily due to the increased revenues and expense reductionsnoted above. The Company recorded income tax expense of $15,983,000 in fiscal2006 as compared to $82,000 in the prior fiscal year. In prior years, theCompany was able to reduce its income tax expense primarily through the releaseof valuation allowance reserves established on tax net operating losscarryforward assets and other tax credits. During fiscal 2006, all remainingreserves were released and all tax net operating loss carryforwards were fullyutilized.

21

----

The Company reported netincome of $29,786,000 in fiscal 2006 as compared to net income of $11,185,000in fiscal 2005.

**2005 Compared to2004**

***Results ofOperations***   Total net sales andcontract revenues increased by $11,972,000 or 16% in fiscal 2005 compared tofiscal 2004. Revenues related to product sales and contracts increased by$6,462,000 or 10% due primarily to increased revenues of approximately$31,630,000 in sales of Z Backscatter Systems. These systems were introduced asa new product with four units delivered in fiscal 2004 and forty-seven unitsdelivered primarily to governmental clients in fiscal 2005. After-market partsrevenues increased by $4,729,000 to $6,883,000 due primarily to a$4.4 million order in fiscal 2005 from one customer. The Company alsoexperienced increased revenues in the contract research and development areawhich earned revenues of $2,534,000 in fiscal 2005 as compared to $444,000 infiscal 2004 due in part to additional funding being received on contractsinitiated in fiscal 2004. These product revenue increases were offset by a$25,539,000 decrease in CargoSearch system sales as the Company had noshipments of MobileSearch systems in fiscal 2005 as compared to $21,525,000 inrevenue in fiscal 2004. This decrease in demand was attributable to a shift infocus to the Company’s Z Backscatter System to address the customer’s currentmobile security requirements. In addition, the Company’s CargoSearch productsexperienced a $4,014,000 decrease in revenues related to the completion of amajor program in fiscal 2005 which contributed significantly to 2004 revenues.The Company’s ParcelSearch products experienced a $3,633,000 decrease in revenueto $12,848,000 in fiscal 2005 as the Company continued to see this sector ofthe business have decreasing demand. Revenues from the Company’s High EnergySystems division decreased by $2,814,000 from 2004 due in part to the sale ofcertain major contracts of this division in the fourth quarter of fiscal 2005.Service revenues increased in fiscal 2005 by $5,510,000 or 40% to $19,404,000due to increases in service contract revenues related to the increasedshipments of systems in 2004 and 2005.

In fiscal 2005, 85% of the Company’s revenues werefrom domestic customers as opposed to 88% in fiscal 2004. In fiscal 2005, theCompany had sales to three major customers which accounted for 43% of totalsales. In fiscal year 2004, the Company had sales to two major customers whichaccounted for 34% of total sales.

Cost of sales and contracts of $57,826,000 in fiscal2005 increased by $1,418,000 or 3% from the previous year. Cost of productsales and contracts decreased by $602,000 or 1% as compared to the prior year.Cost of product sales and contracts totaled 68% of revenues in fiscal 2005 ascompared to 76% of revenues in fiscal 2004. This decrease was primarilyattributable to the Company’s efforts in reducing direct product costs and to ashift in mix from lower margin products to those with higher gross margins. Inaddition, in fiscal 2004, a $1,979,000 loss was recognized on a contractrecognized on a percentage of completion basis which did not incur the samelosses in fiscal 2005. The cost of service revenues increased by $2,020,000 or23% in fiscal 2005 as compared to fiscal 2004. Cost of service revenues totaled55% of revenues in fiscal 2005 as compared to 63% of revenues in fiscal 2004.Service margins improved as the Company entered into several large servicecontracts in fiscal 2005 replacing certain unprofitable service contracts andtime and material service arrangements.

Selling, general and administrative expenses increasedby $2,639,000 to $14,287,000 compared to fiscal 2004 and represented 16% ofrevenues in fiscal 2005 as compared to 15% of revenues in fiscal 2004. Thisincrease can be attributed to increases in incentive compensation costs($953,000) related to the achievement of Company objectives, increased salariesand payroll related costs ($990,000) as the Company increased its sales andmarketing capabilities, increased marketing costs ($121,000) and increasedinsurance related costs ($114,000).

22

----

Company funded research and development spendingincreased $192,000 to $5,727,000 in fiscal 2005, a 3% increase compared to the$5,535,000 spent in fiscal 2004. Research and development spending was 6% ofrevenues in fiscal 2005 as compared to 7% of revenues in fiscal 2004. In fiscal2005, the Company continued to focus on design modifications to its existingproducts and the development of product alternatives to continue to bringinnovative products to its customers.

In January 2005, the Company completed anagreement to sell certain assets, comprised of inventory, fixed assets,intellectual property and certain revenue producing contracts of its HighEnergy Systems Division to Accuray, Incorporated (“Accuray”). The sales pricefor the assets totaled $8,300,000 of which $5,500,000 was received in cash and$2,800,000 in the form of a promissory note, $2,000,000 of which was secured bya letter of credit. The note receivable bore an interest rate of 7% and maturedin January of 2006. The Company recognized a gain, net of relatedexpenses, on the sale of these assets of $5,442,000 which was included inincome from operations in the year ended March 31, 2005.

Other income (expense) was $4,649,000 in expense infiscal 2005 as compared to $931,000 in expense in fiscal 2004. Interest incomeincreased by $468,000 due to increased cash available for investment in higherreturn investment vehicles. This increase in other income was offset by acharge of $5,101,000 related to the fair value mark to market charge associatedwith outstanding warrants issued as part of a private placement of common stockin May of 2002. During fiscal 2004, this mark to market adjustmentresulted in $1,273,000 in expense.

The Company reported pre-tax income of $11,267,000 infiscal 2005 as compared to a pre-tax income of $1,820,000 in the fiscal 2004primarily due to the increased revenues and expense reductions noted above. TheCompany utilized certain net operating loss carryforwards and tax credits fullyreserved for in prior periods to reduce its fiscal 2005 effective tax rate. Theprovision for income taxes recorded for fiscal year 2005 representedliabilities for alternative minimum taxes and foreign taxes. At March 31,2005, the Company had deferred tax assets of $9,740,000. The Company hadapplied over the last two years a full valuation allowance against its deferredtax assets. The Company evaluated its required valuation allowance at March 31,2005 based upon its three year cumulative income and its projections of futureincome and determined that it was more likely than not that its deferred taxasset would not be realized. As such, it maintained a full valuation allowanceon its deferred tax asset at March 31, 2005.

The Company reported netincome of $11,185,000 in fiscal 2005 as compared to net income of $1,911,000 infiscal 2004.

**Liquidity andCapital Resources**

Cash and cashequivalents at year-end increased by $35,237,000 to $50,655,000 at March 31,2006 as compared to $15,418,000 at March 31, 2005. Cash flow provided byoperations of $50,662,000 resulted from the following:

·       Reportednet income of $29,786,000 adjusted for non-cash items of depreciation andamortization of $989,000, provisions for inventory, accounts receivable andunbilled reserves of $2,673,000, gain on sale of assets of $336,000 and achange in the value of warrants issued of $6,094,000.

·       Thereduction of income taxes payable of $10,515,000 due to tax benefits receivedfrom employee stock option exercises.

·       Thedeferral of $5,627,000 in deferred income taxes. Offsetting this was a$2,715,000 reversal of certain deferred tax asset valuation allowances relatedto net operating losses from prior years.

·       Adecrease in inventories of $5,248,000 as inventory acquired for backloggedorders at March 31, 2005 was delivered in fiscal 2006.

23

----

·       Adecrease in accounts receivable of $2,408,000 from the prior year due primarilyto the collection in fiscal 2006 of a number of large past due receivablesoutstanding at March 31, 2005.

·       Anincrease in accrued expenses and other current liabilities of $4,358,000 dueprimarily to incentive compensation accruals.

·       Anincrease in prepaid expenses and other assets of $5,566,000 due primarily tothe prepayment of estimated taxes during the year.

·       Thedecrease in customer deposits of $5,029,000 as milestones received on one largepercentage of completion contract in fiscal 2005 were earned during the currentfiscal year.

·       Theincrease in unbilled costs and fees of $3,338,000 due to the timing ofmilestone payments on certain contracts accounted for on a percentage ofcompletion basis.

Net cash of $30,612,000 was used for investingactivities in fiscal 2006. Fiscal 2006 capital expenditures totaled $11,224,000versus $2,691,000 for fiscal 2005. Investments in fixed assets were comprised primarilyof information technology, leasehold improvements related to the Company’s 2006facilities expansion, and furniture and fixtures. The Company invested$61,334,000 in short-term investments during the year, and had maturities of$39,146,000 on short-term investments. In addition, the Company received$2,800,000 in cash proceeds upon repayment of a note receivable related to thesale of certain assets of the Company’s High Energy Systems division.

Net cash provided by financing activities was $15,190,000in fiscal 2006. Cash was provided primarily by proceeds of $11,972,000 receivedfrom the exercise of employee stock options and the exercise of warrants heldby outside investors.  In addition, theCompany received $3,339,000 in financing from its landlord for leaseholdimprovements related to its corporate facilities expansion. Restricted cashdecreased by $257,000 from the prior year as certain stand-by letters of creditcollateralized by cash expired during the year.

On November 30, 2004, the Company modified itstwo credit agreements with Silicon Valley Bank East. The modifications extendedthe credit facilities which expired on November 30, 2004 through November 29,2006 and reduced the export loan and security facility, guaranteed by theExport-Import Bank of the United States, from $20.0 million to $10.0 million.The domestic facility is a $5.0 million domestic loan and security agreement tosupport the Company’s routine working capital needs. Maximum borrowings forthis facility are set at the lower of (a) the sum of 80% of eligibledomestic accounts receivable plus 10% of finished goods inventory up to$750,000, or; (b) $5 million.

The credit facilities bear an interest rate of thegreater of 4.0% or the Silicon Valley Bank prime rate (7.75% at March 31,2006). The credit agreements are collateralized by certain assets of theCompany and contain certain restrictions, including limitations ondistributions in excess of $100,000 that can be made to stockholders, and thedisposition or encumbrances of assets, and require the maintenance of certainfinancial covenants. As of March 31, 2006, the Company was in compliancewith these covenants.

At March 31, 2006, there were no borrowingsoutstanding against these credit facilities. The Company had outstanding$813,000 in stand-by letters of credit against the domestic facility and$454,000 in stand-by letters of credit against the export facility. Of theoutstanding letters of credit, $300,000 relates to the Company’s building leaseand the remainder is guaranteeing performance on certain international projects. No amounts have been drawn against theseletters of credit. In addition at March 31, 2006, the Company has arestricted cash balance of $98,000 related to certain bank required depositsfor outstanding letters of credits, bid bonds, and other bank-related fees.

In recent years, the Company has funded its operationsand capital expenditures with cash generated by operations, including depositsfrom customers on long-term projects, from proceeds received from stockissuances and option exercises, and from lines of credit available to theCompany. The Company currently 

24

----

has no debt outstandingand believes that its cash flows from operations, cash and investments on handand available lines of credit are sufficient to meet the current andforeseeable operating requirements of the Company’s business.

***Contractual Obligations***   TheCompany leases various office equipment and facilities under non-cancelableleases. In addition, in the normal course of business, the Company enters intopurchase orders with its vendors for the purchase of materials or services tomeet its production needs. The following table summarizes the Company’scontractual obligations as of March 31, 2006.

| ** **                               | ** ** | **Total**  | ** ** | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **After 5 years** | ** ** |
|------------------------------------------|------------|------------|------------|-------------------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------|------------|
| **Recorded Contractual  Obligations:**   | ** ** | ** ** | ** ** |                                | ** ** | ** **         |       |               | ** ** | ** **                  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Lease financing  liability               |       | $          | 10,417     |                                |       | $                  | 787        | ** **         |       |                        | $          | 1,655 | ** ** |   |   | $ | 1,922 | ** ** |   |   | $ | 6,053 | ** ** |   |
| Other long-term  obligations             |       | 69         |       |                                | 17         | ** **         |       |               | 35         | ** **                  |       |   | 17 | ** ** |   |   | — | ** ** |   |
| **Unrecorded  Contractual Obligations:** | ** ** | ** ** | ** ** |                                | ** ** | ** **         |       |               | ** ** | ** **                  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Operating Leases                         |       | 1,437      |       |                                | 153        | ** **         |       |               | 288        | ** **                  |       |   | 288 | ** ** |   |   | 708 | ** ** |   |
| Purchase  Commitments                    |       | 4,498      |       |                                | 4,395      | ** **         |       |               | 100        | ** **                  |       |   | 3 | ** ** |   |   | — | ** ** |   |
| Total                                    |       | $          | 16,421     |                                |       | $                  | 5,352      | ** **         |       |                        | $          | 2,078 | ** ** |   |   | $ | 2,230 | ** ** |   |   | $ | 6,761 | ** ** |   |

*** ***

***Inflation***   TheCompany does not believe that inflation has had a material effect on itsresults of operations. There can be no assurance, however, that the Company’sbusiness will not be affected by inflation in the future.

**Critical AccountingPolicies**

The Company considers certain accounting policiesrelated to revenue recognition, inventories, allowances for obsolete and excessinventory, warrant liability, and income taxes to be critical policies due tothe estimation processes involved in each.

***Revenue Recognition***   TheCompany derives a portion of its revenue from fixed-price contracts, whichrequire the accurate estimation of the cost and scope of each contract. TheCompany’s fixed-site CargoSearch systems are sold under fixed-pricearrangements. Revenue is recognized using percentage of completion accounting,generally using the Company’s best estimate of total costs to measure thepercent complete with revisions to estimates reflected in the periodidentified.

The Company recognizes certain other CargoSearch systemsales and other product revenue in accordance with SEC Staff AccountingBulletin No. 101, Revenue Recognition in Financial Statements (“SAB 101”),modified by Emerging Issues Task Force No. 00-21, Revenue Arrangementswith Multiple Deliverables, and Staff Accounting Bulletin No. 104, RevenueRecognition (“SAB 104”) which requires that four basic criteria must be metbefore revenue can be recognized: (1) persuasive evidence of anarrangement exists; (2) delivery has occurred or services rendered; (3) thefee is fixed and determinable; and (4) collectibility is reasonablyassured. Determination of criteria (3) and (4) are based onmanagement’s judgments regarding the fixed nature of the fee charged forservices rendered and products delivered, and the collectibility of those fees.Should changes in conditions cause management to determine these criteria arenot met for certain future transactions, revenue recognized for any reportingperiod could be adversely affected. In those instances where the Company entersinto agreements involving multiple revenue elements, the agreement is dividedinto separate elements of accounting, the arrangement consideration isallocated to these elements based on fair value, and revenue recognition isconsidered separately for each individual element. The Company recognizes fieldservice revenues as services are performed and generally recognizes revenuesunder maintenance contracts on a straight-line basis over the contract periodwhich reasonably approximates the period under which the services are 

25

----

rendered. Revenuesreceived in advance of services being rendered are deferred until such serviceshave been provided.

Certain of the Company’s products are covered by awarranty for a one-year period. The Company accrues a warranty reserve forestimated costs to provide warranty services. The Company’s estimate of coststo service its warranty obligations is based on historical experience andmanagement’s expectations of future conditions. To the extent the Companyexperiences increased warranty claim activity or increased costs associatedwith servicing those claims, its warranty accrual will increase resulting indecreased gross profit.

***Inventories andRelated Allowance for Obsolete and Excess Inventory***   Inventoriesconsist of material, labor and manufacturing overhead and are recorded at thelower of cost or net realizable value. Excessive manufacturing overhead costssuch as idle facility expense, freight, handling costs and wasted material(spoilage) attributable to abnormally low volumes (levels that materiallydiffer from budgeted production plans due primarily to changes in customerdemand) are excluded from inventory and recorded as an expense in the periodincurred. The Company regularly reviews inventory quantities on hand andrecords a provision for excess and obsolete inventory based primarily on theestimated forecast of product demand over the next twelve to eighteen months.Demand for products can fluctuate significantly. A significant increase in thedemand for the Company’s products could result in a short-term increase ininventory balances, while a significant decrease in demand could result in anincrease in the amount of excess inventory quantities on hand. Additionally,inventory reserves require estimates of future product demand, which maymaterially impact the provision required for excess and obsolete inventory. Inthe future, if inventory were determined to be overvalued, the Company would berequired to recognize 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***   Infiscal 2003, the Company issued 295,475 warrants in connection with a privateplacement offering of common stock. As of March 31, 2006, 57,075 of thesewarrants remain outstanding. These warrants can be exchanged for cash undercertain circumstances including a merger, sale or tender offer of the Companyand as such the Company recorded the fair value of these warrants as along-term liability on the balance sheet. The fair value of these warrants isadjusted each period with the resulting gain or loss recorded as other income(expense) in the statement of operations. The Black-Scholes method is used tovalue the warrants and the calculation requires the use of estimates for stockprice volatility and interest rates. The Black-Scholes value of these warrantscan fluctuate significantly based on the current fair market value of theCompany’s common stock, changes in interest rates or changes in the volatilityof the Company’s stock price.

***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 Companyevaluates the need for a valuation allowance against its net deferred taxassets at year end based upon its three year cumulative income and itsprojections of future income, and records a valuation allowance against any netdeferred tax assets if it is more likely than not that they will not berealized.

26

----

**New AccountingPronouncements**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 123(R), “Share-Based Payment” which establishes accounting standardsfor all transactions in which an entity exchanges its equity instruments forgoods and services. SFAS 123(R) revises SFAS No. 123, “Accountingfor Stock-Based Compensation”, supercedes Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” and amends Financial AccountingStandard No. 95, “Statement of Cash Flows”. SFAS No. 123(R) generallyrequires the Company to measure the cost of employee services received inexchange for an award of equity instruments based on the fair value of theaward on the date of the grant. The standard requires the fair value on thegrant date to be estimated using either an option-pricing model which isconsistent with the terms of the award or a market observed price, if such aprice exists. The resulting cost must be recognized over the period duringwhich an employee is required to provide service in exchange for the award,which is usually the vesting period. In April 2005, the SEC deferred theeffective date for SFAS 123(R) to the beginning of the first fiscal yearthat begins after June 15, 2005. The Company expects to adoptSFAS 123(R) on the effective date on a modified prospective basiswithout restatement of prior period. As a result of SFAS 123(R), the Companycurrently expects that income from continuing operations will decrease byapproximately $5,862,000 in 2007. This amount represents the net of tax expensefor existing stock option awards that will vest during 2007 and does notreflect any new awards or modifications to existing awards that could occur inthe future. Future stock based compensation will be impacted by additionalgrants, forfeiture rates and stock price volatility, among other factors.

In December 2004, the FASB issued SFAS No.151, “InventoryCosts*,*” which amends part ofAccounting Research Bulletin (“ARB”) No. 43, “Inventory Pricing,”concerning the treatment of certain types of inventory costs. The provisions ofARB No. 43 provided that certain inventory-related costs, such as doublefreight and re-handling, might be “so abnormal” that they should be chargedagainst current earnings rather than be included in the cost of inventory. Asamended by SFAS No. 151, the “so-abnormal” criterion has been eliminated.Thus, all such abnormal costs are required to be treated as current periodcharges under all circumstances. In addition, fixed production overhead shouldbe allocated based on the normal capacity of the production facilities, withunallocated overhead charged to expense when incurred. SFAS 151 is required tobe adopted for fiscal years beginning after June 15, 2005. The Companydoes not believe its adoption will have a material impact on its results ofoperations, financial position and cash flows.

In December 2004, theFASB issued a FASB Staff Position (“FSP”) 109-1 “Application of FASB Statement No. 109‘Accounting for Income Taxes’ to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004”. The new actprovides for a special tax deduction on qualified production activities incomethat effectively reduces the Company’s tax rate. The FASB has decided thatthese amounts should be recorded as a special deduction, and recorded in theyear earned. The Company does not believe that the adoption of this FSPstatement will have a material impact on the Company’s consolidated financialstatements.

**ITEM 7A. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The Company is subject to interest rate risk on itscredit facilities which have variable interest rates tied to the Prime Rate. Asof March 31, 2006, the Company had no variable interest rate debtoutstanding. See Note 3 of Notes to Consolidated Financial Statements for adiscussion of our long-term indebtedness.

The cash accounts for the Company’s operations in HongKong, England, and Abu Dhabi are maintained in Hong Kong dollars, poundssterling and dirhams, respectively. Foreign currency accounts are marked tomarket at current rates that resulted in immaterial translation adjustments tostockholders’ equity. The gains and losses from foreign currency transactionsare included in the statement of operations 

27

----

for the period and werealso immaterial. A hypothetical 10% change in foreign currency rates would nothave a material impact on the Company’s results of operations or financialposition.

As of March 31, 2006, the Company holdsshort-term investments consisting of money market funds and U.S. government andgovernment agency bonds. The Company’s primary objective with its investmentportfolio is to invest available cash while preserving principal and meetingliquidity needs. These investments have an average interest rate ofapproximately 4.6% and are subject to interest rate risk. As a result of theaverage maturity and conservative nature of the investment portfolio, a suddenchange in interest rates would not have a material adverse effect on the valueof these investments.

In fiscal 2003, theCompany issued 295,475 warrants in connection with a private placement offeringof common stock. As of March 31, 2006, 57,075 of these warrants remainoutstanding. These warrants can be exchanged for cash under certaincircumstances including a merger, sale or tender offer of the Company and assuch a liability equal to Black-Scholes value of the warrants is recorded onthe balance sheet. Changes in the fair value of the warrants are recorded asother income (expense). The Black-Scholes value of these warrants can fluctuatesignificantly based on the current fair market value of the Company’s commonstock. A 10% change in the fair market value of the Company’s common stock,holding other assumptions constant, would have approximately a $532,000positive or negative impact on earnings.

**ITEM 8. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

The financial statementsand supplementary financial information listed in the Index to ConsolidatedFinancial Statements on page 31 are filed as part of this Annual Report onForm 10-K and are incorporated into this Item by reference.

**ITEM 9. CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

On November 3, 2005, PricewaterhouseCoopers LLP (“PwC”)resigned as the Company’s independent registered public accounting firm uponcompletion of its procedures on the Company’s unaudited interim financialstatements as of and for the three and six-month periods ended September 30,2005 and the Form 10-Q in which such unaudited interim financialstatements would be included. The reports of PwC on the financial statementsfor the years ended March 31, 2005 and 2004 contained no adverse ordisclaimer of opinion and were not qualified or modified as to uncertainty,audit scope or accounting principle. Except for the material weakness ininternal control over financial reporting described in this paragraph, duringthe years ended March 31, 2005 and 2004, and through November 3,2005, the Company did not have any reportable events within the meaning ofItem 304(a)(1)(v) of Regulation S-K. The Company and PwCreported a material weakness in the Company’s internal control over financialreporting in the Company’s Annual Report on Form 10-K for the year ended March 31,2005. That Annual Report stated the Company did not maintain effective controlsover the review and monitoring of the accounting presentation on the sale oflong-lived assets, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission.

During the years ended March 31, 2005 and 2004and through November 3, 2005, there were no disagreements with PwC on anymatter of accounting principles or practices, financial statement disclosure,or auditing scope or procedure, which disagreements if not resolved to thesatisfaction of PwC would have caused PwC to make reference thereto in itsreports on the financial statements of the Company for such years.

On December 13, 2005,the Audit Committee of the Board of Directors of American Science andEngineering, Inc. (the “Company”) engaged Vitale, Caturano &Company, Ltd. (“Vitale”) as its independent registered public accounting firmto audit the Company’s consolidated financial statements 

28

----

andinternal control over financial reporting as of and for the year ending March 31,2006. The Company did not consult with Vitale during the two most recent fiscalyears and through December 13, 2005 regarding either the application ofaccounting principles to a specific transaction, either completed or proposed,or the type of audit opinion that might be rendered on the consolidatedfinancial statements of the Company as well as any matters or reportable eventsdescribed in Items 304(a)(2)(i) or (ii) of Regulation S-K.

**ITEM 9A. CONTROLSAND PROCEDURES**

*Evaluation of Disclosure Controlsand Procedures*

As of the end of theperiod covered by this report, under the supervision and with the participationof our management, including our Chief Executive Officer and Chief FinancialOfficer, the Company reviewed and evaluated the effectiveness of the Company’sdisclosure controls and procedures pursuant to Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”). Based upon their evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of March 31, 2006 to ensure that information required to bedisclosed by the Company in the reports filed and submitted by it under theExchange Act is recorded, processed, summarized and reported within the timeperiod specified in the Securities and Exchange Commission’s rules andforms, and to provide reasonable assurance that information required to bedisclosed by the Company in such reports is accumulated and communicated to theCompany’s management, including its Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

*Management’s Report on InternalControl over Financial Reporting*

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Rules 13a-15(f) and15d-15(f) of the Exchange Act. Our management conducted an evaluation ofthe effectiveness of our internal control over financial reporting using theframework in “Internal Control-Integrated Framework” issued by the Committee ofSponsoring Organizations of the Treadway Commission. Based on this evaluationunder the criteria established in “Internal Control—Integrated Framework”, ourmanagement concluded that the Company’s internal control over financialreporting was effective as of March 31, 2006. Vitale, Caturano &Company, Ltd., our independent registered public accounting firm, has auditedmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and the effectiveness of our internal control over financialreporting as of March 31, 2006, and has issued their report which isincluded herein.

*Changes in Internal Controls overFinancial Reporting*

There have been no changesin our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and15d-15(f) of the Securities Exchange Act of 1934, during the quarter endedMarch 31, 2006 that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

**ITEM 9B. OTHER INFORMATION**

None.

29

----

**PART III**

**ITEM 10. DIRECTORSAND EXECUTIVE OFFICERS OF THE COMPANY**

**Code of Conduct**

The Company has adopted a Code of Conduct that appliesto our Board of Directors, Chief Executive Officer, Chief Financial Officer,and all employees of the Company. The Company’s Code of Conduct is posted onour website at www.as-e.com and may be accessed in the Corporate Governancesection of the Investor Information page. The Company intends to satisfy thedisclosure requirement under Item 10 of Form 8-K, regarding an amendmentto, or waiver from, our Code of Conduct, by posting such information on ourwebsite at the location specified above.

The other informationcalled for by this item is hereby incorporated by reference from the Registrant’sDefinitive Proxy Statement relating to the 2006 Annual Meeting of Stockholders,which Proxy Statement will be filed with the Securities and Exchange Commissionon or about July 28, 2006.

**ITEM 11. EXECUTIVECOMPENSATION**

The information called forby this item is hereby incorporated by reference from the Registrant’sDefinitive Proxy Statement relating to the 2006 Annual Meeting of Stockholders,which Proxy Statement will be filed with the Securities and Exchange Commissionon or about July 28, 2006.

**ITEM 12. SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

The information called forby this item is hereby incorporated by reference from the Registrant’sDefinitive Proxy Statement relating to the 2006 Annual Meeting of Stockholders,which Proxy Statement will be filed with the Securities and Exchange Commissionon or about July 28, 2006.

**ITEM 13. CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

The information called forby this item is hereby incorporated by reference from the Registrant’sDefinitive Proxy Statement relating to the 2006 Annual Meeting of Stockholders,which Proxy Statement will be filed with the Securities and Exchange Commissionon or about July 28, 2006.

**ITEM 14. PRINCIPALACCOUNTING FEES AND SERVICES**

The information called forby this item is hereby incorporated by reference from the Registrant’sDefinitive Proxy Statement relating to the 2006 Annual Meeting of Stockholders,which Proxy Statement will be filed with the Securities and Exchange Commissionon or about July 28, 2006.

**PART IV**

**ITEM 15. EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

The financial statements listed in the Index toConsolidated Financial Statements on page 31 are filed as part of thisreport, and such Index is incorporated in this Item by reference.

The exhibits listed in the Exhibit Index on page 57are filed as part of this report, and such Index is incorporated in this Itemby reference.

30

----

**AMERICAN SCIENCEAND ENGINEERING, INC. AND SUBSIDIARYINDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

(Submitted in answer to Item 8, Item 9A and Item 15 ofForm 10-K, Securities and Exchange Commission)

|                                                                                                                                        | ** ** | **PAGE** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **CONSOLIDATED FINANCIAL STATEMENTS**                                                                                                  |       |     |       |   |   |
| Reports of Independent Registered Public Accounting  Firms                                                                             |       |     | 32         |   |   |
| Consolidated  Balance Sheets—March 31, 2006 and 2005                                                                         |       |     | 36         |   |   |
| Consolidated Statements of Operations for the Years  Ended March 31, 2006, 2005, and 2004                                         |       |     | 37         |   |   |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the Years Ended March 31, 2006, 2005, and 2004 |       |     | 38         |   |   |
| Consolidated Statements of Cash Flows for the Years  Ended March 31, 2006, 2005, and 2004                                         |       |     | 39         |   |   |
| Notes to Consolidated Financial Statements                                                                                             |       |     | 40         |   |   |
| **CONSOLIDATED  SUPPLEMENTARY FINANCIAL INFORMATION**                                                                                  |       |     |       |   |   |
| Unaudited Quarterly Consolidated Financial Data for  the Years Ended March 31, 2006 and 2005                                      |       |     | 55         |   |   |

 

Financial statement schedules have been omittedbecause of the absence of conditions under which they are required or becausethe required information is given in the financial statements or notes thereto.

31

----

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholdersof American Science and Engineering, Inc.

We have audited the accompanying consolidated balancesheet of American Science and Engineering, Inc. and subsidiary as of March 31,2006 and the related consolidated statements of operations, stockholders’equity and comprehensive income, and cash flows for the year then ended. Wealso have audited management’s assessment, included in the accompanyingManagement’s Report on Internal Control over Financial Reporting, appearingunder item 9A, that American Science and Engineering, Inc. and subsidiarymaintained effective internal control over financial reporting as of March 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). American Science and Engineering, Inc.’smanagement is responsible for these financial statements, for maintainingeffective internal control over financial reporting, and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on these financial statements, anopinion on management’s assessment, and an opinion on the effectiveness of thecompany’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement and whether effective internal control over financialreporting was maintained in all material respects. Our audit of the financialstatements included examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. Our audit of internal controlover financial reporting included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audits provide a reasonable basis for ouropinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of American Science andEngineering, Inc. and subsidiary as of March 31, 2006 and the resultsof their operations and their cash flows for the year then ended  in conformity with accounting principlesgenerally accepted in the United States of America. Also, in our opinion,management’s assessment that American Science and Engineering, Inc.maintained effective internal 

32

----

controlover financial reporting as of March 31, 2006 is fairly stated, in allmaterial respects, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Furthermore, in our opinion,American Science and Engineering, Inc. maintained, in all materialrespects, effective internal control over financial reporting as of March 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO).

/s/ Vitale, Caturano & Company, Ltd.

VITALE, CATURANO & COMPANY, LTD.

June 9, 2006Boston, Massachusetts

33

----

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders ofAmerican Science and Engineering, Inc.:

In our opinion, the accompanying consolidated balancesheet as of March 31, 2005 and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income and cash flows foreach of two years in the period ended March 31, 2005 present fairly, in allmaterial respects, the financial position of American Science and Engineering,Inc. and subsidiary at March 31, 2005, and the results of their operations andtheir cash flows for each of the two years in the period ended March 31, 2005,in conformity with accounting principles generally accepted in the UnitedStates of America. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits. We conducted our audits of thesestatements in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

/s/ PricewaterhouseCoopers LLPBoston, MassachusettsJune 17, 2005

34

----

**American Science and Engineering, Inc. andSubsidiaryConsolidated Balance SheetsMarch 31, 2006 and 2005(Amounts in thousands, except share and per share amounts)**

| ** **                                                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Assets**                                                                    |       |     |       |     |       |
| Current assets:                                                               |       |     |       |     |       |
| Cash and cash equivalents                                                     |       | $        | 50,655     |     | $          | 15,418 |   |
| Restricted cash and  investments                                              |       | 98       |       | 355      |       |
| Short-term investments                                                        |       | 43,117   |       | 20,590   |       |
| Accounts receivable, net  of allowances of $345 in 2006 and $501 in 2005      |       | 25,868   |       | 28,170   |       |
| Unbilled costs and fees,  net of allowances of $36 in 2006 and $76 in 2005    |       | 4,057    |       | 691      |       |
| Note receivable                                                               |       | —   |       | 2,800    |       |
| Inventories                                                                   |       | 16,886   |       | 24,941   |       |
| Prepaid expenses and  other current assets                                    |       | 9,862    |       | 1,957    |       |
| Deferred income taxes                                                         |       | 3,381    |       | —   |       |
| **Total current assets**                                                      |       | 153,924  |       | 94,922   |       |
| Building, equipment and  leasehold improvements, net                          |       | 18,717   |       | 3,329    |       |
| Deferred income taxes                                                         |       | 748      |       | —   |       |
| Other assets, net                                                             |       | —   |       | 36       |       |
| **Total assets**                                                              |       | $        | 173,389    |     | $          | 98,287 |   |
| **Liabilities and Stockholders’ Equity**                            |       |     |       |     |       |
| Current liabilities:                                                          |       |     |       |     |       |
| Accounts payable                                                              |       | $        | 6,659      |     | $          | 6,743 |   |
| Accrued salaries and benefits                                                 |       | 6,554    |       | 3,158    |       |
| Accrued warranty costs                                                        |       | 3,606    |       | 2,322    |       |
| Deferred revenue                                                              |       | 3,331    |       | 3,634    |       |
| Customer deposits                                                             |       | 6,103    |       | 11,132   |       |
| Current portion of lease  financing liability                                 |       | 787      |       | —   |       |
| Other current liabilities                                                     |       | 1,853    |       | 3,001    |       |
| **Total  current liabilities**                                                |       | 28,893   |       | 29,990   |       |
| Lease financing  liability, net of current portion                            |       | 9,630    |       | —   |       |
| Warrant liability                                                             |       | 4,038    |       | 6,137    |       |
| Other long term  liabilities                                                  |       | 630      |       | 590      |       |
| **Total liabilities**                                                         |       | 43,191   |       | 36,717   |       |
| Commitments and contingencies (Notes 2 and 8)                                 |       |     |       |     |       |
| Stockholders’ equity:                                                    |       |     |       |     |       |
| Preferred stock, no par value                                                 |       |     |       |     |       |
| Authorized—100,000 shares                                                |       |     |       |     |       |
| Issued—None                                                              |       | —   |       | —   |       |
| Common stock, $0.662/3 par value                                         |       |     |       |     |       |
| Authorized—20,000,000 shares                                             |       |     |       |     |       |
| Issued and outstanding  9,070,679 shares in 2006 and 8,341,480 shares in 2005 |       | 6,047    |       | 5,560    |       |
| Capital in excess of par  value                                               |       | 94,061   |       | 54,098   |       |
| Accumulated other  comprehensive income                                       |       | (16      | )          | (12      | )          |
| Unearned compensation                                                         |       | (1,773   | )          | (169     | )          |
| Retained earnings                                                             |       | 31,879   |       | 2,093    |       |
| **Total stockholders’ equity**                                           |       | 130,198  |       | 61,570   |       |
| **Total liabilities and stockholders’ equity**                           |       | $        | 173,389    |     | $          | 98,287 |   |

 

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

35

----

**American Science and Engineering, Inc. andSubsidiaryConsolidated Statements of OperationsFor the Years Ended March 31, 2006, 2005, and 2004(Amounts in thousands except per share amounts)**

| ** **                                                   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Net sales and contract  revenues:**                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net product sales  and contract revenues                     |       | $          | 128,076    |       | $          | 68,910     |       | $ | 62,448 |   |
| Net service  revenues                                        |       | 35,528     |       | 19,404     |       | 13,894     |       |
| **Total  net sales and contract revenues**                   |       | 163,604    |       | 88,314     |       | 76,342     |       |
| **Cost of  sales and contracts:**                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of product  sales and contracts                         |       | 65,374     |       | 47,074     |       | 47,676     |       |
| Cost of service  revenues                                    |       | 20,032     |       | 10,752     |       | 8,732      |       |
| **Total  cost of sales and contracts**                       |       | 85,406     |       | 57,826     |       | 56,408     |       |
| **Gross profit**                                             |       | 78,198     |       | 30,488     |       | 19,934     |       |
| Selling, general and administrative expenses                 |       | 19,642     |       | 14,287     |       | 11,648     |       |
| Research and  development costs                              |       | 9,601      |       | 5,727      |       | 5,535      |       |
| Gain on sale of  assets                                      |       | (336       | )          | (5,442     | )          | —     |       |
| **Operating expenses**                                       |       | 28,907     |       | 14,572     |       | 17,183     |       |
| **Operating income**                                         |       | 49,291     |       | 15,916     |       | 2,751      |       |
| **Other  income (expense):**                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and  investment income                              |       | 2,513      |       | 575        |       | 107        |       |
| Interest expense                                             |       | (24        | )          | —     |       | —     |       |
| Other, net                                                   |       | 83         |       | (123       | )          | 235        |       |
| Change in warrant  valuation                                 |       | (6,094     | )          | (5,101     | )          | (1,273     | )          |
| **Total  other income (expense)**                            |       | (3,522     | )          | (4,649     | )          | (931       | )          |
| **Income before provision for (benefit from)  income taxes** |       | 45,769     |       | 11,267     |       | 1,820      |       |
| **Provision  for (benefit from) income taxes**               |       | 15,983     |       | 82         |       | (91        | )          |
| **Net  income**                                              |       | $          | 29,786     |       | $          | 11,185     |       | $ | 1,911 |   |
| **Income per share—Basic**                              |       | $          | 3.48       |       | $          | 1.41       |       | $ | 0.27 |   |
| **—Diluted**                                            |       | $          | 3.27       |       | $          | 1.31       |       | $ | 0.26 |   |
| **Weighted  average shares—Basic**                      |       | 8,555      |       | 7,937      |       | 7,155      |       |
| **—Diluted**                                            |       | 9,113      |       | 8,565      |       | 7,345      |       |

 

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

36

----

**American Science and Engineering, Inc. andSubsidiaryConsolidated Statements of Stockholders’ Equity and Comprehensive IncomeFor the Years Ended March 31, 2006, 2005, and 2004(Amounts in thousands, except share amounts)**

| ** **                                               | ** ** | **Common Stock** | ** ** | **Capital in** | ** ** | **Retained  Earnings**             | ** ** | **Accumulated**            | ** ** | ** **                   | ** ** | ** **                 | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|------------------------------------|------------|----------------------------|------------|------------------------------|------------|----------------------------|------------|------------|------------|
| ** **                                               | ** ** | **Shares**            | ** ** | **Par  Value**      | ** ** | **Excess of  Par Value** | ** ** | **(Accumulated  Deficit)** | ** ** | **Other Comp.  Income** | ** ** | **Unearned  Compensation** | ** ** | **Total**  | ** ** | **Comprehensive  Income** | ** ** |
| **Balance, March 31, 2003**                         |       | 6,871,729             |       | $                   | 4,581      |                               |       | $                          | 38,780     |                         |       |                       | $          | (11,003    | )          |   |   | $ | — |   |   |   | $ | — |   |   | $ | 32,358 |   |   | $ | (7,951 | ) |   |
| Net income                                               |       | —                |       | —              |       |                               | —     |                       |       |                         | 1,911      |                       |       |       | —     |   |   |   | — |   |   | 1,911 |   |   | 1,911 |   |   |
| Exercise of stock options                                |       | 477,619               |       | 318                 |       |                               | 3,220      |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 3,538 |   |   | — |   |   |
| Issuance of stock under employee compensation plans      |       | 39,698                |       | 26                  |       |                               | 374        |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 400 |   |   | — |   |   |
| Issuance of restricted stock                             |       | 26,614                |       | 18                  |       |                               | 309        |                       |       |                         | —     |                       |       |       | —     |   |   |   | (327 | ) |   | — |   |   | — |   |   |
| Translation adjustment                                   |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | 14         |   |   |   | — |   |   | 14 |   |   | 14 |   |   |
| Amortization of unearned compensation                    |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | —     |   |   |   | 212 |   |   | 212 |   |   | — |   |   |
| **Balance, March 31, 2004**                         |       | 7,415,660             |       | 4,943               |       |                               | 42,683     |                       |       |                         | (9,092     | )                          |       |       | 14         |   |   |   | (115 | ) |   | 38,433 |   |   | $ | 1,925 |   |   |
| Net income                                               |       | —                |       | —              |       |                               | —     |                       |       |                         | 11,185     |                       |       |       | —     |   |   |   | — |   |   | 11,185 |   |   | 11,185 |   |   |
| Exercise of stock options and warrants                   |       | 900,566               |       | 600                 |       |                               | 10,749     |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 11,349 |   |   | — |   |   |
| Issuance of stock under employee compensation plans      |       | 17,296                |       | 12                  |       |                               | 424        |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 436 |   |   | — |   |   |
| Issuance of restricted stock                             |       | 7,958                 |       | 5                   |       |                               | 242        |                       |       |                         | —     |                       |       |       | —     |   |   |   | (247 | ) |   | — |   |   | — |   |   |
| Translation adjustment                                   |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | (2         | ) |   |   | — |   |   | (2 | ) |   | (2 | ) |   |
| Amortization of unearned compensation                    |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | —     |   |   |   | 193 |   |   | 193 |   |   | — |   |   |
| Unrealized gain (loss) on available for sale  securities |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | (24        | ) |   |   | — |   |   | (24 | ) |   | (24 | ) |   |
| **Balance, March 31, 2005**                         |       | 8,341,480             |       | 5,560               |       |                               | 54,098     |                       |       |                         | 2,093      |                       |       |       | (12        | ) |   |   | (169 | ) |   | 61,570 |   |   | $ | 11,159 |   |   |
| Net income                                               |       | —                |       | —              |       |                               | —     |                       |       |                         | 29,786     |                       |       |       | —     |   |   |   | — |   |   | 29,786 |   |   | 29,786 |   |   |
| Exercise of stock options and warrants                   |       | 695,777               |       | 465                 |       |                               | 19,700     |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 20,165 |   |   | — |   |   |
| Issuance of stock under employee compensation plans      |       | 9,344                 |       | 6                   |       |                               | 484        |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 490 |   |   | — |   |   |
| Issuance of restricted stock                             |       | 24,078                |       | 16                  |       |                               | 2,135      |                       |       |                         | —     |                       |       |       | —     |   |   |   | (2,151 | ) |   | — |   |   | — |   |   |
| Tax benefit accrued on stock option exercises            |       | —                |       | —              |       |                               | 17,540     |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 17,540 |   |   | — |   |   |
| Compensation expense on stock options                    |       | —                |       | —              |       |                               | 104        |                       |       |                         | —     |                       |       |       | —     |   |   |   | — |   |   | 104 |   |   | — |   |   |
| Translation adjustment                                   |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | (3         | ) |   |   | — |   |   | (3 | ) |   | (3 | ) |   |
| Amortization of unearned compensation                    |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | —     |   |   |   | 547 |   |   | 547 |   |   | — |   |   |
| Unrealized gain (loss) on available for sale  securities |       | —                |       | —              |       |                               | —     |                       |       |                         | —     |                       |       |       | (1         | ) |   |   | — |   |   | (1 | ) |   | (1 | ) |   |
| **Balance,  March 31, 2006**                        |       | 9,070,679             |       | $                   | 6,047      |                               |       | $                          | 94,061     |                         |       |                       | $          | 31,879     |       |   |   | $ | (16 | ) |   |   | $ | (1,773 | ) |   | $ | 130,198 |   |   | $ | 29,782 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements

37

----

**American Science and Engineering, Inc. andSubsidiaryConsolidated Statements of Cash FlowsFor the Years Ended March 31, 2006, 2005, and 2004(Amounts in thousands)**

| ** **                                                                                                   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities:**                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                   |       | $          | 29,786     |       | $          | 11,185     |       | $ | 1,911 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities:                           |       |       |       |       |       |       |       |
| Depreciation and  amortization                                                                               |       | 989        |       | 1,234      |       | 1,612      |       |
| Provisions for  contracts, inventory, and accounts receivable reserves                                       |       | 2,673      |       | 2,057      |       | 988        |       |
| Gain on sale of  assets                                                                                      |       | (336       | )          | (5,442     | )          | —     |       |
| Change in value of  warrants                                                                                 |       | 6,094      |       | 5,101      |       | 1,273      |       |
| Realized gain on  short-term investments                                                                     |       | —     |       | (8         | )          | (51        | )          |
| Amortization of  bond discount                                                                               |       | (356       | )          | (95        | )          | —     |       |
| Stock compensation  expense                                                                                  |       | 651        |       | 193        |       | 212        |       |
| Deferred income  taxes                                                                                       |       | 5,627      |       | —     |       | —     |       |
| Reduction of  income taxes paid due to the tax benefit from employee stock option exercises                  |       | 10,515     |       | —     |       | —     |       |
| Reversal of  deferred tax asset valuation allowance relating to the utilization of tax net  operating losses |       | (2,715     | )          | —     |       | —     |       |
| Change in assets and  liabilities:                                                                           |       |       |       |       |       |       |       |
| Accounts  receivable                                                                                         |       | 2,408      |       | (13,650    | )          | (4,299     | )          |
| Unbilled costs and  fees                                                                                     |       | (3,338     | )          | 3,722      |       | (125       | )          |
| Inventories                                                                                                  |       | 5,248      |       | (16,660    | )          | 3,397      |       |
| Prepaid expenses  and other assets                                                                           |       | (5,566     | )          | (67        | )          | (966       | )          |
| Accounts payable                                                                                             |       | (84        | )          | 3,053      |       | (1,637     | )          |
| Deferred revenue                                                                                             |       | (212       | )          | 1,577      |       | (135       | )          |
| Customer deposits                                                                                            |       | (5,029     | )          | 6,713      |       | 1,672      |       |
| Accrued expenses  and other current liabilities                                                              |       | 4,358      |       | 3,476      |       | 1,696      |       |
| Non-current  liabilities                                                                                     |       | (51        | )          | 7          |       | (57        | )          |
| Total adjustments                                                                                            |       | 20,876     |       | (8,789     | )          | 3,580      |       |
| Net cash provided  by operating activities                                                                   |       | 50,662     |       | 2,396      |       | 5,491      |       |
| **Cash flows from investing activities:**                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  maturities of short-term investments                                                          |       | 39,146     |       | 9,987      |       | 5,063      |       |
| Purchases of  short-term instruments                                                                         |       | (61,334    | )          | (28,653    | )          | (2,319     | )          |
| Proceeds from sale  of assets                                                                                |       | 2,800      |       | 5,500      |       | —     |       |
| Purchases of  property and equipment                                                                         |       | (11,224    | )          | (2,691     | )          | (462       | )          |
| Disposals of  property and equipment                                                                         |       | —     |       | 127        |       | 12         |       |
| Cash provided by  (used for) investing activities                                                            |       | (30,612    | )          | (15,730    | )          | 2,294      |       |
| **Cash flows from financing activities:**                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Decrease in  restricted cash and investments                                                                 |       | 257        |       | 230        |       | 1,310      |       |
| Proceeds from  financing of leasehold improvements                                                           |       | 3,339      |       | —     |       | —     |       |
| Repayment of  leasehold financing                                                                            |       | (378       | )          | —     |       | —     |       |
| Proceeds from  exercise of warrants                                                                          |       | 1,854      |       | 1,743      |       | —     |       |
| Proceeds from  exercise of stock options                                                                     |       | 10,118     |       | 8,549      |       | 3,538      |       |
| Cash provided by  financing activities                                                                       |       | 15,190     |       | 10,522     |       | 4,848      |       |
| Foreign currency  translation effect on cash                                                                 |       | (3         | )          | (2         | )          | 14         |       |
| **Net  increase (decrease) in cash and cash equivalents**                                                    |       | 35,237     |       | (2,814     | )          | 12,647     |       |
| **Cash and  cash equivalents at beginning of year**                                                          |       | 15,418     |       | 18,232     |       | 5,585      |       |
| **Cash and  cash equivalents at end of year**                                                                |       | $          | 50,655     |       | $          | 15,418     |       | $ | 18,232 |   |
| **Supplemental disclosures of cash flow  information:**                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest paid                                                                                                |       | $          | 24         |       | $          | —     |       | $ | — |   |
| Income taxes paid                                                                                            |       | $          | 7,598      |       | $          | 166        |       | $ | — |   |
| **Non-cash transactions:**                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Issuance of stock  for 401K match                                                                            |       | $          | 490        |       | $          | 436        |       | $ | 400 |   |
| Issuance of  restricted stock                                                                                |       | $          | 2,151      |       | $          | 247        |       | $ | 327 |   |
| Assumption of debt  / lease financing receivable                                                             |       | $          | 2,303      |       | $          | —     |       | $ | — |   |
| Note receivable in  exchange for sale of assets                                                              |       | $          | —     |       | $          | 2,800      |       | $ | — |   |
| Fair value of  warrants exercised                                                                            |       | $          | 8,193      |       | $          | 1,057      |       | $ | — |   |

 

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

38

----

**American Scienceand Engineering, Inc. and SubsidiaryNotes to Consolidated Financial Statements**

**1.**                 Natureof Operations and Summary of Significant Accounting Policies

American Science and Engineering, Inc. (the “Company”)is engaged in the development and manufacture of sophisticated X-ray inspectionsystems for critical detection and security screening solutions for saleprimarily to U.S. and foreign government agencies.

**Principlesof Consolidation:**   The consolidated financialstatements include the accounts of the Company and its wholly owned subsidiary.All significant inter-company balances and transactions have been eliminated inconsolidation.

**Useof Estimates:**   The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

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

**Cashand Cash Equivalents:**   The Company considers allinvestments with original maturities of 90 ays or less to be cashequivalents. The Company maintains cash and cash equivalent balances withfinancial institutions that exceed federally insured limits. The Company hasnot experienced any losses related to these balances, and management believesits credit risk to be minimal. Cash and cash equivalents are carried at cost,which approximates fair market value at year-end 2006 and 2005. The Company hasrepurchase agreements with its banks. The repurchase agreements arecollateralized by investments principally consisting of U.S. Government Agencysecurities in the amount of at least 100% of such obligation.

**RestrictedCash and Investments:****  **TheCompany’s Export and Security Agreements with its banks require certain cashand investment balances to be restricted as collateral against outstandingstandby letters of credit. The restricted cash amounts with Silicon Valley Bankare in the form of certificates 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 and are recordedat their fair market values. The unrealized holding gains or losses on thesesecurities are included as a component of comprehensive income in theConsolidated Statements of Stockholders’ Equity and Comprehensive Income.

**Accounts Receivable:**   Theallowance for doubtful accounts reflects our best estimate of probable lossesinherent in the accounts receivable balance. We determine the allowance basedon known troubled accounts, historical experience, and other currentlyavailable evidence. Activity in the allowance for doubtful accounts is asfollows (in thousands):

| ** ** | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged  (Credited) to  Costs and Expenses** | ** ** | **Deductions /  Writeoffs  Charged to Reserves** | ** ** | **Balance  at End  of Year** | ** ** |
|------------|------------|----------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| **2006**   |       |                                         | $          | 501                                                           |       |                                                            |       | $                                      | (106       | ) |   |   | $ | 50 |   |   |   | $ | 345 |   |   |
| **2005**   |       |                                         | $          | 250                                                           |       |                                                            |       | $                                      | 251        |   |   |   | $ | — |   |   |   | $ | 501 |   |   |
| **2004**   |       |                                         | $          | 246                                                           |       |                                                            |       | $                                      | 27         |   |   |   | $ | 23 |   |   |   | $ | 250 |   |   |

 

39

----

In fiscal 2006, the Company had a net credit to baddebt expense as it collected on certain accounts receivable balances which weresignificantly aged and deemed to be uncollectible at March 31, 2005.

**Inventories:**   Inventoriesconsist of material, labor and manufacturing overhead and are recorded at thelower of cost, using the weighted average cost method, or net realizable value.Excessive manufacturing overhead costs attributable to idle facility expenses,freight, handling costs and wasted material (spoilage) attributable toabnormally low production volumes (levels that materially differ from budgetedproduction plans due primarily to changes in customer demand) are excluded frominventory and recorded as an expense in the period incurred.

Thecomponents of inventories at March 31, 2006 and 2005 were as follows (inthousands):

| ** **                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|
| Raw materials,  completed subassemblies and spare parts |       | $        | 6,856      |     | $          | 12,763 |   |
| Work-in-process                                         |       | 6,325    |       | 5,458    |       |
| Finished goods                                          |       | 3,705    |       | 6,720    |       |
|                                                    |       | $        | 16,886     |     | $          | 24,941 |   |

 

The Company periodically reviews quantities ofinventory 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.

**Building,Equipment and Leasehold Improvements:**   TheCompany provides for depreciation and amortization of its fixed assets on astraight-line basis over estimated useful lives of 3-11 years orremaining lease terms. Expenditures for normal maintenance and repairs arecharged to expense as incurred. Significant additions, renewals or bettermentsthat extend the useful lives of the assets are capitalized at cost. The costand accumulated depreciation applicable to equipment and leasehold improvementssold, or otherwise disposed of, are removed from the accounts, and anyresulting gain or loss is included in the consolidated statements ofoperations.

Building,equipment and leasehold improvements consisted of the following at March 31(in thousands):

| ** **                                           | ** ** | **Estimated Useful Lives**         | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|----------|------------|----------|------------|
| Building and  leasehold improvements                 |       | Lesser  of 11 years or  remaining lease term |       | $        | 14,380     |     | $          | 2,117 |   |
| Equipment and  tooling                               |       | 3-10  years                                  |       | 2,465    |       | 2,251    |       |
| Computer  equipment and software                     |       | 3-5  years                                   |       | 10,268   |       | 7,791    |       |
| Furniture and  fixtures                              |       | 5-7  years                                   |       | 1,272    |       | 1,023    |       |
| Demo and test  equipment                             |       | 3-7  years                                   |       | 3,122    |       | 1,948    |       |
| Motor vehicles                                       |       | 3  years                                     |       | 18       |       | 18       |       |
| Total                                                |       |                                         |       | 31,525   |       | 15,148   |       |
| Less accumulated  depreciation and amortization      |       |                                         |       | (12,808  | )          | (11,819  | )          |
| Building, equipment and  leasehold improvements, net |       |                                         |       | $        | 18,717     |     | $          | 3,329 |   |

 

**RevenueRecognition:**   The Company recognizes certainCargoSearch and Z Backscatter system sales and other product revenue, primarilyParcelSearch systems and after-market parts, in accordance with SEC StaffAccounting Bulletin (“SAB”) No. 101, Revenue Recognition in FinancialStatements modified by Emerging Issues Task Force (“EITF”) No. 00-21and SAB No. 104 which requires that four basic criteria must be met beforerevenue can be recognized: (1) persuasive evidence of an arrangementexists; 

40

----

(2) delivery has occurredor services rendered; (3) the fee is fixed and determinable; and (4) collectibilityis reasonably assured. In those instances where the Company enters intoagreements involving multiple revenue elements, the agreement is divided intoseparate elements of accounting, the arrangement consideration is allocated tothese elements based on fair value, and revenue recognition is consideredseparately for each individual element. Revenues on cost reimbursable andlong-term fixed price contracts are generally recorded as costs are incurredusing the percentage of completion method. These contracts are for custom-builtsystems or contract engineering projects and the length of these contractstypically range from 9 to 24 months from order to delivery and acceptance.Percentages-of-completion are determined by relating the actual costs of workperformed to date for each contract to its estimated final costs. Revisions incosts and profit estimates are reflected in the period in which the factscausing the revision become known.

Certain contracts require payments from the customerupon execution of the agreement that are included in customer deposits.Individual customer deposits are reduced by the amount of revenue recognized onthe contract until a zero balance is reached. Revenue recognized in excess ofbillings or customer deposits under the contracts is included in unbilled costsand fees in the accompanying balance sheet. The amounts in unbilled costs andfees at March 31, 2006 are expected to be billed and collected duringfiscal 2007.

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

Under the terms of certain of its cost reimbursementcontracts, the Company is not permitted to bill customers a specified portionof the contract value until completion. Such retainages (approximately $77,000and $42,000 at March 31, 2006 and 2005, respectively)  result from both commercial contractretentions and government contract withholdings generally for up to 15% offees, as well as the difference between the actual and provisional indirectcost billing rates. Retainages are included in the accompanying consolidatedbalance sheets as components of unbilled costs and fees. The accuracy andappropriateness of the Company’s direct and indirect costs and expenses underthese cost reimbursement contracts and, therefore, its accounts receivablerecorded pursuant to such contracts, are subject to regulation and audit,including by the U.S. Defense Contract Audit Agency (“DCAA”) or by otherappropriate agencies of the U.S. Government. Such agencies  have the right to  challenge the  Company’s  cost estimates  or allocations  with respect  to any  government contract. Additionally, a portion of the payments to the Company undergovernment contracts are provisional payments that are subject to potentialadjustment upon audit by such agencies. Historically, such audits have notresulted in any significant disallowed costs. Although the Company can give noassurances, in the  opinion  of management,  any  adjustments likely to  result  from inquiries  or audits of its  contracts  will not have a  material adverse impact onthe Company’s financial condition or results of operations.

The Company recognizes sales for its systems that areproduced in a standard manufacturing operation and have shorter order todelivery cycles at the time of shipment of the system to the customer and whenother revenue recognition criteria are met. The costs of installation at thecustomer’s site are accrued at the time of shipment. Management believes thecustomer’s post-delivery acceptance provisions and installation are perfunctoryand inconsequential. The Company has never failed to successfully complete asystem installation. Installation is non-complex and does not requirespecialized skills and the related costs are predictable and insignificant tothe total purchase price. The Company has demonstrated a history of customeracceptance subsequent to shipment and installation of these systems.

Service revenues are recognized on time and materialsengagements as the services are provided. Service contract revenues arerecognized on a straight-line basis over the length of the contract whichreasonably approximates the period service revenues are earned.

41

----

The Company records billed shipping and handling feesand billed out-of-pocket expenses as revenue and the associated costs as costof goods sold in the accompanying consolidated statements of operations.

Includedin accounts receivable and unbilled costs and fees at March 31, 2006 and2005 are $24,241,000 and $27,405,000, respectively, attributable to both primeand subcontracts with federal and state governments. The Company establishes areserve against unbilled costs and fees based on known troubled accounts orcontracts, historical experience, and other currently available evidence.Activity in the allowance for unbilled costs and fees is as follows (inthousands):

| ** ** | ** ** | **Balance at  Beginning of  Year** | ** ** | **Charged  (Credited) to  Costs and Expenses** | ** ** | **Deductions /  Writeoffs  Charged to Reserves** | ** ** | **Balance at  End of  Year** | ** ** |
|------------|------------|----------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| **2006**   |       |                                         | $          | 76                                                            |       |                                                            |       | $                                      | (28        | ) |   |   | $ | 12 |   |   |   | $ | 36 |   |   |
| **2005**   |       |                                         | $          | 394                                                           |       |                                                            |       | $                                      | 55         |   |   |   | $ | 373 |   |   |   | $ | 76 |   |   |
| **2004**   |       |                                         | $          | 437                                                           |       |                                                            |       | $                                      | —     |   |   |   | $ | 43 |   |   |   | $ | 394 |   |   |

 

In fiscal 2006, the Company had a net credit to baddebt expense as it collected on certain unbilled receivable balances which weresignificantly aged and deemed to be uncollectible at March 31, 2005.

**WarrantyCosts:****  **TheCompany generally provides on certain of its products a one year parts andlabor warranty with the purchase of domestic equipment, and a one year partsonly warranty with international equipment. The anticipated cost for this oneyear warranty is accrued for at the time of the sale based upon historicalexperience and management’s estimates of future liabilities, and is recorded asaccrued warranty costs (See Note 5).

**DeferredRevenue:**   The Company offers to its customersextended warranty and service contracts. The coverage period of these contractswill typically range from one to five years, and typically with advancepayments that are recorded as deferred revenue. Revenue is recognized on astraight-line basis over the life of the contract, which reasonablyapproximates the period these revenues are earned. Costs associated with theseextended warranty and service contracts are expensed to cost of goods sold asincurred.

**Impairmentof Long-Lived Assets:**   Long-lived assets arereviewed for possible impairment whenever events or changes in circumstancesindicate that the carrying amount of such assets may not be recoverable inaccordance with SFAS No. 144, Accounting for the Impairment and Disposalof Long-Lived Assets.

Impairment is assessed by comparing the estimatedundiscounted cash flows over the asset’s remaining life to the carrying amountof the asset. If the estimated cash flows are insufficient to recover theinvestment, an impairment loss is recognized based on the difference betweenthe carrying value of the asset and the fair value of the asset less any costsof disposal.

**Accrued Salaries andBenefits:**   Accrued salaries and benefits at March 31,2006 and March 31, 2005 include the following (in thousands):

| ** **                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Accrued payroll  and payroll related taxes |       | $        | 461        |     | $          | 415 |   |
| Accrued benefits                           |       | 166      |       | 143      |       |
| Accrued bonus                              |       | 4,799    |       | 1,673    |       |
| Accrued vacation                           |       | 1,128    |       | 927      |       |
|                                       |       | $        | 6,554      |     | $          | 3,158 |   |

 

**CustomerDeposits:**   For most international orders, theCompany generally includes, as part of its terms and conditions, an advancedeposit with order acceptance. For long-term international contracts, theCompany will generally include milestone payments tied to a specific eventand/or passage of time. These 

42

----

deposit amounts arerecorded as a liability under Customer Deposits until reduced by revenuerecognized against the specific contract.

**DeferredRent:**   The Company has a lease for its office andmanufacturing facilities, which includes escalation clauses. Accountingprinciples generally accepted in the United States of America require therental expense to be recorded on a straight-line basis over the life of the lease,resulting in deferred rent being reflected in the accompanying consolidatedbalance sheets.

**Researchand Development:**   Internally funded research anddevelopment costs including direct labor, material, subcontractor expenses andrelated overheads are expensed as incurred. Internally funded research anddevelopment costs were $9,601,000, $5,727,000 and $5,535,000 in fiscal 2006,2005 and 2004, respectively. In addition, the Company recognized revenues of$2,804,000, $2,534,000, and $444,000, in fiscal 2006, 2005, and 2004,respectively related to government-sponsored research and development earnedprimarily on a cost reimbursement basis as discussed above.

**FairValue of Financial Instruments:**   The Company’sfinancial instruments consist primarily of cash and cash equivalents,short-term investments, accounts receivable, unbilled costs and fees, accountspayable, warrant liability and letters of credit. The carrying amounts of theseinstruments approximate fair value.

**Income Per Common andPotential Common Shares:**   Basic earnings percommon share is computed by dividing net income available to commonstockholders by the weighted average number of shares of common stockoutstanding during the year. Diluted earnings per share include the dilutiveimpact of options and warrants using the average share price of the Company’scommon stock for the period. For the years ended March 31, 2006, 2005 and2004, respectively, 72,000, 42,000, and 875,000 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,**  | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                              | ** ** | **2006**            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                              | ** ** | **(in thousands)**  | ** ** |
| Weighted average  number of common shares outstanding—basic                        |       |                | 8,555      |   |   |   | 7,937 |   |   |   | 7,155 |   |   |
| Assumed exercise  of stock options and warrants, using the treasury stock method        |       |                | 558        |   |   |   | 628 |   |   |   | 190 |   |   |
| Weighted average number  of common and potential common shares outstanding—diluted |       |                | 9,113      |   |   |   | 8,565 |   |   |   | 7,345 |   |   |

 

**IncomeTaxes:**   The Company accounts for income taxes inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 109,“Accounting for Income Taxes.” Accordingly, the Company recognizes deferredincome taxes based on the expected future tax consequences of differencesbetween the financial statement basis and the tax basis of assets andliabilities, calculated using enacted tax rates in effect for the year in whichthe differences are expected to be reflected in the tax return. The Companyrecords a valuation allowance against any net deferred tax assets if it is morelikely than not that they will not be realized.

43

----

**Pro Forma Stock-BasedCompensation Expense:**   As permitted by SFAS No. 123,“Accounting for Stock-Based Compensation,” the Company has elected to continueto apply Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” to account for its stock-based compensationplans. Had compensation cost for outstanding awards in 2006, 2005 and 2004under the Company’s stock-based compensation plans been determined based on thefair value at the 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 (in thousands except per share amounts):

| ** **                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income:                                                                  |       |     |       |     |       |     |       |
| As reported                                                                  |       | $        | 29,786     |     | $          | 11,185   |       | $ | 1,911 |   |
| Add: Stock based compensation recognized in earnings                         |       | 651      |       | 193      |       | 212      |       |
| Less: Stock based compensation using fair value  method for all awards  |       | (9,234   | )          | (5,623   | )          | (3,676   | )          |
| Pro forma                                                                    |       | $        | 21,203     |     | $          | 5,755    |       | $ | (1,553 | ) |
| Income (loss) per  share—Basic:                                         |       |     |       |     |       |     |       |
| As reported                                                                  |       | $        | 3.48       |     | $          | 1.41     |       | $ | 0.27 |   |
| Pro forma                                                                    |       | $        | 2.48       |     | $          | 0.73     |       | $ | (0.22 | ) |
| Income (loss) per  share—Diluted:                                       |       |     |       |     |       |     |       |
| As reported                                                                  |       | $        | 3.27       |     | $          | 1.31     |       | $ | 0.26 |   |
| Pro forma                                                                    |       | $        | 2.34       |     | $          | 0.67     |       | $ | (0.22 | ) |

 

The fair value of each option granted was estimated onthe grant date using the Black-Scholes option pricing model with the followingweighted average assumptions: risk-free interest rates of  3.4% for fiscal year 2006, 3.7% to 5.0% forfiscal year 2005, and 5.0% for fiscal 2004; an expected volatility of 53%, 73%,and 72%, for fiscal years 2006, 2005, and 2004, respectively; an expecteddividend yield of 0% in all periods; and an expected life of 3 years, 5 yearsand 7 years for fiscal 2006, 2005 and 2004, respectively.

**NewAccounting Pronouncements:**   In December 2004,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-BasedPayment” (SFAS 123(R)) which establishes accounting standards for alltransactions in which an entity exchanges its equity instruments for goods andservices. SFAS 123(R) revises SFAS No. 123, supercedes APB No. 25,and amends Financial Accounting Standard No. 95, “Statement of Cash Flows”.SFAS No. 123(R) generally requires the Company to measure the cost ofemployee services received in exchange for an award of equity instruments basedon the fair value of the award on the date of the grant. The standard requiresthe fair value on the grant date to be estimated using either an option-pricingmodel which is consistent with the terms of the award or a market observedprice, if such a price exists. The resulting cost must be recognized over theperiod during which an employee is required to provide service in exchange forthe award, which is usually the vesting period. In April 2005, the SECdeferred the effective date for SFAS 123(R) to the beginning of the firstfiscal year that begins after June 15, 2005. The Company expects to adoptSFAS 123(R) on the effective date on a modified prospective basiswithout restatement of prior periods. As a result of SFAS 123(R), the Companycurrently expects that income from continuing operations will decrease byapproximately $5,862,000 in 2007. This amount represents the expense forexisting stock option awards that will vest during 2007 and does not reflectany new awards or modifications to existing awards that could occur in thefuture. Future stock based compensation will be impacted by additional grants,forfeitures rates and stock price volatility, among other factors.

In December 2004, the FASB issued SFAS No. 151, “InventoryCosts*,*” which amends part ofAccounting Research Bulletin (“ARB”) No. 43, “Inventory Pricing,”concerning the treatment of certain types of inventory costs. The provisions ofARB No. 43 provided that certain inventory-related costs, such 

44

----

as double freight andre-handling, might be “so abnormal” that they should be charged against currentearnings rather than be included in the cost of inventory. As amended by SFAS No. 151,the “so-abnormal” criterion has been eliminated. Thus, all such abnormal costsare required to be treated as current-period charges under all circumstances.In addition, fixed production overhead should be allocated based on the normalcapacity of the production facilities, with unallocated overhead charged toexpense when incurred. SFAS No. 151 is required to be adopted for fiscalyears beginning after June 15, 2005. The Company does not believe itsadoption will have a material impact on its results of operations, financialposition and cash flows.

In December 2004, theFASB issued a FASB Staff Position (FSP) 109-1, Application of FASB 109 tothe Tax Deduction on Qualified Production Activities provided by the AmericanJobs Creation Act of 2004. The new act provides for a special tax deduction onqualified production activities income that effectively reduces the Company’stax rate. The FASB has decided that these amounts should be recorded as aspecial deduction, and recorded in the year earned. The Company does notbelieve that the adoption of this FSP statement will have a material impact onthe Company’s consolidated financial statements.

**2.**                 LeaseAgreements

The Company leases certain equipment under operatinglease arrangements and facilities under non-cancelable operating leases withvarious renewal options. For operating leases which contain fixed escalationsin rental payments, the Company records the total rent payable on astraight-line basis over the original lease term as defined in SFAS 98, “Accountingfor Leases.” Deferred rent, included in other non-current liabilities in theaccompanying balance sheet, represents the difference between rent expensecomputed on a straight-line basis and actual cash payments for rent. TheCompany incurred $634,000, $1,226,000, and $1,115,000 of operating rent expensein 2006, 2005, and 2004 respectively. The security deposits on these leasesamount to $27,000 in cash deposits at March 31, 2006. In conjunction withthe Company’s lease for its headquarters, the Company has issued security inthe form of a standby letter of credit in the amount of $300,000 with anoriginal expiration date of March 1, 2006 and contains automaticextensions through May 15, 2016.

In March 2005, the Company renewed its leaseagreement for its corporate headquarters and manufacturing facilities inBillerica, Massachusetts. As part of the lease agreement, the Company’slandlord agreed to certain renovations to the Billerica facility including theconstruction of additional high bay manufacturing space. The Company wasresponsible for a portion of the construction costs and was deemed to be theowner of the building during the construction period under EITF 97-10, “TheEffect of Lessee Involvement in Asset Construction”. During the year ended March 31,2006, the Company capitalized $5,153,000 to record the facility on its bookswith an offsetting credit to the Lease financing liability. In addition,amounts paid for construction were recorded as construction in progress and thelandlord construction allowances of $5,642,000 (of which $2,303,000 wasreceivable at year end) were recorded as additional lease financing liability.

45

----

At the completion of the construction in February 2006,the lease was reviewed for potential sale-leaseback treatment in accordancewith SFAS No. 98. Based on this review, it was determined that the leasedid not qualify for sale-leaseback treatment in accordance with SFAS No. 98.As a result, building and tenant improvement and associated lease financingliabilities will remain on the Company’s books. The Lease financing liabilitywill be amortized over the lease term based on the payments designated in theagreement and the building and tenant improvement assets will be depreciated ona straight line basis over their useful lives.

Futureminimum rental payments under the Company’s non-cancelable leases, excludingreal estate taxes, insurance and operating costs paid by the Company, requiredover the initial terms of the leases are as follows (in thousands):

| **Year Ending March 31,**            | ** ** | ** ** | ** ** | **Operating Leases** | ** ** | **Capital Leases** | ** ** |
|-----------------------------------------------------|------------|------------|------------|---------------------------|------------|-------------------------|------------|
| 2007                                                |       |       | $          | 153                       |       |                    |       | $ | 1,145 |   |   |
| 2008                                                |       |       | 144        |                      |       |                    | 1,145      |   |   |
| 2009                                                |       |       | 144        |                      |       |                    | 1,146      |   |   |
| 2010                                                |       |       | 144        |                      |       |                    | 1,156      |   |   |
| 2011                                                |       |       | 144        |                      |       |                    | 1,270      |   |   |
| Thereafter                                          |       |       | 708        |                      |       |                    | 6,620      |   |   |
| Total payments                                      |       |       | $          | 1,437                     |       |                    |       | 12,482 |   |   |
| Imputed interest                                    |       |       |       |                      |       |                    | (2,065     | ) |   |
| Lease financing  liability                          |       |       |       |                      |       |                    | $          | 10,417 |   |   |
| Less: Current  portion of lease financing liability |       |       |       |                      |       |                    | 787        |   |   |
| Lease financing  liability, net of current portion  |       |       |       |                      |       |                    | $          | 9,630 |   |   |

 

**3.**                 Lineof Credit

On November 30, 2004, the Company modified itstwo credit agreements with Silicon Valley Bank East. The modifications extendedthe credit facilities which expired on November 30, 2004 through November 29,2006 and reduced the export loan and security facility, guaranteed by theExport-Import Bank of the United States, from $20.0 million to $10.0 million.The domestic facility is a $5.0 million domestic loan and security agreement tosupport the Company’s routine working capital needs. Maximum borrowings forthis facility are set at the lower of (a) the sum of 80% of eligibledomestic accounts receivable plus 10% of finished goods inventory up to$750,000, or; (b) $5 million.

The credit facilities bear an interest rate of thegreater of 4.0% or the Silicon Valley Bank prime rate (7.75% at March 31,2006). The credit agreements are collateralized by certain assets of theCompany and contain certain restrictions, including limitations ondistributions in excess of $100,000 that can be made to stockholders, and thedisposition or encumbrances of assets, and require the maintenance of certainfinancial covenants. As of March 31, 2006, the Company was in compliancewith these covenants.

At March 31, 2006, there were no borrowingsoutstanding against these credit facilities. Under the terms of the creditagreements, the Company was required to pay certain one-time facility feeswhich are being amortized over the lives of the facilities and is required topay a fee of 0.50% quarterly on unused amounts under the line of credits. Totalexpense incurred related to these fees were $172,000,$300,000, and $190,000, infiscal 2006, 2005 and 2004, respectively.

The Company hadoutstanding $813,000 in stand-by letters of credit against the domesticfacility and $454,000 in stand-by letters of credit against the export facility.Of the outstanding letters of credit, $300,000 relates to the Company’sbuilding lease and the remainder is guaranteeing performance on certaininternational projects.  No amounts havebeen drawn against these letters of credit. In addition at 

46

----

March 31,2006, the Company has a restricted cash balance of $98,000 related to certainbank required deposits related to outstanding letters of credits, bid bonds,and other bank-related fees.

**4.**                 IncomeTaxes

The provision for (benefit from) income taxes for theyears ended March 31, 2006, 2005 and 2004 consisted of the following (inthousands):

| ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:                       |       |     |       |     |       |     |       |   |   |
| Federal                        |       | $        | 11,388     |     |       | $46      |       |   | $ | — |   |
| State                          |       | 1,653    |       |     | 6          |     |       | (123 | ) |
| Foreign                        |       | 30       |       |     | 30         |     |       | 32 |   |
|                           |       | 13,071   |       |     | 82         |     |       | (91 | ) |
| Deferred                       |       |     |       |     |       |     |       |   |   |
| Federal                        |       | 5,090    |       |     | —     |     |       | — |   |
| State                          |       | 537      |       |     | —     |     |       | — |   |
| Change in  Valuation Allowance |       | (2,715   | )          |     | —     |     |       | — |   |
|                           |       | 2,912    |       |     | —     |     |       | — |   |
| Total                          |       | $        | 15,983     |     |       | $        | 82         |   |   | $ | (91 | ) |
|                                |            |          |            |          |            |          |            |  |  |  |  |  |

 

Thedifference between the total expected provision for (benefit from) income taxescomputed by applying the statutory federal income tax rate to income beforeprovision for (benefit from) income taxes and the recorded provision for (benefitfrom) income taxes for the three years in the period ended March 31, is asfollows (in thousands):

| ** **                                                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Provision for  (benefit from) income taxes at statutory rate         |       | $        | 16,019     |     | $          | 3,944    |       | $ | 619 |   |
| State tax  provision (benefit) net of federal effect                      |       | 1,424    |       | 4        |       | (90      | )          |
| Permanent tax  differences for non-deductible expenses/non-taxable income |       | 2,133    |       | 1,808    |       | 455      |       |
| Research tax  credits                                                     |       | (226     | )          | (25      | )          | (60      | )          |
| Effect of ETI  exclusion                                                  |       | (678     | )          | (70      | )          | (85      | )          |
| Change in  valuation allowance                                            |       | (2,715   | )          | (5,380   | )          | (940     | )          |
| Qualifying  manufacturing credits                                         |       | (189     | )          | —   |       | —   |       |
| Other                                                                     |       | 215      |       | (199     | )          | 10       |       |
| Provision for (benefit  from) income taxes                                |       | $        | 15,983     |     | $          | 82       |       | $ | (91 | ) |

 

During fiscal 2006, the prior year deferred taxvaluation allowance of $9,740,000 was reversed, due to the determination by theCompany that the benefits of the deferred tax asset will more likely that notbe realized in the current and future years. The prior year valuation allowancewas established by a combination of prior year operating activities and theexercise of non-qualified stock options and disqualifying dispositions ofincentive stock options by employees. The amount that related to prior yearoperating activities totaled $2,715,000 and was recorded as a reduction ofcurrent year income tax expense. The amount that related to the exercise ofstock options of $7,025,000 was recorded as a component of equity in accordancewith the provisions of APB No. 25 and SFAS No. 109.

47

----

Thesignificant components of the net deferred tax assets at March 31, 2006and 2005 are as follows (in thousands):

| ** **                                             | ** ** | **2006**    | ** ** | **2005**        | ** ** |
|--------------------------------------------------------|------------|-------------|------------|-----------------|------------|
| ** **                                             | ** ** | **Current** | ** ** | **Non-current** | ** ** | **Current** | ** ** | **Non-current** | ** ** |
| Assets:                                                |       |        |       |            |       |   |   |   |   |   |   |   |   |   |   |
| Net operating  loss carry forwards                     |       |        | $          | —          |       |   |   | $ | 3 |   |   | $ | — |   |   | $ | 4,206 |   |   |
| Accounts  receivable and unbilled costs and fees       |       |        | 147        |            |       |   | — |   |   | 289 |   |   | — |   |   |
| Inventory                                              |       |        | 1,468      |            |       |   | — |   |   | 1,419 |   |   | — |   |   |
| Deferred revenue                                       |       |        | —     |            |       |   | 131 |   |   | — |   |   | 215 |   |   |
| Accrued vacation                                       |       |        | 338        |            |       |   | — |   |   | 271 |   |   | — |   |   |
| Accrued warranty  costs                                |       |        | 1,396      |            |       |   | — |   |   | 903 |   |   | — |   |   |
| Research &  development and other tax credits |       |        | —     |            |       |   | — |   |   | — |   |   | 2,052 |   |   |
| Depreciation                                           |       |        | —     |            |       |   | 470 |   |   | — |   |   | 341 |   |   |
| Unearned  compensation                                 |       |        | —     |            |       |   | 144 |   |   | — |   |   | — |   |   |
| Other                                                  |       |        | 32         |            |       |   | — |   |   | 20 |   |   | 24 |   |   |
| Deferred income  tax assets                            |       |        | 3,381      |            |       |   | 748 |   |   | 2,902 |   |   | 6,838 |   |   |
| Valuation  allowance                                   |       |        | —     |            |       |   | — |   |   | (2,902 | ) |   | (6,838 | ) |   |
| Net deferred income  taxes                             |       |        | $          | 3,381           |       |   |   | $ | 748 |   |   | $ | — |   |   | $ | — |   |   |

 

Included in prepaidexpenses at March 31, 2006 is $5,157,000 of prepaid taxes for estimatedtax payments made during the course of the year which are refundable as theCompany experienced greater than anticipated tax benefits from exercises ofstock options during the latter half of the fiscal year which have reduced theCompany’s taxable income.

**5.**                 WarrantyObligations

Certainof the Company’s products carry a one-year warranty, the costs of which areaccrued for at time of shipment or delivery. Accrual rates are based uponhistorical experience over the preceding twelve months and management’sjudgment of future exposure. Warranty experience for the years ended March 31,2006 and 2005 is as follows (in thousands):

| ** **                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Warranty accrual  at beginning of period          |       | $        | 2,322      |     | $          | 699 |   |
| Accruals for  warranties issued during the period |       | 2,816    |       | 2,979    |       |
| Warranty costs  incurred during period            |       | (1,532   | )          | (1,356   | )          |
| Warranty accrual at end  of period                |       | $        | 3,606      |     | $          | 2,322 |   |

 

**6.**                 Stockholders’Equity

**PreferredStock:**   The Company’s articles of organizationauthorize its Board of Directors to issue up to 100,000 shares of preferredstock in one or more series, to determine and fix certain relative rights andpreferences of the shares of any series, 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 Company has no presentplans to issue shares of preferred stock. In 1998, the Company designated aseries of Preferred Stock as Series A Junior Participating CumulativePreferred Stock (the “Series A Preferred Stock”) to be issued upon theexercise of Rights issued under the Company’s Shareholder Rights Plan. Underthe Shareholder Rights Plan, adopted in 1998, its stockholders are entitled topurchase shares of its Series A Preferred Stock under certaincircumstances. These circumstances include the purchase of 15% or more of theoutstanding shares of common stock by a person or group, or the announcement ofa tender or exchange offer to acquire 15% or more of the outstanding commonstock.

48

----

**CommonStock and Warrant Offering:**   On May 28,2002, the Company closed on a private placement offering of common stock andwarrants. A total of 1,115,000 shares were sold to accredited investors at aprice of $17.64 each. In addition, warrants to purchase an additional 295,475shares of common stock at a price of $23.52 were issued. Proceeds to theCompany approximated $18.4 million, net of approximately $1.3 million ofissuance costs of which $3.1 million was assigned to the warrants issued. Thewarrants were immediately vested and have a five-year life expiring in May of2007. Due to certain conversion features of these warrants that provide thatthe holder may opt for a cash settlement in certain instances, including amerger, a sale of all or substantially all of the Company’s assets, or a tenderoffer or exchange offer of shares of the Company’s stock, a liability equal tothe Black-Scholes valuation of the warrants at the deal closing date wasrecorded on the Company’s balance sheet. The “mark to market” change in thewarrants valuation of $6,094,000, $5,101,000, and $1,273,000 was recorded asother expense for the years ended March 31, 2006, March 31, 2005, andMarch 31, 2004, respectively. The liability of $4,038,000 and $6,137,000representing the fair market value of outstanding warrants at period end isrecorded as a non-current liability at March 31, 2006 and March 31,2005, respectively. The fair market value of the warrants was determined usingthe Black-Scholes pricing model with an assumed volatility of 49% and 73% at March 31,2006 and March 31, 2005, respectively, an interest rate of 4.6% and 3.25%at March 31, 2006 and March 31, 2005, respectively and a life equalto the remaining term of the warrants at each period end.

During the year ended March 31, 2006, warrants topurchase 78,825 shares of common stock were exercised resulting in totalproceeds received of $1,854,000. In addition, the Company issued 61,998 sharesof common stock upon the cashless exercise of warrants to purchase 85,475shares of common stock. The fair market value of the warrants at the date ofexercise totaled $8,193,000. The cash proceeds and the fair value of theliability were recorded as additional paid in capital at March 31, 2006.

**StockOption and Other Compensation Plans:**   The Companyhas various stock option and other compensation plans for directors, officers,and employees. The Company has the following stock option plans outstanding asof March 31, 2006: the 1995 Combination Plan, the 1996 Plan forNon-Employee Directors, the 1997 Non-Qualified Option Plan, the 1998Non-Qualified Option Plan, the 1999 Combination Plan, the 2000 CombinationPlan, the 2002 Combination Plan, the 2003 Stock Plan for Non-Employee Directorsand the 2005 Equity and Incentive Plan. There are 3,780,000 shares authorizedunder these plans. Vesting periods are at the discretion of the Board ofDirectors and typically range between one and three years. Options under theseplans are granted at fair market value and have a term of five or ten years fromthe date of grant.

The Company’s 2003 Stock Plan for Non-EmployeeDirectors allows for the granting of restricted stock to non-employeedirectors. The Company granted 3,512 shares of restricted common stock duringthe year ended March 31, 2006. Stock-based compensation cost is measuredon these restricted shares based on the fair value on the grant date, and isrecorded as unearned compensation as a separate component of stockholders’equity, and subsequently amortized as compensation expense over the one-yearvesting period.

During fiscal 2006, the Company instituted a long termincentive plan for certain key employees. The plan calls for the issuance ofrestricted stock and options which vest upon the achievement of certainperformance based goals. A total of 20,566 shares of restricted stock andoptions to purchase an additional 5,933 shares were granted during the yearended March 31, 2006. These performance-based awards are subject tovariable accounting. Stock-based compensation cost was measured on therestricted shares based on the fair value on the measurement date, and wasrecorded as unearned compensation as a separate component of stockholders’equity. This compensation cost is remeasured at each period end and is beingamortized to compensation expense over the projected vesting period. Compensationexpense of $372,000 was recorded during the period on these performance basedshares and options when the Company assessed that it was probable that theperformance vesting condition would be met. The compensation 

49

----

expense was measured basedon the intrinsic value of the performance awards as of March 31 2006. Thefair market value of the variable options was determined using theBlack-Scholes pricing model with an assumed volatility of 53%, an interest rateof 3.4 and an expected life of three years.

**Stock Option Activity:****  **A summary of the Company’s stock option activity isas follows:

| ** **                                                                | ** ** | **2006**                   | ** ** | **2005**                                     | ** ** | **2004**                   | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------------------------|------------|----------------------------|------------|
| ** **                                                                | ** ** | **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                                   |       | 1,065,964                  |       |                                         | $          | 20.66                      |       |   | 1,480,641 |   |   | $ | 10.66 |   |   | 2,159,860 |   |   | $ | 10.03 |   |   |
| Options granted                                                           |       | 378,010                    |       |                                         | 55.23      |                       |       | 507,795 |   |   | 31.75 |   |   | 485,685 |   |   | 11.48 |   |   |
| Options exercised                                                         |       | (554,954                   | )          |                                         | 18.23      |                       |       | (826,466 | ) |   | 10.34 |   |   | (477,619 | ) |   | 7.40 |   |   |
| Options canceled  or expired                                              |       | (10,550                    | )          |                                         | 44.44      |                       |       | (96,006 | ) |   | 13.87 |   |   | (687,285 | ) |   | 11.50 |   |   |
| Options  outstanding, end of year                                         |       | 878,470                    |       |                                         | $          | 36.79                      |       |   | 1,065,964 |   |   | $ | 20.66 |   |   | 1,480,641 |   |   | $ | 10.66 |   |   |
| Options  exercisable, end of year                                         |       | 265,778                    |       |                                         | $          | 18.80                      |       |   | 371,585 |   |   | $ | 10.74 |   |   | 863,360 |   |   | $ | 10.11 |   |   |
| Options available  for grant                                              |       | 440,835                    |       |                                         |       |                       |       | 87,943 |   |   |   |   |   | 586,845 |   |   |   |   |   |
| Weighted average fair  value per share of options granted during the year |       |                       |       |                                         | $          | 20.99                      |       |   |   |   |   | $ | 21.68 |   |   |   |   |   | $ | 7.40 |   |   |

 

Thefollowing summarizes certain data for options outstanding and exercisable atMarch 31, 2006:

| ** **            | ** ** | **Number of  Shares** | ** ** | **Range of   Exercise Prices** | ** ** | **Weighted  Average  Exercise  Price** | ** **       | **Weighted   Average  Remaining  Contractual Life** | ** ** |
|-----------------------|------------|----------------------------|------------|-----------------------------------------------|------------|----------------------------------------|------------------|---------------------------------------------------------------|------------|
| Options  outstanding: |       |                       | 10,767     |                                          |       | $                                      | 6.50—$10.00 |                                                          |       | $ | 7.14 |   |   |   | 4.5 |   |   |
|                  |       |                       | 249,003    |                                          |       | 10.01—20.00                       |             |                                                          | 11.96      |   |   |   | 6.9 |   |   |
|                  |       |                       | 116,250    |                                          |       | 20.01—30.00                       |             |                                                          | 27.24      |   |   |   | 8.4 |   |   |
|                  |       |                       | 74,041     |                                          |       | 30.01—40.00                       |             |                                                          | 38.95      |   |   |   | 8.7 |   |   |
|                  |       |                       | 88,199     |                                          |       | 40.01—50.00                       |             |                                                          | 44.88      |   |   |   | 9.0 |   |   |
|                  |       |                       | 243,810    |                                          |       | 50.01—60.00                       |             |                                                          | 53.65      |   |   |   | 9.1 |   |   |
|                  |       |                       | 95,800     |                                          |       | 60.01—80.00                       |             |                                                          | 63.92      |   |   |   | 9.6 |   |   |
|                  |       |                       | 600        |                                          |       | 80.01—83.02                       |             |                                                          | 83.02      |   |   |   | 10.0 |   |   |
|                  |       |                       | 878,470    |                                          |       |                                   |             |                                                          | $          | 36.79 |   |   |   | 8.4 |   |   |
| Options  exercisable: |       |                       | 9,100      |                                          |       | $                                      | 6.50—$10.00 |                                                          |       | $ | 6.98 |   |   |   |   |   |   |
|                  |       |                       | 154,703    |                                          |       | 10.01—20.00                       |             |                                                          | 11.59      |   |   |   |   |   |   |
|                  |       |                       | 85,200     |                                          |       | 20.01—30.00                       |             |                                                          | 28.42      |   |   |   |   |   |   |
|                  |       |                       | 7,375      |                                          |       | 30.01—40.00                       |             |                                                          | 37.96      |   |   |   |   |   |   |
|                  |       |                       | 9,400      |                                          |       | 40.01—47.13                       |             |                                                          | 46.51      |   |   |   |   |   |   |
|                  |       |                       | 265,778    |                                          |       |                                   |             |                                                          | $          | 18.80 |   |   |   |   |   |   |

 

The Company realizes a tax deduction upon the exerciseof non-qualified stock options and disqualifying dispositions of incentivestock options due to the recognition of compensation expense in the calculationof its taxable income. The amount of the compensation recognized for taxpurposes is based on the difference between the market value of the commonstock and the option price at the date the options are exercised and/or sold.These tax 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 2005 or 2004 as available tax benefits of $5,115,000and $550,000 were offset by valuation allowances in accordance with 

50

----

SFAS 109. During fiscal2006, a tax benefit of $10,515,000 was recorded to additional paid-in capitalfor fiscal 2006 exercises and/or sales and an additional $7,025,000 wasrecorded for prior year exercises and/or sales upon the reversal of the valuationallowance on deferred tax assets.

On April 22, 2005American Science and Engineering, Inc. announced that its Board ofDirectors had accelerated the vesting of certain unvested stock optionspreviously awarded to employees. The accelerated options were issued undervarious equity incentive plans maintained by the Company. The acceleration ofoutstanding unvested options was immediately effective on a fully-vested basis.Options held by the Chief Executive Officer, the Chief Financial Officer, all othermembers of management, and any other employees participating in incentive orcommission compensation plans were not included in the acceleration plan.Options held by members of the Board of Directors were also excluded from thevesting acceleration. Options to purchase approximately 193,553 shares ofcommon stock were subject to acceleration. The Company effected thisacceleration in order to provide a deserved reward to relevant employees fortheir significant contributions in connection with the outstanding performanceof the Company. The Board of Directors determined that such action was also inthe best interests of the shareholders as it believed that such plan wouldengender loyalty, promote equity ownership, and encourage increased futureperformance by the subject employee population. The Company recordedcompensation expense of $64,000 during the year ended March 31, 2006related to these accelerated options for options exercised by individuals whoterminated employment prior to the original option vesting date.

**7.**                 BusinessSegment Information

In accordance with the provisions of SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” theCompany has determined that it has only one operating segment, the X-rayproduct segment. This includes X-ray detection and imaging products usedprimarily for the detection of illegal drugs, weapons and explosives, andsmuggled goods. The equipment is purchased by sophisticated government andcommercial clients focused on the detection of organic material in complexbackgrounds and the ability to see the contents of containers with precision.

**Geographical Data:**   Allof the Company’s export sales originate from the United States. Less than 1% ofthe Company’s assets are in any foreign country. The following table shows thebreakdown of net sales and contract revenues to foreign and domestic customersand the major regions of international activity based upon customer country ofdomicile (in thousands):

| ** **                                         | ** ** | **Fiscal Year** | ** ** |
|----------------------------------------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Domestic                                           |       | $                    | 141,491    |   | 86 | % | $ | 75,376 |   | 85 | % | $ | 66,848 |   | 88 | % |
| International                                      |       | 22,113               |       | 14 | % | 12,938 |   | 15 | % | 9,494 |   | 12 | % |
| Net Sales and  Contract Revenues                   |       | $                    | 163,604    |   | 100 | % | $ | 88,314 |   | 100 | % | $ | 76,342 |   | 100 | % |
| Percent of  International Revenue by Major Region: |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Middle East & Africa                      |       | 50.4                 | %          |   |   | 15.9 | % |   |   | 34.2 | % |   |   |
| Pacific Rim                                        |       | 36.4                 | %          |   |   | 62.6 | % |   |   | 34.4 | % |   |   |
| Europe                                             |       | 11.4                 | %          |   |   | 21.5 | % |   |   | 29.1 | % |   |   |
| All Other                                          |       | 1.8                  | %          |   |   | — | % |   |   | 2.3 | % |   |   |

 

**MajorCustomers:**   Sales to major customers(representing in excess of 10% of consolidated revenues) consisted of thefollowing:

***Fiscal 2006:***   $48,722,000and $43,485,000, respectively, to two customers.

51

----

***Fiscal 2005:***   $14,639,000,$11,755,000 and $11,274,000 respectively, to three customers.

***Fiscal 2004:***   $14,674,000and $11,090,000 respectively, to two customers.

Domestically, the Company’s primary client base iscomprised of agencies of the U.S. Government. Approximately 77%, 75%, and 77%of the Company’s sales in fiscal 2006, 2005 and 2004 respectively, were derivedfrom either (i) contracting directly with the U.S. Government, or (ii) contractingwith contractors working directly with the U.S. Government. Certain of theCompany’s contracts with the U.S. Government provide the U.S. Government withthe standard unilateral right to terminate these contracts for convenience. Todate, the Company has not experienced any material losses as a result of thiscontractual provision.

Three customers at March 31, 2006 had accountsreceivable balances representing in excess of 10% of consolidated accountsreceivable. These customers, all agencies of the U.S. Government, hadreceivables totaling $8,128,000 (31%), $3,574,000 (14%) and $2,713,000 (10%) atMarch 31, 2006. Three customers at March 31, 2005 had accountsreceivable balances representing in excess of 10% of consolidated accountsreceivable. Two of these customers, both agencies of the U.S. Government, hadreceivables totaling $9,363,000 (33%) and $2,960,000 (11%) at March 31,2005. The third customer, a subcontractor to the U.S. Government, had a receivabletotaling $5,210,000 (18%) at March 31, 2005.

Included in unbilled costsand fees at March 31, 2006 was $2,414,000 related to two customers, whichis expected to be billed and collected during fiscal 2007. There were noindividually significant unbilled costs and fees outstanding at March 31,2005.

**8.**                 Salesof Assets

In January 2005, theCompany completed an agreement to sell certain assets, comprised of inventory,fixed assets, intellectual property, and certain revenue producing contracts ofits High Energy Systems Division to Accuray, Incorporated (“Accuray”). Thesales price for these assets totaled $8,300,000 of which $5,500,000 wasreceived in cash and $2,800,000 in the form of a promissory note (presented asnote receivable in the consolidated balance sheet at March 31, 2005),$2,000,000 of which was secured by a letter of credit. The note receivable borean interest rate of 7% and matured in January of 2006. The Companyrecognized a gain on the sale of these assets of $5,442,000, which was includedin income (loss) from operations in the year ended March 31, 2005. Duringfiscal 2006, upon expiration of the warranty period for material sold, theunused warranty reserve of $336,000, established at the time of sale, wasreversed and is included as additional gain on sale of assets for the yearended March 31, 2006. In conjunction with this sale, certain employees ofthe High Energy Systems Division were employed by Accuray and the Companyentered into a license agreement and a supply agreement for linear acceleratorswith Accuray.

**9.**                 Commitmentsand Contingencies

**DeferredCompensation:**   The Company had an unfundeddeferred compensation plan, originally adopted in 1976 and amended at varioustimes, for certain retired directors. This plan is closed such that no otherdirectors are qualified for compensation under this plan. This plan providesfor periodic payments beginning at age 65, the amount of which depends on thedirector’s length of service. The Company paid $17,000 in 2006, $18,000 in2005, and $14,000 in 2004 under this deferred compensation plan. As of March 31,2006 and 2005, $69,000 and $93,000 respectively, is accrued for under thisplan.

**LeaseLiability:****  **Inconjunction with the sale of the High Energy Systems division in fiscal 2005(see Note 8), the lease for the California operations of the High EnergySystems Division was assigned to Accuray. The Company remains secondarilyliable for the remaining lease payments in the event of default by Accurayduring the lease term which expires in February 2011. Total remaininglease payments at 

52

----

March 31, 2006totaled $1,803,000. No accrual for this contingent liability has been recordedat March 31, 2006 as payment of this expense is considered remote.

**Litigation:****  **In February 2004, L-3 Communications, Inc.(“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’s patents- United States Patent No. 6,292,533 and No. 5,903,623. The Companyanswered L-3’s underlying complaint, vigorously opposing the plaintiff’snon-infringement and invalidity claims, and subsequently engaged in substantialdiscovery. In November 2005 the Company filed a motion to dismiss the case.Pending the court’s ruling, the parties have suspended discovery as to theunderlying claims.

The Company is also subject to various legalproceedings and claims that arise in the ordinary course of business. At thepresent time, it is not possible to predict the outcome of these matters;however, the Company currently believes that resolving these matters will nothave a material adverse impact on its financial condition, results ofoperations or cash flows.

**PurchaseCommitments:**   In the normal course of business,the Company enters into purchase orders with its vendors for the purchase ofmaterials or services to meet its production needs. At March 31, 2006, theCompany had $ 4,498,000 of open purchase orders which are expected to befulfilled primarily within the next 2 years. Certain single source vendors orvendors producing custom material require significant lead times from order todelivery of their material. Should the demand for the Company’s productsdecline significantly, or should there be a significant shift in the mix ofproducts being demanded, the Company may incur cancellation charges related tothese commitments, that could be material to the Company’s results ofoperations. To date, the Company has not experienced any material lossesrelated to cancellation penalties.

**EmploymentAgreements:**   On September 15, 2005, theCompany’s Board of Directors approved a Change of Control and Termination forConvenience program for the Company’s Chief Executive Officer and other membersof the Company’s executive staff, including its Chief Financial Officer. Underthis program the Company’s Chief Executive Officer, in the event of a change ofcontrol, is eligible to receive a payment equal to three times his average basesalary plus his annual target bonus, the continuation of health benefits for aperiod of three years and the vesting of all options and restricted stock. Inthe event of termination without cause, the Chief Executive Officer is eligiblefor a payment equal to two times his average base salary and the continuationof health benefits for a period of eighteen months. The Company’s otherexecutive staff, in the event of a change of control, are eligible to receive apayment equal to one year’s average base salary plus his or her annual targetbonus , the continuation of health benefits for a period of three years and thevesting of all options and restricted stock.  In the event of termination without cause, themembers of the executive staff are eligible to receive a payment equal to onetimes his or her average base salary and the continuation of health benefitsfor one year.

**RetirementSavings Plan:**   The Company maintains a 401(k) RetirementSavings Plan for all employees with more than 500 hours and 6 months ofcredited service annually. The Plan is funded by elective employeecontributions of up to 15% of their compensation. Under the Plan the Companymatches 50% of employee contributions for each participant up to 3% ofcompensation in the form of Company common stock. Expenses under the Plan,consisting of Company contributions and Plan administrative expenses paid bythe Company, totaled $520,000, $462,000, and $390,000, in 2006, 2005, and 2004respectively.

53

----

**American Scienceand Engineering, Inc. and SubsidiaryUnaudited Quarterly Consolidated Financial DataFor the Years Ended March 31, 2006 and March 31, 2005**

| ** **                       | ** ** | **2006 by quarter**                                         | ** ** | **2005 by quarter** | ** ** |
|----------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **1st**                                                               | ** ** | **2nd**                       | ** ** | **3rd** | ** ** | **4th** | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th(1)** | ** ** |
| ** **                       | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net sales and  contract revenues |       | $                                                                     | 35,162     |                          | $          | 49,141 |   | $ | 38,540 |   | $ | 40,761 |   | $ | 16,812 |   | $ | 21,054 |   | $ | 23,480 |   | $ | 26,968 |   |
| Gross profit                     |       | 14,592                                                                |       | 24,776                        |       | 19,374 |   | 19,456 |   | 5,138 |   | 6,997 |   | 8,509 |   | 9,844 |   |
| Operating income                 |       | 8,032                                                                 |       | 17,607                        |       | 12,627 |   | 11,025 |   | 409 |   | 2,538 |   | 3,368 |   | 9,601 |   |
| Net income (loss)                |       | 6,997                                                                 |       | 8,396                         |       | 9,668 |   | 4,725 |   | (541 | ) | 400 |   | 2,023 |   | 9,303 |   |
| Net income (loss) per  share     |       |                                                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| —Basic                      |       | $                                                                     | 0.84       |                          | $          | 0.99 |   | $ | 1.12 |   | $ | 0.54 |   | $ | (0.07 | ) | $ | 0.05 |   | $ | 0.25 |   | $ | 1.13 |   |
| —Diluted                    |       | $                                                                     | 0.78       |                          | $          | 0.93 |   | $ | 0.95 |   | $ | 0.51 |   | $ | (0.07 | ) | $ | 0.05 |   | $ | 0.23 |   | $ | 1.04 |   |

----

(1)          The fourth quarter of2005 net income includes $5.4 million in operating income related to the gainon the sale of certain assets of Company’s High Energy Systems division in January 2005.

54

----

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Company has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.

|                          |   | AMERICAN SCIENCE AND ENGINEERING, INC. |
|--------------------------|--------|----------------------------------------|
| DATED: June 9, 2006 |   | By:                                    | /s/ ANTHONY R. FABIANO |
|                     |   |                                   | Anthony R. Fabiano |
|                     |   |                                   | President and Chief Executive Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Company and in thecapacities and on the dates indicated:

|                         | **Signature** | ** **                                  | ** ** | ** **        | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------|---------------|---------------------------------------------|------------|-------------------|-----------|------------|------------|------------|----------|------------|
| /s/ ANTHONY R.  FABIANO |          | Director and  President and Chief Executive |       | June 9, 2006 |
| Anthony  R. Fabiano     |          | Officer (Principal  Executive Officer)      |       |              |
| /s/ KENNETH  J.GALAZNIK |          | Chief Financial  Officer and Treasurer      |       | June 9, 2006 |
| Kenneth  J. Galaznik    |          | (Principal Financial  Officer)              |       |              |
| /s/ DENIS R. BROWN      |          | Director                                    |       | June 9, 2006 |
| Denis  R. Brown         |          |                                        |       |              |
| /s/ ROGER P. HEINISCH   |          | Director                                    |       | June 9, 2006 |
| Roger  P. Heinisch      |          |                                        |       |              |
| /s/ HAMILTON  W. HELMER |          | Director                                    |       | June 9, 2006 |
| Hamilton  W. Helmer     |          |                                        |       |              |
| /s/ ERNEST J.  MONIZ    |          | Director                                    |       | June 9, 2006 |
| Ernest  J. Moniz        |          |                                        |       |              |
| /s/ WILLIAM E.  ODOM    |          | Chairman of the  Board, Director            |       | June 9, 2006 |
| William  E. Odom        |          |                                        |       |              |
| /s/ MARK S. THOMPSON    |          | Director                                    |       | June 9, 2006 |
| Mark  S. Thompson       |          |                                        |       |              |
| /s/ CARL W. VOGT        |          | Director                                    |       | June 9, 2006 |
| Carl W. Vogt            |          |                                        |       |              |

 

 

55

----

**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 the 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 the 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 By-laws 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)                                                                                                                    |       |                                                                                              |       |                           |
| (4)(a)        |                 | Shareholder  Rights Agreement (filed as Exhibit to the Company’s filing on  Form 8-A12B dated April 17, 1998 and incorporated herein by  reference)                                                                                           |       |                                                                                              |       |                           |
| (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  Company’s 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 Exhibit 10(c)(ii) 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 (filed as Exhibit 10-1 to the  Company’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 1999 and incorporated herein by reference)                                               |       |                                                                                              |       |                           |
| (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)                                     |       |                                                                                              |       |                           |
|               |                      |                                                                                                                                                                                                                                                                   |            |                                                                                                   |            |                                |        |  |  |

56

----

 

| (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)(xv)    |   | Lease of Mountain  View, California 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)(c)(xvii)  |   | Second Amendment  of Lease of 829 Middlesex Turnpike, Billerica, Massachusetts (filed as Exhibit 10(c)(vii) to  the Company’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2004, and incorporated herein by reference)             |   |   |   |   |
| (10)(c)(xviii) |   | Amendment of 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)(xix)   |   | 2003 Stock Plan  for Non-Employee Directors (filed as Exhibit 4.1 to the Company’s  Registration Statement on Form S-8, File No. 333-117843,  filed on July 30, 2004 and incorporated herein by reference)                                              |   |   |   |   |
| (10)(c)(xx)    |   | Amendment to 2003  Stock Plan for Non-Employee Directors (filed as Exhibit 10(c)(xx) to the  Company’s Annual Report on Form 10-K for the year ended  March 31, 2005 and incorporated herein by reference)                                                   |   |   |   |   |
| (10)(c)(xxi)   |   | 2005 Equity and  Incentive Plan (filed as Exhibit 4.1 to the Company’s Registration  Statement on Form S-8, No. 333-129851, filed on  November 21, 2005 and incorporated herein by reference)                                                           |   |   |   |   |
| (10)(c)(xxii)  |   | Change in  Control & Severance Benefit Agreement between the Company and  Anthony Fabiano, dated November 3, 2005 (filed herewith)                                                                                                                                 |   |   |   |   |
| (10)(c)(xxiii) |   | Form of  Change in Control & Severance Benefit Agreement between the Company  and Named Executives (filed herewith)                                                                                                                                                |   |   |   |   |
| (10)(c)(xxiv)  |   | Form of  Restricted Stock Agreement (Performance) under the AS&E 2005 Equity  and Incentive Plan (filed herewith)                                                                                                                                                  |   |   |   |   |
| (10)(c)(xxv)   |   | Form of  Stock Option Agreement (Performance) under the AS&E 2005 Equity and  Incentive Plan (filed herewith)                                                                                                                                                      |   |   |   |   |
| (10)(c)(xxvi)  |   | Form of  Stock Option Agreement (ISO) under the AS&E 2005 Equity and Incentive  Plan (filed herewith)                                                                                                                                                                   |   |   |   |   |

57

----

 

| (10)(c)(xxvii) |   | Form of  Stock Option Agreement (NQ) under the AS&E 2005 Equity and Incentive Plan  (filed herewith)                                                                                                                                                                                                                                    |   |   |   |   |
|----------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| (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) |   |   |   |   |
| (10)(d)(xiii)  |   | Asset Purchase  Agreement between Accuray Incorporated and American Science and  Engineering, Inc. dated December 11, 2004**                                                                                                                                                                                                           |   |   |   |   |
| (22.1)         |   | Identification of  Company’s subsidiary, AS&E Global, Inc., incorporated in  Massachusetts (filed as Exhibit 22.1 to the 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)         |   | Consent of  Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                        |   |   |   |   |
| (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                                                                                                                                                                                    |   |   |   |   |

----

*                    Contract withManagement

**             The Registrant agreesto furnish a supplemental copy of the schedules to this agreement to the SECupon request

58

----