UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2005

OR

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

For the transition period from               to

Commission File Number 1-6549

American Science and Engineering, Inc.

(Exact name of Registrant as specified in its charter)

(978) 262-8700

(Registrant’s telephone number, including area code)

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

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

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

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

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

American Science and Engineering, Inc. and Subsidiary

Index

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PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

American Science and Engineering, Inc. and Subsidiary

Condensed Consolidated Balance Sheets

(Unaudited)

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

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American Science and Engineering, Inc. and Subsidiary

Condensed Consolidated Statements of Operations

(Unaudited)

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

4

American Science and Engineering, Inc. and Subsidiary

Condensed Consolidated Statements of Cash Flows

(Unaudited)

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

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American Science and Engineering, Inc. and Subsidiary

Notes to Unaudited Condensed Consolidated Financial Statements

1.               General

The condensed consolidated financial statements include the accounts of the Company and its wholly owned Subsidiary. All intercompany transactions and balances have been eliminated.

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

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

Nature of Operations

The Company is engaged in the development and manufacture of sophisticated X-ray inspection systems for critical detection and security screening solutions for sale primarily to U.S. and foreign government agencies.  The Company has only one reporting segment, X-ray screening products.

Significant Accounting Policies

Revenues on cost reimbursable and long-term fixed price contracts are generally recorded as costs are incurred using the percentage of completion method.  For systems that are produced in a standard manufacturing operation and have shorter order to delivery cycles, the Company recognizes sales at the time of shipment of the system to the customer and when other revenue recognition criteria are met.

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

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

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

Comprehensive Income

Comprehensive income is comprised of the following:

Pro Forma Stock-Based Compensation Expense

As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company has elected to continue to apply Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for its stock-based compensation plans. Had compensation cost for awards under the Company’s stock-based compensation plans been determined based on the fair 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 would have been as follows:

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The fair value of each option granted was estimated on the grant date using the Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 3.4% and 3.8% for fiscal 2006 and fiscal 2005, respectively, expected volatility of 62% and 72% for fiscal 2006 and 2005, respectively, an expected dividend yield of 0% for both periods and an expected life of 3 to 5 years and 5 years for fiscal years 2006 and 2005, respectively.

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

2.               Inventories

Inventories consisted of:

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

3.               Income per Common and Common Equivalent Share

Basic earnings (loss) per common share is computed by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding during the period.  Diluted earnings (loss) per share include the dilutive impact of options and warrants using the average share price of the Company’s common stock for the period. For the quarters and six months ended September 30, 2005 and September 30, 2004, common stock equivalents of 177,000, 304,000, 179,000 and 835,000, respectively, are excluded from diluted earnings per share, as their effect is anti-dilutive.

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4.               Borrowings

On November 30, 2004, the Company modified its two credit agreements with Silicon Valley Bank East.  The modifications extended the credit facilities which expired on November 30, 2004 through November 29, 2006 and reduced the export loan and security facility, guaranteed by the Export-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 to support the Company’s routine working capital needs. Maximum borrowings for this facility are set at the lower of (a) the sum of 80% of eligible domestic accounts receivable plus 10% of finished goods inventory up to $750,000, or (b) $5 million.

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

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

5.               Warrant Liability

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

During the quarter ended September 30, 2005, warrants to purchase 18,050 shares of common stock were exercised resulting in total proceeds received of $425,000.  The fair market value of the warrants at the date of exercise totaled $765,000.  The cash proceeds and the fair value of the liability were recorded as additional paid in capital at September 30, 2005.

At September 30, 2005, 167,700 warrants remain outstanding.   Due to certain conversion features of these warrants that provide that the holder may opt for a cash settlement in certain instances, including a merger, a sale of all or substantially all of the Company’s assets, or a tender offer or exchange offer of shares of the Company’s stock, a liability equal to the Black-Scholes valuation of the warrants at the deal closing date was recorded on the Company’s balance sheet. The “mark to market” change in the warrants valuation of $3,450,000 and $2,266,000 was recorded as other expense for the three months ended September 30, 2005 and September 30, 2004, respectively.  The “mark to market” change in the warrants valuation of $2,917,000 and $3,187,000 was recorded as other expense for the six months ended September 30, 2005 and September 30, 2004, respectively.  The liability of $7,592,000 and $6,137,000 representing the fair market value of outstanding warrants at period end is recorded as a non-current liability at September 30, 2005 and March 31, 2005, respectively. The fair market value of the warrants was determined using the Black-Scholes pricing model with an assumed volatility of 72% and 73% at September 30, 2005 and March 31, 2005, respectively, an interest rate of 3.125% and 3.25% at September 30, 2005 and March 31, 2005, respectively and a life equal to the remaining term of the warrants at each period end.

6.               Income Taxes

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

In the first quarter of fiscal 2006, the Company reevaluated its valuation allowance for deferred tax assets and determined that a full release of valuation allowances was appropriate based upon period earnings, the Company’s updated forecasted earnings for fiscal 2006, sales backlog and other factors.  The release of the valuation allowance, as it relates to tax expenses, has been included in determining the Company’s annual effective tax rate for fiscal 2006.  In connection with this release, the Company also recorded a corresponding entry to paid in capital totaling $7,025,000 for net operating loss carry-forwards resulting from the exercise of certain

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employee stock options.

7.               Guarantees

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

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

8.               Lease Commitments

In March 2005, the Company renewed its lease agreement for its corporate headquarters and manufacturing facilities in Billerica, Massachusetts.  As part of the lease agreement, the Company’s landlord agreed to certain renovations to the Billerica facility including the construction of additional high bay manufacturing space.  The Company is responsible for a portion of the construction costs and was deemed to be the owner of the building during the construction period under EITF 97-10 “The Effect of Lessee Involvement in Asset Construction”.  During the quarter ended September 30, 2005, upon commencement of the construction project, the Company capitalized $5,153,000 to record the building facility on its books with an offsetting credit to the Leasehold financing liability.  In addition, amounts paid for construction were recorded as construction in progress and the landlord construction contributions of $1,500,000 in the period were recorded as additional leasehold financing liability.  In connection with the construction, the Company has entered into a construction contract with a total commitment of $6,419,000.

Upon completion of construction, the lease may qualify for sale-leaseback treatment in accordance with SFAS No. 98.  For these leases, the deemed landlord financing liability and the associated construction-in-progress and capitalized building costs will be removed and the difference will be reclassified to prepaid or deferred rent and amortized over the lease term as rent expense.  If the lease does not qualify for sale-leaseback treatment in accordance with SFAS No. 98, the deemed landlord financing liability will be amortized over the lease term based on the payments designated in the agreement and the building and improvement assets will be depreciated on a straight line basis over their useful lives.

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

Results of Operations

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

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

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

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compared to the corresponding period a year ago.  Cost of product sales and contract revenues represented 47% of revenues versus 69% of revenue for the corresponding period last year.  This improvement in gross margin is due primarily to the mix of products sold in the period, improved absorption of fixed overhead costs due to the significant volume increases, and the reduction of direct costs of certain products through improved supplier agreements and a reduction of internal labor costs per system due to operating efficiencies.   Some of the product gross margin improvement was offset by an increase in reserves for excess and obsolete inventory ($1,000,000) in the quarter due to changes in the Company’s projected mix of product usage.  Cost of services revenues increased by $1,889,000 to $4,584,000 as compared to the corresponding period a year ago.  Cost of service revenues represented 64% of revenues versus 59% for the corresponding period last year.  This margin decline is due primarily to comparatively higher costs incurred on certain service contracts during the period.

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

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

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

Company funded research and development expenses of $2,470,000 for the second quarter of fiscal 2006 increased by $1,458,000 compared to the corresponding period last year. Research and development expenses remained constant at 5% of revenues in both periods reported.   These expenditures increased primarily due to three product development programs ongoing during the quarter.

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

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

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

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

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

In the first quarter of fiscal 2006, the Company reevaluated its valuation allowance for deferred tax assets and has determined that a full release of valuation allowance was appropriate based upon period earnings, the Company’s updated forecasted earnings for fiscal 2006, sales backlog and other factors.  The release of the valuation allowance has been included in determining the Company’s annual effective tax rate for fiscal 2006.  In connection with this release, the Company recorded a corresponding entry to paid in capital totaling $7,025,000 for net operating loss carry-forwards resulting from the exercise of certain employee stock options.

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

Liquidity and Capital Resources

Cash and cash equivalents increased by $14,822,000 to $30,240,000 at September 30, 2005 compared to $15,418,000 at March 31, 2005. This increase in cash and cash equivalents is due to cash provided by operations generated primarily from profits earned during the quarter and a decrease in inventory balances and corresponding increase in outstanding accounts receivable attributable to the increased revenues and shipments during the period.  In addition, the Company received $4,417,000 upon exercise of outstanding stock options and warrants and $1,500,000 advance payment received from the landlord for leasehold improvements.   These increases were offset somewhat by net purchases of short term investments of $1,531,000 during the period and $3,522,000 in capital expenditures related primarily to the Company’s ongoing ERP system implementation, the construction of certain systems to be used for marketing demonstration purposes, and construction related costs on a building expansion project commenced during the quarter ended September 30, 2005.

On November 30, 2004, the Company modified its two credit agreements with Silicon Valley Bank East.  The modifications extended the credit facilities which expired on November 30, 2004 through November 29, 2006 and reduced the export loan and security facility, guaranteed by the Export-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 to support the Company’s routine working capital needs. Maximum borrowings for this facility are set at the lower of (a) the sum of 80% of eligible domestic accounts receivable plus 10% of finished goods inventory up to $750,000, or (b) $5 million.

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

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

New Accounting Pronouncements:

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

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

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be included in the cost of inventory. As amended by SFAS No. 151, the “so-abnormal” criterion has been eliminated. Thus, all such abnormal costs are required to be treated as current-period charges under all circumstances. In addition, fixed production overhead should be allocated based on the normal capacity of the production facilities, with unallocated overhead charged to expense when incurred. SFAS 151 is required to be adopted for fiscal years beginning after June 15, 2005. The Company does not believe its adoption will have a material impact on its results of operations, financial position and cash flows.

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

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

The cash accounts for the Company’s operations in Singapore, Hong Kong, England, and Abu Dhabi are maintained in Singapore dollars, Hong Kong dollars, pounds sterling and dirhams, respectively. Foreign currency accounts are marked to market at current rates that resulted in immaterial translation adjustments to stockholders’ equity. The gains and losses from foreign currency transactions are included in the statement of operations for the period and were also immaterial. A hypothetical 10% change in foreign currency rates would not have a material impact on the Company’s results of operations or financial position.

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

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

Item 4 - Controls and Procedures

a)             Evaluation of disclosure controls and procedures.

As of the end of the period covered by this report, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the Company reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 as amended (the “Exchange Act”). Based upon their evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in the reports filed and submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

b)            Changes in internal controls

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

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

In February 2004, L-3 Communications, Inc. (“L-3”) filed a lawsuit against the Company in the United States District Court for the District of Massachusetts in Boston, seeking declaratory judgments 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 Company answered L-3’s underlying complaint, vigorously opposing the plaintiff’s non-infringement and invalidity claims, and subsequently engaged in substantial discovery. In September 2005, the court denied a motion filed by the Company for summary judgment and granted a related motion that was later filed by L-3 regarding certain of the claims in one of the patents.  The court’s ruling, which is currently the subject of a motion for reconsideration,

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does not address other claims in the case, which remain to be adjudicated.  The parties continue to engage in discovery as to the remaining claims.

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

Item 4 - Submission of Matters to a Vote of Security Holders

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

Item 6 - Exhibits

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

SIGNATURES

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

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Safe Harbor Statement

The foregoing 10-Q contains statements concerning the Company’s financial performance and business operations, which may be considered “forward-looking” under applicable securities laws.

The Company wishes to caution readers of this Form 10-Q that actual results might differ materially from those projected in any forward-looking statements.

Factors which might cause actual results to differ materially from those projected in the forward-looking statements contained herein include the following: significant reductions or delays in procurements of the Company’s systems by the United States and other governments; disruption in the supply of any source component incorporated into AS&E’s products; litigation seeking to restrict the use of intellectual property used by the Company; potential product liability claims against the Company; global political trends and events which affect public perception of the threat presented by drugs, explosives and other contraband; global economic developments and the ability of governments and private organizations to fund purchases of the Company’s products to address such threats; and the potential insufficiency of Company resources, including human resources, capital, plant and equipment and management systems, to accommodate any future growth and any future delays in federal funding. These and certain other factors which might cause actual results to differ materially from those projected are more fully set forth under the caption “Forward-Looking Information and Factors Affecting Future Performance” in the Company’s Registration Statement on Form 10-K.

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