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ASEI > SEC Filings for ASEI > Form 10-K on 6-Jun-2014All Recent SEC Filings

Show all filings for AMERICAN SCIENCE & ENGINEERING, INC.

Form 10-K for AMERICAN SCIENCE & ENGINEERING, INC.


6-Jun-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto which appear elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements and should also be read in conjunction with the "Cautionary Statement" included at the beginning of this Annual Report on Form 10-K.

Overview American Science and Engineering, Inc. develops and manufactures state-of-the-art X-ray inspection systems for homeland security, force protection, public safety and other critical defense applications. We provide maintenance, warranty, engineering, and training services related to these products.


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Our primary technologies are Z Backscatter technology which is used to detect explosives, illegal drugs, and other contraband even when artfully concealed in complex backgrounds; and other technologies that expand the detection capability of our products beyond the material discrimination features of the Z Backscatter technology to include the penetration capability of high-energy transmission X-rays for dense cargos and/or other detection techniques.

The following table presents net sales and contract revenues by product and service categories:

                                                        For the fiscal year ended
(In thousands)                                        2014        2013        2012
Cargo Inspection Systems                            $  62,781   $  49,925   $  33,871
Mobile Cargo Inspection Systems                        38,975      31,558      46,874
Parcel and Personnel Screening Inspection Systems      10,994       7,825      20,419
Other product sales and contract revenue                8,501       9,181      12,960
Total net product sales and contract revenues         121,251      98,489     114,124
Net service revenues                                   68,998      88,191      89,428
Total net sales and contract revenues               $ 190,249   $ 186,680   $ 203,552

Net sales and contract revenues for fiscal 2014 increased by 2% to $190,249,000 compared to fiscal 2013 revenues of $186,680,000. We reported income before taxes of $22,733,000 in fiscal 2014 compared to income before taxes of $26,446,000 in the previous fiscal year. Net income for fiscal 2014 was $15,117,000 ($1.91 per share, on a diluted basis) as compared to a net income of $17,454,000 ($2.07 per share, on a diluted basis) in fiscal 2013. Backlog at March 31, 2014 was $176,113,000, a 5% decrease from the year-end backlog of $186,201,000 reported at March 31, 2013.

2014 Compared to 2013

Results of Operations Total net sales and contract revenues of $190,249,000 in fiscal 2014 increased by $3,569,000 or 2% from the previous year. Revenues related to product sales and contracts increased by $22,762,000 or 23% to $121,251,000 in fiscal 2014 due to the factors described further below. Cargo Inspection System revenues increased by $12,856,000 from the prior year due to the completion of numerous system installations related to two multi-unit contracts during the year. Mobile Cargo Inspection System revenues increased by $7,417,000 due primarily to two multi-unit orders received in the third quarter of fiscal 2014 and fulfilled in part during the fourth quarter of fiscal 2014. Parcel and Personnel Screening Inspection System revenues increased by $3,169,000 from the prior year due primarily to one large multi-unit order fulfilled in the current year. Custom Product revenues decreased by $1,426,000 due to the winding down of programs in progress and a reduction in backlog as government spending on these programs has slowed. Service revenues decreased in fiscal 2014 by $19,193,000 or 22% to $68,998,000, due primarily to the expiration or reduction of service contracts for certain systems taken out of service in conjunction with the withdrawal of U.S. forces from Iraq.

In fiscal 2014 and fiscal 2013, 50% and 66% of our revenues, respectively, were from domestic customers (as determined based upon the customer's country of domicile). In fiscal 2014, we had revenue from three customers which accounted for 45% of total sales. In fiscal 2013, we had revenue from two customers which accounted for 41% of total sales.

Cost of sales and contracts of $113,599,000 in fiscal 2014 increased by $6,338,000 or 6% from the previous year. Cost of product sales and contracts of $76,952,000 in fiscal 2014 increased by $8,738,000 or 13% as compared to the prior year. Cost of product sales and contracts totaled 64% of revenues in fiscal 2014, as compared to 69% of revenues in fiscal 2013. The resultant increase in gross margin is primarily due to a reduction in the provision for inventory reserves as compared to the prior year period. In fiscal year 2013, we recorded $5.1 million in inventory reserves as compared to $1.4 million in fiscal 2014. In addition, the Company recorded a $4.1 million charge to settle a contractual issue with a customer in fiscal 2013; this was not repeated in fiscal 2014. Our cost of service revenues of $36,647,000 decreased by $2,400,000, or 6%, from the prior year. Cost of service revenues totaled 53% of revenues in fiscal 2014 as compared to 44% of revenues in fiscal 2013. The resultant decline in gross margin is due primarily to a shift in the cost structure of certain government contracts renewed during the period as well as increased material and labor costs required to support fixed price contracts as compared to the prior year.

Selling, general and administrative expenses in fiscal 2014 increased by $2,272,000 to $31,805,000 as compared to $29,533,000 in fiscal 2013, and represented 17% of revenues in fiscal 2014, as compared to 16% of revenues in fiscal 2013. The increase in selling, general and administrative expenses over the prior period was primarily the result of an increase in incentive compensation expense of $4,258,000 due in part to the reversal during the quarter ended September 30, 2012 of incentive accruals for our former President and Chief Executive Officer as well as the achievement in the current year of certain short-term and long-term incentive goals. Offsetting this increase were decreases in travel related expenses of $178,000, decreases in marketing related costs of $294,000, decreases in consulting costs of $693,000, decreases in the reserve for doubtful accounts of $371,000 and decreases in legal fees of $405,000 as compared to the prior year period.


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Company-funded research and development spending decreased by $1,529,000 to $22,089,000 in fiscal 2014 which is an 6% decrease as compared to the $23,618,000 spent in fiscal 2013. Research and development spending represented 12% of revenues in fiscal 2014 as compared to 13% of revenues in fiscal 2013. Research and development spending in fiscal 2014 focused on new product development, the development of new applications and new technologies, and design modifications and enhancements to our existing products.

Other income (expense) was $23,000 in expense in fiscal 2014 as compared to $178,000 in income in fiscal 2013. The change in other income (expense) was due primarily to a reduction in investment income as a result of a decline in our average investment balance as compared to the prior year.

We reported pre-tax income of $22,733,000 in fiscal 2014 as compared to a pre-tax income of $26,446,000 in the previous fiscal year primarily due to the items noted above. We recorded income tax expense of $7,616,000 in fiscal 2014 as compared to $8,992,000 in the prior fiscal year. Our effective tax rate was 33.5% in fiscal 2014 as compared to 34% in fiscal 2013.

We reported net income of $15,117,000 in fiscal 2014 as compared to net income of $17,454,000 in fiscal 2013.

2013 Compared to 2012

Results of Operations Total net sales and contract revenues of $186,680,000 in fiscal 2013 decreased by $16,872,000 or 8% from the previous year. Revenues related to product sales and contracts decreased by $15,635,000 or 14% due to the factors described further below. Mobile Cargo Inspection system revenues decreased by $15,316,000 due to a decrease in number of units sold during the year as demand continues to be impacted by reduced government spending and unrest in the Middle East. Parcel and Personnel Inspection System revenues decreased by $12,594,000 due to lower volume, as there was one large multi-unit order fulfilled in the prior year was not repeated in fiscal 2013. Custom Product revenues decreased by $2,284,000 due to the winding down of programs in progress and a reduction in backlog as government spending on these programs has slowed. These revenue decreases were offset by an increase of $16,054,000 in Cargo Inspection system revenues from the prior year attributable primarily to the completion on numerous system installations related to one multi-unit contract received in fiscal 2012. Service revenues decreased in fiscal 2013 by $1,237,000 or 1% to $88,191,000, due primarily to the cancellation of service contracts for certain systems taken out of service in conjunction with the withdrawal of U.S. forces from Iraq.

In both fiscal 2013 and fiscal 2012, 66% of our revenues, respectively, were from domestic customers (as determined based upon the customer's country of domicile). In fiscal 2013, we had revenue from two customers which accounted for 41% of total sales. In fiscal 2012, we had revenue from one customer which accounted for 23% of total sales.

Cost of sales and contracts of $107,261,000 in fiscal 2013 decreased by $3,174,000 or 3% from the previous year. Cost of product sales and contracts of $68,214,000 in fiscal 2013 increased by $2,714,000 or 4% as compared to the prior year. Cost of product sales and contracts totaled 69% of revenues in fiscal 2013, as compared to 57% of revenues in fiscal 2012. The resultant decrease in gross margin is primarily the result of the accrual of $4.1 million to settle a contractual issue in the Middle East; the incurrence of $1.3 million in severance related costs due to a force reduction; a $2.0 million increase in the expense for excess and obsolete inventory due primarily to the abandonment of one product development program; $1.1 million of accruals for product maintenance costs; $0.8 million in loss accruals provided for during the year on certain long-term contracts; and $0.6 million in write-downs of certain equipment to a lower of cost or net realizable value. The cost of service revenues decreased $5,888,000 or 13% from the prior year. Cost of service revenues totaled 44% of revenues in fiscal 2013 as compared to 50% of revenues in fiscal 2012. The resultant improvement in gross margin is due primarily to decreased third party service costs for equipment under fixed price service contracts as compared to the prior year.

Selling, general and administrative expenses in fiscal 2013 decreased by $6,091,000 to $29,533,000 as compared to $35,624,000 in fiscal 2012 and represented 16% of revenues in fiscal 2013 as compared to 18% of revenues in fiscal 2012. The decrease in selling, general and administrative expenses over the prior period was primarily the result of a decrease in incentive compensation of $4,874,000 due primarily to the cancellation of certain long-term incentive awards upon the termination of employment of certain executives during the year and a change in estimated payment dates of remaining awards; a decrease in payroll and payroll-related expenses of $483,000 due to a decrease in headcount offset by an increase in severance related costs associated with the workforce reduction; and a decrease in travel-related expenses of $652,000 from the prior year. These expense decreases were offset in part by an increase in consulting and recruiting costs of $860,000.

Company-funded research and development spending decreased by $1,926,000 to $23,618,000 in fiscal 2013 which is an 8% decrease as compared to the $25,544,000 spent in fiscal 2012. Research and development spending represented 13% of revenues in both fiscal 2013 and fiscal 2012. Research and development spending in fiscal 2013 focused on new product development, the development of new applications and new technologies, and design modifications and enhancements to its existing products.


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Other income was $178,000 in income in fiscal 2013 as compared to $509,000 in income in fiscal 2012. The change in other income was due primarily to foreign exchange losses incurred in the current year.

We reported pre-tax income of $26,446,000 in fiscal 2013 as compared to a pre-tax income of $32,458,000 in the previous fiscal year primarily due to the items noted above. We recorded income tax expense of $8,992,000 in fiscal 2013 as compared to $11,036,000 in the prior fiscal year. Our effective tax rate was 34.0% in both fiscal 2013 and in fiscal 2012.

We reported net income of $17,454,000 in fiscal 2013 as compared to net income of $21,422,000 in fiscal 2012.

Liquidity and Capital Resources

Cash and cash equivalents at year-end increased by $21,725,000 to $62,143,000 at March 31, 2014 as compared to $40,418,000 at March 31, 2013. In addition, we had $88,649,000 and $108,546,000 of short-term investments at March 31, 2014 and March 31, 2013, respectively.

Cash flow provided by operations of $32,546,000 resulted from the following:

Reported net income of $15,117,000 adjusted for the following non-cash items:

Depreciation and amortization of $5,303,000;

The provision for contracts, inventory and accounts receivable reserves of $1,328,000;

Increases in deferred income taxes of $378,000;

The amortization of bond premiums of $1,551,000; and

Stock compensation expense of $2,501,000. Stock compensation expense has increased from prior years due to incentive compensation awards in the current year being granted using restricted stock units as compared to cash awards granted in fiscal years 2013 and 2012.

A decrease in gross inventories of $13,761,000 due primarily to the installation of numerous systems which were under construction and in inventory at the end of fiscal 2013;

A decrease of $3,636,000 in prepaid expenses and other assets attributable in part to the receipt of an outstanding refund for approximately $1,500,000 from the Massachusetts Department of Revenue for tax years ending March 31, 2006 through 2008.

These cash contributors were offset by:

A decrease in deferred revenues of $6,430,000 as a number of systems in deferred revenue at the prior year end were delivered and accepted into revenue during the year;

A decrease of $4,051,000 in accrued expenses and other liabilities attributable primarily to the liquidation of prior year accruals of costs related to the resolution of a contractual issue with one customer; and

An increase of $5,813,000 in accounts receivable due to the timing of certain contract milestone invoices at year end;

Net cash of $16,551,000 was provided by investing activities in fiscal 2014. We had sales and maturities of short-term investments of $88,040,000 and purchased $69,668,000 in short-term investments during the year. Net fiscal 2014 capital expenditures totaled $1,821,000 versus $3,508,000 for fiscal 2013. Investments in fixed assets were comprised primarily of information technology expenditures and demonstration and test equipment.

At March 31, 2014, short-term investments and cash equivalents were invested primarily in corporate debentures/bonds, commercial paper, money market funds and certificates of deposit. Although management believes our investment policy is conservative in nature, certain short-term investments in commercial paper can be exposed to the credit risk of the underlying companies to which they relate and interest earned on these investments is subject to interest rate fluctuations. The weighted average days to maturity for investments held at March 31, 2014 was 239 days.

Net cash used for financing activities was $27,372,000 in fiscal 2014. The Company repurchased 201,192 shares of common stock for $12,306,000 under its stock repurchase programs. In addition, we made quarterly dividend payments totaling $15,713,000 and increased our restricted cash needed to collateralize outstanding letters of credit by $1,399,000 from the prior year. Offsetting these outflows, we received proceeds of $3,525,000 from exercises of employee stock options.


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In the normal course of business, we may provide certain customers and potential customers with performance guarantees, which are generally backed by standby letters of credit. In general, we would only be liable for the amount of these guarantees in the event of default in the performance of its obligations, the probability of which is remote in management's opinion. At March 31, 2014, we had outstanding $28,060,000 in standby letters of credit. These outstanding standby letters of credit are cash-secured at amounts ranging from 51% to 74% of the outstanding letters of credit. This resulted in a restricted cash balance of $14,916,000 at March 31, 2014 of which $313,000 was considered long-term restricted cash due to the expiration date of the underlying letters of credit.

As of March 31, 2014, $430,000 of our cash was held offshore, and while we do not currently believe there are any material limitations or restrictions on our ability to repatriate profits there may be tax consequence or changes in statutory rules which would affect our ability to do so without incurring a significant tax burden.

In recent years, we have funded our operations and capital expenditures with cash generated by operations, including deposits from customers on long-term projects and from proceeds received from option exercises. We currently have no line of credit facility and believe that our cash flows from operations, and cash and investments on hand are sufficient to meet the current and foreseeable operating requirements of our business.

Contractual Obligations: We lease certain facilities under non-cancelable leases. In addition, in the normal course of business, we enter into purchase orders with our vendors for the purchase of materials or services to meet our production needs. The following table summarizes our contractual obligations as of March 31, 2014.

                                                             Payment due by period
                                                  Less than 1                                    After 5
(In thousands)                        Total          year          1-3 years     3-5 years        years
Recorded Contractual Obligations:
Lease financing liability            $  2,915    $       1,511    $     1,404    $        -    $         -
Other long-term obligations                52                9             17            17              9

Operating leases                          757              532            225             -              -
Purchase commitments                   25,119           24,380            739             -              -
Total contractual obligations        $ 28,843    $      26,432    $     2,385    $       17    $         9

Inflation: We do not believe that inflation has had a material effect on our results of operations in each of fiscal 2014, 2013 and 2012. There can be no assurance, however, that our business will not be affected by inflation in the future.

Off-Balance Sheet Arrangements: During the fiscal year ended March 31, 2014 we did not have any material off-balance sheet arrangements.

Critical Accounting Policies

We consider certain accounting policies related to revenue recognition, inventories and related allowances for obsolete and excess inventory, and income taxes to be critical policies due to the estimation processes involved in each.

Revenue Recognition: We recognize certain Cargo Inspection, Mobile Cargo Inspection, Parcel and Personnel Screening System, and after-market part sales, in accordance with Financial Accounting Standards Board Accounting Standards Codification ("FASB ASC") 605-10, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured.

Infrequently, the Company receives requests from customers to hold product being purchased from us for a valid business purpose. We recognize revenue for such arrangements provided the transaction meets, at a minimum, the following criteria: a valid business purpose for the arrangement exists; risk of ownership of the purchased product has been transferred to the buyer; there is a fixed delivery date that is reasonable and consistent with the buyer's business purpose; the product is ready for shipment; the Company has no continuing performance obligation in regards to the product and the products have been segregated from our inventories and cannot be used to fill other orders received. There were no products being held under these arrangements at March 31, 2014 or March 31, 2013.

Certain of our contracts are multiple-element arrangements, which include standard products, custom-built systems or contract engineering projects, services (such as training), and service and maintenance contracts. In accordance with FASB ASC 605-25, Revenue Recognition - Multiple Element Arrangements as amended by Accounting Standards Update No. 2009-13 adopted retroactively to April 1, 2009, revenue arrangements that include multiple elements are analyzed to determine whether


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the deliverables can be divided into separate units of accounting or treated as a single unit of accounting. The Company allocates arrangement consideration at the inception of the arrangement to all deliverables using the relative selling price method. The selling price used for each deliverable is based on
(a) vendor-specific objective evidence if available; (b) third-party evidence if vendor-specific objective evidence is not available; or (c) estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. Discounts, if applicable, are allocated proportionally on the basis of the relative selling price of each deliverable. Generally, there is no customer right of return provision in the Company's sales agreements. Revenues are allocated to a delivered product or service when all of the following criteria are met: (1) the delivered item has value to the customer on a standalone basis; and (2) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in our control.

Revenues for certain long-term, custom-built systems or contract engineering projects are recognized on a percentage of completion basis. The lengths of these contracts typically range from one to four years from order to delivery and acceptance. Percentages-of-completion are determined by relating the actual costs of work performed to date for each contract to our estimated final costs. Revisions in costs and profit estimates are reflected in the period in which the facts causing the revision become known.

We recognize sales for our systems that are produced in a standard manufacturing operation, have minimal customer site installation requirements and have shorter order to delivery cycles when title passes and when other revenue recognition criteria are met. Management believes the customer's post-delivery acceptance provisions and installation requirements on certain of these systems are perfunctory and inconsequential and the costs of installation at the customer's site are accrued at the time of revenue recognition. We have demonstrated a history of customer acceptance subsequent to shipment and installation of these systems. For systems which entail more significant installation efforts and site work and/or have non-standard customer acceptance provisions, revenue recognition is deferred until installation is complete and customer acceptance has occurred.

Service revenues are recognized on time and materials engagements as the services are provided. Service contract revenues are recognized as service is performed over the length of the contract which reasonably approximates the period service revenues are earned.

Training and service contracts deliverables are accounted for separately from the delivered product elements as our undelivered products have value to our customers on a stand-alone basis. Accordingly, service revenue is deferred and recognized as such services are performed.

For all fixed price and long-term contracts, if a loss is anticipated on the contract, a provision is made in the period in which such losses are determined.

We record billed shipping and handling fees and billed out-of-pocket expenses as revenue and the associated costs as cost of goods sold in the accompanying consolidated statements of operations.

Certain contracts require payments from the customer upon execution of the agreement that are included in customer deposits. Individual customer deposits are reduced by the amount of revenue recognized on the contract until a zero balance is reached. Revenue recognized in excess of billings under the contracts is included in unbilled costs and fees in the accompanying balance sheet. Of the amounts in unbilled costs and fees at March 31, 2014, $2,484,000 (99.7%) is expected to be billed and collected during fiscal 2015.

Under the terms of certain of our cost reimbursement contracts, we are not permitted to bill customers a specified portion of the contract value until completion. Such retainages (approximately $36,000 and $80,000 at March 31, 2014 and March 31, 2013, respectively) result from both commercial contract retentions and government contract withholdings generally for up to 15% of fees, as well as the difference between the actual and provisional indirect cost billing rates. Retainages are included in the accompanying consolidated balance sheets as components of unbilled costs and fees. The accuracy and appropriateness of our direct and indirect costs and expenses under these cost reimbursement contracts and our accounts receivable recorded pursuant to such contracts, are subject to regulation and audit, including by the U.S. Defense Contract Audit Agency ("DCAA") or by other appropriate 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 under government contracts are provisional payments that are subject to potential adjustment upon audit by such agencies. Historically, such audits have not resulted in any significant disallowed costs. Although we can give no assurances, in the opinion of management, any adjustments likely to result from inquiries or audits of our contracts will not have a material adverse impact on our financial condition or results of operations.

Inventories and Related Allowance for Obsolete and Excess Inventory:
Inventories consist of material, labor and manufacturing overhead and are recorded at the lower of cost or net realizable value. Excessive manufacturing overhead costs such as idle facility expense, freight, handling costs and wasted material (spoilage) attributable to abnormally low volumes (levels that materially differ from budgeted production plans due primarily to changes in customer demand) are excluded from

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