AMERICAN SCIENCE AND ENGINEERING INC.Billerica, Massachusetts; X-Ray Detection Systems Maker Vies For Big Government Contracts

Aug. 24, 2007

Since 9/11, national security has become big business. Whether it's securing borders or the nation's airports and seaports, the need for screening is crucial.

American Science and Engineering is one company rising up to meet the country's security needs.

The firm specializes in X-ray inspection systems that promote border security, fight terrorism and combat the smuggling of drugs and humans.

There are about 1,800 security concourses in the nation's airports. Providing security is a daunting task for the Transportation Security Administration.

On Aug. 1, the TSA awarded American Science a $10.8 million contract to use its SmartCheck personnel screening system.

The contract's first phase provides funding to lease five systems with an option to purchase. The TSA also can buy an additional 75 SmartCheck systems, which are used as secondary screening devices.

Last year, the American Civil Liberties Union objected to the screening device because the group felt it infringed on people's privacy.

At the time, SmartCheck could see through clothes in order to spot bombs and weapons.

Phoenix Trial

But the TSA ran a trial for the system at the Phoenix International Airport, the eighth busiest in the U.S. The agency found that the public preferred the machine over security pat downs.

Analyst Stephen Levenson of Stifel Nicolaus said American Science made the decision easier by creating an algorithm that blurred the image on the screen.

"This (contract) offers TSA the ability to deploy our SmartCheck personnel screening system on a broad basis for use as a safe and effective tool for aviation threat detection," CEO Anthony Fabiano said in a press release.

"SmartCheck provides the most comprehensive personnel screening technology available . . . while ensuring the privacy of the traveling public."

Levenson credits the contract to the effective management team led by Fabiano. He said the CEO, who was brought in to restructure the company earlier this decade, expanded the firm's technology into new applications.

"Some called American Science a one-trick pony," he said. "But it has improved margins and operating efficiency while extending its product line and core technology with new devices."

The Billerica, Mass.-based company has built its business around its Z Backscatter technology that can better uncover dangerous and elusive threats. It is protected by more than 20 patents.

Unlike traditional X-rays, the company's systems pick up lower-frequency waves that bounce off softer objects. Software assembles the data into images to reveal drugs, plastic and liquid explosives, ceramic weapons, human bodies and radioactive devices, such as dirty bombs.

Its biggest seller has been its Z Backscatter Van, which was introduced in 2003. The ZBV is a mobile, X-ray scanning system built into a van. Costs vary depending on options, but on average ZBVs have a price tag of about $800,000.

The ZBV can screen static objects while it is moving or can scan moving objects while it's parked.

In dangerous environments, like Iraqi checkpoints, an unmarked ZBV sits inconspicuously so the operator can scan from a safe distance.

The system requires servicing, which provides the company with a recurring revenue stream. That stream accounts for 30% of total sales. Sixty percent stems from sales of inspection systems.

The company makes smaller systems that screen people entering government buildings, such as the White House.

It makes larger systems ideal for scanning cars, vans, trucks and sea cargo containers. The CargoSearch mounts a system on top of a framework that a truck towing a container can drive through for inspection.

Its Z Backscatter technology attracts an elite class of clientele, which includes the U.S. Department of Defense, Homeland Security, Customs and Border Protection as well as other federal agencies.

The company also has international customers ranging from the British government to custom agencies in Hong Kong, New Zealand, Egypt and Thailand. Major corporations also are on the list.

While newer systems have gained traction, its ZBVs accounted for about a third of the company's revenue in the first quarter, said analyst Timothy Quillin of Stephens.

Sales climbed 49% to $44.47 million in the quarter, while operating profit rose over 47%. It boosted earnings by 61% to 66 cents a share. Analysts expected 48 cents.

Shares of American Science rose nearly 9% a day after results were released.

"(We) recorded the highest first-quarter revenue and operating profit in the company's history," Fabiano said in a press release.

"Revenue increased across all product areas bolstered by the continued rise of international orders for our proprietary X-ray inspection systems."

American Science's short interest amounted to 10.5 days of average volume in July, which means some investors were bearish on the company. Quillin said the reason is the stock's lack of predictability.

"It is an inherently difficult company to project short-term earnings," he said. "It is a relatively volatile stock." However, Levenson said, "American Science will blow the shorts out of the water."

Analysts have mixed views on the company. The reason is American Science can take on a big order in one quarter and the next record next to nothing. This aspect gives it a forward visibility that can be cloudy at times.

But Levenson said the company has a good long-term outlook. The proof is in the pudding.

"This company runs its business for the long-term, not quarterly," he said. "It issued a statement of confidence to its shareholders when it declared an annual dividend of 80 cents a share. It wouldn't do that if it couldn't deliver."

Backlog

American Science recorded $104 million in backlog in the first quarter. It was the fourth straight quarter it posted a backlog of $100 million or more.

That could grow to almost half a billion dollars if it wins part of a Homeland Security contract issued by Homeland Security's Domestic Nuclear Detection Office (DNDO).

American Science was selected along with L3 Communications and SAIC to come up with a Cargo Advanced Automated Radiography System for the DNDO, which detects radiological threats hidden behind lead cargo containers.

Rival Smiths Detection protested the selection of the three competitors, but the U.S. Government Accountability Office denied the security firm's claim.

American Science's prototype was given the most R&D money and received an overall rating of exceptional. The contract is valued at about $1.2 billion and the winner or winners will be announced later this year.

"I'll be surprised if American Science doesn't at least win part of this contract," Levenson said. "This contract would put them in the big leagues."