Airline security has gotten plenty of lip service over the years since September 11, 2001, but the actual investment in new technology has been far from aggressive, despite the fact that the U.S. spends twice as much on defense-related R&D as all other nations combined. Although bomb and weapons screening companies have made remarkable technical progress in the last five years, their advances have garnered little interest. This state of affairs corresponded with almost a decade of seemingly secure aviation operations. The events surrounding the Christmas Day bomb attempt on NW Flight 253 should go a long way to dispel that illusion. After that incident, Homeland Security Secretary Janet Napolitano stated that the DHS will accelerate plans to acquire and deploy full-body scanners at airports. There are 40 full-body scanners in place at this time. The government purchased 150 in 2009 from L-3 (LLL) and Rapiscan (OSIS), but never deployed them. That is typical of the DHS mentality…until now. The Transportation Security Administration (TSA) now expects to purchase another 300 scanners via competitive bid. Still, 450 scanners for a 50 million passenger per month industry is just a first step. U.S. security officials have also been meeting with international counterparts to promote tighter airport security. Amsterdam’s airport operator Schiphol Group will buy 60 body scanners ASAP. L-3 and OSIS have gotten the lion’s share of the orders for body scanners.
American Science and Engineering (ASEI, Nasdaq), however, is the only explosive detection company offering a comprehensive suite of detection equipment, from personal scanning to cargo inspection, from explosives to nuclear weapons. ASEI makes its own proprietary version of the ‘Peeping Tom’ scanners called SmartCheck that will pick up explosives attached to a human body while protecting the privacy of the passenger by showing only body outlines, no private parts. The company also has products that allow an inspector to look inside a truck or cargo container and spot organic material, such as explosives. ASEI is getting repeat orders from Middle East customers to scan vehicles and trucks entering high-risk facilities. Although ASEI was left out of recent TSA purchases, we expect the company will get a fair share of the new orders. In the most recent quarter, ASEI earned $1.18 per share, a 31 cent surprise. Net income rose 45% year over year on a 9% increase in revenues to $61 million. The company has net profit margins of 15% and an ROE of 20%, which compare very favorably to the industry average of 0%. Additionally, ASEI has virtually no debt, while its competitors have an average debt-to-equity ratio greater than 1. All three major explosive detection companies have rallied strongly since Christmas, but we think the current pullback in the market will be a buying opportunity for these names. We particularly favor ASEI.

Gregory Spear
The Spear Report