American Science & Cheap Earnings

Sales slow, margins contract -- but the price is nice.

Rich Smith
Rich Smith
May 23, 2007 at 12:00AM

Right on cue, Motley Fool Rule Breakers pick American Science & Engineering (NASDAQ:ASEI) reported earnings on Monday. Personally, I didn't think the numbers were particularly thrilling, but Mr. Market begged to differ, and has already bid the shares up 10% in response.

For the quarter, sales for the X-ray screening specialist were up 13% in comparison to Q4 of last year. Net profit was up 22%, while the ever-more-diluted share count held per-share earnings back to just an 18% gain. All of which sounds good from a single-quarter perspective, but as management never fails to remind, this is a business with incredibly lumpy earnings, making quarterly impressions easy to misinterpret.

Rather than focus on the fiscal Q4 2007 "tree," therefore, let's take a gander at the fiscal 2007 "forest." For the year, sales declined 6% in comparison to fiscal 2006, and profits fell 17%. The ever-expanding (up 2.8% year over year) share base further eroded profits, such that earnings per diluted share declined 27%. With numbers like these, I'm perplexed as to why investors were so pleased with the results.

Cash profits
Perhaps the answer lies in AS&E's cash profits, as opposed to its GAAP earnings? I end that sentence with a question mark, because the answer remains up in the air, thanks to AS&E's failure to provide its investors with a cash flow statement to review. My grumblings over this oversight aside, however, I'm cautiously optimistic on the free cash flow front, for a couple of reasons. For one, the firm's cash cache is fair to overflowing today, with cash and equivalents now topping $138.5 million -- 47% better than at this time last year.

Also pleasing to the eye, accounts receivable are down 10% year over year, although inventories are up 19%. Quick bill collection further reinforces my impression that AS&E is generating strong cash flows. Meanwhile, although inventories rising faster than sales can be interpreted as a danger sign, they can also signal preparation to fulfill new orders. It all depends on how much of the inventories are comprised of finished goods as opposed to raw materials and works-in-progress -- numbers we won't have access to until AS&E files its 10-K report with the SEC.

My eureka moment
All in all, I find AS&E's earnings report ambiguous at best. I certainly don't see reason for a 10% leap in share price. After racking my brain for a while, though, the reason for the price rise finally came to me: As lukewarm as the results were, investors must have feared something colder still. After all, even after the price spike, these shares trade south of 15 times what trailing free cash flow was at last report. That's cheaper than mega-rival GE (NYSE:GE) at 26 times, and infinitely cheaper than OSI Systems (NASDAQ:OSIS), which is still burning cash. I guess, sometimes, cheap is better than good.

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Fool contributor Rich Smith owns shares of American Science & Engineering. The Fool's disclosure policy is here.