Don't say you weren't warned. Last week, I previewed the first-quarter earnings report out of American Science & Engineering (NASDAQ:ASEI), suggesting that few contract announcements in Q1 proper meant we had "little assurance that Q1's numbers this year will look as good as last year's did."

They didn't.

Sales for the quarter slipped 11%, landing around $39.5 million. Profits fell even harder as AS&E's operating margin dropped to about 8.3%. While that's better than Analogic (NASDAQ:ALOG) or OSI (NASDAQ:OSIS) managed to pull down, it's significantly lower than L-3's (NYSE:LLL) 10.6% operating margin, and a full 10 percentage points less than AS&E achieved in last year's Q1. Result: Per-share profits dropped 55% to just $0.30.

Indeed. AS&E missed Wall Street's revenue target, its earnings target -- basically, any threshold it was supposed to cross, it tripped over instead. But remember the caveat to my warning: I also said "the future sure looks bright" for this Motley Fool Rule Breakers recommendation. It still does.

The real story of the quarter, you see, was not actually what AS&E earned. It's what it might earn going forward.

Backlog's the key
One of the great things about investing in defense contractors, as opposed to, say, a consumer-goods giant like Coke, is that the former reports a metric that the latter cannot: its backlog of orders awaiting fulfillment. I've yet to see a consumer contract to buy a Coke months in advance, but advance contracts to buy big-ticket equipment are de rigeur -- they're a long "tail" that we can follow in search of a company's likely future revenue. So how long is AS&E's tail?

  • The company booked $100 million in new orders during Q1.
  • That's about 2.3 times as much as it booked in last year's Q1.
  • It replaces orders that AS&E fulfilled in this year's Q1 two-and-a-half times over.
  • And it brings total backlog up to $160 million through the end of fiscal Q1 2009.

This backlog increased 53% year over year, even as sales slipped -- which tells us that the slip was only temporary, and AS&E will resume growing over the course of this year.

Good to know, but it's not the end of the good news. I spent some hours studying AS&E's post-earnings conference call transcript last night, comparing it to the earnings release and to recent press releases. Without boring you with the details, here's the upshot: The $160 million in backlog as of June 30 includes the massive $55 million deal that we discussed previously, selling a whole passel of security equipment to the United Arab Emirates. It does not, however, include a raft of contracts awarded over the course of July, during Q2. These include:

  • As much as $15.5 million in service and maintenance (S&M) work for the U.S. government on AS&E's ZBV X-Ray vans.
  • $2.6 million in additional S&M work on cargo systems.
  • $2.6 million in ZBV orders for a "Middle East government agency."
  • And most recently, 10 ZBVs sold south of the border for an undisclosed sum (that I'm estimating to be approximately $4.1 million).

That all adds up to some $25 million in "extra" backlog, and appears to put total backlog as of today closer to $185 million -- more than AS&E booked in annual revenue last year. Furthermore, AS&E expects to receive additional orders for more ZBVs any moment now. That could push backlog to within spitting distance of $200 million.

Long story short, AS&E is at little risk of disappearing any time soon.

One risk down, one to go ... oh, that one's gone, too
In closing, let's look at a risk that I didn't even know existed. On the conference call, AS&E CEO Anthony Fabiano elaborated on one of his company’s few recent press releases that did not carry a multimillion-dollar price tag: Its DHS SAFETY ("Support Anti-terrorism by Fostering Effective Technology") Act Certification.

Fabiano tells us that government contractors that manufacture weapons systems -- firms like Lockheed Martin (NYSE:LMT), Northrop Grumman (NYSE:NOC), or General Dynamics (NYSE:GD) -- have historically enjoyed immunity from liability lawsuits concerning their products used in a war zone. But "nothing [like this] really existed for people that were building security systems and selling them in the continent of [the] United States."

So the objective of the SAFETY Act was to make this protection available for companies that could meet its standards. As of this month, AS&E has secured this protection for several of its most popular cargo-inspection products, such as the ZBV van and the Gemini system.

Personally, I expect that the liability concerns involving tanks, aircraft carriers, and guided missiles are somewhat greater than those for X-ray machines. Still, any reduction in risk is a good reduction in risk.

Further Foolish musings on AS&E are available in:

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.