Annual Reports

 
Quarterly Reports

  • 10-Q (Aug 12, 2010)
  • 10-Q (May 13, 2010)
  • 10-Q (Feb 4, 2010)
  • 10-Q (Aug 6, 2009)
  • 10-Q (May 7, 2009)
  • 10-Q (Feb 6, 2009)

 
8-K

 
Other

STALWART TANKERS INC. 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
e10vq
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended December 28, 2008
or
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Transition period from                      to                     
Commission File Number 000-08193
ARGON ST, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   38-1873250
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
12701 Fair Lakes Circle, Suite 800, Fairfax, Virginia 22033
(Address of principal executive offices)
Registrant’s telephone number (703) 322-0881
     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.
Yes þ       No o
      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o    Accelerated filer þ    Non-accelerated filer   o
(Do not check if a smaller reporting company)
  Smaller reporting company o 
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o       No þ
     As of January 31, 2009, there were 21,722,739 shares of the Registrant’s Common Stock, par value $.01 per share, outstanding.
 
 

 


 

ARGON ST, INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
FOR THE THREE MONTHS ENDED DECEMBER 28, 2008
TABLE OF CONTENTS
         
PART I. FINANCIAL INFORMATION
       
 
       
Item 1. Financial Statements (Unaudited)
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    7-13  
 
       
    14-24  
 
       
    24  
 
       
    24  
 
       
       
 
       
    25  
 
       
    25  
 
       
    25  
 
       
    25  
 
       
    25  
 
       
    25  
 
       
       
 
       
    27  
 
       
Exhibits
    28-29  

2


 

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
                 
    December 28, 2008     September 30, 2008  
    (unaudited)          
ASSETS
               
CURRENT ASSETS
               
Cash and cash equivalents
  $ 3,647     $ 15,380  
Accounts receivable, net
    127,296       104,859  
Inventory, net
    3,849       3,757  
Deferred income tax asset
    4,160       4,534  
Prepaids and other
    4,080       5,416  
 
           
TOTAL CURRENT ASSETS
    143,032       133,946  
Property, equipment and software, net
    27,940       27,558  
Goodwill
    173,948       173,948  
Intangibles, net
    3,715       4,055  
Other assets
    791       831  
 
           
TOTAL ASSETS
  $ 349,426     $ 340,338  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
CURRENT LIABILITIES
               
Accounts payable and accrued expenses
  $ 24,844     $ 29,133  
Accrued salaries and related expenses
    13,050       10,283  
Deferred revenue
    7,491       4,361  
Income taxes payable
    1,953        
Other liabilities
    140       132  
 
           
TOTAL CURRENT LIABILITIES
    47,478       43,909  
Deferred income tax liability, long term
    1,449       1,900  
Deferred rent and other liabilities
    1,841       2,085  
Commitments and contingencies
               
STOCKHOLDERS’ EQUITY
               
Common stock:
               
$.01 Par Value, 100,000,000 shares authorized, 22,832,653 and 22,775,423 shares issued at December 28, 2008 and September 30, 2008
    228       228  
Additional paid in capital
    223,374       222,349  
Treasury stock at cost, 1,126,245 shares at December 28, 2008 and September 30, 2008
    (18,425 )     (18,425 )
Retained earnings
    93,481       88,292  
 
           
TOTAL STOCKHOLDERS’ EQUITY
    298,658       292,444  
 
           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 349,426     $ 340,338  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


 

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (unaudited)
(In thousands, except share and per share amounts)
                 
    For the Three Months Ended  
    December 28, 2008     December 30, 2007  
CONTRACT REVENUES
  $ 84,026     $ 74,266  
 
               
COST OF REVENUES
    68,846       60,337  
 
               
GENERAL AND ADMINISTRATIVE EXPENSES
    5,788       5,457  
 
               
RESEARCH AND DEVELOPMENT EXPENSES
    1,772       1,700  
 
           
 
INCOME FROM OPERATIONS
    7,620       6,772  
 
               
INTEREST INCOME (EXPENSE)
    (14 )     120  
 
           
 
INCOME BEFORE INCOME TAXES
    7,606       6,892  
PROVISION FOR INCOME TAXES
    2,417       2,609  
 
           
NET INCOME
  $ 5,189     $ 4,283  
 
           
 
               
EARNINGS PER SHARE (Basic)
  $ 0.24     $ 0.20  
 
           
EARNINGS PER SHARE (Diluted)
  $ 0.24     $ 0.19  
 
           
 
WEIGHTED-AVERAGE SHARES OUTSTANDING
               
Basic
    21,667,861       21,871,285  
 
           
Diluted
    21,997,425       22,252,225  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

4


 

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
                 
    Three Months Ended  
    December 28, 2008     December 30, 2007  
Cash flows from operating activities
               
Net income
  $ 5,189     $ 4,283  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    2,003       1,935  
Amortization of deferred costs
    42        
Deferred income tax benefit
    (75 )     (242 )
Stock-based compensation
    809       723  
Change in:
               
Accounts receivable
    (22,437 )     (15,489 )
Inventory
    (92 )     (30 )
Prepaids and other
    976       1,278  
Accounts payable and accrued expenses
    (3,889 )     (5,460 )
Accrued salaries and related expenses
    2,767       (660 )
Deferred revenue
    3,130       966  
Income taxes
    2,311       2,824  
Deferred rent and other current liabilities
    (158 )     (113 )
 
           
 
               
Net cash used in operating activities
    (9,424 )     (9,985 )
 
               
Cash flows from investing activities
               
Acquisitions of property, equipment and software
    (2,445 )     (3,323 )
Proceeds from note receivable and other
    4       344  
 
           
 
               
Net cash used in investing activities
    (2,441 )     (2,979 )
 
               
Cash flows from financing activities
               
Stock repurchases
          (2,772 )
Payments on capital leases
    (15 )     (46 )
Tax benefit of stock option exercises
    67       18  
Proceeds from exercise of stock options
    80       64  
 
           
 
               
Net cash provided by (used in) financing activities
    132       (2,736 )
 
               
Net decrease in cash and cash equivalents
    (11,733 )     (15,700 )
Cash and cash equivalents, beginning of period
    15,380       22,965  
 
           
Cash and cash equivalents, end of period
  $ 3,647     $ 7,265  
 
           
Supplemental disclosure Income taxes paid
  $ 92     $ 7  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

5


 

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
(In thousands, except share data)
                                                 
                                            Total  
    Common Stock     Common Stock     Additional Paid in                     Stockholders’  
    Number of Shares     Par Value     Capital     Treasury Stock     Retained Earnings     Equity  
Balance, September 30, 2008
    22,775,423     $ 228     $ 222,349     $ (18,425 )   $ 88,292     $ 292,444  
Net income
                            5,189       5,189  
Shares issued upon exercise of stock options
    16,980             80                   80  
Restricted stock units vested
    40,250                                
Stock-based compensation
                878                   878  
Tax benefit on stock option exercises and restricted stock
                67                   67  
 
                                   
 
                                               
Balance, December 28, 2008
    22,832,653     $ 228     $ 223,374     $ (18,425 )   $ 93,481     $ 298,658  
 
                                   
The accompanying notes are an integral part of these condensed consolidated financial statements.

6


 

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
   1. BASIS OF PRESENTATION
     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for fair presentation have been included. Operating results for the period ended December 28, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2009. Inter-company accounts and transactions have been eliminated in consolidation. For further information, refer to the consolidated financial statements and footnotes thereto included in Argon ST, Inc.’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008. Reclassifications are made to the prior year financial statements when appropriate, to conform to the current year presentation.
     Argon ST, Inc. (“Argon ST” or the “Company”) maintains a September 30 fiscal year-end for annual financial reporting purposes. Argon ST presents its interim periods ending on the Sunday closest to the end of the month for each quarter consistent with labor and billing cycles. As a result, each quarter of each year may contain more or less days than other quarters of the year. Management does not believe that this practice has a material effect on quarterly results or on the comparison of such results.
     Argon ST records contract revenues and costs of operations for interim reporting purposes based on annual targeted indirect rates. At year-end, the revenues and costs are adjusted for actual indirect rates. During the Company’s interim reporting periods, variances may accumulate between the actual indirect rates and the annual targeted rates. Timing-related indirect spending variances are not applied to contract costs, research and development, and general and administrative expenses, but are included in unbilled receivables during these interim reporting periods. These rates are reviewed regularly, and the Company records adjustments for any material, permanent variances in the period they become determinable.
     Argon ST’s accounting policy for recording indirect rate variances is based on management’s belief that variances accumulated during interim reporting periods will be absorbed by management actions to control costs during the remainder of the year. The Company considers the rate variance to be unfavorable when the actual indirect rates are greater than the Company’s annual targeted rates. During interim reporting periods, unfavorable rate variances are recorded as reductions to operating expenses and increases to unbilled receivables. Favorable rate variances are recorded as increases to operating expenses and decreases to unbilled receivables. At December 28, 2008, the unfavorable rate variance totaled $1,421, which was approximately $750 less than the $2,171 unfavorable rate variance planned for the period. If the Company anticipates that actual contract activities will be different than planned levels, there are alternatives the Company can utilize to absorb the variance: the Company can adjust planned indirect spending during the year, modify its billing rates to its customers, or record adjustments to expense based on estimates of future contract activities. Management expects the variance to be eliminated over the course of the fiscal year and therefore, no portion of the variance is considered permanent.
     If the Company’s rate variance is expected to be unfavorable for the entire fiscal year, any modification of the Company’s indirect rates will likely increase revenue and operating expenses. Profit percentages on fixed-price contracts will generally decline as a result of an increase to indirect costs unless compensating savings can be achieved in the direct costs to complete the projects. Profit percentages on cost reimbursement contracts will generally decline as a percentage of total costs as a result of an increase in indirect costs even if the cost increase is funded by the customer. If the Company’s rate variance is favorable, any modification of the Company’s indirect rates will decrease revenue and operating expenses. In this event, profit percentages on fixed-price contracts will generally increase. Profit percentages on cost-reimbursable contracts will generally be unaffected as a result of any reduction to indirect costs, due to the fact that programs will typically expend all of the funds available. Any impact on operating income, however, will depend on a number of other factors, including mix of contract types, contract terms and anticipated performance on specific contracts.

7


 

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
   2. EARNINGS PER SHARE
     Basic earnings per share is computed using the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during each period. The following summary is presented for the fiscal quarters ended December 28, 2008 and December 30, 2007:
                 
    For the three months ended  
    December 28,     December 30,  
    2008     2007  
Net income
  $ 5,189     $ 4,283  
Weighted average shares outstanding — basic
    21,667,861       21,871,285  
 
               
Basic earnings per share
  $ 0.24     $ 0.20  
Effect of dilutive securities:
               
Net shares issuable upon exercise of stock options and awards
    329,564       380,940  
Weighted average shares outstanding — diluted
    21,997,425       22,252,225  
Diluted earnings per share
  $ 0.24     $ 0.19  
     Stock options that could potentially dilute basic EPS in the future that were not included in the computation of diluted EPS, because to do so would have been antidilutive, were 983,785 and 1,047,445 for the three months ended December 28, 2008 and December 30, 2007, respectively.
   3. STOCK-BASED COMPENSATION
Adoption of SFAS No. 123R
     Effective October 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which requires that compensation costs related to share-based payment transactions be recognized in financial statements. The Company applied the modified prospective method which requires that compensation costs for all awards granted after the date of adoption and the unvested portion of previously granted awards outstanding at the date of adoption will be measured at estimated fair value and included in operating expenses over the vesting period during which an employee provides service in exchange for the award.
     Stock-based compensation, which includes compensation recognized on stock option grants and restricted stock awards, has been included in the following line items in the accompanying condensed consolidated statements of earnings.

8


 

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
                 
    For the three months ended  
    December 28,     December 30,  
    2008     2007  
Cost of revenues
  $ 578     $ 528  
General and administrative expense
    231       195  
 
           
Total pre-tax stock-based compensation included in income from operations
    809       723  
Income tax expense (benefit) recognized for stock-based compensation
    (219 )     (128 )
 
           
Total stock-based compensation expense, net of tax
  $ 590     $ 595  
 
           
          As of December 28, 2008, there was $12,616 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. This cost is to be fully amortized in 5 years, with approximately half of the total amortization to be recognized in the next 18 months.
Stock Option Activity
          The following table summarizes stock option activity for the three months ended December 28, 2008. At December 26, 2008, the closing price of our common stock was $17.55.
                                 
                    Weighted-    
                    Average    
            Weighted-   Remaining   Aggregate
    Number   Average   Contractual   Intrinsic
    of Shares   Exercise Price   Term   Value
Shares under option, September 30, 2008
    1,623,967     $ 18.18                  
Options granted
    167,000     $ 18.62                  
Options exercised
    (16,980 )   $ 4.71             $ 249  
Options cancelled and expired
    (12,255 )   $ 25.17                  
 
                               
 
                               
Shares under option, December 28, 2008
    1,761,732     $ 18.31       6.11     $ 6,992  
 
                               
Options vested at December 28, 2008
    1,159,414     $ 16.35       5.12     $ 6,332  
 
                               
As of December 28, 2008, options that are vested and expected to vest prior to expiration
    1,398,448     $ 17.26       5.51     $ 6,824  

9


 

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
Restricted Share Activity
          Restricted shares are those shares issued to the Company’s independent directors, senior management and other employees. The following table summarizes restricted shares activity for the three months ended December 28, 2008:
                 
            Weighted-
    Number   Average Grant
    of Shares   Date Fair Value
Unvested shares, September 30, 2008
    291,975     $ 22.01  
Awards granted
    141,600     $ 18.47  
Awards vested
    (40,250 )   $ 18.00  
Awards forfeited
    (3,400 )   $ 19.07  
 
               
Unvested shares, December 28, 2008
    389,925     $ 21.17  
 
               
          The Company awarded a total of 36,000 shares to its eight non-employee board members on December 9, 2008. The stock will vest one year after the award date. The fair value of these awards is $18.42 and amortization of such fair value is included in General and Administrative expenses in the accompanying Condensed Consolidated Statements of Earnings.
          The Company awarded a total of 105,600 restricted shares to its executive and senior management employees in December 2008. All shares are on a graded vesting schedule over 5 years. The weighted average fair value of these awards is $18.48 per share and the amortization of such fair value is included in Costs of Revenues and General and Administrative expenses in the accompanying Condensed Consolidated Statements of Earnings.
     4. ACCOUNTS RECEIVABLE
          Accounts receivable consists of the following as of:
                 
    December 28, 2008     September 30, 2008  
Billed and billable
  $ 66,482     $ 42,794  
Unbilled costs and fees
    52,468       54,838  
Unfavorable indirect rate variance
    1,421        
Retainages
    7,136       7,438  
Reserve
    (211 )     (211 )
 
           
Accounts receivable, net
  $ 127,296     $ 104,859  
 
           
          The unbilled costs, fees, and retainages result from recognition of contract revenue in advance of contractual or progress billing terms and includes $1,421 of unfavorable indirect rate variance at December 28, 2008 (Refer to Note 1 for further discussion of the basis of presentation of indirect rate variances). Retainages include costs and fees on cost-reimbursable and time and material contracts withheld until audits are completed by DCAA and costs and fees withheld on progress payments on fixed price contracts. Reserves are determined based on management’s best estimate of potentially uncollectible accounts receivable. Argon ST writes off accounts receivable when such amounts are determined to be uncollectible.

10


 

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
     5. INVENTORY
          Inventories are stated at the lower of cost or market, determined on the first-in, first-out basis. Inventories consist of the following at the dates shown below:
                 
    December 28, 2008     September 30, 2008  
Raw Materials
  $ 3,208     $ 2,920  
Component parts, work in process
    39       812  
Finished component parts
    650       410  
 
           
 
    3,897       4,142  
Reserve
    (48 )     (385 )
 
           
Inventory, net
  $ 3,849     $ 3,757  
 
           
     6. PROPERTY, EQUIPMENT AND SOFTWARE
          Property, equipment and software consists of the following as of:
                 
    December     September  
    28, 2008     30, 2008  
Computer, machinery and test equipment
  $ 29,014     $ 27,549  
Leasehold improvements
    11,283       10,947  
Computer software
    4,989       4,926  
Furniture and fixtures
    1,473       1,726  
Equipment under capital lease
    337       337  
Construction in process
    10,893       10,478  
 
           
 
    57,989       55,963  
Less accumulated depreciation and amortization
    (30,049 )     (28,405 )
 
           
 
               
 
  $ 27,940     $ 27,558  
 
           
          As of December 28, 2008, the Company has capitalized $10,893 of construction in progress primarily consisting of $9,714 of costs incurred directly associated with the construction of one asset to be used internally for test equipment, demonstration equipment and other purposes. The Company expects to place this asset into service during fiscal year 2009.
     7. REVOLVING LINE OF CREDIT
          The Company maintains a $40,000 line of credit with Bank of America, N.A. (the “Lender”). The credit facility will terminate no later than February 28, 2010 at which time the facility will be subject to renewal. The credit facility also contains a sublimit of $15,000 to cover letters of credit. In addition, borrowings on the line of credit bear interest at LIBOR plus 150 basis points. An unused commitment fee of 0.25% per annum, payable in arrears, is also required.
          All borrowings under the line of credit are collateralized by all tangible assets of the Company. The line of credit agreement includes customary restrictions regarding additional indebtedness, business operations, permitted acquisitions, liens, guarantees, transfers and sales of assets, and maintaining the Company’s primary accounts with the Lender. Borrowing availability under the line of credit is equal to the product of 1.5 and the Company’s earnings before interest expense, taxes, depreciation and amortization (EBITDA) for the trailing 12 months, calculated as of the end of each fiscal quarter. For the fiscal quarter ending December 28, 2008, EBITDA, on a trailing 12 month basis, was $41,715, and as such, the borrowing availability was $40,000. The agreement requires the Company to comply with a specific EBITDA to Funded Debt ratio, and contains customary events of default, including the failure to make timely payments and the failure to satisfy covenants, which would permit the Lender to accelerate repayment of borrowings under the agreement if not cured within the applicable grace period. As of December 28, 2008, the Company was in compliance with these covenants and the financial ratio.

11


 

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
          At December 28, 2008, there were no borrowings outstanding against the line of credit. Letters of credit and debt consisting of capital lease obligations at December 28, 2008 amounted to $2,163, and $37,837 was available on the line of credit.
     8. INCOME TAXES
          The Company is subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. The Company has substantially concluded all U.S. state income tax matters for years through 2004, except for California and Michigan state returns which have a four year statute of limitations. The Company’s consolidated federal income tax return was examined through September 30, 2004 and all matters have been settled.
          If the examination periods were to expire or, in the event of an examination, the Company’s positions are sustained in favor of the Company, the Company would recognize approximately $339 of tax benefits reducing its effective rate. The Company does not believe there is a reasonable possibility of material changes to the estimated amount of reserves for uncertain tax positions within the next 12 months.
          The Company’s accounting policy is to recognize interest and penalties related to income tax matters in income tax expense. The Company had $84 accrued for interest and penalties as of December 28, 2008.
     9. COMMITMENTS AND CONTINGENCIES
          We are subject to litigation from time to time, in the ordinary course of business including, but not limited to, allegations of wrongful termination or discrimination. The Company believes the outcome of such matters will not have a material adverse effect on our results of operations, financial position or cash flows.
     10. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
          In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, Business Combinations (“SFAS No. 141R”), which replaces SFAS No. 141 Business Combinations. SFAS No. 141R establishes principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and liabilities acquired in a business combination, including noncontrolling interest, contingent consideration, and certain acquired contingencies. SFAS No. 141R also requires acquisition-related transaction expenses and restructuring cost be expensed as incurred rather than capitalized a component of the business combination. SFAS No. 141R will be applicable prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS No. 141R would have an impact on accounting for any business combinations occurring after our fiscal year ending September 30, 2009. The Company is currently assessing the impact, if any, of this statement on its consolidated financial position, results of operations, or cash flows.
          In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. FAS 142-3”). FSP No. FAS 142-3 requires companies estimating the useful life of a recognized intangible asset to consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, to consider assumptions that market participants would use about renewal or extension as adjusted for entity-specific factors. FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company does not believe that the adoption of EITF 07-3 will have any material effect on our consolidated financial position, results of operations, or cash flows.

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ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)
     During the first quarter of fiscal 2009, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements, which defines fair value, provides a framework for measuring fair value, and expands the disclosures required for fair value measurements. The adoption of this Standard did not have a material effect on our consolidated financial position, results of operations, or cash flows. In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2 , Effective Date of FASB Statement No. 157 . FSP 157-2 delays the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) and will be adopted by the Company beginning in the first quarter of fiscal 2010. Although the Company will continue to evaluate the application of FSP 157-2, management does not currently believe adoption will have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
          The following discussion provides information which management believes is relevant to an assessment and an understanding of the Company’s operations and financial condition. This discussion should be read in conjunction with the attached unaudited condensed consolidated financial statements and accompanying notes as well as our annual report on Form 10-K for the fiscal year ended September 30, 2008.
Forward-looking Statements
          Statements in this filing which are not historical facts are forward-looking statements under the provision of the Private Securities Litigation Reform Act of 1995. These statements may contain words such as “expects”, “could”, “believes”, “estimates”, “intends”, “may”, “envisions”, “targets” or other similar words. Forward-looking statements are not guarantees of future performance and are based upon numerous assumptions about future conditions that could prove not to be accurate. Forward-looking statements are subject to numerous risks and uncertainties, and our actual results could differ materially as a result of such risks and other factors. In addition to those risks specifically mentioned in this report and in the other reports filed by the Company with the Securities and Exchange Commission (including our Form 10-K for the fiscal year ended September 30, 2008), such risks and uncertainties include, but are not limited to: the availability of U.S. and international government funding for our products and services, including, without limitation, statements with respect to total estimated remaining contract values and the Company’s expectations regarding the U.S. government’s procurement activities related thereto; changes in the U.S. federal government procurement laws, regulations, policies and budgets (including changes to respond to budgetary constraints and cost-cutting initiatives); changes in appropriations types and amounts due to the priorities of the new Administration in Washington; the number and type of contracts and task orders awarded to us; the exercise by the U.S. government of options to extend our contracts; our ability to retain contracts during any rebidding process; the timing of Congressional funding on our contracts; any delay or termination of our contracts and programs; difficulties in developing and producing operationally advanced technology systems; the timing and customer acceptance of contract deliverables; our ability to attract and retain qualified personnel, including technical personnel and personnel with required security clearances; charges from any future impairment reviews; the future impact of any acquisitions or divestitures we may make; the competitive environment for defense and intelligence information technology products and services; the ability, because of the global economy and issues in the banking industry, to secure financing when and if needed; the financial health and business plans of our commercial customers; general economic, business and political conditions domestically and internationally; and other factors affecting our business that are beyond our control. All of the forward-looking statements should be considered in light of these factors. You should not put undue reliance on any forward-looking statements. We undertake no obligation to update these forward-looking statements to reflect new information, future events or otherwise.
Overview
General
          We are a leading systems engineering and development company providing full-service C5ISR (command, control, communications, computers, combat systems, intelligence, surveillance and reconnaissance) systems in several markets, including without limitation maritime defense, airborne reconnaissance, ground systems, tactical communications and network systems. These systems and services are provided to a wide range of defense and intelligence customers, including commercial enterprises. Our systems provide communications intelligence, electromagnetic intelligence, electronic warfare and information operations capabilities that enable our defense and intelligence customers to detect, evaluate and respond to potential threats. These systems are deployed on a range of military and strategic platforms including surface ships, submarines, unmanned underwater vehicles (UUV), aircraft, unmanned aerial vehicles (UAV), land mobile vehicles, fixed site installations and re-locatable land sites.

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          Given the dramatic dislocations in the financial community, a worldwide recession, a very large federal deficit, and a new Executive Branch with an agenda that may or may not differ than the previous administration’s, we may see significant impacts on our results of operations as a result of pressure on the defense and intelligence budgets. However, we began fiscal year 2009 with a solid backlog. While we understand that there will be significant pressure on the defense and intelligence budgets, we believe that given the current status of global security, the production of our systems, which include critical collection of intelligence and the maintenance of persistent surveillance, are important to our success and will require continued demand of our products and services from our customers.
Revenues
          Our revenues are primarily generated from the entire life cycle of complex sensor systems under contracts primarily with the U.S. Government and major domestic prime contractors, as well as with foreign governments, agencies and defense contractors. This life cycle spans across the design, development, production, installation and support of the system.
          Our government contracts can be divided into three major types: cost reimbursable contracts, fixed-price, and time and materials. Cost reimbursable contracts are primarily used for system design and development activities involving considerable risks to the contractor, including risks related to cost estimates on complex systems, performance risks associated with real time signal processing, embedded software, high performance hardware, and requirements that are not fully understood by the customer or us, the development of technology that has never been used, and interfaces with other systems that are in development or are obsolete without adequate documentation. Fees under these contracts are usually fixed at the time of negotiation; however, in some cases the fee is an incentive or award fee based on cost, schedule, and performance or a combination of those factors. Although the U.S. government customer assumes the cost risk on these contracts, the contractor is not allowed to exceed the cost ceiling on the contract without the approval of the customer.
          Fixed-price contracts are typically used for the production of systems. Development activities similar to activities performed under previous contacts are also usually covered by fixed-price contracts, due to the lower risk involved. In these contracts, cost risks are borne entirely by the contractor. Some fixed-price contracts include an award fee or an incentive fee as well as the negotiated profit. Most foreign customers, and some U.S. customers, use fixed-price contracts for design and development work even when the work is considered high risk.
          Time and material contracts are based on hours worked, multiplied by approved labor rates, plus other costs incurred and allocated.
          The following table represents our revenue concentration by contract type for the three months ended December 28, 2008 and December 30, 2007:
                 
    Three Months Ended
Contract Type   December 28, 2008   December 30, 2007
Fixed-price contracts
    57 %     52 %
 
               
Cost reimbursable contracts
    39 %     44 %
 
               
Time and material contracts
    4 %     4 %

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     Generally, we experience revenue growth when systems move from the development stage to the production stage due to increases in sales volumes from production of multiple systems, and when we add new customers or are successful in selling new systems to existing customers. Much of our current production work has been derived from programs for which we have performed the initial development work. These programs are next generation systems replacing existing, obsolete systems that were developed by other companies. We were able to displace these companies primarily on the basis of technological capability. We believe that the current state of world affairs and the U.S. government’s emphasis on protecting U.S. citizens will cause funding of these programs to continue. The increase in fixed-price contracts as a total percentage of our revenue in the first quarter of fiscal 2009, as compared to the first quarter of fiscal 2008, is primarily due to a significant amount of work performed on a fixed price subcontract to Sierra Nevada for the build of the ORBCOMM Generation Two payload, which was awarded in the third quarter of fiscal 2008 and a decreased amount of work performed on our cost-reimbursable type maritime development programs, as these programs entered the integration and test stages of their life cycle.
Backlog
     We define backlog as the funded and unfunded amount provided in contracts less previously recognized revenue. Contract options are estimated separately and not included in backlog until they are exercised and funded.
     Our funded backlog does not include the full value of our contracts because Congress often appropriates funds for a particular program or contract on a yearly or quarterly basis, even though the contract may call for performance that is expected to take a number of years.
     From time to time, we will exclude from backlog portions of contract values of very long or complex contracts where we judge revenue could be jeopardized by a change in U.S. government policy. Because of possible future changes in delivery schedules and cancellations of orders, backlog at any particular date is not necessarily representative of actual revenue to be expected for any succeeding period, and actual revenue for the year may not meet or exceed the backlog represented. We may experience significant contract cancellations or reductions that were previously booked and included in backlog.
     Our backlog at the dates shown was as follows (in thousands):
                 
    December 28, 2008     September 30, 2008  
               
Funded
  $ 258,077     $ 272,620  
Unfunded
    49,740       54,672  
 
           
Total
  $ 307,817     $ 327,292  
 
           
Cost of Revenues
     Cost of revenues consist of direct costs incurred on contracts such as labor, materials, travel, subcontracts and other direct costs and indirect costs associated with overhead expenses such as facilities, fringe benefits and other costs that are not directly related to the execution of a specific contract. We plan our spending of indirect costs on an annual basis and on cost reimbursable contracts receive government approval to bill those costs as a percentage of our direct labor, other direct costs and direct materials as we execute our contracts. The U.S. government approves the planned indirect rates as provisional billing rates near the beginning of each fiscal year.
General and Administrative Expenses
     Our general and administrative expenses include administrative salaries, costs related to proposal activities and other administrative costs.
Research and Development
     We conduct internally funded research and development into complex signal processing, system and software architectures, and other technologies that are important to continued advancement of our systems and are of interest to our current and prospective customers. The variance from year to year in internal research and development is caused by the status of our product cycles and the level of complementary U.S. government funded research and development. For the three months ended December 28, 2008 internally funded research and development expenditures were $1.8 million, representing 2.1% of revenues in the period. For the three months ended December 30, 2007 internally funded research and development expenditures were $1.7 million, respectively, representing 2.3% of revenues, respectively.

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     Internally funded research and development is a small portion of our overall research and development, as government funded research and development constitutes the majority of our activities in this area.
Interest Income and Expense
     Interest income is derived solely from interest earned on cash reserves maintained in short term investment accounts and are therefore subject to short-term interest rates that have minimal risk.
     Interest expense relates to interest charged on borrowings against our line and credit and capital leases.
Deferred Revenue
     Many of our fixed-price contracts contain provisions under which our customers are required to make payments when we achieve certain milestones. In many instances, these milestone payments occur before we have incurred the associated costs to which the payments will be applied. For example, under certain of our production contracts, our order of materials constitutes a milestone for which we receive a significant payment, but we do not pay the materials vendors until the materials are received and placed into production. We recognize deferred revenue when we receive milestone payments for which we have not yet incurred the applicable costs. As costs are incurred and revenue recognition criteria are met, we recognize revenue.
     As the time lag between our receipt of a milestone payment and our incurrence of associated costs under the contract can be several months, milestone payments under fixed-price contracts can significantly affect our cash position at any given time. The receipt of milestone payments will temporarily increase our cash on hand and our deferred revenue. As costs are incurred under the contract and contract revenue is recognized, cash and deferred revenue associated with the payment will decrease.
     We expect that fluctuations in deferred revenue will occur based on the particular timing of milestone payments under our fixed-price contracts and our subsequent incurrence of costs under the contracts. Due to these fluctuations, our cash position at the end of any fiscal quarter or year may not be indicative of our cash position at the end of subsequent fiscal quarters or years.
Critical Accounting Practices and Estimates
General
     Our discussion and analysis of our financial condition and results of operations are based upon our financial statements. These financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We believe that the estimates, assumptions, and judgments involved in the accounting practices described below have the greatest potential impact on our financial statements and, therefore, consider these to be critical accounting practices.
Revenue and Cost Recognition
     General
     The majority of our contracts, which are with the U.S. government, are accounted for in accordance with the American Institute of Certified Public Accountants Statement of Position 81-1, Accounting for Performance of Construction-Type and Production-Type Contracts. These contracts are transacted using written contractual arrangements, most of which require us to design, develop, manufacture and/or modify complex products and systems, and perform related services according to specifications provided by the customer. We account for fixed-price contracts by using the percentage-of-completion method of accounting and for substantially all contracts, the cost-to-cost method is used to measure progress towards completion. Under this method, contract costs are charged to operations as incurred. A portion of the contract revenue, based on estimated profits and the degree of completion of the contract as measured by a comparison of the actual and estimated costs, is recognized as revenue each period.

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In the case of contracts with materials requirements, revenue is recognized as those materials are applied to the production process in satisfaction of the contracts’ end objectives. We account for cost reimbursable contracts by charging contract costs to operations as incurred and recognizing contract revenues and profits by applying the negotiated fee rate to actual costs on an individual contract basis.
     Contract revenue recognition inherently involves estimation. Examples of estimates include the contemplated level of effort to accomplish the tasks under the contract, the cost of the effort, and an ongoing assessment of our progress toward completing the contract. From time to time, as part of our management processes, facts develop that require us to revise our estimated total costs or revenue. To the extent that a revised estimate affects contract profit or revenue previously recognized, we record the cumulative effect of the revision in the period in which the facts requiring the revision become known.
     Anticipated losses on contracts are also recorded in the period in which they become determinable. Unexpected increases in the cost to develop or manufacture a product, whether due to inaccurate estimates in the bidding process, unanticipated increases in material costs, inefficiencies, or other factors are borne by us on fixed-price contracts, and could have a material adverse effect on results of operations and financial condition. Unexpected cost increases in cost reimbursable contracts may be borne by us for purposes of maintaining customer relationships. If the customer agrees to fund cost increases on cost type contracts, the additional work does not have any profit and therefore dilutes margin.
     Indirect rate variance
     We record contract revenues and costs of operations for interim reporting purposes based on annual targeted indirect rates. At year-end, the revenues and costs are adjusted for actual indirect rates. During our interim reporting periods, variances may accumulate between the actual indirect rates and the annual targeted rates. Timing-related indirect spending variances are not applied to contract costs, research and development, and general and administrative expenses, but are included in unbilled receivables during these interim reporting periods. These rates are reviewed regularly, and we record adjustments for any material, permanent variances in the period they become determinable.
     Our accounting policy for recording indirect rate variances is based on management’s belief that variances accumulated during interim reporting periods will be absorbed by management actions to control costs during the remainder of the year. We consider the rate variance to be unfavorable when the actual indirect rates are greater than our annual targeted rates. During interim reporting periods, unfavorable rate variances are recorded as reductions to operating expenses and increases to unbilled receivables. Favorable rate variances are recorded as increases to operating expenses and decreases to unbilled receivables.
     If we anticipate that actual contract activities will be different than planned levels, there are alternatives we can utilize to absorb the variance: we can adjust planned indirect spending during the year, modify our billing rates to our customers, or record adjustments to expense based on estimates of future contract activities.
     If our rate variance is expected to be unfavorable for the entire fiscal year, any modification of our indirect rates will likely increase revenue and operating expenses. Profit percentages on fixed-price contracts will generally decline as a result of an increase to indirect costs unless compensating savings can be achieved in the direct costs to complete the projects. Profit percentages on cost reimbursement contracts will generally decline as a percentage of total costs as a result of an increase in indirect costs even if the cost increase is funded by the customer. If our rate variance is favorable, any modification of our indirect rates will decrease revenue and operating expenses. In this event, profit percentages on fixed-price contracts will generally increase. Profit percentages on cost-reimbursable contracts will generally be unaffected as a result of any reduction to indirect costs, due to the fact that programs will typically expend all of the funds available. Any impact on operating income, however, will depend on a number of other factors, including mix of contract types, contract terms and anticipated performance on specific contracts.
     At December 28, 2008, the unfavorable rate variance totaled $1.4 million, which was approximately $0.8 million less than the $2.2 million unfavorable rate variance planned for the period.

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     Award Fee Recognition
     Our practice for recognizing interim fee on our cost-plus-award-fee contracts is based on management’s assessment as to the likelihood that the award fee or an incremental portion of the award fee will be earned on a contract-by-contract basis. Management’s assessments are based on numerous factors including: contract terms, nature of the work performed, our relationship and history with the customer, our history with similar types of projects, and our current and anticipated performance on the specific contract. No award fee is recognized until management determines that it is probable that an award fee or portion thereof will be earned. Actual fees awarded are typically within management’s estimates. However, changes could arise within an award fee period causing management to either lower or raise the award fee estimate in the period in which it occurs.
Goodwill
     Costs in excess of the fair value of tangible and identifiable intangible assets acquired and liabilities assumed in a business combination are recorded as goodwill. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we test for impairment at least annually using a two-step approach. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. During the years prior to fiscal year 2008, the Company operated as four reporting units, at which time, the fair value of each reporting unit was estimated using a combination of the income, or discounted cash flows approach and the market approach. During fiscal year 2008, due to the change in the Company’s organizational structure and its operations, the Company operates as a single reporting unit. The fair value of the reporting unit is estimated using a market capitalization approach. If the carrying amount of the unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. We performed the test during the fourth quarter of fiscal year 2008 and found no impairment to the carrying value of goodwill.
Long-Lived Assets (Excluding Goodwill)
     We follow the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”) in accounting for long-lived assets such as property and equipment and intangible assets subject to amortization. SFAS No.144 requires that long-lived assets be reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. An impairment loss is recognized if the sum of the long-term undiscounted cash flows is less than the carrying amount of the long-lived asset being evaluated. Impairment losses are treated as permanent reductions in the carrying amount of the assets.
Accounts Receivable
     We are required to estimate the collectability of our accounts receivable. Judgment is required in assessing the realization of such receivables, and the related reserve requirements are based on the best facts available to us. Since most of our revenue is generated under U.S. government contracts, our current accounts receivable reserve is not significant to our overall receivables balance.
Stock-Based Compensation
     In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS No. 123R”) which requires that compensation costs related to share-based payment transactions be recognized in financial statements. SFAS No. 123R requires all companies to measure compensation costs for all share-based payments at fair value, and eliminates the option of using the intrinsic method of accounting provided for in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB No. 25”) which generally resulted in no compensation expense recorded in the financial statements related to the grant of stock options to employees and directors if certain conditions were met.
     Effective October 1, 2005, the Company adopted SFAS No. 123R using the modified prospective method. Under this method, compensation costs for all awards granted after the date of adoption and the unvested portion of previously granted awards outstanding at the date of adoption will be measured at estimated fair value and included in cost of revenues and general and administrative expenses over the vesting period during which an employee provides service in exchange for the award.

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Historical Operating Results
Three months ended December 28, 2008 compared to three months ended December 30, 2007
     The following table sets forth certain items, including consolidated revenues, cost of revenues, general and administrative expenses, income tax expense and net income, and the changes in these items for the three months ended December 28, 2008 and December 30, 2007 (in thousands):
                                 
                         
                         
    Three months quarter ended   Amount of    
    December   December   in crease   % increase
  28, 2008   30, 2007   (decrease)   (decrease)
Contract revenues
  $ 84,026     $ 74,266     $ 9,760       13 %
Cost of revenues
    68,846       60,337       8,509       14 %
General and administrative expenses
    5,788       5,457       331       6 %
Research and development expenses
    1,772       1,700       72       4 %
Interest income, net
    (14 )     120       (134 )     -112 %
Provision for income taxes
    2,417       2,609       (192 )     -7 %
Net income
    5,189       4,283       906       21 %
Revenues:
     Revenues increased approximately $9.8 million or 13% for the three months ended December 28, 2008, as compared to the three months ended December 30, 2007. The revenue increase is primarily attributable to $8.9 million of revenue recognized for work completed on contracts related to tactical communications and networking capabilities for three customers. Increases in revenue attributable to other contracts awarded in fiscal year 2008 include $2.7 million from a 22 month modernization program, $2.2 million from a flight test program, and $2.3 million from two other programs including a contract with a customer to build wire harness assemblies and components for aircraft wings and a contract to perform work for maritime signals interception. Offsetting these increases, we experienced a $4.0 million decrease of revenue related to certain development contracts for maritime systems. Other decreases of revenue of $2.3 million related to certain contracts nearing completion primarily attributable to certain contracts related to tactical ground mobile communications technologies.
Cost of Revenues:
     Cost of revenues increased approximately $8.5 million or 14% for the three months ended December 28, 2008 as compared to the three months ended December 30, 2007. The increase was primarily due to increased contract activity and increased revenue as described above. As a result of the increased contract activity, direct materials costs, including subcontract costs, increased $6.8 million. Direct labor increased $0.9 million consistent with our increase in production activity on fixed price contracts. Along with the increase in direct labor and direct material costs, other direct costs and overhead costs allocable to such direct costs increased approximately $2.5 million. Other costs decreased $1.1 million primarily due to a $0.9 million decrease of costs not allocable to specific contracts. Cost of revenues as a percentage of total revenue increased nominally to 82% for the three months ended December 28, 2008 as compared to 81% in the same quarter of fiscal year 2008.

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General and Administrative Expenses:
     General and administrative expenses increased approximately $0.3 million or 6% for the three months ended December 28, 2008, as compared to the three months ended December 30, 2007. This increase was primarily due to increased professional fees, including those related to our defense of claims against us. As a percentage of revenue, general and administrative costs have remained at 7% of revenue for both the three months ended December 30, 2008 and December 30, 2007.
Research and Development Expenses:
     Research and development expenses increased approximately $0.1 million or 4% for the three months ended December 28, 2008, as compared to the three months ended December 30, 2007 due to the timing of specific planned research and development projects. Research and development expenditures represented 2.1% and 2.3% of our consolidated revenues for the three months ended December 28, 2008 and December 30, 2007, respectively. We expect that research and development expenditures will continue to represent approximately 2% to 3% of our consolidated revenue in future periods.
Interest Income, net:
     Interest income, net of interest expense, decreased approximately $0.1 million for the three months ended December 30, 2008, as compared to the three months ended December 30, 2007. This decrease was primarily due to lower average cash balances for the first quarter of fiscal year 2009 as compared to those during the first quarter of fiscal year 2008. During the first quarter of fiscal 2009, we borrowed approximately $7.0 million on our line of credit as a result of the timing of certain milestone billings and cash receipts on such billings. As of December 28, 2008, these borrowings were repaid. Due to the timing of these milestone billings, we expect that from time to time, we will continue to utilize our line of credit to fund operations.
Provision for Income Taxes:
     The provision for income taxes decreased approximately $0.2 million or 7% for the three months ended December 28, 2008, as compared to the three months ended December 30, 2007. Our effective income tax rate decreased to 31.8% for the three months ended December 28, 2008, compared to an effective rate of 37.9% for the three months ended December 30, 2007. The lower effective tax rate in the quarter ended December 28, 2008 was primarily due to a 5.6% reduction related to the renewal of the federal research and development tax credit which was realized retroactive to January 1, 2008 as a result of legislation signed into law during our first fiscal quarter of 2009. We expect our annual effective rate to approximate levels closer to a 35% to 37% range for the annual period ending September 30, 2009.
Net Income:
     As a result of the above, net income increased approximately $0.9 million, or 21%, for the three months ended December 28, 2008 compared to the three months ended December 30, 2007.
Analysis of Liquidity and Capital Resources
     Our liquidity requirements relate primarily to the funding of working capital requirements supporting operations, capital expenditures and strategic initiatives including potential future acquisitions and research and development activities.

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Cash
     At December 28, 2008, we had cash of $3.6 million compared to cash of $15.4 million at September 30, 2008. The $11.7 million decrease in cash was primarily the result of $9.4 million of cash used in operations and $2.4 million of cash paid for acquisitions of property, equipment and software.
     Line of Credit
     The Company maintains a $40.0 million line of credit with Bank of America, N.A. (the “Lender”). The credit facility will terminate no later than February 28, 2010 at which time the facility will be subject to renewal. The credit facility also contains a sublimit of $15.0 million to cover letters of credit. In addition, borrowings on the line of credit bear interest at LIBOR plus 150 basis points. An unused commitment fee of 0.25% per annum, payable in arrears, is also required.
     All borrowings under the line of credit are collateralized by all tangible assets of the Company. The line of credit agreement includes customary restrictions regarding additional indebtedness, business operations, permitted acquisitions, liens, guarantees, transfers and sales of assets, and maintaining the Company’s primary accounts with the Lender. Borrowing availability under the line of credit is equal to the product of 1.5 and the Company’s earnings before interest expense, taxes depreciation and amortization (EBITDA) for the trailing 12 months, calculated as of the end of each fiscal quarter. For the fiscal quarter ending December 28, 2008, EBITDA, on a trailing 12 month basis, was $41.7 million. The agreement requires the Company to comply with a specific EBITDA to Funded Debt ratio, and contains customary events of default, including the failure to make timely payments and the failure to satisfy covenants, which would permit the Lender to accelerate repayment of borrowings under the agreement if not cured within the applicable grace period. As of December 28, 2008, the Company was in compliance with these covenants and the financial ratio.
     At December 28, 2008, there were no borrowings outstanding against the line of credit. Letters of credit and debt consisting of capital lease obligations at December 28, 2008 amounted to $2.2 million, and $37.8 million was available on the line of credit.
     Cash Flows
     Net cash used in operating activities was $9.4 million for the three months ended December 28, 2008, compared to net cash used in operating activities of $10.0 million for the three months ended December 30, 2007. Cash provided by operating activities during the three months ended December 28, 2008 was comprised of $8.0 million of net income as adjusted for non-cash reconciling items including depreciation and amortization, changes in deferred income taxes and stock-based compensation. Net income, as adjusted for non-cash reconciling items, was reduced by $17.4 million as a result of changes in operating assets and liabilities. This change was driven by a $19.3 million increase in accounts receivable net of increases in deferred revenue, and a $3.9 million decrease in accounts payable, which were partially offset by $5.8 million of changes in other operating assets and liabilities.
     The increase in accounts receivable is due primarily to the timing of our contractual ability to bill our customers and subsequently receive payments on such billings. Many of our fixed-price contracts contain provisions under which our customers are required to make payments when we achieve certain milestones. In many instances, these milestone payments occur after we have incurred the associated costs to which the payments will be applied. For example, under some of our contracts providing certain deliverables constitutes a milestone for which we receive a significant payment near the end of the contract, but we incur costs to complete the deliverables ratably over the life of the contract. We recognize revenue as costs are incurred and revenue recognition criteria are met, with a corresponding increase in unbilled receivables.
     The time lag between our receipt of a milestone payment and our incurrence of associated costs under the contract can be several months. Therefore, milestone payments under fixed-price contracts can significantly affect our cash position at any given time. The receipt of milestone payments will temporarily increase our cash on hand and decrease our unbilled receivables. As milestone payments under the contract are billed and received, cash will increase and unbilled receivables associated with the payment will decrease. Over the years, these milestone payments have had a significant effect on our comparative cash balances.

22


 

     We expect that fluctuations in unbilled receivables and deferred revenue will occur based on the particular timing of milestone payments under our fixed-price contracts and our incurrence of costs under the contracts. Due to these fluctuations, our cash position at the end of any fiscal quarter or year may not be indicative of our cash position at the end of subsequent fiscal quarters or years.
     Net cash provided by investing activities was $2.4 million for the three months ended December 28, 2008, compared to net cash used in investing activities of $3.0 million for the nine months ended December 30, 2007. Significant capital expenditures have occurred related to internally constructed assets.
     Net cash provided by financing activities was $0.1 million for the three months ended December 28, 2008 compared to net cash used in financing activities of $2.7 million for the three months ended December 30, 2007. In the first quarter of fiscal year 2008, cash used in financing activities was primarily comprised of $2.8 million of cash used to purchase shares of our common stock under our stock repurchase program. The shares purchased in fiscal year 2008 occurred under a stock repurchase plan which expired in August 2008. In December 2008, our Board of Directors approved a plan to repurchase up to 1.0 million additional shares of our common stock. Through January 2008, we have not repurchased any shares under the approved plan.
Contractual Obligations and Commitments
     As of December 28, 2008, our contractual cash obligations were as follows (in thousands):
                                                         
            Due in 1     Due in 2     Due in 3     Due in 4     Due in 5        
    Total     year     years     years     years     years     Thereafter  
Capital leases
  $ 96     $ 60     $ 27     $ 9                    
Operating leases
    38,250       8,179       7,319       6,833       6,518       6,412       2,989  
Earn-out obligation (a)
    3,200       3,200                                
 
                                         
 
                                                       
Total
  $ 41,546     $ 11,439     $ 7,346     $ 6,842     $ 6,518     $ 6,412     $ 2,989  
 
                                         
 
(a)   Under the Coherent purchase agreement, as amended, we have agreed to pay shareholders of Coherent an additional $3.2 million in cash in the event that certain bookings targets are met as of July 2009. 
     As of December 28, 2008, our other commercial commitments were as follows:
                         
(in thousands)   Total   Less Than 1 Year   1-3 Years
                         
Letters of credit
  $ 2,079     $ 2,079        
     Contingent income tax obligations. As of December 28, 2008, we have recorded a net liability of $339,000 for uncertain tax positions. For further discussion of these contingencies, see Note 8 to the condensed consolidated financial statements included in this report.
     We have no long-term debt obligations, capital lease obligations, other operating lease obligations, contractual purchase obligations, or other long-term liabilities other than those shown above. We also have no off-balance sheet arrangements of any kind.
Market Risks
     In addition to the risks inherent in our operations, we are exposed to financial, market, political and economic risks. The following discussion provides additional detail regarding our exposure to credit, interest rates and foreign exchange rates.
Cash and Cash Equivalents:
     All unrestricted, highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents. We maintain cash and cash equivalents with various financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. We believe that any credit risk related to these cash and cash equivalents is minimal.

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Access to Bank Credit:
     Our liquidity position is influenced by our ability to obtain sufficient levels of working capital. Continuing access to bank credit for the purposes of funding operations during periods in which cash fluctuates is an important factor in our overall liquidity position. We have a line of credit with Bank of America effective through February 2010 and we believe we have a good working relationship with Bank of America (see “—Analysis of Liquidity and Capital Resources—Line of Credit” above). However, as recent events in the financial markets have demonstrated, dramatic shifts in market conditions could materially impact our ability to continue to secure bank credit, and a continued steep deterioration in market conditions could materially impact our liquidity position. Absent these dramatic shifts and steep deteriorations in market conditions, we believe we have access to sufficient bank credit.
Interest Rates:
     Our line of credit financing provides available borrowing to us at a variable interest rate tied to the LIBOR rate. There were no outstanding borrowings under this line of credit at December 28, 2008. Accordingly, we do not believe that any movement in interest rates would have a material impact on future earnings or cash flows. In the event that we borrow on our line of credit in future periods, we will be subject to the risks associated with fluctuating interest rates.
Foreign Currency:
     We have contracts to provide services to certain foreign countries approved by the U.S. government. Our foreign sales contracts require payment in U.S. dollars, and therefore are not affected by foreign currency fluctuations. We occasionally issue orders or subcontracts to foreign companies in local currency. The current obligations to foreign companies are of an immaterial amount and we believe the associated currency risk is also immaterial.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
     The information called for by this item is provided under Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 4. CONTROLS AND PROCEDURES
  (a)   Our management has evaluated, with the participation of the our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
  (b)   During the last quarter, there were no significant changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that have materially affected these controls, or are reasonably likely to materially affect these controls subsequent to the evaluation of these controls.

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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
     There were no material changes from the legal proceeding disclosed in our Form 10-K for the fiscal year ended September 30, 2008, filed on December 5, 2008.
ITEM 1A. RISK FACTORS
     There were no other material changes from the risk factors disclosed in our Form 10-K for the fiscal year ended September 30, 2008, filed on December 5, 2008.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
     None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
     None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
     None.
ITEM 5. OTHER INFORMATION
     None.

25


 

ITEM 6. EXHIBITS
     
Exhibit    
Number   Description of Exhibit
2 .1
  Agreement and Plan of Merger dated as of June 7, 2004, by and between Sensytech, Inc. and Argon Engineering Associates, Inc. (incorporated by reference to Exhibit 2.1 of the Company’s Registration Statement on Form S-4 filed on July 16, 2004, Registration Statement No. 333-117430)
 
   
2.2
  Agreement and Plan of Merger, Dated as of June 9, 2006, by and among Argon ST, Inc., Argon ST Merger Sub, Inc., San Diego Research Center, Incorporated, Lindsay McClure, Thomas Seay and Harry B. Lee, Trustee of the HBL and BVL Trust (incorporated by reference to the Company’s Current Report on Form 8-K, filed June 14, 2006)
 
   
2.3
  Equity Purchase Agreement by and among Argon ST, Inc., CSIC Holdings LLC, Coherent Systems International, Corp., the Stockholders of Coherent Systems International, Corp. and Richard S. Ianieri, as Seller Representative (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed August 16, 2007)
 
   
3.1
  Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form S-1 (Registration Statement No. 333-98757) filed on August 26, 2002)
 
   
3.1.1
  Amendment, dated September 28, 2004, to the Company’s Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed October 5, 2004 covering Items 2.01, 5.01, 5.02, 8.01 and 9.01 of Form 8-K).
 
   
3.1.2
  Amendment, dated March 15, 2005 to the Company’s Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended April 5, 2005, filed May 11, 2005)
 
   
3.2
  Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K, filed May 12, 2008)
 
   
4.1
  Form of Common Stock Certificate (incorporated by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-3 (Registration Statement No. 333-128211) filed on September 9, 2005)
 
   
10.1
  Second Amended and Restated Line of Credit Agreement with Bank of America (incorporated by reference to Exhibit 10.1 of the Company’s Registration Statement on Form S-1 (Registration Statement No. 333-98757) filed on August 27, 2002)
 
   
10.1.1
  Fifth Amendment to Second Amended and Restated Financing and Security Agreement, dated as of March 31, 2006 (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed April 6, 2006)
 
   
10.1.2
  Sixth Amendment to the Second Amended and Restated Financing and Security Agreement, dated as of February 28, 2008 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed March 4, 2008)
 
   
10.2+
  Argon ST, Inc. 2002 Stock Incentive Plan, as amended (incorporated by reference to Appendix A to the Company’s definitive proxy statement on Schedule 14A for its 2006 annual meeting of stockholders, filed January 27, 2006)
 
   
10.2.1
  Form of Stock Option Agreement under Argon ST 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.2.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005, filed December 14, 2005)
 
   
10.3+
  Argon Engineering Associates, Inc. Stock Plan (incorporated by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2004, filed December 14, 2004)
 
   
10.4+
  2008 Argon Equity Plan (incorporated by reference to Appendix A to the Company’s definitive proxy statement on Schedule 14A, filed January 5, 2008)
 
   
10.5.1+
  Change in Control Agreement — between the Company and Terry Collins (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed January 22, 2009)
 
   
10.5.2+
  Change in Control Agreement — between the Company and Kerry Rowe (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed January 22, 2009)
 
   
10.5.3+
  Change in Control Agreement — between the Company and Aaron Daniels (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed January 22, 2009)
 
   
31.1*
  Certification of the Company’s Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act
 
   
31.2*
  Certification of the Company’s Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act
 
   
32.1**
  Certification pursuant to Rule 13a-14(b)/15d-14(b) under the Securities Exchange Act and Section 1350 of Chapter 63 of Title 8 of the United States Code
 
*   Filed herewith
 
**   Furnished herewith
 
+   Indicates management contract or compensatory plan or arrangement

26


 

SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
 
  ARGON ST, INC.
(Registrant)
   
 
       
 
  By: /s/ Terry L. Collins
 
   
 
  Terry L. Collins, Ph.D.    
 
  Chairman, Chief Executive Officer and President    
 
       
 
  By: /s/ Aaron N. Daniels
 
   
 
  Aaron N. Daniels    
 
  Vice President, Chief Financial Officer, and Treasurer    
Date: February 6, 2009

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