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 April 1, 2007


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		(I.R.S. Employer
incorporation or organization)		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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer þ Non-accelerated filer 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 May 4, 2007, there were 22,401,020 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 QUARTER ENDED APRIL 1, 2007

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets at April 1, 2007 and September 30, 2006	3

	Condensed Consolidated Statements of Earnings for the three and six months ended April 1, 2007 and April 2, 2006	4

	Condensed Consolidated Statements of Cash Flows for the six months ended April 1, 2007 and April 2, 2006	5

	Notes to Condensed Consolidated Financial Statements	6-11

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12-21

Item 3.	Quantitative and Qualitative Disclosures about Market Risks	22

Item 4.	Controls and Procedures	22

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	22

Item 1A.	Risk Factors	22

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22

Item 3.	Defaults Upon Senior Securities	22

Item 4.	Submission of Matters to a Vote of Security Holders	22

Item 5.	Other Information	22

Item 6.	Exhibits	23

Signatures		24

Exhibits		25-27

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)


	April 1, 2007			September 30, 2006
	(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	34,735		$	33,498
Accounts receivable, net		92,553			86,842
Inventory		3,992			3,954
Income taxes receivable		267			23
Deferred project costs		—			5,597
Deferred income tax asset		2,553			2,083
Prepaids and other		996			1,481

TOTAL CURRENT ASSETS		135,096			133,478
Property, equipment and software, net		17,203			16,726
Goodwill		149,171			148,719
Intangibles, net		12,037			13,200
Other assets		1,715			1,408

TOTAL ASSETS	$	315,222		$	313,531


LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	17,460		$	19,124
Accrued salaries and related expenses		10,943			10,678
Deferred revenue		4,066			13,053
Other liabilities		552			452

TOTAL CURRENT LIABILITIES		33,021			43,307
Deferred income tax liability, long term		3,334			2,937
Deferred rent and other liabilities		1,405			1,591
Commitments and contingencies		—			—
STOCKHOLDERS’ EQUITY
Common stock:
$.01 Par Value, 100,000,000 shares authorized, 22,488,165 and 22,313,709 shares issued at April 1, 2007 and September 30, 2006		225			223
Additional paid in capital		215,028			212,610
Treasury stock at cost, 126,245 shares		(534	)		(534	)
Retained earnings		62,743			53,397

TOTAL STOCKHOLDERS’ EQUITY		277,462			265,696

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	315,222		$	313,531

The accompanying notes are an integral part of these consolidated financial statements.

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (unaudited)
(In Thousands, Except Per Share Data)


	Second Quarter Ended				Six Months Ended
	April 1, 2007		April 2, 2006		April 1, 2007		April 2, 2006

CONTRACT REVENUES	$	64,310	$	55,681	$	124,715	$	123,788

COST OF REVENUES		51,901		43,686		97,655		96,438

GENERAL AND ADMINISTRATIVE EXPENSES		5,908		5,096		12,851		11,204


INCOME FROM OPERATIONS		6,501		6,899		14,209		16,146

INTEREST INCOME, NET		267		355		597		355


INCOME BEFORE INCOME TAXES		6,768		7,254		14,806		16,501
PROVISION FOR INCOME TAXES		2,605		2,732		5,460		6,376

NET INCOME	$	4,163	$	4,522	$	9,346	$	10,125


EARNINGS PER SHARE (Basic)	$	0.19	$	0.21	$	0.42	$	0.48

EARNINGS PER SHARE (Diluted)	$	0.18	$	0.20	$	0.41	$	0.46


WEIGHTED-AVERAGE SHARES OUTSTANDING
Basic		22,332		22,006		22,280		21,185

Diluted		22,779		22,618		22,755		21,855

The accompanying notes are an integral part of these consolidated financial statements.

ARGON ST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In Thousands)


	Six Months Ended
	April 1, 2007			April 2, 2006
Cash flows from operating activities
Net income	$	9,346		$	10,125
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,772			2,715
Deferred income tax benefit		(61	)		(471	)
Stock-based compensation		865			886
Bad debt expense		30			—
Loss on sale of equipment		2			—
Change in:
Accounts receivable		(5,805	)		26,851
Inventory		(38	)		(357	)
Deferred project costs		5,597			—
Prepaids and other		485			(267	)
Accounts payable and accrued expenses		(1,664	)		(17,709	)
Accrued salaries and related expenses		265			411
Deferred revenue		(8,987	)		(2,686	)
Income taxes receivable		(244	)		1,285
Deferred rent		(135	)		159


Net cash provided by operating activities		3,428			20,942

Cash flows from investing activities
Acquisitions of property, equipment and software		(3,091	)		(1,909	)
Reduction in advances and cash held in escrow		—			10,900
Radix Technologies, Inc. acquisition		(400	)		(9,935	)
Acquisitions of ProDesign Solutions, LLC net of cash acquired		—			(1,712	)
Proceeds from sale of equipment		5			—
Deposits and other assets		(309	)		298


Net cash used in investing activities		(3,795	)		(2,358	)

Cash flows from financing activities
Repayment on line of credit, net of borrowings		—			(11,000	)
Payment on note payable		—			(56	)
Payments on capital leases		49			(10	)
Tax benefit of stock option exercises		438			1,512
Proceeds from exercise of stock options		722			1,932
Proceeds from employee stock purchase plan exercises		395			444
Proceeds from secondary offering		—			46,768


Net cash provided by financing activities		1,604			39,590

Net increase in cash and cash equivalents		1,237			58,174
Cash and cash equivalents, beginning of period		33,498			4,064

Cash and cash equivalents, end of period	$	34,735		$	62,238

Supplemental disclosure
Income taxes paid	$	5,389		$	4,051

Interest expense paid	$	3		$	161

The accompanying notes are an integral part of these consolidated financial statements.

ARGON ST, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

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 April 1, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2007. 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, 2006. Reclassifications are made to the prior year financial statements when appropriate, to conform to the current year presentation.

Argon ST 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 April 1, 2007, the unfavorable rate variance totaled $3.4 million of which $1.9 million was 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 unfavorable, the 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, the 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.

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 common equivalent shares outstanding during each period. The following summary is presented for the indicated periods (in thousands, except per share amounts):


	Second Quarter Ended				Six Months Ended
	April 1, 2007		April 2, 2006		April 1, 2007		April 2, 2006

Net Income	$	4,163	$	4,522	$	9,346	$	10,125
Weighted Average Shares Outstanding — Basic		22,332		22,006		22,280		21,185

Basic Earnings per Share	$	0.19	$	0.21	$	0.42	$	0.48
Effect of Dilutive Securities:
Net Shares Issuable Upon Exercise of Stock Options		447		612		475		670
Weighted Average Shares Outstanding — Diluted		22,779		22,618		22,755		21,855
Diluted Earnings per Share	$	0.18	$	0.20	$	0.41	$	0.46

3. STOCK-BASED COMPENSATION

Adoption of SFAS No. 123R

The Company has 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 recorded $476,000 ($396,000 net of tax) and $518,000 ($406,000 net of tax) of stock-based compensation expense in its statement of earnings for the fiscal quarters ended April 1, 2007 and April 2, 2006, respectively. The Company recorded $865,000 ($705,000 net of tax) and $886,000 ($722,000 net of tax) of stock-based compensation expense in its statement of earnings for the six months ended April 1, 2007 and April 2, 2006, respectively. This stock-based compensation expense reduced both basic and diluted earnings per share by $0.02 and $0.02 for the fiscal quarters ended April 1, 2007 and April 2, 2006, respectively. This stock-based compensation expense reduced both base and diluted earnings per share by $0.03 and $0.03 for the six months ended April 1, 2007 and April 2, 2006, respectively. Tax benefits from option exercises were $438,000 and $1,512,000 for six months ended April 1, 2007 and April 2, 2006 respectively, and are included in cash flows from financing activities.

Stock Awards

The Company awarded a total of 21,000 shares to its six non-employee board members on December 13, 2006. The stock will vest one year after the award date. The closing price of the Company’s stock on the date of award was $21.39 per share. The fair value of the award is $21.39 per share, and $112,000 and $134,000 of stock-based compensation expense attributable to these awards was recorded in the three months and six months ended April 1, 2007, all of which is classified under General and Administrative expenses.

On February 28, 2007 40,450 restricted shares were awarded to certain senior level employees. These shares have a two year cliff vesting period and a value of $24.23 per share, the closing price on the date of award, is attributable to each share. Stock-based compensation of $43,000 has been recognized for the three and six months ended April 1, 2007, of which $40,000 is included in the Cost of Revenue and $3,000 is included in General and Administrative Expenses.

Stock Options

Fair Value Determination

The Company has elected to use both the Binomial option pricing model and straight-line amortization of compensation expense over the requisite service period of the grant. The Company will reconsider use of the Binomial model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model.

The Company has 10-year options. In calculating fair value, the following weighted-average assumptions were used for option grants during the six months ended April 1, 2007.

Expected Volatility. The expected volatility of the Company’s shares was estimated based upon the historical volatility of the Company’s share price from September 29, 2004 to the award date, as being representative of the price volatility expected in the future. This volatility is comparable to the volatilities reported by companies within our peer group. The expected volatility factor used in valuing options granted during the six months ended April 1, 2007 was 34%.

Risk-free Interest Rate. The Company bases the risk-free interest rate used in the Binomial valuation method on the implied yield available on a U.S. Treasury note on the applicable grant date, with a term equal to the expected term of the underlying grants. The risk-free interest rates used in valuing options granted during the six months ended April 1, 2007 were 4.60% and 4.53%.

Dividend Yield. The Binomial valuation model calls for a single expected dividend yield as an input. The Company has not paid dividends in the past nor does it expect to pay dividends in the future. As such, the Company used a dividend yield percentage of zero.

Expected Term. The expected term used in the Company’s Binomial model is ten years, the contractual term of the options.

Exercise Factor. The exercise factor is the ratio by which the stock price must increase from the exercise price before the employee is expected to exercise, as estimated by management. The exercise factors used in valuing employee and director options granted during the six months ended April 1, 2007 were 1.6391 and 1.7685, respectively.

Post-vest Percentage. The post-vest percentage is the rate at which employees are likely to exercise their options earlier than usual because they are leaving the Company, as estimated by management. Employees have 90 days and directors have 1 year to exercise upon termination of employment or resignation from the board. The post-vest percentage used in valuing options granted during the six months ended April 1, 2007 was 3.08%. For options granted to executive personnel, the post vest percentage was zero.

Stock Option Expense

The Company recorded $321,000 and $688,000, respectively, of stock-based compensation expense related to stock options for the three and six months ended April 1, 2007. Of that total $292,000 was recorded as Cost of Revenues and $29,000 was recorded as General and Administrative Expenses during the fiscal quarter and $475,000 was recorded as Cost of Revenue and $213,000 was recorded as General and Administrative Expenses for the six months ended April 1, 2007.

As of April 1, 2007, there was $6,228,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. This cost is expected to be fully amortized in seven years, with half of the total amortization cost being recognized within the next 24 months.

Stock Option Activity

During the six months ended April 1, 2007, the Company granted stock options to purchase 317,875 shares of common stock at a weighted-average exercise price of $24.01 per share. The Binomial weighted-average fair value of the options granted during the six months ended April 1, 2007 was $9.66 per share. Of these options, 292,875 vest at the rate of 20% per year over five years from the date of grant and 25,000 of these options vest over seven years from the date of grant. All of the options expire ten years from the grant date. For the six months ended April 1, 2007, the weighted average closing price was $23.29 per share.

The following table summarizes stock option activity for the six months ended April 1, 2007:


						Aggregate Intrinsic
				Weighted-Average		Value
	Number of Shares			Exercise Price		(in thousands)
Shares under option, September 30, 2006		1,859,088			$14.78
Options granted		317,875			$24.01
Options exercised		(155,010	)		$ 4.65		$ 2,881
Options cancelled and expired		(44,440	)		$17.22


Shares under option, April 1, 2007		1,977,513			$16.92		$12,597

Options exercisable at April 1, 2007		1,035,410			$13.92		$ 9,702

Shares reserved for equity awards at April 1, 2007		650,587

Information with respect to stock options outstanding and stock options exercisable at April 1, 2007 was as follows:


			Weighted-Average
			Remaining		Weighted-Average
Range of Exercise Price	Options Outstanding		Contractual Life		Exercise Price
$0.10 —$0.90		153,658	4.1 years		$	0.62
$2.25 —$4.63		277,250		5.1		4.04
$5.00 —$6.88		248,640		6.5		5.70
$7.54 — $17.63		204,000		6.0		12.26
$20.40 — $29.87		1,093,965		8.5		25.89


			Weighted-Average
			Remaining		Weighted-Average
Range of Exercise Price	Options Exercisable		Contractual Life		Exercise Price
$0.10 —$0.90		153,658	4.1 years		$	0.62
$2.25 —$4.63		136,102		4.6		3.97
$5.00 —$6.88		114,960		6.5		5.72
$7.54 — $17.63		204,000		6.0		12.26
$20.40 — $29.87		426,690		7.4		24.87

Employee Stock Purchase Plan

The Company maintains an employee stock purchase plan (ESPP), as provided under the Argon ST Stock Incentive Plan, and has reserved 100,000 shares for issuance under the plan. The ESPP is available to all employees eligible on the start date of the semi-annual enrollment periods. Eligible employees may purchase the Company’s common stock through payroll deductions up to 10% of the employee’s compensation, at a price equal to 95% of the of the fair market value of the common stock on the purchase date. For the six months ended April 1, 2007, 19,446 shares were purchased under the ESSP at a price of $20.31 per share. No stock compensation expense was recorded.

4. ACCOUNTS RECEIVABLE

Accounts receivable consists of the following as of:


	April 1, 2007			September 30, 2006

Billed and Billable	$	31,360,000		$	43,314,000
Unbilled Costs and Fees		56,811,000			33,333,000
Retainages		4,662,000			10,475,000
Reserves		(280,000	)		(280,000	)

	$	92,553,000		$	86,842,000

Unbilled costs, fees, and retainages result from recognition of contract revenue in advance of contractual or progress billing terms.

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.

5. REVOLVING LINE OF CREDIT

The Company maintains a $40,000,000 line of credit with Bank of America, N.A. (the “Lender”). The credit facility will terminate February 28, 2008 at which time the facility will be subject to renewal. The credit facility also contains a sublimit of $15,000,000 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 Company’s earnings before interest, taxes depreciation and amortization (EBITDA) for the trailing 12 months, calculated as of the end of each fiscal quarter. As of April 1, 2007, EBITDA, on a trailing 12 month basis, was $34,169,000. 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 April 1, 2007, the Company was in compliance with these covenants and the financial ratio.

At April 1, 2007, there were no borrowings outstanding against the line of credit. Letters of credit outstanding at April 1, 2007 amounted to $1,040,000, and $33,129,000 was available on the line of credit.

6. INCOME TAXES

For the six months ended April 1, 2007, the Company recorded a discrete income tax benefit of $104,000 related to the federal research and development tax credit which was reinstated effective January 1, 2006, but not reflected in the tax provision for the fiscal year ended September 30, 2006. In addition, discrete income tax benefits of $45,000 and $54,000 were recorded relating to a true-up of deferred taxes and disqualifying dispositions of incentive stock options, respectively. The effective rate increased to 38.5% from 37.7% for the three month periods ended April 1, 2007 and April 2, 2006, respectively. The two discrete items reduced the effective annual tax rate of 36.9% for the six months ended April 1, 2007 from 38.6% for the six months ended April 2, 2006.

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, 2006.

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. Such forward-looking statements include, without limitation, statements with respect to total estimated remaining contract values and the Company’s expectations regarding the U.S. government’s procurement activities. 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, 2006), such risks and uncertainties include, but are not limited to: the availability of U.S. and international government funding for our products and services; changes in the U.S. federal government procurement laws, regulations, policies and budgets (including changes to respond to budgetary constraints and cost-cutting initiatives); 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 government delay in award of 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; 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, except as provided by law.

Overview

General

We are a leading systems engineering and development company providing full-service C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) systems to a wide range of defense and intelligence customers. 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.

Revenues

Our revenues are primarily generated from the design, development, installation and support 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.

Our government contracts can be divided into three major types: cost reimbursable, fixed-price, and time and material. 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 low 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 periods indicated:


	Second Quarter Ended						Six Months Ended
Contract Type	April 1, 2007			April 2, 2006			April 1, 2007			April 2, 2006
Fixed-price contracts		60	%		58	%		63	%		67	%
Cost reimbursable contracts		35	%		28	%		31	%		23	%
Time and material contracts		5	%		14	%		6	%		10	%

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. 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.

Backlog

We define backlog as the funded and unfunded amount provided in our contracts less previously recognized revenue and exclude all unexercised options on contracts. Some contracts where work has been authorized carry a funding ceiling that does not allow us to continue work on the contract once the customer obligations have reached the funding ceiling. In such cases, we may be required to stop work until additional funding is added to the contract. Our experience in this case is very rare and therefore we generally carry the entire amount that the customer intends to execute as backlog when we are confident that the customer has access to the required funding for the contract.

In general, most of our backlog results in sales in subsequent fiscal years, as we maintain very minimal inventory and therefore the lead time on ordering and receiving material and increasing staff to execute programs has a lag time of several months from the receipt of order.

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 sales to be expected for any succeeding period, and actual sales for the year may not meet or exceed the backlog represented. We may experience significant contract cancellations that were previously booked and included in backlog.

Our backlog at the dates shown was as follows (in thousands):


	April 1, 2007		April 2, 2006

Funded	$	231,917	$	187,592
Unfunded		77,367		31,005

*Total*	$	309,284	$	218,597

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 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 government approves the planned indirect rates as provisional billing rates near the beginning of each fiscal year.

Stock-Based Compensation Expense

Effective October 1, 2005, we 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 operating expenses over the vesting period during which an employee or director provides service in exchange for the award.

We recorded $865,000 ($705,000 net of tax) and $886,000 ($722,000 net of tax) of stock-based compensation expense in our statement of earnings for the six months ended April 1, 2007 and April 2, 2006, respectively. The stock-based compensation expense for the six months ended April 1, 2007, includes $134,000 attributable to stock awards issued to non-employee directors during the period. This stock-based compensation expense reduced both basic and diluted earnings per share by $0.03 and $0.03 for the six months ended April 1, 2007 and April 2, 2006, respectively.

As of April 1, 2007, there was $6.2 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements. This cost is expected to be fully amortized in seven years, with half of the total amortization cost being recognized within the next 24 months.

General and Administrative Expenses

Our general and administrative expenses include administrative salaries, costs related to proposal activities, internally funded research and development, and other administrative costs.

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 of credit and capital leases.

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. In the six months ending April 1, 2007 and April 2, 2006, internal research and development expenditures (“IRAD”) were $3,964,000 and $2,904,000, respectively, representing 3.2% and 2.3% respectively, of revenues in each period. The increase in IRAD is attributable to increased funding of a major R&D effort, and the additional R&D performed by acquired companies.

Internal 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.

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. During the six months ended April 1, 2007, we incurred cost on certain fixed-price contracts resulting in a decrease of approximately $9.1 million of deferred revenues, as compared to the year ended September 30, 2006.

Critical Accounting Practices and Estimates

General

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated 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. 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. 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. Management reviews contract performance, costs incurred, and estimated completion costs regularly and adjusts revenues and profits on contracts in the period in which changes become determinable.

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 unfavorable, the 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, the 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 April 1, 2007, the unfavorable rate variance totaled $3.4 million of which $1.9 million was planned. Management expects this variance will be eliminated over the course of the fiscal year and therefore, no portion of this variance is considered permanent.

Award Fee Recognition

Our policy 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. The fair values of the reporting units are estimated using a combination of the income, or discounted cash flows approach and the market approach, which utilizes comparable companies’ data. 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 test for impairment annually in the fourth fiscal quarter.

We currently determine goodwill impairment on three reporting units. Each reporting unit is a component of the Company’s single homogeneous business segment with discrete financial information. Goodwill allocated to the reporting units was determined as of the acquisition dates. There was no structural change to the reporting units during the six months ended April 1, 2007.

Stock-based Compensation

We account for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected volatility, dividend yield, expected term and estimated forfeitures of the options granted.

Historical Operating Results

Fiscal quarter ended April 1, 2007 compared to fiscal quarter ended April 2, 2006

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 fiscal quarters ended April 1, 2007 and April 2, 2006 (in thousands):


	Fiscal quarter ended				Increase
	April 1, 2007		April 2, 2006		(Decrease)

Contract revenues	$	64,310	$	55,681		8,629
Cost of revenues	$	51,901	$	43,686		8,215
General and administrative expenses	$	5,908	$	5,096		812
Provision for income taxes	$	2,605	$	2,732		(127	)
Net income	$	4,163	$	4,522		(359	)

Revenues:

Revenues increased approximately 15% for the fiscal quarter ended April 1, 2007, as compared to the fiscal quarter ended April 2, 2006. The revenue increase is attributable to new contracts, primarily for the production of surface ship systems as well as the impact of acquisitions completed after the second quarter of fiscal year 2006. These increases were partially offset by the completion or near completion of several mobile systems, as well as a number of submarine systems.

Cost of Revenues:

Cost of revenues increased approximately 19% for the fiscal quarter ended April 1, 2007 as compared to the fiscal quarter ended April 2, 2006. The increase was primarily comprised of increases in direct materials and subcontract costs of $2.5 million and $1.4 million, respectively, related to increased contract activities during the quarter. Direct labor and other direct costs increased by $1.8 million and $0.8 million, respectively, also related to increased contract activities. Engineering overhead increased by $1.7 million. Cost of revenues as a percentage of revenue increased to 81% for the quarter ended April 1, 2007 from 78% for the quarter ended April 2, 2006. This increase in costs was due primarily to an increase in the amortization of intangible assets related to companies acquired subsequent to April 2, 2006; an increase in costs beyond planned expenditures involving a single time and material contract; and a change in contract mix from fixed price to cost plus fixed fee resulting in lower profit margins.

General and Administrative Expenses:

General and administrative expenses increased approximately 16% for the fiscal quarter ended April 1, 2007, as compared to the fiscal quarter ended April 2, 2006. The increase was due primarily to the impact of acquisitions completed after the second quarter of fiscal year 2006, and an increase in infrastructure to support related business growth and employee population. General and administrative expenses as a percentage of revenue was 9% for the quarters ended April 1, 2007 and April 2, 2006.

Income Tax Expense:

Our effective income tax rate increased to 38.5% for the fiscal quarter ended April 1, 2007, compared to an effective rate of 37.7% for the fiscal quarter ended April 2, 2006. The increase is due mainly to increased activity in states with higher tax rates, a decreased effect from tax exempt interest and the domestic production activities deduction, partially offset by an increased effect from the R&D tax credit.

Net Income:

As a result of the above, net income decreased approximately $0.4 million, or 8%, for the fiscal quarter ended April 1, 2007 compared to the fiscal quarter ended April 2, 2006.

Six Months Ended April 2, 2007 compared to Six Months Ended April 2, 2006

The following table sets forth certain items, including consolidated contract revenues, cost of revenues, general and administrative expenses, interest income and interest expense, provision for income taxes and net income, and the changes in these items for the periods indicated (in thousands) :


	Six Months Ended				Increase
	April 1, 2007		April 2, 2006		(Decrease)

Contract revenues	$	124,715	$	123,788	$	927
Cost of revenues		97,655		96,438		1,217
General and administrative expenses		12,851		11,204		1,647
Provision for income taxes		5,460		6,376		(916	)
Net income		9,346		10,125		(779	)

Contract Revenues:

Revenues increased approximately 1% for the six months ended April 1, 2007, as compared to the same period in the prior year. Increased revenue from acquisitions completed after April 2, 2006 as well as new surface ship production and development contracts were partially offset by decreased revenue due to the completion of submarine and other systems.

Cost of Revenues:

Cost of revenues increased approximately 1% for the six months ended April 1, 2007 as compared to the six months ended April 2, 2006. The increase was comprised primarily of an increase in direct labor of $3.6 million. This increase was partially offset by decreases in material costs and other direct costs of $8.4 million and $2.9 million, respectively, due to our nearing completion of two significant production programs. Fringe benefits and facilities costs increased by $1.6 million and $1.1 million, respectively. Engineering overhead, including business development cost, increased by $4.1 million. The increase in fringe benefits and facilities costs are related to an increase in employee population, while the increase in business development costs is consistent with our emphasis on penetrating new markets. The amortization of intangibles and other non-contract cost increased by $1.3 million. Cost of revenues as a percentage of revenue was 78% in both the six month period ended April 1, 2007 and the six month period ended April 2, 2006.

General and Administrative Expenses:

General and administrative expenses increased approximately 15% for the six months ended April 1, 2007, as compared to the six months ended April 2, 2006. The increase was primarily due to acquisitions completed after April 2, 2006. General and administrative expenses as a percentage of revenue increased to 10% for the six months ended April 1, 2007 from 9% for the six months ended April 2, 2006.

Provision for Income Taxes:

Our effective income tax rate decreased to 36.9% for the six months ended April 1, 2007, compared to 38.6% for the six months ended April 2, 2006. The decrease in the effective rate is attributable to a true-up of deferred taxes, the R&D tax credit and a reduced effect of incentive stock option expense during the six months ended April 1, 2007.

Net Income:

As a result of the above, net income decreased approximately $779,000, or 8%, for the six months ended April 1, 2007 compared to the six months ended April 2, 2006.

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 research and development activities and any acquisitions we may make.

Cash

At April 1, 2007, we had cash of $34.7 million compared to cash of $33.5 million on September 30, 2006. This increase in cash of $1.2 million was the result of net cash provided by operating activities, partially offset by cash used in investing activities (see Cash Flows discussion below).

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 February 28, 2008 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 Company’s EBITDA for the trailing 12 months, calculated as of the end of each fiscal quarter. As of April 1, 2007, EBITDA, on a trailing 12 month basis, was $34.2 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 April 1, 2007, the Company was in compliance with these covenants and the financial ratio.

At April 1, 2007, there were no borrowings outstanding against the line of credit. Letters of credit outstanding at April 1, 2007 amounted to $1.0 million, leaving $33.2 million available on the line of credit.

Cash Flows

Many of the Company’s larger fixed price contracts contain milestone billing provisions. These contracts have arrangements which allow us to bill our customer only upon completion of specified milestone activities. As a result, the Company must often fund operating working capital requirements in advance of the billings associated with those activities. In addition, to the extent cash flows from milestone billings are tied to early activities on a contract, revenue related to these billings is deferred until recognition. See “—Overview—Deferred Revenue” above.

Net cash provided by operating activities was $3.4 million for the six months ending April 1, 2007, compared to net cash provided by operating activities of $20.9 million for the six months ending April 2, 2006. The decrease in cash provided by operating activities is primarily due to the increase in accounts receivable which was partially offset by a decrease in accounts payable. The increase in accounts receivable was primarily due to contractual milestones which were not scheduled for completion until a later date. In the first six months of fiscal 2007, we were able to put into production $5.5 million of project costs deferred at the end of fiscal year 2006; however, this was offset by $9.0 million of deferred revenue recognized during the first six months ended April 1, 2007.

Net cash used in investing activities was $3.8 million for the six months ended April 1, 2007, compared to net cash used in investing activities of $2.4 million for the six months ended April 2, 2006. This is due primarily to an increase in capital expenditures for property, equipment and software of $1.1 million. During the period, we made an additional payment of $0.4 million to Radix shareholders for achieving certain financial targets.

Net cash provided by financing activities was $1.6 million for the six months ended April 1, 2007 compared to $39.6 million for the fiscal quarter ended April 2, 2006. The decrease in net cash provided by financing activities was primarily due to the net proceeds from our secondary stock offering of $46.8 million, partially offset by the repayment of the line of credit in December 2005.

We believe our existing funds plus cash generated from operations and amounts available for borrowing under our line of credit will be sufficient to provide liquidity and capital resources to fund ongoing operations, customary capital expenditures, and other working capital requirements.

Contractual Obligations and Commitments

As of April 1, 2007, our contractual cash obligations were as follows (in thousands):


	Total		Due in 2007		Due in 2008		Due in 2009		Due in 2010		Due in 2011		Thereafter
Capital leases	$	123	$	22	$	46	$	43	$	12		—	—
Operating leases		24,737		3,736		7,667		5,288		2,526		1,970		3,550


Total	$	24,860	$	3,758	$	7,713	$	5,331	$	2,538	$	1,970	$	3,550

As of April 1, 2007, other commercial commitments were as follows (in thousands):


	Total		Less Than 1 Year		1-3 Years
Letters of credit	$	1,040	$	977	$	63

We have no long-term debt 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.

Recent Accounting Pronouncements

On February 15, 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS 159”), including an amendment of FASB Statement No. 115, (“SFAS 159”). SFAS 159 provides for the option to recognize most financial assets and liabilities and certain other items at fair value. SFAS 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. SFAS 159 is effective for use beginning October 1, 2008. We are evaluating the statement to determine the effect, if any, on our future financial statements and related disclosures.

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 a remaining 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.

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 April 1, 2007. Accordingly, we do not believe that any movement in interest rates would have a material impact on future earnings or cash flows.

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 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.

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.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not party to any material legal proceedings. 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.

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, 2006, filed on December 14, 2006.

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

Incorporated by reference to Exhibit 99.2 to our Current Report on Form 8-K, filed March 6, 2007

ITEM 5. OTHER INFORMATION

None.

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)

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 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 13(a)(i) of the Company’s Annual Report on Form 10-KSB for the fiscal year ended September 30, 2001)

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)

10.2+		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)

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


	ARGON ST, INC. (Registrant)
	By:	/s/ Terry L. Collins
		Terry L. Collins, Ph.D.
		Chairman, Chief Executive Officer and President


	By:	/s/ Victor F. Sellier
		Victor F. Sellier
		Vice President, Chief Financial Officer, Secretary and Treasurer

	a.		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	b.		Designed such internal control over financial reporting or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c.		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	d.		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	a.		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b.		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	a.		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	b.		Designed such internal control over financial reporting or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c.		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	d.		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	a.		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b.		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

1.		I have reviewed this quarterly report on Form 10-Q of Argon ST, Inc.;

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:


/s/ Terry L. Collins Terry L. Collins Chief Executive Officer


/s/ Victor F. Sellier Victor F. Sellier Chief Financial Officer