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 4, 2010


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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o 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	Smaller reporting company o
		(Do not check if a smaller reporting company)

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 April 30, 2010, there were 21,899,450 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 AND SIX MONTHS ENDED APRIL 4, 2010

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets at April 4, 2010 and September 30, 2009			3

Condensed Consolidated Statements of Earnings for the three and six months ended April 4, 2010 and March 29, 2009			4

Condensed Consolidated Statements of Cash Flows for the three and six months ended April 4, 2010 and March 29, 2009			5

Condensed Consolidated Statements of Stockholders’ Equity for the six months ended April 4, 2010			6

Notes to Condensed Consolidated Financial Statements			7-13

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14-26

Item 3. Quantitative and Qualitative Disclosures about Market Risks			27

Item 4. Controls and Procedures			27

PART II. OTHER INFORMATION

Item 1. Legal Proceedings			28

Item 1A. Risk Factors			28

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			28

Item 3. Defaults Upon Senior Securities			28

Item 4. Submission of Matters to a Vote of Security Holders			28-29

Item 5. Other Information			29

Item 6. Exhibits			30

Signatures			31

Exhibits			32-34
EX-31.1
EX-31.2
EX-32.1

ARGON ST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)


	April 4, 2010			September 30, 2009
	(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	24,551		$	43,108
Accounts receivable, net		147,721			116,656
Inventory, net		6,598			6,021
Deferred project costs		1,304			2,296
Deferred income tax asset		5,296			5,137
Prepaids and other		1,530			1,499

TOTAL CURRENT ASSETS		187,000			174,717
Property, equipment and software, net		26,134			28,042
Goodwill		173,948			173,948
Intangibles, net		2,344			2,745
Other assets		485			573

TOTAL ASSETS	$	389,911		$	380,025


LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	22,862		$	32,526
Accrued salaries and related expenses		13,810			13,887
Deferred revenue		15,146			5,504
Income taxes payable		1,319			4,784
Other current liabilities		45			155

TOTAL CURRENT LIABILITIES		53,182			56,856
Deferred income tax liability, long-term		1,609			1,942
Other long-term liabilities		2,869			1,649
Commitments and contingencies
STOCKHOLDERS’ EQUITY
Common stock: $.01 Par Value, 100,000,000 shares authorized, 23,103,807 and 22,965,952 shares issued at April 4, 2010 and September 30, 2009		231			230
Additional paid in capital		230,636			227,288
Treasury stock at cost, 1,219,077 shares at April 4, 2010 and September 30, 2009		(19,923	)		(19,923	)
Retained earnings		121,307			111,983

TOTAL STOCKHOLDERS’ EQUITY		332,251			319,578

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	389,911		$	380,025

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

ARGON ST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (unaudited)
(In thousands, except share and per share amounts)


	For the Three Months Ended					For the Six Months Ended
	April 4, 2010		March 29, 2009			April 4, 2010		March 29, 2009
CONTRACT REVENUES	$	77,344	$	95,572		$	150,531	$	179,598

COST OF REVENUES		62,499		77,695			121,466		146,541

GENERAL AND ADMINISTRATIVE EXPENSES		4,355		6,128			8,760		11,916

RESEARCH AND DEVELOPMENT EXPENSES		2,922		2,366			5,279		4,138


INCOME FROM OPERATIONS		7,568		9,383			15,026		17,003

INTEREST INCOME (EXPENSE), NET		7		(11	)		7		(25	)


INCOME BEFORE INCOME TAXES		7,575		9,372			15,033		16,978
PROVISION FOR INCOME TAXES		2,869		3,556			5,709		5,973

NET INCOME	$	4,706	$	5,816		$	9,324	$	11,005


EARNINGS PER SHARE (Basic)	$	0.22	$	0.27		$	0.43	$	0.51

EARNINGS PER SHARE (Diluted)	$	0.21	$	0.26		$	0.42	$	0.50


WEIGHTED-AVERAGE SHARES OUTSTANDING
Basic		21,865,320		21,713,793			21,816,641		21,691,082

Diluted		22,295,103		22,009,828			22,353,743		22,016,996

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

ARGON ST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)


	For the Six Months Ended
	April 4, 2010			March 29, 2009
Cash flows from operating activities
Net income	$	9,324		$	11,005
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		4,622			4,508
Claims resolution		—			640
Amortization of deferred costs		84			84
Deferred income tax expense (benefit)		(527	)		448
Stock-based compensation		3,118			1,807
Other		102			(93	)
Change in:
Accounts receivable, net		(31,167	)		(26,032	)
Inventory		(577	)		(101	)
Prepaids and other		961			1,929
Accounts payable and accrued expenses		(9,404	)		7,855
Accrued salaries and related expenses		(77	)		2,689
Deferred revenue		9,642			3,653
Income taxes		(3,430	)		238
Other liabilities		698			(217	)


Net cash provided by (used in) operating activities		(16,631	)		8,413

Cash flows from investing activities
Acquisitions of property, equipment and software		(2,365	)		(4,452	)
Other activity		(204	)		66


Net cash used in investing activities		(2,569	)		(4,386	)

Cash flows from financing activities
Stock repurchases		—			(1,498	)
Payments on capital leases		(18	)		(30	)
Tax benefit of stock option exercises		188			4
Proceeds from exercise of stock options		416			171
Restricted shares reacquired in net share issuance		(212	)		—
Proceeds from employee stock purchase plan exercises		269			251


Net cash provided by (used in) financing activities		643			(1,102	)

Net increase (decrease) in cash and cash equivalents		(18,557	)		2,925
Cash and cash equivalents, beginning of period		43,108			15,380

Cash and cash equivalents, end of period	$	24,551		$	18,305

Supplemental disclosure
Income taxes paid	$	9,447		$	5,253

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

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						Retained		Stockholders’
	Number of Shares		Par Value		Capital			Treasury Stock			Earnings		Equity
Balance, September 30, 2009		22,965,952	$	230	$	227,288		$	(19,923	)	$	111,983	$	319,578
Net income		—		—		—			—			9,324		9,324
Shares issued upon exercise of stock options		49,240		—		416			—			—		416
Restricted stock units vested		75,555		1		(212	)		—			—		(211	)
ESPP		13,060		—		269			—			—		269
Stock-based compensation		—		—		2,687			—			—		2,687
Tax benefit on stock option exercises		—		—		188			—			—		188


Balance, April 4, 2010		23,103,807	$	231	$	230,636		$	(19,923	)	$	121,307	$	332,251

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

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 accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and disclosures required by GAAP 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 three and six month periods ended April 4, 2010, are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2010. 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, 2009. 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. The quarterly periods ending April 4, 2010 and March 29, 2009 each contained 13 weeks. 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 due to necessarily uneven rates of spending throughout the year. 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. To the extent such amounts are recoverable, favorable rate variances are recorded as increases to operating expenses and decreases to unbilled receivables. At April 4, 2010, the unfavorable rate variance totaled $5,481, which was approximately $1,055 more than the $4,426 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 for the portion of rate variance that is considered permanent, if any. 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.

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 three and six months ended April 4, 2010 and March 29, 2009:


	For the three months ended				For the six months ended
	April 4, 2010		March 29, 2009		April 4, 2010		March 29, 2009
Net income	$	4,706	$	5,816	$	9,324	$	11,005
Weighted average shares outstanding — basic		21,865,320		21,713,793		21,816,641		21,691,082

Basic earnings per share	$	0.22	$	0.27	$	0.43	$	0.51
Effect of dilutive securities:
Net shares issuable upon exercise of stock options and awards		429,783		296,035		537,102		325,914
Weighted average shares outstanding — diluted		22,295,103		22,009,828		22,353,743		22,016,996
Diluted earnings per share	$	0.21	$	0.26	$	0.42	$	0.50

Stock options and awards 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 1,012,401 and 1,163,561 for the three and six months ended April 4, 2010, respectively, and were 1,240,504 and 1,175,217 for the three and six months ended March 29, 2009, respectively.

3. STOCK-BASED COMPENSATION

The Company issues stock options, restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) on an annual or selective basis to our directors and key employees. The fair value of the RSUs is computed using the closing price of the stock on the date of grant. The fair value of the stock options and the SARs is computed using a binomial option pricing model. Assumptions related to the volatility are based on an analysis of our historical volatility. The estimated fair value of each award is included in cost of revenues or general and administrative expenses over the vesting period during which an employee provides services 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.


	For the three months ended						For the six months ended
	April 4,			March 29,			April 4,			March 29,
	2010			2009			2010			2009
Cost of revenues	$	1,198		$	666		$	2,259		$	1,244
General and administrative expense		504			332			859			563

Total pre-tax stock-based compensation included in income from operations		1,702			998			3,118			1,807
Income tax expense (benefit) recognized for stock-based compensation		(481	)		(258	)		(868	)		(478	)

Total stock-based compensation expense, net of tax	$	1,221		$	740		$	2,250		$	1,329

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)

As of April 4, 2010, there was $11,866 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. This cost is to be fully amortized in 5 years, with the weighted average remaining vesting period being 3.02 years.

Stock Option Activity

The following table summarizes stock option activity for the six months ended April 4, 2010. On April 1, 2010, the closing price of our common stock was $26.63.


						Weighted-
						Average
				Weighted-		Remaining		Aggregate
	Number of			Average		Contractual		Intrinsic
	Shares			Exercise Price		Term		Value
Shares under option, September 30, 2009		1,675,872		$	18.50
Options granted		155,500			21.23
Options exercised		(49,240	)		8.46			$	780
Options cancelled and expired		(12,720	)		25.27


Shares under option, April 4, 2010		1,769,412			18.97		5.41	$	14,804

Options vested at April 4, 2010		1,270,805			18.01		4.46	$	12,002

As of April 4, 2010, options that are vested and expected to vest prior to expiration		1,758,449		$	18.93		5.41	$	14,784

Restricted Share Activity

Restricted share awards are those shares issued to the Company’s Board of Directors, senior management and other employees. The following table summarizes restricted share award activity for the six months ended April 4, 2010:


				Weighted-
	Number of			Average Grant
	Shares			Date Fair Value
Unvested shares, September 30, 2009		425,663		$	20.37
Award shares granted		151,250			21.16
Award shares vested		(75,555	)		18.31
Award shares surrendered for taxes		(9,954	)		18.31
Award shares forfeited		(5,000	)		22.20

Unvested shares, April 4, 2010		486,404		$	20.96

The Company awarded a total of 40,000 shares to its ten non-employee board members on December 14, 2009. The stock will vest one year after the award date. The grant date market price of these awards was $21.09 per share 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 111,250 restricted shares to its executive, senior management and other employees during the six months ended April 4, 2010. All awards vest on a graded five-year schedule. The weighted average grant date market value of these awards was $21.19 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.

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)

4. ACCOUNTS RECEIVABLE

Accounts receivable consist of the following as of:


	April 4 ,			September 30,
	2010			2009
Billed and billable	$	65,649		$	46,070
Unbilled costs and fees		69,388			64,779
Unfavorable indirect rate variance		5,481			—
Retainages		7,425			6,109
Reserve		(222	)		(302	)

Accounts receivable, net	$	147,721		$	116,656

The unbilled costs, fees, and retainages result from recognition of contract revenue in advance of contractual or progress billing terms. Retainages include costs and fees on cost-reimbursable and time and material contracts withheld until audits are completed by Defense Contract Audit Agency (“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. The company writes off accounts receivable when such amounts are determined to be uncollectible.

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:


	April 4,			September 30,
	2010			2009
Raw Materials	$	2,889		$	3,212
Component parts, work in process		1,800			797
Finished component parts		2,200			2,303

		6,889		$	6,313
Reserve		(291	)		(291	)

Inventory, net	$	6,598		$	6,021

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)

6. PROPERTY, EQUIPMENT AND SOFTWARE

Property, equipment and software consist of the following as of:


	April 4,			September 30,
	2010			2009
Computer, machinery and test equipment	$	37,099		$	29,841
Leasehold improvements		13,127			12,238
Computer software		5,580			5,575
Furniture and fixtures		1,516			1,514
Equipment under capital lease		337			337
Construction in progress		5,268			11,813

		62,927			61,318
Less accumulated depreciation and amortization		(36,793	)		(33,276	)

	$	26,134		$	28,042

As of April 4, 2010, the Company has capitalized $5,268 of construction in progress primarily consisting of $3,983 of costs incurred in connection 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 2010.

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, 2012. The credit facility contains a sublimit of $15,000 to cover letters of credit. In addition, borrowings on the line of credit bear interest at LIBOR plus 175 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 April 4, 2010, EBITDA, on a trailing 12 month basis, was $42,995 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 April 4, 2010, the Company was in compliance with these covenants and the financial ratio.

On April 4, 2010, there were no borrowings outstanding against the line of credit. Letters of credit and debt consisting of capital lease obligations at April 4, 2010, amounted to $2,390, and $37,610 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.

With respect to income tax uncertainties, based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits on April 4, 2010, is not material to the

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)

results of operations, financial condition or cash flows. The Company also believes that the total amount of unrecognized tax benefits on April 4, 2010, if recognized, would not have a material impact on the effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the results of operations, financial condition or cash flows.

The Company’s accounting policy is to recognize interest and penalties related to income tax matters in income tax expense. The Company had no accrued interest and penalties as of April 4, 2010.

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

Our financial instruments include cash and cash equivalents and SARs. We do not have any significant non-financial assets and liabilities measured at fair value on April 4, 2010. The valuation techniques required by the Financial Accounting Standards Board Accounting Standard Codification (“FASB ASC”) Topic 820, Fair Value Measurements and Disclosures, are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 — Quoted prices for identical instruments in active markets.

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 — Significant inputs to the valuation model are unobservable.

Our SAR liabilities are valued using Level Two inputs as the valuation is based on a model-derived valuation. The liability at April 4, 2010 was $752.

10. COMMITMENTS AND CONTINGENCIES

The Company is 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.

11. RELATED PARTY TRANSACTIONS

On September 30, 2009, in the ordinary course of the Company’s business operations, the Company was awarded a $475 contract to develop a technology related to global positioning for Strata Products Worldwide, LLC (“Strata”). Strata designs and manufactures emergency refuge chambers and innovative underground mining roof support products and provides mine construction services to underground mining operations. S. Kent Rockwell, a member of our Board of Directors, owns approximately 57 percent of the voting interests of Strata. The Company’s expected profit on the program is consistent with similar business arrangements that the Company maintains with its other customers. As of April 4, 2010, the Company has recognized $427 in revenue related to the work awarded under this contract.

12. SUBSEQUENT EVENTS

The Company evaluated all events or transactions that occurred after April 4, 2010 up through the issuance of these financial statements. During this period the Company did not have any significant subsequent events.

13. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued an amendment which requires entities to provide more information about the sale of securitized financial assets and similar transactions in which the entity retains some risk related to the

ARGON ST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(In thousands, except share and per share amounts)

assets. This amendment is effective for fiscal years beginning after November 15, 2009. The Company does not believe the adoption of this amendment will have a material impact on its consolidated financial position, results of operations, or cash flows.

In June 2009, the FASB issued an amendment, which changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. Under this guidance, determining whether a company is required to consolidate an entity will be based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. This amendment is effective for fiscal years beginning after November 15, 2009. The Company does not believe the adoption will have a material impact on its consolidated financial position, results of operations, or cash flows.

In October 2009, the FASB revised the accounting guidance for revenue arrangements with multiple deliverables. The revision: (1) removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, (2) provides a hierarchy that entities must use to estimate the selling price, (3) eliminates the use of the residual method for allocation, and (4) expands the ongoing disclosure requirements. This guidance is effective for the Company beginning October 1, 2010 and can be applied prospectively or retrospectively. The Company does not believe the adoption will have a material impact on its consolidated financial position, results of operations, or cash flows.

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, 2009.

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 and uncertainties 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, 2009), such risks and uncertainties include, but are not limited to: the availability of U.S. and international government and commercial funding for our products and services, including total estimated remaining contract values and 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 as well as changes increasing internal costs for monitoring, audit and reporting activity); changes in appropriations types and amounts due to the expenditures priorities in Washington; the future impact of any acquisitions, reorganizations or divestitures we may make, including any outcome of our exploration of strategic alternatives; the government’s ability to hire and retain contracting personnel; 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; decisions by government agencies on the methods of seeking contractor support; 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; our ability to secure business with government prime contractors; our ability to maintain adequate and unbroken supplier performance; 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 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.

As a result of shifts in governmental budgets and priorities over the last two years, we have continually reviewed our technology and capability offerings. We continue to believe that the U.S. government will retain prioritization of and focus on C5ISR spending as sources of threat have increased in both quantity and complexity. However, during fiscal year 2009 and in the first half of 2010, we have experienced delays in the government procurement and contract administration cycles, which has resulted in lower than anticipated bookings. We continue to see opportunities across a broad spectrum of our technology and capability offerings.

Revenues

Our revenues are generated from the entire life cycle of complex systems under contracts primarily with the U.S. government and major domestic prime contractors, but also with foreign governments, agencies and defense contractors. This life cycle spans the design, development, production, installation and support of the system.

Our government contracts can be divided into three major types: cost reimbursable, 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. Lower risk development activities are also usually covered by fixed-price contracts. 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 pre-negotiated labor rates, plus other costs incurred, allocated and approved.

The following table represents our revenue concentration by contract type for the three and six months ended April 4, 2010 and March 29, 2009:


	Three Months Ended		Six Months Ended
Contract Type	April 4, 2010	March 29, 2009	April 4, 2010	March 29, 2009
Fixed-price contracts	52%	55%	53%	56%

Cost reimbursable contracts	45%	40%	44%	39%

Time and material contracts	3%	5%	3%	5%

Our primary business model is to capture the full life cycle of a system beginning with concept development and progressing through development, production and end of cycle support and logistics. Additional cycles developing and producing next generation systems are sought to provide multi-year and multi-decade opportunities. Early cycle programs are typically cost-type contracts carrying lower margins while production cycle programs are typically fixed-price type contracts carrying higher margins. End of cycle programs can be of a variety of contract types. Through our business model, we optimize the long-term growth of the company by leveraging long-term relationships into multiple cycles each carrying higher margin production cycles. As such, much of our current production work has been derived from programs for which we have performed the initial development

work. With the current higher cost-type contract mix, we are continuing to lay the groundwork for future low-rate and high-rate production orders and future generation development and production cycles. Cost-reimbursable mix has increased as a percentage of total revenue over the past few years, primarily as a result of our continued work on certain large and long-run development programs, including Ships Signal Exploitation Equipment (“SSEE”) Increment F, Operational Test-Tactical Engagement System (“OT-TES”) and Common Range Integrated Instrumentation System (“CRIIS”), and the mix of contracts acquired in recent business combinations. In all three of these programs we have either completed or are near completion of the test and integration phases. We believe we will receive production orders during the coming fiscal years. These production orders could cause a significant impact to our mix of contract types and may result in larger percentages of more desirable and potentially higher margin fixed price work although the capture of new development work generally on cost-type contracts continues to be an important element of our business. Further, the ORBCOMM Generation Two Payload (“OG2”) development program, a fixed price contract, entered the integration and test phases in late 2009 and early 2010 which caused a decrease in fixed price work in fiscal 2010. During these phases, the level of effort of both labor and materials are much less than the large level of efforts needed during the development work which continued in the second quarter of fiscal year 2009. We believe declines in the fixed price work on OG2 will offset with newer fixed price work on other programs.

Backlog

We define backlog as the funded and unfunded amount provided in our contracts, less previously recognized revenue. Contract options are estimated separately and not included in backlog until they are exercised and funded. Backlog does not include the value of a contract where the customer has given permission to begin or continue working, but where a formal contract or contract extension has not yet been signed.

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, or less, 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 believe revenue could be jeopardized by a change in government policy. Because of possible future changes in delivery schedules and/or cancellations of orders, backlog at any particular date is not necessarily representative of actual sales to be expected for any future period, and actual sales for the year may not meet 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 4,		September 30,
	2010		2009
Funded	$	167,963	$	137,947
Unfunded		90,843		95,413

*Total*	$	258,806	$	233,360

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, we 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 and six months ended April 4, 2010, internally funded research and development expenditures were $2.9 million and $5.3 million, respectively, representing approximately 4% of revenues in both periods. For the three and six months ended March 29, 2009, internally funded research and development expenditures were $2.4 million and $4.1 million, respectively, representing 3% of revenues in both periods.

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 of credit and capital leases.

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 Financial Accounting Standards Board Accounting Standard Codification (“FASB ASC”) Topic 605-35-25, Revenue Recognition — Construction-Type and Production-Type Contracts — General. 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. 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.

In certain circumstances, and based on correspondence with the end customer, management authorizes work to commence or to continue on a contract option, addition or amendment prior to the signing of formal modifications or amendments. We recognize revenue to the extent it is probable that the formal modifications or amendments will be finalized in a timely manner and that it is probable that the revenue recognized will be collected.

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 may use to absorb the variance: we may adjust planned indirect spending during the year, modify our billing rates to our customers, or record adjustments to expense for the portion of rate variance deemed to be permanent.

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 April 4, 2010, the unfavorable rate variance totaled $5.5 million, which was approximately $1.1 million more than the $4.4 million unfavorable rate variance planned for the period. Management expects the variance to be eliminated over the course of the fiscal year, and therefore, no portion of the variance is considered permanent.

Award Fee Recognition

Our practice for recognizing interim fees 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 FASB ASC Topic 350-20, Goodwill, 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 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 2009 and found no impairment to the carrying value of goodwill.

Long-Lived Assets (Excluding Goodwill)

We follow the provisions of FASB ASC topic 360-10-35, Impairment or Disposal of Long-Lived Assets in accounting for long-lived assets such as property and equipment and intangible assets subject to amortization. This topic 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

We issue stock options, restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) on an annual or selective basis to our directors and key employees. The fair value of the RSUs is computed using the closing price of the stock on the date of grant. The fair value of the stock options and the SARs is computed using a binomial option pricing model. Assumptions related to the volatility are based on an analysis of our historical volatility. The estimated fair value of each award is included in cost of revenues or general and administrative expenses over the vesting period during which an employee provides services in exchange for the award.

Historical Operating Results

Three months ended April 4, 2010 compared to three months ended March 29, 2009

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 April 4, 2010, and March 29, 2009 (in thousands):


	Three months ended
						Amount of			%
	April 4,		March 29,			increase			increase
	2010		2009			(decrease)			(decrease)
Contract revenues	$	77,344	$	95,572			($18,228	)		-19	%
Cost of revenues		62,499		77,695			(15,196	)		-20	%
General and administrative expenses		4,355		6,128			(1,773	)		-29	%
Research and development expenses		2,922		2,366			556			23	%
Interest income, net		7		(11	)		18			-164	%
Provision for income taxes		2,869		3,556			(687	)		-19	%
Net income	$	4,706	$	5,816			($1,110	)		-19	%

Revenues

Revenues decreased approximately $18.2 million or 19% for the three months ended April 4, 2010, as compared to the three months ended March 29, 2009. The second quarter of fiscal 2010 remained a quarter of replenishing low levels of backlog resulting from delays in our bookings in fiscal 2009. During the quarter, backlog increased approximately $50 million resulting from the booking of our initial production lots of the SSEE Increment F program, along with other significant bookings on new contracts. While we anticipate these bookings, along with further replenishment of backlog throughout the year, will drive revenue growth in the third and fourth quarters of fiscal 2010, the timing of these bookings has impacted our year over year revenue metrics. The decline in these year over year revenue metrics were driven by two key areas: our SSEE program and the development and production of ORBCOMM Generation Two payload (“OG2”).

Throughout 2009, we continued to transition from the SSEE Increment E program to the SSEE Increment F program. During fiscal 2009, including the second quarter, we worked aggressively on the final stages of development and began the integration and test phases of SSEE Increment F. At the end of fiscal year 2009, we were completing work on the final production lot of Increment E and were in the final test and integration phases of the development work for Increment F. While the booking of the initial lot of the SSEE Increment F program has resulted in a significant amount of work performed during the second quarter, the combined aspects of this transition resulted in an $11.6 million decrease in revenue in the quarterly year over year metrics. We anticipate an aggressive work schedule on the initial production lots of SSEE Increment F in the remaining quarters of fiscal 2010.

levels of effort. Entering fiscal 2010, the OG2 program was in its test and integration phases, and we expect to begin delivery of the final payloads in the second half of fiscal 2010. The final test, integration and delivery stages have a lower level of effort than the development and production phases. As a result, revenue for the OG2 program decreased approximately $2.2 million in the second quarter of fiscal 2010 as compared to 2009. While we are considering multiple space related programs, we believe the production work declines on the OG2 program will be offset with production increases in other areas.

There were other revenue decreases of $4.5 million due to timing and lower backlog across a multitude of other programs. However, we anticipate remaining fiscal 2010 bookings will positively impact revenue during the remainder of fiscal year 2010.

Cost of Revenues

Cost of revenues decreased approximately $15.2 million or 20% for the three months ended April 4, 2010, as compared to the three months ended March 29, 2009. The decrease was primarily due to decreased contract activity and decreased revenue as described above. As a result of the decreased contract activity, direct materials costs, including subcontract costs, decreased $14.1 million consistent with lower material costs in the SSEE production lots and lower subcontractor costs with the OG2 contract, among others. All other direct costs and overhead costs allocable to such direct costs decreased approximately $1.4 million. These decreases were partially offset by an increase in costs not allocable to a specific program of $0.3 million, primarily attributable to increased stock-based compensation. Certain stock-based instruments are accounted for as a liability. With recent increases in our stock price, the portion of stock-based compensation attributable to these instruments has increased significantly. Cost of revenues as a percentage of total revenue remained at 81% for the three months ended April 4, 2010 and the three months ended March 29, 2009.

General and Administrative Expenses

General and administrative expenses decreased approximately $1.8 million or 29% for the three months ended April 4, 2010, as compared to the three months ended March 29, 2009. This decrease was primarily due to reduced legal fees and charges for claims resolution, which elevated general and administrative fees in 2009 as a result of claims brought against us and settled in the second quarter of fiscal 2009. As a result, legal fees decreased $1.1 million and claims resolution decreased $0.6 million in the second quarter of fiscal 2010 as compared to fiscal 2009. As a percentage of revenue, general and administrative costs have remained at 6% of revenue for the three months ended April 4, 2010 and the three months ended March 29, 2009.

Research and Development Expenses

Research and development expenses increased approximately $0.1 million or 23% for the three months ended April 4, 2010, as compared to the three months ended March 29, 2009, due to the timing of specific planned research and development projects. Research and development expenditures represented 4% and 3% of our consolidated revenues for the three months ended April 4, 2010 and March 29, 2009, respectively. We expect that research and development expenditures will continue to represent approximately 2% to 3% of our consolidated revenue in future periods.

Provision for Income Taxes

The provision for income taxes decreased approximately $0.1 million or 19% for the three months ended April 4, 2010, as compared to the three months ended March 29, 2009. Our effective income tax rate was 37.9% for both the three months ended April 4, 2010 and the three months ended March 29, 2009. Fiscal 2009 included a full year of the research and development tax credit, which expired at the end of our fiscal 2010 first quarter. While 2009 included a slightly larger tax deduction for the research and development tax credit, the 2010 effective rate included several other favorable impacts. In the event that Congress renews the tax credit during our fiscal year 2010, we will recognize a benefit in our effective rate at the time of renewal.

Net Income

As a result of the above, net income decreased approximately $1.1 million, or 19%, for the three months ended April 4, 2010, compared to the three months ended March 29, 2009.

Six months ended April 4, 2010 compared to six months ended March 29, 2009:

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 six months ended April 4, 2010 and March 29, 2009 (in thousands):


	Six months ended
						Amount of			%
	April 4,		March 29,			in crease			increase
	2010		2009			(decrease)			(decrease)
Contract revenues	$	150,531	$	179,598		$	(29,067	)		-16	%
Cost of revenues		121,466		146,541			(25,075	)		-17	%
General and administrative expenses		8,760		11,916			(3,156	)		-26	%
Research and development expenses		5,279		4,138			1,141			28	%
Interest income, net		7		(25	)		32			-128	%
Provision for income taxes		5,709		5,973			(264	)		-4	%
Net income		9,324		11,005			(1,681	)		-15	%

Revenues

Revenues decreased approximately $29.1 million or 16% for the six months ended April 4, 2010, as compared to the six months ended March 29, 2009. The second quarter of fiscal 2010 included significant bookings. However, we entered fiscal 2010 with a lower backlog than fiscal 2009, which began with record backlog numbers. As a result, the work performed on beginning backlog during fiscal 2009 outpaced the work performed on beginning backlog during the first half of fiscal 2010. While we anticipate the significant second quarter bookings, along with further replenishment of backlog throughout the year, will drive revenue growth in the third and fourth quarters, the timing of these bookings has impacted our year over year revenue metrics. The decline in these year over year revenue metrics was driven by two key areas: our SSEE program and OG2.

Throughout 2009, we continued to transition from the SSEE Increment E program to the SSEE Increment F program. During fiscal 2009, we worked aggressively on the final stages of development and began the integration and test phases of SSEE Increment F. At the end of fiscal year 2009, we were completing work on the final production lot of Increment E and were in the final test and integration phases of the development work for Increment F. While the booking of the initial lot of the SSEE Increment F program has resulted in a significant amount of work performed during the first half of fiscal 2010, the combined aspects of this transition resulted in an $13.3 million decrease in revenue in the year over year metrics. We anticipate an aggressive work schedule on the initial production lots of SSEE Increment F in the remaining quarters of fiscal 2010.

Likewise, the OG2 program was a significant contribution to fiscal 2009 revenue. We continued the development and production of the satellite payloads during the first half of fiscal 2009, which required substantial levels of effort. Entering fiscal 2010, the OG2 program was in its test and integration phases, and we expect to begin delivery of the final payloads in the second half of fiscal 2010. The final test, integration and delivery stages have a lower level of effort than the development and production phases. As a result, revenue for the OG2 program decreased approximately $6.0 million in the first half of fiscal 2010 as compared to 2009. While we are considering multiple space related programs, we believe the production work declines on the OG2 program will be offset by production increases in other areas.

Across the broad spectrum of our business, we experienced a $9.8 million decrease in revenue including a $5.3 million decrease in airborne reconnaissance technologies, a $2.7 million decrease in a wing-set production contract, and a $2.2 million decrease from a strategic decision to exit a foreign contract providing security services. While the airborne reconnaissance technologies experienced a decrease as certain quick response contracts with significant 2009 revenue contributions were completed during 2010 or are near completion, we have seen a $4.9 million increase in revenue from our airborne program providing a modernization to the U.S. Army’s communication intelligence capabilities.

Cost of Revenues

Cost of revenues decreased approximately $25.1 million or 17% for the six months ended April 4, 2010 as compared to the six months ended March 29, 2009. The decrease was primarily due to decreased contract activity and decreased revenue as described above. As a result of the decreased contract activity, direct materials costs, including subcontract costs, decreased $23.4 million. All other direct costs and overhead costs allocable to such direct costs decreased approximately $2.6 million. These decreases were partially offset by an increase in costs not allocable to a specific program of $0.9 million, primarily attributable to increased stock-based compensation. Certain stock-based instruments are accounted for as a liability. With recent increases in our stock price, the portion of stock-based compensation attributable to these instruments has increased significantly. Cost of revenues as a percentage of total revenue decreased to 81% for the six months ended April 4, 2010 as compared to 82% for the six months ended March 29, 2009.

General and Administrative Expenses

General and administrative expenses decreased approximately $3.2 million or 26% for the six months ended April 4, 2010, as compared to the six months ended March 29, 2009. This decrease was primarily due to a $1.7 million decrease in legal fees associated with the settlement of claims in the second quarter of fiscal 2009. Additionally, we incurred a one-time charge of $0.6 million related to the resolution of claims. Additionally, at interim periods, we record our general and administrative expenses at target rates. As a result of lower contract activity year over year, which is more fully discussed in the revenue section above, less general and administrative expenses have been applied to our direct costs. As a percentage of revenue, general and administrative costs have decreased to 6% of revenue for the six months ended April 4, 2010 as compared to 7% of revenue for the six months ended March 29, 2009.

Research and Development Expenses

Research and development expenses increased approximately $1.1 million or 28% for the six months ended April 4, 2010, as compared to the six months ended March 29, 2009 due to the timing of specific planned research and development projects. Research and development expenditures represented 4% and 2% of our consolidated revenues for the six months ended April 4, 2010 and March 29, 2009, respectively. We expect that research and development expenditures will continue to represent approximately 2% to 3% of our consolidated revenue in future periods.

Provision for Income Taxes

The provision for income taxes decreased approximately $0.3 million for the six months ended April 4, 2010, as compared to the six months ended March 29, 2009. Our effective income tax rate increased to 38.0% for the six months ended April 4, 2010, compared to an effective rate of 35.2% for the six months ended March 29, 2009. The higher effective tax for the six months ended April 4, 2010 was primarily due to a 3.0% 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. In the event that Congress renews the tax credit during our fiscal year 2010, we will recognize a benefit in our effective rate at the time of renewal.

Net Income

As a result of the above, net income decreased approximately $1.7 million, or 15%, for the six months ended April 4, 2010 compared to the six months ended March 29, 2009.

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.

Cash

At April 4, 2010, we had cash of $24.6 million compared to cash of $43.1 million at September 30, 2009. Given the large balance of cash during recent periods, we are continuing to assess alternative uses of cash, such as investments in our operations, mergers and acquisitions, and stock repurchases. The $18.5 million decrease in cash during the year was primarily the result of $16.6 million of cash used by operations and $2.6 million of cash paid for acquisitions of property, equipment, software and intangibles.

Cash Flows

Net cash used in operating activities for the six months ended April 4, 2010 was $16.6 million compared to $8.4 million provided by operating activities for the six months ended March 29, 2009. Cash provided by operating activities in the six months ended April 4, 2010 was primarily comprised of $16.7 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 $33.3 million as a result of changes in operating assets and liabilities. This change was driven by a $21.5 million increase in accounts receivable net of deferred revenue, and a $9.4 million decrease in accounts payable. The remaining decrease is a $2.4 million decrease in other operating assets and liabilities.

Our cash from operations is highly dependent on the balance of our billed and unbilled receivables, along with deferred revenue. As discussed in more detail below under “Contractual Billing Provisions”, the timing of contractual milestone billing terms has a significant impact on our unbilled receivable balances. We use days sales outstanding (“DSO”) as a measure to assess the impact of milestone billings on our cash balances. We calculate DSO using the trailing twelve months of revenue. As of April 4, 2010, our DSO was 160 days as compared to 116 days at September 30, 2009. Our receivable balances were significantly higher at the end of our second quarter due to unbilled balances on the OG2 program, a significant billing on the SSEE Increment F program that billed in the last few days of the quarter, and rate variances which are included in unbilled at April 4, 2010. The OG2 program holds milestones that are heavily weighted towards the final testing and delivery phases. With the booking of the SSEE Increment F program in second quarter approximately $22.6 million was invoiced during the last few days of the quarter end. Had this invoice been collected, our receivable balances would have been significantly lower. Exclusive of these three items, our DSO was 100 days and 97 days at April 4, 2010 and September 30, 2009, respectively.

Net cash used in investing activities for the six months ended April 4, 2010 was $2.6 million compared to $4.4 million for the six months ended March 29, 2009. Investing activities included $2.4 million and $4.5 million of cash used to purchase property and equipment during the first half of fiscal 2010 and 2009, respectively. We expect to make additional investments in property and equipment as we upgrade and replace older equipment, as our employee base increases and as we invest in advanced C5ISR technology assets.

Net cash provided by financing activities for the six months ended April 4, 2010 was $0.6 million compared to $1.1 million of cash used in financing activities for the six months ended March 29, 2009. In fiscal year 2010, approximately $0.6 million of cash was generated from stock option exercises and related tax benefits compared to $0.2 million for the six months ended March 29, 2009. During the six months ended April 4, 2010, the Company retired certain restricted share units in respect of related payroll tax liabilities.

We believe that the combination of internally generated funds, cash and cash equivalents on hand and available bank credit will provide the required liquidity and capital resources necessary to fund ongoing operations, customary capital expenditures and other working capital needs over the next 12 months.

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, 2012. The credit facility contains a sublimit of $15,000 to cover letters of credit. In addition, borrowings on the line of credit bear interest at LIBOR plus 175 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 April 4, 2010, EBITDA, on a trailing 12 month basis, was $43.0 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 4, 2010, the Company was in compliance with these covenants and the financial ratio.

In addition to the terms of the line of credit, the credit facility includes a guidance line facility, which provides the option to expand the total borrowing capacity to $60.0 million. While the credit facility still requires the Lender’s final approval of a request to borrow an additional $20 million, this provision provides an expeditious medium for expanded borrowing capacity.

At April 4, 2010, there were no borrowings outstanding against the line of credit. Letters of credit and debt consisting of capital lease obligations at April 4, 2010 amounted to $2.4 million, and $37.6 million was available on the line of credit.

Contractual Billing Provisions

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. 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.

Contractual Obligations and Commitments

As of April 4, 2010, our contractual cash obligations were as follows (in thousands):


	Total		Due in 1 year		Due in 2 years		Due in 3 years		Due in 4 years		Due in 5 years		Thereafter
Capital leases	$	25	$	20	$	5		—		—		—		—
Operating leases		34,988		7,663		7,444		7,127		6,949		5,749		56


Total	$	35,013	$	7,683	$	7,449	$	7,127	$	6,949	$	5,749	$	56

As of April 4, 2010, our other commercial commitments were as follows:


(in thousands)	Total		Less Than 1 Year		1-3 Years
Letters of credit	$	2,368	$	1,615	$	753

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, 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 our cash and cash equivalents is minimal.

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 2012 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 and current banking relationship. Absent these dramatic shifts and steep deteriorations in market conditions, we believe we have access to sufficient bank credit through alternative lending sources if needed.

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 4, 2010. 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 generally 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 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. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this Quarterly Report on Form 10-Q has been appropriately recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

	(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.

PART II – OTHER INFORMATION

ITEM 1. 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 material changes from the risk factors disclosed in our Form 10-K for the fiscal year ended September 30, 2009, filed on December 4, 2009 and our Form 10-Q for the quarter ended January 3, 2010.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information about purchases that we made during the second quarter of fiscal year 2010 of our equity securities that are registered by us pursuant to Section 12 of the Exchange Act.


					Total Number of		Approximate Number
	Total Number of				Shares Purchased as		of Shares that May
	Shares Purchased		Average Price Paid		Part of Publicly		Yet Be Purchased
Period	(1)		per Share		Announced Plan		Under the Plan
January 4, 2010 to January 31, 2010		385	$	25.85		—		—
February 1, 2010 to February 28, 2010		82	$	24.69		—		—
March 1, 2010 to April 4, 2010		—		—		—		—


Second quarter fiscal 2010 totals		467	$	25.65		—		—


(1)		These amounts represent shares surrendered to satisfy tax withholding obligations in connection with restricted stock units.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On February 23, 2010, the Company held its Annual Meeting of Stockholders. The following items were voted upon and approved by the requisite number of shares present in person or by proxy at the meeting:

The inspector of election tabulated the following votes for the election of directors. There were 4,349,242 broker non-votes.


Nominee for Office	Number of Votes In Favor		Number of Votes Withheld
Terry L. Collins		17,044,676		438,588
Thomas E. Murdock		17,228,159		255,105
Victor F. Sellier		16,513,497		969,767
S. Kent Rockwell		17,225,472		257,792
David C. Karlgaard		17,227,208		256,056
Lloyd A. Semple		17,226,388		256,876
Robert McCashin		17,221,098		262,166
John Irvin		17,224,178		259,086
Peter A. Marino		17,227,549		255,715
Maureen Baginski		17,193,533		289,731
Delores M. Etter		17,227,533		255,731

The inspector of election tabulated the following votes for the proposal to ratify the selection by the Audit Committee of Grant Thornton LLP as the Company’s independent registered public accounting firm for the fiscal year ending September 30, 2010. There were 1,557,754 broker non-votes.


Number of Votes “In Favor”	Number of Votes “Against”	Abstain
20,166,653	58,520	49,579

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS


Exhibit
Number		Description of Exhibit
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 February 26, 2010)

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

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 and Chief Executive Officer


	By:	/s/ Aaron N. Daniels
		Aaron N. Daniels
		Vice President, Chief Financial Officer, and Treasurer

Date: May 13, 2010

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ARGON ST, Inc. 10-Q