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Executives

Terry L. Collins - Chief Executive Officer

Victor Sellier - Executive Vice President

Kerry M. Rowe - Vice President and Chief Operating Officer

Aaron N. Daniels - Chief Financial Officer

Analyst

Michael Lewis - BB&T Capital Markets

Myles Walton - Oppenheimer & Company

Steve Levenson - Stifel Nicolaus

Patrick McCarthy - FBR

Robert Kirkpatrick

Argon St Inc. (STST-OLD) Q2, 2008 Earnings Call May 8, 2008 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 Argon ST Earnings Conference Call. My name is Erica and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Vic Sellier, Executive Vice President. Please proceed sir.

Mr. Victor Sellier - Executive Vice President.

Thank you, Erica, and good morning everyone. And welcome to our second quarter conference call. I will start by saying that we are very excited about the prospects of updating you on what we've accomplished this quarter. And including our record revenue and strong operating results, as well as the opportunity to give you insight into some of the significant events and activities that are ahead of us. But before we launch into the discussion of our quarter performance I would like to make a couple comments. I am here with Kerry Rowe, our COO and Aaron Daniels, the CFO for the corporations. Terry Collins our CEO is not with us today and I would like to explain why. As part of our concerted effort to aggressively pursue new programs with new customers we submitted a proposal on a major multi-year program with potential value to the Company of hundreds of millions of dollars to US DOD customer.

We have bid this program as the prime contractor and have assembled what we consider to be a very strong team which includes some well known large and small businesses. And that is becoming more common in large program competitions like this one the proposal calls for an oral presentation to be given as part of the evaluation process. That presentation was recently scheduled by the government and conflicted with the time of this call. Early in the proposal process the entire team had decided that our competitive position would be enhanced if Terry participated in giving the presentation. And so doing he will be demonstrating our commitment and high level of support to the program. We decided that despite the schedule conflict with this call we follow through with that strategy. We hope that as investors, employees, customers or simply followers of the company you would appreciate the fact that we think that this decision is consistent with our commitment to grow and expand your company. We’re confident that the team that we we've assembled here for this call, all of whom you are familiar with from prior calls of very capable given you details insight into our recent and planned accomplishments. So we appreciate your understanding, but I would also like to emphasize because of the competitive nature of this initiative we won't be taking given any more clarity on the program and will not be taking any questions on subject.

So with that I will turn this over to Aaron to get us started on the heart of our presentation, Aaron.

Aaron N. Daniels – Chief Financial Officer

Thanks very much Vic and good morning everyone. As is customary I would like to begin with our Safe Harbor Statement. The news release today on this conference call contains certain forward-looking-statements within the meaning of Federal Securities Laws. Investors are caution that all forward-looking-statements involved risk and uncertainties that could cause actual results to differ and sometimes materially from those anticipated or suggested by such statements. Risk and uncertainties are contained in our periodic reports including our Form 10-K for the Fiscal year ended September 30, 2007, as well as all of our other SEC filings. We undertake no obligation following the date of this release to update or revise our forward-looking-statements including guidance with update to reasons actual results could differ materially from those anticipated in these forward-looking-statements. We caution you not to place undue reliance on any forward-looking-statements which speak only as of the date such statements were made.

Now I would like continue with the discussion of our quarterly results. We are very pleased to report record revenue on our second quarter and proud of the performance our employees, in achieving this important milestone. Our performance this quarter is in our minds a clear indicator of capability for discipline and robust program execution. In recent business with investor some perspective investor’s one message that we heard loud and clear with the need of demonstrate consistent and reliable execution against our plan. In the first half of this year we began to establish stronger credibility and meeting our performance objectives. We are on target to meet our 2008 guidance.

Revenue for the second quarter ended March 30, 2008 was 88.4 million which represents of 38% of our revenue 64.3 million in the same quarter of 2007 and a sequential improvement of 19% over revenue 74.3 million in the first quarter of 2008. Revenue for the sixth month ended March 30 2008 will 162.7 million which represent 30% improvement over revenue above revenue of 124.7 million in the sixth months of last year. Again we are really pleased with these results. During the first quarter we announced the booking of next production lot of the Navy's SSEE program strong program execution over all and especially in our ships business most notably and earlier then expected it commitments of our SSEE Lot 5 program booked in the first quarter contributed towards strong performance last quarter.

I think its important to discuss for a moment how Argon program of evolve over time. Upon award of a program our team puts in place a final baseline plan execution for the entire program which typically spends most of quarters. Our teams must be agile in the management at expectations and commitments from customers some contractors and suppliers its change often those results in the movement of executables across calendar months and quarter in those directions. What might move a week or two in a program plan could impact a quarter either positively or negatively.

However, often the impact on the overall program schedule is negligible As a result, it's important to note that we are not expecting that the early commencement of Lot 5 production will require us to increase guidance for fiscal year 2008. Operating income for the cycle quarter end of the march 30 2008 was 9 million or 10.1% of revenue. This compare operating income was 6.5 million or 10.1% in the second quarter of prior year and operating income of 6.8 million on 9.1% of revenue in the first quarter of this fiscal year.

Operating income for this sixth month's ended march 30 was 15.7 million which represents 11% improvement over operating income of 14.2 million in the prior year. As important reference in the first quarter fiscal year 2008 our margin levels were 9.1% on contracts mix of 44% cost-reimbursable type contracts. In the second quarter of 2008 the makes of fix price and timing material type contracts increase to 68% driving in increase and operating margin to 10.1% in the quarter. As mention before strong program execution assisted by earlier than expected commitments of our SSEE Lot 5 program booked in the first quarter contributed to an increase in fix price tight next and therefore an increase in the margin percentage will a first quarter we do issue our customary caution about the lumpiness us in our business and we are seeing it good example of the ebb and flow our contracts mix in the second quarter of 2008.

The contract mix ix expected to the modulate back to higher percentage cost members were tight business in the remainder of the fiscal year. Adjusted EBITDA for the second for the second quarter fiscal year 2008 was 12.1 million were 13.7% of revenue this compare to adjusted EBITDA are 9 million or 13.9% of revenue in the second quarter of fiscal year 2007 and 9.6 million or 13% in the first quarter of fiscal 2008. As 13.7% of revenue be adjusted EBITDA margin in the second quarter its consistent lower margin expectations based on our product life cycle and contract next. Adjusted EBITDA for the sixth month's ended march 30 with 21.8 million which represent of 14% improvement of adjusted EBITDA of 19 million in the prior year.

To remind you the definition of adjusted EBITDA is earnings before interest, taxes, depreciation, and amortization excluding impairments, as well as stock compensation acquisition-related retention and other one time items as appropriate. As solid proxy indicators for operational performance we continue believe that this was operational performance metric in combination with our other customer emerges in the metrics provided additional transference in our financial results.

Net income was 5.5 million compare to 4.2 million in the same period in the prior year and 4.3 million for the first quarter of fiscal year 2008. Net income for six months ended March 30 2008 was 9.8 million which represents of 5% improvement over net income of 9.3 million in the prior year. Fully-diluted EPS was $0.25 and 22 million shares and share equivalents compare to $0.18 on 20.8 million shares and share equivalent in the second of last year and $0.19 on 22.3 million shares and share equivalents for the quarter of fiscal year 2008. The increase in fully diluted earnings per share is due primarily to the higher revenue and margins as well a lower share count as a result of our stock repurchases program. Fully diluted earnings per share for the six months ended March 30, 2008 was $0.44 on 22.1 million shares and share equivalent which represents a 7% improvement over a fully diluted EPS of $0.41 on 22.8 million share and equivalent in the prior year.

The effective tax rate for the second quarter of fiscal 2008 was 38.8% compared to 38.5% in the second quarter of last year and 37.9% in the first quarter of this fiscal year. The increase in the rate from last quarter is due primarily to the expiration of the R&D tax credit which is widely expected to reenact. At this point however the timing of any reenactment is uncertain. On the last call, we indicated the effective tax rate would remain at a normalized level between 37% and 38%. However if the tax credit is not reenacted in this fiscal year we expect that our effective tax rate will settle in at a higher range between 38% and 39%.

I would now like to make a few comments on our balance sheet and cash flow situation. Our balance sheet continues to show strength and stability. From a cash perspective we ended the quarter with $14 million in cash compared to 23 million in cash at the end of the last fiscal year and 7.3 million at the end of our last quarter.

Cash flows from operations during the second quarter of fiscal 2008 were 14.9 million with just under half of that being generated from working capital. We’ve made a lot of progress on working management which continues to be an important focus for us going forward. Cash outflows from investing and financing during the quarter were 3.4 million and 4.8 million respectively.

Investing cash flows were related to CapEx capital expenditures of 1.9 million and net payments of 1.5 million related to our coherent acquisition which we completed in fiscal year 2007. Financing cash flows in the quarter included continued purchases under our stock repurchase program. We purchased 302,000 shares in the second quarter at a cost of approximately 5.1 million which brings for total of one million shares purchased since inception on our repurchase program announced last August. The board is authorized up to 2 million shares under this program which is currently set to expire in August of 2008.

We continue to believe we are good investment at current prices. We will continue to asses alternative uses of our cash and borrowing capacity which includes operations, merger and acquisitions and stock repurchases.

At end of the second quarter of fiscal 2008 with a 102.5 million in total accounts receivable which was down 8.6 million from accounts receivable of a 111 million at December 30, 2007, and up 6.8 million from accounts receivable of 95.6 million at September 30, 2007. The old accounts receivable increased to 42.3 million from 39.7 million at December 30, 2007 our last quarter and 37 million at our last fiscal year end September 30, 2007

Unbilled accounts receivable were 60.2 million which was down 11.1 million from 71.3 million as of December 30, 2007 and up slightly compared to 58.6 million at the end of fiscal year 2007.

Excluding the indirect rate variance which is accumulated and held on the balance sheet during the year while it is worked down to zero by fiscal year end unbilled accounts receivable declined 13 million in the second quarter.

We expect continued progress and improvement reducing the unbilled accounts receivable balance. But although the timing of milestones will always cause fluctuations both up and down in the billed and unbilled accounts receivable.

DSO's for total receivables were approximately 117 days which was a decrease of 20 days compared to the DSO's for the quarter ended December 30, 2007 and a decrease of 13 days compared to the quarter ended April 1st, 2007.

DSO's for unbilled accounts receivable were approximately 48 days compared to 49 days in the first quarter of 2008 and 43 days in the second quarter of 2007. DSO's for unbilled accounts receivable were approximately 69 days compared to 88 days in the first quarter of fiscal 2008 and 86 days in the second quarter of fiscal 2007.

While we are pleased with the improvements this quarter, we continue to monitor the DSO's closely and expect to see continued improvements going forward. We are targeting total DSO's of between a 110 and 115 days for the fiscal year. As I mentioned on the last call the company drew 7 million against its line of credit in January to meet its cash flow requirements resulting primarily from the first quarter operations and stock repurchases. With the increased cash flows this quarter we are be able to repay this borrowing during this quarter. We continue to emphasize that it is possible we may borrow additional sums to fund operations, repurchase our stock or make acquisitions.

Now I would like to talk about few of our metrics. Our bookings for that quarter come in at 74.1 million for a book-to-bill for the quarter of 0.84 times, and a book-to-bill on our trailing 12 month basis of 0.83 times. On a year-to-date basis bookings totaled a 130.1 million for a book-to-bill of 0.8 times.

As Kerry will discuss later, our pipeline remains healthy and we continue to target our long term book-to-bill ratio 1.2 times with some periods being higher and some being lower. With the strong bookings during fiscal 2007 as well as the addition of backlog accompanying the acquisition of Coherent, we entered fiscal year 2008 with backlog of approximately 305 million. Backlog at the end of the second quarter, is a healthy 270 million of which approximately 224 million is funded.

Bookings subsequent to quarter end is strong and there has been a tremendous amount of proposal activity in recent months. We continue to be confident on the new business front and now Kerry will highlights some of new business efforts and provide an operational update. Kerry?

Kerry Rowe - Vice President and Chief Operating Officer

Thanks Aaron. Good morning everyone. I take just few minutes to provide an update on current business operations and our key markets. In Q2, our tactical communications and networking systems business continue to show key growth and positive results. We brought additional technical efforts in the quarter for the Operational Test Tactical Engagement System or our routine test communications upgrade program. As a remainder, OT test provides a networked, mobile, tactical engagement, stimulation and field instrumentation system to support the testing and evaluation of advance weapon systems.

We also completed deliveries of dismounted troop and vehicle mounted navigation communication units for the DOD’s common range integrated instrumentation system, rapid prototype initiative, CRIIS-RPI, at White Sands missile range. We expect that throughout the remainder of 2008 additional skill will be added to both the OT test and CRIIS-RPI efforts as we accomplished system integration and test and prepare for initial production of works.

In fact, just late last week the DOD awarded Rockwell Collins and Boeing parallel development contract for the overarching CRIIS program out of Eglin Air force base Florida. Argon ST is a member of the winning Rockwell Collins team with our CRIIS RPI work baseline for the load dynamic and dismounted communications, networking, and navigations solutions.

Additionally our OT test customer the Army’s Program Executive Office for simulation, training, and range instrumentation or PEO-STRI has recently initiated their next omnibus contract. The simulation and training omnibus contract were stopped too.

STOC 1 was a very successful tools for PEO-STRI and STOC II we had a vehicle used to contract and estimated $17 billion for test and training requirements over the next 10 years. As PEO-STRI is one of our key customers we have bid STOC-II as prime to facilitate a significant increase of our presence in the test and training instrumentation market.

In another exciting tactical communications and networking initiative we received a new start of word for the Defense Advanced Research project agencies LANDroid program.

DARPA’s LANDroid initiative will provide our autonomous adaptable wireless networking be a small soldier-deployed robots to expand soldier connectivity and to disadvantage environments such as buildings and towns. The advanced development of our noble ad hoc networking will continue as the enabler for the LANDroid program.

On to our commercial SATCOM endeavors we continue to provide technical support under contract to overcome on the existing OG1 constellations and system. As many of you are aware Serria Nevada Corporation just this week signed the next generation satellite constellations contract with ORBCOMM. We supported SNC throughout their pursued of OG2 and are one of the two ORBCOMM specified competitors currently responding to their formal request for the proposal for the communications payload.

Lastly and as we commented last quarter, much of the integration of our recent coherent systems acquisition is happening in the tactical communication, and networking systems arena and that progress further in Q2 with the rationalization of overhead costs and further consolidation of operations.

Q3 we will see the combination of these efforts with the consolidation of the variety of the accounting systems currently maintained by the SDRC and coherent acquisitions into a single corporate accounting system. The result will be streamlined financial processing and reporting, increased insight into the details of these groups financial performance, and more flexibility and alignment of programs and resources throughout the corporation.

Our next key area is ground systems which you will recall includes fixed site, vehicle-mounted and transportable signals intelligence and communication systems for both United States and international markets.

As discuss last quarter, we are currently developing two major ground transportable systems under separate contracts. During Q2 we prepared for the release of the Request for Proposal for a significant fix site ground system fixed site ground system procurement. This RFT was received in Q3 and Argon ST recently submitted our prime proposal for this program.

We also responded to a request for information for a multi-vehicle mobile ground system for an international customer. We were invited to build on this program and our proposal will be submitted later this quarter.

In summary, our working in the ground systems market has matured significantly in the last year and we believe that we are poised to earn additional business in the United States and abroad.

Our opportunities in the global security market continue to expand. In Q2, the team lead by Argon ST completed its first year of activities to enhance the security operations of the air force basis of the key international customers. We were awarded the follow on contract for the second year of this activity early in Q2 and has expanded our in-country team to continue this important work. We also continue to pursue opportunities with the department of Homeland Security and those associated state and municipal organizations charted with protecting US borders. We led a team of several niche providers of imaging services and infrastructure to recently bid a Texas Department of Emergency Management opportunity.

Also in the quarter our high performance highly accurate gimbal for tactical UAV collection missions successfully passed the second of several acceptance test. Competition for this large system by program with flyoff and downselect is now expected in late FY `08.

Moving to our Maritime market, our surface ship torpedo defense programs continue production deliveries with additional option orders expected throughout the remainder of the year. These option order continue to upgrade to 25 A configuration to 25 C configuration as well as provide a non-recurring engineering for the formation of 25D baseline. We are expecting the award from NAVSEA in Q3 for the R&D engineering development to complete the 25D baseline and we will also received orders for additionally United States and international 25C kits, along with likely orders for complete 25D systems later in the year. The new 25 D baseline will be compatible with the detection, classification, and localization system and include an open architecture modular winch and flexible-tow body.

Also last quarter we discussed the award the Mark 52 torpedo homing systems to US Navy as result of our continued push into the acoustic sensor market. Work is begun on this program to provide a sensor system for the Navy’s mainline medium weigh torpedo. Our key note during the quarter the protest of the US Navy Common Display System CDS, formerly CEDS, the Common Enterprise Display System. The competition or the protest was denied and the General Dynamics Argon ST 901D Themis team was awarded this contract in early April.

In Phase I of the program Argon ST will integrate the four first article units which will be done in Smithfield Pennsylvania and will provide program-based logistic support. Phase II will be based on future requirements not yet negotiated with the Navy.

Our core maritime business continues to deliver current generation Electronic Warfare and Lighthouse information Warfare production systems on regular schedule to the United States Navy and our airlines.

As we mentioned last quarter, US Navy exercised the second half of SSEE Increment E Lot 5 order for the FY 2008 production light in the first quarter. This accelerated award has been plan for early Q2. This, along with an aggressive programs start contributed positively to our quarter.

Again as we have previously discussed and in parallel with the execution and delivery of the current generation of these systems, the design and development of the next generation surface ship systems SSEE Increment F is ongoing. These advanced lighthouse systems will provide technology insertions focused on future threats as well as a service-oriented architecture, transforming the center data into actionable information.

As we emphasize to you each quarter in these calls, Argon is now positioned in the maritime market to leverage our various installed ship or electronic systems to gain a greater presence on new and current ship classes and on ships of allied navies. For new ship classes, like the DDG 1000, the Littoral Combat ship, and the Australian Air Warfare Destroyer, we are targeting providing Torpedo Defense, EW and combat information operation systems. Again, our key strategy and our core maritime market is to continue to work with existing and new customers on roadmaps for integration of this next generation information operations product on airborne, surface, and subsurface platforms in both manned and unmanned applications.

Finally, in the airborne reconnaissance market, we continue to expand our pod based center activities to address specific urgent operational needs. We previously discussed an opportunity to integrate and deliver 40 additional surveillance products similar to those that were rapidly developed and put into service in 2007.

Recent changes to the program technical requirements now have us focusing on additional R&D through 2008. So instead of integrating 40 units this year as we previously discussed, we will accomplish the R&D in preparation to integrate and deliver as many as 60 units in 2009 to better meet the rapidly changing requirements of this important operational mission.

Also in the quarter, we made significant progress on our special airborne mission installation and response or SABER system initiative. The SABER approach is to design, develop and fabricate a roll-on roll-off system that provides a slick C-130 aircraft, the ability to deploy a mission specific pod utilizing the aft paratroop doors. SABER includes the strut and pod that can work in tandem with an upgraded aircraft door and seat. In Q2, we completed demonstrations for United States Special Operations Command leadership, submitted extensive documentation in preparation for flight test and accomplished a fit check of the system on the C-130H aircraft. We are currently targeting flight testing later this FY and are working with a special operations command to transition SABER to a program of record.

As previously discussed, we are currently under contract to produce and deliver aircraft harness panels for the Bombardier 215T and 415 amphibious firefighting fleet. Our first 215T delivery took place during Q2 as performance and quality inspects by Bombardier and was readily accepted. Our 415 program is also on schedule and deliveries will commence later this year. Our performance today with Bombardier has yield joint discussions on additional opportunities for supporting other Bombardier aircraft lines and has also led to discussions with other aircraft providers in the areas of both engineering and production support.

Lastly, our efforts in support of the United States Army Project Manger Aerial Common Sensors and NAVAIR's maritime patrol and reconnaissance aircraft program office PMA 290 continue to progress on schedule. As previously discussed, our PMA-290 EP-3E contract provides upgrades to the Banshee system for the EP-3E JCC program Spirla 3 aircraft utilizing our widely deployed Lighthouse SIGINT architecture.

In Q2, we successfully completed a major critical design milestone on the Banshee program. Our partnership with Boeing Integrated Defense Systems is stronger than ever on the EPX programs pursuit as we ready ourselves for the technology development phase competition. On the US Army side of the airborne business and as reported in our last call, our I-band common subsystem work for Northrop Grumman Mission Systems on the Guardrail Modernization program will be definitized and on contract in Q3.

Finally, and as you may have recently heard, the Army has announced that their Aerial Common Sensor Industry Day will be held in late May. We continue to evaluate teaming strategies for ACS, which as you know is scheduled for 2009.

That concludes our summary of Argon's current operations. I will now turn it back over to Vic for some summary comments. Vic?

Victor Sellier - Executive Vice President

Thanks Gary and congratulations to you and your entire team for the way you've accomplished not only in the quarter but throughout this year so far.

Before we go to questions, I would like to pick up on the theme that Kerry has laid out. It's all about opportunities and capitalizing on those opportunities. We hope that you continue to see as we do that we are making steady progress toward our objectives for the year of growing the company through the pursuit and capture of large multi-year programs with the diverse customer set as prime wherever is possible but always with an eye toward building on our full cycle program strategy. That is to identify programs where we can participate in the development, migrate the development to production or along life cycle and support to produce systems in their operational environment.

Kerry opened his remarks by talking about the progress we have made in our tactical communications area and specifically referred to the recent announcement of our inclusion on a team that received a CRIIS award. This is our perfect example of our strategy of pursuing programs that have a long term life cycle.

The strategy started with the identification of some key technology that was being developed at SDRC, which joined the Argon family through acquisition in 2006. It was enhanced by the subsequent strong performance on the OT test program and with operational support from the broader Argon capabilities. It was then followed by the award in 2007 of the CRIIS RPI contract for the building of prototypes to demonstrate technical feasibility and now we have the larger CRIIS award. There is still a lot of work ahead of us before we succeed in getting to full production for this program but all of this indicates that we really are on a good path.

Of course, this SSEE program is the greatest example of benefits of sticking with the life cycle strategy and reaping the rewards of strong performance at every phase of the cycle. Our deployed SSEE systems continue to perform well in full operation giving our customers the confidence to task us with building additional systems and spearing and supporting existing systems. At the same time, as Kerry has pointed out, we are simultaneously working on the enact development which is the next generation of SSEE, which is at the beginning of the next program cycle. The breadth and depth of the opportunity pipeline is a direct result of staying focused on what we do well, the early pursuit and capture of technically challenging development efforts that lead to long term production and support.

We are staying focused on our long term bookings objectives. In fact, the third quarter has gone out to a good start but for a matter of a week or two, the bookings that we have seen in early April embedded to Q2 bookings would have had us comfortably over a one-to-one book to bill for the second quarter. As Aaron mentioned in his remarks, we continue to target a long term book to bill of 1.2 to 1 and are convinced that the pipeline of business supports that target. So we remain confident in our guidance for this fiscal year and perhaps more importantly believe that while we are accomplishing this year is laying a solid foundation for long term sustained growth in an opportunity rich market and a rapidly growing and diversified customer base.

So, now if you have any questions, we will be happy to take them and thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Michael Lewis. Please proceed.

Michael Lewis

Good morning. Vic, I was wondering if you could discuss in some more detail what you are seeing with regard to international opportunities within the next few quarters specifically addressing lighthouse and I guess you could talk a little bit about the 25 system, if you could just address that for us?

Victor Sellier

Mike, I actually think -- I would be happy to address the question, but I think Kerry is probably a better guy to do that for you if you don’t mind.

Kerry Rowe

If you don’t mind Mike, is that okay?

Michael Lewis

Yeah, that’s fine I will come up with the question for you next.

Kerry Rowe

Well, then I will give it back to Vic. Certainly Mike and I think we have talked to you about this before on I will take the SSEE side first. Australia is leading the international chart with regard to orders. We have received a few orders from Australia already. We expect that they will definitely follow the 25D and will again place more orders at the 25D comes on line. So that’s the trailblazer on the SSTD side. On the Lighthouse side specifically we've looked at smaller footprint type applications as well as the larger sea and other submarine Blic10 types of footprints. We have a tremendous opportunity we believe in Japan for both surface and sub-surface opportunities. We’ve been tracking that and working with them for quite a while and hopefully we can start to see some orders there as soon as next year.

Michael Lewis

Okay that's helpful and then Kerry can we get an update on the EPX's competition with Boeing.

Kerry Rowe

Sure can. I don't think I can reflect that one to Vic. As you now right now Mike we’re currently in the concept refinement phase and that phase of the program completes in July. And in fact, just a real time data point we had an interim review in Seattle this week with Boeing and the Navy I think had 40 to 45 attendees and it went very, very well. The next phase of the program is going to be the technology development phase and we told to expect that RPF in late summer of this year. So we are kind of mapping that to Q4 of FY008. We think Mike that the proposals will be due 60 to 90 days after the release of RFP which kind of puts that in the Q1, Q2 FY09 type of range.

In terms of downselect we expect that they will be a downselect too in Q2 FY09 and the awards will likely be in that Q2, Q3 FY09 type time frame. We think the TD efforts are going to be tens of millions of dollars type of think. We think the following phase which is the system development and demonstration phase will be hundreds of millions of dollars and certainly the overall EPX program is a multi-billion dollar program.

Michael Lewis

Okay and then just one more question Aaron and I will go all the way Aaron. Could you talk to us a little bit about what your expectations would be for G&A versus R&D investment? I was a little bit off in my model this quarter I just want to make sure that I am clear that I am clear on what we should we except on this side?

Aaron Daniels

Sure I think we've talked in the past about R&D in the kind of 2 to 3% range that’s company R&D and I have no reason to believe that we would move off of that in any substantial way. On the G&A side we continue as Kerry highlighted in his comments we drive on some of the accounting systems, financial infrastructure and really trying to make sure that we are optimized there and then on the indirect side in the company as a whole as well not necessarily part of G&A. But on both fronts we just continue to drive that down and we believe that we are going to be able to really hold that at a reasonable level through the rest of the fiscal year.

Michael Lewis

Would you say maybe to assume between 9 and 10% sales on a combined basis R&D and G&A?

Aaron Daniels

You know I am not really prepared to throw a number out on that but let me give that some thought.

Michael Lewis

Okay I will circle back with you.

Operator

And next question comes from the line of Myles Walton. Please proceed.

Myles Walton

Thanks good morning.

Aaron Daniels

Good morning Myles.

Myles Walton

So no good deed goes unpunished. The sales is great in the quarter and so I am curious are you now looking at the top end of your guidance for sales. I did get the comments Aaron about that the margin into the back half of the year the mix might shift a little bit. But given the strength of the first half sales kind of what caution should we take as to flattening or slowing down in the back half of as opposed what has been historical trend of actual growth sequentially into back half of the year?

Aaron Daniels

I guess I can't be any clear when I say that we are say that we are absolutely reaffirming our guidance. I think that’s the answer to your question Myles.

Myles Walton

Okay. And I would imagine you feel more comfortable than you have in years past at this phase of the year with that statement?

Aaron Daniels

Yes absolutely I mean we obviously feel very comfortable with the guidance level on the double digit revenue growth that we have talked about.

Myles Walton

Okay, and maybe asking in a different way in terms of your back log of business. Is there a requirement for any – I guess what is the coverage for the remaining back half of the year that you currently have in backlog?

Aaron Daniels

If I am circling your question correctly, this is something that we've talked about quite a bit in the past, and I don't think there has really been anything that has changed. There are elements, of course, of new bookings that are required in order to meet our guidance and there is strong execution against the backlog that we came into the year with and that we have generated with bookings so far this year. There is nothing -- I will answer it this way. There is nothing unusual in that mix compared to the past, and so, I think the answer just kind of stands.

Myles Walton

Great, and so then, I know you don't give quarterly guidance, but on a revenue basis, this is kind of -- we have gotten to a run rate and this is kind of where we expect to be for the rest of the year, at this type of level?

Aaron Daniels

The basic answer to your question is yes, we are reaffirming that guidance pretty clearly.

Myles Walton

Fair enough. Then on the indirect rate variance in the quarter, what was it? You threw out a couple of numbers and I probably could have backed into it, but what was the actual unfavorable rate variance --?

Aaron Daniels

I believe the variance to plan was 4.8. The actual rate variance was 4.8 million, the total variance.

Myles Walton

Yeah, and versus your plan? Was that above or below?

Aaron Daniels

That was above, and it was about -- I'd have to look at the number, but I think it is about 1.5 to 2 million above.

Myles Walton

Okay, so last quarter, you were maybe 1 million above and now you're maybe 1 million more above?

Aaron Daniels

As you know, this is pretty typical for where we are in the year. And having gotten bigger, the numbers have gotten a little bit bigger.

Myles Walton

Okay. I guess just the sales strength; I would have guessed it would've maybe come down a little bit. But I guess it would've just been timing on your part more than anything else.

Aaron Daniels

Right.

Myles Walton

Then one of the contracts was awarded in the quarter to Northrop BAMS. I'm not sure if you were playing a role on that particular team or a competing team. Could you comment on that one?

Kerry Rowe

Sure can, Myles. We have been tracking the BAMS program. We are not currently on the Northrop team, but as you know, and we have talked about before, we have a number of dialogue discussions with Northrop regarding Army opportunities, Navy opportunities, and Air Force opportunities. I will point out to you on the BAMS fronts; BAMS is broad area maritime surveillance for the broader audience here. It's a Navy program, high-altitude UAV program. It does not have a baseline SIGINT requirement, Myles. SIGINT -- COMINT and SIGINT are what they call an objective requirement, so kind of a future requirement. And we are certainly tracking that very closely.

Myles Walton

Okay, is there a timeline when Northrop and the Navy would come to grips with making that objective into an actual --?

Kerry Rowe

Yeah I'm sure there probably is a point-of-departure timeline, but at this point they are just kicking the program off and probably focused mostly on the baseline requirement. So we'll just have to watch and see how it evolves.

Myles Walton

Okay, fair enough. What was the employee count at the end of the quarter versus last quarter?

Aaron Daniels

Pretty close to -- right at a 1000 employees. Just under…..

Myles Walton

And sequentially is that about flat?

Aaron Daniels

Up a little bit, but essentially flat.

Myles Walton

Okay, and no challenges there on the hiring front?

Aaron Daniels

Not really, Myles. As you know, we have been engaged actively in the integration of Coherent into our operations and the rationalization of staff across the organization. So we have been able to really take advantage of access to that group of talent, and that has helped us meet our demands with reaching into a broader pool. So no real challenges this quarter.

Myles Walton

Okay, that’s great, thank you very much.

Aaron Daniels

Thank you.

Operator

And next question comes from the line of Patrick McCarthy. Please proceed.

Patrick McCarthy

Hi good afternoon and good morning and congratulation on great results I was wondering if you could talk about OT-TES. How much is remaining on the IDIQ that is out there today?

Kerry Rowe

I would say on the order of a handful of million dollars, maybe $4 million --. Take it actually.

Aaron Daniels

(Multiple speakers) between 30.and 40 million.

Kerry Rowe

Yeah that’s great.

Patrick McCarthy

Okay, great. Do we know how long that remaining ceiling is in the existence for?

Aaron Daniels

Appear for that I do.

Patrick McCarthy

Okay, no problem. Then I was wondering if -- there are obviously a lot of moving programs now. Could you look at your revenue today and kind of give us a sense as to how it mixes across tactical communications, ships, the ground systems, and airborne, and then maybe what it looks like in the backlog?

Aaron Daniels

Yes, we really don't guide on the mix of business. We have pointed out to folks in some of our recent visits and in our corporate presentation that the Navy represents last year represented about 61% of our revenue. And certainly while that is not all in the maritime defense area, a large portion of it is. And I think you can kind of use that as a guide.

Patrick McCarthy

Okay. On the DSOs, obviously it came down very strongly sequentially. It looks like you're kind of looking for maybe down a little bit more through the remainder of the year, but flattening out a little bit. Is there a structural reason why it slows down for the remainder of the year? And then could you also just talk about what your longer-term targets are, maybe even just next year's target would be?

Aaron Daniels

In terms of why it might slow down, I think you really have to kind of look to the timing of system deliveries, and just we are looking forward and we're understanding kind of how programs are going to execute and projecting it to be in that 110 to 115 day range. And as far as 2009 we haven't settled on a target yet, and when we do, we will let you know what that is.

Patrick McCarthy

Okay, great. Thank you.

Operator

Our next question comes from the line of Steve Levenson, please proceed.

Steve Levenson

Thanks. Good morning, everybody. Just out of curiosity, what do you think will come next -- the production order on Increment F or do you think there could be a Lot 6 of Increment E?

Kerry Rowe

Steve, the production order for Increment F will not occur until, at the earliest right now I'd say the end of FY '09. So there would likely be -- and we expect that the government will want to put in another production lot for E systems. So that is where I would put my money, is that there would be an interim production lot and then I think that will appear at the end of either '09 or beginning of 2010.

Steve Levenson

Right Okay thanks. Want to talk about Radix a little bit, and how important you think that was to getting the position you have now got on the guardrail upgrade and how you think it might help if there is a SIGINT requirement for BAMS and as well as EPX, ACS, and Northrop's ASIP program.

Kerry Rowe

That is a great question, Steve. Let me kind of hopefully take it in that order. If I don't quite get all of those in order, you can come back at me.

Steve Levenson

Okay, thanks.

Kerry Rowe

We believe that the acquisition of Radix -- and let me remind you and remind everyone -- we had worked with Radix over a number of years prior to the acquisition, so we were very familiar with their capabilities, their staff, their program sets, and their customers. So -- in fact, just as another data point, they were actually a subcontractor to us on ACS when we were doing ACS with Lockheed. So we worked quite a bit together before becoming the same company. Their technology in the area of interference mitigation beam-forming for high-altitude signals collection is the best in the industry. And so the short answer to your question is would we have gotten the high band COMINT work on Guardrail Modernization without Radix? I don't believe so. And in fact, right now, we operate the airborne reconnaissance business area as sort of an East and West operations. We do not distinguish between the work that is done here in Fair Lakes, primarily in support of the Navy and other customers, and the work is done in Mountain View. We really, really operate really as one extended group.

I think you asked a little bit about ASIP. As you know, the guardrail mod is somewhat of a quasi ASIP-based system. So certainly, we continue to talk to Northrop about -- and we believe that not only the Radix technology but Lighthouse technology in general is very complementary to ASIP. So we have ongoing dialogue with regard to applications for a combined Lighthouses Radix and ASIP Crownpoint type of approach. Taking that forward now of you asked about EPX. Certainly they will be and are part of our current team and approach on EPX. I won't go into too much of that, just given the competition. But analyzing the requirements and looking at what EPX has to do as a weapons system, having that capability in our stable is very, very, very good for us.

Steve Levenson

Great thanks very much. Last question is what you think you are hearing you know there is concern about change in administration and defense budgets going down, but it sounds like it shouldn't affect your area just looking for a comment on what you guys think?

Aaron Daniels

Yeah Steve I will take that one on. Certainly there is a lot of uncertainty out there but we are not terribly concerned about a change in the administration. Budgets coming down we actually believe that as most people expect that the effort more in Iraq will start winding down but that might actually free up budget availability for investment in technology related initiatives that we think we might be well poised to capture. So obviously we like others are going to wait and see how this plays out and keep a close eye on it.

Steve Levenson

Great thank you very much.

Kerry Rowe

Thank you.

Aaron Daniels

Thanks Steve.

Operator

(Operators Instructions) Our next question comes from the line of Robert Kirkpatrick. Please proceed.

Robert Kirkpatrick

Good morning. Congratulations on giving us a great deal of color which is greatly appreciated. Could you talk a little bit about why there is this tremendous activity that has gone on kind of year to date and maybe within those remarks address the Pentagon's ISR task force that seems to have been formed very recently with a very short time fuse?

Aaron Daniels

Rob could you clarify your question as to the tremendous activity and what specifically perhaps might you be referring to?

Robert Kirkpatrick

I believe that Kerry made comments during his remarks or maybe it was Vic about year-to-date there being so much activity on the proposal side and the pipeline side.

Kerry Rowe

I got it. I would be happy to comment on that. This is Kerry Rowe. On the proposal side it was – none of these proposals were unexpected but I tell you that changes in RPF release schedules and so forth kind of resulted almost in positive perfect storm if you will. We ended up with over half a dozen maybe as 8 to 10 major proposals all occurring here within the last 45 to 60 days. We view that as a good thing. It certainly was a challenge for us but we believe that we are pleased to have those opportunities and get those proposals in.

On the ISR task force we've seen the charter for that. We understand what's going on with that certainly as we look at programs that we like to talk about EPX, ACS and others, UAV, SIGINT, those types of things. We certainly had expect to continue to play roles in there and will support the task force anyway that’s required.

Robert Kirkpatrick

And then Kerry could you provide us with kind of an up date as to at a very high level obviously where Increment S stands in terms of its development that you are doing?

Kerry Rowe

Yeah sure can. We are actually in the development phase. We've successfully completed the critical design review. So if you just think about program schedule we are in the early integration spiral type integration phases as well as software development and obviously hardware procurement and integration.

Robert Kirkpatrick

Okay. And then Aaron I wouldn't want you to feel left out. Can you give us a few statics funded un-funded backlog and percent of revenues that were time and materials?

Aaron Daniels

Yes, as a percent of revenues for time and materials I believe is in the 3, 4% range. It really doesn't change that much quarter-to-quarter. Looks like 4% in the quarter. And then un-funded, un-funded back log looked at like it was about 46 million.

Robert Kirkpatrick

46 million of the 270 right?

Aaron Daniels

Correct.

Robert Kirkpatrick

Okay. And then Vic you didn't think you were going to get off easy did you? Could you comment on the M&A market. We have seen potential speculation of buyer coming in for DRS this morning. We have seen some changes at the executive level in your industry. And if you just could talk about the general pipeline and the opportunities and people's viewing of either potential activity or pricing?

Aaron Daniels

Sure. I'd say first of all that maybe as reflected in what we've done so far this year and the proposal activity, as Kerry pointed to, we have really been focusing internally on executing and growing the existing business. But that is not to say that we've taken our eye off of the market for potential acquisitions. And we continue to do that. I would say that there is nothing horizon that we are prepared to speak to, but we will continue to keep our eye on it. As far as pricing, we have seen no let up in pricing. In fact, there may be a little bit of a more robust demand for the available firms out there that are -- that we see, anyway. So we keep our eye on it. We've been focused on internal execution. We are going to look for the right opportunities and act when we see the right opportunity, but nothing imminent.

Robert Kirkpatrick

Great. Thank you so much gentlemen. Enjoy the day.

Representative

Thanks Rob.

Operator

We have the follow up question from the line of Michael Lewis, please proceed.

Michael Lewis

Aaron, I was wondering if you would provide us with some free cash flow targets for '08.

Aaron Daniels

I think what we said on the last call, that we -- first, as you know, the definition of free cash flow does move around a little bit. But we're looking at something close to one-to-one on net income. It could be a little bit below this year, but that is what we're targeting. And we are certainly, as we have highlighted on the call and we have been talking about in our investor brief, working very, very hard to optimize our working capital and to really keep that cash flow improving and getting better and better.

Michael Lewis

Okay. Then just a final for Kerry. Kerry, can you interested in the CRIIS opportunity here. Can you talk to us about what the term of this opportunity is? And have you discussed what the potential value to Argon would be over the entire term?

Kerry Rowe

I can certainly outline that for you, Mike. I don't -- I believe the press releases are out there for Boeing and Rockwell, but it is a 22 month risk reduction and what they call technology maturation award, this first award, Phase I. And we are with the Rockwell Collins team. Our initial effort here is a handful of million dollars, on the order of a couple of million dollars. And what we're doing in Phase I is it’s really the system architecture and design, and we're focused, as I mentioned earlier, on the dismounted soldier and the low-dynamic vehicle aspects. So over the next 22 months, in essence, we will be putting the overarching CRIIS system design in place. As we get into full-scale production, Phase II and the SD&D efforts in productions, I think we are talking on the order of high tens of millions of dollars for Argon in terms of total production availability to us.

Michael Lewis

Okay. With regard to the second phase, would that be multi-year on a five-year basis or a three-year basis?

Kerry Rowe

I think it will definitely be multi-year. And again, it is 2010-2012 and beyond type of thing. So thinking about it in terms of a five-year type span is probably a good thing.

Michael Lewis

Okay, thank you very much.

Kerry Rowe

Welcome.

Operator

There are no further questions. I would now like to turn the call over to Vic Sellier for closing remarks.

Vic Sellier

Thank you very much Erica. Just thank you very, very much, everyone, for your interest in Argon ST and for participating in the call. We will see you the next quarter. Thank you.

Operator

Thank you for your participation on today's conference. This concludes the presentation. You may now disconnect. Everyone have a great day.

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Source: Argon St. Inc. Q2, 2008 Earnings Call Transcript
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