Applied Signal Technology, Inc. F3Q08 (Qtr End 08/01/08) Earnings Call Transcript

Applied Signal Technology, Inc. (APSG)

F3Q08 Earnings Call

August 26, 2008 5:00 pm ET

Executives

William B. Van Vleet, III - President, Chief Executive Officer, Chief Operating Officer and Director

James E. Doyle - Chief Financial Officer and Vice President, Finance

Analysts

Stephen Levinson – Stifel Nicolaus & Company, Inc.

James McIlree – Collins Stewart LLC

Michael Lewis – BB&T Capital Markets

[Ed Keller – Oppenheimer]

Robert Kirkpatrick – Cardinal Capital

Presentation

Operator

Welcome to the Applied Signal Technology fiscal year 2008 third quarter earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Bill Van Vleet, CEO for Applied Signal Technology.

William B. Van Vleet, III

Before we begin I’d like to just lead off with a Safe Harbor statement and that’s just an indication that our discussion will reflect the company’s current judgment on future events and those are subject to change as a result of a number of factors that are beyond our control.

With that, over the last quarter AST has been quite busy, a lot of changes going on within the company and outside. We have experienced a very high volume of proposal activity over the last quarter which is coincident with the government’s fiscal year end particularly also with the change in Administration coming up here. For example over the last month we have submitted over $70 million in proposals and we expect to hear the outcome of most of those by the end of the government fiscal year. Orders are increasing as we normally see in the last half of our fiscal year and we think the reason for that high volume is due to a number of reasons. One is that we are seeing a surge in interest in the government in intelligence, surveillance and reconnaissance. Some of you may have seen a news article that was released by Defense News a couple of weeks ago that identified a $1.3 billion shift in DOD funding to intelligence, surveillance and reconnaissance which also included new payloads for unmanned systems which is an area that we address.

Today for instance I also had a good meeting at the Pentagon to review our recent successes in synthetic aperture sonar payloads for unmanned underwater vehicles and the flag officers were very impressed with the maturity of our technology and just dazzled by a lot of the spectacular imagery that we’re able to collect and as a result of those meetings have signed actions to determine how the US Navy can increase its acceptance and incorporate it into their programs of record. So we’re hopeful for future growth in those areas.

Another major initiative for the DOD is the cyber security initiative and again many of you may have heard that. That’s a major initiative aimed at the defense of our cyber networks for our nation. It’s rumored to be receiving as much as $37 billion over the next five year, $7 billion a year and all the major defense contractors are positioning themselves to capture pieces of that program. We are also pursuing this initiative and we’re starting to see interest in funding opportunities with our customers and we anticipate seeing new program opportunities in fiscal 09.

From a business standpoint we’re also broadening our options to partner with other industry prime contractors. We’re engaging with potential industry partners to address the Department of Homeland Security’s SAFECON program and that’s the safe container program for sea-based cargo container inspection. We’re also teaming with a new industry prime, or at least new to us rather, to pursue the US Air Force’s Advanced Technical Exploitation Program with is a $600 million five year program that’s based out of Wright-Patterson Air Force Base.

In addition to addressing a number of business items and to achieve growth in the company we have also had a fairly significant emphasis over the last quarter in implementing a broad initiative to really take a close examination of our business operations with the objective of reducing our cost structure and enhancing our overall competitiveness. Some of the things that we’re going to be putting in place to do that is we’re reducing our facility footprint in areas where we have excess capacity. That will be offset slightly as we may open small regional field offices to increase access for our customers. For example something we will probably announce in the next month is we’re looking at opening a facility in the Dayton area to address a new program at Wright-Patterson Air Force Base.

We’re also considering additional changes to our stock-based compensation and right now we’re in the process of finalizing our assessment and we’re implementing those cost reductions. We hope to have more information available at the next quarterly earnings conference to let you know what we’re doing and what outcome we expect.

With that I’d like to turn it over to our Chief Financial Officer, Jim Doyle, and he’ll go through the details of our third quarter financial results.

James E. Doyle

There was good order activity during the third quarter. New orders received during the third quarter were approximately $70.3 million compared to new orders of approximately $74 million received during the third quarter of fiscal 2007. New orders for the first nine months were approximately $145.3 million compared to approximately $150.9 million for the same period of fiscal 2007. I should mention that new orders in backlog could be reduced by $2 million to $4 million following the settlement of a notice to terminate several delivery orders for the convenience of the customer. As Bill has been talking about we continue to focus our operations on assuring program performance, maintaining a competitive cost structure and penetrating our marketplace. Our customers continue to come to us with new requirements for ISR solutions that are weighted heavily toward new developments.

Revenues for the third quarter of fiscal 2008 were approximately $49.9 million representing a 26% increase when compared to revenues of approximately $39.5 million for the third quarter of fiscal 2007. Revenues for the first nine months of 2008 were approximately $138 million representing an 11% increase when compared to revenues of approximately $124 million for the first nine months of fiscal 2007. Third quarter revenues increased primarily due to increased sales related to our engineering development programs, our standard products, and revenue recognized on approximately $1.9 million of pre-contract costs.

Operating income for the third quarter of fiscal 2008 was approximately $3.2 million compared to operating income of approximately $1.6 million for the third quarter of fiscal 2007. Operating income increased for the third quarter of fiscal 2008 due to increased royalties associated with a licensing of our intellectual property into commercial satellite communications markets and as a result of improvements in company operations. Operating income for the first nine months of fiscal 2008 was approximately $8.4 million compared to operating income of approximately $7.2 million recorded during the same period of fiscal 2007. The increase in operating income during the first nine months of fiscal 2008 compared to the same period in 2007 is due to increased royalties.

Debt income for the third quarter and first nine months of fiscal 2008 was approximately $2 million or $0.15 per diluted share and approximately $5.5 million or $0.43 per diluted share respectively compared to net income for the third quarter and first nine months of fiscal 2007 of approximately $1 million or $0.08 per diluted share and $4.4 million or $0.36 per diluted share respectively. Effect tax rate for fiscal 2008 is estimated to be 45.9% compared to an effective tax rate of 43.2% for fiscal 2007.

I’d like to briefly review the balance sheet and after I’ve concluded that we’ll open it up to questions. The combined cash and investment balances at the end of the third quarter were approximately $52.8 million representing an increase of about $13.8 million from the $39 million balance at October 31^st, 2007. Accounts receivable balances were approximately $42.3 million. Inventory balance at August 1^st, 2008 was approximately $8.3 million compared to approximately $6 million at October 31^st, 07. Included the inventory balance is the unfavorable indirect rate variance of approximately $2.2 million. Prepaid and other current assets included pre-contract or at risk costs of about $1.2 million at August 1^st, 2008. This compares to about $4.5 million of at risk costs at October 31^st 2007.

Current liabilities are $22.3 million compared to $20.4 million at the end of October 31, 2007. The increase included accrued severance for our former CEO of approximately $1.1 million. We paid dividends of approximately $1.6 million and $4.7 million during the third quarter and first nine months of fiscal 2008 respectively. As a reminder we do pay an annual dividend of $0.50 per share.

With that I’ll turn it over back to Bill and we will open it up for questions.

William B. Van Vleet, III

Questions, please.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Stephen Levinson – Stifel Nicolaus & Company, Inc.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

Are there any costs in your G&A that relate to the severance? I think last quarter you said there was about $250,000 of stock-based compensation that was going in there.

James E. Doyle

Correct.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

So that is in there. Is there a difference or that’s where the amount actually came out?

James E. Doyle

The stock-based compensation?

Stephen Levinson – Stifel Nicolaus & Company, Inc.

Yes, related to severance.

James E. Doyle

Correct. For the acceleration of that it would primarily flow through G&A.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

So that was about $0.01 impact to earnings I guess?

James E. Doyle

$250,000, $300,000 was the stock compensation going through, Steve.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

Normal RAS 123R stock-based compensation during the quarter?

James E. Doyle

During the quarter stock comp before taxes was approximately $1.2 million and then for the nine months it’s right at about $4 million.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

Going forward on some of these programs, Bill, I know you mentioned the reprogramming that’s planned. I guess one of the items in there is an aircraft they’re referring to as RC12 which sounds an awful lot like guardrail. Is that an area that you expect to have participation? I know you mentioned the unmanned programs.

William B. Van Vleet, III

The unmanned programs we’re certainly addressing the local primes on that. On the guardrail program we are talking to the prime contractor on that. There’s an overall capability that they have for that called ASIP and I don’t recall what the acronym stands for, ASIP. And we are talking to them about using some of the new AST products and software capabilities for upgrades to address some of the emerging signal environment.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

So that is something then that would likely go on these other aircraft they’re planning on purchasing?

William B. Van Vleet, III

Yes. And we’re in discussions as are our other competitors obviously but we are in discussions with the prime contractor on that, yes.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

Last two items, depreciation and amortization during the quarter?

James E. Doyle

I can give you year-to-date, Steve, is that all right?

Stephen Levinson – Stifel Nicolaus & Company, Inc.

Okay.

James E. Doyle

Depreciation and amortization year-to-date for 08 is roughly $4.6 million.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

And the other item is.

James E. Doyle

Was it cap ex you wanted?

Stephen Levinson – Stifel Nicolaus & Company, Inc.

I guess I forgot that one, so an extra. Yes, please.

James E. Doyle

Cap ex was right about $3 million year-to-date.

Stephen Levinson – Stifel Nicolaus & Company, Inc.

And then you said the tax rate for the year would be about 45.9%. Am I wrong here, does that imply a tax rate in excess of 50% in the fourth quarter?

James E. Doyle

No, the effective tax rate is 45.9% and so what it would imply is a 45.9% tax rate for the fourth quarter. There were some discreet events that happened in the third quarter of this year that lowered the tax rate slightly. But the effective tax rate stayed the same at 45.9% and then it gets reduced as a result of the discreet items. We don’t anticipate any discreet items in the fourth quarter so the tax rate for the fourth quarter we anticipate to be 45.9%.

Operator

Your next question comes from James McIlree – Collins Stewart LLC.

James McIlree – Collins Stewart LLC

Were there any big orders in the quarter that accounted for such a good result this quarter?

James E. Doyle

Yes, there were. We had a nice order from one of our primary customers. Unfortunately it’s classified and I can’t talk much about it, but we did receive a nice order during the quarter.

William B. Van Vleet, III

We’ve also seen, Jim, a number of increases to our IDIQ contracts that we have and two of those IDIQ contracts are among the five largest contracts we’ve got in the company and so what we’re seeing is increases in scope and additional task orders are being placed on those in order to add more capability to existing programs. So we’re seeing good improvement on engineering change proposals to existing efforts as well. It’s all classified at this point but I guess there no large unclassified or open source programs that we can discuss.

James McIlree – Collins Stewart LLC

Has the Singapore bid been evaluated yet or where do you stand on that?

William B. Van Vleet, III

Good question, Jim. It’s still in evaluation. They’re going back and forth on that. It’s actually down to two contractors now. We are teamed with Atlas, a German firm. They have the platform and we’ve got the payload that goes on board that and the competitor is a French company. It’s down to the two of us overall now and there are some final demonstrations that will be taking place in Europe in October and the we’re hoping to hear by the end of the calendar year that award announcement. No award yet, it’s still in final selection and they want to have one more demonstration.

James McIlree – Collins Stewart LLC

Jim, can you tell us what the dollar amount of the royalty income was this quarter or year-to-date?

James E. Doyle

The royalty income during the third quarter of fiscal 08 was approximately $1.3 million. The royalty income for the first nine months was approximately $3.8 million.

James McIlree – Collins Stewart LLC

Bill, you spoke about a high level of bids that you’ve put out. I think you said in the last 30 days.

William B. Van Vleet, III

We have, yes.

James McIlree – Collins Stewart LLC

I’m just trying to get a feel for the total amount of bids outstanding that you have out there and how that might compare to 12 months ago.

William B. Van Vleet, III

I don’t have the exact number but I believe in total the values are quite a bit higher at this point than they were a year ago and again I attribute some of that to the fact that we believe with the change of Administration coming up that some of the customers are planning ahead and getting their funding vehicles in place so that if there is a continuing resolution the contract is in place so that the programs can continue uninterrupted. But I don’t have the exact number as to how much that is. Overall we still have a total outstanding proposal amount well over $100 million in raw proposals, rough order magnitude proposals that are still to be determined.

James McIlree – Collins Stewart LLC

I’m assuming that the proposal activity doesn’t end simply because June 30^th came around is that you’ll continue to have a high level of proposal activity or since it’s the end of the fiscal year it’s winding down now.

William B. Van Vleet, III

We still expect to see a pretty good volume of it through the end of the government fiscal year which will end in September. Beyond that again with the election year that we’ve got going on we anticipate that new competitive awards may delay and we actually expect that that’ll probably delay maybe as much as until spring of next year. But anything where you’ve got an existing contract we think we’ll still see proposal and ECPs in that timeframe, after October. We think it’ll return more to normal maybe come October is what we’re saying.

James McIlree – Collins Stewart LLC

Last one, Bill, in your remarks you were talking about broadening your partnering initiatives and you mentioned the SAFECON program and that after that you said something US Air Force and I just missed what you said. Could you just repeat what that was all about?

William B. Van Vleet, III

It’s a program called the Advanced Technical Exploitation Program and it’s out of Wright-Patterson Air Force Base and we’re pursuing that with one of the incumbents overall. It’s a new area that we haven’t been involved in. It’s a measurement in signatures, intelligence program that uses sensor information to provide indications of threat areas around the world and we’re pursuing that as a diversification marketplace for us.

James McIlree – Collins Stewart LLC

Would you be displacing another vendor on that program or would this be a new capability that they’re asking for?

William B. Van Vleet, III

The program overall is a continuation. They’ve had a five year program and they’re re-competing the next five year program is what’s going on. We would be displacing other competitors because what they’re doing is some of the incumbents are split into multiple teams and so one will be selected and if we’re part of the winning team we would displace someone who was previously in that space.

James McIlree – Collins Stewart LLC

My real question is, does the old capability have [inaudible] on it and they’re just asking for something else and that gives you your shot or why is that you were able to get in this time around and not last time?

William B. Van Vleet, III

They’re looking to upgrade their capability to include new sensors that we address.

Operator

Our next question is from Michael Lewis – BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

Just a comment first, Bill I wanted to congratulate you. I think the Board made the right decision retaining you as the CEO and not bringing someone from the outside in who’s unfamiliar with the problems that AST has had over the past few years, so I just wanted to congratulate you there.

Also just a few questions here, if we look at the digital signal processing business which has leaned heavily on the hardware side over the past few years, can you give us an update on the transition moving to a more software oriented architecture model? Can you talk to us a little bit about what's going on there?

William B. Van Vleet, III

We are seeing more of a trend toward software. As you know AST is a company that really was built on hardware and was one of the first companies that took advantage of the transition from analog signal processing to digital signal processing. There’s a new inflection point coming as the computing technology is increasing in capability and they’re moving to the higher and higher capacities on commercial computing and also on field programmable [geta] rays. We’re seeing much more demand from the government for software and also going to open systems architectures overall. The company has been migrating that way. If you look at our engineering staff about four-fifths of our staff or 80% right now is software based and only about 20% is hardware based. One of the things that we’re working on internally as an initiative is not only just delivering that capability through AST products but also creating software products that we can place and use in other contractor’s open source architectures.

Michael Lewis – BB&T Capital Markets

Just a quick question with regard to the funding environment, our understanding has been that the NSA is still very tight with regards to the funding outlook. What’s your experience right now? Are they actually spending money right now or is this what we're seeing in there?

William B. Van Vleet, III

We’re seeing a pretty good volume of activity. I guess I am surprised to hear that it’s tight because again the biggest effort that might change is this new cyber security initiative. Again that's a current Presidential emphasis. In fact I think there was some congressional language even recently that allocated some budget toward that and that’s primarily I think going to be administered through NSA, that would be the primary agency that has command over that funding, maybe some Department of Homeland Security. They’re still working out where the funding is going to go as far as that goes. But that’s going to provide a significant impact in those markets I believe.

Michael Lewis – BB&T Capital Markets

I agree there but let me ask with regard to the cyber initiative, where do you think your opportunity is better? Do you anticipate that your opportunity is better with regard to money flowing from DHS or money flowing from National Security Agency?

William B. Van Vleet, III

We’ve done more work with the intelligence agencies than we have with Department of Homeland Security so for us we’re more of a known quantity with existing customers and so obviously if it were to go through the intelligence agencies I think we would be able to provide a value offer sooner than if it went through DHS. That said, we are actively campaigning and bidding into Department of Homeland Security to increase our recognition and brand name, if you will, in that area as well.

Michael Lewis – BB&T Capital Markets

Just one more question and I’ll get out of the way here, with regard to the time that you’ve had to visit some of your operations around the country, what changes have you made to the cost structure right now to bring your costs more in line with the industry?

William B. Van Vleet, III

The first thing we’re doing right now in fact I’m sitting in our DC office is we’re reducing the footprint in some of our facilities. We benchmarked ourselves against our competitors and found that if you look at normal metrics in square foot per employer or costs of the facility per employee and so forth we were in the top 10% overall of probably industry competitors and so we’ve taken a hard look at our facilities, we’ve just given up a third of the space here in our DC office. We’re also looking at other facilities in order to bring those costs down. Right now we’ve done a par ado stack if you will on what our biggest drivers are and facility is one of the top three overall. So that was one of the first ones we took a look at. That’s a reduction. We’re also again taking a look at some of our other operational and cost items and as I said before we’re just beginning to finish our assessment on that and put implementation in place and hope to have more news on that in another quarter.

Michael Lewis – BB&T Capital Markets

Just a follow up to that, you’re not contemplating employee cuts, just infrastructure?

William B. Van Vleet, III

No employee cuts, we’re still hiring overall, we’re still looking for staff for direct work. In fact that’s one of items we have to continue to grow on. But yes, we’re looking at operational cuts and infrastructural cuts.

Operator

Our next question is from [Ed Keller – Oppenheimer].

[Ed Keller – Oppenheimer]

Just a quick housekeeping question, I think you gave it but I missed it. Indirect rate variance for the quarter was how much and what was the plan?

James E. Doyle

Indirect rate variance for the quarter, or at the end of the quarter, is approximately $2.2 million unfavorable variance.

[Ed Keller – Oppenheimer]

And that’s versus what planned? Versus the planned it was?

James E. Doyle

It’s consistent with our plan. It compares to last year we had an unfavorable variance at the end of third quarter of approximately $5.4 million. We had taken a charge of about $1.3 million to reduce the unfavorable variance at that time to $4.1 million.

[Ed Keller – Oppenheimer]

Could you give operating cash flow and free cash flow for the quarter?

James E. Doyle

I gave you the cap ex and the deprecation and amortization. I can give you cash provided by operating activities if you want that.

[Ed Keller – Oppenheimer]

Sure.

James E. Doyle

It’s $19.4 million.

[Ed Keller – Oppenheimer]

I don’t think you gave your total backlog at quarter end, but it’s look it’s probably about in line with last year at this time?

James E. Doyle

Yes, it’s a little over $133 million is our backlog at the end of Q3. Yes, that’s similar to where we were last year at this time.

[Ed Keller – Oppenheimer]

In terms of growth for next year, trying to put that in perspective, I know you’ve got some things in the hopper now that might come to fruition before the end of the next quarter, but where should we be looking for the growth to come from for next year?

William B. Van Vleet, III

We’ve got three operating divisions and we’re seeing growth in all three of those. We’re seeing growth in our broadband communication systems, that’s where any results of the cyber security initiative will cause growth in that area. In our intelligence and electronic warfare systems, or what used to be our wireless communication, we’re seeing quite a bit of interest in our capability that will address the next generation communication signals on that. So we’re seeing opportunities in that. Also we’re talking to a lot of the UAV providers and that’s starting to get traction. In the past the government has primarily put optical payloads on their UAVs and now they’re starting to look at second payloads to be able to put on their UAVs to listen to signals and so we’re seeing some growth there. We think that opportunity is in that area s well as also in the ground and manned portable segment. We think that’s an opportunity for us. And on the synthetic side, as I said before our synthetic aperture sonar is producing very strong results and we’re expecting growth in that and also our associated powerful imaging in the sensor side.

[Ed Keller – Oppenheimer]

Going into the fourth quarter last year I think you had about a book-to-bill of .9 times, it sounds like you’re in a little bit better shape this year. Do you expect greater than one times in the fourth quarter or how do you look at that?

James E. Doyle

Let me help a little bit on that, Ed, for the full year we anticipate book-to-bill of greater than one for the full year.

Operator

Our next question is from Robert Kirkpatrick – Cardinal Capital.

Robert Kirkpatrick – Cardinal Capital

Could you give us the mix of revenue between cost reimbursement fixed price and time and materials please?

James E. Doyle

To give you some rough numbers here, Rob, for this third quarter cost reimbursable contracts about 68% of revenues, fixed price about 14%, in time and material contracts about 18%. Year-to-date for the first nine months cost reimbursable contracts about 70%, fixed price about 11% and time and materials about 19%.

Robert Kirkpatrick – Cardinal Capital

So the fixed price looks like it has picked up a little bit sequentially here, is there something going on there or is that just the [inaudible]?

James E. Doyle

It’s more in line with the way the government’s spending cycles go and we typically see more product sales come along in the third and fourth quarter.

Robert Kirkpatrick – Cardinal Capital

Were there excess costs or one time costs or non-recoverable costs associated with the space reduction effort and some of the other cost reduction things that you’re doing?

William B. Van Vleet, III

We’ve not incurred any costs. We were able to negotiate terms with our landlord due to a clause we had in our lease. We did not incur additional costs at that point.

Robert Kirkpatrick – Cardinal Capital

Your cash flow was particularly strong in the quarter, anything different that you’ve done there?

James E. Doyle

No.

Robert Kirkpatrick – Cardinal Capital

Bill, any changes in what you’re able to accomplish with the change in your status from interim to permanent?

William B. Van Vleet, III

One thing is I don’t have to answer questions about how is the search going anymore.

Robert Kirkpatrick – Cardinal Capital

Then you’re obviously much more productive.

William B. Van Vleet, III

Seriously our focus over the last three months while the search was going on was primarily internally on, hey let’s take a look at our operations and let’s optimize the company for efficiency. And while the search was going in parallel it allowed us a good time to be able to focus inside on that. Now that that change has been made permanent and announced I’d say that my personal focus is much more so on the external growth. We’ve been very busy answering the proposals and that’s good but now one of the things we want to do to is to demonstrate a record of continuous year-over-year growth and that requires us to stay in focus on that front. It’s a long ways to move forward on not only our implementation of the cost reduction effort but also implementation of the efforts we have to return this company to a growth company.

Robert Kirkpatrick – Cardinal Capital

Could you talk a little bit more about how acquisitions fit into that especially given that you’ve now got a fairly healthy cash balance on the balance sheet?

William B. Van Vleet, III

In fact we just finished our Board meeting last week and there are two items that were primary subjects of focus. One was cost reduction for efficiency and as we discussed and the other one was what’s the strategic vision for growth? And we are looking to again return this company to growth through a combination of organic growth and we do see good organic growth still here over the next couple of years but also through small and smart acquisitions and so we are going forward and doing that. We’ve identified our gaps overall and we are in the process of doing some discovery with some potential candidates to see if we can come up with something that makes sense. It is an element of our play book that will be part of our growth going forward.

Robert Kirkpatrick – Cardinal Capital

Given the small number of acquisitions that have been done in the past few years, is there anything that’s going to be done you think differently as you go through those I believe you called them small and smart select acquisitions?

William B. Van Vleet, III

Correct. Yes, absolutely. One of the things we’ve also taken a look at is the management team we’ve got and we will be looking to supplement our management team, to bring in some experience within the company and also rely on some assistance outside the company to help us with that.

Operator

Our next question is a follow up from Michael Lewis – BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

Jim, with regard to the historics R&D typically has averaged about 12.4% of sales since 2000 and I’m starting to notice a trend of lower R&D expense. Can you help us out with regard to where should we be looking? What are our expectations for R&D over say the next year to year and a half?

James E. Doyle

They have trended down and so we anticipate probably in a similar range to about where they are right now, Mike. You’re seeing numbers reported in the 7.5% to 8.5% of total revenue. We think we’ll still be in that kind of a similar range on a going forward basis.

Michael Lewis – BB&T Capital Markets

And if I look back say 12 months were you talking about 9% to 10% as the range, just to clarify my memory?

James E. Doyle

Yes, we were maybe a little higher than that. It’s hard to remember exactly. I’m sorry I just don’t recall.

William B. Van Vleet, III

I recall on that a little bit. I think we were probably in the 8% to 9% of total revenue that is on R&D so we’re a little lower now because of the emphasis we’ve got on delivering on our contract work. But, we see returning to about 8%.

Michael Lewis – BB&T Capital Markets

Then with regard to top line, a nice number this quarter, were there any early revenue that came in that you anticipated in Q4 that hit early in Q3?

James E. Doyle

One of the things that did come in that we were anticipating by the end of the year, there were some at risk efforts that we were able to recognize those revenues.

Michael Lewis – BB&T Capital Markets

Can you quantify that?

James E. Doyle

Yes, it was roughly $1.9 million of at risk costs that we were able to recognize in the third quarter.

Michael Lewis – BB&T Capital Markets

Then just one final question, margin expectations, I was anticipating a little bit more lift moving through the end of the year, it looks like we’re going to kind of hover in around 6.5%. But, if we were to look from the Q408 moving in through Q4 of 09, what should we be looking for? Should we be looking for 100 basis points improvement? 200 basis points improvement? Can you help us at least frame the expectation?

James E. Doyle

What we’ll see, or what we anticipate for next year is we still anticipate a significant amount of development work. So, as you know the type of contract drives our margins and the development work is typically a cost reimbursable basis or a time and material basis so we’ll would anticipate seeing a large portion of that. The other thing that we anticipate happening is a decline in our stock-based compensation expense. Some of the options and non calls that we had granted have run their course and their vesting will essentially be completed and so we’ll get some favorable effect as a result of that. We’ll also get some favorable effect from our use of restricted stock and the fact that we granted lower amounts of restricted stock than we did with options and then we had also previously changed our employee stock purchase plan from a 24 month offering to a six month offering. So, we’ll be seeing the positive effect of a reduction in stock-based compensation.

Michael Lewis – BB&T Capital Markets

So just to follow up, we should anticipate some lift on the margin next year?

James E. Doyle

Yes, a slight lift on that.

Operator

Our next question comes from James McIlree – Collins Stewart LLC.

James McIlree – Collins Stewart LLC

Last quarter you talked a lot about the packet program, I think you had just come back from either a customer briefing or demo. Could you give an update on that?

William B. Van Vleet, III

You bet, we’ve released the new packet based processing product last quarter and in fact we’ll show more of that in our fall product and technologies [inaudible] which is scheduled in November and that has received strong interest. We have not seen orders for that yet but we are anticipating seeing orders for that if not late this fiscal year, I would early in to the next fiscal year. I’d say 4Q08 or 1Q09 by then.

James McIlree – Collins Stewart LLC

Does that cannibalize any existing product line or would that be incremental to the results?

William B. Van Vleet, III

Well, it doesn’t cannibalize an existing product line but just like any technology, as technology continues to advance, products have a finite lifetime. This is really addressing the next generation of communications technologies. So it enhances and extends our product base but we will see some of our older products tail off just as the demand decrease for those over time.

Operator

Mr. Van Vleet we have no further questions in the queue at this time.

William B. Van Vleet, III

I’d like to thank everyone for participating and also for the great questions that we received and we look forward to speaking to you again next quarter. Thanks very much.

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