##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-K [X]    
 Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Fiscal Year Ended September 30, 2004 [  ]    
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. 
 )
 Delaware
    
    38-1873250(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 12701 Fair Lakes Circle, Suite 800, Fairfax Virginia 22033
(Address of principal executive offices) (Zip Code) Registrants telephone number, including area code (703) 322-0881 Securities registered pursuant to Section 12(b) of the Act: Name of Exchange onTitle of Class
    
    Which RegisteredCommon Stock, par value $.01 per share
    
    NASDAQ National Market
 Securities registered pursuant to Section 12(g) of the Act: None 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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
[ü]
       No [  ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [  ] Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes
[ü]      
No [  ]    1




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As of December 6, 2004, there were 19,392,029 shares of the registrants
common stock, par value $.01 per share, outstanding. The aggregate market value
of the voting and non-voting shares of the Common Stock held by non-affiliates
on March 31, 2004, the last business day of registrants second quarter of
fiscal 2004, was approximately $79,580,000 based on 5,127,551 shares held by
non-affiliates multiplied by the closing price on that date for the
registrants common stock on the Nasdaq National Market of $15.52 per share. DOCUMENTS INCORPORATED BY REFERENCE Part III of this report incorporates by reference specific portions of the
registrants proxy statement relating to the Annual Meeting of Stockholders to
be held on February 28, 2005. 2




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##### 



ARGON ST, INC. AND SUBSIDIARIES For the Fiscal Year Ended September 30, 2004   TABLE OF CONTENTS PART I1. Business
    
    
    42. Properties
    
    
    123. Legal Proceedings
    
    
    134. Submission of Matters to a Vote of Security Holders
    
    
    13Supplemental Item. Executive Officers of the Registrant
    
    
    13PART II5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    146. Selected Financial Data
    
    
    157. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    177A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    268. Financial Statements and Supplementary Data
    
    
    279. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    449A. Controls and Procedures
    
    
    459B. Other Information
    
    
    45PART III10. Directors and Executive Officers of the Registrant
    
    
    4511. Executive Compensation
    
    
    4512. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    4613. Certain Relationships and Related Transactions
    
    
    4614. Principal Accountant Fees and Services
    
    
    46PART IV15. Exhibits and Financial Statement Schedules
    
    
    46Signatures
    
    
    48Exhibits
    
    
    50-54
 3




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PART I ITEM 1. BUSINESS Business Description. Argon ST, Inc. (Argon ST or the Company) is a broadly diversified
provider of high performance sensor systems designed to meet the needs of
defense, homeland security, intelligence, and environmental users. We develop
and manufacture communications intelligence software systems and a broad line
of acoustic, communications, radar, electronic warfare, infra-red and optical
sensor products. Our systems and products collect and process signals and
other information used in our customers intelligence gathering, reconnaissance
and surveillance activities. Our primary customer is the U.S. Department of Defense. We also provide
systems and products to other U.S. federal government agencies and major
domestic prime contractors, as well as to foreign governments, agencies and
defense contractors. Many of our products are used in national defense
programs for the U.S. federal government intelligence community and approved
international customers. With technology and production centers in five states and major corporate
and development centers in the greater Washington, DC area, we are well
positioned to responsively serve our U.S. and international defense and
non-defense customers, as well as to provide them with ready access to our
highly qualified, cleared engineering staff during the design, development,
test, manufacturing, integration, and delivery phases of our contracts. The Company is a Delaware corporation which resulted from the merger of a
wholly-owned subsidiary of Sensytech, Inc. (Sensytech), which was organized
in 1968, and Argon Engineering Associates Inc. (Argon Engineering), which was
organized in 1997. The acquisition was effective on September 29, 2004, and
concurrently, Sensytech changed its name to Argon ST, Inc. Sensytech had been
a publicly traded company since 1998, and prior to the merger, Argon
Engineering was privately held. As a result of the merger, the former Argon
Engineering stockholders acquired approximately 65.6% of the outstanding common
stock of the Company. In connection with the merger, Terry L. Collins, the
former Chairman and CEO of Argon Engineering, became the Chairman and CEO of
the Company, and the Companys board of directors was increased to ten members,
with seven new members (including Mr. Collins) elected to the board, and three
Sensytech directors continuing on the board. While Sensytech was the legal acquirer, the acquisition was accounted for
as a reverse acquisition, whereby Argon Engineering was deemed to have acquired
Sensytech for financial reporting purposes. Consistent with the reverse
acquisition accounting treatment, the historical financial statements presented
for periods prior to the acquisition date are the statements of Argon
Engineering, except for stockholders equity which has been retroactively
restated for the equivalent number of shares of the legal acquirer. The
operations of the former Sensytech businesses have been included in the
financial statements from the date of acquisition. Both companies had their
fiscal year ending on September 30. The names Argon ST, Sensytech, and Argon Engineering are used throughout
this document. Argon ST, also the Company, refers to the entity created by the
merger of Argon Engineering and Sensytech. Argon Engineering refers to Argon
Engineering Associates, Inc., which operated as a stand alone private company
until the September 29, 2004 merger with Sensytech. Sensytech refers to
Sensytech, Inc., which combined with its wholly owned subsidiaries made up the
public entity Sensytech until the September 29, 2004 merger with Argon
Engineering. Our headquarters are located at 12701 Fair Lakes Circle, Fairfax, VA
22033. Our website is located at http://www.argonst.com. The information
contained on our website is not incorporated by reference into this Annual
Report. However, investors can obtain a copy of this Annual Report on Form
10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to such reports filed or furnished with the SEC on our website free
of charge. Strategic Approach Our business objective is to profitably grow our business as a premier
provider of high quality and state of the art intelligence gathering and
electronic warfare technology, products, and systems. Our strategies for
achieving this objective include:  
    
    Expanding Our Customer Base.We intend to capitalize on our
long-term relationships with our customers and our reputation within
the intelligence community and Department of Defense to attract new
customers within those
communities. We believe we have a successful performance record and
demonstrated technical expertise that gives us 4




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credibility with
prospective customers and enhances our ability to be successful in
bidding on follow-on contracts. As our revenue base grows through
internal growth as well as acquisitions, we intend to seek larger
contracts, which have historically been awarded to larger suppliers.  
    
    Targeting High Growth Segments of the Market.We believe the
projected growth in government intelligence gathering and electronic
warfare technology products and services spending will offer
opportunities for development and delivery of advanced technology
solutions for defense and intelligence agencies. We intend to expand
our product and service offerings in these areas, particularly where
there is a possibility for significant long-term sales. We believe
that friendly foreign governments would like to increase their
capabilities in these areas, as the events of September 11, 2001, have
global security implications.  
    
    Attracting and Retaining Highly Skilled Personnel.We intend to
continue to attract, develop and retain skilled professionals to ensure
we have the capabilities to fulfill our customers requirements. Our
ideal candidates are exceptional recent college graduates and former
military or civilian experts in the intelligence community and
Department of Defense. We believe we can continue to retain our
employees by offering competitive compensation and by providing
opportunities for career growth through company-supported education
programs and involvement in diverse and challenging engineering
developments.  
    
    Leveraging Customer Funded Research and Development.Many of our
products were or are being developed through funding provided by the
customer in the form of research and development contracts. While
these contracts tend to be relatively small, many of these contracts
contain provisions for the customer to exercise multi-year options that
increase the values of these programs significantly should the customer
decide to go into full production. Some of our contracts can be
extended or increased at the option of the customer.  
    
    Pursuing Strategic Acquisitions.We plan to enhance our internal
growth by selectively pursuing strategic acquisitions of businesses
that can cost-effectively broaden our technology expertise and our
product offerings. We are primarily focused on acquiring businesses
that provide value-added solutions for the intelligence community and
Department of Defense, but will also consider opportunities to acquire
other businesses where we can utilize our reputation and experienced
management team to expand our core business areas. Products The Companys systems are found on a broad range of U.S. national and
international platforms that include ships, submarines, aircraft, Unmanned
Aerial Vehicles (UAV), Unmanned Underwater Vehicles (UUV), land mobile
vehicles, fixed site installations, and re-locatable land sites. Our systems and products fall into the following categories: Imaging Systems. We provide state-of-the-art airborne hyper-spectral and
multi-spectral collection systems supporting both a broad range of defense
requirements and environmental applications that include forest fire, wildlife
and water management and pollution sensing. Infra-Red Sensors. Our Forward Looking Infra-Red (FLIR) sensors combine
our own and other sensors into compact payloads that provide high resolution
visual Infrared (IR) images that can be combined with TV video, laser range
finding, and radar for sensing, targeting, and perimeter security. Highly
stable gimbals provide platforms for use on fixed and rotary wing aircraft,
land mobile vehicles, and stationary tri-pod mountings. Signals Intelligence and Electronic Warfare. Our Signals Intelligence
(SIGINT) and Electronic Warfare (EW) systems offer a range of product
configurations to accommodate virtually every platform type in use by the
military. Our Commercial Off the Shelf (COTS) product line is currently in use
in significant quantities by US and UK Navies in a wide range of new
construction and existing surface ship, submarine, land mobile, and aircraft
applications. Ship Protection and Communications.Our recently opened production and
engineering centers in Pennsylvania presently focus on the delivery of
shipboard system for the AN/SRQ-4 LAMPS MK III communications system and the
AN/SLQ-25A Surface Ship Torpedo Defense system which is an acoustic protection
systems used on US and international surface ships. Argon STs product lines are in continual development and improvement to
remain current with improved technology and emerging customer requirements.
Individual system implementations vary in size and complexity, but typical
systems consist of one to several racks of equipment and provide support for
one to three operators. Several configurations of Argon STs products have been 5




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delivered or are currently under contract to be delivered, including
installations on submarines and navy surface ships, and different variations of
airborne, land mobile, and fixed site systems. In addition to the procurement, integration, test and delivery of systems,
Argon ST provides full-service support for its systems world-wide. Customers Our products are currently sold primarily for the ultimate use of either
the U.S. government or certain approved allied governments. As a result, most
of our contracts are either directly with the U.S. government or a prime
contractor whose contact is direct with a government. The following table identifies the sources of revenues earned by Argon
Engineering. As shown, our revenue is dominated by our work with the United
States Navy: Years Ended September 30,2004
    
    2003
    
    2002United States Navy
    
    
    77
    %
    
    
    68
    %
    
    
    75
    %Other U.S. Government Agencies
    
    
    11
    %
    
    
    26
    %
    
    
    19
    %Foreign
    
    
    12
    %
    
    
    6
    %
    
    
    6
    %
 Contracts Most of Argon STs business is conducted under contracts related to U.S.
government security requirements. Argon STs contracts with U.S. government
agencies can be categorized in several ways. Sole source contracts.The U.S. government awards sole-source contracts
when it determines that a single contractor has an expertise or technology
that is superior to that of competing contractors. Potential suppliers
compete informally for sole-source contracts through research and
development investment and marketing efforts. This competition requires a
contractor to identify the governments requirements early and demonstrate
a distinguishing expertise or technology promptly after the government has
identified a requirement. Sole-source contracts are awarded without a
formal competition. Competitive bid contracts.Competitive-bid contracts are awarded based on
proposal evaluation criteria established by the procuring agency.
Interested contractors prepare a bid and proposal in response to the
agencys request. A bid and proposal is usually prepared in a short time
period in response to a deadline, and requires the extensive involvement
of numerous technical and administrative personnel. Competitive-bid
contracts are awarded after a formal bid and proposal competition among
suppliers. Argon Engineerings revenues for the periods shown, under contracts
awarded on a sole-source and contracts awarded on a competitive basis, were: Fiscal Year
    
    Fiscal Year
    
    Fiscal YearEnded
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2002Sole Source Contracts
    
    
    55
    %
    
    
    48
    %
    
    
    62
    %Competitive Contracts
    
    
    45
    %
    
    
    52
    %
    
    
    38
    %
 Government Contracts The funding of government programs is subject to Congressional
appropriations. Although multi-year contracts may be authorized in connection
with major procurements, Congress generally appropriates funds on a fiscal year
basis, even though a program may continue for many years. Consequently,
programs are often only partially funded initially, and additional funds are
committed only as Congress makes further appropriations. 6




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Generally, government contracts are subject to oversight audits by
government representatives. Provisions in these contracts permit termination,
in whole or in part, without prior notice, at the governments convenience.
Compensation in the event of a termination is limited to work completed at the
time of termination. In the event of termination, the contractor will receive
a certain allowance for profit on the work performed. In addition, all
contracts with the federal government contain provisions, and are subject to
laws and regulations, that give the government rights and remedies not
typically found in commercial contracts, including rights that allow the
government to:  
    
    terminate existing contracts for convenience, which affords the
federal government the right to terminate the contract in whole or in
part anytime it wants for any reason or no reason, as well as for
default;  
    
    reduce or modify contracts or subcontracts, if its requirements
or budgetary constraints change;  
    
    cancel multi-year contracts and related orders, if funds for
contract performance for any subsequent year become unavailable;  
    
    claim rights in products and systems produced by us;  
    
    adjust contract costs and fees on the basis of audits completed by its agencies;  
    
    suspend or debar us from doing business with the U.S. federal government; and  
    
    control or prohibit the export of our products. Our U.S. federal government contracts include fixed-price contracts, cost
reimbursable contracts, including, cost-plus-fixed-fee, cost-plus-award fee,
and cost-plus-incentive fee, and time and material contracts.  
    
    Fixed-price.These contracts are not subject to adjustment by
reason of costs incurred in the performance of the contract. With
this type of contract, we assume the risk that we will be able to
perform at a cost below the fixed-price, except for costs incurred
because of contract changes ordered by the customer.  
    
    Cost reimbursable.  
    
    Cost-plus-fixed-fee contracts are cost reimbursable
contracts that provide for payment to us of a negotiated fee that
is fixed at the inception of the contract. This fixed fee does
not vary with actual cost of the contract, but may be adjusted as
a result of changes in the work to be performed under the
contract. This contract poses less risk than a fixed price
contract, but our ability to win future contracts from the
procuring agency may be adversely affected if we fail to perform
within the maximum cost set forth in the contract.  
    
    A cost-plus-award-fee contract is a cost reimbursable
contract that provides for a fee consisting of a base amount
(which may be zero) fixed at inception of the contract and an
award amount, based upon the governments satisfaction with our
performance under the contract. With this type of contract, we
assume the risk that we may not be awarded the award fee, or only
a portion of it, if we do not perform satisfactorily.  
    
    A cost-plus-incentive-fee contract is a cost reimbursable
contract that provides for an initially negotiated fee to be
adjusted later by a formula based on the relationship of total
allowable costs to total target costs. As is the case with all
cost reimbursable contracts, we assume the risk that, if our costs
are not allowable under the terms of the contract or applicable
regulations, we may not be able to recover these costs.  
    
    Time-and-Materials.These contracts require us to deliver
services on the basis of direct labor hours at specified fixed hourly
rates that include all our direct and indirect costs, such as wages,
overhead, general and administrative expenses, and profit, and other
materials at cost. With respect to these contracts, we assume the
risk that we will be able to perform these contracts at these
negotiated hourly rates. 7




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Argon Engineerings revenues for the periods shown by contract type were: Fiscal Year
    
    Fiscal Year
    
    Fiscal YearEnded
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2002Cost reimbursable Contracts
    
    
    19
    %
    
    
    51
    %
    
    
    50
    %Firm Fixed Price Contracts
    
    
    71
    %
    
    
    46
    %
    
    
    49
    %Time and Materials Contracts
    
    
    10
    %
    
    
    3
    %
    
    
    1
    %
 We are subject to various statutes and regulations governing government
contracts generally and defense contracts specifically. These statutes and
regulations carry substantial penalty provisions including suspension or
debarment from government contracting or subcontracting for a period of time,
if we are found to have violated any of these regulations. Among the causes
for debarment are violations of various statutes, including those related to
procurement integrity, export control, government security regulations,
employment practices, the protection of the environment, the accuracy of
records, and the recording of costs. We carefully monitor all of our contracts
and contractual efforts to minimize the possibility of any violation of these
regulations. As a government contractor, we are subject to government audits, inquiries
and investigations. We have experienced minimal audit adjustments in the past.
The Defense Contract Audit Agency has completed its audit of our contracts
through the fiscal year ended September 30, 2001. We are still subject to
adjustment on our performance during subsequent years. We believe that markets in which we participate will continue to be
important in future years, as the military branches and intelligence agencies
continue to rely upon technological advances for defense and intelligence
purposes. We cannot assure you, however, that federal appropriations will
continue to exist at their current levels or that our products will be utilized
in the future. Backlog Our backlog consists of the following as of September 30: 2004
    
    2003
    
    2002Funded
    
    $
    222,222,000
    
    
    $
    146,418,000
    
    
    $
    81,533,000Unfunded
    
    
    6,597,000
    
    
    
    10,652,000
    
    
    
    15,266,000Total
    
    $
    228,819,000
    
    
    $
    157,070,000
    
    
    $
    96,799,000
 Argon ST defines backlog as the funded and unfunded amount provided in its
contracts, less previously recognized revenue. Contract options are estimated
separately and not included in backlog. Backlog does not include the value of
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.
Backlog as of September 30, 2004 includes backlog acquired from Sensytech of
$30,715,000. For fiscal years 2003 and 2002 backlog refelcts only Argon
Engineering backlog. Argon STs funded backlog does not include the full value of its
contracts, because Congress often appropriates funds for a particular program
or contract on a yearly or quarterly basis, even though the contract may call
for performance that is expected to take a number of years. From time to time, Argon ST will exclude from backlog portions of contract
values of very long or complex contracts where Argon ST judges revenue could be
jeopardized by a change in government policy. Because of possible future
changes in delivery schedules and cancellations of orders, backlog at any
particular date is not necessarily representative of actual sales to be
expected for
any succeeding period, and actual sales for the year may not meet or
exceed the backlog represented. Argon ST may experience significant contract
cancellations that were previously booked and included in backlog. 8




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Research and Development Argon ST conducts substantial research and development using both
government and company funds. During its early years, Argon Engineering used
mostly internal investments to broaden the capabilities of its product line, as
customer-sponsored research was not sufficient to fund these activities. During
this period, Argon ST made focused research and development investments in
areas the company deemed critical to its product line development, and used
these activities to gain competitive advantage in future programs. Argon STs current customers are now investing in new capabilities
required to keep systems current with modern threats. As a result, Argon STs
internal investments have shifted to examinations of future technologies and to
products of interest to potentially new customers. Argon ST believes that its continued success depends, in a large part, on
our ability to develop new technology and apply new technology developed by
others to solve the problems of its customers. Total research and development
expenditures incurred by Argon Engineering consist of the following for the
years ended September 30: 2004
    
    2003
    
    2002Internal research and development
    
    $
    1,301,000
    
    
    $
    2,187,000
    
    
    $
    3,015,000Customer-funded development
    
    
    26,730,000
    
    
    
    47,005,000
    
    
    
    24,471,000Total
    
    $
    28,031,000
    
    
    $
    49,192,000
    
    
    $
    27,486,000
 Competition Argon STs market is highly competitive and is served by companies of
varying size and capability. Large prime contractors who develop
general-purpose signals reconnaissance systems include Boeing, British
Aerospace, General Dynamics, Harris Corporation, L-3 Communications, Lockheed
Martin, Northrop Grumman, and Raytheon. Medium size firms in this market
include Applied Signal Technologies, DRS, EDO, and Southwest Research
Institute. Any of these firms is capable of committing large sums to duplicate
Argon STs efforts and to erode its competitiveness. These competitors can also
choose to subsidize their actual cost from other resources to achieve a more
favorable market position and receive new contract awards. The competition for competitive-bid contracts differs from the competition
for sole-source contracts. Companies competing for competitive-bid contracts
prepare bids and proposals in response to either commercial or government
requests and typically compete on price. Potential suppliers compete informally
for sole-source contracts through research and development investment and
marketing efforts. The principal factors of competition for sole-source
contracts include investments in research and development, the ability to
respond promptly to government needs, product price relative to performance,
quality, and customer support. Argon ST believes that it competes effectively with
respect to each of the factors upon which competitive and sole-source contracts
are awarded. Environmental Argon ST has incurred no material costs in the past two years related to
environmental issues. Employees We are a people company whose success is solidly dependent on the skills
and dedication of our associates. Our staff is a mix of experienced veterans
and recent college graduates, who combine the vitality of new ideas and the
latest technical skills with experience to meet the tremendous challenges posed
to a sensor company in the rapidly changing security environment that faces the
U.S. and its allies today. Many of our employees hold security clearances and
we are well supported with the appropriate cleared facilities and support
equipment for the range of classified programs on which we perform. As of September 30, 2004, Argon ST had 601 employees. Argon STs business
requires that a large number of its technical employees obtain security
clearances from the U.S. government, which limits the available pool of
eligible candidates for such positions to those who can satisfy the
prerequisites to obtaining these clearances. Approximately 83% of Argon STs
staff has security clearances. Argon STs success is dependent on attracting,
retaining, and motivating qualified key management and technical personnel, the
loss of whom could adversely affect Argon STs business materially. This must
be accomplished in the Washington, DC and Northern Virginia labor markets where
there is substantial demand for cleared engineering and support staff. 9




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Business Risks Our future performance is subject to a variety of risks. If any of the
following risks actually occurs, our business could be harmed and the trading
price of our common stock could decline. In addition to the following
disclosures, please refer to the other information contained in this report,
including the historical consolidated financial statements and related notes. Argon STs future success will depend in part on its ability to meet the
changing needs of its customers. Virtually all of the products produced and sold by Argon ST are highly
engineered and require sophisticated design, software implementation and system
integration techniques and capabilities. The product and program needs of Argon
STs government customers regularly change and evolve. There is no assurance
that Argon ST will continuously have at its disposal the engineering, technical
and manufacturing capabilities necessary to meet these evolving needs. Argon ST faces competition from other firms, many of which have substantially
greater resources. Argon ST operates in highly competitive markets and generally encounters
intense competition to win contracts. Argon ST competes with many other firms,
ranging from small specialized firms to large diversified firms, many of which
have substantially greater financial, management and marketing resources than
Argon ST. Argon STs competitors may be able to provide customers with
different or greater capabilities or benefits than Argon ST can provide in
areas such as technical qualifications, past contract performance, geographic
presence, price and the availability of key professional personnel. Argon STs
failure to compete effectively with respect to any of these or other factors
could have a material adverse effect on its business, prospects, financial
condition or operating results. In addition, Argon STs competitors also have
established or may establish relationships among themselves or with third
parties to increase their ability to address customer needs. Accordingly, it is
possible that new competitors or alliances among competitors may emerge. Argon ST may be liable for systems and service failures. Argon ST creates, implements and maintains communications, information
technology and technical services solutions that are often critical to its
customers operations, including the operations of government defense and
intelligence agencies and their personnel. Argon ST has experienced and may in
the future experience some systems and service failures, schedule or delivery
delays and other problems in connection with its work. If Argon STs solutions,
services, products or other applications have significant defects or errors,
are subject to delivery delays or fail to meet customers expectations, Argon
ST may:  
    
    lose revenues due to adverse customer reaction;  
    
    be required to provide additional services to a customer at no charge;  
    
    receive negative publicity, which could damage its reputation
and adversely affect its ability to attract or retain customers; or  
    
    suffer claims for substantial damages. In addition to any costs resulting from product warranties, contract
performance or required corrective action, these failures may result in
increased costs or loss of revenues if they result in customers postponing
subsequently scheduled work or canceling or failing to renew contracts. While many of Argon STs contracts with the federal government limit Argon
STs liability for damages that may arise from negligence in rendering services
to customers, Argon ST cannot be sure that these contractual provisions will
protect it from liability for damages if Argon ST is sued. Furthermore, Argon
STs errors and omissions and product liability insurance coverage may not
continue to be available on reasonable terms or in sufficient amounts to cover
one or more large claims, or the insurer may disclaim coverage as to some types
of future claims. The successful assertion of any large claim against Argon ST
could seriously harm Argon STs business. Even if not successful, these claims
could result in significant legal and other costs and may be a distraction to
Argon
STs management. In certain new business areas, including in the area of
homeland security, Argon ST may not be able to obtain sufficient
indemnification or insurance and may decide not to accept or solicit business
in these areas. Developing new technologies entails significant risks and uncertainties that
may not be covered by indemnity or insurance. Argon ST is exposed to liabilities that are unique to the products and
services it provides. A significant portion of Argon STs business relates to
designing, developing and manufacturing advanced communications and technology
systems and products used in military defense and intelligence systems and
products. New technologies may be untested or unproven. In addition, from time
to 10




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time, Argon ST has employees deployed on-site at active military
installations or locations. Although indemnification by the U.S. government may
be available in some instances for Argon STs defense businesses, U.S.
government indemnification may not be available to cover potential claims or
liabilities resulting from a failure of technologies developed and deployed. Substantial claims resulting from an accident in excess of U.S. government
indemnity and Argon STs insurance coverage could harm Argon STs financial
condition and operating results. Moreover, any accident or incident for which
Argon ST is liable, even if fully insured, could negatively affect Argon STs
reputation among its customers and the public, thereby making it more difficult
for Argon ST to compete effectively, and could significantly impact the cost
and availability of adequate insurance in the future. Argon STs employees or subcontractors may engage in misconduct or other
improper activities. Argon ST is exposed to the risk that employee fraud or other misconduct
could occur. In addition, from time to time Argon ST enters into arrangements
with subcontractors to bid on and execute particular contracts or programs and
Argon ST is exposed to the risk that fraud or other misconduct or improper
activities by such persons may occur. Misconduct by employees or subcontractors
could include intentional failures to comply with federal laws, federal
government procurement regulations or the terms of contracts that Argon ST
receives and failing to disclose unauthorized or unsuccessful activities to
Argon ST, which could lead to civil, criminal, and/or administrative penalties
(including fines, imprisonment, suspension and/or debarment from performing
federal government contracts) and reputational harm. Misconduct by Argon STs
employees or subcontractors could also involve the improper collection,
handling or use of Argon STs customers sensitive or classified information,
which could result in regulatory sanctions and serious harm to Argon STs
reputation. It is not always possible to deter misconduct by employees or
subcontractors. The precautions Argon ST takes to prevent and detect such
activity may not be effective in controlling unknown or unmanaged risks or
losses and such misconduct by employees or subcontractors could result in
serious civil or criminal penalties or sanctions or reputational harm. Security breaches by Argon ST could adversely affect its business. Many of the programs Argon ST supports and systems Argon ST develops,
installs and maintains involve managing and protecting information involved in
intelligence, national security and other classified government functions. A
security breach by Argon ST or its employees in the course of its development,
production or service activities could cause serious harm to Argon STs
business, damage its reputation and prevent Argon ST from being eligible for
further work on critical classified systems for federal government customers.
Losses that Argon ST could incur from such a security breach could exceed the
policy limits that Argon ST has for errors and omissions or product liability
insurance. Argon STs business is dependent upon obtaining and maintaining required
security clearances. Many of Argon STs federal government contracts require Argon STs
employees to maintain various levels of security clearances, and Argon ST is
required to maintain certain facility security clearances complying with
Department of Defense requirements. Obtaining and maintaining security
clearances for employees involves a lengthy process, and it is difficult to
identify, recruit and retain employees who already hold security clearances. If
Argon STs employees are unable to obtain or retain security clearances in a
timely manner, or at all, or if Argon STs employees who hold security
clearances terminate employment with Argon ST, the customer whose work requires
cleared employees could terminate the contract or decide not to renew it upon
its expiration. In addition, Argon ST expects that many of the contracts on
which Argon ST will bid will require Argon ST to demonstrate its ability to
obtain facility security clearances and perform work with employees who hold
specified types of security clearances. To the extent Argon ST is not able to
obtain facility security clearances or engage employees with the required
security clearances for a particular contract, Argon ST may not be able to bid
on or win new contracts, or effectively rebid on expiring contracts. Argon STs quarterly operating results may vary widely. Argon STs quarterly revenues and operating results may fluctuate
significantly in the future. A number of factors cause Argon STs revenues,
cash flow and operating results to vary from quarter to quarter, including:  
    
    Fluctuations in revenues earned on fixed-price contracts and contracts with a performance-based fee structure;
    
    commencement, completion or termination of contracts during any particular quarter;  
    
    variable purchasing patterns under government GSA schedule
contracts, blanket purchase agreements and indefinite delivery,
indefinite quantity contracts;  
    
    changes in Presidential administrations and senior federal
government officials that affect the timing of technology
procurement; 11




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##### 




    
    changes in policy or budgetary measures that adversely affect
government contracts in general; and  
    
    increased purchase requests from customers for equipment and
materials in connection with the federal governments fiscal year
end, which may affect Argon STs fourth quarter operating results. Changes in the volume of services provided under existing contracts and
the number of contracts commenced, completed or terminated during any quarter
may cause significant variations in Argon STs cash flow from operations
because a relatively large amount of Argon STs expenses are fixed. Argon ST
incurs significant operating expenses during the start-up and early stages of
large contracts and typically does not receive corresponding payments in that
same quarter. Argon ST may also incur significant or unanticipated expenses
when contracts expire or are terminated or are not renewed. In addition,
payments due to Argon ST from government agencies may be delayed due to billing
cycles or as a result of failures of governmental budgets to gain Congressional
and Presidential administration approval in a timely manner. ITEM 2. PROPERTIES Argon ST conducts a major portion of its operations at its headquarters
located at 12701 Fair Lakes Circle, Fairfax, VA 22033. This is a 10 story
building in a mixed use office park that includes commercial, residential, and
retail properties. Argon STs leased space encompasses 153,000 square feet of
the 253,000 square feet available in the building. This space includes
appropriately constructed office, laboratory and meeting areas suitable for
Argon STs classified and unclassified government work. The lease extends until
March 2009 and has two 5-year options. Argon ST believes that our leased facilities are suitable for the
operations we have in each of them. Each facility is well maintained and
capable of supporting higher levels of revenue. The table below sets forth
certain information about our principal facilities. EstimatedAddress
    
    Square Feet
    
    Lease Term
    
    Description
    
    Principal Activity12701 Fair Lakes Circle
Fair Lakes, VA 22033
    
    
    153,000
    
    
    Leased,
Expiration Date:
5/31/2009
    
    Multifloor tenant
in ten-story office
building.
    
    Engineering/
Administration8419 Terminal Road
Newington, VA 22122
    
    
    67,220
    
    
    Leased,
Expiration Date:
6/30/2014
    
    Two 1-story and one partial 2-story
adjacent block
buildings.
Buildings are in an
industrial park.
    
    Engineering/Manufacturing/
Administration30 Parkland Plaza
Ann Arbor, MI 48103
    
    
    12,419
    
    
    Leased,Expiration
Date:
11/30/2008
    
    One-story facility
in a research park.
    
    Engineering/Manufacturing/
Administration3883 Via Pescador
Suite D
Camarillo, CA 93012
    
    
    5,318
    
    
    Leased,
Expiration Date:
1/31/2007
    
    One-story facility
in an industrial
park.
    
    Engineering/Manufacturing/
Administration925 South Semoran Blvd
Winter Park, FL.
    
    
    6,620
    
    
    Leased,
Expiration Date:
12/31/2004
    
    One-story facility.
    
    Engineering/
Manufacturing90 Laurel View Drive
Smithfield, PA
    
    
    60,000
    
    
    Leased,
Expiration Date:
9/15/2013
    
    One-story facility.
    
    Engineering/Manufacturing/
Administration1386-1390 Connellsville Rd
North Union Township, PA
    
    
    40,000
    
    
    Leased,
Expiration Date:
4/1/2014
    
    One-story facility.
    
    Engineering/
Manufacturing
 12




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##### 



ITEM 3. LEGAL PROCEEDINGS While Argon ST is not party to any pending legal proceeding, which, in the
opinion of management, is material to the Companys business or financial
condition, it 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 or governmental agency investigations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Sensytech held a special meeting of its stockholders on September 28,
2004. At the special meeting, stockholders were asked to consider and vote upon
the following proposals:  (a)
    
    To consider and vote upon a proposal to approve the issuance of
approximately 14,340,700 shares of Company common stock to Argon
Engineering stockholders pursuant to the Agreement and Plan of
Merger, dated as of June 7, 2004, by and between the Sensytech and
Argon Engineering;(b)
    
    To consider and vote upon a proposal to approve and adopt an
amendment to the Companys certificate of incorporation to increase
the total number of authorized shares of the Companys capital stock
from 25 million to 100 million shares, consisting of 90 million
shares of common stock and 10 million shares of preferred stock; and(c)
    
    To consider and vote upon a proposal to approve and adopt an
amendment to the Companys certificate of incorporation to change the
name of the Company to ARGON ST, Inc. The following are the results of the votes at the special meeting: Number of Votes
    
    Number of Votes
    
    Abstentions andItem
    
    In Favor
    
    Against
    
    Broker Non-Votes(1)
    
    
    3,896,743
    
    
    
    8,624
    
    
    
    6,640(2)
    
    
    3,055,076
    
    
    
    846,330
    
    
    
    10,601(3)
    
    
    3,877,161
    
    
    
    25,778
    
    
    
    9,068
 Proposals (1) and (3) were approved by stockholders. Proposal (2) did
not receive the requisite number of votes for approval. As a result of stockholder approval of Proposal (1) and the subsequent
consummation of the merger transaction with Argon Engineering, the following
persons were appointed as directors of the Company as of September 29, 2004:
Terry L. Collins, Victor F. Sellier, Thomas E. Murdock, Delores M. Etter, David
C. Karlgaard, Peter A. Marino and Robert McCashin. Upon the closing of the
merger, each of S. Kent Rockwell, John Irvin and Lloyd A. Semple continued as
directors, and each of Charles W. Bernard, S.R. Perrino, Phillip H. Power and
John D. Sanders resigned as directors. 
 SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT The following is a list of the Executive Officers of the Registrant,
including their names, ages and offices held, as of December 6, 2004. Name
    
    Age
    
    Position with RegistrantTerry L. Collins,
Ph.D.
    
    
    59
    
    
    Chairman and Chief Executive OfficerS. Kent Rockwell
    
    
    60
    
    
    Vice Chairman and Vice President, Corporate
DevelopmentVictor F. Sellier
    
    
    55
    
    
    Vice President, Business OperationsThomas E. Murdock
    
    
    62
    
    
    Vice President, Strategic PlanningDonald F. Fultz
    
    
    51
    
    
    Chief Financial OfficerKerry M. Rowe
    
    
    45
    
    
    Vice President, Reconnaissance SystemsW. Joseph Carlin
    
    
    41
    
    
    Vice President, Information Operations SystemsRobert S. Tamaru
    
    
    49
    
    
    Vice President, Surveillance Systems
 13




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##### 



PART II ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES The Companys common stock has traded on the Nasdaq National Market under
the symbol STST since November 20, 2002. Before that time, it was traded on
the Nasdaq SmallCap Market. The following table sets forth the range of high and low actual sales
prices of common stock for the periods indicated. High
    
    LowFiscal 2004Fourth Quarter
    
    
    29.43
    
    
    
    18.80Third Quarter
    
    
    24.97
    
    
    
    15.52Second Quarter
    
    
    15.87
    
    
    
    13.45First Quarter
    
    
    17.27
    
    
    
    11.91Fiscal 2003Fourth Quarter
    
    
    20.45
    
    
    
    13.25Third Quarter
    
    
    14.74
    
    
    
    9.52Second Quarter
    
    
    12.43
    
    
    
    9.11First Quarter
    
    
    12.02
    
    
    
    6.93
 There were 266 registered holders of our common stock on December 6, 2004.
On December 6, 2004, the closing sale price of our common stock on the NASDAQ
National Market was $31.26 per share. Dividend Policy Sensytech has never paid cash dividends on its common stock. During the
fiscal years ended September 30, 2004 and 2003, prior to the merger with
Sensytech, Argon Engineering paid dividends to its stockholders of $7,851,000
and $2,462,000, respectively. For the foreseeable future, we intend to retain earnings to reinvest for
future operations and growth of our business and do not anticipate paying any
cash dividends on our common stock. However our board of directors, in its
discretion, may decide to declare a dividend at an appropriate time in the
future. A decision to pay a dividend would depend, among other factors, upon
our results of operations, financial condition and cash requirements and the
terms of our credit facility and other financing agreements at the time such a
payment is considered. Equity Compensation Plan Information Set forth below is information as of September 30, 2004 regarding the
Companys equity compensation plans. Number of securities
    
    Weighted averageto be issued upon
    
    exercise price ofexercise of
    
    outstanding
    
    Number of securitiesoutstanding options,
    
    options, warrants
    
    remaining availablePlan category
    
    warrants and rights
    
    and rights
    
    for future issuance(a)
    
    (b)
    
    ( c)Equity compensation
plans approved by
security holders

    
    
    779,100
    
    
    $
    12.505
    
    
    
    453,766Equity compensation
plans not approved
by security holders (1)
    
    
    1,639,497
    
    
    $
    6.256
    
    
    
    Total
    
    
    2,418,597
    
    
    $
    8.270
    
    
    
    453,766
  (1)
    
    Consists entirely of shares of common stock issuable upon
exercise of options under the Argon Engineering Associates, Inc.
Stock Plan. There will be no further options granted under this
plan. 14




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##### 



The Argon Engineering Associates, Inc. Stock Plan (the Plan) provides
for the for the issuance of incentive and non-statutory stock options and
restricted stock to eligible employees of Argon Engineering and its affiliates.
As a result of the merger with the Company, each outstanding option to
purchase Argon Engineering common stock under the Plan was converted into an
option to purchase Company common stock, with the number of shares able to be
purchased and the exercise price adjusted in accordance with the merger
exchange ratio. No acceleration of vesting of options under the Plan occurred
in connection with the merger. As a result of the merger, the Plan covers
6,240,000 shares of Company common stock; however, the Plan has been frozen as
of September 29, 2004 and no additional awards will be granted under the Plan
subsequent to that date. The only participants in the Plan are those employees
who received awards prior to September 29, 2004. The Plan is administered by a compensation committee of the Argon
Engineering board of directors, or, in the absence of such a committee, the
full board of directors (the Administrator). The Administrator determines
the exercise price of each option at the time of grant; provided that the
exercise price of incentive stock options must be not less than 100% of the
fair market value of the underlying common stock on the grant date, and the
exercise price of options granted to a person holding more than 10% of Argon
Engineerings common stock must not be less than 110% of such fair market
value. The maximum term of the options under the Plan is ten years; provided
that the maximum term for options granted to greater than 10% holders is five
years. Individual option agreements specify vesting terms and/or the dates
upon which the option will be exercisable. Payment upon exercise of options
may be made either in cash or by the surrender of shares of Company common
stock. If a grantees employment terminates for any reason other than death,
disability or retirement, the grantee may not exercise the option following the
date of termination. Upon a termination due to death or permanent disability,
unless otherwise provided in the award agreement, the option will become 100%
vested and exercisable within six months of termination. Upon a grantees
retirement, unless otherwise provided in the award agreement, the option will
become 100% vested and may be exercised immediately prior and on the date of
retirement, but no later. Options granted under the Plan are not transferable,
other than by will or the laws of descent and distribution. ITEM 6. SELECTED FINANCIAL DATA The following table sets forth the selected statement of earnings data and
balance sheet data for each of the periods indicated. The selected financial
data for the years ended September 30, 2004, 2003, 2002, 2001 and 2000 are
derived from our audited consolidated financial statements and related notes,
except for 2000 which is unaudited. The selected financial data presented below should be read in conjunction
with our consolidated financial statements and the notes to our consolidated
financial statements and Managements Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this Form 10-K. On September 29, 2004, a wholly-owned subsidiary of Sensytech merged with
and into Argon Engineering. While Sensytech was the legal acquirer, the
acquisition was accounted for as a reverse acquisition, whereby Argon
Engineering was deemed to have acquired Sensytech for financial reporting
purposes. Consistent with the reverse acquisition accounting treatment, the
historical financial statements presented for periods prior to the acquisition
date are the statements of Argon Engineering except for stockholders equity
which has been retroactively restated for the equivalent number of shares of
the legal acquirer. The operations of the former Sensytech businesses have
been included in the financial statements from the date of acquisition. Please
refer to Note 2 of the consolidated financial statements included in this
report. The selected financial data, other than September 30, 2004 balance sheet
and backlog information, reflect the results from operations of Argon
Engineering and includes only the results from operations of
Sensytech Inc. from September 29, 2004, (one day) the date of the merger. 15




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##### 



Years Ended September 302004
    
    2003
    
    2002
    
    2001
    
    2000(unaudited)(In thousands, except per share data)Contract revenues
    
    $
    129,184
    
    
    $
    79,349
    
    
    $
    61,759
    
    
    $
    41,396
    
    
    $
    19,103Cost of revenues
    
    
    107,307
    
    
    
    65,271
    
    
    
    51,034
    
    
    
    35,169
    
    
    
    16,397Gross Margin
    
    
    21,877
    
    
    
    14,078
    
    
    
    10,725
    
    
    
    6,227
    
    
    
    2,706General and Administrative Expenses
    
    
    5,905
    
    
    
    5,844
    
    
    
    5,181
    
    
    
    3,101
    
    
    
    964Income from operations
    
    
    15,972
    
    
    
    8,234
    
    
    
    5,544
    
    
    
    3,126
    
    
    
    1,742Interest
income, net
    
    
    154
    
    
    
    31
    
    
    
    62
    
    
    
    42
    
    
    
    102Income before income taxes
    
    
    16,126
    
    
    
    8,265
    
    
    
    5,606
    
    
    
    3,168
    
    
    
    1,844Provision for income taxes
    
    
    (6,177
    )
    
    
    (2,696
    )
    
    
    (2,021
    )
    
    
    (1,139
    )
    
    
    (702
    )Net income
    
    $
    9,949
    
    
    $
    5,569
    
    
    $
    3,585
    
    
    $
    2,029
    
    
    $
    1,142Earnings per shareBasic
    
    $
    0.81
    
    
    $
    0.47
    
    
    $
    0.32
    
    
    $
    0.21
    
    
    $
    0.12Diluted
    
    $
    0.74
    
    
    $
    0.44
    
    
    $
    0.29
    
    
    $
    0.16
    
    
    $
    0.10
 Years Ended September 302004
    
    2003
    
    2002
    
    2001
    
    2000(unaudited)(In thousands)Balance sheet dataCash and cash equivalents
    
    $
    29,732
    
    
    $
    4,100
    
    
    $
    5,231
    
    
    $
    4,215
    
    
    $
    1,505Total assets
    
    $
    221,741
    
    
    $
    23,736
    
    
    $
    20,090
    
    
    $
    15,163
    
    
    $
    5,641Total debt
    
    $
    282
    
    
    $
    34
    
    
    $
    172
    
    
    $
    309
    
    
    $
    447Stockholders Equity
    
    $
    160,925
    
    
    $
    11,010
    
    
    $
    7,944
    
    
    $
    4,323
    
    
    $
    2,352Other dataBacklog (unaudited)
    
    $
    228,819
    
    
    $
    157,070
    
    
    $
    96,799
    
    
    $
    76,380
    
    
    $
    25,134Dividends
    
    $
    7,851
    
    
    $
    2,462
    
    
    $
    
    
    
    $
    
    
    
    $
    
 16




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##### 



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS The following discussion contains forward-looking statements that involve
risks and uncertainties. Actual results could differ substantially from those
anticipated in these forward-looking statements as a result of many factors,
including those set forth in Risk Factors under Item 1  Business, 
beginning on page 4. 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 1955. All forward-looking statements involve risks
and uncertainties. These statements are based upon numerous assumptions about
future conditions that could prove not to be accurate. Actual events,
transactions or results may materially differ from the anticipated events,
transactions or results described in such statements. The Companys ability to
consummate such transactions and achieve such events or results is subject to
certain risks and uncertainties including those set forth in
Business Risks
under Item 1  Business, beginning on page 4. In addition to those risk
specifically mentioned in this report, such risks and uncertainties include,
but are not limited to, the existence of demand for, and acceptance of the
Companys products and services, regulatory approvals, export approvals,
economic conditions both domestically and internationally, the impact of
competition and pricing, results of financing efforts and other factors
affecting the Companys business that are beyond the Companys 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. The
Company undertakes no obligation to update these forward-looking statements to
reflect new information, future events or otherwise, except as provided by law. Overview General Argon ST provides advanced software intensive systems that are used in
intelligence collection, surveillance, reconnaissance activities, threat
warning and monitoring, simulation, and force protection and communication.
The systems are primarily for the United States government and select
international customers. The systems run on commercial off-the-shelf (COTS)
hardware or special purchase hardware designed and manufactured to our
specification or the specifications of our customers. Recently, Argon ST has
begun to use the technology developed for these systems in other applications,
such as software radios, high accuracy targeting, counter-terrorism, and
wideband transmission. Basis of Discussion/Acquisition On September 29, 2004, a wholly-owned subsidiary of Sensytech merged with
and into Argon Engineering in an acquisition whereby each outstanding share of
Argon Engineering common stock was converted into two shares of Sensytech
common stock. As a result of the merger, the former Argon Engineering
stockholders acquired approximately 65.6% of the issued and outstanding shares
of Sensytech common stock. As part of the overall transaction, Sensytech
changed its name to ARGON ST, Inc. While Sensytech was the legal acquirer, the
acquisition was accounted for as a reverse acquisition, whereby Argon
Engineering was deemed to have acquired Sensytech for financial reporting
purposes. Managements discussion and analysis addresses the Companys historical
results of operations and financial condition as shown in its consolidated
financial statements for the fiscal years ended September 30, 2004, 2003 and
2002. Consistent with the reverse acquisition accounting treatment applied to
the merger, the historical financial statements of the Company presented in
this Form 10-K for periods prior to the acquisition date are the statements of
Argon Engineering (except for stockholders equity which has been retroactively
restated for the equivalent number of shares of the Company as the legal
acquirer). Therefore, the consolidated historical financial statements included
in this Form 10-K differ from the consolidated historical financial statements
of the Company as previously reported. The operations of the former Sensytech
businesses have been included in the financial statements only from September
29, 2004, the date of acquisition. Both companies had their fiscal year ending
on September 30. Segments Argon Engineering historically operated in a single business segment.
Prior to the merger, Sensytech operated in two business segments. The results
of operations included in this report are those related to Argon
Engineerings
single business segment. Management is currently reviewing its business
operations and intends to report results of operations for business segments in
the first quarter of fiscal year 2005. During that time, management will also
allocate the goodwill arising from the merger to its reporting segments in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 142 Goodwill and Other
Intangible Assets. 17




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##### 



Revenues Argon STs revenues are primarily generated from the design, development,
installation and support of complex sensor systems under contracts primarily
with the U.S. Government and major domestic prime contractors, as well as with
foreign governments, agencies and defense contractors. Argon STs contracts can be divided into three major types: cost
reimbursable contracts, fixed price and time and material contracts. 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 the company,
risks associated with the development of technology that has never been used,
and interface risks 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 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. Time and material contracts are
based on hours worked, multiplied by approved labor rates, plus other costs
incurred and allocated. Firm fixed price contracts are typically used for the production of
systems. Development activities similar to activities performed under previous
contacts are also usually covered by fixed price contracts, due to the low risk
involved. In these contracts, cost risks are borne entirely by the contractor.
Some fixed price contracts include an award fee or an incentive fee as well as
the negotiated profit. Most foreign customers, and some U.S. customers, use
fixed price contracts for design and development work even when the work is
considered high risk. The following table represents Argon Engineerings revenue concentration
by contract type for the periods indicated: Fiscal Year
    
    Fiscal Year
    
    Fiscal YearEnded
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,Contract Type
    
    2004
    
    2003
    
    2002Cost Reimbursable Contracts
    
    
    19
    %
    
    
    51
    %
    
    
    50
    %Firm Fixed Price Contracts
    
    
    71
    %
    
    
    46
    %
    
    
    49
    %Time and Material Contracts
    
    
    10
    %
    
    
    3
    %
    
    
    1
    %
 All of Argon STs products are currently sold for the ultimate use of
either the U.S. government agencies or certain approved allied governments.
Although our work is concentrated in the Navy, we have contracts from multiple
commands and organizations within the Navy. The table below identifies Argon
Engineerings revenue concentration from major customers: Fiscal Year
    
    Fiscal Year
    
    Fiscal YearEnded
    
    Ended
    
    EndedSeptember 30,
    
    September 30,
    
    September 30,Contract Type
    
    2004
    
    2003
    
    2002United States Navy
    
    
    77
    %
    
    
    68
    %
    
    
    75
    %Other
    
    
    23
    %
    
    
    32
    %
    
    
    25
    %
 Argon Engineering experienced significant revenue growth in fiscal year
2004 as compared to fiscal year 2003 as it increased production of systems
under fixed price contracts following development completion under fixed price
and cost reimbursable contracts. Generally, the Company experiences revenue
growth when systems move from the development stage to the production stage due
to increases in sales volumes from production of multiple systems. Argon STs
current production work has been derived from programs for which the Company
has performed the initial development work. These programs are next generation
systems replacing existing, obsolete systems that were developed by other
companies. Argon ST was able to displace these companies primarily on the basis
of technological capability. Argon ST believes that the current state of world
affairs and the U.S. governments emphasis on protecting U.S. citizens will
cause funding of these programs to continue. 18




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##### 



Backlog Argon ST defines backlog as the funded and unfunded amount provided in our
contracts less previously recognized revenue and excludes all unexercised
options on contracts. Some contracts where work has been authorized carry a
funding ceiling that does not allow Argon ST to continue work on the contract
once the customer obligations have reached the funding ceiling. In such cases,
the Company is required to stop work until additional funding is added to the
contract. Argon STs experience in this case is very rare and therefore it
generally carries the entire amount that the customer intends to execute as
backlog when it is confident that the customer has access to the required
funding for the contract. In general, most of Argon STs backlog results in sales in subsequent
fiscal years, as the Company maintains no or very minimal inventory and
therefore the lead time on ordering and receiving material and increasing staff
to execute programs has a lag time of several months from the receipt of order. Backlog at the end of fiscal year 2004 was approximately $228,819,000
representing a 45.7% increase over the backlog of approximately $157,070,000 at
the end of fiscal year 2003. The backlog amount at the end of fiscal year 2004
includes backlog of the acquired Sensytech business of $30,715,000. Backlog
increased during fiscal year 2004 and 2003 primarily due to customers
exercising production options on existing contracts, new production contracts,
and new program wins. These contracts and exercised options will require two
years or more in order to complete the delivery of the required systems. As of September 30, 2004, approximately 16% of Argon STs backlog
represented work that is planned after September 2006 and through 2009.
Additionally, Argon ST has fixed price options on contracts exercisable
unilaterally by the government from fiscal year 2006 through fiscal year 2008
representing approximately $150 million in potential revenue. These backlog
amounts include the backlog of the acquired Sensytech business. 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. Argon ST plans indirect costs on an annual basis and on cost
reimbursable contracts receives government approval to bill those costs as a
percentage of Argon STs direct labor, other direct costs and direct materials
as the Company executes its contracts. The government approves the planned
indirect rates as provisional billing rates near the beginning of each fiscal
year. Provisional billing rates have increased slightly at the beginning of
each of the last two years as increased government regulation has caused Argon
ST to incur additional expenses. General and Administrative Expenses Argon STs general and administrative expenses include administrative
salaries, costs related to proposal activities, internally funded research and
development, and other administrative costs. Interest Income, net Net interest income is derived solely from interest earned on cash
reserves maintained in short term bank accounts and are therefore subject to
short-term interest rates that have minimal risk. Interest rates were lower in
fiscal year 2004 and fiscal year 2003 than in fiscal year 2002, but Argon STs
cash reserves increased due to operating income, partially mitigating the
effect of lower interest rates. Net interest income for fiscal year 2004 was approximately $154,000 as
compared to approximately $31,000 for fiscal year 2003, and was $62,000 for
fiscal year 2002. Income Taxes Provision for
income tax for fiscal year 2004 was approximately $6,177,000
as compared to approximately $2,696,000 for the fiscal year 2003. Income tax
expense was $2,021,000 for fiscal year 2002. The effective tax rate for fiscal year
2004 was 38.3% compared to 32.6% for fiscal year 2003. The effective tax rate
was 36.1% for fiscal year 2002. The fiscal year 2004 effective tax rate was
higher than the 2003 effective tax rate because the effect of the
research and development tax credit decrease from 4.1% of net income in 2003 to 1.9% of net
income in 2004. 19




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##### 



Research and Development Argon ST conducts internally funded research and development into complex
signal processing, system and software architectures, and other technologies
that are important to continued advancement of its systems and are of interest
to its current and prospective customers. In fiscal years 2004, 2003 and 2002,
internal research and development expenditures were $1,301,000, $2,187,000 and
$3,015,000, representing 1.0%, 2.8% and 4.9% of revenues, respectively. The
variance from year to year in internal research and development is caused by
the status of the Companys product cycles and the level of complimentary
government funded research and development. Internal research and development is a small portion of Argon STs overall
research and development, as government funded research and development
constitutes the majority of the companys activities in this area. Most of
Argon STs cost type contracts are research and development contracts, and
historically less than 33% of Argon STs fixed price contract work has been of
a research and development nature. Critical Accounting Practices and Estimates General Argon STs discussion and analysis of its financial condition and results
of operations are based upon its 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. Argon ST believes that the estimates, assumptions, and judgments
involved in the accounting practices described below have the greatest
potential impact on Argon STs financial statements and, therefore, consider
these to be critical accounting practices. Revenue and Cost Recognition The majority of Argon STs contracts, which are with the U.S. government,
are accounted for in accordance with the American Institute of Certified Public
Accountants Statement of Position 81-1, Accounting for Performance of
Construction-Type and Production-Type Contracts.These contracts are transacted
using written contractual arrangements, most of which require Argon ST to
design, develop, manufacture and/or modify complex products and systems, and
perform related services according to specifications provided by the customer.
Argon ST accounts for fixed-price contracts by using the
percentage-of-completion method of accounting. Under this method, contract
costs are charged to operations as incurred. A portion of the contract revenue,
based on estimated profits and the degree of completion of the contract as
measured by a comparison of the actual and estimated costs, is recognized as
revenue each period. In the case of contracts with materials requirements,
revenue is recognized as those materials are applied to the production process
in satisfaction of the contracts end objectives. Argon ST accounts for cost
reimbursable contracts by charging contract costs to operations as incurred and
recognizing contract revenues and profits by applying the negotiated fee rate
to actual costs on an individual contract basis. Management reviews contract
performance, costs incurred, and estimated completion costs regularly and
adjusts revenues and profits on contracts in the period in which changes become
determinable Anticipated losses
on contracts are also
recorded in the period in which they become determinable. Unexpected increases
in the cost to develop or manufacture a product, whether due to inaccurate
estimates in the bidding process, unanticipated increases in material costs,
inefficiencies, or other factors are borne by Argon ST 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 Argon ST 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. Sensytech
historically has recorded the AN/SLQ-25A Surface Ship Torpedo
Defense System (SSTD) contract at zero margin. Revenue from this contract
amounted to approximately 22% of Sensytechs revenues in both
2004 and 2003, and 19% in 2002. This contract was acquired as part of Sensytechs
acquisition of certain assets of FEL Corporation and was performing at a
potential
loss at the date of acquisition. Based on the historical experience of
awarded change orders on the SSTD contract and Sensytechs ongoing discussions
with the customer, Sensytech deemed future change orders probable to enable the
contract to break even (i.e., eliminating any potential loss on the contract).
Sensytech has favorably performed under the contract since the date of
acquisition and management has worked with the customer to reduce any potential
loss through change orders approved to date. As of September 30, 20




---



##### 



2004 there
have been 21 change orders awarded for a total value of $35,891,000. While
management currently estimates that the contract will be profitable, the
profitability is dependent upon future change orders, expected by management,
but that have not yet been finalized. Based upon the current funding of the contract,
should no additional funding be received, a loss of $1,800,000 would be
recognized. However, after considering the effect of anticipated change
orders, the Company projects the contract to complete at a modest profit.
Change orders are under continuous negotiation with the customer. When these
change orders are received, Argon ST will reassess the contract based on
current estimates, and such reassessments are currently expected to result in
increases to the margins recorded on the contract. Such increases would impact
operations in the period such change orders are finalized as well as future
periods. If such change orders are not finalized under currently expected
terms, or if Argon ST does not perform as expected under the contract, contract
losses may be required to be accrued. Management expects that the change
orders to be received in the first half of fiscal year 2005 will be sufficient
to enable the contract to realize a marginal profit beginning in the third
quarter of fiscal year 2005 and continuing through the completion date of the
contract in fiscal year 2008. Until such time, Argon ST will continue to
recognize zero margin on the contract. Goodwill Costs in excess of the fair value of tangible and identifiable intangible
assets acquired and liabilities assumed in a business combination are recorded
as goodwill. In accordance with SFAS No. 142, Goodwill and Other Intangible
Assets, companies no longer amortize goodwill, but instead test for impairment
at least annually using a two-step approach. Impairment of goodwill is tested
at the reporting unit level by comparing the reporting units carrying amount,
including goodwill, to the fair value of the reporting unit. The fair values
of the reporting units are estimated using a combination of the income, or
discounted cash flows, approach and the market approach, which utilizes
comparable companies data. If the carrying amount of the unit exceeds its
fair value, goodwill is considered impaired and a second step is performed to
measure the amount of impairment loss, if any. The Company will test for
impairment annually in the fourth quarter beginning in fiscal year 2005. Award Fee Recognition Argon STs practice for recognizing interim fee on its 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, Argon STs
relationship and history with the customer, Argon STs history with similar
types of projects, and Argon STs 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. Accounts Receivable Argon ST is required to estimate the collectibility of its accounts
receivables. Judgment is required in assessing the realization of such
receivables, and the related reserve requirements are based on the best facts
available to Argon ST. Since most of Argon STs revenue is generated under
U.S. Federal Government contracts, its current accounts receivable reserve is
not significant. Historical Operating results Fiscal Year ended September 30, 2004 compared to fiscal year ended September
30, 2003 Revenues: Revenues increased approximately $49,835,000 to approximately $129,184,000
for the fiscal year 2004 compared with approximately $79,349,000 for fiscal
year 2003. This represents a 63% increase for the fiscal year 2004 compared to
the fiscal year 2003, and was caused by increased contract award activities.
This increased order activity led to a significant increase in contract work
during 2004 and was supplemented by the start of a full rate production
contract. The increase in revenue was comprised of an increase in fixed price
contract revenue of $55,204,000, offset in part by a decrease in cost type
contract revenue of $5,369,000. This change in contract revenue mix is the
result of the transition of systems to production following completion of
development cycles. Fiscal year 2004 year-end backlog increased approximately 46% compared
with fiscal year 2003 year-end backlog. The increase in backlog in 2004 was
primarily the result of an increase in new orders from the U.S. government for
production of ship and submarine systems under fixed price contracts, and
backlog of approximately $30,715,000 acquired in the merger with Sensytech. 21




---



##### 



New orders increased 21% for the fiscal year 2004 compared to fiscal year
2003. This increase is a result of full rate production orders for ship
systems. Argon ST expects new order growth in early fiscal year 2005 to
continue to be strong based on outstanding current proposals expected to be
awarded in that period that Argon ST believes it has a reasonable chance of
winning. Cost of Revenues: Cost of revenues increased $42,036,000 or 64% to $107,307,000 for fiscal
year 2004 from $65,271,000 for fiscal year 2003. This increase was primarily
comprised of an increase in direct labor of $3,712,000 and an increase in
materials of $32,578,000 to support the increase in production activities for
system delivery. The increase in materials costs is a direct result of work
being performed on production contracts during 2004. The increase in cost of
revenue reflected an increase of fixed price contract costs of $46,690,000,
offset in part by a decrease in cost type contract costs of $5,246,000. The
change in contract cost mix is the result of the increase in system production
work during 2004. Cost of revenues as a percentage of revenues was 83% and 82%
for the fiscal years ended September 30, 2004 and 2003, respectively. General and Administrative Expenses: General and administrative expenses increased $61,000, or 1% to $5,905,000
for the fiscal year 2004 from $5,844,000 for fiscal year 2003. The
substantially flat level of general and administrative expenses reflects a
reduction in internally funded research and development expenses of $886,000
from $2,187,000 in 2003 to $1,301,000 in 2004 as personnel resources were
diverted to contract efforts, partially offset by an increase in other general
and administrative labor costs associated with the increase in business volume. Interest Income and Interest Expense: Interest income increased $132,000 to $167,000 for the fiscal year 2004
from $35,000 for the fiscal year 2003. This increase was a result of a larger
average cash balance, which allowed for investment in higher yield short-term
investments resulting in higher average interest rates during the fiscal year
2004 compared to the fiscal year 2003. Interest expense was not significant in
fiscal years 2004 and 2003. Income Tax Expense: Provision for income tax increased $3,481,000 or 129% to $6,177,000 for
fiscal year 2004 from $2,696,000 for fiscal year 2003. The fiscal year 2004
effective tax rate was 38.3% compared to 32.6% in 2003. This increase was
primarily due to the reduced impact that the research and development tax
credit had on the 2004 effective tax rate compared to the 2003 effective tax
rate. Net Income: As a result of the above, net income increased $4,380,000 or 79% to $9,949,000 for fiscal year 2004
from $5,569,000 for fiscal year 2003. Fiscal year ended September 30, 2003 compared to fiscal year ended September
30, 2002 Revenues: Revenues increased
$17,590,000 to approximately $79,349,000 for the fiscal
year ended September 30, 2003 compared with approximately $61,759,000 for the
fiscal year ended September 30, 2002. This represents a 28% increase for the
fiscal year ended September 30, 2003 compared to the fiscal year ended
September 30, 2002, and was caused primarily by increased backlog at the end of
fiscal year 2002 and initial work on a production contract. Backlog at the end
of the fiscal year 2002 increased approximately $20,400,000 over the backlog of
year ending September 30, 2001. Approximately $12,000,000 of the increased
revenue was the result of the development of a U.S. submarine system and the
initial production revenue from a ship system. Over $4,000,000 of increased
revenue was a result of design work for a U.S. Army airborne reconnaissance
system. In accordance with Argon Engineerings revenue recognition practices on
the percentage-of-completion basis, receipt of the materials and the
application of those materials to production represented achievement against
the contracts end objectives. Argon
Engineering was awarded the contract in the second quarter of fiscal year
2003, and began receiving materials for system production in the third and
fourth quarters of fiscal year 2003. 22




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##### 



Cost of Revenues: Cost of revenue increased $14,237,000 to approximately $65,271,000 for the
fiscal year ended September 30, 2003 compared with approximately $51,034,000
for the fiscal year ended September 30, 2002. This represents a 28% increase
for the fiscal year ended September 30, 2003 compared to the fiscal year ended
September 30, 2002. The increase was primarily a result of an increase in
direct labor of $2,580,000, an increase in direct material of $8,544,000, and
an increase in subcontracted work of $918,000. The increase in direct labor
also increased overhead expenses associated with the direct labor. The
increased labor and material costs were a result of increased backlog and new
orders in fiscal year ending September 30, 2003. Cost of revenues as a
percentage of revenues was 82% for the fiscal years ended September 30, 2003
and 2002, respectively. General and Administrative Expenses: General and administrative expenses increased $663,000 to approximately
$5,844,000 for the fiscal year ended September 30, 2003 compared to
approximately $5,181,000 for the fiscal year ended September 30, 2002. This
represents a 13% increase for the fiscal year ended September 30, 2003 compared
to the fiscal year ended September 30, 2002. This increase was primarily
attributable to significant increases in bid and proposal costs associated with
the pursuit of major new business opportunities. Interest Income and Income Expense: Interest income decreased $43,000 for the fiscal year ended September 30,
2003 to $35,000, from interest income of $78,000 for the fiscal year ended
September 30, 2002. The decrease was primarily the result of significantly
lower interest rates during the period. Interest expense was not significant in
the fiscal years ending September 30, 2003 and 2002. Income Tax Expense: Income tax expense increased $675,000 to approximately $2,696,000 for the
fiscal year ended September 30, 2003 compared to approximately $2,021,000 for
the fiscal year ended September 30, 2002. The effective rate decreased to
32.6% in 2003 from 36.1% in 2002. This decrease was primarily due to the
increased research and development tax credit and its impact on the 2003
effective tax rate compared to the 2002 effective tax rate. Net Income: As
a result of the above, net income increased $1,984,000, or 55%, to
$5,569,000 for fiscal year 2003 from $3,585,000 for fiscal year 2002. Pro forma Financial Results of Operations The following unaudited condensed combined pro forma results of operations
reflect the pro forma combination of the Argon Engineering and the acquired
Sensytech business as if the combination had occurred at the beginning of the
periods presented, compared with the historical results of operations for Argon
Engineering for the same periods. These unaudited pro forma condensed combined pro forma results of
operations were prepared based on the historical financial statements of Argon
Engineering under the assumptions set forth in the footnotes accompanying the
financial statements. Argon Engineering believes
that the assumptions used provide a reasonable basis for presenting the
significant effects directly attributable to the merger transaction. The
unaudited pro forma condensed combined results of operations do not purport to
represent what Argon STs results of operations would have been if such
transaction had occurred at the beginning of
the periods presented, and are not necessarily indicative of Argon STs future
results. These unaudited pro forma condensed combined results of operations
should be read in conjunction with the historical consolidated financial
statements of Argon ST and notes thereto included in this Form 10-K. 23




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##### 



Twelve Months Ended September 30,2004
    
    2003
    
    2002Historical
    
    Proforma
    
    Historical
    
    Proforma
    
    Historical
    
    ProformaRevenue
    
    $
    129,184,000
    
    
    $
    189,792,000
    
    
    $
    79,349,000
    
    
    $
    132,532,000
    
    
    $
    61,759,000
    
    
    $
    94,049,000Income from operations
    
    
    15,972,000
    
    
    
    23,132,000
    
    
    
    8,234,000
    
    
    
    13,874,000
    
    
    
    5,544,000
    
    
    
    8,144,000Net income
    
    
    9,949,000
    
    
    
    14,386,000
    
    
    
    5,569,000
    
    
    
    8,979,000
    
    
    
    3,585,000
    
    
    
    5,132,000Basic earnings per share
    
    $
    0.81
    
    
    $
    0.76
    
    
    $
    0.47
    
    
    $
    0.50
    
    
    $
    0.32
    
    
    $
    0.34Diluted earnings per share
    
    $
    0.74
    
    
    $
    0.71
    
    
    $
    0.44
    
    
    $
    0.48
    
    
    $
    0.29
    
    
    $
    0.31Basic wt average shares
    
    
    12,308,000
    
    
    
    18,914,000
    
    
    
    11,770,000
    
    
    
    17,874,000
    
    
    
    11,166,000
    
    
    
    15,220,000Diluted wt average shares
    
    
    13,367,000
    
    
    
    20,156,000
    
    
    
    12,620,000
    
    
    
    18,882,000
    
    
    
    12,558,000
    
    
    
    16,738,000
 Revenues attributable to Sensytech were $60,608,000, $53,183,000, and
$32,290,000 for fiscal years 2004, 2003, and 2002, respectively. Income from
operations attributable to Sensytech were $6,033,000, $6,693,000 and
$3,653,000 for fiscal years 2004, 2003, and 2002, respectively. Net income
attributable to Sensytech was $3,749,000, $4,052,000, and $2,189,000 for
fiscal years 2004, 2003, and 2002, respectively. Depreciation and
amortization on the write up of tangible and intangible assets, in accordance
with SFAS 141, was $82,000 and $971,000 respectively for fiscal years
2004, 2003 and 2002 and
the after tax effect was $50,000 and $592,000 respectively. The one time
merger costs and expenses, incurred by Sensytech, of approximately $2,180,000
before tax and $1,330,000 after tax were added back to the pro forma results
for 2004. Analysis of Liquidity and Capital Resources Argon STs primary source of liquidity is cash provided by operations. On
September 30, 2004, Argon ST had cash of $29,732,000 compared to cash of
$4,100,000 on September 30, 2003. This increase in cash of $25,632,000 was the
result of net income earned during fiscal year 2004 of $9,949,000 and an
increase in deferred revenue of $23,969,000, offset by a $7,851,000 dividend
paid to Argon Engineering stockholders in September 2004 and a slowdown in
receivables payment from the U.S. government due to problems at government pay
centers. Historically, Argon Engineering has been able to grow rapidly while
maintaining a positive cash position and no debt. Over the last six years,
Argon Engineering has maintained a revolving line of credit with James Monroe
Bank that has increased several times and is now $5,000,000 with interest at
prime plus one-half percent. The James Monroe line will be allowed to lapse at
the end of December 2004. Argon Engineering also has a letter of credit of
$976,000 securing its obligations under its office lease agreement. Currently
Argon Engineering has no balance outstanding on the line of credit and in the
last six years the line of credit has been used only twice for brief periods as
a result of government payments into incorrect accounts. Argon ST, formerly Sensytech, has a $15,000,000 line of credit with Bank
of America. The line of credit is for two years and is set to expire on
February 28, 2006. The total borrowing base generally cannot exceed the sum of
90% of qualified government accounts receivable and 80% of qualified
non-government accounts receivable. Total letters of credit at September 30,
2004 were $1,083,000. The line of credit is available to finance the
performance of government contracts, to support the issuance of stand-by
letters of credit, and for short-term working capital purposes. At September
30, 2004, there were no borrowings under the line of credit. The borrowing base
at September 30, 2004 was $10,412,000. Based on current backlog, planned
contract revenue, and planned capital expenditures, Argon ST does not
anticipate the need for any cash other than cash generated from operations
during the next twelve months. This planning does not assume any acquisitions
that would require cash. The bank agreement establishes the interest rate at the LIBOR plus 200 to
285 basis points, determined by Argon STs ratio of funded debt to earnings
before interest, taxes, depreciation and amortization. All borrowings under the
line of credit are collateralized by all personal property of Argon ST. The
agreement also contains various covenants as to dividends restrictions, working
capital, tangible net worth, earnings and debt-to-equity ratios. Unused
commitment fees of one quarter of one percent per annum are required. Net cash provided by operating activities was $29,088,000 in fiscal year
2004 compared to net cash provided by operating activities of $2,881,000 in fiscal
year 2003 and $2,905,000 in fiscal year 2002. The increase in net cash from
operating activities for fiscal year 2004 compared to fiscal year 2003 was
primarily caused by an increase in deferred revenues of $25,172,000, an
increase in accounts payable and accrued salaries of $1,893,000 and change in income tax payable and receivable of $8,861,000 offset by an
increase in billed and unbilled receivables of $8,954,000 due to an
increase in contract work. The increase in deferred revenue resulted from
event-based payments received on firm fixed-price contracts 24




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##### 



that Argon
Engineering accounts for as deferred revenue and subsequently recognizes as
revenue over time as costs are incurred and revenue recognition criteria are
met. Argon Engineering received significant event-based payments during fiscal
year 2004 in connection with placement of materials orders on three separate
firm fixed price production contracts. Net
cash provided by investing activities was $4,521,000 in fiscal year
2004, compared to cash used of $1,371,000 in fiscal year 2003, and $1,788,000
in the fiscal year ending 2002. Cash of $6,952,000 was acquired in
the merger with Sensytech, offset by $2,460,000 used in acquiring test equipment, computer
resources, software, and other infrastructure to
support the general operations of Argon Engineering. It is expected that these
costs will continue as Argon ST replaces older equipment and will increase in
approximately the same proportion as Argon STs employee base increases. Net
cash used in financing activities was $7,977,000 in fiscal year 2004
as compared to $2,641,000 in fiscal year 2003, and $101,000 in fiscal years
2002. The large increase in fiscal year cash used in financing activities is
primarily the result of cash dividends of $7,851,000 and $2,462,000 paid to
Argon Engineering stockholders during the last quarter of fiscal years 2004 and
2003, respectively. In each case, the dividend was paid because management and
the board determined that the cash was not required to fund the growth of Argon
Engineering and was therefore returned to the stockholders. Although Argon
Engineering received approximately $427,000 from the exercise of employee stock
options since the beginning of fiscal year 2002, it has retired more than
$354,000 of common stock during that same period, resulting in a cash provided
of $73,000 in stock transactions. Argon Engineering paid $34,000, $138,000 and
$137,000 annually in fiscal years 2004, 2003, and 2002 respectively, as
principal on a note to LGA, Inc. as part of an agreement made in late 1998 to
divest LGA. Argon Engineering had acquired LGA in September 1998. This note was
paid in full as of September 30, 2004. Contractual Obligations and Commitments Contractual Cash Obligations: Due in
    
    Due in
    
    Due in
    
    Due in
    
    Due inTotal
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    ThereafterOperating leases
    
    $
    30,907,000
    
    
    $
    5,609,000
    
    
    $
    5,371,000
    
    
    $
    5,329,000
    
    
    $
    5,328,000
    
    
    $
    3,229,000
    
    
    $
    6,041,000Note Payable
    
    
    282,000
    
    
    
    226,000
    
    
    
    56,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Line of credit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    31,189,000
    
    
    $
    5,835,000
    
    
    $
    5,427,000
    
    
    $
    5,329,000
    
    
    $
    5,328,000
    
    
    $
    3,229,000
    
    
    $
    6,041,000
 Other Commercial Commitments: Total
    
    Less Than 1 Year
    
    1-3 YearsLetters of credit
    
    $
    2,059,000
    
    
    $
    1,482,000
    
    
    $
    577,000
 Argon ST has 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. Argon ST also has no
off-balance sheet arrangements of any kind. 25




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##### 



Recent Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. The Interpretation requires an investor with a
majority of the variable interests in a variable interest entity to consolidate
the entity and also requires majority and significant variable interest
investors to provide certain disclosures. A variable interest entity is an
entity in which the equity investors do not have a controlling interest or the

equity investment at risk is insufficient to finance the entitys activities
without receiving additional subordinated financial support from the other
parties. This pronouncement requires the consolidation of variable interest
entities created after January 31, 2003. Consolidation provisions apply for
periods ending after March 15, 2004 for variable interest entities, other than
special purpose entities, created prior to February 1, 2003. Argon ST does not
have any variable interest entities, including special purpose entities, that
must be consolidated and therefore the adoption of the provision of FASB issued
Interpretation No. 46 will not have an impact on Argon STs financial position
or results of operations. Market Risks In addition to the risks inherent in its operations, Argon ST is exposed
to financial, market, political and economic risks. The following discussion
provides additional detail regarding its exposure to credit, interest rates and
foreign exchange rates. Cash and Cash Equivalents: All unrestricted, highly liquid investments purchased with a remaining
maturity of three months or less are considered to be cash equivalents. Argon
ST maintains cash and cash equivalents with various financial institutions in
excess of the amount insured by the Federal Deposit Insurance Corporation. It
believes that any credit risk related to these cash and cash equivalents is
minimal. Interest Rates: Argon STs line of credit financing provides available borrowing to it at
a variable interest rate tied to the prime interest rate. There were no
outstanding borrowings under this line of credit at September 30, 2004.
Accordingly, Argon ST does not believe that any movement in interest rates
would have a material impact on future earnings or cash flows Foreign Currency: Argon ST has contracts to provide services to U.S. approved foreign
countries. Argon STs foreign sales contracts require payment in U.S. dollars,
and therefore the Company is not affected by foreign currency fluctuations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The information called for by this item is provided under Item 7 -
Managements Discussion and Analysis of Financial Condition and Results of
Operations. 26




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##### 



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm
    
    
    28Consolidated Balance Sheets
    
    
    29As of September 30, 2004 and 2003Consolidated Income Statements
    
    
    30For the years ended September 30, 2004, 2003 and 2002Consolidated Statements of Stockholders Equity
    
    
    31For the years ended September 30, 2004, 2003 and 2002Consolidated Statements of Cash Flows
    
    
    32For the years ended September 30, 2004, 2003 and 2002Notes to Consolidated Financial Statements
    
    
    33
 27




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##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders
Argon ST, Inc. We have audited the accompanying consolidated balance sheets of ARGON ST,
Inc. and Subsidiaries (the Company), as of September 30, 2004 and 2003, and the
related consolidated statements of earnings, stockholders equity and cash
flows for each of the three years in the period ended September 30, 2004. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of September
30, 2004 and 2003, and the results of its operations and its cash flows for
each of the three years in the period ended September 30, 2004, in conformity
with accounting principles generally accepted in the United States of America. /s/ GRANT THORNTON LLP Vienna, Virginia December 3, 2004 28




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##### 



ARGON ST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS September 30,2004
    
    2003ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    29,732,000
    
    
    $
    4,100,000Accounts receivable, net
    
    
    59,716,000
    
    
    
    15,851,000Inventory
    
    
    1,574,000
    
    
    
    Income taxes receivable
    
    
    
    
    
    
    704,000Deferred income tax asset
    
    
    4,822,000
    
    
    
    Prepaids and other
    
    
    1,288,000
    
    
    
    512,000TOTAL CURRENT ASSETS
    
    
    97,132,000
    
    
    
    21,167,000Property, equipment and software, net
    
    
    13,949,000
    
    
    
    2,460,000Goodwill
    
    
    107,776,000
    
    
    
    Intangibles, net
    
    
    2,190,000
    
    
    
    Other assets
    
    
    694,000
    
    
    
    109,000TOTAL ASSETS
    
    $
    221,741,000
    
    
    $
    23,736,000LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable and accrued expenses
    
    $
    12,727,000
    
    
    $
    3,645,000Accrued salaries and related expenses
    
    
    10,606,000
    
    
    
    4,856,000Deferred revenue
    
    
    28,336,000
    
    
    
    3,739,000Notes payable - current portion
    
    
    226,000
    
    
    
    34,000Income taxes payable
    
    
    5,810,000
    
    
    
    Deferred rent
    
    
    200,000
    
    
    
    35,000Deferred income tax liability, current
    
    
    
    
    
    
    243,000TOTAL CURRENT LIABILITIES
    
    
    57,905,000
    
    
    
    12,552,000Deferred income tax liability, long term
    
    
    1,901,000
    
    
    
    174,000Notes payable, net of current portion
    
    
    56,000
    
    
    
    Deferred rent
    
    
    954,000
    
    
    
    Commitments and contingencies
    
    
    
    
    
    
    STOCKHOLDERS EQUITYCommon stock:$.01 Par Value, 25,000,000 shares authorized, 19,468,734
and 12,305,962 shares issued and outstanding,
at September 30, 2004 and 2003
    
    
    195,000
    
    
    
    123,000Additional paid in capital
    
    
    149,043,000
    
    
    
    91,000Treasury stock at cost, 126,245 shares
    
    
    (534,000
    )
    
    
    Retained earnings
    
    
    12,221,000
    
    
    
    10,796,000TOTAL STOCKHOLDERS EQUITY
    
    $
    160,925,000
    
    
    $
    11,010,000TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    221,741,000
    
    
    $
    23,736,000
 The accompanying notes are an integral part of these consolidated financial statements. 29




---



##### 



ARGON ST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS For the Year Ended September 30,2004
    
    2003
    
    2002CONTRACT REVENUES
    
    $
    129,184,000
    
    
    $
    79,349,000
    
    
    $
    61,759,000COST OF REVENUES
    
    
    107,307,000
    
    
    
    65,271,000
    
    
    
    51,034,000GROSS MARGIN
    
    
    21,877,000
    
    
    
    14,078,000
    
    
    
    10,725,000GENERAL AND ADMINISTRATIVE
EXPENSES
    
    
    5,905,000
    
    
    
    5,844,000
    
    
    
    5,181,000INCOME FROM OPERATIONS
    
    
    15,972,000
    
    
    
    8,234,000
    
    
    
    5,544,000OTHER INCOME (EXPENSE)Interest income
    
    
    167,000
    
    
    
    35,000
    
    
    
    78,000Interest expense
    
    
    (13,000
    )
    
    
    (4,000
    )
    
    
    (16,000
    )154,000
    
    
    
    31,000
    
    
    
    62,000INCOME BEFORE INCOME TAXES
    
    
    16,126,000
    
    
    
    8,265,000
    
    
    
    5,606,000PROVISION FOR INCOME TAXES
    
    
    6,177,000
    
    
    
    2,696,000
    
    
    
    2,021,000NET INCOME
    
    $
    9,949,000
    
    
    $
    5,569,000
    
    
    $
    3,585,000EARNINGS PER SHARE (BASIC)
    
    $
    0.81
    
    
    $
    0.47
    
    
    $
    0.32EARNINGS PER SHARE (DILUTED)
    
    $
    0.74
    
    
    $
    0.44
    
    
    $
    0.29WEIGHTED-AVERAGE SHARES
OUTSTANDINGBasic
    
    
    12,308,412
    
    
    
    11,769,788
    
    
    
    11,165,622Diluted
    
    
    13,366,916
    
    
    
    12,620,308
    
    
    
    12,557,550
 The accompanying notes are an integral part of these consolidated financial statements. 30




---



##### 



ARGON ST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY Common StockTotalNumber of
    
    
    
    
    
    Additional
    
    
    
    
    
    Retained
    
    StockholdersShares
    
    Par Value
    
    Paid in Capital
    
    Treasury Stock
    
    Earnings
    
    EquityBalance, September 30, 2001
    
    
    10,958,748
    
    
    $
    110,000
    
    
    $
    
    
    
    $
    
    
    
    $
    4,212,000
    
    
    $
    4,322,000Shares issued upon exercise
of stock options
    

    
    707,742
    
    
    
    7,000
    
    
    
    31,000
    
    
    
    
    
    
    
    
    
    
    
    38,000Retirement of shares
    
    
    (1,920
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,000
    )
    
    
    (1,000
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,585,000
    
    
    
    3,585,000Balance, September 30, 2002
    
    
    11,664,570
    
    
    
    117,000
    
    
    
    31,000
    
    
    
    
    
    
    
    7,796,000
    
    
    
    7,944,000Shares issued upon exercise
of stock options
    
    
    666,792
    
    
    
    7,000
    
    
    
    71,000
    
    
    
    
    
    
    
    
    
    
    
    78,000Retirement of shares
    
    
    (25,400
    )
    
    
    (1,000
    )
    
    
    (11,000
    )
    
    
    
    
    
    
    (107,000
    )
    
    
    (119,000
    )Dividend declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,462,000
    )
    
    
    (2,462,000
    )Net income
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,569,000
    
    
    
    5,569,000Balance, September 30, 2003
    
    
    12,305,962
    
    
    
    123,000
    
    
    
    91,000
    
    
    
    
    
    
    
    10,796,000
    
    
    
    11,010,000Shares issued upon exercise
of stock options
    
    
    514,356
    
    
    
    6,000
    
    
    
    306,000
    
    
    
    
    
    
    
    
    
    
    
    312,000Retirement of shares
    
    
    (120,320
    )
    
    
    (1,000
    )
    
    
    (11,000
    )
    
    
    
    
    
    
    (673,000
    )
    
    
    (685,000
    )Dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,851,000
    )
    
    
    (7,851,000
    )Issuance of shares in
connection with merger
    
    
    6,768,736
    
    
    
    67,000
    
    
    
    148,657,000
    
    
    
    (534,000
    )
    
    
    
    
    
    
    148,190,000Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,949,000
    
    
    
    9,949,000Balance, September 30, 2004
    
    
    19,468,734
    
    
    $
    195,000
    
    
    $
    149,043,000
    
    
    $
    (534,000
    )
    
    $
    12,221,000
    
    
    $
    160,925,000
 The accompanying notes are an integral part of these consolidated financial statements. 31




---



##### 



ARGON ST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended September 30,2004
    
    2003
    
    2002Cash flows from operating activities:Net income
    
    $
    9,949,000
    
    
    $
    5,569,000
    
    
    $
    3,585,000Adjustments to reconcile net income to net cash provided by
(used in) operating activities:Depreciation and amortization
    
    
    1,317,000
    
    
    
    1,065,000
    
    
    
    829,000Deferred income tax (benefit) provision
    
    
    (4,700,000
    )
    
    
    1,478,000
    
    
    
    (504,000
    )Change in:Billed accounts receivable
    
    
    (13,334,000
    )
    
    
    (795,000
    )
    
    
    (986,000
    )Unbilled accounts receivable
    
    
    (627,000
    )
    
    
    (4,212,000
    )
    
    
    (870,000
    )Inventory
    
    
    20,000
    
    
    
    
    
    
    
    Income taxes receivable
    
    
    705,000
    
    
    
    (705,000
    )
    
    
    Prepaids and other
    
    
    (248,000
    )
    
    
    180,000
    
    
    
    (592,000
    )Accounts payable and accrued expenses
    
    
    2,378,000
    
    
    
    1,343,000
    
    
    
    (2,185,000
    )Accrued salaries and related expenses
    
    
    1,732,000
    
    
    
    874,000
    
    
    
    1,756,000Deferred revenue
    
    
    23,969,000
    
    
    
    (1,203,000
    )
    
    
    1,974,000Income taxes payable
    
    
    6,808,000
    
    
    
    (643,000
    )
    
    
    (207,000
    )Deferred rent
    
    
    1,119,000
    
    
    
    (70,000
    )
    
    
    105,000Net cash provided by (used in) operating activities
    
    
    29,088,000
    
    
    
    2,881,000
    
    
    
    2,905,000Cash flows from investing activitiesNet cash acquired in merger
    
    
    6,952,000
    
    
    
    
    
    
    
    Acquisitions of property, equipment and software
    
    
    (2,460,000
    )
    
    
    (1,344,000
    )
    
    
    (1,779,000
    )Deposits
    
    
    29,000
    
    
    
    (27,000
    )
    
    
    (9,000
    )Net cash provided by (used in) investing activities
    
    
    4,521,000
    
    
    
    (1,371,000
    )
    
    
    (1,788,000
    )Cash flows from financing activitiesPayment on note payable
    
    
    (204,000
    )
    
    
    (138,000
    )
    
    
    (137,000
    )Retirement of common stock
    
    
    (234,000
    )
    
    
    (118,000
    )
    
    
    (2,000
    )Proceeeds from exercise of stock options
    
    
    312,000
    
    
    
    77,000
    
    
    
    38,000Dividends paid
    
    
    (7,851,000
    )
    
    
    (2,462,000
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    (7,977,000
    )
    
    
    (2,641,000
    )
    
    
    (101,000
    )Net increase (decrease) in cash and cash equivalents
    
    
    25,632,000
    
    
    
    (1,131,000
    )
    
    
    1,016,000Cash and cash equivalents, beginning of year
    
    
    4,100,000
    
    
    
    5,231,000
    
    
    
    4,215,000Cash and cash equivalents, end of year
    
    $
    29,732,000
    
    
    $
    4,100,000
    
    
    $
    5,231,000Supplemental disclosureIncome taxes paid
    
    $
    (3,275,000
    )
    
    $
    (1,813,000
    )
    
    $
    (2,732,000
    )Interest expense paid
    
    $
    (13,000
    )
    
    $
    (7,000
    )
    
    $
    (15,000
    )Note payable issued for stock redemption
    
    $
    451,000
    
    
    $
    
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. 32




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##### 



Note 1  Summary of Significant Accounting Policies Nature of Business Argon ST (the Company) provides advanced software intensive systems that
are used in intelligence collection, surveillance, reconnaissance activities,
threat warning and monitoring, simulation, and force protection and
communication. The systems are primarily for the United States government and
select international customers. The systems run on commercial off-the-shelf
(COTS) hardware or special purchase hardware designed and manufactured to our
specification or the specifications of our customers. Recently, Argon ST has
begun to use the technology developed for these systems in other applications,
such as software radios, high accuracy targeting, counter-terrorism, and
wideband transmission. Principles of Consolidation The consolidated financial statements include the accounts of Argon ST,
Inc. and its wholly owned subsidiaries, Argon Engineering Associates, Inc.
(Argon Engineering), ST Production Systems, Inc., Imaging Sensors and
Systems, Inc., Sensytech Financial Services, Inc. and Daedalus Enterprises
Export Corporation. All intercompany transactions and balances have been
eliminated in consolidation. Basis of Presentation As further described in Note 2, on September 29, 2004, Argon Engineering
merged with a wholly-owned subsidiary of Sensytech, Inc. (Sensytech). As a
result of this merger, each outstanding share of Argon Engineering stock was
converted into two shares of Sensytech common stock. Immediately following the
merger, the combined company was renamed Argon ST, Inc. While Sensytech was the legal acquirer, the merger was accounted for as a
reverse acquisition, whereby Argon Engineering was deemed to have acquired
Sensytech for financial reporting purposes. This determination was based on
factors including relative stock ownership and voting rights, board
control, and senior management composition. Consistent with the reverse
acquisition accounting treatment, the historical financial statements presented
for periods prior to the acquisition date are the financial statements of Argon
Engineering. Earnings per share have been adjusted to reflect the two for one
exchange ratio. The operations of the former Sensytech businesses have been
included in the financial statements from the date of acquisition. Stockholders equity has been restated to give retroactive recognition to
the exchange ratio for all periods presented by reclassifying additional paid
in capital and retained earnings to reflect the additional shares. Argon
Engineerings class A and class B shares have been combined to report a single
class of common stock for all periods presented. The names Argon ST, Sensytech, and Argon Engineering are used throughout
these footnotes. Argon ST, also the Company, refers to the entity created by
the merger of Argon Engineering and Sensytech. Argon Engineering refers to
Argon Engineering Associates, Inc. which operated as a stand alone private
company until the September 29, 2004 merger with Sensytech. Sensytech refers
to Sensytech Inc., which combined with its wholly owned subsidiaries made up
the publicly held entity Sensytech until the September 29, 2004 merger with
Argon Engineering. Revenue and Cost Recognition Contract revenue is accounted for in accordance with the American
Institute of Certified Public Accountants Statement of Position 81-1,
Accounting for Performance of Construction-Type and Production-Type Contracts.
These contracts are transacted using written contractual arrangements, most of
which require Argon ST to design, develop, manufacture and/or modify complex
products, and perform related services according to specifications provided by
the customer. Argon ST accounts for fixed-price contracts by using the
percentage-of-completion method of accounting. Under this method, contract
costs are charged to operations as incurred. A portion of the contract revenue,
based on estimated profits and the degree of completion of the contract as
measured by a comparison of the actual and estimated costs, is recognized as
revenue each period. Unexpected increases in the cost to develop or manufacture
a product under a fixed-price contract, whether due to inaccurate estimates in
the bidding process, unanticipated increases in material costs, inefficiencies,
or other factors are borne by Argon ST, and could have a material adverse
effect on Argon STs results of operations. Argon ST accounts for cost
reimbursable contracts by charging contract costs to operations as incurred and
recognizing contract revenues and profits by applying contractually agreed to
fee rates to actual costs on an individual contract basis. Revenue 33




---



##### 



under time
and material contracts is based on hours incurred multiplied by approved loaded
labor rates plus other direct costs incurred and allocated. The following table represents Argon Engineerings revenue concentration
by contract type: Years Ended September 30,2004
    
    2003
    
    2002Firm Fixed-Price Contracts
    
    
    71
    %
    
    
    46
    %
    
    
    49
    %Cost Reimbursable Contracts
    
    
    19
    %
    
    
    51
    %
    
    
    50
    %Time and Materials Contracts
    
    
    10
    %
    
    
    3
    %
    
    
    1
    %
 Management reviews contract performance, costs incurred, and estimated
completion costs regularly, and adjusts revenues and profits on contracts in
the period in which changes become determinable. Anticipated losses on
contracts are also recorded in the period in which they become determinable. Argon
STs policy for recognizing interim fee on 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 to be performed, the relationship and
history with the customer, the history with similar types of projects, and the
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. Revenues recognized in excess of billings are recorded as unbilled
accounts receivable. Cash collections in excess of revenues recognized are
recorded as deferred revenues until the revenue recognition criteria are met.
Reimbursements, including those related to travel, other out of pocket expenses
and any third party costs, are included in revenues, and an equivalent amount
of reimburseable expenses are included in cost of revenues. Cash and Cash Equivalents Cash and cash equivalents include cash and investments that are readily
convertible into cash and have original maturities of three months or less. Accounts Receivable Argon ST reviews its receivables regularly to determine if there are any
potential uncollectible accounts. The majority of Argon STs receivables are
from agencies of the U.S. government, where there is no credit risk. There were
no material provisions for bad debts recorded during 2004, 2003 or 2002. Property, Equipment and Software Property, equipment and software are stated at cost. Depreciation is
provided over the estimated useful lives of the assets, which range from three
to five years, using the straight-line method. Leasehold improvements are
amortized over the respective lease terms, which range from one to six years,
using the straight-line method. Stock-Based Compensation Argon ST accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, (APB No. 25) and related
interpretations using the intrinsic value method. Argon ST complies with the
disclosure provisions of Financial Accounting Board Statement No. 123,
Accounting for Stock-based Compensation, (SFAS No. 123) and Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation, Transition and Disclosure. Had compensation cost for Argon
Engineerings stock-based compensation plans been determined based on the fair
value at the grant dates for awards under the plans in 2004, 2003 and 2002
consistent with the method of SFAS No. 123, net earnings and net earnings per
share would have been reduced to the pro forma amounts indicated below. 34




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##### 



Years Ended September 30,2004
    
    2003
    
    2002Net income as reported
    
    $
    9,949,000
    
    
    $
    5,569,000
    
    
    $
    3,585,000Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects
    
    
    
    
    
    
    
    
    
    
    Less: Total stock-based employee
compensation expense determined
under fair value method for all
awards, net of related tax effects
    
    
    172,000
    
    
    
    135,000
    
    
    
    38,000Pro forma net income
    
    $
    9,777,000
    
    
    $
    5,434,000
    
    
    $
    3,547,000
 Years Ended September 30,2004
    
    2003
    
    2002Earnings per share:Basic  as reported
    
    $
    0.81
    
    
    $
    0.47
    
    
    $
    0.32Basic  pro forma
    
    $
    0.79
    
    
    $
    0.46
    
    
    $
    0.32Earnings per share:Diluted  as reported
    
    $
    0.74
    
    
    $
    0.44
    
    
    $
    0.29Diluted  pro forma
    
    $
    0.73
    
    
    $
    0.43
    
    
    $
    0.28
 Intangibles Intangible assets consist of the value of customer related intangibles of
$1,938,000 and developed technology of $252,000 acquired in the merger between
of Argon Engineering and Sensytech (see Note 2). Intangible assets are
amortized on a straight line basis over their estimated useful lives. The
Company will amortize $971,000 and $719,000 respectively, for fiscal years 2005
and 2006, and the remainder will amortize over fiscal years 2007 through 2010
at $125,000 per year. Goodwill Costs in excess of the fair value of tangible and identifiable intangible
assets acquired and liabilities assumed in a business combination are recorded
as goodwill. In accordance with SFAS No. 142, Goodwill and Other Intangible
Assets, companies no longer amortize goodwill, but instead test for impairment
at least annually using a two-step approach. Impairment of goodwill is tested
at the reporting unit level by comparing the reporting units carrying amount,
including goodwill, to the fair value of the reporting unit. The fair values
of the reporting units are estimated using a combination of the income, or
discounted cash flows, approach and the market approach, which utilizes
comparable companies data. If the carrying amount of the unit exceeds its
fair value, goodwill is considered impaired and a second step is performed to
measure the amount of impairment loss, if any. The Company will test for
impairment beginning in the fourth quarter of fiscal year 2005, or sooner if
events or circumstances warrant a test for impairment. Income Taxes Deferred tax assets and liabilities have been established for the
temporary differences between financial statement and tax bases of assets and
liabilities existing at the balance sheet date using expected tax rates. A
valuation allowance is recorded to reduce deferred income taxes to that portion
that is expected to more likely than not be realized. Use of Estimates Management uses estimates and assumptions in preparing these financial
statements in accordance with accounting principles generally accepted in the
United States of America. These estimates and assumptions affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities, and the reported revenues and expenses. Actual results could vary
from the estimates that were used. 35




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##### 



Operating Cycle In accordance with industry practice, the Company classifies as current
assets amounts relating to long-term contracts which may have terms extending
beyond one year but are expected to be realized during the normal operating
cycle of the Company. The liabilities in the accompanying balance sheets which
have been classified as current liabilities are those expected to be satisfied
by the use of assets classified as current assets, all within the next twelve
months. Recently Issued Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. The Interpretation requires an investor with a
majority of the variable interests in a variable interest entity to consolidate
the entity and also requires majority and significant variable interest
investors to provide certain disclosures. A variable interest entity is an
entity in which the equity investors do not have a controlling interest or the
equity investment at risk is insufficient to finance the entitys activities
without receiving additional subordinated financial support from the other
parties. This pronouncement requires the consolidation of variable interest
entities created after January 31, 2003. Consolidation provisions apply for
periods ending after March 15, 2004 for variable interest entities, other than
special purpose entities, created prior to February 1, 2003. Argon ST does not
have any variable interest entities, including special purpose entities, that
must be consolidated and therefore the adoption of the provision of FIN 46 will
not have an impact on Argon STs financial position or results of operations. Earnings Per Share: Basic earnings per share is computed using the weighted average number of
common shares outstanding during each period. Diluted earnings per share is
computed using the weighted average number of common and common equivalent
shares outstanding during each period. The following summary is presented for
the years ended September 30: 2004
    
    2003
    
    2002Net Income
    
    $
    9,949,000
    
    
    $
    5,569,000
    
    
    $
    3,585,000Weighted Average Shares Outstanding  Basic
    
    
    12,308,412
    
    
    
    11,769,788
    
    
    
    11,165,622Basic Earnings per Share
    
    $
    0.81
    
    
    $
    0.47
    
    
    $
    0.32Effect of Dilutive Securities:Net Shares Issuable Upon Exercise of Stock
Options
    
    
    1,058,504
    
    
    
    850,520
    
    
    
    1,391,928Weighted Average Shares Outstanding  Diluted
    
    
    13,366,916
    
    
    
    12,620,308
    
    
    
    12,557,550Diluted Earnings per Share
    
    $
    0.74
    
    
    $
    0.44
    
    
    $
    0.29
 Note 2  Merger On September 29, 2004, a wholly-owned subsidiary of Sensytech merged with
and into Argon Engineering whereby each outstanding share of Argon Engineering
common stock was exchanged for two shares of Sensytech common stock. As a
result of the merger, the former Argon Engineering stockholders acquired
approximately 65.6% of the issued and outstanding shares of Sensytech common
stock. In accordance with SFAS 141 Business Combinations, the merger was
accounted for as a reverse acquisition, whereby Argon Engineering was deemed to
have acquired Sensytech for financial reporting purposes. Consistent with the
reverse acquisition accounting treatment, the historical financial statements
presented for periods prior to the acquisition date are the statements of Argon
Engineering except for stockholders equity which has been retroactively
restated for the equivalent number of shares of the legal acquirer. The
operations of the former Sensytech businesses have been included in the
financial statements from the date of acquisition (1 day). Both companies had
their fiscal year ending on September 30. The average market value of the Sensytech common stock for the period of
two business days before and after the announcement of the acquisition is used
to determine the purchase price for accounting purposes. The average market
value of Sensytech stock used to record the purchase was $20.72 per share and
there were 6,642,689 shares issued and outstanding at the acquisition date and
689,300 options with a weighted average fair value of $15.31 per share. As a
result, the aggregate value of the stock and options used to record the
purchase was approximately $148,190,000. Direct expenses of $1,717,000
consisting of legal, accounting and other fees were also included in the
recorded purchase price. Also included in the purchase price was a retention
liability of $820,000 resulting from change of control agreements with two
Sensytech executive officers and a $2,128,000 deferred tax liability related to
the differences between the assigned values and the tax bases of property,
equipment and other intangible assets. 36




---



##### 



The Company has followed the guidance of SFAS No. 141 to record this
purchase. SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 1, 2001 and that goodwill,
as well as any intangible assets believed to have an indefinite life, shall not
be amortized for financial accounting purposes. The Company has recognized
goodwill in the amount of $107,776,000 (none of which is tax deductible) in
connection with this acquisition. In accordance with SFAS No. 142, Goodwill
and Other Intangible Assets, the goodwill will be reviewed periodically to
determine if there has been any impairment to its value. The Company will
perform an impairment test as of September 30, 2005, unless circumstances or
events indicate that an impairment test should be performed sooner. The following table summarizes the estimated fair value of the assets
acquired and the liabilities assumed at the date of acquisition. The Company
has obtained third party valuations of certain tangible and intangible assets
acquired from Sensytech. Current assets
    
    $
    42,315,000Property, plant and equipment
    
    
    10,346,000Other assets
    
    
    758,000Other intangibles
    
    
    2,190,000Goodwill
    
    
    107,776,000Total assets acquired
    
    
    163,385,000Current liabilities assumed
    
    
    (10,530,000
    )Total purchase price
    
    $
    152,855,000
 The board of directors of both Argon Engineering and Sensytech unanimously
determined that the merger was in the best interests of Argon Engineering and
Sensytech stockholders because the combined company will be able to provide
more integrated or complete solutions to the customers needs, thereby allowing
the combined company to grow faster than either one would separately. The following unaudited condensed proforma results of operations reflect
the proforma combination of Argon Engineering and Sensytech as if the
combination had occurred at the beginning of the periods presented, compared
with the actual results of operations of Argon Engineering for the
same periods. 37




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##### 



Twelve Months Ended September 30,2004
    
    2003
    
    2002Historical
    
    Proforma
    
    Historical
    
    Proforma
    
    Historical
    
    ProformaRevenue
    
    $
    129,184,000
    
    
    $
    189,792,000
    
    
    $
    79,349,000
    
    
    $
    132,532,000
    
    
    $
    61,759,000
    
    
    $
    94,049,000Income from operations
    
    
    15,972,000
    
    
    
    23,132,000
    
    
    
    8,234,000
    
    
    
    13,874,000
    
    
    
    5,544,000
    
    
    
    8,144,000Net income
    
    
    9,949,000
    
    
    
    14,386,000
    
    
    
    5,569,000
    
    
    
    8,979,000
    
    
    
    3,585,000
    
    
    
    5,132,000Basic earnings per share
    
    $
    0.81
    
    
    $
    0.76
    
    
    $
    0.47
    
    
    $
    0.50
    
    
    $
    0.32
    
    
    $
    0.34Diluted earnings per share
    
    $
    0.74
    
    
    $
    0.71
    
    
    $
    0.44
    
    
    $
    0.48
    
    
    $
    0.29
    
    
    $
    0.31Basic wt average shares
    
    
    12,308,000
    
    
    
    18,914,000
    
    
    
    11,770,000
    
    
    
    17,874,000
    
    
    
    11,166,000
    
    
    
    15,220,000Diluted wt average shares
    
    
    13,367,000
    
    
    
    20,156,000
    
    
    
    12,620,000
    
    
    
    18,882,000
    
    
    
    12,558,000
    
    
    
    16,738,000
 Revenues
attributable to Sensytech were
$60,608,000, $53,183,000, and
$32,290,000 for fiscal years 2004, 2003, and 2002 respectively. Income from
operations attributable to Sensytech were $6,033,000, $6,693,000 and $3,653,000
for fiscal years 2004, 2003, and 2002 respectively. Net income
attributable to Sensytech was $3,749,000, $4,052,000, and $2,189,000 for fiscal years 2004,
2003, and 2002 respectively. Depreciation and amortization on the write up of
tangible and intangible assets, in accordance with SFAS 141, was $82,000 and
$971,000 respectively for fiscal years 2004, 2003 and 2002 and the after tax effect was $50,000
and $592,000 respectively. The one time merger costs and expenses, incurred by
Sensytech, of approximately $2,180,000 before tax and $1,330,000 after tax were
added back to the pro forma results for 2004. Note 3  Customer Concentrations of Credit and Other Business Risks Customer Concentrations The following table identifies the source of Argon Engineerings revenues
by major market: Years Ended September 30,2004
    
    2003
    
    2002U.S. Navy
    
    
    77
    %
    
    
    68
    %
    
    
    75
    %Other U.S. Government Agencies
    
    
    11
    %
    
    
    26
    %
    
    
    19
    %Foreign
    
    
    12
    %
    
    
    6
    %
    
    
    6
    %
 Revenues for the U.S. military can also be categorized as direct purchases
and subcontracts, where Argon Engineering is a supplier to another contractor.
The following table distinguishes Argon Engineerings revenue between these two
categories: Years Ended September 30,2004
    
    2003
    
    2002Direct Purchases
    
    
    87
    %
    
    
    69
    %
    
    
    71
    %Subcontracts
    
    
    13
    %
    
    
    31
    %
    
    
    29
    %
 Sensytech historically has recorded the
AN/SLQ-25A Surface Torpedo Defense
System contract at zero margin. Revenue from this contract amounted
to approximately 22% of Sensytechs revenues in both 2004 and
2003, and 19% in 2002.
This contract was acquired as part of Sensytechs acquisition of certain assets
of FEL Corporation and was performing at a potential loss at the date of
acquisition. Sensytech has favorably performed under the contract since the
date of acquisition and management has worked with the customer to reduce any
potential loss through change orders approved to date. While management
currently estimates that the contract will be profitable, the profitability is
dependent upon change orders, expected by management, but that have not yet
been finalized. Based upon the funding of the contract, should no additional
funding be received, a loss of $1,800,000 would be recognized. However, after
considering the effect of anticipated change orders, the Company projects the
contract to complete at a modest profit. Change orders are under continuous
negotiation with the customer. When these change orders are received, Argon ST
will reassess the contract based on current estimates, and such reassessments
are currently expected to result in increases to the margins recorded on the
contract. Such increases would impact operations in the period such change
orders are finalized as well as future periods. If such change orders are not
finalized under currently expected terms, or if Argon ST does not perform as
expected under the contract, contract losses may be required to be accrued.
Management expects the change orders to be received in the first half of 2005. 38




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##### 



Cash Balances The Company maintains cash balances at commercial banks in excess of
Federal Deposit Insurance Corporation (FDIC) limits. Management believes the
risk in these situations to be minimal. Argon ST had cash and cash
equivalents held by commercial banks and financial institutions totaling $29,732,000 as of September 30, 2004. The
federally insured limit is $100,000. Note 4  Accounts Receivable Accounts receivable consists of the following as of: September 30,2004
    
    2003Billed and Billable
    
    
    35,856,000
    
    
    $
    8,810,000Unbilled Costs and Fees
    
    
    23,062,000
    
    
    
    6,102,000Retainages
    
    
    998,000
    
    
    
    939,000Reserves
    
    
    (200,000
    )
    
    
    $
    59,716,000
    
    
    $
    15,851,000
 Unbilled costs, fees, and retainages result from recognition of contract
revenue in advance of contractual or progress billing terms. The cost reimbursable and time and material contract payments to Argon ST
under government contracts are provisional payments that are subject to
adjustment upon audit by the U.S. Defense Contract Audit Agency (DCAA) or other
appropriate agencies of the U.S. Government. Historically, such audits have not
resulted in any significant disallowed costs. When final determination and
approval of the allowable rates have been made, receivables may be adjusted
accordingly. In managements opinion, any adjustments will not be material.
Incurred cost audits have been completed by DCAA through September 30, 2001. Reserves are determined based on managements best estimate of potentially
uncollectible accounts receivable. Argon ST writes off accounts receivable when
such amounts are determined to be uncollectible Note 5  Property, Equipment and Software Property, equipment and software consists of the following as of: September 30,2004
    
    2003Computer, Machinery and Test Equipment
    
    
    9,859,000
    
    
    $
    2,481,000Leasehold Improvements
    
    
    3,558,000
    
    
    
    1,279,000Computer Software
    
    
    1,445,000
    
    
    
    719,000Furniture and Fixtures
    
    
    904,000
    
    
    
    444,000Construction in process
    
    
    1,958,000
    
    
    
    17,724,000
    
    
    
    4,923,000Less Accumulated Depreciation and Amortization
    
    
    3,775,000
    
    
    
    2,463,000$
    13,949,000
    
    
    $
    2,460,000
 Depreciation and amortization expense
totaled $1,317,000, $1,065,000 and
$829,000, for the years ended September 30, 2004, 2003 and 2002, respectively.
As of September 30, 2004, there was $1,958,000 of leasehold improvements under
construction. When this project is completed those costs will be reclassified
to leasehold improvements and amortized over the term of the lease. Note 6  Revolving Line of Credit Argon Engineering has a revolving line of credit in the amount of
$5,000,000 with James Monroe Bank. There were no amounts outstanding under the
line of credit at September 30, 2004 and 2003. Amounts outstanding under the
line bear interest at prime plus one-half percent. The bank also requires
quarterly and annual line fees. The line is due for renewal on December 31,
2004; however, the Company expects that this line will be replaced by the line
of credit with Bank of America described below. There is a 39




---



##### 



letter of credit in
the amount of $976,000 outstanding at September 30, 2004 securing Argon
Engineerings obligations under its office lease agreement. Borrowings on the
line are collateralized by all assets of Argon Engineering. The financing and
security agreement for the line contains covenants including those related to
certain financial ratios and minimum net worth requirements. For the year ended
September 30, 2003, Argon Engineering did not meet a covenant relating to
required ownership by certain key stockholders. The bank waived the requirement
through December 31, 2004. Sensytech entered into a line of credit and related note payable with Bank
of America in February 2001. Effective February 2004, the Company renewed its
$15,000,000 line of credit, which expires on February 28, 2006. The total
borrowing base generally cannot exceed the sum of 90% of qualified government
accounts receivable and 80% of qualified non-government accounts receivable.
The borrowing base at September 30, 2004 was $10,412,000. The line of credit
is available to finance the performance of government contracts, to support the
issuance of stand-by letters of credit, and for short-term working capital
purposes. At September 30, 2004, there were no borrowings under the line of
credit. A stand-by letter of credit is issued to certain foreign customers in
lieu of posting a performance bond. Letters of credit are also used to cover
certain contract prepayments received from foreign customers. Total letters of
credit at September 30, 2004 were $1,083,000. The bank agreement establishes the interest rate at the LIBOR plus 200 to
285 basis points, determined by Argon STs ratio of funded debt to earnings
before interest, taxes, depreciation and amortization. All borrowings under the
line of credit are collateralized by all tangible assets of Argon ST. The agreement also contains various covenants as to
dividend restrictions, working capital, tangible net worth, earnings and
debt-to-equity ratios. Unused commitment fees of one quarter of one percent
per annum are required. Note 7  Stock Option Plans The Argon Engineering Associates, Inc. Stock Plan (the Argon Engineering
Plan) provides for the for the issuance of incentive and non-statutory stock
options and restricted stock to eligible employees of Argon Engineering and its
affiliates. As a result of the merger, each outstanding option to purchase
Argon Engineering common stock under the Argon Engineering Plan was converted
into an option to purchase Argon ST common stock, with the number of shares
able to be purchased and the exercise price adjusted in accordance with the
merger exchange ratio. No acceleration of vesting of options under the Argon
Engineering Plan occurred in connection with the merger. As a result of the
merger, the Argon Engineering Plan covers 6,240,000 shares of Company common
stock; however, the Argon Engineering Plan has been frozen as of September 29,
2004 and no additional awards will be granted under the Argon Engineering Plan
subsequent to that date. The only participants in the Argon Engineering Plan
are those employees who received awards prior to September 29, 2004. The Argon Engineering Plan is administered by a compensation committee of
the Argon Engineering board of directors, or, in the absence of such a
committee, the full board of directors (the Administrator). The
Administrator determined the exercise price of each option at the time of
grant; provided that the exercise price of incentive stock options must be not
less than 100% of the fair market value of the underlying common stock on the
grant date, and the exercise price of options granted to a person holding more
than 10% of Argon Engineerings common stock must not be less than 110% of such
fair market value. The maximum term of the options under the Argon Engineering
Plan is ten years; provided that the maximum term for options granted to
greater than 10% holders is five years. Individual option agreements specify
vesting terms and/or the dates upon which the option will be exercisable.
Payment upon exercise of options may be made either in cash or by the surrender
of shares of Company common stock. If a grantees employment terminates for any reason other than death,
disability or retirement, the grantee may not exercise the option following the
date of termination. Upon a termination due to death or permanent disability,
unless otherwise provided in the award agreement, the option will become 100%
vested and exercisable within six months of termination. Upon a grantees
retirement, unless otherwise provided in the award agreement, the option will
become 100% vested and may be exercised immediately prior and on the date of
retirement, but no later. Options granted under the Argon Engineering Plan are
not transferable, other than by will or the laws of descent and distribution. The Sensytech 2002 Stock Incentive Plan (the Sensytech Plan), approved
by the shareholders on May 30, 2002, provides for the granting of incentive
stock options, restricted stock, and or performance awards to key employees and
outside members of the board of directors. The Sensytech Plan is administered
by the Compensation Committee of its board of directors. Options granted under
the plan are awarded at the closing price of the stock as reported on the NASDQ
national market on the grant date. The maximum term of the option is ten
years. Options may vest over a period of 1 to 5 years. If a grantees
employment terminates for any reason other than death, disability or
retirement, the grantee may exercise the option within 90 days of the date of
termination. Upon a termination due to death or permanent disability, unless
otherwise provided in the award agreement, the option will become 100% vested
and exercisable within twelve months of termination. Upon a grantees
retirement, unless otherwise provided in the award agreement, the option will
become 100% vested and may be exercised within 90 days of the date of
retirement. The Sensytech Plan also provides for full vesting of all options
upon certain events including a change in control. Options granted under the
Sensytech Plan are not transferable, other than by will or the laws of descent
and distribution. 40




---



##### 



The following table summarizes Argon Engineerings activity, which has
been restated to give retroactive recognition to the merger exchange ratio, for
all of its stock option awards granted under the plan, including those assumed
through the merger with Sensytech: Number of
    
    Range of
    
    Weighted-AverageOptions
    
    Exercise Prices
    
    Exercise PriceBalance, September 30, 2001
    
    
    2,454,532
    
    
    $
    0.04  $0.91
    
    
    $
    0.22Granted
    
    
    
    
    
    $
      
    
    
    $
    Exercised
    
    
    (709,236
    )
    
    $
    0.04  $0.91
    
    
    $
    0.06Canceled
    
    
    (12,480
    )
    
    $
    0.10  $0.91
    
    
    $
    0.41Balance, September 30, 2002
    
    
    1,732,816
    
    
    $
    0.04  $0.91
    
    
    $
    0.29Granted
    
    
    471,500
    
    
    $
    4.11  $4.11
    
    
    $
    4.11Exercised
    
    
    (666,782
    )
    
    $
    0.04  $0.91
    
    
    $
    0.12Canceled
    
    
    (47,400
    )
    
    $
    0.10  $4.11
    
    
    $
    1.52Balance, September 30, 2003
    
    
    1,490,134
    
    
    $
    0.04  $4.11
    
    
    $
    1.53Granted
    
    
    790,400
    
    
    $
    5.69  $28.10
    
    
    $
    13.85Exercised
    
    
    (514,356
    )
    
    $
    0.04  $4.13
    
    
    $
    0.58Canceled
    
    
    (36,881
    )
    
    $
    0.10  $5.69
    
    
    $
    3.46Assumed in merger
    
    
    689,300
    
    
    $
    2.25  $17.63
    
    
    $
    10.47Balance, September 30, 2004
    
    
    2,418,597
    
    
    $
    0.04  $28.10
    
    
    $
    8.27
 Options to purchase 923,608, 442,914 and 337,082, shares of Argon STs
common stock were exercisable as of September 30, 2004, 2003 and 2002
respectively, at weighted-average per share exercise prices of $8.12, $.34 and
$.29, respectively. The following table summarizes additional information about all Argon ST
stock options outstanding as of September 30, 2004: Options Outstanding
    
    Options ExercisableWeighted-Average
    
    Weighted-
    
    
    
    
    
    Weighted-Remaining
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseRange of Exercise Prices
    
    Options
    
    Life (Years)
    
    Price
    
    Exercisable
    
    Price$  0.04  $  0.90
    
    
    537,017
    
    
    
    6.34
    
    
    $
    0.49
    
    
    
    188,980
    
    
    $
    0.51$  2.25  $  4.63
    
    
    624,880
    
    
    
    7.21
    
    
    $
    3.96
    
    
    
    253,728
    
    
    $
    3.74$  5.00  $  6.88
    
    
    403,200
    
    
    
    8.99
    
    
    $
    5.71
    
    
    
    15,400
    
    
    $
    6.26$  7.51  $14.22
    
    
    253,000
    
    
    
    8.21
    
    
    $
    10.31
    
    
    
    253,000
    
    
    $
    10.31$17.63  $28.10
    
    
    600,500
    
    
    
    9.19
    
    
    $
    20.57
    
    
    
    212,500
    
    
    $
    17.63Total
    
    
    2,418,597
    
    
    
    7.91
    
    
    $
    8.28
    
    
    
    923,608
    
    
    $
    8.12
 The fair value of each option grant was established on the date of grant
using the minimum value method, with the following assumptions used for grants
in the years ended September 30, 2004, 2003, and 2002 respectively: no
dividends yield; risk-free interest rates of approximately 3.41 percent and
2.95 percent; and expected lives of 5 years. Argon Engineering assumed no
dividend yield due to a lack of history of paying dividends in the normal course of business and no intention to declare dividends in the future. Under the Sensytech Plan, the fair
value of the options granted in 2004, used the following assumptions: no
dividends yield; risk-free rate of 4.14% and expected volatility of 49.7%. All unvested options under the
Sensytech Plan fully vested as of the effective date of the merger, September
29, 2004. The weighted average fair values per share for stock option grants,
awarded in fiscal years 2004 and 2003, were $3.73 and $1.12, respectively. No
grants were awarded in fiscal year 2002. Note 8  Retirement Plans Argon Engineering has a 401(k) profit sharing plan and a money purchase
pension plan covering employees who have worked at least 1,000 hours and meet
certain other eligibility requirements. Under the plan, the employer can
voluntarily match employee 401(k) salary deferrals up to a maximum of six
percent of eligible compensation, as well as make a discretionary profit
sharing contribution. Profit sharing contributions to the 401(k) plan are
determined annually by the employer. The 401(k) plan match, 41




---



##### 



discretionary
profit sharing, and money purchase pension plan contributions were $2,965,000,
$2,419,000 and $2,048,000 for the years ended September 30, 2004, 2003, and
2002, respectively. Sensytech also maintains a 401(k) plan, which will merge
into the Argon plan effective January 1, 2005 and will be renamed the Argon ST
Employee 401(k) Plan. Note 9  Income Taxes The provisions for income taxes consist of the following: Years Ended September 30,2004
    
    2003CurrentFederal
    
    $
    9,119,000
    
    
    $
    951,000State
    
    
    1,758,000
    
    
    
    267,000Total Current
    
    
    10,877,000
    
    
    
    1,218,000DeferredFederal
    
    
    (3,975,000
    )
    
    
    1,256,000State
    
    
    (725,000
    )
    
    
    222,000Total Deferred
    
    
    (4,700,000
    )
    
    
    1,478,000Income Tax Expense
    
    $
    6,177,000
    
    
    $
    2,696,000
 The components of Argon STs net deferred tax asset (liability) are as
follows: As of September 30,2004
    
    2003Total Deferred Tax Assets
    
    $
    8,432,000
    
    
    $
    1,745,000Total Deferred Tax Liabilities
    
    
    (5,511,000
    )
    
    
    (2,162,000
    )Valuation Allowance
    
    
    
    
    
    
    Net Deferred Tax Asset (Liability)
    
    $
    2,921,000
    
    
    $
    (417,000
    )
 The tax effect of temporary differences that give rise to the net deferred
tax asset (liability) is as follows: As of September 30,2004
    
    2003Unbilled Receivables
    
    $
    (2,983,000
    )
    
    $
    (2,018,000
    )Deferred Revenues
    
    
    6,706,000
    
    
    
    1,419,000Property, Equipment and Software
    
    
    (1,791,000
    )
    
    
    (144,000
    )Accrued Vacation
    
    
    706,000
    
    
    
    313,000Deferred Rent
    
    
    449,000
    
    
    
    13,000Net Operating Losses & Tax Credits
    
    
    207,000
    
    
    
    Warranty
    
    
    127,000
    
    
    
    Intangibles
    
    
    (737,000
    )
    
    
    Uncollectible Accounts
    
    
    76,000
    
    
    
    Stock-Based Compensation
    
    
    86,000
    
    
    
    Other, net
    
    
    75,000
    
    
    
    Net Deferred Tax Asset (Liability)
    
    $
    2,921,000
    
    
    $
    (417,000
    )
 Based on its historical profitability, Argon ST has determined that there
is not a need for a valuation allowance with respect to the utilization of net
operating loss carry forward (NOLs) or other deferred tax assets. The NOLs
expire principally in 2011, 2012, and 2013. At September 30, 2004,
NOLs amounted to $648,000. The NOLs were acquired
in Sensytechs acquisition of Daedalus Enterprises, Inc. in 1998 and are
subject to limitations as to their utilization under the Internal Revenue Code. 42




---



##### 



A reconciliation between Argon STs statutory tax rate and the effective
tax rate is as follows: Years Ended September 30,2004
    
    2003
    
    2002Statutory Federal Rate
    
    
    35.0
    %
    
    
    34.0
    %
    
    
    34.0
    %State Income Taxes, Net of Federal Benefit
    
    
    3.9
    %
    
    
    4.0
    %
    
    
    4.0
    %Research and Development Tax Credit
    
    
    (1.9
    )%
    
    
    (4.1
    )%
    
    
    (2.3
    )%Other
    
    
    1.3
    %
    
    
    (1.3
    )%
    
    
    0.4
    %38.3
    %
    
    
    32.6
    %
    
    
    36.1
    %
 Note 10  Operating Leases Argon ST leases office facilities and equipment under operating lease
agreements. Rental payments on certain of the leases are subject to increases
based on a three percent escalation factor and increases in the lessors
operating expenses. Rent expense amounted to $3,302,000, $2,262,000 and
$1,713,000 for the years ended September 30, 2004, 2003 and 2002, respectively.
Rent expense includes deferred rent relating to escalation clauses. The 2002
rent expense is reported net of sublease income of $590,000. Following is a schedule of future minimum lease payments due under the
lease agreements: Year Ending
    
    FutureSeptember 30,
    
    Minimum Payments2005
    
    $
    5,609,0002006
    
    
    5,371,0002007
    
    
    5,329,0002008
    
    
    5,328,0002009
    
    
    3,229,000Thereafter
    
    
    6,041,000Total
    
    $
    30,907,000
 Note 11  Research and Development Expenses Internally funded research and development costs are included in general
and administrative expenses in the consolidated income statements. Research and
development expenses amounted to $1,301,000, $2,187,000 and $3,015,000 for the
years ended September 30, 2004, 2003 and 2002, respectively. Note 12  Fair Value of Financial Instruments Based on existing rates, economic conditions and short maturities, the
carrying amount of all of the financial instruments at September 30, 2004 and
2003 are reasonable estimates of their fair values. Argon STs financial
instruments include cash and cash equivalents, accounts receivable, accounts
payable and notes payable. Note 13 Related Party Transactions An individual who is a director, executive officer and significant
shareholder of Argon ST is also a director and significant shareholder of James
Monroe Bank, where the Company has a revolving line of credit in the amount of
$5,000,000. There were no outstanding advances on the line as of September 30,
2004, except for a letter of credit in the amount of $976,000 securing the
Companys obligation under its office lease agreement. The line of credit
expires December 31, 2004 and the letter of credit will be transferred to Bank
of America, see Note 6. At September 30, 2004, the Company had $21,559,000 on deposit
at James Monroe Bank. Note 14  Treasury Stock In connection with the merger with Sensytech, 126,245 shares of treasury
stock at a cost of $534,000 was recorded in the consolidated statements of
stockholders equity. During 2000, Sensytech began acquiring shares of its
common stock in connection with a stock repurchase program announced in May,
2000. That program authorizes the Company to purchase up to 500,000 common 43




---



##### 



shares from time to time on the open market. Note 15  Segment Reporting Argon Engineering historically operated in a single business segment.
Sensytech historically operated in two business segments. For the fiscal years
ended September 30, 2004, 2003, and 2002, the results of operations included in
this report are reported for Argon Engineerings single business segment. Management is
reviewing its business operations and intends to report results of operations
for business segments in the first quarter of fiscal year 2005. During that
time, management will also allocate the goodwill arising from the merger to its
reporting segments in accordance with SFAS 142. Note 16  Quarterly Financial Information (Unaudited) Argon Engineering maintains a September 30 fiscal year-end for annual
financial reporting purposes. Argon Engineering presents its interim periods ending on the
last Sunday of the month for each quarter consistent with labor and billing
cycles. As a result, the fourth quarter of each year may contain more days than
earlier quarters of the year. Management does not believe that this practice
has a material effect on quarterly results. The following tables contain
selected unaudited consolidated statement of earnings data for each quarter of
fiscal years 2004 and 2003. 2004
    
    2003December 28,
    
    March 28,
    
    June 27,
    
    September 30,
    
    December 29,
    
    March 30,
    
    June 29,
    
    September 30,2003
    
    2004
    
    2004
    
    2004
    
    2002
    
    2003
    
    2003
    
    2003(unaudited)
    
    (unaudited)(In thousands, except per share data)
    
    (In thousands, except per share data)Contract Revenues
    
    $
    27,293
    
    
    $
    22,683
    
    
    $
    39,050
    
    
    $
    40,158
    
    
    $
    15,157
    
    
    $
    18,920
    
    
    $
    18,173
    
    
    $
    27,099Direct and Allocable
Contract Costs
    
    
    24,993
    
    
    
    19,631
    
    
    
    33,653
    
    
    
    34,935
    
    
    
    13,964
    
    
    
    17,126
    
    
    
    16,192
    
    
    
    23,833Income from
Operations
    
    
    2,300
    
    
    
    3,052
    
    
    
    5,397
    
    
    
    5,223
    
    
    
    1,193
    
    
    
    1,794
    
    
    
    1,981
    
    
    
    3,266Other Income
(Expense), Net
    
    
    8
    
    
    
    38
    
    
    
    34
    
    
    
    74
    
    
    
    15
    
    
    
    (1
    )
    
    
    7
    
    
    
    10Income before
Provision for
Income Taxes
    
    
    2,308
    
    
    
    3,090
    
    
    
    5,431
    
    
    
    5,297
    
    
    
    1,208
    
    
    
    1,793
    
    
    
    1,988
    
    
    
    3,276Provision for Income
Taxes
    
    
    851
    
    
    
    1,141
    
    
    
    2,004
    
    
    
    2,181
    
    
    
    436
    
    
    
    647
    
    
    
    718
    
    
    
    895Net Income
    
    $
    1,457
    
    
    $
    1,949
    
    
    $
    3,427
    
    
    $
    3,116
    
    
    $
    772
    
    
    $
    1,146
    
    
    $
    1,270
    
    
    $
    2,381Earnings Per ShareBasic
    
    $
    0.12
    
    
    $
    0.16
    
    
    $
    0.28
    
    
    $
    0.25
    
    
    $
    0.07
    
    
    $
    0.09
    
    
    $
    0.11
    
    
    $
    0.20Diluted
    
    $
    0.11
    
    
    $
    0.14
    
    
    $
    0.26
    
    
    $
    0.23
    
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.09
    
    
    $
    0.19
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On May 18, 2004, Argon Engineering replaced Watkins, Meegan, Drury &
Company, L.L.C. (WMD&C), its outside Public Accounting Firm, with Grant
Thornton LLP, (Grant Thornton) an Independent Registered Public Accounting
Firm, which reported on Argon Engineerings financial statements for the fiscal
years ended September 30, 2003 and 2002. 44




---



##### 



The report of WMD&C, the outside Public Accounting Firm on Argon
Engineerings financial statements for the fiscal years ended September 30,
2003 and 2002 did not contain an adverse opinion or disclaimer of opinion, nor
was it qualified as to the audit scope or accounting principles. During the
fiscal years ended September 30, 2003 and 2002 and the subsequent periods
preceding the decision to change its public accounting firm, there were no
disagreements with WMD&C on any matter of accounting principles or practices,
financial statement disclosures, or auditing scope or procedures, or other
reportable event (of the type described in Item 304 (a) (1) (v) of Regulation
S-K), which disagreements(s), if not resolved to the satisfaction of WMD&C, would
have caused it to make reference to the subject matter of the disagreements(s)
in connection with its report. On September 30, 2004, the Audit Committee of the Companys Board of
Directors dismissed PricewaterhouseCoopers LLP (PricewaterhouseCoopers) and
appointed Grant Thornton as the Companys Independent Registered Public
Accounting Firm. The report of PricewaterhouseCoopers on Sensytechs consolidated financial
statements for the fiscal years ended September 30, 2003 and 2002 did not
contain an adverse opinion or disclaimer of opinion, nor was it qualified or
modified as to uncertainty, audit scope or accounting principle. During the
fiscal years ended September 30, 2003 and 2002 and through September 30, 2004,
there were no disagreements with PricewaterhouseCoopers on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements if not resolved to the satisfaction of
PricewaterhouseCoopers, would have caused them to make reference thereto in
their reports on the financial statements for such years. During the fiscal
years ended September 30, 2003 and 2002 and through September 30, 2004, there
were no reportable events as defined in Item 304 (a) (1) (v) of Regulation S-K. ITEM 9A. 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 of the end of the period
covered by this Annual Report on Form 10-K. Based on this evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded
that our disclosure controls and procedures are effective to ensure
that information we are required to disclose in reports that we file
or submit under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.(b)
    
    During the last fiscal quarter, there were no significant changes
in the Companys internal controls or in other factors that have
materially affected these controls, or are reasonably likely to
materially affect these controls subsequent to the evaluation of these
controls. ITEM 9B. OTHER INFORMATION. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to Executive Officers and Directors of the
Company, the Audit Committee Financial Expert and the Companys Code of Ethics
is incorporated by reference from the registrants definitive proxy statement
for its annual meeting of stockholders to be filed not later than 120 days
after September 30, 2004, with the Securities and Exchange Commission pursuant
to Regulation 14A (the Proxy Statement). Certain information relating to
Executive Officers of the Company appears on page 10 of this Form 10-K Annual
Report. ITEM 11. EXECUTIVE COMPENSATION Information with respect to this item is incorporated by reference from
the Proxy Statement. 45




---



##### 



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information with respect to this item is incorporated by reference from
the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information with respect to this item is incorporated by reference from
the Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information with respect to Principal Accountant Fees and Services is
contained under the caption Principal Accountant Fees and Services in the
Proxy Statement and such information is incorporated herein by reference. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES Financial Statements
Schedules All of the financial statement schedules to be filed as part of the Annual
report on Form 10-K are included in Item 8. 46




---



##### 



Exhibits ExhibitNumber
    
    Description of Exhibit2.1
    
    Agreement and Plan of Merger dated as of June
7, 2004, by and between Sensytech, Inc. and
Argon Engineering Associates, Inc.
(incorporated by reference to Exhibit 2.1 of
registrants Registration Statement on Form
S-4 filed on July 16, 2004, Registration
Statement No. 333-117430)3.1
    
    Amended and Restated Certificate of
Incorporation of the registrant (incorporated
by reference to Exhibit 3.1 of registrants
Registration Statement on Form S-1 filed on
August 26, 2002, Registration Statement No.
333-98757)3.1.1
    
    Amendment to the registrants Amended and
Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 the
registrants Current Report on Form 8-K
covering Items 2.10, 5.01, 5.02, 8.01 and 9.01
of Form 8-K, filed October 5, 2004).3.2
    
    Amended and Restated Bylaws of the registrant
(incorporated by reference to Exhibit 13(a)(i)
of registrants Report on Form 10-KSB for the
Year Ended September 30, 2001, Commission File
No. 000-08193)4.1
    
    Form of Common Stock Certificate (incorporated
by reference to Exhibit 4.1 of registrants
Registration Statement on Form S-1 filed on
August 26, 2002, Registration Statement No.
333-987570)10.1
    
    Amended and Restated Line of Credit Agreement
with Bank of America (incorporated by
reference to Exhibit 10.1 of registrants
Registration Statement on Form S-1 filed on
August 26, 2002, Registration Statement No.
333-98757)10.1.1
    
    Third Amendment to Second Amended and Restated
Financing and Security Agreement (incorporated
by reference to Exhibit 10.1 of registrants
Report on Form 10-Q for the quarter ended
March 31, 2004, Commission File No. 000-08193)10.2+
    
    The Sensytech, Inc. 2002 Stock Incentive Plan
(incorporated by reference to registrants
Schedule 14A filed with the Commission on
April 22, 2002, Commission File No. 000-08193)10.3*+
    
    Argon Engineering Associates, Inc. Stock Plan10.4+
    
    Retention Agreement dated February 17, 2004,
by and between the registrant and Donald F.
Fultz (incorporated by reference to Exhibit
10.3 of registrants Registration Statement on
Form S-4 filed on July 16, 2004, Registration
Statement No. 333-117430)10.5+
    
    Retention Agreement dated February 17, 2004,
by and between the registrant and S. Kent
Rockwell (incorporated by reference to Exhibit
10.4 of registrants Registration Statement on
Form S-4 filed on July 16, 2004, Registration
Statement No. 333-117430)16.1
    
    Letter of PricewaterhouseCoopers LLP regarding
change in certifying accountant (incorporated
by reference to Exhibit 16.1 to the
registrants Current Report on Form 8-K
covering Items 4.01 and 9.01 of Form 8-K,
filed October 5, 2004)16.2
    
    Letter of Watkins, Meegan, Dury & Company,
L.L.C. regarding change in certifying
accountant (incorporated by reference to
Exhibit 16.2 to the registrants Current
Report on Form 8-K covering Items 4.01 and
9.01 of Form 8-K, filed October 5, 2004)21.1*
    
    Subsidiaries of the registrant23.1*
    
    Consent of Grant Thornton LLP31.1*
    
    Certification of the registrants Chief
Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities
Exchange Act31.2*
    
    Certification of the registrants Chief
Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities
Exchange Act32.1**
    
    Certification pursuant to Rule
13a-14(b)/15d-14(b) under the Securities
Exchange Act and Section 1350 of Chapter 63 of
Title 8 of the United States Code
   *
    
    Filed herewith**
    
    Furnished herewith+
    
    Indicates management contract or compensatory plan or arrangement 47




---



##### 



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. CollinsTerry L. Collins, Ph.D.Chairman and Chief Executive Officer Date: December 14, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title/s/ Terry L. Collins
    
    Chairman and Chief Executive OfficerTerry L. CollinsDate: December 14, 2004/s/ S. Kent Rockwell
    
    Vice Chairman and Vice President, Corporate DevelopmentS. Kent RockwellDate: December 14, 2004/s/ Victor F. Sellier
    
    Vice President, Business Operations and DirectorVictor F. SellierDate: December 14, 2004/s/ Thomas E. Murdock
    
    Vice President, Strategic Planning and DirectorThomas E. MurdockDate: December 14, 2004/s/ Donald F. Fultz
    
    Chief Financial Officer
(Principal Financial and Accounting Officer)Donald F. FultzDate: December 14, 2004/s/Delores M. Etter
    
    DirectorDelores M. Etter, Ph.D.Date: December 14, 2004/s/David C. Karlgaard
    
    DirectorDavid C. KarlgaardDate: December 14, 2004/s/ Peter A. Marino
    
    DirectorPeter A. MarinoDate: December 14, 2004/s/Robert McCashin
    
    DirectorRobert McCashinDate: December 14, 2004
 48




---



##### 



Signature
    
    Title/s/John Irvin
    
    DirectorJohn IrvinDate: December 14, 2004/s/Lloyd A. Semple
    
    DirectorLloyd A. SempleDate: December 14, 2004
 49