Segments
We have reviewed our business operations and determined that we operate in a single homogeneous business segment. Our financial information is reviewed and evaluated by the chief operating decision maker on a consolidated basis relating to the single business. We sell similar products and services that exhibit similar economic characteristics to similar classes of customers, primarily the U.S. government. Revenue is internally reviewed monthly by management on an individual contract basis as a single business. Revenues
Our revenues are primarily generated from the entire life cycle of complex sensor systems under contracts predominately with the U.S. government and major domestic prime contractors, as well as with foreign governments, agencies and defense contractors. This life cycle spans across the design, development, production, installation and support of the system.
Our government contracts can be divided into three major types: cost reimbursable, fixed-price and time and materials.
Cost reimbursable contracts are primarily used for system design and development activities in the early stages of the life cycle. Cost reimbursable contracts typically have profit margins that are less than fixed price contracts as the U.S. government customer assumes the cost risk on these contracts. However, even though the U.S. Government customer bears the cost risk, the contractor is not allowed to exceed the cost ceiling on the contract without the approval of the customer. Cost reimbursable contracts are used in the early stages of the life cycle since these activities typically involve considerable risks to the contractor, including risks related to cost estimates on complex systems, performance risks associated with real time signal processing, embedded software, high performance hardware, and requirements that are not fully understood by the customer or us, the development of technology that has never been used, and interfaces with other systems that are in development or are obsolete without adequate documentation. Fees under these contracts are usually fixed at the time of negotiation; however, in some cases the fee is an incentive or award fee based on cost, schedule, and performance or a combination of those factors.
Fixed-price contracts are typically used for the production stages of the life cycle of our systems. Development activities similar to activities performed under previous contacts may also be covered by fixed-price contracts, due to the low risk involved. In these contracts profit margins are generally higher than the cost reimbursable contracts as cost risks are borne entirely by the contractor. Some fixed-price contracts include an award fee or an incentive fee as well as the negotiated profit. Most foreign customers, and some U.S. customers, use fixed-price contracts for design and development work even when the work is considered high risk.
Time and materials contracts are based on hours worked, multiplied by approved labor rates, plus other costs incurred and allocated.
The following table represents our revenue concentration by contract type for the periods indicated:

                                                           Fiscal Year Ended
                                                             September 30,            Fiscal Year Ended          Fiscal Year Ended
Contract Type                                                    2008                September 30, 2007         September 30, 2006
Fixed-price contracts                                                 58 %                       60 %                       65 %

Cost reimbursable contracts                                           38 %                       35 %                       25 %

Time and materials contracts                                           4 %                        5 %                       10 %

We approach each program with attentiveness to the system life cycle to optimize the opportunity for longer tem relationships involving the higher margin production content. As such, much of our current production work has been derived from programs for which we have performed the initial development work. These programs are next generation systems replacing existing, obsolete systems that were developed by other companies. We were able to displace these companies primarily on the basis of technological capability. We believe that the current state of world affairs and the U.S. government's emphasis on protecting U.S. citizens will cause funding of these programs to continue.
The increase in our contract mix of cost-reimbursable contracts for the year ended September 30, 2008 as compared to the year ended September 30, 2007 resulted primarily from the addition of contracts from Coherent and the effects of the contributed revenue from our cost-reimbursable development type contracts, including the SSEE Increment F program. Coherent was acquired in the fourth quarter of fiscal year 2007 and had a significant amount of cost-reimbursable type contracts.
Backlog
We define backlog as the funded and unfunded amount provided in our contracts, less previously recognized revenue. Contract options are estimated separately and not included in backlog until they are exercised and funded. Backlog does not include the value of a contract where the customer has given permission to begin or continue working, but where a formal contract or contract extension has not yet been signed.
Our funded backlog does not include the full value of our contracts, because Congress often appropriates funds for a particular program or contract on a yearly or quarterly basis, even though the contract may call for performance that is expected to take a number of years.
From time to time, we will exclude from backlog portions of contract values of very long or complex contracts where we judge revenue could be jeopardized by a change in government policy. Because of possible future changes in delivery schedules and cancellations of orders, backlog at any particular date is not necessarily representative of actual sales to be expected for any succeeding period, and actual sales for the year may not meet or exceed the backlog represented. We may experience significant contract cancellations that were previously booked and included in backlog.
Our backlog consisted of the following at September 30:

                  (In thousands)     2008          2007          2006
                  Funded           $ 272,620     $ 246,571     $ 162,796
                  Unfunded            54,672        58,279        62,373

                  Total            $ 327,292     $ 304,850     $ 225,169

Our total, funded and unfunded backlog as of the end of any fiscal quarter or year may fluctuate due to numerous factors, including the schedule for and timing of contract awards we are pursuing, the timing of government contracts we have been awarded and our success in winning new and follow-on contract awards. Cost of Revenues
Cost of revenues consist of direct costs incurred on contracts such as labor, materials, travel, subcontracts and other direct costs and indirect costs associated with overhead expenses such as facilities, fringe benefits and other costs that are not directly related to the execution of a specific contract. We plan indirect costs on an annual basis and on cost reimbursable contracts receive government approval to bill those costs as a percentage of our direct labor, other direct costs and direct materials as we execute our contracts. The U.S. government approves the planned indirect rates as provisional billing rates near the beginning of each fiscal year.
General and Administrative Expenses
Our general and administrative expenses include administrative salaries, costs related to proposal activities, and other administrative costs.

Research and Development
We conduct internally funded research and development into complex signal processing, system and software architectures, and other technologies that are important to continued advancement of our systems and are of interest to our current and prospective customers. The variance from year to year in internal research and development is caused by the status of our product cycles and the level of complementary U.S. government funded research and development.
The table below shows our research and development expenditures for the periods indicated. As shown in this table, internal research and development is a small portion of our overall research and development, as government funded research and development constitutes the majority of our activities in this area.

      (In thousands)                               2008         2007         2006
      Internal research and development          $  6,656     $  7,035     $  6,286
      Customer-funded research and development     80,005       73,397       50,130

      Total                                      $ 86,661     $ 80,432     $ 56,416

In fiscal years 2008, 2007 and 2006, internal research and development expenditures represented 2.0%, 2.5% and 2.4% of our revenues, respectively. We expect that research and development expenses will continue to represent approximately 2% to 3% of our consolidated revenue in future periods. Interest Income, net
Net interest income is derived solely from interest earned on cash reserves maintained in short-term investment accounts and are therefore subject to short-term interest rates that have minimal risk. Critical Accounting Policies and Estimates General
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements. These financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We believe that the estimates, assumptions, and judgments involved in the accounting practices described below have the greatest potential impact on our financial statements and, therefore, consider these to be critical accounting policies. Revenue and Cost Recognition
General
The majority of our contracts, which are with the U.S. government, are accounted for in accordance with the American Institute of Certified Public Accountants Statement of Position 81-1, Accounting for Performance of Construction-Type and Production-Type Contracts. These contracts are transacted using written contractual arrangements, most of which require us to design, develop, manufacture and/or modify complex products and systems, and perform related services according to specifications provided by the customer. We account for fixed-price contracts by using the percentage-of-completion method of accounting and for substantially all contracts, the cost-to-cost method is used to measure progress towards completion. Under this method, contract costs are charged to operations as incurred. A portion of the contract revenue, based on estimated profits and the degree of completion of the contract as measured by a comparison of the actual and estimated costs, is recognized as revenue each period. In the case of contracts with materials requirements, revenue is recognized as those materials are applied to the production process in satisfaction of the contracts' end objectives. We account for cost reimbursable contracts by charging contract costs to operations as incurred and recognizing contract revenues and profits by applying the negotiated fee rate to actual costs on an individual contract basis.

Contract revenue recognition inherently involves estimation. Examples of estimates include the contemplated level of effort to accomplish the tasks under the contract, the cost of the effort, and an ongoing assessment of our progress toward completing the contract. From time to time, as part of our management processes, facts develop that require us to revise our estimated total costs or revenue. To the extent that a revised estimate affects contract profit or revenue previously recognized, we record the cumulative effect of the revision in the period in which the facts requiring the revision become known.
Anticipated losses on contracts are also recorded in the period in which they become determinable. Unexpected increases in the cost to develop or manufacture a product, whether due to inaccurate estimates in the bidding process, unanticipated increases in material costs, inefficiencies, or other factors are borne by us on fixed-price contracts, and could have a material adverse effect on results of operations and financial condition. Unexpected cost increases in cost reimbursable contracts may be borne by us for purposes of maintaining customer relationships. If the customer agrees to fund cost increases on cost type contracts, the additional work does not have any profit and therefore dilutes margin.
Indirect Rate Variance
We apply overhead and general and administrative expenses (indirect expenses) as a percentage of direct contract costs based on annual budgeted indirect expense rates. To the extent actual expenses for an interim period are greater than the budgeted rates, the variance is deferred if management believes it is probable that the variance will be absorbed by future contract activity. This probability assessment includes projecting whether future indirect costs will be sufficiently less than the annual budgeted rates or can be absorbed by seeking increased billing rates applied on cost-plus-fee contracts. At the end of each interim reporting period, management assesses the recoverability of any amount deferred to determine if any portion should be charged to expense. In assessing the recoverability of variances deferred, management takes into consideration estimates of the amount of direct labor and other direct costs to be incurred in future interim periods, the feasibility of modifications for provisional billing rates, and the likelihood that an approved increase in provisional billing rates can be passed along to a customer. Variances are charged to expense in the periods in which it is determined that such amounts are not probable of recovery. At the end of the fiscal year 2008, indirect rates are applied using actual costs incurred. Indirect rate variances of approximately $2.3 million were applied against contracts in the fourth quarter of fiscal year 2008. The variance was primarily due to a reduced direct labor base from several anticipated contracts commencing later than expected as well as a higher than anticipated expenditure related to business development initiatives.
Award Fee Recognition
Our practice for recognizing interim fee on our cost-plus-award-fee contracts is based on management's assessment as to the likelihood that the award fee or an incremental portion of the award fee will be earned on a contract-by-contract basis. Management's assessments are based on numerous factors including:
contract terms, nature of the work performed, our relationship and history with the customer, our history with similar types of projects, and our current and anticipated performance on the specific contract. No award fee is recognized until management determines that it is probable that an award fee or portion thereof will be earned. Actual fees awarded are typically within management's estimates. However, changes could arise within an award fee period causing management to either lower or raise the award fee estimate in the period in which it occurs.
Goodwill
Costs in excess of the fair value of tangible and identifiable intangible assets acquired and liabilities assumed in a business combination are recorded as goodwill. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we test for impairment at least annually using a two-step approach. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit's carrying amount, including goodwill, to the fair value of the reporting unit. During the years prior to fiscal year 2008, the Company operated as four reporting units, at which time, the fair value of each reporting unit was estimated using a combination of the income, or discounted cash flows approach and the market approach. During fiscal year 2008, due to the change in the Company's organizational structure and its operations, the Company operates as a single reporting unit.

The fair value of the reporting unit is estimated using a market capitalization approach. If the carrying amount of the unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. We performed the test during the fourth quarter of fiscal year 2008 and found no impairment to the carrying value of goodwill. Long-Lived Assets (Excluding Goodwill)
We follow the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS No. 144") in accounting for long-lived assets such as property and equipment and intangible assets subject to amortization. SFAS No.144 requires that long-lived assets be reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. An impairment loss is recognized if the sum of the long-term undiscounted cash flows is less than the carrying amount of the long-lived asset being evaluated. Impairment losses are treated as permanent reductions in the carrying amount of the assets. For the year ended September 30, 2007, we recorded a $6.7 million loss for the impairment of customer related intangible assets initially recorded at the time of the SDRC, ProDesign and IRIS acquisitions. A change in our assumptions used to measure impairment could cause an additional impairment in the future. Accounts Receivable
We are required to estimate the collectability of our 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 us. Since most of our revenue is generated under U.S. government contracts, our current accounts receivable reserve is not significant to our overall receivables balance.
Stock-Based Compensation
Effective October 1, 2005, the Company adopted Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, ("SFAS No. 123R") using the modified prospective method. Under this method, compensation costs for all awards granted after the date of adoption and the unvested portion of previously granted awards outstanding at the date of adoption are measured at estimated fair value. The compensation expense is amortized on a straight-line basis over the requisite service period of the grant and included in operating expenses over the vesting period during which an employee provides service in exchange for the award. See Note 8 for further disclosure of our stock-based benefit plans and related activity.
Fair Value Determination
We use a Binomial option pricing model, based on the Hull and White model. We will reconsider use of the Binomial model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model.
In calculating fair value, we use the following assumptions.
Expected Volatility. The expected volatility of the our shares was estimated based upon the historical volatility of share price of our common stock over a historical period, as being representative of the price volatility expected in the future. This volatility is comparable to the volatilities reported by companies within the Company's peer group.
Risk-free Interest Rate. We based the risk-free interest rate used in the Binomial valuation method on the implied yield available on a U.S. Treasury note on the applicable grant date, with a term equal to the expected term of the underlying grants.

Dividend Yield. The Binomial valuation model calls for a single expected dividend yield as an input. The Company has not paid dividends in the past nor does it expect to pay dividends in the future. As such, we used a dividend yield percentage of zero.
Expected Term. The expected term used in this Binomial model is ten years, the contractual term of the options.
Exercise Factor. The exercise factor is the ratio by which the stock price must increase from the exercise price before the employee is expected to exercise, as estimated by management.
Post-vest Percentage. The post-vest percentage is the rate at which employees are likely to exercise their options earlier than usual as a result of their termination of employment, as estimated by management. Employees have 90 days and directors have 1 year to exercise their options upon termination of employment or resignation from the board. The post-vest percentages used in valuing options granted during the years ended September 30, 2008, 2007 and 2006 were 1.94%, 5.78% and 3.08%, respectively. For options granted to directors and certain individual awards, the post vest percentage was zero. Historical Operating Results
Fiscal year ended September 30, 2008 compared to fiscal year ended September 30, 2007
The following table sets forth certain items, including consolidated revenues, cost of revenues, general and administrative expenses, research and development expenses, impairment of intangible assets, interest income and expense and income tax expense and net income, and the changes in these items for the fiscal years indicated:

                                                                                                            Increase
                                                           September 30,          September 30,          (Decrease) 2007
(Amounts in thousands)                                         2008                   2007              Compared to 2006
Contract revenues                                         $     340,934          $     282,209           $       58,725
Cost of revenues                                                279,932                229,767                   50,165
General and administrative expenses                              22,432                 17,342                    5,090
Research and development expenses                                 6,656                  7,035                     (379 )
Impairment of intangible assets                                       -                  6,748                   (6,748 )
Interest income and interest expense                                615                  1,318                     (703 )
Provision for income taxes                                       12,256                  7,933                    4,323
Net income                                                       20,273                 14,702                    5,571

Contract Revenues:
Revenues increased approximately $58.7 million or 21% during fiscal year 2008. The increase in revenues is primarily attributable to the inclusion of Coherent operations, which were acquired in the fourth quarter of fiscal 2007, and contributed approximately $27 million of the increase. Additionally, three contracts related to tactical communications and networking capabilities contributed approximately $13 million the increase in revenues. The remaining increase is due to work performed on backlog existing as of the beginning of our fiscal year and additional contract awards in 2008 across a broad spectrum of our business.

Cost of Revenues:
Cost of revenues increased approximately $50.2 million or 22% for fiscal year 2008 as compared to fiscal year 2007. The increase was primarily due to increased contract activity and increased revenue as well as the inclusion of the operations of Coherent. Direct materials costs increased $14.8 million and direct labor increased $7.6 million consistent with the increase in production activity, including the SSEE programs. Other direct costs, including costs related to subcontracted work, increased $15.0 million. As a result of the increased direct costs, overhead costs allocable to such direct costs increased $11.4 million. We also realized increases in other costs including a $1.0 million increase in stock-based compensation included in cost of revenue and a $0.4 million increase in costs associated with a retention bonus related to the acquisition of SDRC. Cost of revenues as a percentage of total revenue increased to 82% for the year ended September 30, 2008 as compared to 81% for the year ended September 30, 2007. This increase is due to both the increase in the stock-based compensation and retention bonus amounts as well as an increase . . .