Applied Signal Needs a Boost

Our country is at war, and we're going on five years of elevated terror threat levels, but that doesn't mean that defense and homeland-security companies are guaranteed to excel. Case in point: Applied Signal Technology (NASDAQ:APSG), a company that makes radio-frequency and microwave scanners, as well as detection devices that can find explosives and other hazardous materials through walls. Applied Signal depends on homeland-security orders for its livelihood, but maybe it's time for the company to look for new markets to enter.

Sales this quarter barely budged from last year, up 8.8% to $39.5 million, and net earnings were nearly cut in half at $0.08 per share, versus the year-ago figure of $0.15. The difference, according to management, results from stock-based compensation expenses of $0.9 million, a higher tax rate than last year because some option costs are not deductible, and an increase of $250,000 in reserves set aside to account for contract costs that will not be recovered on this fiscal year's income. That's about $1.3 million of costs, or about $0.10 per diluted share. Ouch.

But that's just the latest painful performance in a long line of them. Eighteen months ago, Applied Signal sported a trailing-12-month net margin of 8.2% and trailing return on equity of 13.8%. After a steady march downward, last quarter's TTM net margin was down to 4.5% and ROE to 7.9%. This report brings the measures down to 3.9% and 6.5%, respectively.

In all fairness, other homeland-security suppliers -- like Applied Signal's closest competitor Argon ST (NASDAQ:STST), Motley Fool Rule Breakers pick American Science & Engineering (NASDAQ:ASEI), and the much larger L-3 Communications (NYSE:LLL) -- have seen some compression of margins and ROE the past couple of quarters, but with none of the magnitude or persistence shown at Applied Signal.

In the earnings report, CEO Gary Yancey tries to spin this as a successful quarter based on good "program performance." He used that term four times in two paragraphs of business discussion, with no mention of the weak financial performance. A prolonged drop-off in important financial metrics sometimes signals feeble management, and bringing out the spin doctors only serves to further reduce my trust in the people in charge. There are plenty of better places to invest your money, in my humble opinion.

Further Foolishness:

• American Science requires a stoic investor.
• Is your vacuum cleaner fighting for freedom?
• Read up on defense and security issues the Foolish way.

American Science & Engineering is a Motley Fool Rule Breakers recommendation. To see why, try a 30-day free trial to our newsletter service that's on a quest for the ultimate growth stock.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. You can check out Anders' holdingsif you like. Foolishdisclosureis clearly readable without neutron imaging equipment.