APPLIED SIGNAL TECHNOLOGY INC, 10-Q, 1997-06-16

APPLIED SIGNAL TECHNOLOGY INC
10-Q, 1997-06-16
RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT

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<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

FOR THE PERIOD ENDED MAY 2, 1997

[ ] 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 0-21236

APPLIED SIGNAL TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)

CALIFORNIA 77-0015491
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

400 WEST CALIFORNIA AVENUE, SUNNYVALE, CA 94086
(408) 749-1888
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)

Indicate by a check 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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days YES [X] NO [ ]

Applicable Only to Corporate Issuers

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.

Common Stock, no par value, 8,052,548 shares outstanding as of May 29, 1997.

This Quarterly Report on Form 10-Q consists of pages. The Exhibit Index is on
page 20.

<PAGE> 2
INDEX

APPLIED SIGNAL TECHNOLOGY, INC.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Balance Sheets -- May 2, 1997 and October 31, 1996

Statements of Operations -- Three months ended May 2, 1997 and
May 3, 1996; Six months ended May 2, 1997 and May 3, 1996

Statements of Cash Flows -- Six months ended May 2, 1997 and
May 3, 1996

Notes to Financial Statements -- May 2, 1997

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 4. Submission of Matters to a Vote of Security Holders

Item 6. Exhibits and Reports on Form 8-K

Signatures

Index to Exhibits

<PAGE> 3
PART I. FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

APPLIED SIGNAL TECHNOLOGY, INC.
BALANCE SHEETS

(In thousands, except share data)

<TABLE>
<CAPTION>
ASSETS MAY 2, 1997 OCTOBER 31, 1996
(UNAUDITED) (NOTE)
-------- --------
<S> <C> <C>
Current assets:
Cash $ -- $ 1,559
Short term investments 1,564 767
Accounts receivable:
Billed 13,964 14,491
Unbilled 17,606 15,527
-------- --------
Total accounts receivable 31,570 30,018
Inventory 5,390 3,208
Prepaid and other current assets 2,586 2,236
-------- --------
Total current assets 41,110 37,788

Property and equipment, at cost:
Machinery and equipment 25,034 23,221
Furniture and fixtures 3,471 3,301
Leasehold improvements 4,422 3,356
Construction in process 279 191
-------- --------
33,206 30,069
Accumulated depreciation and amortization (19,164) (17,198)
-------- --------
Net property and equipment 14,042 12,871

Long-term investments 525 1,326

Other assets 116 118
-------- --------

Total assets $ 55,793 $ 52,103
======== ========
</TABLE>

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<PAGE> 4
APPLIED SIGNAL TECHNOLOGY, INC.
BALANCE SHEETS (continued)

(In thousands, except share data)

<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY MAY 2, 1997 OCTOBER 31, 1996
(UNAUDITED) (NOTE)
-------- --------
<S> <C> <C>
Current liabilities:
Accounts payable $ 3,100 $ 3,045
Accrued payroll and related benefits 4,469 4,337
Other accrued liabilities 2,484 1,900
Income taxes payable 1,796 2,029
-------- --------
Total current liabilities 11,849 11,311

Deferred income taxes 827 827

Shareholders' equity:
Common stock, no par value: 20,000,000 shares
authorized; issued and outstanding--8,034,928 at
May 2, 1997 and 7,873,347 at October 31, 1996 20,669 20,099
Retained earnings 22,459 19,872
Net unrealized gain/(loss) on securities (11) (6)
-------- --------
Total shareholders' equity 41,117 39,965
-------- --------
Total liabilities and
shareholders' equity $ 55,793 $ 52,103
======== ========
</TABLE>

Note: The balance sheet at October 31, 1996 has been derived from the audited
financial statements at that date but does not include all of the information
and features required by generally accepted accounting principles for complete
financial statements.

See notes to financial statements.

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<PAGE> 5
APPLIED SIGNAL TECHNOLOGY, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share data)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- ------------------------------
MAY 2, 1997 MAY 3, 1996 MAY 2, 1997 MAY 3, 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues from contracts $ 23,987 $ 16,970 $ 44,071 $ 32,768

Operating expenses:
Contract costs 15,742 12,180 28,878 22,995
Research and development 2,394 2,155 4,864 4,067
General and administrative 3,171 2,528 6,353 5,368
-------- -------- -------- --------

Total operating expenses 21,307 16,863 40,095 32,430
-------- -------- -------- --------

Operating income 2,680 107 3,976 338
Interest income/(expense), net 37 (4) 98 15
-------- -------- -------- --------
Income before provision for
taxes on income 2,717 103 4,074 353
Provision for taxes on income 992 24 1,487 124
-------- -------- -------- --------

Net income $ 1,725 $ 79 $ 2,587 $ 229
======== ======== ======== ========

Earnings per share $ 0.21 $ 0.01 $ 0.32 $ 0.03

Weighted average common shares
outstanding 8,156 7,905 8,135 7,840
</TABLE>

5
<PAGE> 6
APPLIED SIGNAL TECHNOLOGY, INC.
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH
(UNAUDITED)
(In thousands)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------
MAY 2, 1997 MAY 3, 1996
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 2,587 $ 229
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,966 1,771
Accounts receivable (1,552) 4,878
Inventory, prepaids and other current assets (2,533) (3,801)
Other assets 2 66
Accounts payable and accrued expenses 538 (1,426)
------- -------
Net cash provided by operating activities 1,008 1,717

INVESTING ACTIVITIES:
Additions to property and equipment (3,137) (3,170)
------- -------
Net cash (used in) investing activities (3,137) (3,170)

FINANCING ACTIVITIES:
Increase in bank line of credit -- 500
Issuance of common stock 570 585
Repurchase of common stock -- (1)
------- -------
Net cash provided by financing activities 570 1,084
------- -------
Net decrease in cash and cash equivalents (1,559) (369)
Cash at beginning of period 1,559 369
------- -------
Cash at end of period $ 0 $ 0
======= =======
Supplemental disclosures of cash flow information:
Interest paid $ 30 $ 51
Taxes paid $ 1,720 $ 780
</TABLE>

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APPLIED SIGNAL TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

May 2, 1997

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the six month period
ending May 2, 1997 are not necessarily indicative of the results that may be
expected for the year ending October 31, 1997. For further information, refer to
the financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended October 31, 1996.

INVESTMENTS

The Company's investment securities, which consist primarily of
U.S. Treasury securities, are classified as available-for-sale and are carried
at fair market value. Unrealized gains and losses, net of tax, are reported as a
separate component of shareholders' equity. Realized gains and losses on
available-for-sale securities are included in interest income (expense), net.
The cost of securities sold is based on the specific identification method.
Interest on securities classified as available-for-sale is included in interest
income (expense), net. As of May 2, 1997, the contractual maturities of the debt
securities will mature by June 30, 1998.

REVENUES FROM CONTRACTS

The Company accounts for fixed price contracts using the
percentage-of-completion method of accounting. Under this method, all contract
costs are charged to operations as incurred; and a portion of the contract
revenues, 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 revenues each quarter. The Company accounts for cost reimbursement
contracts by charging contract costs to operations as incurred and recognizing
contract revenues and profits by applying an estimated fee rate to actual costs.
Management reviews contract performance, costs incurred and estimated completion
costs regularly and adjusts revenues and profits on contracts in the month in
which changes become determinable.

EARNINGS PER SHARE

Earnings per share (EPS) are based on the weighted average number
of common and common equivalent shares outstanding. Common equivalent shares
result from the assumed exercise of outstanding stock options that have a
dilutive effect when applying the treasury stock method. Earnings per share is
calculated using the weighted average number of common shares outstanding during
the period.

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<PAGE> 8
In February 1997, the Financial Accounting Standards Board issued
Statement of Accounting Standards No. 128 (SFAS No. 128), "Earnings per Share."
The Statement is effective for periods ending after December 15, 1997, at which
time the Company will be required to change the method currently used to compute
EPS. SFAS No. 128 will require entities to report "basic" and "diluted" earnings
per share. For the Company, the "basic" earnings per share calculation is
equivalent to its present EPS calculation, excluding the effect of dilutive
stock options. The "diluted" earnings per share calculation is equivalent to the
existing EPS calculation. The Company has determined that, on a pro forma basis
with respect to each income statement line for which it presently reports an EPS
amount, "basic" earnings per share would have been $0.22 and $0.01 for the three
months ended May 2, 1997 and May 3, 1996 respectively, and $0.33 and $0.03 for
the six month period ending on those respective dates.

ACCOUNTING FOR STOCK-BASED COMPENSATION

In October 1995, the Financial Accounting Standards Board issued
Statement No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." SFAS
123 encourages entities to adopt a fair value based method of accounting for
employee stock compensation plans, however it also allows an entity to continue
to measure compensation cost for those plans using the intrinsic value method of
accounting. Under the intrinsic value based method, many companies, including
Applied Signal Technology, Inc., have not recognized compensation cost for stock
options granted to their employees.

The Company will adopt SFAS 123 during fiscal year 1997. While
the Company has not yet determined the total effect of adopting SFAS 123, it
believes that the adoption of the standard will not result in material charges
to operations in fiscal 1997 and thereafter.

NOTE 2 -- INVENTORY

The components of inventory consist of the following (in thousands):

<TABLE>
<CAPTION>
MAY 2, 1997 OCTOBER 31, 1996
----------- ----------------
<S> <C> <C>
Raw Materials $ 722 $ 591
Work in Process 4,413 2,195
Finished Goods 243 322
------ ------
5,378 3,108
Precontract Costs 12 100
------ ------
$5,390 $3,208
====== ======
</TABLE>

The Company records contract revenues and costs for interim reporting purposes
based on annual targeted indirect rates. At year end, the revenues and costs are
adjusted for actual indirect rates. During the interim reporting periods
variances may accumulate between the actual indirect rates and the annual
targeted rates. All timing-related indirect spending variances are inventoried
as part of work in process during these interim reporting periods. These rates
are reviewed regularly and any permanent variances are reflected in the income
statement as they become known. At May 2, 1997, the inventoried variance was
approximately $70,000 ($2,330,000 at May 3, 1996) and was included in work in
process. At October 31, 1996 the variance was zero since all revenues and costs
were recorded at the actual indirect rates for the fiscal year end.

8
<PAGE> 9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following information should be read in conjunction with the attached
financial statements and notes thereto.

This report contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the factors set forth in the "Summary of Business Considerations and Certain
Factors that May Affect Future Results of Operations and/or Stock Price."

BUSINESS ENVIRONMENT/BACKGROUND:

Applied Signal Technology designs, develops, manufactures and markets advanced
digital signal processing equipment to collect and process a wide range of
telecommunication signals for both signal reconnaissance and commercial
applications. This equipment is purchased by the U.S. Government as well as
allied foreign governments and is used for foreign signal reconnaissance. The
Company's commercial telecommunication processing equipment is used in digital
video transmission, cellular radio communication systems and as equipment for a
variety of both cable and wireless communication technologies.

Accurate and comprehensive information regarding foreign affairs and
developments continues to be important to the United States Government. The
reduction of United States military tactical forces overseas and the end of the
Cold War, compounded with political instability in certain regions such as the
Middle East, Eastern Europe, Africa and South America, has heightened the United
States Government's need to be able to monitor overseas activities. In order to
obtain information about activities within foreign countries, the United States
Government gathers and analyzes telecommunication signals emanating from those
countries.

The Company devotes significant resources toward understanding the United States
Government's signal reconnaissance goals, capabilities and perceived future
needs. The Company obtains information about these signal reconnaissance needs
through frequent marketing contact between its employees and technical and
contracting officials of the United States Government. The Company believes that
it has much more marketing contact with customers and potential customers than
is customary among its competitors. In addition, the Company invests in research
and development (R&D) which it anticipates will enable it to develop signal
reconnaissance equipment that meets these needs. The Company believes that it
invests a greater percentage of its revenues in R&D than is typical among its
competitors.

Traditionally, the United States Government has addressed its signal
reconnaissance needs with custom signal processing solutions which tend to be
both expensive and have long delivery times. These factors, combined with
budgetary constraints, have caused many government agencies to search for more
flexible and cost-effective signal reconnaissance solutions that can be deployed
promptly. The Company's signal reconnaissance products can be used, with or
without further modification, to satisfy requirements of a variety of customers.
The Company believes that custom equipment generally cannot be as readily
deployed in as wide a variety of circumstances as the Company's products. The
Company designs its products to use advanced circuitry, including
Company-designed application-specific integrated circuits

9
<PAGE> 10
(ASICs). This enables the Company to offer products that are smaller, consume
less power and cost customers less when multiple units are built.

Through a combination of customer and internally funded development, the Company
is judiciously seeking opportunities to expand its market reach. This is being
accomplished by capitalizing on the Company's accumulated knowledge of advanced
digital signal processing and telecommunications technologies in an effort to
either license the technology to the commercial sector or perform low-to-medium
volume manufacturing on select commercial subsystems.

The following table sets forth selected commercial telecommunications projects
for which the Company is currently in development and identifies the primary
customers:

<TABLE>
<CAPTION>
PRODUCT DESCRIPTION CUSTOMER(S)
------- ----------- -----------
<S> <C> <C>
QAMalyzer(TM) Digital test equipment for cable TCI,
service providers Southwestern Bell

Cell Phone Modem Modem chip design for the Ericsson
"Freeset 1900(TM)" PCS cellular phone Ericsson
</TABLE>

SUMMARY OF BUSINESS CONSIDERATIONS AND CERTAIN FACTORS THAT MAY AFFECT FUTURE
RESULTS OF OPERATIONS AND/OR STOCK PRICE:

The Company's future business, results of operations, and stock price may be
adversely affected in a material way due to the following factors:

CUSTOMER CONCENTRATION: Historically, U.S. Government defense and intelligence
agencies have accounted for almost all of the Company's revenues. Future
reductions in United States Government spending on signal reconnaissance
equipment or future changes in the kind of signal reconnaissance products or
services required by the United States Government agencies could limit demand
for the Company's products, which would have a material adverse effect on the
Company's future results of operations and financial condition.

Due to the award of certain larger contracts, the Company is experiencing a
higher concentration of revenues from a single contract. Revenue related to a
single contract comprised 23.6% of revenues for the first six months of fiscal
1997. This compares to 21.5% of revenue attributable to the single contract for
all of fiscal 1996.

COMPETITION: The signal reconnaissance equipment market is highly competitive
and the Company expects that competition will increase in the future. Some of
the Company's current and potential competitors have significantly greater
technical, manufacturing, financial and marketing resources than the Company.
Substantial competition could have a material adverse effect on the Company's
future operating results and financial condition.

10
<PAGE> 11
DEPENDENCE UPON PERSONNEL: The Company believes its employees are its most
valuable resource and, accordingly, focuses much of its attention on attracting
and retaining staff members. During the last year, the Company experienced an
increase in its attrition rate as well as difficulty in attracting new talent
into the Company due to increased competition for qualified personnel.
Management believes these effects are attributable to the expanding U.S. economy
and, in particular, the local California economy where the Company must compete
for new talent in the rapidly expanding telecommunications sector. The Company
has implemented a more aggressive recruiting program and an employee referral
program aimed at countering this environment. The Company's ability to execute
its business plan is contingent upon attracting and retaining qualified
employees. While the Company believes progress has been made during the most
recent quarters, there can be no assurance that the Company will be successful
at attracting and retaining sufficient personnel. Failure to do so will have a
material adverse effect on the Company's future results of operations and
financial condition.

DEPENDENCE UPON FIXED PRICE CONTRACTS; RISK OF CONTRACT TERMINATION: A
significant portion of the Company's revenues are derived from fixed-price
contracts. Under fixed-price contracts, unexpected increases in the cost to
develop or manufacture a product, whether due to inaccurate estimates in the
bidding process, unanticipated increases in materials costs, inefficiencies or
other factors, are borne by the Company. The Company has experienced cost
overruns in the past that have resulted in losses to the Company on contracts.
There can be no assurance that the Company will not experience cost overruns in
the future or that such overruns will not have a material adverse effect on the
Company's results of operations.

In addition, almost all of the Company's contracts contain termination clauses
which permit contract termination upon the Company's default or for the
convenience of the other contracting party. In either case, termination could
adversely affect the Company's operating results. Although the Company has not
experienced any material cancellations to date, there can be no assurance that
such cancellations will not occur in the future.

NARROW OPERATING MARGINS: The Company has experienced some constraint in
earnings resulting from lower average profitability on its production jobs. This
is due, in part, to the unfavorable adjustments in estimated costs-to-complete
on production jobs recorded during the prior fiscal year and due, in part, to
absorbing unrecoverable indirect costs at a rate higher than was provided for in
the contract prices of particular projects. The Company has taken several steps
aimed at improving its contract margins. These steps include revising prices of
its products and services, reviewing operational processes for efficiency and
examining cost structures. Although the Company believes improvements are
apparent in the operating results for the recent quarters, there can be no
assurances that these steps will result in improved future margins.

POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS AND MARKET VOLATILITY: The Company
has experienced significant fluctuations in operating results from quarter to
quarter and expects that it will continue to experience such fluctuations in the
future. These fluctuations are caused by, among other factors, conditions
inherent in government contracting and the Company's business, such as the
timing of cost and expense recognition for contracts and the United States
Government contracting and budget cycles. Fluctuations in quarterly results may
cause the price of the Company's common stock to fluctuate substantially. In
addition, there can be no assurance that an active trading market will be
sustained for the Company's common stock. The stock market in recent years has
experienced extreme price and volume fluctuations that have

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particularly affected the market prices of many technology companies and that
have been unrelated or disproportionately related to the operating performance
of such companies. These fluctuations, as well as general economic and market
conditions, may adversely affect the future market price of the Company's common
stock.

RAPID TECHNOLOGICAL CHANGE: The market for the Company's products is
characterized by rapidly changing technology. The Company believes that it has
been successful to date in identifying United States Government signal
reconnaissance needs early, investing in research and development to meet these
needs and delivering products before the Company's competitors. The Company
believes that its future success will depend upon continuing to develop and
introduce, in a timely manner, products capable of collecting or processing new
types of telecommunications signals. There can be no assurance that the Company
will be able to develop and market new products successfully in the future or
respond effectively to technological changes, such as data encryption technology
and others, or that new products introduced by others will not render the
Company's products or technologies noncompetitive or obsolete.

DEPENDENCE UPON CERTAIN SUPPLIERS: Although the Company procures most of its
parts and components from multiple sources or believes that these components are
readily available from numerous other sources, certain components are available
only from sole sources or from a limited number of sources. A number of the
Company's products contain critical components like single board computers
available solely from Motorola and Force Computers and digital signal processing
integrated circuits available solely from Texas Instruments. While the Company
believes that substitute components or assemblies could be obtained, use of
substitutes would require development of new suppliers or would require the
Company to re-engineer its products, or both, which could delay the Company's
shipment of its products and could have a material adverse effect on the
Company's results of operations.

EXPLORATION OF NEW MARKET OPPORTUNITIES: The Company has had numerous
discussions with companies in the commercial cable TV/video compression and
telecommunications marketplaces. The Company's primary business strategy in this
area is to capitalize on its experience as a technology company and to explore
areas where current or newly developed technology can be licensed or products
can be manufactured and sold into the commercial marketplace. To date, revenues
from the commercial marketplace have been less than 5% of the Company's revenues
and have consisted primarily of product development fees. There can be no
assurance that the Company's commercial marketplace strategy will be successful
or that the Company will maintain or increase revenues from the commercial
marketplace.

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<PAGE> 13
THREE MONTHS AND SIX MONTHS ENDED MAY 2, 1997 COMPARED TO THREE MONTHS AND SIX
MONTHS ENDED MAY 3, 1996:

RESULTS OF OPERATIONS:

REVENUES AND BACKLOG: Revenues for the second quarter of fiscal 1997 were
$23,987,000, representing a 41% increase over the second quarter of fiscal 1996
revenues of $16,970,000. Revenues for the six months ended May 2, 1997 were
$44,071,000, up 34% from $32,768,000 for the first six months of fiscal 1996.
The increase in the second quarter and year-to-date revenues of fiscal 1997
reflects the continued demand for the Company's products and services and the
increased contract activity resulting from hiring new staff members during the
last half of fiscal 1996.

New order levels for the second quarter were $24,181,000, down 62% from record
order levels of $64,044,000 reported for the second quarter of fiscal 1996.
Included in the second quarter orders for fiscal 1997 is a subcontract award,
the second largest award in the Company's history, for development of special
signal processing subsystems to support the Joint SIGINT Avionics Family Low
Band Subsystem recently awarded to Sanders, a Lockheed Martin Company. For
comparison purposes, the Company recorded the Scalpel program multi-year
competitive award of $51,035,000--the largest in the Company's history during
the second quarter of fiscal 1996. New orders for the first six months of fiscal
1997 were $32,875,000 compared to $78,173,000 reported for the same period of
fiscal 1996.

The Company's backlog, which consists of anticipated revenues from the
uncompleted portions of existing contracts (excluding unexercised options) was
$71,923,000 at May 2, 1997, a decrease of 4% when compared to $75,110,000 at May
3, 1996.

CONTRACT COSTS: Contract costs consist of direct costs on contracts, including
materials and labor, and manufacturing overhead costs. Contract costs as a
percentage of revenues were 65.6% for the second quarter of fiscal 1997 versus
71.8% for the same period of fiscal 1996. Contract costs as a percentage of
revenues for the six months ended May 2, 1997 were 65.5% versus 70.2% for the
first six months of fiscal 1996. Contract costs as a percentage of revenues for
the second quarter and first six months of fiscal 1997 were down primarily due
to price decreases realized for component parts as well as efficiencies related
to larger production runs on certain contracts. Further, contract costs as a
percentage of revenues for the six months of fiscal 1996 were abnormally high
due primarily to unfavorable adjustments in estimated costs-to-complete on
production jobs.

RESEARCH AND DEVELOPMENT (R&D): Company-directed investment in research and
development consists of expenditures recoverable from customers through the
Company's billing rates and expenditures funded by the Company from earnings. It
is the Company's accounting practice to record R&D expenses based on annual
targeted indirect rates. (See "Notes to Financial Statements; Note 2 -
Inventory.") Research and development expenses as a percentage of revenues were
10.0% and 12.7% for the second quarter of fiscal years 1997 and 1996,
respectively. For the first six months of fiscal years 1997 and 1996, research
and development expenses as a percentage of revenues were 11.0% and 12.4%,
respectively. While R&D spending increased in absolute dollars, the lower R&D
spending as a percentage of revenues for the quarter and the six month periods
of fiscal 1997 reflect a shift in labor resources directed toward the increased
contract activity compared to the same periods of fiscal 1996.

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<PAGE> 14
The Company-funded investment in R&D for the first six months of fiscal 1997 was
$962,000 or 2.2% of revenues compared to $1,476,000 or 4.5% of revenues for the
first six months of fiscal 1996. During fiscal 1997, the Company made a decision
to recover more of its R&D spending in its billing rates.

GENERAL AND ADMINISTRATIVE: General and administrative expenses include
administrative salaries, costs related to the Company's marketing and proposal
activities and other administrative costs. It is the Company's accounting
practice to record general and administrative expenses based on annual targeted
indirect rates. (See "Notes to Financial Statements; Note 2 - Inventory.")
General and administrative expenses were $3,171,000 or 13.2% of revenues for the
second quarter of fiscal 1997 compared to $2,528,000 or 14.9% of revenues for
the second quarter of fiscal 1996. General and administrative expenses were
$6,353,000 or 14.4% and $5,368,000 or 16.4% of revenues for the six months ended
May 2, 1997 and May 3, 1996, respectively.

Although spending for general and administrative expenses increased for the
second quarter and first six months of fiscal 1997 over the first six months of
fiscal 1996, the percentage to revenues decreased. The decrease is due primarily
to the higher revenue volume recorded during these time periods (see "Contract
Costs" above).

INTEREST INCOME/(EXPENSE): For the quarter ended May 2, 1997, interest income
was $37,000, up from $4,000 interest expense for the same period of fiscal 1996.
Interest income for the first six months of fiscal 1997 was $98,000 compared to
interest income of $15,000 for the same period of fiscal 1996. The increase in
interest income for the second quarter and for the first six months of fiscal
1997 is due primarily to the Company's ability to generate cash from operations
due to improved margins. In addition, the Company was able to generate interest
income on investments without any offsetting interest expense from the use of
bank lines of credit.

PROVISION FOR INCOME TAXES: The provision for income taxes as a percentage of
income before income taxes was 36.5% for the second quarter of fiscal 1997,
compared to 23.3% for the same period of fiscal 1996. The effective tax rate for
the six months ended May 2, 1997 and May 3, 1996 was 36.5% and 35.0%,
respectively. The increase in the quarter and year-to-date tax rate is primarily
a result of the increased federal and state tax liability as a result of the
increase in profitability and offset by state income tax credits.

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ANALYSIS OF LIQUIDITY AND CAPITAL RESOURCES:

The Company's primary source of liquidity in fiscal 1997 has been the cash flow
generated from operations as well as issuance of common stock through its
employee stock plans.

The Company has a bank credit agreement to augment cash flow needs and to
provide term financing for capital investments. The Company maintains a
$6,000,000 unsecured, revolving line of credit for short-term cash requirements
and a $1,000,000 line of credit for use in purchasing capital investments. The
unsecured, revolving line of credit bears interest at the bank's reference rate
(8.5% as of May 2, 1997). The line of credit for use in purchasing capital
investments bears interest at the bank's reference rate plus one-half percent
(9.0% as of May 2, 1997). Outstanding amounts on the unsecured, revolving line
of credit were zero at May 2, 1997 and October 31, 1996. Outstanding amounts on
the line of credit for use in purchasing capital investments were zero at May 2,
1997 and October 31, 1996. Both lines expire March 1, 1998.

NET CASH FROM OPERATING ACTIVITIES: Net cash from operating activities has
varied significantly from quarter to quarter. These quarter-to-quarter variances
are primarily the result of changes in net income, changes in the rate of
investment in accounts receivable and the change in inventories held by the
Company. During the first six months of fiscal 1997, $1,008,000 was provided by
operating activities versus $1,717,000 during the comparable period of fiscal
1996. Although net income of $2,587,000 was considerably higher for the first
six months of fiscal 1997 as compared to the net income of $220,000 reported for
the same period of fiscal 1996, the decrease in cash from operating activities
in the first six months of fiscal 1997 is primarily due to the increase in
accounts receivable and inventories. During the first six months of fiscal 1997,
accounts receivable grew by $1,552,000 compared to a $4,878,000 decrease in
accounts receivable during the same period of fiscal 1996. The cash generated by
accounts receivable is due, in part, to greater contract activity and, in part,
to a slight increase in the time to collect outstanding invoices. Cash used in
the investment in inventories, prepaids and other current assets during the
first six months of fiscal 1997 was $2,533,000, compared to $3,801,000 of cash
used during the comparable period of fiscal 1996. This reduction is in part due
to the reduction of timing-related targeted indirect rate variances (See "Notes
to Financial Statements; Note 2 - Inventory") and, in part, to a management
initiative to more aggressively manage the Company's investment in inventory.

NET CASH FROM INVESTING ACTIVITIES: Cash used in investing activities during the
first six months of fiscal 1997 was $3,137,000 compared to $3,170,000 used in
investing activities during the same period of fiscal 1996, all attributable to
additions to property and equipment. Capital investment continues to be driven
by an increase in the number of contracts awarded and by the level of
development-type contracts that have required test and computing equipment.

NET CASH FROM FINANCING ACTIVITIES: Cash provided by financing activities during
the first six months of fiscal 1997 was $570,000 versus $1,084,000 provided
during the same period of fiscal 1996. The reduction in cash provided by
financing activities during the first six months of fiscal 1997 is primarily
attributable to the absence of borrowings under the bank line of credit; such
borrowings were $500,000 in the fiscal 1996 period.

The Company believes that the funds generated from operations, existing working
capital and amounts available under existing lines of credit will be sufficient
to meet its cash needs for the next twelve months.

15
<PAGE> 16
PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In April 1994, the Company was served with a subpoena by the
Department of Defense Office of Inspector General (OIG) in connection with
approximately six contracts, several of which had been audited by the Defense
Contract Audit Agency (DCAA) the previous year. As is routine in such matters
involving government contracts, the OIG referred the matter to another
government agency which also had contracts with the Company. Shortly thereafter,
this second agency issued a request for information related to nine additional
contracts. To date, the Company has not received any allegations of wrong-doing
from the OIG or the other agency. At the request of the Board of Directors, the
Company initiated its own review of the contracts in conjunction with its legal
counsel.

Further review of the contracts in question and related contracts
through April 1995 indicates the Company was not compliant with Public Law
87-653, Truth in Negotiations Act, which requires disclosure of all actual costs
available on the date of cost certification on certain contracts performed
during the 1989 and 1990 timeframe. These findings have resulted in a voluntary
disclosure to the government which is expected to result in a downward price
adjustment on certain contracts. In June 1995, the Company announced it was
taking a charge against the fiscal 1995 third quarter operating results in
anticipation of a settlement with the government on the subject contracts. The
charge resulted in a reduction of the fiscal 1995 third quarter's operating
income of $1.2 million.

In April 1996, the Company was served with a second subpoena by
the OIG in connection with all contracts entered into between 1990 and the
present related to three products: the Model 102P Voice Channel Demodulator, the
Model 120 Multichannel Processor, and the Model 150 FAX Scanner. The Company is
presently in discussions with the OIG to determine the scope of the subpoena and
intends to fully comply with the request.

While management believes the fiscal 1995 third quarter charge is
adequate to cover all related risks, the government has not concluded its
investigation or agreed to a settlement with the Company. There can be no
assurances the Company will not be required to take additional charges in
connection with this matter in future periods. However, management believes that
any such charges would not have a material effect on the operating results and
financial condition of the Company.

16
<PAGE> 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The annual meeting of shareholders of the Company was held March 6, 1997.

The shareholders approved a proposal to elect three Class I Directors
of the Board of Directors of the Company to serve until the 1999 Annual Meeting
of Shareholders and/or until their respective successors are duly elected and
qualified. The proposal received the following votes:
<TABLE>
<CAPTION>

FOR WITHHELD ABSTENTIONS BROKER NON-VOTES
--- -------- ----------- ----------------
<S> <C> <C>
John P. Devine 6,333,416 541,513
David D. Elliman 6,337,316 537,613
Gary L. Yancey 6,331,439 543,490

</TABLE>

The shareholders ratified the appointment of Ernst & Young LLP as
independent public accountants of the Company for the fiscal year ending October
31, 1997. The proposal received the following votes:
<TABLE>
<CAPTION>

FOR AGAINST WITHHELD ABSTENTIONS BROKER NON-VOTES
--- ------- -------- ----------- ----------------
<S> <C> <C>
6,802,229 63,141 9,559

</TABLE>

The shareholders approved a proposal to amend the Company's 1991 Stock
Option Plan (the "Option Plan") to (i) increase by 500,000 shares the number of
shares of the Company's Common Stock reserved for issuance under its Option Plan
and (ii) limit to 400,000 shares the number of shares of Common Stock for which
options may be granted to any one employee during any fiscal year of the
Company. The proposal received the following votes:

<TABLE>
<CAPTION>
FOR AGAINST WITHHELD ABSTENTIONS BROKER NON-VOTES
--- ------- -------- ----------- ----------------
<S> <C> <C> <C>
3,430,243 1,280,396 56,393 2,107,987

</TABLE>

The shareholders also approved a proposal to amend the Company's 1993
Employee Stock Purchase Plan (the "Stock Purchase Plan") to increase by 600,000
shares the number of shares of Common Stock reserved for issuance under the
Stock Purchase Plan. The proposal received the following votes:

<TABLE>
<CAPTION>
FOR AGAINST WITHHELD ABSTENTIONS BROKER NON-VOTES
--- ------- -------- ----------- ----------------
<S> <C> <C> <C> <C>
3,948,092 872,423 27,369 2,027,045

</TABLE>

17
<PAGE> 18
Item 6. Exhibits and Reports on Form 8-K

Exhibits -- See Index to Exhibits on page 20

Reports on Form 8-K -- The Company did not file any reports on
Form 8-K during the six months ended May 2, 1997.

18
<PAGE> 19
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned therewith duly authorized.

Applied Signal Technology, Inc.

/Brian M. Offi/ June 12, 1997
- ----------------------------- ---------------------------
Brian M. Offi
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

19
<PAGE> 20
APPLIED SIGNAL TECHNOLOGY

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
<S> <C>
10.15 Commercial Credit Agreement dated March 3, 1997 with Sanwa Bank California
10.16 Certified Corporate Resolution to borrow dated March 3, 1997 with Sanwa Bank
California
10.17 1991 Stock Option Plan as Amended January 25, 1997
10.18 1993 Employee Stock Purchase Plan as Amended January 25, 1997
11.1 Computation of Net Income Per Share
27.1 Financial Data Schedule
</TABLE>

<PAGE> 1
EXHIBIT 10.15

COMMERCIAL CREDIT AGREEMENT

This Commercial Credit Agreement ("Agreement") is made and entered into this 3rd
day of March 1997 by and between SANWA BANK CALIFORNIA (the "Bank") and APPLIED
SIGNAL TECHNOLOGY, INC. (the "Borrower").

SECTION I
DEFINITIONS

1.01. CERTAIN DEFINED TERMS. Unless elsewhere defined in this Agreement the
following terms shall have the following meanings (such meanings to be generally
applicable to the singular and plural forms of the terms defined):

A. "ADVANCE" shall mean an advance to the Borrower under any line of
credit facility or similar facility provided for in Section II of this
Agreement which provides for draws by the Borrower against an established
credit line.

B. "BUSINESS DAY" shall mean a day, other than a Saturday or Sunday, on
which commercial banks are open for business in California.

C. "COLLATERAL" shall mean any personal or real property in which the Bank
may be granted a lien or security interest to secure payment of the
Obligations.

D. "DEBT" shall mean all liabilities of the Borrower less Subordinated
Debt.

E. "EFFECTIVE TANGIBLE NET WORTH" shall mean the Borrower's stated net
worth plus Subordinated Debt but less all intangible assets of the
Borrower (i.e., goodwill, trademarks, patents, copyrights, organization
expense and similar intangible items).

F. "ENVIRONMENTAL CLAIMS" shall mean all claims, however asserted, by any
governmental authority or other person alleging potential liability or
responsibility for violation of any Environmental Law or for release or
injury to the environment or threat to public health, personal injury
(including sickness, disease or death), property damage, natural resources
damage, or otherwise alleging liability or responsibility for damages
(punitive or otherwise), cleanup, removal, remedial or response costs,
restitution, civil or criminal penalties, injunctive relief, or other type
of relief, resulting from or based upon (i) the presence, placement,
discharge, emission or release (including intentional and unintentional,
negligent and non-negligent, sudden or non-sudden, accidental or
non-accidental placement, spills, leaks, discharges, emissions or
releases) of any Hazardous Materials at, in, or from property owned,
operated or controlled by the Borrower, or (ii) any other circumstances
forming the basis of any violation, or alleged violation, of any
Environmental Law.

G. "ENVIRONMENTAL LAWS" shall mean all federal, state or local laws,
statutes, common law duties, rules, regulations, ordinances and codes,
together with all administrative orders, directed duties, requests,
licenses, authorizations and permits of, and agreements with, any
governmental authorities, in each case relating to environmental, health,
safety and land use matters; including the Comprehensive Environmental
Response, Compensation and Liability Act of 1980 ("CERCLA"), the Clean Air
Act, the Federal Water Pollution Control Act of 1972, the Solid Waste
Disposal Act, the Federal Resource Conservation and Recovery Act, the
Toxic Substances Control Act, the Emergency Planning and Community
Right-to-Know Act, the California Hazardous Waste Control Law, the
California Solid Waste Management, Resource, Recovery and Recycling Act,
the California Water Code and the California Health and Safety Code.

H. "EQUIPMENT" shall mean, in connection with the Equipment Purchase
Facility contained in Section II of this Agreement, equipment as defined
in the California Uniform Commercial Code.

I. "EQUIPMENT VALUE" shall mean, in connection with the Equipment Purchase
Facility contained in Section II of this Agreement, the lesser of: (i) the
invoice cost of the Equipment (excluding taxes, license fees,
transportation costs, insurance premiums and installation and connection
expenses, fees and costs); (ii) the book value of the Equipment; or (iii)
the liquidation value of the Equipment as determined by the Bank.

J. "ERISA" shall mean the Employee Retirement Income Security Act of 1974,
as amended from time to time, including (unless the context otherwise
requires) any rules or regulations promulgated thereunder.

K. "EVENT OF DEFAULT" shall have the meaning set forth in the section
herein entitled "Events of Default".

L. "HAZARDOUS MATERIALS" shall mean all those substances which are
regulated by, or which may form the basis of liability under any
Environmental Law, including all substances identified under any
Environmental Law as a pollutant, contaminant, hazardous waste, hazardous
constituent, special waste, hazardous substance, hazardous material, or
toxic substance, or petroleum or petroleum derived substance or waste.

M."INDEBTEDNESS" shall mean, with respect to the Borrower, (i) all
indebtedness for borrowed money or for the deferred purchase price of
property or services in respect of which the Borrower is liable,
contingently or otherwise, as obligor, guarantor or otherwise, or in
respect of which the Borrower otherwise assures a creditor against loss
and (ii) obligations under leases which shall have been or should be, in
accordance with generally accepted accounting principles, reported as
capital leases in respect of which the Borrower is liable, contingently or
otherwise, or in respect of which the Borrower otherwise assures a
creditor against loss.

N. "OBLIGATIONS" shall mean all amounts owing by the Borrower to the Bank
pursuant to this Agreement including, but not limited to, the unpaid
principal amount of Advances.

O. "PERMITTED LIENS" shall mean: (i) liens and security interests securing
indebtedness owed by the Borrower to the Bank; (ii) liens for taxes,
assessments or similar charges either not yet due or being contested in
good faith, provided proper reserves are maintained therefor in accordance
with generally accepted accounting procedure; (iii) liens of materialmen,
mechanics, warehousemen, or carriers or other like liens arising in the
ordinary course of business and securing obligations which are not yet
delinquent; (iv) purchase money liens or purchase money security interests
upon or in any property acquired or held by the Borrower in the ordinary
course of business to secure Indebtedness outstanding on the date hereof
or permitted to be incurred pursuant to this Agreement; (v) liens and
security interests which, as of the date hereof, have been disclosed to
and approved by the Bank in writing; and (vi) those liens and security
interests

(1)

<PAGE> 2
which in the aggregate constitute an immaterial and insignificant monetary
amount with respect to the net value of the Borrower's assets.

P. "REFERENCE RATE" shall mean an index for a variable interest rate which
is quoted, published or announced from time to time by the Bank as its
reference rate and as to which loans may be made by the Bank at, below or
above such reference rate.

Q. "SUBORDINATED DEBT" shall mean such liabilities of the Borrower which
have been subordinated to those owed to the Bank in a manner acceptable to
the Bank.

1.02. ACCOUNTING TERMS. All references to financial statements, assets,
liabilities, and similar accounting items not specifically defined herein shall
mean such financial statements or such items prepared or determined in
accordance with generally accepted accounting principles consistently applied
and, except where otherwise specified, all financial data submitted pursuant to
this Agreement shall be prepared in accordance with such principles.

1.03. OTHER TERMS. Other terms not otherwise defined shall have the meanings
attributed to such terms in the California Uniform Commercial Code.

SECTION II
CREDIT FACILITIES

2.01. COMMITMENT TO LEND. Subject to the terms and conditions of this Agreement
and so long as no Event of Default occurs, the Bank agrees to extend to the
Borrower the credit accommodations that follow.

2.02. LINE OF CREDIT FACILITY.
The Bank agrees to make loans and Advances to the Borrower, upon the Borrower's
request therefor made prior to the Expiration Date (as defined below in this
Section 2.02), up to a total principal amount from time to time outstanding of
not more than $6,000,000.00. Within the foregoing limits, the Borrower may
borrow, partially or wholly prepay, and reborrow under this Line of Credit
facility.

A. PURPOSE. Advances made under this Line of Credit shall be used for
working capital purposes.

B. INTEREST RATE. Interest shall accrue on the outstanding principal
balance of Advances under this Line of Credit at a variable rate equal to
the Bank's Reference Rate, per annum, as it may change from time to time.
(Such rate is referred to in this Section 2.02 as the "Variable Rate".)
The Variable Rate shall be adjusted concurrently with any change in the
Reference Rate. Interest shall be calculated on the basis of 360 days per
year but charged on the actual number of days elapsed.

C. PAYMENT OF INTEREST. The Borrower hereby promises and agrees to pay
interest monthly on the first day of each month, commencing on April 1,
1997.

D. REPAYMENT OF PRINCIPAL. Unless sooner due in accordance with the terms
of this Agreement, on March 1, 1998 the Borrower hereby promises and
agrees to pay to the Bank in full the aggregate unpaid principal balance
of all Advances then outstanding, together with all accrued and unpaid
interest thereon. Any payment received by the Bank shall, at the Bank's
option, first be applied to pay any late fees or other fees then due and
unpaid, and then to interest then due and unpaid and the remainder thereof
(if any) shall be applied to reduce principal.

E. LATE FEE. If any regularly scheduled payment of principal and/or
interest (exclusive of the final payment upon maturity), or any portion
thereof, under this Line of Credit is not paid within ten (10) calendar
days after it is due, a late payment charge equal to five percent (5%) of
such past due payment may be assessed and shall be immediately payable.

F. MAKING LINE ADVANCES/NOTICE OF BORROWING. Each Advance made hereunder
shall be conclusively deemed to have been made at the request of and for
the benefit of the Borrower (i) when credited to any deposit account of
the Borrower maintained with the Bank or (ii) when paid in accordance with
the Borrower's written instructions. Subject to any other requirements set
forth in this Agreement, Advances shall be made by the Bank upon
telephonic or written notice received from the Borrower in form acceptable
to the Bank, which notice shall be received not later than 2:00 p.m.
(California Time) on the date specified for such Advance, which date shall
be a Business Day. Requests for Advances received after such time may, at
the Bank's option, be deemed to be a request for an Advance to be made on
the next succeeding Business Day.

G. NON-USAGE FEE. The Borrower hereby promises and agrees to pay the
following fees in connection with this facility: The Borrower shall be
assessed and shall pay to the Bank each quarter in arrears, a fee in an
amount equal to 0.25% of the difference (if any) between $6,000,000.00 and
the average daily outstanding principal balance of Advances under this
Line of Credit Facility, and the total face amount of all Letters of
Credit outstanding under the Letter of Credit Facility contained in
section 2.03 of this Agreement during the preceding quarter.

H. EXPIRATION OF THE LINE OF CREDIT FACILITY. Unless earlier terminated in
accordance with the terms of this Agreement, the Bank's commitment to make
Advances to the Borrower hereunder shall automatically expire on March 1,
1998 (the "Expiration Date"), and the Bank shall be under no further
obligation to advance any monies thereafter.

I. LINE ACCOUNT. The Bank shall maintain on its books a record of account
in which the Bank shall make entries for each Advance and such other
debits and credits as shall be appropriate in connection with the Line of
Credit facility (the "Line Account"). The Bank shall provide the Borrower
with a monthly statement of the Borrower's Line Account, which statement
shall be considered to be correct and conclusively binding on the Borrower
unless the Bank is notified by the Borrower to the contrary within thirty
(30) days after the Borrower's receipt of any such statement which is
deemed to be incorrect.

J. AMOUNTS PAYABLE ON DEMAND. If the Borrower fails to pay on demand any
amount so payable under this Agreement, the Bank may, at its option and
without any obligation to do so and without waiving any default occasioned
by the Borrower's failure to pay such amount, create an Advance in an
amount equal to the amount so payable, which Advance shall thereafter bear
interest as provided under this Line of Credit facility.

In addition, the Borrower hereby authorizes the Bank, if and to the extent
payment owed to the Bank under this Line of Credit facility is not made
when due, to charge, from time to time, against any or all of the deposit
accounts maintained by the Borrower with the Bank any amount so due.

2.03. LETTER OF CREDIT FACILITY. The Bank agrees to issue standby letters of
credit (each a "Letter of Credit") on behalf of the Borrower; provided however,
that at no time shall the total face amount of all Letters of Credit
outstanding, including the aggregate outstanding amount of those Letters of
Credit issued under Section 2.02 of the Line of Credit Agreement dated June 10,
1993, and any and all addenda and riders thereto, (the "Prior Agreement") less
any partial draws paid by the Bank, exceed the sum of $3,000,000.00; and
provided further, that this Letter of Credit facility is a sub-facility of the
above $6,000,000.00 Line of Credit facility

(2)
<PAGE> 3
and at no time shall the total amount outstanding under such facility together
with the total face amount of all Letters of Credit outstanding, including those
issued under the Prior Agreement, less any partial draws paid by the Bank, (plus
any amounts outstanding under any other sub-facilities of the above main
facility) exceed the sum of $6,000,000.00.

A. ISSUANCE FEES, COSTS AND COMMISSIONS. Upon the Bank's request, the
Borrower shall promptly pay to the Bank issuance fees and such other fees,
commissions, costs and any out-of-pocket expenses charged or incurred by
the Bank with respect to any Letter of Credit.

B. EXPIRATION OF FACILITY. The commitment by the Bank to issue Letters of
Credit shall, unless earlier terminated in accordance with the terms of
this Agreement, automatically terminate on March 1, 1998 and no Letter of
Credit shall expire on a date which is more than 90 days after such date.

C. LIMITATIONS ON LETTERS OF CREDIT. Each Letter of Credit shall be in
form and substance and in favor of beneficiaries satisfactory to the Bank,
provided that the Bank may refuse to issue a Letter of Credit due to the
nature of the transaction or its terms or in connection with any
transaction where the Bank, due to the beneficiary or the nationality or
residence of the beneficiary, would be prohibited by any applicable law,
regulation or order from issuing such Letter of Credit.

D. ISSUANCE OF LETTERS OF CREDIT. Prior to the issuance of each Letter of
Credit but in no event later than 10:00 a.m. (California time) on the day
such Letter of Credit is to be issued (which shall be a Business Day), the
Borrower shall deliver to the International Department of the Bank a duly
executed form of the Bank's standard form of application for issuance of a
letter of credit with proper insertions.

2.04. EQUIPMENT PURCHASE FACILITY. The Bank agrees to make
loans and Advances to the Borrower, upon the Borrower's written request therefor
made prior to the Expiration Date (as defined below in this Section 2.04), to
assist the Borrower in purchasing items of Equipment. Each Advance made
hereunder shall be in an amount not to exceed 100% of the Value of the items of
Equipment being purchased; provided however, that at no time shall the total
aggregate outstanding principal amount of Advances made under this Equipment
Purchase Facility exceed the sum of $1,000,000.00. This Equipment Purchase
Facility is on a non-revolving basis and any amounts repaid under the Equipment
Purchase Facility may not be reborrowed.

A. PURPOSE. Advances made under this Equipment Purchase Facility shall be
used for the purchase of equipment by the Borrower for use in the
Borrower's business.

B. INTEREST RATE. Interest shall accrue on the outstanding principal
balance of Advances under this Equipment Purchase Facility at a variable
rate equal to the Bank's Reference Rate, as it may change from time to
time, plus 0.500% per annum. (Such rate is referred to in this Section
2.04 as the "Variable Rate".) The Variable Rate shall be adjusted
concurrently with any change in the Reference Rate. Interest shall be
calculated on the basis of 360 days per year but charged on the actual
number of days elapsed.

C. PAYMENT OF INTEREST. The Borrower hereby promises and agrees to pay
interest monthly on the first day of each month, commencing on April 1,
1997.

E. FIXED RATE ALTERNATIVE PRICING. In addition to Advances based upon the
Variable Rate ("Variable Rate Advances"), at the Borrower's election, the
Bank hereby agrees to make Advances to the Borrower under this Equipment
Purchase facility at a fixed rate ("Fixed Rate") to be quoted and offered
by the Bank from time to time upon the request of the Borrower. The Bank
shall only quote and offer such Fixed Rate for Advances in the minimum
amount of $100,000.00 and in $100,000.00 increments thereafter and for
such period of time (each an "Interest Period") as the Bank may quote and
offer, provided that the Interest Period shall be for a minimum of at
least 30 days and provided further that any Interest Period shall not
extend beyond the Expiration Date (as defined below) of this facility.
Advances based upon the Fixed Rate are hereinafter referred to as "Fixed
Rate Advances".

Interest on any Fixed Rate Advance shall be computed on the basis of 360 days
per year but charged on the actual number of days elapsed.

The Borrower hereby promises and agrees to pay the Bank interest on any Fixed
Rate Advance on the basis described above with respect to the Variable Rate. If
interest is not paid as and when it is due, the amount of such unpaid interest
shall bear interest, until paid in full, at a rate of interest equal to the
Variable Rate.

(i) REPAYMENT OF FIXED RATE ADVANCES. Unless sooner due in
accordance with other terms of this Agreement, or unless adjusted at
the end of the relevant Interest Period as described below, the
Borrower hereby promises and agrees to pay the Bank the principal
amount of each Fixed Rate Advance, together with accrued and unpaid
interest thereon, on the last day of the Interest Period pertaining
to such Fixed Rate Advance.

(ii) NOTICE OF ELECTION TO ADJUST INTEREST RATE. Upon telephonic
notice which shall be received by the Bank at or before 11:00 am
(California time) on a Business Day, the Borrower may elect:

(a) That interest on a Variable Rate Advance shall be adjusted
to accrue at a quoted and offered Fixed Rate; provided,
however, that such notice shall be received by the Bank no
later than two business days prior to the day (which shall be
a business day) on which the Borrower requests that interest
be adjusted to accrue at the Fixed Rate.

(b) That interest on a Fixed Rate Advance shall continue to
accrue at a newly quoted Fixed Rate or shall be adjusted to
commence to accrue at the Variable Rate; provided however,
that such notice shall be received by the Bank no later than
two business days prior to the last day of the Interest Period
pertaining to such Fixed Rate Advance. If the Bank shall not
have received notice as prescribed herein of the Borrower's
election that interest on any Fixed Rate Advance shall
continue to accrue at the Fixed Rate, the Borrower shall be
deemed to have elected that interest thereon shall be adjusted
to accrue at the Variable Rate upon the expiration of the
Interest Period pertaining to such Advance.

(iii) PROHIBITION AGAINST PREPAYMENT OF FIXED RATE ADVANCES.
NOTWITHSTANDING ANYTHING TO THE CONTRARY IN THE AGREEMENT, NO
PREPAYMENT SHALL BE MADE ON ANY FIXED RATE ADVANCE EXCEPT ON A DAY
WHICH IS THE LAST DAY OF THE INTEREST PERIOD PERTAINING THERETO. IF
THE WHOLE OR ANY PART OF ANY FIXED RATE ADVANCE IS PREPAID BY REASON
OF ACCELERATION OR OTHERWISE, THE BORROWER SHALL, UPON THE BANK'S
REQUEST, PROMPTLY PAY TO AND INDEMNIFY THE BANK FOR ALL COSTS AND
ANY LOSS (INCLUDING INTEREST) ACTUALLY INCURRED BY THE BANK AND ANY
LOSS (INCLUDING LOSS OF PROFIT RESULTING FROM THE RE-EMPLOYMENT OF
FUNDS) SUSTAINED BY THE BANK AS A

(3)
<PAGE> 4
CONSEQUENCE OF SUCH PREPAYMENT.

(iv) INDEMNIFICATION FOR FIXED RATE COSTS. During any period of time
in which interest on any Advance is accruing on the basis of a Fixed
Rate, the Borrower shall, upon the Bank's request, promptly pay to
and reimburse the Bank for all costs incurred and payments made by
the Bank by reason of any future assessment, reserve, deposit or
similar requirements or any surcharge, tax or fee imposed upon the
Bank or as a result of the Bank's compliance with any directive or
requirement of any regulatory authority pertaining or relating to
funds used by the Bank in quoting and determining the Fixed Rate.

(v) INVOLUNTARY CONVERSION FROM FIXED RATE TO VARIABLE RATE. In the
event that the Bank shall at any time determine that the accrual of
interest on the basis of the Fixed Rate (a) is infeasible because
the Bank is unable to determine the Fixed Rate due to the
unavailability of U.S. dollar deposits, contracts or certificates of
deposit in an amount approximately equal to the amount of the
relevant Advance and for a period of time approximately equal to the
relevant Interest Period; or (b) is or has become unlawful or
infeasible by reason of the Bank's compliance with any new law,
rule, regulation, guideline or order, or any new interpretation of
any present law, rule, regulation, guideline or order, then the Bank
shall give telephonic notice thereof (confirmed in writing) to the
Borrower, in which event any Fixed Rate Advance shall be deemed to
be a Variable Rate Advance and interest shall thereupon immediately
accrue at the Variable Rate.

F. MAKING LINE ADVANCES/NOTICE OF BORROWING. Each Advance made hereunder
shall be conclusively deemed to have been made at the request of and for
the benefit of the Borrower (i) when credited to any deposit account of
the Borrower maintained with the Bank or (ii) when paid in accordance with
the Borrower's written instructions. Subject to any other requirements set
forth in this Agreement, Advances shall be made by the Bank upon written
notice received from the Borrower in form acceptable to the Bank, which
notice shall be received by the Bank at or before 11:00 am (California
time) on a Business Day. The Borrower may borrow under this Equipment
Purchase Facility by requesting either:

(i) A VARIABLE RATE ADVANCE. A Variable Rate Advance may be made on
the day notice is received by the Bank; provided however, that if
the Bank shall not have received notice at or before 11:00 am
(California time) on the day such Advance is requested to be made,
such Variable Rate Advance may be made, at the Bank's option, on the
next Business Day.

(ii) A FIXED RATE ADVANCE. The Borrower may elect that an Advance be
made as a Fixed Rate Advance by requesting the Bank to provide a
quote as to the rate which would apply for a designated Interest
Period and concurrently with receiving such quote, giving the Bank
irrevocable notice of the Borrower's acceptance of the rate quoted,
provided such notice shall be given to the Bank not later than 10:00
a.m. (California time) on a date (which shall be a Business Day) at
least two days prior to the first day of the requested Interest
Period. Any telephonic or oral quote or offer by the Bank of a Fixed
Rate for a given Interest Period may be confirmed in writing by the
Bank upon the election (as provided herein) of the Borrower to
accept such terms and such confirmation shall be deemed conclusive
as to the terms quoted and offered.

G. SECURITY INTEREST IN EQUIPMENT. Upon the Bank's request, the Borrower
shall execute and deliver to the Bank, prior to the making of any Advance
under this Equipment Purchase Facility, such documents and instruments (in
form and substance satisfactory to the Bank) which the Bank may require
with respect to such Advance and the perfection of the Bank's security
interest in the Equipment pertaining to such Advance.

H. LATE FEE. If any regularly scheduled payment of principal and/or
interest (exclusive of the final payment upon maturity), or any portion
thereof, under this Equipment Purchase Facility is not paid within ten
(10) calendar days after it is due, a late payment charge equal to five
percent (5%) of such past due payment may be assessed and shall be
immediately payable.

I. CONVERSION TO TERM LOAN. It is hereby agreed that the Borrower may, by
giving written notice to the Bank at least one (1) day prior to March 1,
1998, convert the principal balance outstanding under the Equipment
Purchase facility as of March 1, 1998 to be payable on a term loan basis.
The term loan (the "Converted Term Loan") shall be in the amount of such
outstanding principal balance and shall be evidenced by a promissory note
or credit agreement (the "Term Agreement") containing the following
payment terms: Interest shall be paid concurrently with principal.
Principal shall be paid in equal monthly installments based upon a maximum
of 60 equally amortized payments of the principal amount outstanding at
the time of conversion. Accrued and unpaid interest under the Equipment
Purchase facility shall be paid to the Bank concurrently with the
Borrower's execution of the Term Agreement. Interest shall accrue and
principal and interest shall be paid in accordance with the terms and
provisions of the Term Agreement.

J. NON-USAGE FEE. The Borrower shall be assessed and shall pay to the Bank
each quarter, a fee in an amount equal to 0.250% of the difference (if
any) between $1,000,000.00 and the average daily outstanding principal
balance of Advances under this Equipment Purchase facility during the
preceding quarter.

K. EXPIRATION OF THE EQUIPMENT PURCHASE FACILITY. Unless earlier
terminated in accordance with the terms of this Agreement, the Bank's
commitment to make Advances to the Borrower hereunder shall automatically
expire on March 1, 1998 (the "Expiration Date").

L. LINE ACCOUNT. The Bank shall maintain on its books a record of account
in which the Bank shall make entries for each Advance and such other
debits and credits as shall be appropriate in connection with this
Equipment Purchase Facility (the "Line Account"). The Bank shall provide
the Borrower with a monthly statement of the Borrower's Line Account,
which statement shall be considered to be correct and conclusively binding
on the Borrower unless the Bank is notified by the Borrower to the
contrary within thirty (30) days after the Borrower's receipt of any such
statement which is deemed to be incorrect.

M. AMOUNTS PAYABLE ON DEMAND. If the Borrower fails to pay on demand any
amount so payable under this Agreement, the Bank may, at its option and
without any obligation to do so and without waiving any default occasioned
by the Borrower's failure to pay such amount, create an Advance in an
amount equal to the amount so payable, which Advance shall thereafter bear
interest as provided under this Equipment Purchase Facility.

In addition, the Borrower hereby authorizes the Bank, if and to the extent
payment owed to the Bank under this Equipment Purchase Facility is not
made when due, to charge, from time to time, against any or all deposit
accounts maintained with the Bank by the Borrower any amount so due.

SECTION III
CONDITIONS PRECEDENT

3.01. CONDITIONS PRECEDENT TO THE INITIAL EXTENSION OF CREDIT AND/OR FIRST
ADVANCE. The obligation of the Bank to make the initial extension of credit
and/or the first Advance hereunder is subject to the conditions precedent that
the Bank shall have received before the date of such extension of credit and/or
the first Advance

(4)
<PAGE> 5
all of the following, in form and substance satisfactory to the Bank:

A. AUTHORITY TO BORROW. Evidence relating to the duly given approval and
authorization of the execution, delivery and performance of this
Agreement, all other documents, instruments and agreements required under
this Agreement and all other actions to be taken by the Borrower hereunder
or thereunder.

B. LOAN FEES. Evidence that any required loan fees and expenses as set
forth above with respect to each credit facility have been paid or
provided for by the Borrower.

C. AUDIT. The opportunity to conduct an audit of the Borrower's books,
records and operations and the Bank shall be satisfied as to the condition
thereof.

D. MISCELLANEOUS DOCUMENTS. Such other documents, instruments, agreements
and opinions as are necessary, or as the Bank may reasonably require, to
consummate the transactions contemplated under this Agreement, all fully
executed.

3.02. CONDITIONS PRECEDENT TO ALL EXTENSIONS OF CREDIT AND/OR ADVANCES. The
obligation of the Bank to make any extensions of credit and/or each Advance to
or on account of the Borrower (including the initial extension of credit and/or
the first Advance) shall be subject to the further conditions precedent that, as
of the date of each extension of credit or Advance and after the making of such
extension of credit or Advance:

A. REPRESENTATIONS AND WARRANTIES. The representations and warranties set
forth in the Section entitled "Representations and Warranties" herein and
in any other document, instrument, agreement or certificate delivered to
the Bank hereunder are true and correct.

B. EVENT OF DEFAULT. No event has occurred and is continuing which
constitutes, or, with the lapse of time or giving of notice or both, would
constitute an Event of Default.

C. SUBSEQUENT APPROVALS, ETC. The Bank shall have received such
supplemental approvals, opinions or documents as the Bank may reasonably
request.

3.03. REAFFIRMATION OF STATEMENTS. For the purposes hereof, the Borrower's
acceptance of the proceeds of any extension of credit and the Borrower's
execution of any document or instrument evidencing or creating any Obligation
hereunder shall each be deemed to constitute the Borrower's representation and
warranty that the statements set forth above in this Section are true and
correct.

SECTION IV
REPRESENTATIONS AND WARRANTIES

The Borrower hereby makes the following representations and warranties to the
Bank, which representations and warranties are continuing:

4.01. STATUS. The Borrower is a corporation duly organized and validly existing
under the laws of the State of California and is properly licensed, qualified to
do business and in good standing in, and, where necessary to maintain the
Borrower's rights and privileges, has complied with the fictitious name statute
of every jurisdiction in which the Borrower is doing business.

4.02. AUTHORITY. The execution, delivery and performance by the Borrower of this
Agreement and any instrument, document or agreement required hereunder have been
duly authorized and do not and will not: (i) violate any provision of any law,
rule, regulation, writ, judgment or injunction presently in effect affecting the
Borrower; (ii) require any consent or approval of the stockholders of the
Borrower or violate any provision of the articles of incorporation or by-laws of
the Borrower; or (iii) result in a breach of or constitute a default under any
material agreement to which the Borrower is a party or by which it or its
properties may be bound or affected.

4.03. LEGAL EFFECT. This Agreement constitutes, and any document, instrument or
agreement required hereunder when delivered will constitute, legal, valid and
binding obligations of the Borrower enforceable against the Borrower in
accordance with their respective terms.

4.04. FICTITIOUS TRADE STYLES. The Borrower currently uses no fictitious trade
styles in connection with its business operations. The Borrower shall notify the
Bank within thirty (30) days of the use of any fictitious trade style at any
future date, indicating the trade style and state(s) of its use.

4.05. FINANCIAL STATEMENTS. All financial statements, information and other data
which may have been and which may hereafter be submitted by the Borrower to the
Bank are true, accurate and correct and have been and will be prepared in
accordance with generally accepted accounting principles consistently applied
and accurately represent the Borrower's financial condition and, as applicable,
the other information disclosed therein. Since the most recent submission of any
such financial statement, information or other data to the Bank, the Borrower
represents and warrants that no material adverse change in the Borrower's
financial condition or operations has occurred which has not been fully
disclosed to the Bank in writing.

4.06. LITIGATION. Except as have been disclosed to the Bank in writing, there
are no actions, suits or proceedings pending or, to the knowledge of the
Borrower, threatened against or affecting the Borrower or the Borrower's
properties before any court or administrative agency which, if determined
adversely to the Borrower, would have a material adverse effect on the
Borrower's financial condition or operations.

4.07. TITLE TO ASSETS. The Borrower has good and marketable title to all of its
assets and the same are not subject to any security interest, encumbrance, lien
or claim of any third person except for Permitted Liens.

4.08. ERISA. If the Borrower has a pension, profit sharing or retirement plan
subject to ERISA, such plan has been and will continue to be funded in
accordance with its terms and otherwise complies with and continues to comply
with the requirements of ERISA.

4.09. TAXES. The Borrower has filed all tax returns required to be filed and
paid all taxes shown thereon to be due, including interest and penalties, other
than taxes which are currently payable without penalty or interest or those
which are being duly contested in good faith.

4.10. ENVIRONMENTAL COMPLIANCE. The operations of the Borrower comply, and
during the term of this Agreement will at all times comply, in all respects with
all Environmental Laws; the Borrower has obtained licenses, permits,
authorizations and registrations required under any Environmental Law
("Environmental Permits") and necessary for its ordinary operations, all such
Environmental Permits are in good standing, and the Borrower is in compliance
with all material terms and conditions of such Environmental Permits; neither
the Borrower nor any of its present properties or operations are subject to any
outstanding written order from or agreement with any governmental authority nor
subject to any judicial or docketed administrative proceeding, respecting any
Environmental Law, Environmental Claim or Hazardous Material; there are no
Hazardous Materials or other conditions or circumstances existing, or arising
from operations prior to the date of this Agreement, with respect to any
property of the Borrower that would reasonably be expected to give rise to
Environmental Claims; provided however, that with respect to property

(5)
<PAGE> 6
leased from an unrelated third party, the foregoing representation is made to
the best knowledge of the Borrower. In addition, (i) the Borrower does not have
or maintain any underground storage tanks which are not properly registered or
permitted under applicable Environmental Laws or which are leaking or disposing
of Hazardous Materials off-site, and (ii) the Borrower has notified all of its
employees of the existence, if any, of any health hazard arising from the
conditions of their employment and have met all notification requirements under
Title III of CERCLA and all other Environmental Laws.

SECTION V
COVENANTS

The Borrower covenants and agrees that, during the term of this Agreement, and
so long thereafter as the Borrower is indebted to the Bank under this Agreement,
the Borrower shall, unless the Bank otherwise consents in writing:

5.01. PRESERVATION OF EXISTENCE; COMPLIANCE WITH APPLICABLE LAWS. Maintain and
preserve its existence and all rights and privileges now enjoyed; not liquidate
or dissolve, merge or consolidate with or into, or acquire any other business
organization; and conduct its business in accordance with all applicable laws,
rules and regulations.

5.02. MAINTENANCE OF INSURANCE. Maintain insurance in such amounts and covering
such risks as is usually carried by companies engaged in similar businesses and
owning similar properties in the same general areas in which the Borrower
operates and maintain such other insurance and coverages as may be required by
the Bank. All such insurance shall be in form and amount and with companies
satisfactory to the Bank. With respect to insurance covering properties in which
the Bank maintains a security interest or lien, such insurance shall be in an
amount not less than the full replacement value thereof, at the Bank's request,
shall name the Bank as loss payee pursuant to a loss payable endorsement
satisfactory to the Bank and shall not be altered or canceled except upon ten
(10) days' prior written notice to the Bank. Upon the Bank's request, the
Borrower shall furnish the Bank with the original policy or binder of all such
insurance.

5.03. MAINTENANCE OF PROPERTIES. The Borrower shall maintain and preserve all
its properties in good working order and condition in accordance with the
general practice of other businesses of similar character and size, ordinary
wear and tear excepted.

5.04. LOCATION AND MAINTENANCE OF EQUIPMENT.

A. LOCATION. The Equipment shall at all times be in the Borrower's
physical possession, shall not be held for sale or lease and shall be kept
only at the following location(s): 160 Sobrante Way, Sunnyvale, CA 94086.
The Borrower shall not secrete, abandon or remove, or permit the removal
of, the Equipment, or any part thereof, from the location(s) shown above
or remove or permit to be removed any accessories now or hereafter placed
upon the Equipment.

B. EQUIPMENT SCHEDULES. Upon the Bank's demand, the Borrower shall
immediately provide the Bank with a complete and accurate description of
the Equipment including, as applicable, the make, model, identification
number and serial number of each item of Equipment. In addition, the
Borrower shall immediately notify the Bank of the acquisition of any new
or additional Equipment or the replacement of any existing Equipment and
shall supply the Bank with a complete description of any such additional
or replacement Equipment.

C. MAINTENANCE OF EQUIPMENT. The Borrower shall, at the Borrower's sole
cost and expense, keep and maintain the Equipment in a good state of
repair and shall not destroy, misuse, abuse, illegally use or be negligent
in the care of the Equipment or any part thereof. The Borrower shall not
remove, destroy, obliterate, change, cover, paint, deface or alter the
name plates, serial numbers, labels or other distinguishing numbers or
identification marks placed upon the Equipment or any part thereof by or
on behalf of the manufacturer, any dealer or rebuilder thereof, or the
Bank. The Borrower shall not be released from any liability to the Bank
hereunder because of any injury to or loss or destruction of the
Equipment. The Borrower shall allow the Bank and its representatives free
access to and the right to inspect the Equipment at all times and shall
comply with the terms and conditions of any leases covering the real
property on which the Equipment is located and any orders, ordinances,
laws, regulations or rules of any federal, state or municipal agency or
authority having jurisdiction of such real property or the conduct of
business of the persons having control or possession of the Equipment.

D. FIXTURES. The Equipment is not now and shall not at any time hereafter
be so affixed to the real property on which it is located as to become a
fixture or a part thereof. The Equipment is now and shall at all times
hereafter be and remain personal property of the Borrower.

5.05. PAYMENT OF OBLIGATIONS AND TAXES. Make timely payment of all assessments
and taxes and all of its liabilities and obligations including, but not limited
to, trade payables, unless the same are being contested in good faith by
appropriate proceedings with the appropriate court or regulatory agency. For
purposes hereof, the Borrower's issuance of a check, draft or similar instrument
without delivery to the intended payee shall not constitute payment.

5.06. INSPECTION RIGHTS. At any reasonable time and from time to time permit the
Bank or any representative thereof to examine and make copies of the records and
visit the properties of the Borrower and to discuss the business and operations
of the Borrower with any employee or representative thereof. If the Borrower now
or at any time hereafter maintains any records (including, but not limited to,
computer generated records and computer programs for the generation of such
records) in the possession of a third party, the Borrower hereby agrees to
notify such third party to permit the Bank free access to such records at all
reasonable times and to provide the Bank with copies of any records it may
request, all at the Borrower's expense, the amount of which shall be payable
immediately upon demand.

5.07. REPORTING REQUIREMENTS. Deliver or cause to be delivered to the Bank in
form and detail satisfactory to the Bank:

A. ANNUAL STATEMENTS. Not later than 90 days after the end of each of the
Borrower's fiscal years, a copy of the annual financial report of the
Borrower for such year, which report shall be CPA audited and certified by
an officer of the corporation.

B. ANNUAL 10K REPORTS. Not later than 10 days after filing with the
Securities Exchange Commission ("SEC"), a copy of the Borrower's annual
10K report.

C. INTERIM STATEMENTS. Not later than 45 days after the end of each
quarter, the Borrower's financial statement as of the end of such quarter,
certified by an officer of the corporation.

D. QUARTERLY 10Q REPORTS. Not later than 10 days after filing with the
SEC, a copy of the Borrower's quarterly 10Q report.

E. OTHER INFORMATION. Promptly upon the Bank's request, such other
information pertaining to the Borrower or any Guarantor as the Bank may
reasonably request.

(6)
<PAGE> 7
5.08. PAYMENT OF DIVIDENDS. The Borrower shall not declare or pay any dividends
on any class of its stock now or hereafter outstanding except dividends payable
solely in the corporation's capital stock.

5.09. REDEMPTION OR REPURCHASE OF STOCK. The Borrower shall not redeem or
repurchase any class of its corporate stock now or hereafter outstanding in
excess of $2,000,000.00 in any one fiscal year.

5.10. LIENS AND ENCUMBRANCES. Not create, assume or permit to exist any security
interest, encumbrance, mortgage, deed of trust or other lien (including, but not
limited to, a lien of attachment, judgment or execution) affecting any of the
Borrower's properties, or execute or allow to be filed any financing statement
or continuation thereof affecting any such properties, except for Permitted
Liens or as otherwise provided in this Agreement.

5.11. TRANSFER ASSETS. Not sell, contract for sale, transfer, convey, assign,
lease or sublet any assets of the Borrower except in the ordinary course of
business as presently conducted by the Borrower, and then, only for full, fair
and reasonable consideration.

5.12. CHANGE IN THE NATURE OF BUSINESS. Not make any material change in the
Borrower's financial structure or in the nature of the Borrower's business as
existing or conducted as of the date of this Agreement.

5.13. FINANCIAL CONDITION. Maintain at all times:

A. NET WORTH. A minimum Effective Tangible Net Worth of not less than
$33,000,000.00.

B. CURRENT RATIO. A ratio of current assets to current liabilities of not
less than 2.00 to 1.00.

C. MINIMUM NET INCOME. A minimum net profit after tax of $1.00 on a
quarterly basis.

D. DEBT SERVICE COVERAGE RATIO. A Debt Service Coverage ratio (which is
defined herein as the sum of net profit plus depreciation divided by the
current portion of long term debt) of not less than 2.00 to 1.00.

5.14. ENVIRONMENTAL COMPLIANCE. The Borrower shall:

A. Conduct the Borrower's operations and keep and maintain all of its
properties in compliance with all Environmental Laws.

B. Give prompt written notice to the Bank, but in no event later than 10
days after becoming aware, of the following: (i) any enforcement, cleanup,
removal or other governmental or regulatory actions instituted, completed
or threatened against the Borrower or any of its affiliates or any of its
respective properties pursuant to any applicable Environmental Laws, (ii)
all other Environmental Claims, and (iii) any environmental or similar
condition on any real property adjoining or in the vicinity of the
property of the Borrower or its affiliates that could reasonably be
anticipated to cause such property or any part thereof to be subject to
any restrictions on the ownership, occupancy, transferability or use of
such property under any Environmental Laws.

C. Upon the written request of the Bank, the Borrower shall submit to the
Bank, at its sole cost and expense, at reasonable intervals, a report
providing an update of the status of any environmental, health or safety
compliance, hazard or liability issue identified in any notice required
pursuant to this Section.

D. At all times indemnify and hold harmless the Bank from and against any
and all liability arising out of any Environmental Claims.

5.15. NOTICE. Give the Bank prompt written notice of any and all (i) Events of
Default; (ii) litigation, arbitration or administrative proceedings to which the
Borrower is a party and in which the claim or liability exceeds $1,000,000.00;
and (iii) other matters which have resulted in, or might result in a material
adverse change in the financial condition or business operations of the
Borrower.

SECTION VI
EVENTS OF DEFAULT

Any one or more of the following described events shall constitute an event of
default under this Agreement:

6.01. NON-PAYMENT. The Borrower shall fail to pay any Obligations within 10 days
of when due.

6.02. PERFORMANCE UNDER THIS AND OTHER AGREEMENTS. The Borrower shall fail in
any material respect to perform or observe any term, covenant or agreement
contained in this Agreement or in any document, instrument or agreement
evidencing or relating to any indebtedness of the Borrower (whether owed to the
Bank or third persons), and any such failure (exclusive of the payment of money
to the Bank under this Agreement or under any other document, instrument or
agreement, which failure shall constitute and be an immediate Event of Default
if not paid when due or when demanded to be due) shall continue for more than 30
days after written notice from the Bank to the Borrower of the existence and
character of such Event of Default.

6.03. REPRESENTATIONS AND WARRANTIES; FINANCIAL STATEMENTS. Any representation
or warranty made by the Borrower under or in connection with this Agreement or
any financial statement given by the Borrower or any Guarantor shall prove to
have been incorrect in any material respect when made or given or when deemed to
have been made or given.

6.04. INSOLVENCY. The Borrower or any Guarantor shall: (i) become insolvent or
be unable to pay its debts as they mature; (ii) make an assignment for the
benefit of creditors or to an agent authorized to liquidate any substantial
amount of its properties or assets; (iii) file a voluntary petition in
bankruptcy or seeking reorganization or to effect a plan or other arrangement
with creditors; (iv) file an answer admitting the material allegations of an
involuntary petition relating to bankruptcy or reorganization or join in any
such petition; (v) become or be adjudicated a bankrupt; (vi) apply for or
consent to the appointment of, or consent that an order be made, appointing any
receiver, custodian or trustee for itself or any of its properties, assets or
businesses; or (vii) any receiver, custodian or trustee shall have been
appointed for all or a substantial part of its properties, assets or businesses
and shall not be discharged within 30 days after the date of such appointment.

6.05. EXECUTION. Any writ of execution or attachment or any judgment lien shall
be issued against any property of the Borrower and shall not be discharged or
bonded against or released within 30 days after the issuance or attachment of
such writ or lien.

6.06. REVOCATION OR LIMITATION OF GUARANTY. Any Guaranty shall be revoked or
limited or its enforceability or validity shall be contested by any Guarantor,
by operation of law, legal proceeding or otherwise or any Guarantor who is a
natural person shall die.

(7)
<PAGE> 8
6.07. SUSPENSION. The Borrower shall voluntarily suspend the transaction of
business or allow to be suspended, terminated, revoked or expired any permit,
license or approval of any governmental body necessary to conduct the Borrower's
business as now conducted.

6.08. CHANGE IN OWNERSHIP. There shall occur a sale, transfer, disposition or
encumbrance (whether voluntary or involuntary), or an agreement shall be entered
into to do so, with respect to more than 10% of the issued and outstanding
capital stock of the Borrower.

SECTION VII
REMEDIES ON DEFAULT

Upon the occurrence of any Event of Default, the Bank may, at its sole
election, without demand and upon only such notice as may be required by law:

7.01. ACCELERATION. Declare any or all of the Borrower's indebtedness owing to
the Bank, whether under this Agreement or under any other document, instrument
or agreement, immediately due and payable, whether or not otherwise due and
payable.

7.02. CEASE EXTENDING CREDIT. Cease making Advances or otherwise extending
credit to or for the account of the Borrower under this Agreement or under any
other agreement now existing or hereafter entered into between the Borrower and
the Bank.

7.03. TERMINATION. Terminate this Agreement as to any future obligation of the
Bank without affecting the Borrower's obligations to the Bank or the Bank's
rights and remedies under this Agreement or under any other document, instrument
or agreement.

7.04. LETTERS OF CREDIT. In addition to any other remedies available to the Bank
under this Agreement or otherwise, the Bank may require the Borrower to pay
immediately to the Bank, for application against any drawings under any
outstanding Letters of Credit, the outstanding principal amount of any such
Letters of Credit which have not expired. Any portion of the amount so paid to
the Bank which is not applied to satisfy draws under any such Letters of Credit
or any other obligations of the Borrower to the Bank shall be repaid to the
Borrower without interest.

7.05. NON-EXCLUSIVITY OF REMEDIES. Exercise one or more of the Bank's rights set
forth herein or seek such other rights or pursue such other remedies as may be
provided by law, in equity or in any other agreement now existing or hereafter
entered into between the Borrower and the Bank, or otherwise.

SECTION VIII
MISCELLANEOUS PROVISIONS

8.01. DEFAULT INTEREST RATE. If an Event of Default has occurred and is
continuing, the Bank, at its option, may require the Borrower to pay to the Bank
interest on any Indebtedness or amount payable under this Agreement at a rate
which is 3% in excess of the rate or rates otherwise then in effect under this
Agreement.

8.02. REIMBURSEMENT OF CERTAIN COSTS IN CONNECTION WITH LETTERS OF CREDIT. The
Borrower shall, upon the Bank's request, promptly pay to and reimburse the Bank
for all costs incurred and payments made by the Bank by reason of any future
assessment, reserve, deposit or similar requirement or any surcharge, tax or fee
imposed upon the Bank or as a result of the Bank's compliance with any directive
or requirement of any regulatory authority pertaining or relating to any Letters
of Credit.

8.03. RELIANCE. Each warranty, representation, covenant and agreement contained
in this Agreement shall be conclusively presumed to have been relied upon by the
Bank regardless of any investigation made or information possessed by the Bank
and shall be cumulative and in addition to any other warranties,
representations, covenants or agreements which the Borrower shall now or
hereafter give, or cause to be given, to the Bank.

8.04. DISPUTE RESOLUTION.

A. DISPUTES. It is understood and agreed that, upon the request of any
party to this Agreement, any dispute, claim or controversy of any kind,
whether in contract or in tort, statutory or common law, legal or
equitable, now existing or hereinafter arising between the parties in any
way arising out of, pertaining to or in connection with: (i) this
Agreement, or any related agreements, documents or instruments, (ii) all
past and present loans, credits, accounts, deposit accounts (whether
demand deposits or time deposits), safe deposit boxes, safekeeping
agreements, guarantees, letters of credit, goods or services, or other
transactions, contracts or agreements of any kind, (iii) any incidents,
omissions, acts, practices, or occurrences causing injury to any party
whereby another party or its agents, employees or representatives may be
liable, in whole or in part, or (iv) any aspect of the past or present
relationships of the parties, shall be resolved through a two-step dispute
resolution process administered by the Judicial Arbitration & Mediation
Services, Inc. ("JAMS") as follows:

B. STEP I - MEDIATION. At the request of any party to the dispute, claim
or controversy, the matter shall be referred to the nearest office of JAMS
for mediation, which is an informal, non-binding conference or conferences
between the parties in which a retired judge or justice from the JAMS
panel will seek to guide the parties to a resolution of the case.

C. STEP II - ARBITRATION (CONTRACTS NOT SECURED BY REAL PROPERTY). Should
any dispute, claim or controversy remain unresolved at the conclusion of
the Step I Mediation Phase, then (subject to the restriction at the end of
this subparagraph) all such remaining matters shall be resolved by final
and binding arbitration before a different judicial panelist, unless the
parties shall agree to have the mediator panelist act as arbitrator. The
hearing shall be conducted at a location determined by the arbitrator in
Los Angeles, California (or such other city as may be agreed upon by the
parties) and shall be administered by and in accordance with the then
existing Rules of Practice and Procedure of JAMS and judgement upon any
award rendered by the arbitrator may be entered by any State or Federal
Court having jurisdiction thereof. The arbitrator shall determine which is
the prevailing party and shall include in the award that party's
reasonable attorneys' fees and costs. This subparagraph shall apply only
if, at the time of the submission of the matter to JAMS, the dispute or
issues involved do not arise out of any transaction which is secured by
real property collateral or, if so secured, all parties consent to such
submission.

As soon as practicable after selection of the arbitrator, the arbitrator,
or the arbitrator's designated representative, shall determine a
reasonable estimate of anticipated fees and costs of the arbitrator, and
render a statement to each party setting forth that party's pro-rata share
of said fees and costs. Thereafter, each party shall, within 10 days of
receipt of said statement, deposit said sum with the arbitrator. Failure
of any party to make such a deposit shall result in a forfeiture by the
non-depositing party of the right to prosecute or defend the claim which
is the subject of the arbitration, but shall not otherwise serve to abate,

(8)
<PAGE> 9
stay or suspend the arbitration proceedings.

D. STEP II - TRIAL BY COURT REFERENCE (CONTRACTS SECURED BY REAL
PROPERTY). If the dispute, claim or controversy is not one required or
agreed to be submitted to arbitration, as provided in the above
subparagraph, and has not been resolved by Step I mediation, then any
remaining dispute, claim or controversy shall be submitted for
determination by a trial on Order of Reference conducted by a retired
judge or justice from the panel of JAMS appointed pursuant to the
provisions of Section 638(1) of the California Code of Civil Procedure, or
any amendment, addition or successor section thereto, to hear the case and
report a statement of decision thereon. The parties intend this general
reference agreement to be specifically enforceable in accordance with said
section. If the parties are unable to agree upon a member of the JAMS
panel to act as referee, then one shall be appointed by the Presiding
Judge of the county wherein the hearing is to be held. The parties shall
pay in advance, to the referee, the estimated reasonable fees and costs of
the reference, as may be specified in advance by the referee. The parties
shall initially share equally, by paying their proportionate amount of the
estimated fees and costs of the reference. Failure of any party to make
such a fee deposit shall result in a forfeiture by the non-depositing
party of the right to prosecute or defend any cause of action which is the
subject of the reference, but shall not otherwise serve to abate, stay or
suspend the reference proceeding.

E. PROVISIONAL REMEDIES, SELF HELP AND FORECLOSURE. No provision of, or
the exercise of any rights under any portion of this Dispute Resolution
provision, shall limit the right of any party to exercise self help
remedies such as set off, foreclosure against any real or personal
property collateral, or the obtaining of provisional or ancillary
remedies, such as injunctive relief or the appointment of a receiver, from
any court having jurisdiction before, during or after the pendency of any
arbitration. At the Bank's option, foreclosure under a deed of trust or
mortgage may be accomplished either by exercise of power of sale under the
deed of trust or mortgage, or by judicial foreclosure. The institution and
maintenance of an action for provisional remedies, pursuit of provisional
or ancillary remedies or exercise of self help remedies shall not
constitute a waiver of the right of any party to submit the controversy or
claim to arbitration.

8.05. WAIVER OF JURY. The Borrower and the Bank hereby expressly and voluntarily
waive any and all rights, whether arising under the California constitution, any
rules of the California Code of Civil Procedure, common law or otherwise, to
demand a trial by jury in any action, matter, claim or cause of action
whatsoever arising out of or in any way related to this Agreement or any other
agreement, document or transaction contemplated hereby.

8.06. RESTRUCTURING EXPENSES. In the event the Bank and the Borrower negotiate
for, or enter into, any restructuring, modification or refinancing of the
Indebtedness under this Agreement for the purposes of remedying an Event of
Default, The Bank, may require the Borrower to reimburse all of the Bank's costs
and expenses incurred in connection therewith, including, but not limited to
reasonable attorneys' fees and the costs of any audit or appraisals required by
the Bank to be performed in connection with such restructuring, modification or
refinancing.

8.07. ATTORNEYS' FEES. In the event
of any suit, mediation, arbitration or other action in relation to this
FAgreement or any document, instrument or agreement executed with respect to,
evidencing or securing the indebtedness hereunder, the prevailing party, in
addition to all other sums to which it may be entitled, shall be entitled to
reasonable attorneys' fees.

8.08. NOTICES. All notices, payments, requests, information and demands which
either party hereto may desire, or may be required to give or make to the other
party shall be given or made to such party by hand delivery or through deposit
in the United States mail, postage prepaid, or by Western Union telegram,
addressed to the address set forth below such party's signature to this
Agreement or to such other address as may be specified from time to time in
writing by either party to the other.

8.09. WAIVER. Neither the failure nor delay by the Bank in exercising any right
hereunder or under any document, instrument or agreement mentioned herein shall
operate as a waiver thereof, nor shall any single or partial exercise of any
right hereunder or under any document, instrument or agreement mentioned herein
preclude other or further exercise thereof or the exercise of any other right;
nor shall any waiver of any right or default hereunder or under any other
document, instrument or agreement mentioned herein constitute a waiver of any
other right or default or constitute a waiver of any other default of the same
or any other term or provision.

8.10. CONFLICTING PROVISIONS. To the extent that any of the terms or provisions
contained in this Agreement are inconsistent with those contained in any other
document, instrument or agreement executed pursuant hereto, the terms and
provisions contained herein shall control. Otherwise, such provisions shall be
considered cumulative.

8.11. BINDING EFFECT; ASSIGNMENT. This Agreement shall be binding upon and inure
to the benefit of the Borrower and the Bank and their respective successors and
assigns, except that the Borrower shall not have the right to assign its rights
hereunder or any interest herein without the Bank's prior written consent. The
Bank may sell, assign or grant participations in all or any portion of its
rights and benefits hereunder. The Borrower agrees that, in connection with any
such sale, grant or assignment, the Bank may deliver to the prospective buyer,
participant or assignee financial statements and other relevant information
relating to the Borrower and any guarantor.

8.12. JURISDICTION. This Agreement, any notes issued hereunder, and any
documents, instruments or agreements mentioned or referred to herein shall be
governed by and construed according to the laws of the State of California, to
the jurisdiction of whose courts the parties hereby submit. 8.13. HEADINGS. The
headings set forth herein are solely for the purpose of identification and have
no legal significance.

8.14. ENTIRE AGREEMENT. This Agreement and all documents, instruments and
agreements mentioned herein constitute the entire and complete understanding of
the parties with respect to the transactions contemplated hereunder. All
previous conversations, memoranda and writings between the parties or pertaining
to the transactions contemplated hereunder that are not incorporated or
referenced in this Agreement or in such documents, instruments and agreements
are superseded hereby.

(9)
<PAGE> 10
IN WITNESS WHEREOF, this Agreement has been executed by the parties hereto as of
the date first hereinabove written.

BANK: BORROWER:

SANWA BANK CALIFORNIA APPLIED SIGNAL TECHNOLOGY, INC.

BY: [SIG] BY: [SIG]
--------------------------------- -----------------------------------
JILLIAN MATHUR, AUTHORIZED OFFICER GARY L. YANCEY, CHIEF EXECUTIVE OFFICER
AND PRESIDENT

ADDRESS: BY: [SIG]
-----------------------------------
San Jose Commercial Banking Center BRIAN OFFI, CHIEF FINANCIAL OFFICER
220 Almaden Blvd.
San Jose, CA 95113
ADDRESS:
160 Sobrante Way
Sunnyvale, CA 94086

(10)

<PAGE> 1
[SANWA BANK LOGO]

EXHIBIT 10.16

CERTIFIED CORPORATE RESOLUTION TO BORROW

WHEREAS, APPLIED SIGNAL TECHNOLOGY, INC. (the "Corporation") has made
application to SANWA BANK CALIFORNIA (the "Bank") for credit accommodations
which may consist of but shall in no way be limited to the following: the
renewal, continuation or extension of an existing obligation; the extension of a
new loan, line of credit or commitment; the issuance of letters of credit or
banker's acceptances; or the purchase or sale through the Bank of foreign
currencies. RESOLVED, that any one (1) of the following named officers,
employees, or agents of the Corporation, whose signatures are shown below:

<TABLE>
<CAPTION>
NAME POSITION SIGNATURE
- ---- -------- ---------

<S> <C> <C>
GARY L. YANCEY Chief Executive Officer and President /S/Gary L. Yancey
--------------------------

BRIAN OFFI Chief Financial Officer /S/Brian Offi
--------------------------
</TABLE>

is authorized, in the name of and on behalf of the Corporation to take the
following actions:

1. Borrow money from the Bank in such amounts and upon such terms and
conditions as are agreed upon by the officers of the Corporation and the
Bank; and execute and deliver or endorse such evidences of indebtedness
or renewals thereof or agreements therefor as may be required by the
Bank, all in such form and content as the officers of the Corporation
executing such documents shall approve (which approval shall be
evidenced by the execution and delivery of such documents); provided,
however, that the maximum amount of such indebtedness shall not exceed
the principal sum of $8,500,000.00 exclusive of any interest, fees,
attorneys' fees and other costs and expenses related to the
indebtedness.

2. Grant security interests and liens in any real, personal or other
property belonging to or under the control of the Corporation as
security for any indebtedness of the Corporation to the Bank; and
execute and deliver to the Bank any and all security agreements,
pledges, mortgages, deeds of trust and other security instruments and
any other documents to effectuate the grant of such security interests
and liens, which security instruments and other documents shall be in
such form and content as the officers of the Corporation executing such
security instruments and other documents shall approve and which
approval shall be evidenced by the execution and delivery of such
security instruments and other documents.

3. Waive on behalf of the Corporation, and in any agreement, instrument,
or document executed by the Corporation include a waiver of, any and all
rights of the Corporation to require the Bank to adhere to certain
processes, including without limitation, the right to a jury trial in an
action or suit against the Bank.

4. Execute such evidences of indebtedness, agreements, security
instruments and other documents and to take such other actions as are
herein authorized.

5. Include in any agreement, instrument or document executed by the
Corporation in connection with the actions herein authorized a provision
requiring that any dispute arising under such agreement, instrument or
document shall be resolved by mediation, arbitration, or other similar
dispute resolution method.

6. Sell to or discount or re-discount with the Bank any and all
negotiable instruments, contracts or instruments or evidences of
indebtedness at any time held by the Corporation; and endorse, transfer
and deliver the same, together with guaranties of payment or repurchase
thereof, to the Bank (for which the Bank is hereby authorized and
directed to pay the proceeds of such sale, discount or re-discount as
directed by such endorsement without inquiring into the circumstances of
its issue or endorsement or the disposition of such proceeds).

7. Apply for letters of credit or seek the issuance of banker's
acceptances under which the Corporation shall be liable to the Bank for
repayment.

8. Purchase and sell foreign currencies, on behalf of the Corporation,
whether for immediate or future delivery, in such amounts and upon such
terms and conditions as the officers of the corporation may deem
appropriate, and give any instructions for transfers or deposits of
monies by check, drafts, cable, letter or otherwise for any purpose
incidental to the foregoing, and authorize or direct charges to the
depository account or accounts of the Corporation for the cost of any
foreign currencies so purchased through the Bank.

9. Designate in writing to the Bank in accordance with the terms of any
agreement or other document executed by the above-named individuals one
or more individuals who shall have the authority as provided herein, to
(a) request advances under lines of credit extended by the Bank to the
Corporation; (b) apply for letters of credit or seek the issuance of
banker's acceptances under which the Corporation shall be liable to the
Bank for repayment; (c) make deposits and receive and execute receipts
for deposits on accounts of the Corporation maintained with the Bank;
(d) make withdrawals and receive and execute receipts for withdrawals on
account of the Corporation maintained with the Bank; and (e) purchase
and sell foreign currencies.

10. Transact any other business with the Bank incidental to the powers
hereinabove stated.

RESOLVED FURTHER, that all such evidences of indebtedness, agreements, security
instruments and other documents executed in the name of and on behalf of the
Corporation and all such actions taken on behalf of the Corporation in
connection with the matters described herein are hereby ratified and approved.

RESOLVED FURTHER, that the Bank is authorized to act upon these resolutions
until written notice of their revocation is delivered to the Bank.

RESOLVED FURTHER, that any resolution set forth herein is in addition to and
does not supersede any resolutions previously given by the Corporation to the
Bank.

RESOLVED FURTHER, that the Secretary of the Corporation be, and hereby is,
authorized and directed to prepare, execute and deliver to the Bank a certified
copy of the foregoing resolutions.

I DO HEREBY CERTIFY that I am the Secretary of APPLIED SIGNAL TECHNOLOGY, INC.,
a California corporation, and I do hereby further certify that the foregoing is
a true copy of the resolutions of the Board of Directors of the Corporation
adopted and approved in accordance with all applicable provisions of law and

(1)

<PAGE> 2

the Articles and By-Laws of the Corporation either by unanimous written consent
or at a meeting which was duly called and held, at which meeting a majority of
the Board of Directors of the Corporation was present and voted in favor of the
resolutions.

I HEREBY FURTHER CERTIFY that
such resolutions are presently in full force and effect and have not been
amended or revoked. I do further certify that the above persons have been duly
elected and qualified as and, this day are, officers of the Corporation, holding
their respective offices appearing by their names, and that the signatures
appearing opposite their names are the genuine signatures of such persons. IN
WITNESS WHEREOF, this certificate has been executed on March 3, 1997.
-----------------

CERTIFIED TO AND ATTESTED BY:

X /Signed/?
----------------------------------
*SECRETARY OR ASSISTANT SECRETARY

X
----------------------------------

*Note: In case the Secretary or other certifying officer is designated by the
foregoing resolutions as one of the signing officers, this certificate should
also be signed by a second Officer or Director of the Corporation.

(2)

<PAGE> 1
EXHIBIT 10.17

APPLIED SIGNAL TECHNOLOGY, INC.

1991 STOCK OPTION PLAN, AS AMENDED

(AS AMENDED JANUARY 25, 1997)

1. Purpose. On January 18, 1991, the Applied Signal Technology, Inc.,
1991 Stock Option Plan (the "Prior Plan") was adopted. The Prior Plan is hereby
amended and restated in its entirety and renamed the Applied Signal Technology,
Inc. 1991 Stock Option Plan, as Amended (the "Plan"). The Plan is established to
attract, retain and reward persons providing services to Applied Signal
Technology, Inc. and any successor corporation thereto (collectively referred to
as the "Company"), and any present or future parent and/or subsidiary
corporations of such corporation (all of whom along with the Company being
individually referred to as a "Participating Company" and collectively referred
to as the "Participating Company Group"), and to motivate such persons to
contribute to the growth and profits of the Participating Company Group in the
future. For purposes of the Plan, a parent corporation and a subsidiary
corporation shall be as defined in sections 424(e) and 424(f) of the Internal
Revenue Code of 1986, as amended (the "Code").

2. Administration.

(a) Administration by Board and/or Committee. The Plan shall
be administered by the Board of Directors of the Company (the "Board") and/or by
a duly appointed committee of the Board having such powers as shall be specified
by the Board. Any subsequent references herein to the Board shall also mean the
committee if such committee has been appointed and, unless the powers of the
committee have been specifically limited, the committee shall have all of the
powers of the Board granted herein, including, without limitation, the power to
terminate or amend the Plan at any time, subject to the terms of the Plan and
any applicable limitations imposed by law. All questions of interpretation of
the Plan or of any options granted under the Plan (an "Option") shall be
determined by the Board, and such determinations shall be final and binding upon
all persons having an interest in the Plan and/or any Option.

(b) Options Authorized. Options may be either incentive stock
options as defined in section 422 of the Code ("Incentive Stock Options") or
nonqualified stock options.

(c) Authority of Officers. Any officer of a Participating
Company shall have the authority to act on behalf of the Company with respect to
any matter, right, obligation, or election which is the responsibility of or
which is allocated to the Company herein, provided the officer has apparent
authority with respect to such matter, right, obligation, or election.

(d) Administration with Respect to Insiders. With respect to
the participation in the Plan of officers or directors of the Company or any
other person whose transactions in the

1
<PAGE> 2
common stock of the Company are subject to Section 16 of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), the Plan shall be administered by
the Board in compliance with the requirements, if any, of Rule 16b-3, as
promulgated under the Exchange Act and amended from time to time or any
successor rule or regulation.

(e) Compliance with Section 162(m) of the Code. If a
Participating Company is a "publicly held corporation" as defined in paragraph
(2) of section 162(m) of the Code, as amended by the Revenue Reconciliation Act
of 1993 (P.L. 103-66), and the regulations promulgated thereunder ("Section
162(m)"), the Company may establish a committee of "outside directors" within
the meaning of Section 162(m) to approve the grant of any Option which might
reasonably be anticipated to result in the payment of employee remuneration that
would otherwise exceed the limit on employee remuneration deductible for income
tax purposes pursuant to Section 162(m).

3. Eligibility and Option Limitations.

(a) Eligible Persons. Options may be granted only to employees
(including officers) and directors of the Participating Company Group or to
individuals who are rendering services as consultants, advisors, or other
independent contractors to the Participating Company Group. The Board shall, in
its sole discretion, determine which persons shall be granted Options (an
"Optionee"). Eligible persons may be granted more than one (1) Option.

(b) Restrictions on Option Grants. A director of the Company
may only be granted a nonqualified stock option unless the director is also an
employee of the Company. An individual who is rendering services as a
consultant, advisor, or other independent contractor may only be granted a
nonqualified stock option.

(c) Section 162(m) Grant Limit. Subject to adjustment as
provided in paragraph 8 below, at any such time as a Participating Company is a
"publicly held corporation" as defined in paragraph 2 of Section 162(m), no
employee shall be granted within any fiscal year of the Company Options which in
the aggregate cover more than four hundred thousand (400,000) shares (the
"Section 162(m) Grant Limit").

4. Shares Subject to Option. Options shall be for the purchase of
authorized but unissued or reacquired shares of the common stock of the Company
(the "Stock"), subject to adjustment as provided in paragraph 8 below. The
maximum number of shares of Stock which may be issued under the Plan shall be
two million (2,000,000) shares. In the event that any outstanding Option for any
reason expires or is terminated or cancelled and/or shares of Stock subject to
repurchase are repurchased by the Company, the shares allocable to the
unexercised portion of such Option, or such repurchased shares, may again be
subject to an Option grant.

5. Time for Granting Options. All Options shall be granted, if at all,
within ten (10) years from January 18, 1991.

2
<PAGE> 3
6. Terms, Conditions and Form of Options. Subject to the provisions of
the Plan, the Board shall determine for each Option (which need not be
identical) the number of shares of Stock for which the Option shall be granted,
the option price of the Option, the timing and terms of exercisability and
vesting of the Option, whether the Option is to be treated as an Incentive Stock
Option or as a nonqualified stock option and all other terms and conditions of
the Option not inconsistent with the Plan. Options granted pursuant to the Plan
shall be evidenced by written agreements specifying the number of shares of
Stock covered thereby, in such form as the Board shall from time to time
establish, and shall comply with and be subject to the following terms and
conditions:

(a) Option Price. The option price for each Option shall be
established in the sole discretion of the Board; provided, however, that (i) the
option price per share for an Incentive Stock Option shall be not less than the
fair market value, as determined by the Board, of a share of Stock on the date
of the granting of the Option, (ii) the option price per share for a
nonqualified stock option may be greater than, equal to, or less than the fair
market value, as determined by the Board, of a share of Stock on the date of the
granting of the Option, and (iii) no Incentive Stock Option granted to an
Optionee who at the time the Option is granted owns stock possessing more than
ten percent (10%) of the total combined voting power of all classes of stock of
a Participating Company within the meaning of section 422(b)(6) of the Code (a
"Ten Percent Owner Optionee") shall have an option price per share less than one
hundred ten percent (110%) of the fair market value of a share of Stock on the
date the Option is granted. Notwithstanding the foregoing, an Option (whether an
Incentive Stock Option or a nonqualified stock option) may be granted with an
exercise price lower than the minimum exercise price set forth above if such
Option is granted pursuant to an assumption or substitution for another option
in a manner qualifying with the provisions of section 424(a) of the Code.

(b) Exercise Period of Options. The Board shall have the power
to set the time or times within which each Option shall be exercisable or the
event or events upon the occurrence of which all or a portion of each Option
shall be exercisable and the term of each Option; provided, however, that (i) no
Option shall be exercisable after the expiration of ten (10) years after the
date such Option is granted and (ii) no Incentive Stock Option granted to a Ten
Percent Owner Optionee shall be exercisable after the expiration of five (5)
years after the date such Option is granted.

3
<PAGE> 4
(c) Payment of Option Price.

(i) Forms of Payment Authorized. Payment of the
option price for the number of shares of Stock being purchased pursuant to any
Option shall be made (i) in cash, by check, or cash equivalent, (ii) by tender
to the Company of shares of the Company's stock owned by the Optionee having a
value, as determined by the Board (but without regard to any restrictions on
transferability applicable to such stock by reason of federal or state
securities laws or agreements with an underwriter for the Company), not less
than the option price, (iii) by the Optionee's recourse promissory note, (iv) by
the assignment of the proceeds of a sale of some or all of the shares being
acquired upon the exercise of an Option (including, without limitation through
an exercise complying with the provisions of Regulation T as promulgated from
time to time by the Board of Governors of the Federal Reserve System), or (v) by
any combination thereof. The Board may at any time or from time to time, by
adoption of or by amendment to the standard form or forms of stock option
agreement described in paragraph 7 below, or by other means, grant Options which
do not permit all of the foregoing forms of consideration to be used in payment
of the option price and/or which otherwise restrict one (1) or more forms of
consideration.

(ii) Tender of Company Stock. Notwithstanding the
foregoing, an Option may not be exercised by tender to the Company of shares of
the Company's stock to the extent such tender of stock would constitute a
violation of the provisions of any law, regulation and/or agreement restricting
the redemption of the Company's stock. Unless otherwise provided for by the
Board, an Option may not be exercised by tender to the Company of shares of the
Company's stock unless such shares of the Company's stock either have been owned
by the Optionee for more than six (6) months or were not acquired, directly or
indirectly, from the Company.

(iii) Payment by Promissory Note. No promissory note
shall be permitted if an exercise using a promissory note would be a violation
of any law. Any permitted promissory note shall be due and payable not more than
five (5) years after the Option is exercised, and interest shall be payable at
least annually and be at least equal to the minimum interest rate necessary to
avoid imputed interest pursuant to all applicable sections of the Code. The
Board shall have the authority to permit or require the Optionee to secure any
promissory note used to exercise an Option with the shares of Stock acquired on
exercise of the Option and/or with other collateral acceptable to the Company.
Unless otherwise provided by the Board, in the event the Company at any time
becomes subject to the regulations promulgated by the Board of Governors of the
Federal Reserve System or any other governmental entity affecting the extension
of credit in connection with the Company's securities, any promissory note shall
comply with such applicable regulations, and the Optionee shall pay the unpaid
principal and accrued interest, if any, to the extent necessary to comply with
such applicable regulations.

(iv) Assignment of Proceeds of Sale. The Company
reserves, at any and all times, the right, in the Company's sole and absolute
discretion, to establish, decline to approve and/or terminate any program and/or
procedures for the exercise of Options by means of

4
<PAGE> 5
an assignment of the proceeds of a sale of some or all of the shares of Stock to
be acquired upon such exercise.

(d) Transfer of Control. A "Transfer of Control" shall be
deemed to have occurred in the event any of the following occurs with respect to
the Company:

(i) the direct or indirect sale or exchange by the
shareholders of the Company of all or substantially all of the stock of the
Company where the shareholders of the Company before such sale or exchange do
not retain, directly or indirectly, at least a majority of the beneficial
interest in the voting stock of the Company after such sale or exchange;

(ii) a merger in which the Company is not the
surviving corporation;

(iii) a merger in which the Company is the surviving
corporation where the shareholders of the Company before such merger do not
retain, directly or indirectly, at least a majority of the beneficial interest
in the voting stock of the Company after such merger;

(iv) the sale, exchange, or transfer of all or
substantially all of the Company's assets (other than a sale, exchange, or
transfer to one (1) or more subsidiary corporations (as defined in paragraph 1
above) of the Company); or

(v) a liquidation or dissolution of the Company.

In the event of a Transfer of Control, the surviving, continuing,
successor, or purchasing corporation, as the case may be (the "Acquiring
Corporation"), shall either assume the Company's rights and obligations under
outstanding stock option agreements or substitute options for the Acquiring
Corporation's stock for such outstanding Options. With respect to outstanding
Options granted by the Board prior to January 4, 1992, in the event the
Acquiring Corporation elects not to assume or substitute for such outstanding
Options in connection with a merger described in (ii) above or a sale of assets
described in (iv) above, the Board shall provide that any unexercisable and/or
unvested portion of the outstanding Options shall be immediately exercisable and
vested as of a date prior to the Transfer of Control, as the Board so
determines. The exercise and/or vesting of any Option that was permissible
solely by reason of this paragraph 6(d) shall be conditioned upon the
consummation of the Transfer of Control. Any Options which are neither assumed
or substituted for by the Acquiring Corporation nor exercised as of the date of
the Transfer of Control shall terminate effective as of the date of the Transfer
of Control.

7. Standard Forms of Stock Option Agreement. The Board may, from time
to time adopt or amend a standard form or forms of stock option agreement. Any
standard form of stock option agreement for an Option shall properly reflect
such Option's status as an Incentive Stock Option or a nonqualified stock
option, as the case may be. The Board may, from time to time,

5
<PAGE> 6
vary the terms of the standard form or forms of stock option agreement, either
in connection with the grant of an individual Option or in connection with the
authorization of a new standard form or forms; provided, however, that the terms
and conditions of such revised standard form or forms of stock option agreement
shall be in accordance with the terms of the Plan. Such authority shall include,
but not by way of limitation, the authority to grant Options which are
immediately exercisable subject to the Company's right to repurchase any
unvested shares of Stock acquired by an Optionee on exercise of an Option in the
event such Optionee's employment with the Participating Company Group is
terminated for any reason, with or without cause. Unless otherwise provided by
the Board at the time an Option is granted, or unless otherwise provided in the
standard form or forms of stock option agreement as revised from time to time,
the terms of the standard form of stock option agreement shall include the
following:

(a) Tax Withholding. At the time an Option is exercised, in
whole or in part, or at any time thereafter as requested by the Company, an
Optionee shall authorize payroll withholding and otherwise agree to make
adequate provision for foreign, federal and state tax withholding obligations of
the Company, if any, which arise in connection with the Option, including,
without limitation, obligations arising upon (i) the exercise, in whole or in
part, of the Option, (ii) the transfer, in whole or in part, of any shares of
Stock acquired on exercise of the Option, (iii) the operation of any law or
regulation providing for the imputation of interest, or (iv) the lapsing of any
restriction with respect to any shares acquired on exercise of the Option.

(b) Certificate Registration. The certificate or certificates
for the shares of Stock as to which an Option shall be exercised shall be
registered in the name of the Optionee, or, if applicable, the heirs of the
Optionee.

(c) Restrictions on Grant of the Option and Issuance of
Shares. The grant of an Option and the issuance of shares of Stock on exercise
of the Option shall be subject to compliance with all applicable requirements of
federal and state law with respect to such securities. An Option may not be
exercised if the issuance of shares of Stock upon such exercise would constitute
a violation of any applicable federal or state securities laws or other law or
regulations. In addition, no Option may be exercised unless (i) a registration
statement under the Securities Act of 1933, as amended (the "Securities Act"),
shall at the time of exercise of the Option be in effect with respect to the
shares of Stock issuable on exercise of the Option or (ii) in the opinion of
legal counsel to the Company, the shares issuable upon exercise of the Option
may be issued in accordance with the terms of an applicable exemption from the
registration requirements of the Securities Act. As a condition to the exercise
of an Option, the Company may require the Optionee to satisfy any qualifications
that may be necessary or appropriate, to evidence compliance with any applicable
law or regulation and to make any representation or warranty with respect
thereto as may be requested by the Company.

(d) Fractional Shares. The Company shall not be required to
issue fractional shares of Stock upon the exercise of an Option.

6
<PAGE> 7
(e) Termination of Employment.

(I) Termination of the Option. If the Optionee
ceases to be an employee of the Participating Company Group for any reason
except death or disability within the meaning of section 422(c) of the Code, an
Option, to the extent unexercised and exercisable by the Optionee on the date on
which the Optionee ceased to be an employee, may be exercised by the Optionee
within three (3) months after the date on which the Optionee's employment
terminates, but in any event no later than the date of expiration of the Option
term. If the Optionee's employment with the Participating Company Group is
terminated because of the death or disability of the Optionee within the meaning
of section 422(c) of the Code, an Option, to the extent unexercised and
exercisable by the Optionee on the date on which the Optionee ceased to be an
employee, may be exercised by the Optionee (or the Optionee's legal
representative) at any time prior to the expiration of twelve (12) months from
the date the Optionee's employment terminated, but in any event no later than
the date of expiration of the Option term. An Optionee's employment shall be
deemed to have terminated on account of death if the Optionee dies within three
(3) months after the Optionee's termination of employment.

(ii) Termination of Employment Defined. For purposes
of this paragraph 7(e), an Optionee's employment shall be deemed to have
terminated either upon an actual termination of employment or upon the
Optionee's employer ceasing to be a Participating Company.

(iii) Extension if Exercise Prevented by Law.
Notwithstanding the foregoing, if the exercise of an Option within the
applicable time periods set forth above is prevented because the issuance of
shares of Stock upon such exercise would constitute a violation of any
applicable federal or state securities law or other law or regulation, the
Option shall remain exercisable until three (3) months after the date the
Optionee is notified by the Company that the Option is exercisable, but in any
event no later than the date of expiration of the Option term.

(iv) Leave of Absence. For purposes hereof, an

Optionee's employment with the Participating Company Group shall not be deemed
to terminate if the Optionee takes any military leave, sick leave, or other bona
fide leave of absence approved by the Company of ninety (90) days or less. In
the event of a leave in excess of ninety (90) days, an Optionee's employment
shall be deemed to terminate on the ninety-first (91st) day of the leave unless
the Optionee's right to reemployment with the Participating Company Group
remains guaranteed by statute or contract. Notwithstanding the foregoing,
however, a leave of absence shall be treated as employment for purposes of
determining the exercisability and/or vesting of the Options held by an Optionee
if and only if the leave of absence is designated by the Company as (or required
by law to be) a leave for which vesting credit is given.

(v) Application to Directors, Consultants and
Advisors. In the event an Optionee is a director or consultant, advisor, or
other independent contractor but not an

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<PAGE> 8
employee of a Participating Company at the time an Option is granted,
termination of the Optionee's status as a director or consultant, advisor, or
other independent contractor of the Participating Company shall be deemed to be
termination of the Optionee's "employment" for purposes of interpreting this
paragraph 7(e).

(f) Legends. The Company may at any time place legends
referencing any applicable federal or state securities law restrictions and the
fact that the shares of Stock were issued by the Company pursuant to the
exercise of an Incentive Stock Option (as defined in section 422(b) of the
Code), as the case may be, on all certificates representing shares of Stock
subject to the provisions of this paragraph 7. An Optionee shall, at the request
of the Company, promptly present to the Company any and all certificates
representing shares of Stock acquired pursuant to the exercise of an Option in
the possession of the Optionee in order to effectuate the provisions of this
paragraph.

(g) Rights as a Shareholder or Employee. An Optionee shall
have no rights as a shareholder with respect to any shares of Stock covered by
an Option until the date of the issuance of a certificate or certificates for
the shares for which the Option has been exercised. No adjustment shall be made
for dividends or distributions or other rights for which the record date is
prior to the date such certificate or certificates are issued, except as
provided in paragraph 8 below. Nothing in an Option shall confer upon an
Optionee any right to continue in the employ of a Participating Company or
interfere in any way with any right of the Participating Company Group to
terminate the Optionee's employment at any time.

8. Effect of Change in Stock Subject to Plan. Appropriate adjustments
shall be made in the number and class of shares of Stock subject to the Plan, to
the Section 162(m) Grant Limit set forth in paragraph 3(c) above, and to any
outstanding Options and in the option price of any outstanding Options in the
event of a stock dividend, stock split, reverse stock split, combination,
reclassification, or like change in the capital structure of the Company. In the
event a majority of the shares which are of the same class as the shares of
Stock that are subject to an Option are exchanged for, converted into, or
otherwise become shares of another corporation (the "New Shares"), the Company
may unilaterally amend the Option to provide that the Option is exercisable for
New Shares. In the event of any such amendments, the number of shares of Stock
and the option price of the outstanding Options shall be adjusted in a fair and
equitable manner.

9. Provision of Information. Each Optionee shall be given access to
information concerning the Company equivalent to that information generally made
available to the Company's common shareholders.

10. Nontransferability of Incentive Stock Options. During the lifetime
of the Optionee, the Option shall be exercisable only by the Optionee. No Option
shall be assignable or transferable by the Optionee, except by will or by the
laws of descent and distribution. Notwithstanding the foregoing, a nonqualified
stock option shall be assignable or transferable to the extent permitted by the
Board and set forth in the option agreement evidencing such Option.

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11. Termination or Amendment of Plan. The Board, including any duly
appointed committee of the Board, may terminate or amend the Plan at any time;
provided, however, that without the approval of the Company's shareholders,
there shall be (a) no increase in the total number of shares of Stock covered by
the Plan (except by operation of the provisions of paragraph 8 above), (b) no
change in the class of persons eligible to receive Incentive Stock Options and
(c) no expansion in the class of persons eligible to receive nonqualified stock
options. In any event, no termination or amendment may adversely affect any then
outstanding Option or any unexercised portion thereof, without the consent of
the Optionee, unless such amendment is required to enable an Option designated
as an Incentive Stock Option to qualify as an Incentive Stock Option.

12. Continuation of Prior Plan as to Outstanding Options.
Notwithstanding any other provision of the Plan to the contrary, the terms of
the Prior Plan shall remain in effect and apply to Options granted pursuant to
the Prior Plan.

IN WITNESS WHEREOF, the undersigned Secretary of the Company certifies
that the foregoing is the Applied Signal Technology, Inc. 1991 Stock Option
Plan, As Amended, as amended by the Board through January 25, 1997.

-------------------------------
Secretary

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<PAGE> 10
PLAN HISTORY

January 18, 1991 Plan adopted by Board of Directors with 1,500,000
shares in the reserve

February 28, 1991 Plan approved by Shareholders

March 6, 1992 Plan amended by Board of Directors re terms of
Transfer of Control

March 7, 1996 Plan amended by Board of Directors to eliminate
private company provisions no
longer applicable

January 25, 1997 Plan amended by Board of Directors to (a) increase
share reserve to 2,000,000, (b) establish a Section
162(m) Grant Limit of 400,000 shares, and (c)
permit the grant of transferable nonqualified stock
options

March 6, 1997 Shareholders approve Plan, with a share reserve of
2,000,000 shares

<PAGE> 1
EXHIBIT 10.18

APPLIED SIGNAL TECHNOLOGY, INC.

1993 EMPLOYEE STOCK PURCHASE PLAN

(As Amended January 25, 1997)

1. Purpose. The Applied Signal Technology, Inc. 1993 Employee Stock
Purchase Plan (the "Plan") is established to provide eligible employees of
Applied Signal Technology, Inc., a California corporation, and any successor
corporation thereto (collectively, "Applied Signal"), and any current or future
parent corporation or subsidiary corporations of Applied Signal (collectively
referred to as the "Company"), with an opportunity to acquire a proprietary
interest in the Company by the purchase of common stock of Applied Signal.
Applied Signal and any parent or subsidiary corporation shall be individually
referred to as a "Participating Company." For purposes of the Plan, a parent
corporation and a subsidiary corporation shall be as defined in sections 424(e)
and 424(f), respectively, of the Internal Revenue Code of 1986, as amended (the
"Code").

The Company intends that the Plan shall qualify as an "employee stock
purchase plan" under section 423 of the Code (including any amendments or
replacements of such section), and the Plan shall be so construed. Any term not
expressly defined in the Plan but defined for purposes of section 423 of the
Code shall have the same definition herein.

An employee participating in the Plan (a "Participant") may withdraw
such Participant's accumulated payroll deductions (if any) and terminate
participation in the Plan or any Offering (as defined below) therein at any time
during a Purchase Period (as defined below). Accordingly, each Participant is,
in effect, granted an option pursuant to the Plan (a "Purchase Right") which may
or may not be exercised at the end of a Purchase Period.

2. Administration. The Plan shall be administered by the Board of
Directors of Applied Signal (the "Board") and/or by a duly appointed committee
of the Board having such powers as shall be specified by the Board. Any
subsequent references to the Board shall also mean the committee if a committee
has been appointed. All questions of interpretation of the Plan or of any
Purchase Right shall be determined by the Board and shall be final and binding
upon all persons having an interest in the Plan and/or any Purchase Right.
Subject to the provisions of the Plan, the Board shall determine all of the
relevant terms and conditions of Purchase Rights granted pursuant to the Plan;
provided, however, that all Participants granted Purchase Rights pursuant to the
Plan shall have the same rights and privileges within the meaning of section
423(b)(5) of the Code. All expenses incurred in connection with the
administration of the Plan shall be paid by the Company.

3. Share Reserve. The maximum number of shares which may be issued
under the Plan shall be 1,600,000 shares of Applied Signal's authorized but
unissued common stock (the

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"Shares"). In the event that any Purchase Right for any reason expires or is
canceled or terminated, the Shares allocable to the unexercised portion of such
Purchase Right may again be subjected to a Purchase Right.

4. Eligibility. Any employee of a Participating Company is
eligible to participate in the Plan except employees who own or hold options to
purchase or who, as a result of participation in the Plan, would own or hold
options to purchase, stock of the Company possessing five percent (5%) or more
of the total combined voting power or value of all classes of stock of the
Company within the meaning of section 423(b)(3) of the Code. Notwithstanding
anything herein to the contrary, any individual performing services for a
Participating Company solely through a leasing agency or employment agency shall
not be deemed an "employee" of such Participating Company.

5. Offering Dates.

(a) Offering Periods. Except as otherwise set forth below, the
Plan shall be implemented by offerings (individually, an "Offering") of
twenty-four (24) months duration (an "Offering Period"). The initial Offering
shall commence on June 1, 1993 and end on May 31, 1995 (the "Initial Offering
Period"). Subsequent Offerings shall commence on June 1 and December 1 of each
year and end on the second May 31 and November 30, respectively, occurring
thereafter. Notwithstanding the foregoing, the Board may establish a different
term for one or more Offerings and/or different commencing and/or ending dates
for such Offerings. An employee who becomes eligible to participate in the Plan
after an Offering Period has commenced shall not be eligible to participate in
such Offering but may participate in any subsequent Offering provided such
employee is still eligible to participate in the Plan as of the commencement of
any such subsequent Offering. Eligible employees may not participate in more
than one Offering at a time. The first day of an Offering Period shall be the
"Offering Date" for such Offering Period. In the event the first and/or last day
of an Offering Period is not a business day, Applied Signal shall specify the
business day that will be deemed the first or last day, as the case may be, of
the Offering Period.

(b) Purchase Periods. Each Offering Period shall consist of
four (4) consecutive purchase periods of six (6) months duration (individually,
a "Purchase Period"). The last day of each Purchase Period shall be the
"Purchase Date" for such Purchase Period. A Purchase Period commencing on June 1
shall end on the next November 30. A Purchase Period commencing on December 1
shall end on the next May 31. Notwithstanding the foregoing, the Board may
establish a different term for one or more Purchase Periods and/or different
commencing dates and/or Purchase Dates for such Purchase Periods. In the event
the first and/or last day of a Purchase Period is not a business day, Applied
Signal shall specify the business day that will be deemed the first or last day,
as the case may be, of the Purchase Period.

(c) Governmental Approval; Shareholder Approval.
Notwithstanding any other provision of the Plan to the contrary, any Purchase
Right granted pursuant to the Plan shall

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<PAGE> 3
be subject to (i) obtaining all necessary governmental approvals and/or
qualifications of the sale and/or issuance of the Purchase Rights and/or the
Shares, and (ii) obtaining shareholder approval of the Plan.

6. Participation in the Plan.

(a) Initial Participation. An eligible employee shall become a
Participant on the first Offering Date after satisfying the eligibility
requirements and delivering to the Company's payroll office not later than the
close of business for such payroll office on the last business day before such
Offering Date (the "Subscription Date") a subscription agreement indicating the
employee's election to participate in the Plan and authorizing payroll
deductions. An eligible employee who does not deliver a subscription agreement
to the Company's payroll office on or before the Subscription Date shall not
participate in the Plan for that Offering Period or for any subsequent Offering
Period unless such employee subsequently enrolls in the Plan by filing a
subscription agreement with the Company by the Subscription Date for such
subsequent Offering Period. Applied Signal may, from time to time, change the
Subscription Date as deemed advisable by Applied Signal in its sole discretion
for proper administration of the Plan.

(b) Continued Participation. A Participant shall automatically
participate in the Offering Period commencing immediately after the final
Purchase Date of each Offering Period in which the Participant participates
until such time as such Participant (i) ceases to be eligible as provided in
paragraph 4, (ii) withdraws from the Plan pursuant to paragraph 11(b) or (iii)
terminates employment as provided in paragraph 12. If a Participant is
automatically withdrawn from an Offering at the end of a Purchase Period of such
Offering pursuant to paragraph 11(d), then the Participant shall automatically
participate in the Offering Period commencing on the next business day. If a
Participant automatically may participate in a subsequent Offering Period
pursuant to this paragraph 6(b), then the Participant is not required to file
any additional subscription agreement for such subsequent Offering Period in
order to continue participation in the Plan. However, a Participant may file a
subscription agreement with respect to a subsequent Offering Period if the
Participant desires to change any of the Participant's elections contained in
the Participant's then effective subscription agreement.

7. Right to Purchase Shares. Except as set forth below, during an
Offering Period each Participant in such Offering Period shall have a Purchase
Right consisting of the right to purchase that number of whole Shares arrived at
by dividing Fifty Thousand Dollars ($50,000.00) by the fair market value of a
share of the common stock of Applied Signal on the Offering Date of such
Offering Period. The fair market value of such share shall be determined in
accordance with paragraph 8 below. Shares may only be purchased through a
Participant's payroll withholding pursuant to paragraph 9 below.

8. Purchase Price. The purchase price at which Shares may be acquired
in a given Purchase Period pursuant to the exercise of all or any portion of a
Purchase Right granted under the Plan (the "Offering Exercise Price") shall be
set by the Board; provided, however, that the

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<PAGE> 4
Offering Exercise Price shall not be less than eighty-five percent (85%) of the
lesser of (a) the fair market value of the Shares on the Offering Date of the
Offering Period of which the Purchase Period is a part, or (b) the fair market
value of the Shares on the Purchase Date for such Purchase Period. Unless
otherwise provided by the Board prior to the commencement of an Offering Period,
the Offering Exercise Price for each Purchase Period in that Offering Period
shall be eighty-five percent (85%) of the lesser of (a) the fair market value of
the Shares on the Offering Date of such Offering Period or (b) the fair market
value of the Shares on the given Purchase Date. The fair market value of the
Shares on the applicable dates shall be the closing price quoted on the National
Association of Securities Dealers Automated Quotation System (or the average of
the closing bid and asked prices if the Shares are so quoted instead), or as
reported on such other stock exchange or market system if the Shares are traded
on such other exchange or system instead, or as determined by the Board if the
Shares are not so reported.

9. Payment of Purchase Price. Shares which are acquired pursuant to the
exercise of all or any portion of a Purchase Right may be paid for only by means
of payroll deductions from the Participant's Compensation accumulated during the
Offering Period. For purposes of the Plan, a Participant's "Compensation" with
respect to an Offering (a) shall include the Participant's base salary before
deduction for any contributions to any plan maintained by a Participating
Company and described in Section 401(k) or Section 125 of the Code, and (b)
shall not include overtime, bonuses, annual awards, other incentive payments,
shift premiums, long-term disability, worker's compensation or any other
payments not specifically referenced in (a). Except as set forth below, the
amount of Compensation to be withheld from a Participant's Compensation during
each pay period shall be determined by the Participant's subscription agreement.

(a) Election to Increase or Decrease Withholding. During an
Offering Period, a Participant may elect to increase or decrease the amount
withheld from his or her Compensation by filing an amended subscription
agreement with the Company on or before the "Change Notice Date." The "Change
Notice Date" shall initially be the seventh (7th) day prior to the end of the
first pay period for which such election is to be effective; however, the
Company may change such Change Notice Date from time to time. Notwithstanding
the foregoing, the ability of a Participant to increase the amount withheld from
his or her Compensation during an Offering Period shall be effective only for
Offering Periods beginning on or after June 1, 1997.

(b) Limitations on Payroll Withholding. The amount of payroll
withholding with respect to the Plan for any Participant during any pay period
shall be in one percent (1%) increments not to exceed ten percent (10%) of the
Participant's Compensation for such pay period. Notwithstanding the foregoing,
the Board may change the limits on payroll withholding effective as of a future
Offering Date, as determined by the Board. Amounts withheld shall be reduced by
any amounts contributed by the Participant and applied to the purchase of
Company stock pursuant to any other employee stock purchase plan qualifying
under section 423 of the Code.

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<PAGE> 5
(c) Payroll Withholding. Payroll deductions shall commence on
the first payday following the Offering Date and shall continue to the end of
the Offering Period unless sooner altered or terminated as provided in the Plan.

(d) Participant Accounts. Individual accounts shall be
maintained for each Participant. All payroll deductions from a Participant's
Compensation shall be credited to such account and shall be deposited with the
general funds of the Company. All payroll deductions received or held by the
Company may be used by the Company for any corporate purpose.

(e) No Interest Paid. Interest shall not be paid on sums
withheld from a Participant's Compensation, unless the Board elects to make such
payments to all Participants on a non-discriminatory basis.

(f) Exercise of Purchase Right. On each Purchase Date of an
Offering Period, each Participant who has not withdrawn from the Offering or
whose participation in the Offering has not terminated on or before such
Purchase Date shall automatically acquire pursuant to the exercise of the
Participant's Purchase Right the number of whole Shares arrived at by dividing
the total amount of the Participant's accumulated payroll deductions for the
Purchase Period by the Offering Exercise Price; provided, however, in no event
shall the number of Shares purchased by the Participant exceed the number of
Shares subject to the Participant's Purchase Right. No Shares shall be purchased
on a Purchase Date on behalf of a Participant whose participation in the
Offering or the Plan has terminated on or before such Purchase Date.

(g) Return of Cash Balance. Any cash balance remaining in the
Participant's account shall be refunded to the Participant as soon as
practicable after the Purchase Date. In the event the cash to be returned to a
Participant pursuant to the preceding sentence is an amount less than the amount
necessary to purchase a whole Share, the Company may establish procedures
whereby such cash is maintained in the Participant's account and applied toward
the purchase of Shares in the subsequent Purchase Period or Offering Period.

(h) Tax Withholding. At the time the Purchase Right is
exercised, in whole or in part, or at the time some or all of the Shares are
disposed of, the Participant shall make adequate provision for the foreign,
federal and state tax withholding obligations of the Company, if any, which
arise upon exercise of the Purchase Right and/or upon disposition of Shares,
respectively. The Company may, but shall not be obligated to, withhold from the
Participant's Compensation the amount necessary to meet such withholding
obligations.

(i) Company Established Procedures. The Company may, from time
to time, establish (i) a minimum required withholding amount for participation
in an Offering, (ii) limitations on the frequency and/or number of changes in
the amount withheld during an Offering, (iii) an exchange ratio applicable to
amounts withheld in a currency other than U.S. dollars, (iv) payroll withholding
in excess of or less than the amount designated by a Participant in order to
adjust for delays or mistakes in the Company's processing of subscription
agreements, and/or (v) such other limitations or procedures as deemed advisable
by the Company in the

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<PAGE> 6
Company's sole discretion which are consistent with the Plan and in accordance
with the requirements of Section 423 of the Code.

(j) Expiration of Purchase Right. Any portion of a
Participant's Purchase Right remaining unexercised after the end of the Offering
Period to which such Purchase Right relates shall expire immediately upon the
end of such Offering Period.

10. Limitations on Purchase of Shares; Rights as a Shareholder.

(a) Fair Market Value Limitation. Notwithstanding any other
provision of the Plan, no Participant shall be entitled to purchase Shares under
the Plan (or any other employee stock purchase plan which is intended to meet
the requirements of section 423 of the Code sponsored by Applied Signal or a
parent or subsidiary corporation of Applied Signal) at a rate which exceeds
$25,000 in fair market value, which fair market value is determined for Shares
purchased during a given Offering Period as of the Offering Date for such
Offering Period (or such other limit as may be imposed by the Code), for each
calendar year in which Participant participates in the Plan (or any other
employee stock purchase plan described in this sentence).

(b) Pro Rata Allocation. In the event the number of Shares
which might be purchased by all Participants in the Plan exceeds the number of
Shares available in the Plan, the Company shall make a pro rata allocation of
the remaining Shares in as uniform a manner as shall be practicable and as the
Company shall determine to be equitable.

(c) Rights as a Shareholder and Employee. A Participant shall
have no rights as a shareholder by virtue of the Participant's participation in
the Plan until the date of the issuance of a stock certificate(s) for the Shares
being purchased pursuant to the exercise of the Participant's Purchase Right. No
adjustment shall be made for cash dividends or distributions or other rights for
which the record date is prior to the date such stock certificate(s) are issued.
Nothing herein shall confer upon a Participant any right to continue in the
employ of the Company or interfere in any way with any right of the Company to
terminate the Participant's employment at any time.

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<PAGE> 7
11. Withdrawal.

(a) Withdrawal From an Offering. A Participant may withdraw
from an Offering by signing and delivering to the Company's payroll office, a
written notice of withdrawal on a form provided by the Company for such purpose.
Such withdrawal may be elected at any time prior to the end of an Offering
Period; provided, however, if a Participant withdraws after the Purchase Date
for a Purchase Period of an Offering, the withdrawal shall not affect Shares
acquired by the Participant in such Purchase Period. Unless otherwise indicated,
withdrawal from an Offering shall not result in a withdrawal from the Plan or
any succeeding Offering therein. By withdrawing from an Offering effective as of
the close of a given Purchase Date, a Participant may have Shares purchased on
such Purchase Date and immediately commence participation in the new Offering
commencing immediately after such Purchase Date. A Participant is prohibited
from again participating in an Offering at any time upon withdrawal from such
Offering. The Company may impose, from time to time, a requirement that the
notice of withdrawal be on file with the Company's payroll office for a
reasonable period prior to the effectiveness of the Participant's withdrawal
from an Offering.

(b) Withdrawal from the Plan. A Participant may withdraw from
the Plan by signing a written notice of withdrawal on a form provided by the
Company for such purpose and delivering such notice to the Company's payroll
office. Withdrawals made after a Purchase Date for a Purchase Period shall not
affect Shares acquired by the Participant on such Purchase Date. In the event a
Participant voluntarily elects to withdraw from the Plan, the Participant may
not resume participation in the Plan during the same Offering Period, but may
participate in any subsequent Offering under the Plan by again satisfying the
requirements of paragraphs 4 and 6(a) above. The Company may impose, from time
to time, a requirement that the notice of withdrawal be on file with the
Company's payroll office for a reasonable period prior to the effectiveness of
the Participant's withdrawal from the Plan.

(c) Return of Payroll Deductions. Upon withdrawal from an
Offering or the Plan pursuant to paragraphs 11(a) or 11(b), respectively, the
withdrawn Participant's accumulated payroll deductions which have not been
applied toward the purchase of Shares shall be returned as soon as practicable
after the withdrawal, without the payment of any interest (unless the Board
decides otherwise pursuant to paragraph 9(e) above), to the Participant, and the
Participant's interest in the Offering and/or the Plan, as applicable, shall
terminate. Such accumulated payroll deductions may not be applied to any other
Offering under the Plan.

(d) Automatic Withdrawal From an Offering. If the fair market
value of the Shares on a Purchase Date of an Offering (other than the final
Purchase Date of such Offering) is less than the fair market value of the Shares
on the Offering Date for such Offering, then every Participant shall
automatically (i) be withdrawn from such Offering at the close of such Purchase
Date and after the acquisition of Shares for such Purchase Period and (ii) be
enrolled in the Offering commencing on the first business day subsequent to such
Purchase Period.

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12. Termination of Employment. Termination of a Participant's
employment with the Company for any reason, including retirement, disability or
death or the failure of a Participant to remain an employee eligible to
participate in the Plan, shall terminate the Participant's participation in the
Plan immediately. In such event, the payroll deductions credited to the
Participant's account since the last Purchase Date shall, as soon as
practicable, be returned to the Participant or, in the case of the Participant's
death, to the Participant's legal representative, and all of the Participant's
rights under the Plan shall terminate. Interest shall not be paid on sums
returned to a Participant pursuant to this paragraph 12 unless the Board elects
otherwise pursuant to paragraph 9(e) above. A Participant whose participation
has been so terminated may again become eligible to participate in the Plan by
again satisfying the requirements of paragraphs 4 and 6(a) above.

13. Transfer of Control. A "Transfer of Control" shall be deemed to
have occurred in the event any of the following occurs with respect to Applied
Signal.

(a) a merger or consolidation in which Applied Signal is not
the surviving corporation; or

(b) a reverse triangular merger or consolidation in which
Applied Signal is the surviving corporation where the shareholders of Applied
Signal before such merger or consolidation do not retain, directly or
indirectly, at least a majority of the beneficial interest in the voting stock
of Applied Signal; or

(c) the sale, exchange, or transfer of all or substantially
all of Applied Signal's assets (other than a sale, exchange, or transfer to one
(1) or more corporations where the shareholders of Applied Signal before such
sale, exchange, or transfer retain, directly or indirectly, at least a majority
of the beneficial interest in the voting stock of the corporation(s) to which
the assets were transferred); or

(d) the direct or indirect sale or exchange by the
shareholders of Applied Signal of all or substantially all of the stock of
Applied Signal where the shareholders of Applied Signal before such sale or
exchange do not retain, directly or indirectly, at least a majority of the
beneficial interest in the voting stock of Applied Signal after such sale or
exchange; or

(e) the liquidation or dissolution of Applied Signal.

In the event of a Transfer of Control, the Board, in its sole
discretion, may arrange with the surviving, continuing, successor, or purchasing
corporation, as the case may be (the "Acquiring Corporation"), that such
corporation assume the Company's rights and obligations under the Plan. In the
event the Acquiring Corporation elects not to assume the Company's rights and
obligations under the Plan in connection with a merger described in (a) or (b)
above, the Board shall provide that all outstanding Purchase Rights shall be
immediately exercisable as of a date prior to the Transfer of Control, as the
Board so determines. The exercise of a Purchase

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<PAGE> 9

Right that was permissible solely by reason of this paragraph 13 shall be
conditioned upon the consummation of the Transfer of Control. All Purchase
Rights shall terminate effective as of the date of the Transfer of Control to
the extent that the Purchase Right is neither exercised as of the date of the
Transfer of Control nor assumed by the surviving, continuing, successor, or
purchasing corporation, as the case may be.

14. Capital Changes. In the event of changes in the common stock of the
Company due to a stock split, reverse stock split, stock dividend,
recapitalization, combination, reclassification, or like change in the Company's
capitalization, or in the event of any merger (including a merger effected for
the purpose of changing Applied Signal's domicile), sale or other
reorganization, appropriate adjustments shall be made by the Company in the
securities subject to purchase under a Purchase Right, the Plan's share reserve,
the number of shares subject to a Purchase Right, and in the purchase price per
share.

15. Non-Transferability. A Purchase Right may not be transferred in any
manner otherwise than by will or the laws of descent and distribution and shall
be exercisable during the lifetime of the Participant only by the Participant.
The Company, in its absolute discretion, may impose such restrictions on the
transferability of the Shares purchasable upon the exercise of a Purchase Right
as it deems appropriate and any such restriction shall be set forth in the
respective subscription agreement and may be referred to on the certificates
evidencing such Shares.

16. Reports. Each Participant who exercised all or part of his or her
Purchase Right for a Purchase Period shall receive, as soon as practicable after
the Purchase Date of such Purchase Period, a report of such Participant's
account setting forth the total payroll deductions accumulated, the number of
Shares purchased, the fair market value of such Shares, the date of purchase and
the remaining cash balance to be refunded or retained in the Participant's
account pursuant to paragraph 9(g) above, if any. Each Participant shall be
provided information concerning the Company equivalent to that information
generally made available to the Company's common shareholders.

17. Plan Term. This Plan shall continue until terminated by the Board
or until all of the Shares reserved for issuance under the Plan have been
issued.

18. Restriction on Issuance of Shares. The issuance of shares under the
Plan shall be subject to compliance with all applicable requirements of federal
or state law with respect to such securities. A Purchase Right may not be
exercised if the issuance of shares upon such exercise would constitute a
violation of any applicable federal or state securities laws or other law or
regulations. In addition, no Purchase Right may be exercised unless (i) a
registration statement under the Securities Act of 1933, as amended, shall at
the time of exercise of the Purchase Right be in effect with respect to the
shares issuable upon exercise of the Purchase Right, or (ii) in the opinion of
legal counsel to the Company, the shares issuable upon exercise of the Purchase
Right may be issued in accordance with the terms of an applicable exemption from
the registration requirements of said Act. As a condition to the exercise of a
Purchase Right, the Company may

9
<PAGE> 10
require the Participant to satisfy any qualifications that may be necessary or
appropriate, to evidence compliance with any applicable law or regulation, and
to make any representation or warranty with respect thereto as may be requested
by the Company.

19. Legends. The Company may at any time place legends or other
identifying symbols referencing any applicable foreign, federal and/or state
securities restrictions or any provision convenient in the administration of the
Plan on some or all of the certificates representing shares of stock issued
under the Plan. The Participant shall, at the request of the Company, promptly
present to the Company any and all certificates representing shares acquired
pursuant to a Purchase Right in the possession of the Participant in order to
carry out the provisions of this paragraph. Unless otherwise specified by the
Company, legends placed on such certificates may include but shall not be
limited to the following:

"THE SHARES EVIDENCED BY THIS CERTIFICATE WERE ISSUED BY THE
CORPORATION TO THE REGISTERED HOLDER UPON THE PURCHASE OF SHARES UNDER THE
EMPLOYEE STOCK PURCHASE PLAN AS DEFINED IN SECTION 423 OF THE INTERNAL REVENUE
CODE OF 1986, AS AMENDED. THE TRANSFER AGENT FOR THE SHARES EVIDENCED HEREBY
SHALL NOTIFY THE CORPORATION IMMEDIATELY OF ANY TRANSFER OF THE SHARES BY THE
REGISTERED HOLDER HEREOF MADE ON OR BEFORE , 19 . THE REGISTERED HOLDER SHALL
HOLD ALL SHARES PURCHASED UNDER THE OPTION IN THE REGISTERED HOLDER'S NAME (AND
NOT IN THE NAME OF ANY NOMINEE) PRIOR TO THIS DATE."

20. Notification of Sale of Shares. The Company may require the
Participant to give the Company prompt notice of any disposition of Shares
acquired by exercise of a Purchase Right within two years from the date of
granting such Purchase Right or one year from the date of exercise of such
Purchase Right. The Company may direct that the certificates evidencing Shares
acquired by exercise of a Purchase Right refer to such requirement to give
prompt notice of disposition.

21. Amendment or Termination of the Plan. The Board of Directors of
Applied Signal may at any time amend or terminate the Plan, except that such
termination shall not affect Purchase Rights previously granted under the Plan,
nor may any amendment make any change in a Purchase Right previously granted
under the Plan which would adversely affect the right of any Participant (except
as may be necessary to qualify the Plan as an employee stock purchase plan
pursuant to section 423 of the Code or to obtain qualification or registration
of the Shares under applicable federal or state securities laws). In addition,
an amendment to the Plan must be approved by the shareholders of the Company
within twelve (12) months of the adoption of such amendment if such amendment
would authorize the sale of more shares than are authorized for issuance under
the Plan or would change the definition of the corporations that may be
designated by the Board as Participating Companies.

10
<PAGE> 11
IN WITNESS WHEREOF, the undersigned Secretary of Applied Signal
Technology, Inc. certifies that the foregoing Applied Signal Technology, Inc.
1993 Employee Stock Purchase Plan was duly adopted by the Board on January 22,
1993 and amended by the Board on January 25, 1997.

-------------------------------
Secretary

11
<PAGE> 12
PLAN HISTORY

January 22, 1993 Board adopts Plan, with an initial reserve of 1,000,000
shares.

February 22, 1993 Shareholders approve Plan, with an initial reserve of
1,000,000 shares.

January 25, 1997 Board amends Plan to increase reserve to 1,600,000
shares and to permit participants to increase rate of
withholding during an offering.

March 6, 1997 Shareholders approve Plan, with a reserve of 1,600,000
shares.

<PAGE> 1
APPLIED SIGNAL TECHNOLOGY, INC.
EXHIBIT 11.1
COMPUTATION OF NET INCOME PER SHARE
(In thousands except per share data)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ---------------------------
MAY 2, 1997 MAY 3, 1996 MAY 2, 1997 MAY 3, 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Number of shares:
Weighted average outstanding
common 8,000 7,168 7,745 7,256
Dilutive common stock equivalents of:
Stock options (treasury stock
method) (1) 156 737 390 584
------ ------ ------ ------
8,156 7,905 8,135 7,840
====== ====== ====== ======
Net income $1,725 $ 79 $2,587 $ 229
Net income per common share $ .21 $ .01 $ .32 $ .03
</TABLE>

(1) Effect of assumed exercise of all dilutive stock options and assumed
repurchase of shares from proceeds.

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS INCLUDED
IN THE COMPANY'S FORM 10-Q FOR THE PERIODS ENDED MAY 2, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> OCT-31-1997
<PERIOD-END> MAY-2-1997
<CASH> 0
<SECURITIES> 1,564
<RECEIVABLES> 31,570
<ALLOWANCES> 0
<INVENTORY> 5,390
<CURRENT-ASSETS> 41,110
<PP&E> 33,206
<DEPRECIATION> 19,164
<TOTAL-ASSETS> 55,793
<CURRENT-LIABILITIES> 11,849
<BONDS> 0
0
0
<COMMON> 20,669
<OTHER-SE> 11,217
<TOTAL-LIABILITY-AND-EQUITY> 55,793
<SALES> 44,071
<TOTAL-REVENUES> 44,071
<CGS> 28,878
<TOTAL-COSTS> 40,095
<OTHER-EXPENSES> 11,217
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,074
<INCOME-TAX> 1,487
<INCOME-CONTINUING> 2,587
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,587
<EPS-PRIMARY> .32
<EPS-DILUTED> .32

</TABLE>