UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 1998
or
[ ] 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.
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(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0015491
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 WEST CALIFORNIA AVE., SUNNYVALE, CA 94086
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(Address of principal executive offices)
(408) 749-1888
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act: Not
Applicable.
Securities registered pursuant to Section 12(g) of the Exchange Act: Common
Stock, without par value.
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 / /
Indicate by a check mark if disclosure by delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. [ ]
Aggregate market value of the voting stock held by non-affiliates of the
registrant:
Common Stock, without par value -- $70,251,078 as of January 5, 1999.
Number of shares of registrant's common stock outstanding:
Common Stock, without par value -- 8,528,375 shares as of January 5, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's Proxy Statement for the Annual Meeting of Shareholders
to be held on March 11, 1999 is incorporated herein by reference
in Part III to the extent stated herein.
This Annual Report on Form 10-K consists of 58 pages, including exhibits; the
exhibit index is on page 56.
<PAGE>
INDEX
APPLIED SIGNAL TECHNOLOGY, INC.
PART I.
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Executive Officers of Registrant
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
PART III.
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item 13. Certain Relationships and Related Transactions
PART IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
Signatures
<PAGE>
PART I
ITEM 1: BUSINESS
Forward-looking statements in this Report are made pursuant to the
safe harbor provisions of Section 21E of the Securities Exchange Act
of 1934. In this report, the words "anticipates," "believes,"
"expects," "future," "intends," and similar expressions identify
forward-looking statements. Shareholders are cautioned that all
forward-looking statements pertaining to the Company involve risks and
uncertainties, including, without limitation, those contained under
the caption, "Business Considerations and Certain Factors that May
Affect Future Results of Operations and/or Stock Price" and other
risks detailed from time to time in the Company's periodic reports and
other information filed with the Securities and Exchange Commission.
Actual events and results may differ materially from the Company's
current expectations and beliefs.
GENERAL
Applied Signal Technology, Inc. (Applied Signal Technology or the
Company) designs, develops, and manufactures signal processing equipment to
collect and process a wide range of telecommunication signals. This
equipment is used for reconnaissance of foreign telecommunications
predominantly by the United States Government and allied foreign
governments, for certain industrial applications and for defense
communications systems. Signal reconnaissance systems are composed of
collection equipment and processing equipment. Collection equipment
consists of sophisticated receivers that scan the radio frequency (RF)
spectrum (cellular telephone, microwave, ship-to-shore, and military
transmissions) to collect certain signals from, potentially, thousands of
signals within the RF spectrum. Signal processing equipment, using
sophisticated software and hardware, evaluates the characteristics of the
collected signals and selects signals that are likely to contain relevant
information. Industrial applications include commercial communication
system quality monitoring and data network intrusion detection. Defense
communication equipment provide reliable, high-speed data transfer for
military applications. Since inception, the Company has focused its efforts
primarily on processing equipment, but also provides specialized collection
equipment, as well as complete systems.
Signal Reconnaissance
In recent years, accurate and comprehensive information
regarding foreign affairs and developments has become increasingly
important to the United States Government. The reduction of United
States military tactical forces overseas, coupled 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. (See
"Research and Development.")
Budgetary constraints and critical time-to-deployment
requirements have caused many United States 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 its products can be readily deployed in a wide
variety of circumstances to meet current United States Government
signal reconnaissance requirements. The Company designs its products
to use advanced circuitry and highly integrated components, including
Company-designed application-specific integrated circuits (ASICs).
This enables the Company to offer products that are smaller, consume
less power, and cost customers less when multiple units are built than
equipment of similar functionality that use fewer advanced designs and
materials.
Industrial Applications
The volume of data transferred and made available to individuals is
growing exponentially worldwide. This trend dictates maximum efficiency of
spectrum usage by the commercial telecommunications companies. The
spectrum usage is especially critical in the band limited radio
frequency (RF) environment that personal communication systems (e.g.,
cellular systems) and communication satellite systems (e.g., PanAmSat,
Intelsat, InMarSat) utilize. As these systems attempt to maximize this
usage, there is an increasingly higher probability that data transfer
will be impaired. This creates demand for sophisticated data quality
monitoring.
The Company believes that its signal processing prowess in non-
intrusive signal reconnaissance developed over the years, lends
itself nicely to this quality monitoring requirement. In addition, as
the Company continues to stay abreast of the United States
Government's future signal reconnaissance needs, it naturally stays
abreast of trends in telecommunication technology. The Company
believes this knowledge places it in the favorable position of understanding
the data transfer techniques that will require quality monitoring
in the future.
As the world becomes more reliant upon data transfer and data
access for its day-to-day activities (i.e., E-Commerce), it also
becomes more vulnerable to unauthorized data access or manipulation.
This creates a requirement for data system intrusion detection. This
intrusion detection must obviously be performed without impact upon
the data transfer.
The Company believes that the technological expertise it has
developed for signal reconnaissance positions the Company to develop
and commercialize intrusion detection technology. In particular, the
Company's signal processing prowess provides the fundamentals for the
development of intrusion detection equipment.
Defense Communications
Just as the civilian world is becoming increasingly dependent
upon data transfer and access, so is the military. The military
branches utilize data transfer for guidance, computer-to-computer
battlefield planning, high quality communications, and so forth. Many
times this data transfer must occur under non-ideal transport modes.
The transport invariably is in the radio frequency spectrum and must
occur under sub-optimum conditions such as minimal frequency planning for
interference mitigation; inaccurate antenna pointing; and moving
platforms. These defense communication systems must be able to
mitigate these data transfer anomalies in an automated or semi-
automated manner in order to provide reliable, rapidly deployed
communications.
The Company believes that the technological expertise it has
developed for signal reconnaissance systems to adequately process data
collected in non-ideal situations lends itself to these defense
communication system requirements. In particular, our vast experience
in adaptive equalization/demodulation of sophisticated data
telecommunication signals provide the capability to develop equipment
that overcomes these data transport anomalies.
DESCRIPTION OF THE BUSINESS
Applied Signal Technology designs, develops, and manufactures
equipment to collect and process telecommunication signals for signal
reconnaissance, industrial applications, and defense communication
systems. The signal reconnaissance equipment is purchased by military
and intelligence organizations of the United States Government and
foreign countries to be used for foreign signal reconnaissance. The
industrial signal processing equipment can be purchased by private
industry as well as government organizations (United States and
foreign) for telecommunication quality monitoring and data network
intrusion detection applications. The defense communication equipment
is purchased by the Unites States Military to provide high-speed data
transfer capabilities.
Signal Reconnaissance
In recent years, accurate and comprehensive information
regarding foreign affairs and developments has become increasingly
important to the United States Government. The reduction in United
States military tactical forces overseas has heightened the United
States Government's need to quickly assess military risks,
particularly in areas of instability as they develop around the world.
The breakup of the Soviet Union and civil unrest in certain nations in
Eastern Europe, Africa, and South America indicate an increase in
geographic areas that might require monitoring. In addition, the
United States Government requires information regarding overseas
activities to conduct drug interdiction operations.
As part of its efforts to obtain information, the United States
Government gathers and analyzes telecommunication signals emanating
from foreign countries. In recent years, the use of established
telecommunication technologies has increased throughout the world and
new telecommunication technologies, supplementing rather than
replacing prior technologies, have been developed and commercialized.
These trends have led to a significant increase in the overall volume
of information communicated and an increase in the density of signals
transmitted throughout the radio frequency spectrum. This increase can
be seen in the proliferation of facsimile, cellular, and digital
signal telecommunications equipment and the global information network
(World Wide Web) in the last decade, resulting in a significant
increase in the amount of information being communicated. These trends
have required the development of signal reconnaissance equipment
capable of collecting and processing an increased volume of signals as
well as new types of signals.
Traditionally, organizations within the United States Government
have satisfied their signal reconnaissance needs by first identifying
their specific requirements and then contracting with government
contractors to provide equipment. Contractors typically designed and
built custom signal processing systems optimized to satisfy the
particular needs of various agencies. Development of custom systems
usually required many years of effort and involved great expense. The
time required to develop these systems often meant that when a system
was delivered, it did not address new telecommunications technologies
that had evolved during the development process. These factors,
combined with growing budgetary constraints, have caused many agencies
to search for more flexible and cost-effective signal reconnaissance
solutions that can be deployed promptly.
Industrial Applications
The current technological trend worldwide is exponential growth
in the volume of data transferred and made available to the
individual. This trend dictates maximum efficiency of frequency
spectrum usage by the commercial telecommunication companies. The
spectrum usage is especially critical in the band limited radio
frequency (RF) environment that personal communication systems (e.g.,
cellular systems) and communication satellite systems (e.g., PanAmSat,
Intelsat, InMarSat) utilize. As these systems attempt to maximize this
usage, there is an increasingly higher probability that data transfer
will be impaired. This creates demand for sophisticated data quality
monitoring.
Traditionally, telecommunication techniques have been
sufficiently low technology that fairly unsophisticated techniques
could be used for quality monitoring. The rapid advancement of
telecommunication technology and desire to maximize data transfer in
the recent years has created a major technological challenge for the
quality monitoring. the commercial telecommunication companies are
just now realizing the need for sophisticated signal processing
equipment to perform quality monitoring.
As the world become more reliant upon data transfer and data
access for its day-to-day activities (i.e., E-Commerce), it also
becomes more vulnerable to unauthorized data access or manipulation.
This creates a requirement for data system intrusion detection. This
intrusion detection must obviously be performed without impact upon
the data transfer.
The information providers and database ownerso of data networks
are increasingly assessing their vulnerabilities and protection needs.
Data network protection is becoming a concern of organizations
worldwide.
Defense Communications
Just as the civilian world is becoming increasingly dependent
upon data transfer and access, so is the military. The military
branches utilize data transfer for guidance, computer-to-computer
battlefield planning, high quality communications, and so forth. This
data transfer many times must occur under non-ideal transport modes.
The transport invariably is in the radio frequency spectrum and must
occur under sub-optimum conditions such as minimal frequency planning for
interference mitigation; inaccurate antenna pointing; and moving
platforms. These defense communication systems must be able to
mitigate data transfer anomalies in an automated or semi-
automated manner in order to provide reliable, rapidly deployed
communications.
The military branches are adapting to advancing state-of-the-
art data transfer technologies. As they are adopting these capabilities
and understanding the new technologies they are faced with
added complexities compared to commercial applications. The United
States Government started investing in research and development to
overcome these complexities. The goal is to provide a reliable all-
digital battlefield by 2010.
STRATEGY
Applied Signal Technology's objective is to anticipate the needs
of the telecommunication processing marketplace and to invest in
research and development in an effort to provide solutions before the
Company's competitors. In some cases, this involves the development of
equipment to address new telecommunications technologies. In other
cases, it involves the development of equipment that offers smaller
size, lower power consumption, and lower cost than potentially
competitive products. The Company's strategy to accomplish its
objective includes the following elements:
- Anticipate Marketplace Needs. The Company devotes significant
resources in order to understand perceived future
telecommunication processing needs. The Company monitors
technological and commercial advances in telecommunications
to identify advances it believes will create new opportunities.
The Company obtains information about marketplace needs
through frequent contact with customer employees and technical and
contracting officials. In contrast, the Company believes that
competitors often wait until potential customers request
competitive proposals for equipment to satisfy specific
requirements and then respond to these requests.
Many times, sole source contracts are granted by the United States
Governments when a single contractor is deemed to have an expertise
or technology that is superior to that of competing contractors.
Since the Company's inception, the majority of its revenues have
been from sole source contracts. The Company believes that the
large number of sole source contracts it obtains demonstrates
that it often anticipates marketplace needs correctly. There
can be no assurance, however, that the Company will
anticipate correctly the marketplace needs in the future.
- Invest in Research and Development. The Company invests in
research and development it believes will enable it to
develop equipment that will satisfy the telecommunication
processing needs of the future. The Company believes that it
invests a greater percentage of its revenues in R&D than is
typical among its competitors. The Company believes its R&D
investments often enable it to offer superior products before
its competitors.
- Develop Flexible Products. The Company develops products that
can be used, with or without further modification, to satisfy
the needs of a variety of customers. The Company uses its
prior product development efforts to offer customers cost-
effective solutions and to offer these solutions promptly.
The Company believes that custom equipment developed by many
of the Company's competitors generally cannot be as readily
deployed in as wide a variety of circumstances as the
Company's products.
- Develop Highly Integrated Products. The Company designs its
products to use advanced circuitry and highly integrated
components. This enables the Company to offer products that
are smaller, consume less power, and cost customers less when
multiple units are built than equipment of similar
functionality that use fewer advanced designs and materials.
The lower cost of many of the Company's products appeals to
customers with budget constraints, and the smaller size and
low power consumption of many of the Company's products
appeal to customers with physical installation constraints.
- Focus on Signal Processing. Since inception, the Company has
focused much of its attention on developing signal processing
equipment. The Company believes that there have been and will
continue to be more opportunities to develop specialized
signal processing equipment to satisfy emerging technological
requirements.
- Increase Penetration and Broaden Customer Base. The Company
believes that its traditional customers offer significant
opportunities for sales growth, both in terms of additional
units of developed products and the development of new products
and, accordingly, directs much of its marketing efforts toward
these customers in order to increase the Company's penetration
of these markets.
In addition, more recently, the Company has been attempting to
broaden its customer base through the aggressive pursuit of new
markets relating to quality monitoring of commercial
satellite communications, data network intrusion protection, and
defense communications.
PRODUCTS
The Company's products consist of signal collection and
processing equipment that use software and hardware developed over
many years by the Company in the course of performing development
contracts to provide signal reconnaissance equipment to the United
States Government. This software and hardware enable the Company's
processing equipment to evaluate large numbers of radio frequency
signals and to select the relatively small proportion which contain
information likely to be useful in the signal reconnaissance programs
of the United States Government. More recently, the Company has
leveraged its product and technology base into some products outside
the traditional signal reconnaissance market.
The Company offers a variety of signal reconnaissance products,
which can be categorized as follows:
- Voice Grade Channel Processors. These processors are designed
to process voice grade channels (VGCs) which carry audio and
other signals. The standard telecommunication systems used
throughout the world put a large number of VGCs on a single
carrier channel to increase the number of signals that can be
transmitted at a particular frequency. VGC processors can
scan thousands of signals in less than one second and use
sophisticated processing technology to detect and record
relevant data, which is then analyzed by United States
Government personnel. These processors evaluate the
characteristics of collected signals and select those signals
that are likely to contain relevant information. The
Company's VGC processors currently range in price from
approximately $40,000 to approximately $200,000.
- Wideband Processors. These processors "clean"
telecommunication signals for further processing by VGC
processors by adjusting for signal distortions that commonly
occur during transmission. The two primary types of
distortion these processors correct are multipath
interference (caused by the reception of a signal and its
reflections) and cochannel interference (caused by the
reception of multiple interfering signals). Commercial
telecommunications companies overcome these distortions with
careful alignment and tuning which requires interruption of
the telecommunication signals. The Company's wideband
processors perform this alignment independently and
automatically by adjusting processing parameters using
proprietary adaptive algorithms that let the processors
"learn" how to process the incoming signals. One of the
Company's wideband processors processes signals that carry
thousands of VGCs in a digital format which is rapidly being
proliferated through the world and is particularly
susceptible to distortions. The Company's wideband processors
currently range in price from approximately $80,000 to
approximately $150,000.
- Processing Systems. Although the Company has emphasized
subsystem or "product" development since its inception, it
has also developed and delivered signal processing systems in
situations where the capabilities of its products have
enabled it to obtain a system development contract on a sole
source basis from the United States Government. The Company's
two largest system installations, for which the Company
developed custom systems software, integrated a number of the
Company's standard VGC processors and were developed to
exacting United States Government software and documentation
standards. Pricing for processing systems can vary widely
depending on the system requirements. Prices may range from
$100,000 to millions of dollars.
- Collection Products. The Company offers a limited number of
signal collection products designed to complement certain of
the Company's processing products. The Company's collection
products include a low-cost, small-size receiver that
collects very complex signaling formats and a receiver that
overcomes cochannel interference and certain forms of
multipath interference by optimizing multiple antenna inputs.
The Company's collection products currently range in price
from approximately $20,000 to approximately $60,000.
The Company is now developing industrial telecommunication
processing equipment and defense communications equipment marketplaces with
the following product categories:
- Communication Satellite Quality Monitors. These products
collect a variety of radio frequency signals as they are
emitted from the satellites and perform precise signal
parameter measurements using advanced digital signal
processing techniques to provide signal quality monitoring.
The equipment interfaces with system control networks to
provide total system quality monitoring. These products are
priced in a range of approximately $50,000 to $100,000.
- Telephone Intrusion Detection Equipment. This equipment is a
variant of the voice grade channel processor using the multi-
channel processing capability to detect unusual channel
activity within a telephone network. This activity could be
indicative of attempts at unauthorized data network entry.
These products currently range in price from approximately
$40,000 to $150,000.
- Defense Communication Products. This equipment is based on
the wideband processor technology. The communication products
not only "clean" the signals for subsequent processing, but
also include the signal generation capability to provide the
complete function of an adaptive equalization wideband modem.
These products currently range in price from approximately $20,000
to $40,000.
CUSTOMERS, CONTRACTS, AND MARKETING
CUSTOMERS
To date, purchases by the United States Government have accounted for
almost all of the Company's revenues. Most of the Company's revenues
have come from contracts directly with the United States Government.
The Company also has subcontracts under which it supplies products or
services to prime contractors that have contracts with the United
States Government. Subcontract revenues accounted for approximately
34%, 29%, and 27% of the Company's total revenues for its fiscal years
1998, 1997, and 1996, respectively. In addition, the Company
occasionally sells small quantities of equipment to foreign governments.
Foreign revenues have accounted for approximately 9%, 2%,
and 3% of the Company's total revenues for fiscal years 1998, 1997,
and 1996, respectively.
The Company's United States Government customers consist of
approximately six military and intelligence agencies with signal
reconnaissance needs. Within these six major customers, the Company
has contracts with approximately 20 different offices, each with
separate budgets and contracting authority. Concentration of revenue
sources is significant for the United States Government. The Company's
largest contract accounted for 18% of the Company's revenues in fiscal
year 1998, 22% in fiscal year 1997, and 15% in fiscal year 1996.
Two intelligence agencies accounted for approximately 39% and 28%,
respectively, of revenues in fiscal year 1998; approximately 57% and
28%, respectively, of revenues in fiscal year 1997; and approximately
52% and 26%, respectively, of revenues in fiscal year 1996.
In recent years, the United States defense budget has been reduced,
causing customers and potential customers of the Company's products to
re-evaluate their needs. The Company believes that budget reductions
have caused agencies increasingly to favor standard products similar
to the Company's products rather than custom products that generally
are more expensive, take longer to deliver, and provide solutions to a
narrower range of signal reconnaissance problems. Future reductions in
United States Government spending on signal reconnaissance equipment
or future changes in the kinds of signal reconnaissance products or
services required by United States Government agencies, however, could
limit demand for the Company's products, which would have a material
adverse effect on the Company's operating results.
CONTRACTS
Most of the Company's business is conducted under contracts that
include United States Government security requirements. The Company's
contracts with United States Government agencies can be categorized
in several ways.
Sole source contracts are let by the United States Government when a
single contractor is deemed to have an expertise or technology that is
superior to that of competing contractors. Potential suppliers compete
informally for sole source contracts through R&D investment and
marketing efforts. This competition requires a contractor to identify
the United States Government's requirements early and invest in
developing potential solutions so that the contractor can demonstrate
a distinguishing expertise or technology promptly after the United
States Government has identified a signal reconnaissance requirement.
Competitive bid contracts are awarded after a formal bid and proposal
competition among suppliers, and sole source contracts are awarded
without a formal competition. During fiscal years 1998, 1997, and
1996, approximately 62%, 69%, and 75%, respectively, of the Company's
revenues were from sole source contracts, and approximately 38%, 31%,
and 25%, respectively, were from competitively bid contracts.
During fiscal years 1998, 1997 and 1996, the Company experienced an
increase in the percentage of revenues from contracts awarded on a competitive
basis. This increase is primarily due to an increase in the number of
subcontracts awarded to the Company; subcontracts are generally awarded on a
competitive basis. Management does not believe the shift in the percentage
of revenues from subcontracts via competitive bidding will have a material
impact on future operating results or financial condition of the Company.
Competitive bid contracts are awarded based on objective proposal
evaluation criteria established by the procuring agency. Interested
contractors prepare a bid and proposal that responds to the agency's
request for proposal. A bid and proposal is usually prepared in a
short period of time (for example, 45 days) in response to a deadline
and requires the extensive involvement of numerous technical and
administrative personnel.
Competitive bid or sole source contracts can be either fixed-price
contracts, pursuant to which the Company agrees to deliver equipment
for a fixed price and assumes the risk of cost overruns, or cost-plus
contracts, pursuant to which the Company is reimbursed for its direct
and indirect costs and paid a negotiated profit. During fiscal year
1998, approximately 46% of the Company's revenues were from fixed-
price contracts and approximately 54% were from cost-plus contracts.
During fiscal year 1997, approximately 50% of the Company's revenues
were from fixed-price contracts and approximately 50% were from cost-plus
contracts. During fiscal year 1996, approximately 52% of the Company's
revenues were from fixed-price contracts and approximately 48% were
from cost-plus contracts.
Most of the Company's fixed-price contracts are for the manufacture of
multiple units of its products, rather than the development of new
products. The Company believes that the risk of cost overruns is much
less in the case of fixed-price manufacturing contracts, where the
product already has been developed and at least a prototype made, than
in the case of fixed-price development contracts.
The Company is subject to price redetermination on certain fixed-
price U. S. Government contracts if it is determined that the Company
did not price its products and services consistent with the requirements
of the Federal Acquisition Regulations. As of October 31, 1998, the
Company has not had a material claim sustained against it for
noncompliance. See Item 3: "Legal Proceedings."
Almost all of the Company's contracts contain termination clauses that
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 in
the past, there can be no assurance such cancellations will not occur
in the future.
MARKETING
The Company's primary marketing efforts consist of personal contact
between technical representatives of customers and potential customers and
technical personnel of the Company. The Company involves all technically
qualified staff members in its marketing program. The Company believes
it is extremely important to have technically knowledgeable staff make
marketeing contacts since an initial system concept is often developed
during the first such contact. The Company believes that it has much more
marketing contact with government customers and potential government
customers than is customary among its competitors generally, and that this
contact enables the Company to anticipate telecommunication signal
processing needs, thereby giving the Company a potential advantage over
its competitors.
In addition to its primary technical marketing, the Company also
conducts marketing activities designed to increase its visibility with
existing and potential customers. Each year the Company conducts two
equipment shows in the Washington, D.C. area demonstrating the
operation of many of its signal reconnaissance products. The Company uses
direct mail and magazine advertising from time to time to inform potential
customers of available products. The Company also produces a signal
reconnaissance product summary catalog that is updated every six months,
and a quarterly newletter for direct mailing. The Company's mailing list
includes contacts at private sector companies that may purchase the
Company's products for their own use or for inclusion in systems they are
developing, as well as contacts at United States Government agencies
that buy products but do not contract for development efforts.
BACKLOG
The Company's backlog, which consists of anticipated revenues from the
uncompleted portions of existing contracts, was $49.4 million, $83.3
million, and $82.9 million at October 31, 1998, 1997, and 1996,
respectively. Anticipated revenues included in backlog may be realized
over a multi-year period. The Company includes a contract in backlog
when the contract is signed by both the Company and the customer. The Company
believes that the backlog figures are firm, subject only to the cancellation
and modification provisions contained in its contracts. See Item7: "-Backlog."
RESEARCH AND DEVELOPMENT
Research and Development
The Company conducts R&D pursuant to United States Government R&D
contracts and as part of its own R&D program. United States Government
R&D contracts generated approximately $60.9 million of revenues in
fiscal year 1998, approximately $48.0 million in fiscal year 1997, and
approximately $23.0 million in fiscal year 1996. The Company's R&D
program is funded by the billing rates charged to its customers.
The Company's R&D expenditures as a percentage of revenues in fiscal
years 1998, 1997, and 1996 were 11.1%, 10.5%, and 12.1%, respectively.
Research and development conducted by the Company was approximately
$12.2 million for fiscal year 1998, $10.1 million for fiscal year 1997,
and $9.4 million for fiscal year 1996. The Company believes that its
investment in R&D provides it with a significant competitive advantage.
The Company seeks to develop technology capable of addressing new
telecommunication signal processing requirements before its competitors.
In addition, the Company focuses its R&D on developing products that
can be used, with or without further modification, to satisfy various
needs of a variety of customers, thereby permitting the Company to
offer a solution promptly. The Company attempts to allocate its R&D
funds among projects intended to yield revenues within one to two
years, projects intended to yield revenues in two to five years, and
projects intended to yield revenues in more than five years. Most of
the Company's R&D expenditures are for projects intended to yield
revenues within one to two years.
An important aspect of the Company's R&D efforts is understanding
telecommunication trends to anticipate the future signal
processing needs of its customers. Not only does this allow the
Company to direct its R&D engineering efforts to produce solutions
promptly once a customer expresses a need, but it often allows the
Company to educate the customer about its potential needs and
simultaneously present a conceptual solution to those needs.
COMPANY DIVISIONS
The Company is organized into three technical divisions and a finance
division. Two of the three technical divisions-Communication Systems
and Strategic Systems-are engineering divisions which perform all of
the Company's development. The engineering divisions are primarily
responsible for conducting R&D and the initial development of
products, while the Operations Division is primarily responsible for
manufacturing multiple units of products. All divisions work together
to ensure that production-related issues, such as manufacturability,
reliability, and maintainability, are addressed from initial product
definition through final product shipment. The Company's technical
staff includes personnel with systems development expertise, which the
Company applies not only to system development but also to its product
development in order to ensure the compatibility of its products with
a variety of system requirements. As of January 5, 1999, there were
339 employees in the engineering divisions and 180 employees in the
operations division. (See "-Employees.")
Engineering. The engineering divisions are responsible for the
Company's R&D. The Company's R&D activities include both United States
Government R&D contracts and the Company's R&D projects. The
engineering division activities are directed toward developing
products that will ultimately be produced by the Operations Division.
The engineering divisions work in conjunction with the Operations
Division to assure that the development efforts will culminate in a
product able to be manufactured efficiently in quantity.
In addition to corporate headquarters in Sunnyvale, California,
the Company has offices in Herndon, Virginia and Annapolis Junction, Maryland.
As of January 5, 1999, there were 15 employees in the Virginia office and
31 employees in the Maryland office. Most of the personnel staffing these
offices are technical personnel and, in addition to marketing activities,
are involved in research and development and customer support (for example,
installation, training, and troubleshooting). Recently, the Company
relocated an employee to Salt Lake City, Utah to open an office in March 1999.
Operations. The Operations Division is responsible for completing
final product development and manufacturing multiple units of
products. By combining engineering and production expertise within the
Operations Division, the Company believes it is able to maximize
manufacturing efficiency and, therefore, reduce overall production
costs. Operations manufactures products using batch production
methods. The division achieves labor efficiency by extensive cross-
training of its personnel, which permits these personnel to
participate in the production of all of the Company's products. The
division is also responsible for managing the Company's purchases of
goods and services, including third party manufacturing and assembly
services. (See "-Suppliers.")
SUPPLIERS
The Company uses suppliers in order to obtain quality goods and
services without incurring the costs of providing those goods and
services in-house. The Company purchases from suppliers nearly all
circuit boards, integrated circuits, and other components used in its
products. In addition, the Company contracts with suppliers to
assemble some of its products. The Company's reliance on suppliers
involves several risks, including the possibility of a shortage of
certain key components and assemblies and reduced control over
delivery schedules, manufacturing yields, quality, and costs. If the
Company experiences significant availability or quality control
problems in the future, its operating results could be adversely
affected.
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, Inc. and Force
Computers, Inc. and digital signal processing integrated circuits
available solely from Texas Instruments, Inc. 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 operating results.
COMPETITION
The telecommunication signal processing 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. The Company's current competitors include
L-3 Communications Corporation; Boeing-North America;
E-Systems, Inc. (a subsidiary of Raytheon Corporation); GTE Government
Systems Corporation; Harris Corporation; Lockheed Martin Corporation;
Motorola Government Electronics Group (a subsidiary of Motorola,
Inc.); SAT Corporation; Stanford Telecommunications, Inc.; Comsat
Corporation; and TRW, Inc. Substantial competition could have a material
adverse effect on the Company's results of operations.
The competition for competitively bid contracts differs from the
competition for sole source contracts. Companies competing for
competitive bid contracts prepare bids and proposals in response to
either a commercial or government request and typically compete on price.
Potential suppliers compete informally for sole source contracts
through R&D investment and marketing efforts.
Companies competing for sole source contracts attempt to
identify the customer's requirements early and invest in solutions
so that they can demonstrate a distinguishing expertise or technology
promptly after the customer has identified a signal processing
requirement. The principal factors of competition for sole source
contracts include investments in R&D; the ability to respond to
government needs promptly; product price relative to performance,
quality, and customer support. The Company believes that it competes
favorably on each of these factors.
PROPRIETARY RIGHTS
The United States Government has rights to most of the technology
developed by the Company under government contracts, including rights
to permit other companies, including the Company's competitors, to use
this technology to develop products for the United States Government.
The Company is not aware that the United States Government has
exercised these rights.
The Company has filed patent applications for certain of its
technology. As of October 31, 1998, three patents have been granted to
the Company. The Company believes that given the rapidly changing
nature of signal collection and processing technology, its future
success will depend primarily upon the technical competence and
creative skills of its personnel. The Company attempts to protect its
trade secrets and other proprietary information through agreements with
customers, employees, and consultants and other security measures.
There can be no assurance that the measures adopted by the Company for
the protection of its intellectual property will be adequate.
Although the Company does not believe and has not received notice
that it is infringing upon the intellectual property rights of others,
there can be no assurance that such a claim will not be asserted
against the Company. In the event any third party made a valid claim
against the Company and a license was not made available to the Company
on commercially reasonable terms, this could have a material adverse
effect on the Company's results of operations.
GOVERNMENT REGULATIONS
Many of the Company's operations are subject to compliance with
regulatory requirements of federal, state and municipal authorities,
including regulations concerning employment obligations and
affirmative action, workplace safety and protection of the
environment. While compliance with applicable regulations has not
adversely affected the Company's operations in the past, there can be
no assurance that the Company will continue to be in compliance in the
future or that these regulations will not change.
In particular, the Company must comply with detailed government
procurement and contracting regulations and with United States
Government security regulations, certain of which carry substantial
penalty provisions for nonperformance or misrepresentation in the
course of negotiations. Failure of the Company to comply with its
government procurement or contracting obligations or security
obligations could result in penalties or suspension of the Company
from government contracting, which would have a material adverse
effect on the Company's results of operations. (See Item 1
"-Customers, Contracts, and Marketing," and Item 3 "-Legal
Proceedings.")
EMPLOYEES
As of January 5, 1999, the Company had approximately 648 full-time
employees, 170 of whom hold advanced technical degrees (master and/or
doctoral degrees), including 21 with doctoral degrees.
The Company's business requires that a large number of its technical
employees obtain security clearances from the United States
Government, which limits the available pool of eligible candidates for
such positions to those who can satisfy the prerequisites to obtaining
these clearances. In particular, the personnel involved in signal
reconnaissance marketing require the appropriate clearances to meet with
government technical representatives and discuss the government's
needs. The Company has a United States Government-sanctioned security
program that allows staff members to obtain appropriate clearances.
Approximately 62% of the Company's staff have security clearances. The
success of the Company is dependent on attracting, retaining, and
motivating qualified key management and technical personnel, the loss
of whom, could adversely affect the Company's business. Such personnel
are in great demand and limited supply.
The Company believes its employees are its most valuable resource and
that its workforce possesses a strong feeling of dedication to and
pride in the Company. This dedication is reinforced through incentive
compensation arrangements based on Company performance. The Company's
employees are not represented by any collective bargaining agreements,
and the Company has never experienced a work stoppage.
SUMMARY OF BUSINESS CONSIDERATIONS AND CERTAIN FACTORS THAT MAY AFFECT FUTURE
RESULTS OF OPERATIONS AND/OR STOCK PRICE
The Company's future operating results and stock price may be subject
to volatility, particularly on a quarterly basis, due to the following:
Customer Concentration: Historically, defense and intelligence
agencies of the United States Government have accounted for almost all
of the Company's revenues. Future reductions in United States
Government spending on signal reconnaissance and communications
equipment or future changes in the kind of signal reconnaissance and
communications 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 operating
results and financial condition. In addition, as a supplier of these
agencies, the Company must comply with numerous regulations, including
regulations governing security and contracting practices. Failure to
comply with these regulations could disqualify the Company as a
supplier of these agencies, which would have a material adverse effect
on the Company's future results of operation and financial condition.
Revenue Concentration: Due to the award of certain larger contracts,
the Company has experienced a significant concentration of revenues
from a single contract in recent periods. Revenue related to a single
contract comprised 18% of revenue for fiscal 1998. This compares to
22% and 15% attributable to the same contract in fiscal years 1997 and 1996,
respectively. This contract may be terminated at the sole discretion of the
United States Government. If this contract or other larger contracts of the
Company were terminated, this could have a material adverse effect
on the Company's future results of operation and financial condition.
Competition: The telecommunication signal processing
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 results of operations and financial condition.
Dependence Upon Personnel: The Company's ability to execute its
business plan is contingent upon successfully attracting and retaining
qualified employees. There can be no assurance that the Company will
continue to be successful at attracting and retaining sufficient personnel.
Failure to do so could have a material adverse effect on the Company's
future results of operations and financial condition.
Risk of Fixed Price and Contract Terminations: 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
on certain 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 future results of
operations and financial condition.
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 contract
terminations to date, there can be no assurance that such terminations
will not occur in the future.
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,
shortfalls in revenues or earnings from levels forecast by securities
analysts, changes in estimates by analysts, competition, or
announcements of extraordinary events such as acquisitions or
litigation 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 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 future results of operations and
financial condition.
Year 2000 (Y2K) Risks:
The Company has been implementing a program over the last 18 months to define
and minimize risks related to transitioning into the Year 2000 and beyond.
The program and associated risk assessment is segregated into the following
three main areas: 1)Product Readiness Program, 2)Internal Infrastructure
Readiness Program and 3)Business Partners Readiness Program. For each
readiness area, the Company is systematically performing risk assessment and
conducting tests and remediation as well as developing contingency plans to
mitigate risk. Further, the Company is communicating with its employees,
suppliers and customers regarding the Year 2000 issue in an effort to raise
awareness and further mitigate risk by requesting compliance letters from its
key business partners. Specific status of each area is as follows:
Product Readiness Program
Prior to January 1, 1997 (the "Certification Date"), the Company had no
contractual obligation to provide Y2K compliant products/systems. As is the
nature with most government contractors, the Company either developed or
delivered a product to customer-defined acceptance criteria. As the government
became more concerned regarding the impact of Y2K on their systems, they began
requiring contractors, as part of the contractual terms and conditions, to
certify all deliveries are Y2K compliant. The risk assessment for products
and systems delivered prior to and after the certification date is as follows:
Products and Systems Delivered Prior to the Certifications Date:
The Company will bring all products delivered under contracts entered
into prior to the certification date into compliance upon the customer's
request. The Company has performed a risk assessment for the
government so they have an understanding of what previously delivered
products have Y2K exposure. Since the Company's products and systems met the
original contract acceptance criteria, it is generally expected that the
customers would pay for the necessary upgrades.
Products and Systems Delivered After to the Certifications Date:
Company personnel have worked with customers to develop a comprehensive
test plan and are now certifying that our products meet a mutually agreed
upon set of criteria for testing Y2K.
Internal Infrastructure Readiness Program
The Company has embarked on a comprehensive inventory, evaluation,
remediation and/or replacement of all internal applications and
hardware used to run its business. The Company expects a fully
compliant internal infrastructure by September 1999. The
compliance matrix the Company is using includes all network
switches, hubs, routers, servers, critical business systems
software and hardware, engineering support applications and tools,
desktop systems, and telephone/voicemail systems.
Business Partners Readiness Program
The Company is working with its suppliers and service providers to
minimize risk and provide uninterrupted service including unimpeded
flow of materials to its programs. Specific status is as follows:
Suppliers (Hardware and Software for Programs):
The Company has investigated all purchased items which may have an
impact on its products resulting from the suppliers'
hardware/software not being Y2K compliant. The risk in this area
has been reduced to two areas: 1) key software providers and 2)
providers of the single board computers.
1) Key software providers include Sun Microsystems and Wind
River Systems. Wind River has provided a certification
of their Y2K compliance. Sun Microsystems is
implementing a Y2K compliance program.
2) The manufacturers of the Company's single board computers
used in certain products include Force, Ariel, Actel and
Motorola. All of these manufacturers have provided
certification of Y2K compliance.
Suppliers (Operational Controls):
The Company's goal is to insure the unimpeded flow of materials
to its programs. A review of all other components than those
described above indicates that there are multiple sources
available from which the Company could procure the items in the
event one of the Company's suppliers has an internal control problem
related to Y2K.
Other Business Partners
The Company has been in contact with its other critical business
partners (such as its 401K plan carrier and insurance provider) to
insure there will be uninterrupted availability of services. All
critical business partners have provided compliance letters to the
Company.
Summary
The Company expects to implement successfully the systems and programming
changes necessary to insure continued operations as a normal part of the
Company's activities (upgrades, maintenance, normal communications, etc.).
Additionally, since the programs described in this section are ongoing, all
potential Year 2000 issues may have not been identified. Therefore, the
potential impact of these issues on the Company's financial condition are not
determinable at this time.
Costs related to the Year 2000 compliance program are either borne by
certain contracts which are paid directly by the customer or
administrative costs which are reimbursed indirectly through the
Company's billing rates. While the Year 2000 administrative costs
incurred to date have not been material, the Company anticipates
incurring additional costs as the phases are completed. The Company
has set aside $140,000 for investigating and remedying issues directly
related to Year 2000 compliance. The Company has not included Year
2000 costs for activities which are accomplished as part of normal system
upgrades and/or improvements since other factors are driving these
requirements.
However, the Company does not believe that the cost of such actions will have
a material effect on the Company's results of operations or financial
condition. There can be no assurance, however, that there will not be a delay
in, or increased costs associated with, the implementation of such changes,
and the Company's inability to implement such changes could have an adverse
effect on future results of operations.
The Company has not developed extensive formal contingency plans as
backup to that discussed above. The Company expects the plans
discussed above to be successful and not limit the ability of the
Company to develop and sell its products and services.
ITEM 2: PROPERTIES
The Company currently leases six buildings (76,379, 58,000, 58,000,
52,364, 51,851, and 34,862 square feet, respectively) in Sunnyvale,
California pursuant to leases which expire in March 2012. These
buildings are used as the Company's headquarters and include
development, engineering, production, marketing, and administrative
offices. In July 1998, under the terms of its lease, the Company exercised an
option to construct a building with occupancy targeted for September 1999.
Additionally, under the terms of its lease, the Company has options to
construct two buildings over a 5 year period commencing September 1999.
The Company leases a 15,250 square foot building in Herndon, Virginia
pursuant to a lease which expires in February 1999. This building
houses a small development facility and marketing and administrative
offices.
The Company leases 29,121 square feet of a 90,000 square foot building
in Annapolis Junction, Maryland pursuant to a lease which expires in
April 2004. This building also houses a small development facility and
marketing and administrative offices.
In addition, the Company also leases a 5,900 square foot warehouse
in Sunnyvale, California which expires in October 2000. The warehouse is
used as a storage facility.
The Company recently signed a lease for approximately 9,500 square feet
of a 28,000 square foot building in Salt Lake City, Utah. The five year lease
is expected to commence in March 1999. This building will house a small
development facility with marketing and administrative offices.
The Company's business requires that it maintain at each of its
offices a facility clearance sponsored and approved by the United
States Government. This approval could be suspended or revoked if the
Company is found not to have complied with security regulations
applicable to such facilities. Any revocation of such approval, and
any suspension of such approval that materially delayed the Company's
delivery of its products to customers would materially adversely
affect the Company's results of operations. Although the Company has
adopted policies directed at assuring its compliance with relevant
regulations, there can be no assurance that the approved status of the
Company's facilities will continue without interruption.
ITEM 3: 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 its 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 indicated 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 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 by $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
date of the subpoena 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 etermine the scope of the subpoena and intends to fully
comply with the request.
In February 1998, the Company was contacted by one of its primary
customers to negotiate an administrative settlement regarding voluntary
disclosure discussed above. The Company has provided the necessary information
to the Government.
While management believes the fiscal year 1995 third quarter charge is
adequate to cover all potential liabilities associated with this
investigation by the United States Government, the United States 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.
EXECUTIVE OFFICERS OF THE REGISTRANT
As of January 5, 1999, set forth below is certain information with
respect to age and background for each of the executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- -------
<S> <C> <C>
Gary L. Yancey 53 President, CEO and Chairman of the Board
Brian M. Offi 45 Vice President-- Finance and Chief Financial Officer
Mary Rogge 52 Secretary
Bani M. Scribner, Jr. 54 Vice President-- Strategic Systems Division
Ken Snow 58 Vice President-- Operations Division
Kenway Wong 49 Vice President-- Communication System Division
</TABLE>
Gary L. Yancey, a co-founder of the Company, has served the Company as
President, CEO and Chairman of the Board since the Company's incorporation
in January 1984. Prior to co-founding the Company, he was employed for
10 years by ARGOSystems, a manufacturer of electronic reconnaissance
systems.
Brian M. Offi joined the Company in October 1990 as Chief Financial
Officer and was elected Vice President-Finance in May 1991. From May
1987 to October 1990, he served as Chief Financial Officer of S-Tron,
Inc., a manufacturer of life-support equipment worn by military
personnel.
Mary Rogge joined the Company in 1986 as an executive secretary
reporting to the President and was elected Secretary of the Company in
March 1988.
Bani M. Scribner, Jr. joined the Company in 1992 as senior staff
reporting to the President. In November 1996 he was elected Vice
President of the Strategic Systems Division.
Ken Snow joined the Company in January 1990 as a senior staff
engineer. He was promoted to the position of Deputy Director of
Engineering in 1991. In October of 1994 he became the Director of the
Operations Division and in March 1995 he was elected Vice President of
Operations.
Kenway Wong joined the Company in 1988 as a senior engineer. He was
promoted to Department Manager in 1989, and Engineering Director in
1994. In November 1997, he was elected Vice President of the
Communication Systems Division.
<PAGE>
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Selected Common Stock Data:
Applied Signal Technology, Inc. Common Stock was first offered to the public
on March 26, 1993. Since the initial public offering, the stock has been
traded on The Nasdaq National Market under the symbol "APSG". As of
January 5, 1999, the Company had approximately 570 shareholders of record.
The following table sets forth the range of high, low and closing sale
prices for the Company's Common Stock over the last eight (8) quarters
ending October 31, 1998. The "last" price per share in the table represents
the closing price on the last trading day of the quarter. The quotations
represent inter-dealer quotations, without retail markups, markdowns, or
commissions and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
Share
Volume
High Low Last (in 000'S)
-------- -------- -------- ----------
<S> <C> <C> <C> <C>
Fiscal year ended October 31, 1997
First quarter $5.63 $4.13 $4.38 1,431.0
Second quarter $5.13 $4.00 $4.38 833.9
Third quarter $10.13 $4.25 $8.00 8,682.0
Fourth quarter $13.88 $7.50 $12.07 9,853.4
Fiscal year ended October 31, 1998
First quarter $13.63 $13.38 $13.50 5,647.1
Second quarter $11.75 $11.06 $11.50 10,255.8
Third quarter $12.88 $11.63 $11.63 3,765.6
Fourth quarter $11.88 $11.25 $11.31 2,080.0
</TABLE>
The Company has not paid any dividends on its stock since its inception
and anticipates that for the foreseeable future, it will retain its
earnings for use in operations. The Company's line of credit agreement
prohibits the Company from making dividend payments without the lender's
approval.
Nasdaq Market Makers:
As of December 31, 1998, the following firms were registered market
makers of the Company's Common Stock on the Nasdaq National Market:
Cowen & Co.; Fahnestock & Co. Inc.; Mayer & Schweitzer Inc.; Sherwood
Securities Corp.; Troster Singer Corp.; Tucker Anthony Incorporated; G.V.R.
Company; Herzog, Heine, Geduld, Inc.; Barber & Bromin, Inc.; Knight
Securities L.P.
<PAGE>
Item 6. SELECTED FINANCIAL DATA
All data is in thousands except per share data.
<TABLE>
<CAPTION>
Summary of Operations Fiscal Year Ended: October 31,
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues from contracts $110,087 $96,259 $77,410 $67,664 $64,341
Operating expenses:
Contract costs 67,840 60,404 53,333 45,418 40,830
Research and development 12,208 10,137 9,380 9,873 8,551
General and administrative 14,262 13,642 11,954 11,221 10,219
--------- --------- --------- --------- ---------
Total operating expenses 94,310 84,183 74,667 66,512 59,600
--------- --------- --------- --------- ---------
Operating income 15,777 12,076 2,743 1,152 4,741
Interest income/(expense), net 584 190 49 187 409
--------- --------- --------- --------- ---------
Income before provision for income taxes 16,361 12,266 2,792 1,339 5,150
Provision for income taxes 6,217 4,600 977 435 2,010
--------- --------- --------- --------- ---------
Net income $10,144 $7,666 $1,815 $904 $3,140
========= ========= ========= ========= =========
Earnings per Share:
Basic $1.20 $0.94 $0.23 $0.12 $0.42
Diluted $1.15 $0.91 $0.23 $0.12 $0.40
Average Shares:
Basic 8,468 8,128 7,754 7,454 7,442
Diluted 8,859 8,435 7,919 7,635 7,769
Financial Position at End of Fiscal Year:
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
Working capital $39,716 $34,936 $26,477 $24,269 $21,888
Total assets 72,463 64,161 52,103 49,030 47,316
Retained earnings 37,711 27,569 19,866 18,052 17,153
Shareholders' equity 56,866 49,766 39,965 36,947 35,809
Book value per common share $6.77 $5.96 $5.08 $4.90 $4.84
</TABLE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
Applied signal Technology, Inc. designs, develops, and
manufactures signal processing equipment to collect and process a wide
range of telecommunication signals for reconnaissance and industrial
application. Signal reconnaissance equipment is used for the
monitoring of foreign telecommunications, predominantly by the United
States Government and allied foreign governments. Industrial
applications include spectrum monitoring equipment for commercial
communication satellite systems, and data intrusion detection equipment
for data network protection.
Signal reconnaissance systems are composed of collection
equipment and processing equipment. Signal collection equipment
consist of sophisticated receivers that can scan the radio frequency
(RF) spectrum (cellular telephone, microwave, ship-to-shore, military
transmissions, etc.) to collect certain signals from potentially
thousands of signals within the RF spectrum. Process equipment, using
sophisticated software and hardware, evaluates the characteristics of
collected signals and selects those signals likely to contain relevant
information.
Spectrum monitoring equipment evaluate a communication
satellite's frequency spectrum usage to detect any misuse that could
cause substandard service. Data intrusion detection equipment monitor
commercial data networks to detect unauthorized system entry for the
purpose of altering or pirating data.
Since inception, the Company has focused its efforts primarily on
processing equipment, but also provides specialized collection
equipment, as well as complete signal processing systems. The
Company's business involves risks and uncertainties, including, without
limitation, those contained in this report in "Business Considerations
and Certain Factors That May Affect Future Results of Operations and/or
Stock Prices."
The Company's revenues are primarily generated from sales of its
products and services to two agencies of the United States Government.
The two agencies accounted for 39% and 34%, respectively, of revenues
for fiscal 1998. For fiscal 1997, the two agencies accounted for 57%
and 29%, respectively, of revenues and for fiscal 1996, the
percentages of revenues derived from these two agencies were 52% and
27%, respectively.
The Company's revenues are derived from either fixed price contracts,
which provide that the Company perform a contract for a fixed price
and assume the risk of any cost overruns or cost plus reimbursement
contracts, which provide that the Company receive the direct and
indirect costs of performance plus a negotiated profit. In fiscal
1998, approximately 46% of the Company's revenues were derived from
fixed price contracts, and approximately 54% of the Company's revenues
were derived from cost plus reimbursement contracts. In fiscal 1997,
approximately 50% of the Company's revenues were derived from fixed
price contracts, and approximately 50% of the Company's revenues were
derived from cost plus reimbursement contracts. In fiscal 1996,
approximately 52% of the Company's revenues were derived from fixed
price contracts, and approximately 48% of the Company's revenues were
derived from cost plus reimbursement 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 material costs,
inefficiencies or other factors, are borne by the Company, and could
have a material adverse effect on the Company's results of operations.
In accounting for cost plus reimbursement type contracts, all costs
are charged to operations as incurred (including allowable
administrative expenses), and revenues are recognized based on costs
incurred plus estimated fee rates at the date of evaluation. In
accounting for fixed price type contracts, revenue is recognized using
the percent completion method which is substantially the same as that
used for cost type contracts described above.
All costs are charged to operations (including allowable
administrative expenses) as incurred, and revenues are recognized
based on estimated costs and profits at completion on a contract by
contract basis. Losses on any individual contracts are provided for at
the time they become known. (See Note 1 to Financial Statements.)
Operating Results-Fiscal Years Comparison
The following table sets forth, for the periods indicated, statements of
operations data as a percentage of revenues from contracts and, at the
end of each period indicated, the Company's backlog:
<TABLE>
<CAPTION>
Year Ended October 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues from contracts 100.0% 100.0% 100.0%
Operating expenses:
Contract costs 61.6% 62.8% 68.9%
Research and development 11.1% 10.5% 12.1%
General and administrative 13.0% 14.2% 15.5%
------------ ------------ ------------
Total operating expenses 85.7% 87.5% 96.5%
------------ ------------ ------------
Operating income 14.3% 12.5% 3.5%
Interest income/(expense), net 0.6% 0.2% 0.1%
------------ ------------ ------------
Income before provision for income 14.9% 12.7% 3.6%
Provision for income taxes 5.7% 4.7% 1.3%
------------ ------------ ------------
Net income 9.2% 8.0% 2.3%
============ ============ ============
Backlog (thousands of dollars) $49,380 $83,268 $82,886
</TABLE>
Revenues
Revenues from contracts increased by 14% from approximately
$96,259,000 in fiscal 1997 to approximately $110,087,000 in fiscal 1998.
Revenues increased by 24% from approximately $77,410,000 in fiscal 1996 to
approximately $96,259,000 in fiscal 1997. The revenue increase in fiscal
1998 is due in part to increased contract activity experienced in the
military marketplace and, in part, due to an increasing demand from the
intelligence agencies for development contracts. The revenue increase in
fiscal 1997 over the revenue reported in fiscal 1996 was due in part to
the introduction of new products and services, as well as an increase in
average fees recorded for production contracts.
The following table identifies the source of the Company's revenues for
fiscal years 1998, 1997 and 1996 by major market:
<TABLE>
<CAPTION>
FY98 FY97 FY96
----- ----- -----
<S> <C> <C> <C>
Intelligence Agencies 81% 91% 81%
Military 9% 7% 12%
Foreign 9% 2% 3%
Commercial 1% --% 4%
</TABLE>
Backlog
The Company's backlog, which consists of anticipated revenues from
the uncompleted portions of existing contracts (excluding unexercised
options), was approximately $49,380,000 at the end of fiscal 1998. This
represents an approximate decrease of 40.7% from the prior year's ending
backlog of approximately $83,268,000. The backlog for fiscal year 1997
was nominally greater than the backlog of approximately $82,886,000 for fiscal
year 1996. Regarding the decrease in backlog experienced during fiscal
1998, management believes the decrease in backlog between fiscal 1997 and
fiscal 1998 is due in part to a delay in specific contract awards from the
United States Government and, in part, due to a reduced number of awards
for the Company's off-the-shelf products. Although it is impossible to
determine the precise cause of the order slowdown, management believes it is
caused in part by a diversion of the Government's focus to the Year 2000 problem
and in part, caused by a preponderance of product sales to a certain
intelligence office during fiscal year 1997 who, consequently, purchased less
in fiscal year 1998. While management believes that the demand for global
intelligence and tactical communications systems should continue, there can
be no assurances that the reduced order flow experienced during fiscal 1998
will not have an impact on future revenues.
Contract Costs
Contract costs consist of direct costs on contracts, such as
labor, materials and manufacturing overhead costs. Contract costs, as
a percentage of revenues, decreased to 61.6% in fiscal year 1998 from
62.8% in fiscal year 1997. As a percentage of revenues, contract costs
for fiscal year 1997 were lower than contract costs of 68.9% of
revenues for fiscal year 1996. The continued decrease in contract
costs as a percentage of revenue for fiscal year 1998 compared to
fiscal year 1997 is in part attributable to higher contract fees and,
in part due to the lower manufacturing overhead applied to contracts
during fiscal 1998 compared to fiscal 1997. The decrease in contract
costs as a percentage of revenue for fiscal year 1997, compared to
fiscal year 1996, is attributable to economies of scale related to a
higher percentage of production contracts in fiscal 1997, and fewer
products being transitioned from development stage to production stage
in fiscal 1997.
Research and Development Expenses
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. Research
and development expenses as a percentage of revenues were 11.1%, 10.5%
and 12.1% for fiscal years 1998, 1997, and 1996, respectively.
Research and development spending grew by approximately $2,070,000 in
fiscal 1998 from $10,137,000 in fiscal 1997, and, correspondingly, grew as a
percentage of revenues in fiscal 1998 when compared to the percentage
of revenue in fiscal 1997. This increase in research and development
spending during fiscal 1998 is due to management's decision to increase
research and development activities for the benefit of future business.
Although R&D spending grew approximately $757,000 to approximately
$10,137,000 in fiscal 1997 from approximately $9,380,000 in fiscal
1996, research and development expenses as a percentage of revenues
decreased in fiscal 1997 when compared to fiscal 1996. The decrease in
research and development spending as a percentage of revenues in fiscal
1997 was attributable to the demands of contract work which resulted in
limited availability of staff to work on research and development
contracts.
General and Administrative Expenses
General and administrative expenses include administrative salaries,
costs related to the Company's marketing and proposal activities, and other
administrative costs. General and administrative expenses were
approximately $14,262,000 or 13.0% of revenues in fiscal 1998 compared to
approximately $13,642,000 or 14.2% of revenues in fiscal 1997 and
approximately $11,954,000 or 15.5% of reveunes in fiscal 1996. The decrease
in general and administrative expenses as a percentage of revenues in fiscal
1998 is primarily attributable to the higher profit recognized on
contracts during fiscal 1998 compared to fiscal 1997. The higher general
and administrative expenses in fiscal years 1997 and 1996 reflect an
increase in bid and proposal activity experienced during the fiscal years,
as well as, an increase in marketing costs. In recent years, management
has continued to emphasize the marketing component of G&A in an effort to
generate revenues in future periods.
Interest Income/Expense (Net)
Net interest income/expense for fiscal 1998 increased approximately
$394,000 from approximately $190,000 net interest income in fiscal 1997 to
approximately $584,000 in fiscal 1998. Net interest income in fiscal 1997
increased approximately $141,000 over net interest income in fiscal 1996
of approximately $49,000. The increase in interest income during fiscal
1998 is due primarily to investing higher cash balances generated from
operations as well as from additional efforts expended to collect
outstanding receivable balances. The higher interest income received in
fiscal 1997 was primarily due to funds received on short-term investments
because of cash generated from higher profit margins and due to the
interest expense incurred during fiscal 1996 for the Company's higher
average outstanding line of credit balances throughout fiscal 1996.
Provision for Income Taxes
Income taxes as a percentage of income before provision for income taxes
have been provided for at a combined federal and state rate of 38% for
fiscal 1998 versus 37.5% for fiscal 1997 and 35% for fiscal 1996. The
1998 effective tax rate is lower than the combined federal and state
statutory income tax rates primarily due to the benefit derived from
federal and state income tax credits. The increases in the effective tax
rate from fiscal 1997 to fiscal 1998 and from fiscal 1996 to fiscal 1997
are primarily a result of the increases in federal and state tax
liabilities as a result of the lower impact of federal and state tax
credits on increased profitability.
Quarterly Results
The following table sets forth certain unaudited quarterly financial data for
the eight quarters ending October 31, 1998. In the opinion of the Company's
management, the unaudited information set forth below has been prepared on
the same basis as the audited information and includes all adjustments
necessary to present fairly the information set forth herein. The operating
results for any quarter are not indicative of results for any future period.
All data is in thousands except per common share data.
<TABLE>
<CAPTION>
FISCAL YEAR 1998 FISCAL YEAR 1997
---------------------------------------------- ------------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
---------- ---------- ---------- ---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues from contracts $24,361 $27,732 $27,373 $30,621 $20,084 $23,987 $22,600 $29,588
Operating expenses
Contract costs 15,095 17,327 16,695 18,723 13,136 15,742 13,793 17,733
Research and development 1,593 1,823 1,742 7,050 2,470 2,394 2,269 3,004
General and administrative 4,205 4,524 4,604 929 3,182 3,171 3,062 4,227
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Total operating expenses 20,893 23,674 23,041 26,702 18,788 21,307 19,124 24,964
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Operating income 3,468 4,058 4,332 3,919 1,296 2,680 3,476 4,624
Interest income/(expense), net 147 145 140 152 60 37 18 75
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Income before provision for
income taxes 3,615 4,203 4,472 4,071 1,356 2,717 3,494 4,699
Provision for income taxes 1,410 1,639 1,621 1,547 495 992 1,351 1,762
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Net income $2,205 $2,564 $2,851 $2,524 $861 $1,725 $2,143 $2,937
========== ========== ========== ========== ========= ========= ========= =========
Net income per common share
Basic $0.26 $0.30 $0.34 $0.30 $0.11 $0.21 $0.26 $0.35
Diluted $0.25 $0.28 $0.32 $0.29 $0.11 $0.21 $0.25 $0.34
Average shares outstanding
Basic 8,480 8,580 8,429 8,388 7,978 8,032 8,188 8,317
Diluted 8,954 9,000 8,776 8,708 8,113 8,156 8,517 8,749
</TABLE>
The Company has at times experienced fluctuations in its quarterly results
due to both seasonal and nonseasonal factors inherent in its business. These
have included costs associated with uneven flows of incoming material, the
level of research and development spending during any given quarter, fee
recognition on development contracts in the early phases of contract
performance where the financial risk is not entirely known until the contract
is further along in the development cycle, the United States Government
and the timing of contract awards. Management expects these fluctuations
to continue into the future.
Analysis of Liquidity and Capital Resources
The Company's primary source of liquidity has been the cash flow
generated from operations, as well as the issuance of common stock through
its employee stock plans.
The Company has a $3,000,000 unsecured, revolving line of credit
for short-term cash requirements bearing interest at the bank's reference
rate (8% as of October 31, 1998). Outstanding amounts on the line of credit
were zero at October 31, 1998 and 1997. The line expires on March 15, 1999;
the Company intends to renew the line at that time.
Net cash from operating activities: Net cash provided by
operating activities has varied significantly from year to year. For
fiscal years 1998, 1997 and 1996, cash provided by operating activities
was approximately $16,035,000, $9,806,000 and $5,378,000 million,
respectively. The year-to-year variances are primarily the result of
changes in net income, changes in accounts receivable, changes in the
level of accrued liabilities and the change in inventories held by the
Company. During fiscal 1998 net income increases to approximately
$10,144,000. During fiscal 1997, net income increased to approximately
$7,666,000 from approximately $1,815,000 in fiscal 1996. The
improvement in net income for fiscal 1998 is primarily due to an
increase in the average gross margin profitability recorded on
contracts during the year, and in part to a reduction in general and
administrative expenses recorded as a percentage of revenue for the
fiscal year. During fiscal 1998, accounts receivable decreased by
approximately $2,068,000 when compared to an increase of approximately
$2,630,000 for fiscal 1997. The cash generated by accounts receivable
in fiscal 1998 is due, in part to greater collection efforts and, in
part, due to collections received from a one-time billing modification
authorized by the U.S. Government in the fourth quarter of fiscal 1997.
The increased level of accounts receivable during fiscal 1997 was
primarily due to greater contract activity, and in part to certain
limitations and terms stipulated in certain engineering and production
contracts. Cash generated by the increased levels of liabilities for
fiscal 1998 approximated $1,203,000 and was primarily due to increased
tax liabilities associated with higher profit margins. Cash generated
by the increased levels of accrued liabilities for fiscal 1997 was
approximately $2,132,000 and was primarily due to the year-end accrual
for payroll and employee benefits. Cash used by the increased levels
of inventories, prepaid expenses and other current assets of
approximately $1,589,000 in fiscal 1998 is primarily due to the
increase in work-in-progress for engineering and production contracts
and, in part, due to the increase in prepaid income taxes related to
higher profits. Cash used by the increased levels of inventories,
prepaid expenses and other current assets in fiscal 1997 was primarily
due to the purchase of parts required for future production, as well as
for purchases for anticipated future contract awards.
Net cash from investing activities: Net cash used in investing activities
was approximately $5,925,000 for fiscal 1998 compared to approximately
$5,822,000 during fiscal 1997 and approximately $5,322,000 in fiscal 1996.
The use of cash for investing activities for the last three fiscal years
was primarily for additions to property and equipment. The Company's
capital investment continues to be driven by an increase in the number of
new employees and by the level of development-type contracts that have
required test and computing equipment. Cash provided by investing
activities throughout fiscal 1998 for the purchase and maturity of short-
term investments, primarily in U.S. Government treasuries, was
approximately $300,000. Other cash provided by investing activities
during fiscal 1997 included the maturity of approximately $800,000 of the
Company's short-term investments in U.S. Government treasuries.
Net cash from financing activities: Net cash used in financing activities
was approximately $3,429,000 during fiscal 1998 compared to approximately
$1,860,000 provided by investing activities during fiscal 1997 and
approximately $1,134,000 provided by investing activities during fiscal
1996. During fiscal 1998, the $3,429,000 used in financing activities is
attributable to the issuance of approximately $2,778,000 of common stock
under the Employee Stock Purchase Plan and stock option plan offset by
approximately $6,207,000 of common stock repurchases initiated and
completed under the Company's buyback program. The $1,860,000 and
$1,134,000 provided by financing activities during fiscal 1997 and
fiscal 1996, respectively, were predominately due to the issuance of
common stock under the Company's employee stock purchase plan and stock
option plans.
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 at least the next 12 months.
Year 2000 Risks
A complete discussion of the impact of Year 2000 issues on the Company's
Year 2000 readiness programs is set forth in Item 1: "Summary of Business
Consideration and Certain Factors that May Affect Future Results of Operations
Operations and/or Stock Price."
<PAGE>
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
<PAGE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders
Applied Signal Technology, Inc.
We have audited the accompanying balance sheets of Applied Signal Technology,
Inc. as of October 31, 1998 and 1997, and the related statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended October 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Applied Signal Technology, Inc.
at October 31, 1998 and 1997 and the results of its operations and its cash
flows for each of the three years in the period ended October 31, 1998 in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Palo Alto, California
December 10, 1998
<PAGE>
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended October 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues from contracts $110,087,178 $96,258,831 $77,410,481
Operating expenses:
Contract costs 67,840,318 60,403,961 53,333,328
Research and development 12,207,696 10,137,304 9,380,007
General and administrative 14,261,997 13,641,613 11,953,861
------------ ------------ ------------
Total operating expenses 94,310,012 84,182,878 74,667,196
------------ ------------ ------------
Operating income 15,777,166 12,075,953 2,743,285
Interest income/(expense), net 583,863 189,953 48,843
------------ ------------ ------------
Income before provision for income taxes 16,361,029 12,265,906 2,792,128
Provision for income taxes 6,217,191 4,599,715 977,245
------------ ------------ ------------
Net income $10,143,838 $7,666,191 $1,814,883
============ ============ ============
Net income per common share
Basic $1.20 $0.94 $0.23
Diluted $1.15 $0.91 $0.23
Number of shares used in calculating
net income per common share
Basic 8,468,463 8,128,062 7,753,886
Diluted 8,858,662 8,435,191 7,918,603
</TABLE>
See accompanying notes.
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
October 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $14,084,727 $7,403,128
Short term investments 1,029,223 1,330,656
Accounts receivable:
Billed 14,298,029 20,495,931
Unbilled 16,282,067 12,152,475
------------ ------------
Total accounts receivable 30,580,096 32,648,406
Inventory 5,551,312 4,821,541
Prepaid expenses and other current assets 3,034,544 2,175,087
------------ ------------
Total current assets 54,279,902 48,378,818
Property and equipment, at cost:
Machinery and equipment 31,653,925 27,311,561
Furniture and fixtures 4,010,924 3,650,412
Leasehold improvements 5,812,967 5,310,361
Construction in process 1,438,036 418,689
------------ ------------
42,915,852 36,691,023
Accumulated depreciation and amortization (24,775,359) (20,979,847)
------------ ------------
Net property and equipment 18,140,493 15,711,176
Other assets 42,221 70,573
------------ ------------
Total Assets $72,462,616 $64,160,567
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $3,841,929 $3,704,581
Accrued payroll and related benefits 6,330,405 6,294,724
Other accrued liabilities 2,091,566 1,877,054
Income taxes payable 2,300,098 1,566,676
------------ ------------
Total current liabilities 14,563,998 13,443,035
Deferred income taxes 1,032,910 951,372
Commitments
Shareholders' equity:
Preferred stock, no par value: 2,000,000 shares
authorized; none issued and outstanding
Common stock, no par value: 20,000,000 shares
authorized; issued and outstanding
shares - 8,393,526 at October 31, 1998
and 8,351,629 at October 31, 1997 19,154,309 22,197,167
Retained earnings 37,711,399 27,568,993
------------ ------------
Total shareholders' equity 56,865,708 49,766,160
------------ ------------
Total Liabilities and Shareholders' Equity $72,462,616 $64,160,567
============ ============
</TABLE>
See accompanying notes.
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended October 31,
-----------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Operating activities:
Net income $10,143,838 $7,666,191 $1,814,883
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,795,512 3,781,431 3,706,093
Tax benefit related to stock plans 385,895 238,114 69,448
Changes in:
Accounts receivable 2,068,310 (2,630,098) (453,670)
Inventory, prepaid expenses and other current assets (1,589,228) (1,553,618) 127,382
Other assets 28,352 47,560 58,143
Accounts payable, taxes payable and accrued expenses 1,120,964 2,132,001 75,718
Deferred income taxes 81,538 123,944 (19,914)
----------- ----------- -----------
Net cash provided by operating activities 16,035,181 9,805,525 5,378,083
Investing activities:
Purchases of available-for-sale securities (6,000,000) -- --
Maturity of available-for-sale securities 6,300,000 800,000 --
Additions to property and equipment (6,224,829) (6,621,535) (5,322,077)
----------- ----------- -----------
Net cash used in investing activities (5,924,829) (5,821,535) (5,322,077)
Financing activities:
Issuances of common stock 2,777,870 1,866,925 1,135,129
Repurchases of common stock (6,206,623) (6,999) (760)
----------- ----------- -----------
Net cash provided by (used in) financing activities (3,428,753) 1,859,926 1,134,369
----------- ----------- -----------
Net increase in cash and cash equivalents 6,681,599 5,843,916 1,190,375
Cash and cash equivalents at beginning of year 7,403,128 1,559,212 368,837
----------- ----------- -----------
Cash and cash equivalents at end of year $14,084,727 $7,403,128 $1,559,212
=========== =========== ===========
Supplemental disclosures of cash flow information:
Interest paid $33,509 $49,089 $82,983
Taxes paid $5,574,000 $4,374,800 $1,128,686
=========== =========== ===========
</TABLE>
See accompanying notes.
<PAGE>
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Total
Common Retained Shareholders'
Stock Earnings Equity
------------ ------------ ------------
<S> <C> <C> <C>
Balance at October 31, 1995 $18,895,310 $18,051,858 $36,947,168
Issuance of 340,949 common shares to
employees under stock purchase
agreements and stock option plan 1,135,129 -- 1,135,129
Repurchase of 245 common shares (760) -- (760)
Tax benefit related to stock plans 69,448 -- 69,448
Net unrealized loss on securities
available for sale -- (1,116) (1,116)
Net income -- 1,814,883 1,814,883
------------ ------------ ------------
Balance at October 31, 1996 20,099,127 19,865,625 39,964,752
Issuance of 483,259 common shares to
employees under stock purchase
agreements and stock option plan 1,866,925 -- 1,866,925
Repurchase of 4,977 common shares (6,999) -- (6,999)
Tax benefit related to stock plans 238,114 -- 238,114
Net unrealized gain on securities
available for sale -- 37,177 37,177
Net income -- 7,666,191 7,666,191
------------ ------------ ------------
Balance at October 31, 1997 22,197,167 27,568,993 49,766,160
Issuance of 529,397 common shares to
employees under stock purchase
agreements and stock option plan 2,777,870 -- 2,777,870
Repurchase of 487,500 common shares (6,206,623) -- (6,206,623)
Tax benefit related to stock plans 385,895 -- 385,895
Net unrealized loss on securities
available for sale -- (1,432) (1,432)
Net income -- 10,143,838 10,143,838
------------ ------------ ------------
Balance at October 31, 1998 $19,154,309 $37,711,399 $56,865,708
============ ============ ============
</TABLE>
See accompanying notes.
<PAGE>
NOTES TO FINANCIAL STATEMENTS OCTOBER 31, 1998
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Applied Signal Technology, Inc. (the Company) was incorporated in
California on January 12, 1984. The Company designs, develops,
manufactures signal processing equipment to collect and process a wide
range of telecommunication signals. This equipment is used for
reconnaissance of foreign telecommunications predominantly by the
United States Government and allied foreign governments, for certain
industrial applications and for defense communications systems. For the
three years ended October 31, 1998, substantially all of the Company's
revenues were from contracts with the U.S. Government, its agencies, or
prime contractors for the U.S. Government.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from
those estimates.
Contracts and Contract Accounting
Approximately 54% of contract revenues in fiscal 1998 (50% in fiscal
1997 and 48% in fiscal 1996) is represented by cost reimbursement type
contracts. In accounting for these contracts, all costs are charged to
operations as incurred (including allowable administrative expenses)
and revenues are recognized based on costs incurred plus estimated
effective fee rates. Estimated fee rates are determined on a contract-
by-contract basis according to the type of fee (e.g., fixed,
incentive, or award) and the most recent estimated cost of completion
of the individual contract.
Approximately 46% of contract revenues in fiscal 1998 (50% in fiscal
1997 and 52% in fiscal 1996) is represented by fixed price type
contracts. In accounting for these contracts, the Company uses the
percentage-of-completion method which is substantially the same method
as that used for cost reimbursement type contracts as described above.
All contract costs (including administrative expenses) are charged to
operations as incurred and revenues are recognized based on estimates
of costs and profits at completion on a contract-by-contract basis.
Losses on any individual contract are provided for at the time they
become known.
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 material costs, inefficiencies or other factors, are borne by the
Company, and could have a material adverse effect on the Company's
results of operations.
Accounts receivable are segregated between billed and unbilled
accounts. The Company bills incurred costs and ratable portions of
fees regularly under its cost reimbursement type contracts. Under
fixed price contracts, the Company either regularly progress bills 90%
of incurred costs or bills contract costs on a milestone or unit of
delivery basis. Unbilled amounts result from recognition of contract
revenue in advance of contractual billing or progress billing terms.
The Company regards the credit risk of its business to be minimal.
Price Redetermination
As a government contractor, the Company is subject to price
redetermination on certain fixed price contracts if it is determined
that the Company did not price its products and services consistent
with the requirements of the Federal Acquisition Regulations.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid debt investments purchased
with a maturity of three months or less to be cash equivalents.
Short-term investments are comprised of U.S. Government treasury
bills and notes, with contract maturities staggered through November
1998.
Management determines the appropriate classification of debt
securities at the time of purchase and reevaluates such designation as
of each balance sheet date. The Company's debt securities, which
consist of U.S. Treasury securities, are classified as available-for-
sale and are carried at fair market value in short-term investments
and long-term investments. Unrealized gains and losses, net of tax,
are reported in shareholders equity as part of retained earnings and
were immaterial as of October 31, 1998. Realized gains and losses on
available-for-sale securities have not been material. The cost of
securities sold is based on the specific identification method.
Property and Equipment
Machinery and equipment as well as furniture and fixtures are
depreciated using the straight-line method over the estimated useful
lives of the assets, ranging from three to five years. Leasehold
improvements are amortized using the straight-line method over the
lesser of the useful life of the assets or the lease term.
Per Share Data
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128"). Basic earnings per share
is based on the weighted effect of all common shares issued and outstanding
during the period. Diluted earnings per share is calculated by dividing net
income available to common stockholders, adjusted for the effect, if any, from
assumed conversion of all potentially dilutive common shares outstanding,
by the weighted average number of common shares used in the basic earnings
per share calculation plus the number of common shares that would be issued
assuming conversion of all potentially dilutive common shares outstanding.
All historical earnings per share amounts have been restated to conform to the
provision of this statement.
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
Years Ended October 31,
--------------------------------------
1998 1997 1996
<S> <C> <C> <C>
------------- ----------- -----------
Net Income $10,144 $7,666 $1,815
Share used to compute net income per
common share - basic 8,468 8,128 7,754
Effect of dilutive options 391 307 165
------------- ----------- -----------
Share used to compute net income per
common share - diluted 8,859 8,435 7,919
------------- ----------- -----------
Net income per common share - basic $1.20 $0.94 $0.23
------------- ----------- -----------
Net income per common share - diluted $1.15 $0.91 $0.23
------------- ----------- -----------
</TABLE>
Impact of Recently Issued Accounting Standards
In 1997, the Financial Accounting Standards Board ("FASB") issued
the Statement of Financial Accounting Standards No. 130 ("SFAS 130")
"Reporting Comprehensive Income," and the Statement of Financial
Accounting Standards No. 131 ("SFAS 131"), "Disclosure About Segments
of an Enterprise and Related Information."
The Company is required to adopt the provisions of SFAS 130 and SFAS 131
in fiscal year 1999 and expects the adoption will not impact results
of operations or financial position, but may require additional
financial statement disclosure.
NOTE 2: INVENTORY
The Company manufactures product subassemblies in inventory to be able
to quickly meet the requirements of future contracts. Inventories are
stated at the lower of average cost or market and consisted of the following:
<TABLE>
<CAPTION>
October 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
Raw materials $ 1,101,992 $ 1,121,625
Work-in-process 4,113,729 3,130,648
Finished goods 244,869 278,832
----------- -----------
5,460,590 4,531,105
Precontract costs 90,722 290,436
----------- -----------
$ 5,551,312 $ 4,821,541
=========== ===========
</TABLE>
Precontract costs represent costs incurred in connection with ongoing
level-of-effort type contracts for which contract modifications have not been
definitized ($87,424 at October 31, 1998 and $216,726 at October 31, 1997) and
production costs incurred in anticipation of specific expected future contract
awards. The production items in the latter group generally would be usable if
the expected contract awards did not occur. Allocable administrative expenses
included in precontract costs have not been material.
NOTE 3: LINES OF CREDIT
As of October 31, 1998, the Company has a $3,000,000 revolving line of
credit available with a bank. Borrowings under the line of credit bear
interest at the bank's reference rate (8% at October 31, 1998), payable
monthly, and expires on March 15, 1999; the Company intends to renew this
line of credit. At both October 31, 1998 and 1997 this facility was unused.
Under this credit facility, the Company is subject to certain commitment
and utilization fees on the unused portion of the committed amount.
Fees incurred were not material during the last three fiscal years. The
line of credit agreement requires compliance with certain financial covenants
and restricts dividend payments, stock repurchases and any loans or advances
made to any third parties without the prior written consent of the lender.
At both October 31, 1998 and 1997, the Company was in compliance with the
Bank's required covenants and restrictions.
NOTE 4: COMMITMENTS
Facility Commitment
The Company leases its facilities under noncancelable lease agreements
which expire at various dates between fiscal years 1999 and 2012.
Certain of the leases contain escalation clauses and requirements for
the payment of property taxes, insurance and maintenance expenses. The
aggregate minimum annual lease commitments at October 31, 1998 under
long-term operating leases are as follows:
<TABLE>
Fiscal Year:
-----------
<S> <C>
1999 $ 3,921,597
2000 3,899,987
2001 4,023,162
2002 4,056,097
2003 4,073,208
Thereafter 32,172,179
-----------
$51,146,230
===========
</TABLE>
Rent expense under operating leases was $4,013,335 in fiscal 1998
($3,296,185 in fiscal 1997; $3,078,843 in fiscal 1996).
The Company had outstanding letters of credit at October 31, 1998 of $1,000,000
of which $218,250 and $11,755 are used as security deposits for its leased
operating facilities.
The Company had no noncancelable purchase commitments for materials as of
October 31, 1998 and as of October 31, 1997.
NOTE 5: SHAREHOLDERS' EQUITY
Employee Stock Purchase Plan
Under the Company's 1993 Employee Stock Purchase Plan ("1993 Plan"), a total of
1,600,000 shares of common stock have been reserved for issuance. The 1993 Plan
permits eligible employees to purchase common stock through payroll deductions
(which cannot exceed 10% of any employee's compensation) at 85% of the lower of
its fair market value at the beginning or end of the purchase period. As of
October 31, 1998, 594,948 shares remain eligible for purchase under the
1993 Plan.
Stock Option Plan
The Company's 1991 Stock Option Plan ("1991 Plan") provides for the granting
of incentive stock options and non-qualified stock options to employees,
directors, and consultants of the Company at prices ranging from 85% to 110%
(depending on the type of grant) of the fair market value of the common stock on
the date of grant. Some options are only exercisable at the end of a two-
year vesting period and some options are exercisable at the rate of 1/5 per
year over five years.
A summary of the option activity under the 1991 Plan is as follows:
<TABLE>
<CAPTION>
Options Outstanding
---------------------------------------------------
Options
Available Weighted
for Number of Aggregate Average
Grant Shares Price Exercise Price
------------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Balance at October 31, 1995 377,143 989,414 $4,256,185 $4.30
Granted (263,080) 263,080 1,203,860 $4.58
Exercised -- (82,321) (220,420) $2.68
Canceled 83,434 (83,434) (436,568) $5.23
------------- ----------- -----------
Balance at October 31, 1996 197,497 1,086,739 4,803,057 $4.42
Additional Authorization 500,000
Granted (20,000) 20,000 90,000 $4.50
Exercised -- (179,173) (800,821) $4.47
Canceled 203,183 (203,183) (997,799) $4.91
------------- ----------- -----------
Balance at October 31, 1997 880,680 724,383 3,094,437 $4.27
Granted (295,900) 295,900 4,593,950 $15.53
Exercised -- (229,985) (1,119,663) $4.87
Canceled 10,168 (10,168) (135,860) $13.36
------------- ----------- -----------
Balance at October 31, 1998 594,948 780,130 $6,432,864 $8.25
</TABLE>
Accounting for Stock-Based Compensation
The following table summarizes information about options outstanding at
October 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -------------------------
<S> <C> <C> <C> <C> <C>
Weighted
Number of Shares Average Weighted Number of shares Weighted
Range of Outstanding as Remaining Average Exercisable Average
Exercise Prices of 10/31/98 Contract Life Ex. Price @10/31/98 Exercise Price
- ------------- ----------- ------------- ----------- ----------- --------------
$2.50 143,655 2.46 $2.50 143,655 $2.50
$4.50 190,825 2.59 $4.50 170,825 $4.50
$4.63 138,000 1.97 $4.63 138,000 $4.63
$5.50 20,000 2.35 $5.50 20,000 $5.50
$15.50 281,650 7.05 $15.50 --
$16.75 6,000 7.35 $16.75 --
-------- ------------- ----------- ----------- -------------
$2.50 - $16.75 780,130 4.10 $8.25 472,480 $3.98
</TABLE>
The Company applies Accounting Principles Board Opinion No. 25,
and related interpretations in accounting for its stock option plans.
The Company has opted under Statement of Financial Accounting Standards No.
123, "Accounting for StockBased Compensation" (SFAS 123") to disclose
its stock-based compensation with no financial effect. The pro forma
effects of applying SFAS 123 in this initial phase-in period are not
necessarily representative of the effects on reported net income or loss
for future years. Had compensation expense for the Company's stock
options plans been determined based upon the fair value at the grant date
for awards under these plans consistent with the methodology prescribed
under SFAS 123, the Company's pro forma net income and net income per
share would have been as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net income
As reported $10,143,838 $7,666,191 $1,814,883
Pro forma 8,416,194 5,984,637 396,689
Net income per share
Basic - As reported $1.20 $0.94 $0.23
- Pro forma 0.99 0.74 0.05
Diluted - As reported $1.15 $0.91 $0.23
- Pro forma 0.95 0.71 0.05
</TABLE>
The weighted average fair value at date of grant for options
granted during fiscal years 1998, 1997 and 1996 were $8.78,
$3.17 and $2.29 per option, respectively. The weighted
average fair value at date of grant for shares purchased through
the employee stock purchase plans during fiscal years 1998, 1997
and 1996 were $4.01, $2.51 and $2.56 per share, respectively.
The fair value of options at the date of grant was estimated using
Black Scholes model with the following weighted average assumptions:
<TABLE>
<CAPTION>
Employee Employee Stock
Option Plans Purchase
---------------------------- ---------------------------
1998 1997 1996 1998 1997 1996
-------- -------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Risk-free interest rate 4.9% 6.0% 5.9% 4.0% 6.0% 6.0%
Expected lives (in years) 4.7 2.5 2.5 .5 .5 .5
Expected volatility .63 .84 .84 .63 .84 .84
Dividend yeild 0% 0% 0% 0% 0% 0%
</TABLE>
NOTE 6: INCOME TAXES
The provision for income taxes for the years ended October 31, 1998, 1997 and
1996 consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ----------- -----------
<S> <C> <C> <C>
Federal:
Current $5,759,182 $3,921,838 $1,164,539
Deferred (prepaid) (515,097) 44,731 348,533
------------- ----------- -----------
5,244,085 3,966,569 1,513,072
State:
Current 933,639 218,788 136,388
Deferred (prepaid) 39,467 414,358 (672,215)
------------- ----------- -----------
973,106 633,146 (535,827)
------------- ----------- -----------
$6,217,191 $4,599,715 $977,245
============= =========== ===========
</TABLE>
The tax benefits associated with disqualifying dispositions of stock options or
employee stock purchase plan shares reduce taxes currently payable as shown by
$385,895, $238,114, and $69,448 for fiscal 1998, 1997, and 1996, respectively.
Such benefits are credited to additional paid-in-capital when realized.
The provision for income taxes differs from the amount computed by applying the
federal income tax rate of 35% for fiscal years 1998 and 1997, and 34% for
fiscal year 1996 to income before provision for income taxes as follows:
<TABLE>
<CAPTION>
Years Ended October 31,
-------------------------------------
1998 1997 1996
------------- ----------- -----------
<S> <C> <C> <C>
Computed expected tax provision $5,726,360 $4,293,067 $949,324
State income tax,
net of federal benefit 632,519 411,545 (17,817)
Other individually immaterial
items (141,688) (104,897) 45,738
------------- ----------- -----------
$6,217,191 $4,599,715 $977,245
------------- ----------- -----------
Effective Tax Rate 38.0% 37.5% 35.0%
============= =========== ===========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
October 31,
-----------------------
1998 1997
----------- -----------
<S> <C> <C>
Deferred tax assets:
Accrued expenses and reserves $1,694,481 $1,377,004
Deferred revenue 32,906 (64,998)
State taxes and other 222,817 81,030
----------- -----------
$1,950,204 $1,393,036
=========== ===========
Deferred tax liabilities:
Tax over financial statement depreciation ( 1,032,910) (951,372)
----------- -----------
$917,294 $441,664
=========== ===========
</TABLE>
The Company made total cash payments, net of refunds, of approximately
approximately $5,574,000 during fiscal 1998, $4,347,000 during fiscal 1997,
and $1,279,000 during fiscal 1996 for income tax purposes.
NOTE 7: RETIREMENT PLAN
All employees who perform at least 1,000 hours of service per year are
covered under the Company's retirement plan (the Retirement Plan).
Contributions to the Retirement Plan by the Company are discretionary
and currently are at the rate of 4% of qualified compensation up to
$150,000. The Company accrues for the accumulated contributions which
are payable bi-weekly to the Retirement Plan's administrator. The
Company has expensed approximately $1,655,000 in fiscal 1998
($1,524,000 in fiscal 1997 and $1,275,000 in fiscal 1996), which is
included in general and administrative expenses.
NOTE 8: CONTINGENCY
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 its 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 third quarter operating results in anticipation of a
settlement with the government on the subject contracts. The charge
resulted in a reduction of $1.2 million of the fiscal 1995 third
quarter's operating income.
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
date of the subpoena 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 provision is adequate to
cover all potential liabilities associated with this investigation
by the United States Government, the United States 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.
<PAGE>
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained on pages 6 and 7 of Applied Signal Technology,
Inc.'s Proxy Statement dated February 2, 1999, with respect to directors of the
Company, is incorporated herein by reference. Information with respect to
executive officers of the Company is contained in Part I of this report.
ITEM 11: EXECUTIVE COMPENSATION
The information contained on pages 12 through 14 of Applied Signal
Technology, Inc.'s Proxy Statement dated February 2, 1999, with respect to
executive compensation and other matters, is incorporated herein by reference.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained on pages 4 and 5 of Applied Signal Technology,
Inc.'s Proxy Statement dated February 2, 1999, with respect to security
ownership of certain beneficial owners and management, is incorporated herein by
reference.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
<PAGE>
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) AND (2) -- The following documents of Applied Signal Technology, Inc.
are filed as part of this report under Item 8.
Balance Sheets -- October 31, 1998 and 1997
Statements of Income -- Years ended October 31, 1998, 1997, and 1996
Statements of Shareholders' Equity -- Years ended October 31, 1998,
1997, and 1996
Statements of Cash Flows -- Years ended October 31, 1998, 1997, and
1996
Notes to Financial Statements -- October 31, 1998
Report of Ernst & Young LLP, Independent Auditors.
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable, and therefore have been
omitted.
(3) -- Listing of Exhibits -- See Exhibit Index on page XX of this Report
on Form 10-K.
(b) Reports on Form 8-K filed in the Company's fiscal year ended October 31,
1998:
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, therewith duly authorized.
APPLIED SIGNAL TECHNOLOGY, INC.
(Registrant)
Dated January 26, 1998 /s/ Gary L. Yancey
------------------------------
Gary L. Yancey, President,
Chief Executive Officer and
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE DATE TITLE
--------- ---- -----
<S> <C> <C>
/s/ Gary L. Yancey ____________ President, Chief Executive Officer and
- ----------------------------- Chairman of the Board
(Principal Executive Officer)
/s/ Brian M. Offi ____________ Vice President of Finance and Chief
- ----------------------------- Financial Officer (Principal Financial and
Accounting Officer)
/s/ James F. Collins ____________ Director
- ----------------------------
/s/ John P. Devine ____________ Director
- ----------------------------
/s/ David D. Elliman ____________ Director
- ----------------------------
/s/ John R. Treichler ____________ Director
- ----------------------------
/s/ Stuart G. Whittelsey, Jr. ____________ Director
- ----------------------------
</TABLE>
<PAGE>
APPLIED SIGNAL TECHNOLOGY
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF DOCUMENT
NUMBER ----------------------
- - ------
<S> <C>
3.1(1) Second Amended and Restated Articles of Incorporation
3.2(1) Amended and Restated Bylaws
4.1(1) Specimen Common Stock Certificate
4.2(1) Rights Agreement dated January 25, 1991
10.1(1) Form of Indemnification Agreement for directors and officers
10.2(1) 1984 Stock Purchase Plan and form of agreement thereunder
10.3(1) 1991 Stock Option Plan and forms of agreements thereunder
10.4(1) 1993 Employee Stock Purchase Plan
10.5(1) Profit Sharing Policy
10.6(1) Summary Plan Description of 401(k) Retirement Plan
10.7(1) Warrant to Purchase Common Stock dated June 27, 1990 issued to
Owenoake Partners, L.P. ("Owenoake"), Letter Agreement with
Owenoake dated September 20, 1990, and Amendment Number One to
Warrants to Purchase Common Stock with Owenoake and certain
warrant holders dated February 8, 1993
10.8(1) Warrants to Purchase Common Stock dated September 25, 1990 issued
to certain warrant holders
10.9(2) Line of Credit Agreement dated June 10, 1993 with Sanwa Bank
California and related Equipment Purchase Line of Credit
Agreement dated June 10, 1993
10.10(1) Lease Agreement dated August 21, 1985 with Lincoln Mathilda
Associates, Ltd. and Patrician Associates, Inc., and amendments
thereto
10.11(3) Lease agreements dated November 23, 1994 with Lincoln Property
Company Management Services, Inc. for Buildings H and I
10.12(4) Amendment to Commercial Credit Agreement dated March 7, 1995 with
Sanwa Bank California and related Equipment Purchase Line
Agreement dated March 10, 1995
10.13(5) Amendments to Commercial Credit Agreements dated March 1, 1996
with Sanwa Bank California
10.14(6) Lease agreement dated May 31, 1996 with Constellation Real
Estate, Inc., for 135 National Business Parkway
10.15(6) Amendments to lease agreements dated November 23, 1994 with
Lincoln Property Company Management Services, Inc.
10.16 Commercial Credit Agreement dated March 3, 1997 with Sanwa Bank
California
10.17 Lease agreement dated May 29, 1996 with Constellation Real
Estate, Inc.
23.1 Consent of Independent Auditors
27.1 Financial Data Schedule
</TABLE>
(1) Incorporated by reference to corresponding Exhibit filed as an Exhibit to
Registrant's Registration Statement on Form S-1 filed January 29, 1993
(File No. 33-58168).
(2) Incorporated by reference to corresponding Exhibit filed with the
Registrant's Form 10-K for fiscal year 1993 dated January 22, 1994.
(3) Incorporated by reference to corresponding Exhibit filed with the
Registrant's Form 10-K for fiscal year 1994 dated January 27, 1995.
(4) Incorporated by reference to corresponding Exhibit filed with the
Registrant's Form 10-K for fiscal year 1995 dated January 26, 1996.
(5) Incorporated by reference to corresponding Exhibit filed with the
Registrant's Form 10-Q for fiscal year 1996 dated August 2, 1996.
(6) Incorporated by reference to corresponding Exhibit filed with the
Registrant's Form 10-K for fiscal year 1996 dated January 26, 1997.
APPLIED SIGNAL TECHNOLOGY, INC.
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-21236) pertaining to the Applied Signal Technology, Inc.
Non-Incentive Stock Option Plan of our report dated December 10, 1998, with
respect to the financial statements of Applied Signal Technology, Inc.
included in this Annual Report (Form 10-K) for the year ended
October 31, 1998.
/s/ Ernst & Young LLP
Palo Alto, California
January 29, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted
from the Consolidated Balance Sheet and Consolidated Statement
Income included in the Company's Form 10-K for the period ende
October 31, 1998 and is qualified in its entirety by reference
such Financial Statements.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<EXCHANGE-RATE> 1
<S> <C>
<FISCAL-YEAR-END> Oct-31-1998
<PERIOD-START> Nov-01-1997
<PERIOD-END> Oct-31-1998
<PERIOD-TYPE> 12-MOS
<CASH> 14,085
<SECURITIES> 1,029
<RECEIVABLES> 30,580
<ALLOWANCES> 0
<INVENTORY> 5,551
<CURRENT-ASSETS> 54,280
<PP&E> 42,916
<DEPRECIATION> 24,775
<TOTAL-ASSETS> 72,463
<CURRENT-LIABILITIES> 14,564
<BONDS> 0
0
0
<COMMON> 19,154
<OTHER-SE> 37,711
<TOTAL-LIABILITY-AND-EQUITY> 72,463
<SALES> 110,087
<TOTAL-REVENUES> 110,087
<CGS> 67,840
<TOTAL-COSTS> 94,310
<OTHER-EXPENSES> 26,470
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (49)
<INCOME-PRETAX> 16,361
<INCOME-TAX> 6,217
<INCOME-CONTINUING> 10,144
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,144
<EPS-PRIMARY> $1.20
<EPS-DILUTED> $1.15
</TABLE>
