Back to GetFilings.com
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, 1997
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.
------------------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0015491
---------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 WEST CALIFORNIA AVE., SUNNYVALE, CA 94086
---------------------------------------------
(Address of principal executive offices)
(408) 749-1888
--------------
(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. [X]
Aggregate market value of the voting stock held by non-affiliates of the
registrant:
Common Stock, without par value -- $144,069,063 as of January 5, 1998.
Number of shares of registrant's common stock outstanding:
Common Stock, without par value --8,525,341 shares as of January 5, 1998.
Rider 1.1
The registrant's Proxy Statement dated January 26, 1998 for the Annual Meeting
of Shareholders to be held on March 12, 1998 is incorporated herein by reference
in Part III to the extent stated herein.
This Annual Report on Form 10-K consists of 67 pages, including exhibits. the
exhibit index is on page 49.
INDEX
APPLIED SIGNAL TECHNOLOGY, INC.
PART I.
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
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 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
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. Stockholders 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. 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. Since inception, the Company has focused its
efforts primarily on processing equipment, but also provides
specialized collection equipment, as well as complete signal
reconnaissance systems.
The Company's business strategy is to capitalize on the forces of
change within the U.S. Government and in the world today. As set forth
in Secretary of Defense William Cohen's message preceding the
Quadrennial Defense Review (10/97), the United States Government must
seek out opportunities to outsource and privatize non-core activities
which have been restrained by regulations and practices built up
during the Cold War. The Secretary goes on to say the United States
Government needs to deregulate much of the defense industry to reap
the cost and creativity benefits of full and open private competition.
Further, as stated in the Quadrennial Defense Review, "We must have a
globally vigilant intelligence system to provide early strategic
warning of crisis and detect threats in an environment complicated by
more actors and more sophisticated technology." It is the Company's
intent to capitalize on these forces of change and create
opportunities for continued growth for Applied Signal Technology.
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.
DESCRIPTION OF THE BUSINESS
Applied Signal Technology designs, develops, and manufactures
equipment to collect and process telecommunication signals for signal
reconnaissance applications. The signal reconnaissance equipment is
purchased by both the military as well as the intelligence
organizations of the United States Government and is used for foreign
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.
STRATEGY
Applied Signal Technology's objective is to anticipate the signal
reconnaissance needs of the United States Government 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 Government Needs. The Company devotes significant
resources in order to understand the United States
government's signal reconnaissance goals, capabilities, and
perceived future needs. The Company monitors technological and
commercial advances in telecommunications to identify advances
it believes may have an impact on the United States
Government's signal reconnaissance programs. The Company
obtains information about the United States Government's
signal reconnaissance needs through frequent contact with
employees and technical and contracting officials of the
United States Government. In contrast, the Company believes
that its competitors often wait until the United States
Government requests competitive proposals for equipment to
satisfy specific requirements and then respond to these
requests.
Sole source contracts are granted 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. Since the Company's inception, almost all 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 the signal
reconnaissance needs of the United States Government
correctly. There can be no assurance, however, that the
Company will anticipate correctly the signal reconnaissance
needs of the United States Government in the future.
- Invest in Research and Development. The Company invests in
research and development it believes will enable it to develop
signal reconnaissance equipment that will satisfy the needs of
the United States Government. 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 once the United States Government identifies a
need.
- Develop Flexible Products. The Company develops signal
reconnaissance 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 than collection equipment as new
types of signals can often be collected with available
collection equipment but cannot be processed by available
processing equipment.
- Increase Penetration and Broaden Customer Base. The Company
believes that its current customers offer significant
additional 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. The Company attempts to
broaden its customer base through marketing efforts directed
at United States Government agencies that are not now
customers as well as at offices within its customer agencies
that have not contracted with the Company previously.
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.
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 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.
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.
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
29%, 27%, and 6% of the Company's total revenues for its fiscal years
1997, 1996, and 1995, respectively. In addition, the Company
occasionally sells small quantities of equipment to foreign
governments. Foreign revenues have accounted for approximately 2%, 2%,
and 5% of the Company's total revenues for fiscal years 1997, 1996,
and 1995, 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 largest
contract accounted for 22% of the Company's revenues in fiscal year
1997, 15% in fiscal year 1996, and 3% in fiscal year 1995.
Two intelligence agencies accounted for approximately 57% and 28%,
respectively, of revenues in fiscal year 1997; approximately 53% and
27%, respectively, of revenues in fiscal year 1996; and approximately
64% and 17%, respectively, of revenues in fiscal year 1995. The higher
concentration of revenues generated by a single contract experienced
in recent years is attributable to a significant ramp-up in the level
of effort applied to the Company's largest development contract.
Management does not anticipate a material impact in its future
operating results as the program moves into the ramp-down phase of its
program's life cycle.
In recent years, the United States defense budget has been reduced,
causing customers and potential customers of the Company's products to
reevaluate 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
Government 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 1997, 1996, and
1995, approximately 69%, 75%, and 95%, respectively, of the Company's
revenues were from sole source contracts, and approximately 31%, 25%,
and 5%, respectively, were from competitively bid contracts.
During fiscal years 1997 and 1996, the Company experienced an increase
in the percentage of 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 percentage
towards increasing subcontracts via competitive bidding will have a
material impact on the operating results of the Company.
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. As of
October 31, 1997, the Company has not had a material claim sustained
against it for noncompliance.
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
1997, approximately 50% of the Company's revenues were from fixed-
price contracts and 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. During fiscal year 1995, approximately 66% of the Company's
revenues were from fixed-price contracts and approximately 34% 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.
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 government technical representatives 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 marketing
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 customers and potential customers than is
customary among its competitors generally, and that this contact
enables the Company to anticipate the United States Government's
signal reconnaissance needs, thereby giving the Company a potential
advantage over its competitors.
The Company's marketing occurs at three levels. The top level of
marketing involves contact between the Company's senior management and
officials of the United States Government responsible for signal
reconnaissance policy. The purpose of these contacts is to understand
national level requirements in future years (five to ten years out),
obtain guidance for direction of the Company's R&D, and keep the
United States Government community informed about the Company, its
technology, and its products.
The intermediate level of marketing is performed by the Company's
systems engineers contacting government officials responsible for
allocating budgets. These engineers seek to identify new requirements
that will result in projects within the next six to 18 months and work
with government technical representatives to develop system concepts.
The Company invests in R&D to address these requirements and to obtain
potential projects. To assist with this level of marketing, the
Company's technical staff often constructs a theoretical model of the
problem and tests processing solutions so that the Company and the
customer can determine whether a product can be developed or modified
to meet the customer's requirements. At this stage of marketing, the
customer often awards a sole source contract to the Company.
The final level of marketing involves establishing precise cost
estimates and detailed specifications. This level of marketing is
performed by development engineers who are involved in the actual
development or modification of the product.
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 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 product summary
catalog that is updated every six months and a quarterly newsletter
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 for
United States Government customers, 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 $83.0 million, $82.9
million, and $29.6 million at October 31, 1997, 1996, and 1995,
respectively. Anticipated revenues included in backlog may be realized
over a multi-year period. The Company includes a contract in backlog
when the contract issigne 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 Government contracts.
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 $48.0 million of revenues in
fiscal year 1997, approximately $37.0 million in fiscal year 1996, and
approximately $23.0 million in fiscal year 1995. The Company's own R&D
program to date is funded both by the United States Government,
through reimbursement of certain of the Company's R&D expenditures,
and, at times, by the Company's own investment, which is not
reimbursed. The Company's R&D expenditures as a percentage of revenues
in fiscal years 1997, 1996, and 1995 were 10.7%, 12.1%, and 14.6%,
respectively. Research and development conducted by the Company and
sponsored by the United States Government (excluding United States
Government R&D contracts) was $8.1 million, $6.7 million, and $6.8
million in fiscal years 1997, 1996, and 1995, respectively, while
research and development conducted and sponsored by the Company was
$2.0 million, $2.7 million, and $3.1 million in those same periods,
respectively. 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
signal reconnaissance 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
reconnaissance 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.
Another important aspect of the Company's R&D is the development of
components or products utilizing advanced technology. This enables the
Company to develop products superior to competing products in size,
power consumption, delivery time, and cost. The Company has developed
an in-house capability to design very large scale integration (VLSI)
circuits. Using its VLSI capabilities, the Company has designed
proprietary application specific integrated circuits that enhance the
processing power of many of its signal processing products.
Company Divisions
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 system 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, 1998, there were
299 employees in the engineering divisions and 177 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.
The Company has offices which also support the Company's marketing
activities in Herndon, Virginia and Annapolis Junction, Maryland. As
of January 5, 1998, there were 20 employees in the Virginia office and
15 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).
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 revenues and profitability 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 signal reconnaissance equipment market is highly competitive and
the Company expects that competition will increase in the future. Some
of the Company's current and potential competitors have significantly
greater technical, manufacturing, financial, and marketing resources
than the Company. The Company's current competitors include Adams-
Russell, Inc. (a subsidiary of M/A-Com, Inc.); 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.); and TRW, Inc. Substantial competition could have a material
adverse effect on the Company's results of operations.
The competition for competitive bid contracts differs from the
competition for sole source contracts. Companies competing for
competitive bid contracts prepare bids and proposals in response to
government request for proposals. 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 United States Government's requirements early
and invest in solutions so that they can demonstrate a distinguishing
expertise or technology promptly after the United States Government
has identified a signal reconnaissance requirement. The Company
competes primarily for sole source contracts and conducts its
operations accordingly. 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 limited patent applications for its technology.
As of October 31, 1997, one patent has been granted to the Company for
"Efficient QAM Equalizer Demodulator with Non-Integer Sampling," and
one patent is pending for the "Non-invasive Digital Communication Test
System." 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 - Business
- - "Customers, Contracts, and Marketing," and Item 3 -Legal
Proceedings.)
EMPLOYEES
As of January 5, 1998, the Company had approximately 592 full-time
employees, 144 of whom hold advanced technical degrees (master and/or
doctoral degrees), including 8 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 marketing
require the appropriate clearances to meet with government technical
representatives and discuss the government's signal reconnaissance
needs. The Company has a United States Government-sanctioned security
program that allows staff members to obtain appropriate clearances.
Approximately 58% 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 earnings 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
regulation 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 results of operation.
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 22% of revenue for fiscal 1997. This compares to
15% attributable to the same contract in fiscal 1996. This contract
may be terminated at the convenience 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
results of operations.
Competition: The signal reconnaissance and communications equipment
market is highly competitive and the Company expects that competition
will increase in the future. Some of the Company's current and
potential competitors have significantly greater technical,
manufacturing, financial and marketing resources than the Company.
Substantial competition could have a material adverse effect on the
Company's 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. During the last two years, the Company
experienced difficulty in attracting new talent due to an increasingly
competitive market for qualified personnel. Management believes this
effect is, in part, attributable to the expanding U.S. economy and, in
particular, the local California economy where the Company must
compete for new talent in the rapidly expanding telecommunications
sector and, in part, due to the difficulty in recruiting new staff
capable of obtaining the necessary security clearance. (See Item 1:
Business-Employees.) While the Company believes progress in attracting
and retaining sufficient personnel has been made over the last year,
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
operating results 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 operating results.
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 operating results.
ITEM 2: PROPERTIES
The Company currently leases six buildings (51,851, 52,464, 34,862,
76,379, 58,000, and 58,000 square feet, respectively) in Sunnyvale,
California pursuant to a lease which expires in March 2012. These
buildings are used as the Company's headquarters and include
development, engineering, production, marketing, and administrative
offices. Under the terms of the lease, the Company has options to
construct three additional buildings over a five-year period
commencing February 1998.
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 20,520 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. Commencing December 1998, the
Company is obligated to lease an additional 8,429 square feet in the
existing building.
In addition, the Company also leases two warehouses (19,835 and 5,900
square feet) in Sunnyvale, California for use as storage facilities.
Both leases, which the Company intends to renew, expire in 1998.
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
present related to three products: the Model 102P Voice Channel
Demodulator, the Model 120 Multichannel Processor, and the Model 150
FAX Scanner. The Company is presently in discussions with the OIG to
determine the scope of the subpoena and intends to fully comply with
the request.
While management believes the fiscal year 1995 third quarter charge is
adequate to cover all potential liabilities associated with this
investigation by the United States Government, the government has not
concluded its investigation or agreed to a settlement with the
Company. There can be no assurances the Company will not be required
to take additional charges in connection with this matter in future
periods. However, management believes that any such charges would not
have a material effect on the operating results and financial
condition of the Company.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information with respect to age and background
for each of the remaining officers of the Company:
NAME AGE POSITION
---- --- -------
Gary L. Yancey 52 President and Chairman of the Board
Brian M. Offi 44 Vice President-- Finance and Chief Financial Officer
Mary Rogge 51 Secretary
Bani M. Scribner, Jr. 53 Vice President-- Strategic Systems Division
Ken Snow 56 Vice President-- Operations Division
Kenway Wong 48 Vice President-- Communication System Division
Gary L. Yancey, a co-founder of the Company, has served the Company as
President 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.
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, 2998, the Company had approximately 460 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, 1997. 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. The
Company's line of credit agreement prohibits the Company from making
dividend payments without the lender's approval.
Share
Volume
High Low Last (in 000'S)
-------- -------- -------- ----------
Fiscal year ended October 31, 1996
First quarter $5.00 $3.50 $4.00 1,083.7
Second quarter $7.38 $4.00 $4.38 3,313.3
Third quarter $6.13 $3.75 $4.38 2,077.1
Fourth quarter $5.88 $4.38 $4.75 971.4
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
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.
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.
Item 6. SELECTED FINANCIAL DATA
All data is in thousands except per common share data.
Summary of Operations Fiscal Year Ended:
October 31,
1997 1996 1995 1994
--------- --------- --------- ---------
Revenues from contracts
Operating expenses: $96,259 $77,410 $67,664 $64,341
Contract costs
Research and development 60,404 53,333 45,418 40,830
General and administrative 10,137 9,380 9,873 8,551
13,642 11,954 11,221 10,219
Total operating expenses --------- --------- --------- ---------
84,183 74,667 66,512 59,600
Operating income --------- --------- --------- ---------
Interest income 12,076 2,743 1,152 4,741
Interest expense 239 132 320 522
(49) (83) (133) (113)
Income before provision for income taxes --------- --------- --------- ---------
Provision for income taxes 12,266 2,792 1,339 5,150
4,600 977 435 2,010
Net income --------- --------- --------- ---------
$7,666 $1,815 $904 $3,140
Net income per common share ========= ========= ========= =========
Weighted average shares outstanding $0.91 $0.23 $0.12 $0.40
8,435 7,919 7,635 7,769
Financial Position at End of Fiscal Year:
1997 1996 1995 1994
--------- --------- --------- ---------
Working capital $34,936 $26,477 $24,269 $21,888
Total assets 64,161 52,103 49,030 47,316
Retained earnings 27,569 19,866 18,052 17,153
Shareholders' equity 49,766 39,965 36,947 35,809
Book value per common share $5.96 $5.08 $4.90 $4.84
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
Applied Signal Technology designs, develops, manufactures, and markets
signal processing equipment to collect and process a wide range of
telecommunication signals. This equipment is used for reconnaissance
of telecommunication signals by the United States Government and
allied foreign governments. Signal reconnaissance systems are composed
of collection equipment and processing equipment. Collection equipment
consists of sophisticated receivers that scan the radio frequency
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
collected signals and selects signals that are likely to contain
relevant information.
The Company has focused its efforts, since inception, primarily on
processing equipment, but the Company also provides specialized
collection equipment, as well as complete signal reconnaissance
systems. The Company's business involves risks and uncertainties,
including, without litigation, 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 57% and 28%, respectively, of revenues
for fiscal 1997. For fiscal 1996, the two agencies accounted for 53%
and 27%, respectively, of revenues and for fiscal 1995, the
percentages of revenues derived from these two agencies were 64% and
17%, 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
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. In fiscal 1995,
approximately 66% of the Company's revenues were derived from fixed
price contracts, and approximately 34% 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:
Year Ended October 31,
--------------------------------------
1997 1996 1995
------------ ------------ ------------
Revenues from contracts 100.0% 100.0% 100.0%
Operating expenses:
Contract costs 62.8% 68.9% 67.1%
Research and development 10.5% 12.1% 14.6%
General and administrative 14.2% 15.5% 16.6%
------------ ------------ ------------
Total operating expenses 87.5% 96.5% 98.3%
------------ ------------ ------------
Operating income 12.5% 3.5% 1.7%
Interest income 0.2% 0.2% 0.5%
Interest expense 0.0% -0.1% -0.2%
------------ ------------ ------------
Income before provision for income taxes 12.7% 3.6% 2.0%
Provision for income taxes 4.7% 1.3% 0.5%
------------ ------------ ------------
Net income 8.0% 2.3% 1.4%
============ ============ ============
Backlog (thousands of dollars) $83,268 $82,886 $29,644
Revenues
Revenues from contracts increased by 24% from $77.4 million in fiscal
1996 to $96.3 million in fiscal 1997. Revenues increased by 14% from
$67.7 million in fiscal 1995 to $77.4 million in fiscal 1996. Revenue
increases over these periods reflect the continued demand for the
Company's products and services, the introduction of new products and
services, as well as an increase in average fee recorded for
production contracts.
The following table identifies the source of the Company's revenues for
fiscal years 1995, 1996 and 1997 by major market.
FY97 FY96 FY95
----- ----- -----
Intelligence Agencies 92% 89% 88%
Military 6% 6% 4%
Foreign 2% 2% 5%
Commercial -- 3% 3%
Backlog
The Company's backlog, which consists of anticipated revenues from the
uncompleted portions of existing contracts (excluding unexercised
options), was $83,268,000 at the end of fiscal 1997. This represents a
nominal increase over the prior year's ending backlog of $82,886,000.
Fiscal 1996 backlog increased 179.6% from $29,644,000 to $82,886,000.
Management believes this increase in backlog was attributable to the
Company's continued emphasis on marketing and research and development
activities and the use of inventory to generate off-the-shelf sales.
Contract Costs
Contract costs consist of direct costs on contracts, including labor,
materials, and manufacturing overhead costs. Contract costs as a
percentage of revenues decreased to 62.8% in fiscal 1997 from 68.9% in
fiscal 1996. As a percentage of revenues, contract costs for fiscal
1996 were higher than contract costs of 67.1% of revenues for fiscal
1995. The decrease in contract costs as a percentage of revenue for
fiscal 1997 compared to fiscal 1996 is due, in part, to lower material
acquisition costs and, in part, to economies achieved in the
manufacturing division from higher production quantities. The increase
in contract costs as a percentage of revenues in fiscal 1996 as
compared to fiscal 1995 is attributable, in part, to an increase in
the percent of development jobs (which typically require more labor-
per-revenue dollar) versus production jobs and, in part, due to an
increase in manufacturing overhead costs. The manufacturing overhead
increase is attributable to increased facilities costs resulting from
the addition of a newly constructed 30,000 square foot building
completed during fiscal 1996, an increase in fringe benefit costs
specifically related to health insurance, and an increase in
recruiting costs.
Research and Development
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 10.5%,
12.1%, and 14.6% for fiscal years 1997, 1996, and 1995, respectively.
Although R&D spending grew by $10.1 million in fiscal 1997 from $9.4
million in 1996, the decrease in research and development expenses as
a percentage of revenues in fiscal 1997 when compared to fiscal 1996
is, in part, attributable to actions taken by management to divert
personnel from R&D to other activities since the Company was
experiencing some constraint on labor resources during the fiscal
year. The decrease in research and development spending in fiscal 1996
as compared to fiscal 1995 is attributable to management's actions to
curb R&D spending since the Company was experiencing some constraint
on earnings during fiscal 1996. The Company-funded investment in R&D
for fiscal 1997 was 2.1% of revenues versus 3.5% during fiscal 1996
and 4.5% during fiscal 1995. The Company intends to continue to make
substantial investments in research and development in an effort to
meet the needs of customers before its competitors.
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
$13.6 million or 14.2% of revenues in fiscal 1997 compared to $12.0
million or 15.4% of revenues in fiscal 1996 and $11.2 million or 16.6%
of revenues in fiscal 1995. The successive decreases in general and
administrative expenses as a percentage of revenues in fiscal years
1997 and 1996 are primarily attributable to the Company's higher
revenues during each of the fiscal years following fiscal 1995.
Interest Income/Expense (Net)
Net interest income/expense for fiscal 1997 increased $141,000 from
$49,000 net interest income in fiscal 1996 to $190,000 in fiscal 1997.
Net interest income in fiscal 1996 decreased $139,000 to $49,000 from
$188,000 net interest income in fiscal 1995. The increase in interest
income during fiscal 1997 is primarily the result of higher invested
cash balances generated from higher profit margins. The decrease in
interest income during fiscal 1996 was primarily the result of a
smaller Company portfolio of government treasuries offset by interest
expense on the Company's higher average outstanding line of credit
balance during fiscal 1996. For fiscal 1995, a portion of working
capital was derived from the partial sale of the Company's portfolio
of U.S. Government treasuries and an increase in the average bank line
of credit outstanding; as a result, interest income decreased and
interest expense increased.
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 income
tax rate of 37.5% for fiscal 1997 versus 35% for fiscal 1996 and 32.5%
for fiscal 1995. The 1997 effective tax rate is lower than the
combined federal and state statutory income tax rates primarily due to
the benefit derived from state income tax credits. The increases in
the effective tax rate from fiscal 1996 to fiscal 1997 and from fiscal
1995 to fiscal 1996 are primarily a result of the increases in state
tax liabilities as a result of the lower impact of 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, 1997. 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.
FISCAL YEAR 1997 FISCAL YEAR 1996
---------------------------------------------- ------------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Revenues from contracts $20,084 $23,987 $22,600 $29,588 $15,798 $16,970 $19,504 $25,138
Operating expenses
Contract costs 13,136 15,742 13,793 17,733 10,815 12,180 12,624 17,714
Research and development 2,470 2,394 2,269 3,004 1,912 2,155 2,281 3,032
General and administrative 3,182 3,171 3,062 4,227 2,840 2,528 2,877 3,709
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Total operating expenses 18,788 21,307 19,124 24,964 15,567 16,863 17,782 24,455
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Operating income 1,296 2,680 3,476 4,624 231 107 1,722 683
Interest income/(expense) net 60 37 18 75 19 (4) 23 11
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Income before provision for
income taxes 1,356 2,717 3,494 4,699 250 103 1,745 694
Provision for income taxes 495 992 1,351 1,762 100 24 610 243
---------- ---------- ---------- ---------- --------- --------- --------- ---------
Net income $861 $1,725 $2,143 $2,937 $150 $79 $1,135 $451
========== ========== ========== ========== ========= ========= ========= =========
Net income per common share $0.11 $0.21 $0.25 $0.34 $0.02 $0.01 $0.14 $0.06
Weighted average shares outstan 8,114 8,156 8,517 8,749 7,782 7,905 8,062 8,035
Net income per common
share for the year $0.91 $0.23
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 bank credit agreement to augment cash flow needs and
to provide term financing for capital investments. The Company
maintains a $6,000,000 unsecured, revolving line of credit for short-
term cash requirements and a $1,000,000 line of credit for use in
purchasing capital investments. The unsecured, revolving line of
credit bears interest at the bank's reference rate (8.5% as of October
31, 1997). The line of credit for use in purchasing capital
investments bears interest at the bank's reference rate plus one-half
percent (9.0% as of October 31, 1997). Outstanding amounts on the
unsecured, revolving line of credit were zero at October 31, 1997 and
1996. Outstanding amounts on the line of credit for use in purchasing
capital investments were zero at October 31, 1997 and 1996. Both lines
expire March 1, 1998; the Company intends to renew both lines in March
1998.
Net cash provided by/(used in) operating activities: Net cash provided
by operating activities has varied significantly from year to year. In
fiscal 1997, $9.6 million was provided by operating activities. In
fiscal 1996, $5.4 million was provided by operating activities and in
fiscal 1995, $1.5 million was used in operating activities. These
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 1997, net income increased to $7.7 million. During
fiscal 1996, net income increased to $1.8 million from $0.9 million in
fiscal 1995. The improvement in the year-to-year change in cash
provided by operating activities for fiscal 1997 is primarily due to
higher contract fees and improved margins realized because of lower
material acquisition costs, and economies derived from manufacturing
in larger production quantities than in the prior fiscal year. The
increased level of accounts receivable during fiscal 1997 is primarily
due to greater contract activity, and in part to certain limitations
and terms stipulated in certain engineering and production contracts.
The increased level of inventories, prepaid expenses and other current
assets in fiscal 1997 is primarily due to the purchase of parts
required for future production, purchases for anticipated future
contract awards, as well as due to the timing of rent payments at the
end of the year and for increased tax payments due to higher profits.
Cash provided by increases in accrued liabilities in fiscal 1997 is
primarily due to the year-end timing of the issuance of payroll checks
and accrued employee benefits. The reduction in the increase in
accounts receivable for fiscal 1996 is primarily attributable to a
higher percentage of the Company's billings occurring under cost-type
contracts which generally provide for invoicing twice monthly. The
reduction in the increase in inventory is due to a management
initiative to more aggressively manage the Company's inventory
balances. The cash used in operating activities during fiscal 1995 was
due to a reduction in net income and to an increase in accounts
receivable and inventory. The growth in accounts receivable for fiscal
1995 was primarily due to the growth of the Company's business and the
timing of eligible billings to be submitted to customers. The increase
in inventory in fiscal 1995 is the result of management's anticipation
of future contract awards expected during the following years for the
Company's products and services.
Net cash provided by / (used in) investing activities: Net cash used
in investing activities was $5.8 million for fiscal 1997 compared to
$5.3 million during fiscal 1996, and $0.5 million provided by
investing activities during fiscal 1995. Use of cash for investing
activities was for additions to property and equipment. The continued
heavy investment in capital equipment is driven by the Company's
increased volume of development contracts, the increased number of new
staff hired by the Company, and the continued investment in R&D, which
all have a tendency to create demand for test and computer equipment.
Other cash provided by investing activities during fiscal 1997
included the maturity of $0.8 million of the Company's short-term
investments in U.S. Government treasuries. Other cash provided by
investing activities during fiscal 1995 included the sale of $3.4
million of U.S. Government treasuries and the maturity of $2.5 million
of the Company's short-term investments in U.S. Government treasuries.
Both of the amounts were used as working capital to finance the
increases in inventory, accounts receivable, and investment in fixed
assets.
Net cash provided by/(used in) financing activities: Net cash provided
by financing activities was $1.9 million during fiscal 1997 compared
to $1.1 million during fiscal 1996, and $0.2 million during fiscal
1995. The $1.9 million and the $1.1 million 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. During fiscal
1995, the $0.2 million provided by financing activities is
attributable to the issuance of $1.2 million of common stock under the
employee stock purchase plan, offset by $1.0 million of common stock
repurchases authorized under the Company's buyback program.
In November 1997, the Board of Directors authorized a share repurchase
program which the Company intends to use to offset the dilutive effect
of future issuances under the Company's employee benefit 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.
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, 1997 and 1996, and the related statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended October 31, 1997. 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, 1997 and 1996 and the results of its operations and its cash
flows for each of the three years in the period ended October 31, 1997 in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Palo Alto, California
December 12, 1997
STATEMENTS OF INCOME
Year Ended October 31,
--------------------------------------
1997 1996 1995
------------ ------------ ------------
Revenues from contracts $96,258,831 $77,410,481 $67,664,260
Operating expenses:
Contract costs 60,403,961 53,333,328 45,417,725
Research and development 10,137,304 9,380,007 9,873,295
General and administrative 13,641,613 11,953,861 11,221,096
------------ ------------ ------------
Total operating expenses 84,182,878 74,667,196 66,512,116
------------ ------------ ------------
Operating income 12,075,953 2,743,285 1,152,144
Interest income 239,042 131,825 320,182
Interest expense (49,089) (82,982) (132,441)
------------ ------------ ------------
Income before provision for income taxes 12,265,906 2,792,128 1,339,885
Provision for income taxes 4,599,715 977,245 435,463
------------ ------------ ------------
Net income $7,666,191 $1,814,883 $904,422
============ ============ ============
Net income per common share $0.91 $0.23 $0.12
Number of shares used in calculating
net income per common share 8,435,191 7,918,603 7,634,858
See accompanying notes.
BALANCE SHEETS
October 31,
-------------------------
1997 1996
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $7,403,128 $1,559,212
Short term investments 1,330,656 767,355
Accounts receivable:
Billed 20,495,931 14,491,255
Unbilled 12,152,475 15,527,053
------------ ------------
Total accounts receivable 32,648,406 30,018,308
Inventory 4,821,541 3,207,648
Prepaid and other current assets 2,175,087 2,235,362
------------ ------------
Total current assets 48,378,818 37,787,885
Property and equipment, at cost:
Machinery and equipment 27,311,561 23,220,856
Furniture and fixtures 3,650,412 3,300,754
Leasehold improvements 5,310,361 3,356,327
Construction in process 418,689 191,551
------------ ------------
36,691,023 30,069,488
Accumulated depreciation and amortization (20,979,847) (17,198,416)
------------ ------------
Net property and equipment 15,711,176 12,871,072
Long-term investments 0 1,326,124
Other assets 70,573 118,133
------------ ------------
Total Assets $64,160,567 $52,103,214
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $3,704,581 $3,044,801
Accrued payroll and related benefits 6,294,724 4,336,930
Other accrued liabilities 1,877,054 1,900,501
Income taxes payable 1,566,676 2,028,802
------------ ------------
Total current liabilities 13,443,035 11,311,034
Deferred income taxes 951,372 827,428
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 - 8,351,629 at October 31, 1997
and 7,873,347 at October 31, 1996 22,197,167 20,099,127
Retained earnings 27,568,993 19,865,625
------------ ------------
Total shareholders' equity 49,766,160 39,964,752
------------ ------------
Total liabilities and shareholders' equity $64,160,567 $52,103,214
============ ============
See accompanying notes.
STATEMENTS OF CASH FLOWS
Years Ended October 31,
-----------------------------------
1997 1996 1995
----------- ----------- -----------
Operating activities:
Net income $7,666,191 $1,814,883 $904,422
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,781,431 3,706,093 3,137,566
Tax benefit related to stock plans 238,114 69,448 25,713
Changes in:
Accounts receivable (2,630,098) (453,670) (4,600,988)
Inventory, prepaid expenses and other current assets (1,553,618) 127,382 (1,546,378)
Other assets 47,560 58,143 (13,776)
Accounts payable, taxes payable and accrued expenses 2,132,001 75,718 443,488
Deferred income taxes 123,944 (19,914) 132,342
----------- ----------- -----------
Net cash provided by (used in) operating activities 9,805,525 5,378,083 (1,517,611)
Investing activities:
Sale of available-for-sale securities -- -- 3,400,000
Maturity of available-for-sale securities 800,000 -- 2,500,000
Additions to property and equipment (6,621,535) (5,322,077) (5,419,022)
----------- ----------- -----------
Net cash provided by (used in) investing activities (5,821,535) (5,322,077) 480,978
Financing activities:
Issuance of common stock 1,866,925 1,135,129 1,200,271
Repurchase of common stock (6,999) (760) (986,920)
----------- ----------- -----------
Net cash provided by financing activities 1,859,926 1,134,369 213,351
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 5,843,916 1,190,375 (823,282)
Cash and cash equivalents at beginning of year 1,559,212 368,837 1,192,119
----------- ----------- -----------
Cash and cash equivalents at end of year $7,403,128 $1,559,212 $368,837
=========== =========== ===========
Supplemental disclosures of cash flow information:
Interest paid $49,089 $82,983 $118,866
=========== =========== ===========
See accompanying notes.
STATEMENTS OF SHAREHOLDERS' EQUITY
Common Retained Shareholders'
Stock Earnings Equity
------------ ------------ ------------
Balance at October 31, 1994 $18,656,246 $17,152,841 $35,809,087
Issuance of 363,178 common shares to
employees under stock purchase
agreements and stock option plan 1,200,271 -- 1,200,271
Repurchase of 229,538 common shares (986,920) -- (986,920)
Tax benefit related to stock plans 25,713 -- 25,713
Net unrealized loss on securities
available for sale -- (5,405) (5,405)
Net income -- 904,422 904,422
------------ ------------ ------------
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 loss 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
============ ============ ============
See accompanying notes.
NOTES TO FINANCIAL STATEMENTS OCTOBER 31, 1997
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, and markets signal processing equipment to collect and
process a wide range of telecommunications signals. At October 31,
1997 and 1996, 97% of the accounts receivable and substantially all of
the 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 50% of contract revenues in fiscal 1997 (48% in fiscal
1996 and 34% in fiscal 1995) 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 50% of contract revenues in fiscal 1997 (52% in fiscal
1996 and 66% in fiscal 1995) 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.
completion costs will be revised in the near-term. Such revisions could result
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, Short and Long Term Investments
The Company considers all highly liquid debt investments purchased
with a maturity of three months or less to be cash equivalents. Short-
and long-term investments are comprised of U.S. Government treasury
bills and notes, with contract maturities staggered through June 30,
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, 1997. 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
Net income per share is computed using the weighted average number of
shares of Common Stock outstanding and common equivalent shares from
stock options (using the treasury stock method). Common equivalent
shares from the assumed exercise of warrants are excluded from the
computation as their effect is antidilutive.
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share," which is required to be
adopted for the quarter ended January 30, 1998. At that time, the
Company will be required to change the method currently used to
compute earnings per share and to restate all prior periods. Under the
new requirements for calculating earnings per share, the diluted
effect of stock options will be excluded. The impact to the results
would have only affected the fiscal year ended October 31, 1997; the
impact would have been an increase of $0.05 per share. Fiscal years
ended October 31, 1996 and 1995 would have remained as originally
reported.
Impact of Recently Issued Accounting Standards
In 1997, the Statement of Financial Accounting Standards No. 130
("SFAS 130"), "Reporting Comprehensive Income," was issued and is
effective for fiscal years commencing after December 15, 1997.
In 1997, the Statement of Financial Accounting Standards No. 131
("SFAS 131"), "Disclosure About Segments of an Enterprise and Related
Information," was issued and is effective for fiscal years commencing
after December 15, 1997.
The Company is required to adopt the provisions of SFAS' 130 and 131
in fiscal year 1999 and expects the adoption will not impact results
of operations or financial position, but will require additional
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:
October 31,
--------------------------
1997 1996
----------- -----------
Raw materials $ 1,121,625 $ 590,396
Work-in-process 3,130,648 2,195,125
Finished goods 278,832 322,089
----------- -----------
4,531,105 3,107,610
Precontract costs 290,436 100,038
----------- -----------
$ 4,821,541 $ 3,207,648
=========== ===========
Precontract costs represent costs incurred in connection with ongoing
level-of-effort type contracts for which contract modifications have not been
definitized ($216,726 at October 31, 1997 and $78,405 at October 31, 1996) 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, 1997, the Company has a $6,000,000 revolving line of
credit available with a bank. The line of credit bears interest at the
bank's reference rate (8.5% at October 31, 1997), payable monthly, and
expires on March 1, 1998; the Company intends to renew this line of
credit. There were no borrowings outstanding at October 31, 1997 and
1996.
The line of credit agreement requires compliance with certain
financial covenants and restricts dividend payments and any loans or
advances made to any third parties without the prior written consent
of the lender. The Company was in compliance with these covenants as
of October 31, 1997. The Company has a $1,000,000 line of credit for
use in purchasing capital equipment. Amounts outstanding under the
line of credit bear interest at the bank's reference rate plus 0.5%
(9.0% at October 31, 1997) and is payable monthly. There were no
amounts outstanding as of October 31, 1997 and 1996.
NOTE 4: COMMITMENTS
Facility Commitment
The Company leases its facilities under noncancelable lease agreements
which expire at various dates between fiscal years 1998 and 2011.
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, 1997 under
long-term operating leases are as follows:
1998 $ 3,599,987
1999 3,740,412
2000 3,774,801
2001 3,887,083
2002 3,925,864
Thereafter 33,903,967
-----------
$52,832.114
===========
Rent expense under operating leases was approximately $3,296,185 in 1997
($3,078,843 in 1996; $2,479,581 in 1995).
The Company has outstanding letters of credit at October 31, 1997 of $1,000,000
of which $218,250 and $11,755 are used as security deposits for its leased
operating facilities.
The Company has no noncancelable purchase commitments for materials as of
October 31, 1997 and as of October 31, 1996.
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, 1997, 566,118 shares remain eligible for purchase under the
1993 Plan.
Stock Option Plan
The Company's 1991 Stock Option Plan (the 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. Company stock options are generally exercisable over a
four year period at the rate of one-fourth one year after the date of grant
and 1/48 per month for each month thereafter provided the optionee continues
to be employed by the Company. Some options are only exercisable at the end
of a two-year vesting period. The vesting and exercise provisions of the option
grants are determined by the Board of Directors.
A summary of the option activity under the 1991 Plan is as follows:
Options Outstanding
--------------------------------------------------
Options Weighted
Available Average
for Number of Aggregate Exercise
Grant Shares Price Share Price
------------- ----------- ----------- ------------
Balance at October 31, 1994 557,246 897,960 $3,706,602 $4.13
Granted (250,000) 250,000 1,157,500 $4.63
Exercised -- (88,650) (230,773) $2.60
Canceled 69,897 (69,896) (377,144) $5.40
------------- ----------- -----------
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
Authorized (Note 1) 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
Note 1: Additional shares approved by shareholders on March 6, 1997.
As of October 31, 1997, there were 724,383 options outstanding for which
471,323 options are exercisable to purchase common shares.
Accounting for Stock-Based Compensation
The following table summarizes information about options outstanding at
October 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------- ------------------------
Weighted
Average Weighted
Number Remaining Average Number Weighted
Range of Outstanding Contractual Exercise Exercisable Average
Exercise Prices of 10/31/97 Life (years) Price As of 10/31/97 Exercise Price
- --------------- ------------ ---------- ----------- ----------- ------------
$2.50 - $4.50 435,293 3.53 3.57 202,233 $2.50
$4.63 - $6.75 283,310 2.22 5.29 263,310 $5.27
$7.00 - $7.25 5,780 0.58 7.23 5,780 $7.23
-------- --------
$2.50 - $7.25 724,383 2.99 4.27 471,323 $4.11
======== ========
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:
1997 1996
------- -------
Net income
As reported $7,666,191 $1,814,883
Pro forma 5,984,637 396,689
Net income per share
As reported $0.91 $0.23
Pro forma $0.71 $0.05
The weighted average fair value of the options granted during fiscal
years 1996 and 1997 is estimated on the date of grant using the
Black-Scholes option pricing model. The weighted average fair values
and weighted average assumptions used in calculating the fair values
were as follows:
Employee Employee Stock
Option Plans Purchase Plan
--------------------- -------------------
1997 1996 1997 1996
------- ------- ------- -------
Expected lives (in years) 2.5 2.5 .5 .5
Risk-free interest rate 6.0% 5.9% 6.0% 6.0%
Expected volatility 84% 84% 84% 84%
Dividend yeild 0% 0% 0% 0%
NOTE 6: INCOME TAXES
The provision for income taxes for the years ended October 31, 1997, 1996 and
1995 consists of the following:
1997 1996 1995
------------- ----------- -----------
Federal:
Current $3,921,838 $1,164,539 $785,846
Deferred (prepaid) 44,731 348,533 (292,087)
------------- ----------- -----------
3,966,569 1,513,072 493,759
State:
Current 218,788 136,388 212,687
Deferred (prepaid) 414,358 (672,215) (270,983)
------------- ----------- -----------
633,146 (535,827) (58,296)
------------- ----------- -----------
$4,599,715 $977,245 $435,463
============= =========== ===========
The tax benefits associated with disqualifying dispositions of stock options or
employee stock purchase plan shares reduce taxes currently payable as shown by
$238,114, $69,448, and $25,713 for fiscal 1997, 1996, and 1995, 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 34% to income before provision for income taxes as
follows:
Years Ended October 31,
-------------------------------------
1997 1996 1995
------------- ----------- -----------
Computed expected tax provision $4,293,067 $949,324 $455,561
State income tax,
net of federal benefit 411,545 (17,817) (74,688)
Other individually immaterial
items (104,897) 45,738 54,590
------------- ----------- -----------
$4,599,715 $977,245 $435,463
------------- ----------- -----------
Effective Tax Rate 3750.0% 35.0% 32.5%
============= =========== ===========
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:
October 31,
-----------------------
1997 1996
----------- -----------
Deferred tax assets:
Accrued expenses and reserves $1,377,004 $1,225,231
Deferred revenue (64,998) 16,850
State taxes and other 81,030 486,100
----------- -----------
$1,393,036 $1,728,181
=========== ===========
Deferred tax liabilities:
Tax over book depreciation (951,372) (827,429)
----------- -----------
$441,664 $900,752
=========== ===========
During fiscal 1997, the Company made total cash payments, net of refunds, of
approximately $4,347,000, ($1,279,000 during fiscal 1996: $528,000 during
fiscal 1995) 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 $1,524,000 in fiscal 1997
($1,275,000 in fiscal 1996; $1,206,000 in fiscal 1995), 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
present related to three products: the Model 102P Voice Channel
Demodulator, the Model 120 Multichannel Processor, and the Model 150
FAX Scanner. The Company is presently in discussions with the OIG to
determine the scope of the subpoena and intends to fully comply with
the request.
While management believes the fiscal 1995 third quarter charge is
adequate to cover all potential liabilities associated with this
investigated by the United States Government, the government has not
concluded its investigation or agreed to a settlement with the
Company. There can be no assurances the Company will not be required
to take additional charges in connection with this matter in future
periods. However, management believes that any such charges would not
have a material effect on the operating results and financial
condition of the Company.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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, 1998, 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 9 through 10 of Applied Signal
Technology, Inc.'s Proxy Statement dated February 2, 1998, 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, 1998, 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.
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) AND (2) -- The following financial statements of Applied Signal
Technology, Inc., included in this Reporting.
Balance Sheets -- October 31, 1997 and 1996
Statements of Income -- Years ended October 31, 1997, 1996, and 1995
Statements of Shareholders' Equity -- Years ended October 31, 1997,
1996, and 1995
Statements of Cash Flows -- Years ended October 31, 1997, 1996, and
1995
Notes to Financial Statements -- October 31, 1997
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 49 of this Report
on Form 10-K.
(b) Reports on Form 8-K filed in the Company's fiscal year ended October 31,
1997:
None.
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 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.
SIGNATURE DATE TITLE
--------- ---- -----
/s/ Gary L. Yancey ____________ President 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
- ----------------------------
APPLIED SIGNAL TECHNOLOGY
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION OF DOCUMENT
NUMBER ----------------------
- - ------
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.
11.1 Statement regarding computation of net income per share
23.1 Consent of Independent Auditors
27.1 Financial Data Schedule
(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.