-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QbfkHC6Pns21Up88YwbkiDnsMpNq5FQGM563mf5BZ/OsAMX0yfyAjpSCxabs1zGC KUITRT6FmqNYPNFDTLfVtA== 0000741696-00-000004.txt : 20000203 0000741696-00-000004.hdr.sgml : 20000203 ACCESSION NUMBER: 0000741696-00-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991031 FILED AS OF DATE: 20000128 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APPLIED SIGNAL TECHNOLOGY INC CENTRAL INDEX KEY: 0000741696 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 770015491 STATE OF INCORPORATION: CA FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21236 FILM NUMBER: 515625 BUSINESS ADDRESS: STREET 1: 400 WEST CALIFORNIA AVENUE CITY: SUNNYVALE STATE: CA ZIP: 94086 BUSINESS PHONE: 4087491888 MAIL ADDRESS: STREET 1: 400 W CALIFORNIA CITY: SUNNYVALE STATE: CA ZIP: 94086 10-K 1 FORM 10-K 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, 1999 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. [ ] Aggregate market value of the voting stock held by non-affiliates of the registrant: Common Stock, without par value -- $79,772,491 as of January 3, 2000. Number of shares of registrant's common stock outstanding: Common Stock, without par value -- 8,330,956 shares as of January 3, 2000. DOCUMENTS INCORPORATED BY REFERENCE The registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on March 9, 2000 is incorporated herein by reference in Part III to the extent stated herein. This Annual Report on Form 10-K consists of 59 pages, including exhibits; the exhibit index is on page 57. INDEX APPLIED SIGNAL TECHNOLOGY, INC. PART I. Item 1. Business Pg. 4 Item 2. Properties 20 Item 3. Legal Proceedings 20 Executive Officers of Registrant 21 PART II. Item 5 Market for Registrant's Common Equity and Related Shareholder Matters 23 Item 6. Selected Financial Data 25 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 26 Item 7A. Quantitative and Qualitative Disclosure about Market Risk 34 Item 8. Financial Statements and Supplementary Data 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 50 PART III. Item 10. Directors and Executive Officers of the Registrant 51 Item 11. Executive Compensation 51 Item 12. Security Ownership of Certain Beneficial Owners and Management 51 Item 13. Certain Relationships and Related Transactions 51 PART IV. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 52 Signatures 53 PART I ITEM 1: BUSINESS Forward-looking statements in this Report are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934. In this report, the words "anticipates," "believes," "expects," "future," "intends," and similar expressions identify forward-looking statements. Shareholders are cautioned that all forward-looking statements pertaining to the Company involve risks and uncertainties, including, without limitation, those contained under the caption, "Summary of 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. DESCRIPTIOM OF BUSINESS Applied Signal Technology, Inc. (Applied Signal Technology or the Company) designs, develops, and manufactures signal processing equipment to collect and process a wide range of telecommunication signals. This equipment is used for reconnaissance of foreign telecommunications predominantly by the United States Government and allied foreign governments, for certain industrial applications and for defense communications systems. Signal reconnaissance systems are composed of collection equipment and processing equipment. Collection equipment consists of sophisticated receivers that scan the radio frequency (RF) spectrum (cellular telephone, microwave, ship-to-shore, and military transmissions) to collect certain signals from, potentially, thousands of signals within the RF spectrum. Signal processing equipment, using sophisticated software and hardware, evaluates the characteristics of the collected signals and selects signals that are likely to contain relevant information. Industrial applications include commercial communication system quality monitoring and data network intrusion detection. Defense communication equipment provides reliable, high-speed data transfer for military applications. Since inception, the Company has focused its efforts primarily on processing equipment, but also provides specialized collection equipment, as well as complete systems. Signal Reconnaissance In recent years, accurate and comprehensive information regarding foreign affairs and developments has become increasingly important to the United States Government. The reduction of United States military tactical forces overseas, coupled with political instability in certain regions such as the Middle East, Eastern Europe, Africa and Central 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. Additionally, 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 (e.g., the Internet) 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. 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.") 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. This enables the Company to offer products that are smaller, consume less power, and cost customers less when multiple units are built than equipment of similar functionality that use fewer advanced designs and materials. Industrial Applications The volume of data transferred and made available to individuals is growing exponentially worldwide. This trend dictates maximum efficiency of frequency spectrum usage by the commercial telecommunication companies. The spectrum usage is especially critical in the band-limited radio frequency (RF) environment that personal communication systems (e.g., cellular systems) and communication satellite systems (e.g., PanAmSat, Intelsat, and InMarSat) utilize. As these systems attempt to maximize this usage, there is an increasingly higher probability that data transfer will be impaired. This creates demand for sophisticated data quality monitoring. The Company believes that its signal processing prowess in non- intrusive signal reconnaissance developed over the years, positions the Company to capitalize on this quality monitoring requirement. In addition, as the Company continues to stay abreast of the United States Government's future signal reconnaissance needs, it should stay abreast of trends in telecommunication technology. The Company believes its knowledge and experience will permit the Company to understand the data transfer techniques that will require quality monitoring in the future. As the world becomes more reliant upon data transfer and data access for its day-to-day activities (i.e., e-commerce), it also becomes more vulnerable to unauthorized data access or manipulation. This creates a requirement for data system intrusion detection. This intrusion detection must be performed without impact upon the data transfer. The Company believes that the technological expertise it has developed for signal reconnaissance, positions the Company to develop and market intrusion detection technology. In particular, the Company's signal processing prowess provides the fundamentals for the development of intrusion detection equipment. Defense Communications Just as the civilian world is becoming increasingly dependent upon data transfer and access, so is the military. The military branches utilize data transfer for guidance, computer-to-computer battlefield planning, high quality communications, and other applications. Many times this data transfer must occur under non-ideal transport modes. The transport invariably is in the radio frequency spectrum and must occur under sub-optimum conditions such as minimal frequency planning for interference mitigation, inaccurate antenna pointing, and moving platforms. These defense communication systems must be able to mitigate these data transfer anomalies in an automated or semi-automated manner in order to provide reliable, rapidly deployed communications. The military branches are committed to adopting to advancing state-of-the-art data transfer technologies. As they adopt these new technologies, they are faced with added complexities not confronted in commercial applications. Accordingly, the United States Government is investing in research and development to overcome these complexities, with the goal of providing a reliable all-digital battlefield by 2010. The Company believes that the technological expertise it has developed for signal reconnaissance systems to adequately process data collected in non-ideal situations positions the Company to capitalize in developing products that satisfy these defense communication system requirements. In particular, the Company's experience in adaptive equalization/demodulation of sophisticated data telecommunication signals enable the Company to develop equipment that overcomes these data transport anomalies. STRATEGY Applied Signal Technology's objective is to anticipate the needs of the telecommunication processing marketplace and to invest in research and development in an effort to provide solutions before the Company's competitors. In some cases, this involves the development of equipment to address new telecommunications technologies. In other cases, it involves the development of equipment that offers smaller size, lower power consumption, and lower cost than potentially competitive products. The Company's strategy to accomplish its objective includes the following elements: - Anticipate Marketplace Needs. The Company devotes significant resources in order to understand perceived future telecommunication processing needs. The Company monitors technological and commercial advances in telecommunications to identify advances it believes will create new opportunities. The Company obtains information about marketplace needs through frequent contact with employees and technical and contracting officials. In contrast, the Company believes that its competitors often wait until potential customers request competitive proposals for equipment to satisfy specific requirements and then respond to these requests. Many times, sole source contracts are granted by the United States 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, a significant portion of its revenues have been from sole source contracts. The Company believes that the large number of sole source contracts it obtains demonstrates that it often anticipates marketplace needs correctly. There can be no assurance, however, that the Company will anticipate correctly the marketplace needs in the future. - Invest in Research and Development. The Company invests in research and development it believes will enable it to develop equipment that will satisfy the telecommunication processing needs of the future. The Company believes that it invests a greater percentage of its revenues in R&D than is typical among its competitors. The Company believes its R&D investments often enable it to offer superior products before its competitors. - Develop Flexible Products. The Company develops products that can be used, with or without further modification, to satisfy the needs of a variety of customers. The Company uses its prior product development efforts to offer customers cost- effective solutions and to offer these solutions promptly. The Company believes that custom equipment developed by many of the Company's competitors generally cannot be as readily deployed in as wide a variety of circumstances as the Company's products. - Develop Highly Integrated Products. The Company designs its products to use advanced circuitry and highly integrated components. This enables the Company to offer products that are smaller, consume less power, and cost customers less when multiple units are built than equipment of similar functionality that use fewer advanced designs and materials. The lower cost of many of the Company's products appeals to customers with budget constraints, and the smaller size and low power consumption of many of the Company's products appeal to customers with physical installation constraints. - Focus on Signal Processing. Since inception, the Company has focused much of its attention on developing signal processing equipment. The Company believes that there have been and will continue to be opportunities to develop specialized signal processing equipment to satisfy emerging technological requirements. - Increase Penetration and Broaden Customer Base. The Company believes that its current customers offer significant opportunities for sales growth, both in terms of additional units of developed products and the development of new products and, accordingly, directs much of its marketing efforts toward these customers in order to increase the Company's penetration of these markets. In addition, more recently, the Company has been attempting to broaden its customer base through the aggressive pursuit of new markets relating to quality monitoring of commercial satellite communications, data network intrusion protection and defense communications. PRODUCTS The Company's products consist of signal collection and processing equipment that use software and hardware developed over many years by the Company in the course of performing development contracts to provide signal reconnaissance equipment to the United States Government. This software and hardware enable the Company's processing equipment to evaluate large numbers of radio frequency signals and to select the relatively small proportion which contain information likely to be useful in the signal reconnaissance programs of the United States Government. More recently, the Company has leveraged its product and technology base into some products outside the traditional signal reconnaissance market. The Company offers a variety of signal reconnaissance products, which can be categorized as follows: - Voice Grade Channel Processors. These processors are designed to process voice grade channels (VGCs) which carry audio and other signals. The standard telecommunication systems used throughout the world put a large number of VGCs on a single carrier channel to increase the number of signals that can be transmitted at a particular frequency. VGC processors can scan thousands of signals in less than one second and use sophisticated processing technology to detect and record relevant data, which is then analyzed by United States Government personnel. These processors evaluate the characteristics of collected signals and select those signals that are likely to contain relevant information. The Company's VGC processors currently range in price from approximately $40,000 to approximately $200,000. - Wideband Processors. These processors "clean" telecommunication signals for further processing by VGC processors by adjusting for signal distortions that commonly occur during transmission. The two primary types of distortion these processors correct are multipath interference (caused by the reception of a signal and its reflections) and cochannel interference (caused by the reception of multiple interfering signals). Commercial telecommunications companies overcome these distortions with careful alignment and tuning which requires interruption of the telecommunication signals. The Company's wideband processors perform this alignment independently and automatically by adjusting processing parameters using proprietary adaptive algorithms that let the processors "learn" how to process the incoming signals. One of the Company's wideband processors processes signals that carry thousands of VGCs in a digital format which is rapidly being proliferated through the world and is particularly susceptible to distortions. The Company's wideband processors currently range in price from approximately $80,000 to approximately $150,000. - Processing Systems. Although the Company has emphasized subsystem or "product" development since its inception, it has also developed and delivered signal processing systems in situations where the capabilities of its products have enabled it to obtain a system development contract on a sole source basis from the United States Government. The Company's two largest system installations, for which the Company developed custom systems software, integrated a number of the Company's standard VGC processors and were developed to exacting United States Government software and documentation standards. Pricing for processing systems can vary widely depending on the system requirements. Prices may range from $100,000 to millions of dollars. - Collection Products. The Company offers a limited number of signal collection products designed to complement certain of the Company's processing products. The Company's collection products include a low-cost, small-size receiver that collects very complex signaling formats and a receiver that overcomes cochannel interference and certain forms of multipath interference by optimizing multiple antenna inputs. The Company's collection products currently range in price from approximately $20,000 to approximately $60,000. Over the last 24 months, the Company has entered into the industrial telecommunication processing equipment and defense communications equipment marketplaces with the following categories: - Communication Satellite Quality Monitors. These products collect a variety of radio frequency signals emitted from satellites and perform precise signal parameter measurements, using advanced digital signal processing techniques, to monitor signal quality. The equipment interfaces with system control networks to provide total system quality monitoring. These products are priced in a range of approximately $50,000 to $100,000. - Telephone Intrusion Detection Equipment. This equipment is a variant of the voice grade channel processor using the multi- channel processing capability to detect unusual channel activity within a telephone network. This activity could be indicative of attempts at unauthorized data network entry. These products currently range in price from approximately $40,000 to $150,000. - Defense Communication Products. This equipment is based on the wideband processor technology. The communication products not only "clean" the signals for subsequent processing, but also include the signal generation capability to provide the complete function of an adaptive equalization wideband modem. These products currently range in price from approximately $20,000 to $40,000. CUSTOMERS, CONTRACTS, AND MARKETING CUSTOMERS To date, purchases by the United States Government have accounted for almost all of the Company's revenues. Most of the Company's revenues have come from contracts directly with the United States Government. The Company also has subcontracts under which it supplies products or services to prime contractors that have contracts with the United States Government. Subcontract revenues accounted for approximately 46%, 34%, and 29% of the Company's revenues for its fiscal years 1999, 1998, and 1997 respectively. In addition, the Company occasionally sells small quantities of equipment to foreign governments. Foreign revenues have accounted for approximately 5%, 9%, and 2% of the Company's revenues in fiscal years 1999, 1998, and 1997, respectively. The Company's United States Government customers consist of approximately six military and intelligence agencies with signal reconnaissance needs. Within these six major customers, the Company has contracts with approximately 20 different offices, each with separate budgets and contracting authority. Concentration of revenue sources is significant for the United States Government. The Company's largest contract accounted for 21%, 18% and 22% of the Company's revenues in fiscal years 1999, 1998, and 1997, respectively. Two intelligence agencies accounted for approximately 42% and 34%, respectively, of revenues in fiscal year 1999; approximately 39% and 34%, respectively, of revenues in fiscal year 1998; and approximately 57% and 29%, respectively, of revenues in fiscal year 1997. 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 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 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 1999, 1998, and 1997, approximately 59%, 62%, and 69%, respectively, of the Company's revenues were from sole source contracts, and approximately 41%, 38%, and 31%, respectively, were from competitively bid contracts. During fiscal years 1999, 1998 and 1997, the Company experienced a continued increase in the percentage of revenues from contracts awarded on a competitive basis. Management believes this increase is primarily due to a continuing diversification of the customer base as the Company grows. Management does not believe this shift towards a higher percentage of revenues from sole source to competitive bidding will have a material impact on future operating results of financial condition on the Company. 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 1999, approximately 45% of the Company's revenues were from fixed-price contracts and approximately 55% were from cost-plus contracts. During fiscal year 1998, approximately 46% of the Company's revenues were from fixed-price contracts an approximately 54% were from cost-plus contracts. During fiscal year 1997, approximately 50% of the Company's revenues were from fixed-price contracts and approximately 50% were from cost-plus contracts. Most of the Company's fixed-price contracts are for the manufacture of multiple units of its products, rather than the development of new products. The Company believes that the risk of cost overruns is much less in the case of fixed-price manufacturing contracts, where the product already has been developed and at least a prototype made, than in the case of fixed-price development contracts. The Company is subject to price redetermination on certain fixed- price U.S. Government contracts if it is determined that the Company did not price its products and services consistent with the requirements of the Federal Acquisition Regulations. As of October 31, 1999, the Company has not had a material claim sustained against it for noncompliance. Almost all of the Company's contracts contain termination clauses that permit contract termination upon the Company's default or for the convenience of the other contracting party. In either case, termination could adversely affect the Company's operating results. Although the Company has not experienced any material cancellations in the past, there can be no assurance such cancellations will not occur in the future. MARKETING The Company's primary marketing efforts consist of personal contact between technical representatives of customers and potential customers and technical personnel of the Company. The Company involves all technically qualified staff members in its marketing program. The Company believes it is extremely important to have technically knowledgeable staff make 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 telecommunication signal processing needs, thereby giving the Company a potential advantage over its competitors. In addition to its primary technical marketing, the Company also conducts marketing activities designed to increase its visibility with existing and potential customers. Each year the Company conducts two equipment shows in the Washington, D.C. area demonstrating the operation of many of its signal reconnaissance products. The Company uses direct mail and magazine advertising from time to time to inform potential customers of available products. Annually the Company updates a signal reconnaissance product summary catalog, and produces a quarterly, technical 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, 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 $64.9 million, $49.4 million and $83.3 million at October 31, 1999, 1998, and 1997, respectively. Anticipated revenues included in backlog may be realized over a multi-year period. The Company includes a contract in backlog when the contract is signed by both the Company and the customer. The Company believes the backlog figures are firm, subject only to the cancellation and modification provisions contained in its contracts. (See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations: "Backlog.") RESEARCH AND DEVELOPMENT The Company conducts research and development (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 $76.l million of revenues in fiscal year 1999, approximately $60.9 million of revenues in fiscal year 1998, and approximately $48.0 million of revenues in fiscal year 1997. The Company's R&D program is funded by the billing rates charged to its customers. The Company's R&D expenditures as a percentage of revenues in fiscal years 1999, 1998, and 1997 were 11.2%, 11.1%, and 10.5%, respectively. Research and development conducted by the Company was approximately $12.9 million for fiscal year 1999, $12.2 million for fiscal year 1998, and $10.1 million for fiscal year 1997. The Company believes that its investment in R&D provides it with a significant competitive advantage. The Company seeks to develop technology capable of addressing new telecommunication signal processing requirements before its competitors. In addition, the Company focuses its R&D on developing products that can be used, with or without further modification, to satisfy various needs of a variety of customers, thereby permitting the Company to offer a solution promptly. The Company attempts to allocate its R&D funds among projects intended to yield revenues within one to two years, projects intended to yield revenues in two to five years, and projects intended to yield revenues in more than five years. Most of the Company's R&D expenditures are for projects intended to yield revenues within one to two years. An important aspect of the Company's R&D efforts is understanding telecommunication trends to anticipate the future signal processing needs of its customers. Not only does this allow the Company to direct its R&D engineering efforts to produce solutions promptly once a customer expresses a need, but it often allows the Company to educate the customer about its potential needs and simultaneously present a conceptual solution to those needs. COMPANY DIVISIONS The Company is organized into a Technical Operations Group and a finance division. The Technical Operations Group has four divisions. Three of these divisions - Communication Systems, Multichannel Systems and Personal Communications Systems - are engineering divisions which are primarily responsible for conducting all R&D activities as well as the initial development of products. The fourth division is the Operations Division which is primarily responsible for manufacturing multiple units of products. All divisions work together to ensure that production-related issues such as manufacturability, reliability and maintainability are addressed from initial product definition through final product shipment. The Company's technical staff includes personnel with systems development expertise, which the Company applies not only to systems 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 3, 2000, there were 319 employees in the engineering divisions and 168 employees in the operations division. (See "Employees.") Engineering. The engineering divisions are responsible for all R&D. The Company's R&D activities include both United States Government R&D contracts and the Company's R&D projects. The engineering division activities are directed toward developing products that will ultimately be produced by the Operations Division. The engineering divisions work in conjunction with the Operations Division to assure that the development efforts will culminate in a product able to be manufactured efficiently in quantity. In addition to corporate headquarters in Sunnyvale, California, the Company maintains engineering offices in Herndon, Virginia; Annapolis Junction, Maryland; Salt Lake City, Utah; and Hillsboro, Oregon. As of January 3, 2000 there were 55 employees in these locations. 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 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 goos 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 cots. If the Company experiences significant availability or quality control problems in the future, its operating results could be adversely affected. Although the Company procures most of its parts and components from multiple sources or believes that these components are readily available from numerous other sources, certain components are available only from sole sources or from a limited number of sources. A number of the Company's products contain critical components like single board computers available solely from Motorola, Inc. and Force Computers, Inc. and field programmable gate arrays available solely from Xilinx, Inc. While the Company believes that substitute components or assemblies could be obtained, use of substitutes would require development of new suppliers or would require the Company to re- engineer its products, or both, which could delay the Company's shipment of its products and could have a material adverse effect on the Company's operating results. COMPETITION The telecommunication signal processing equipment market is highly competitive and the Company expects that competition will increase in the future. Some of the Company's current and potential competitors have significantly greater technical, manufacturing, financial, and marketing resources that the Company. The Company's current competitors include L-3 Communications Corporation; Boeing- North America; E-Systems, Inc. (a subsidiary of Raytheon Corporation); General Dynamics Corporation; Harris Corporation; Lockheed Martin Corporation; Motorola Government Electronics Group (a subsidiary of Motorola, Inc.); SAT Corporation; Comsat Corporation; TRW, Inc.; and ITT Corp. 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 either to a commercial or government request and typically compete on price. Potential suppliers compete informally for sole source contracts through R&D investment and marketing efforts. Companies competing for sole source contracts attempt to identify the customer's requirements early and invest in solutions so that they can demonstrate a distinguishing expertise or technology promptly after the customer has identified a signal processing requirement. The principal factors of competition for sole source contracts include investments in R&D; the ability to respond to government needs promptly; product price relative to performance, quality, and customer support. The Company believes that it competes favorably on each of these factors. PROPRIETARY RIGHTS The United States Government has rights to most of the technology developed by the Company under government contracts, including rights to permit other companies, including the Company's competitors, to use this technology to develop products for the United States Government. The Company is not aware that the United States Government has exercised these rights. The Company has filed patent applications for certain of its technology. As of October 31, 1999, three patents have been granted to the Company. The Company believes that given the rapidly changing nature of signal collection and processing technology, its future success will depend primarily upon the technical competence and creative skills of its personnel. The Company attempts to protect its trade secrets and other proprietary information through agreements with customers, employees, and consultants and other security measures. There can be no assurance that the measures adopted by the Company for the protection of its intellectual property will be adequate. Although the Company does not believe and has not received notice that it is infringing upon the intellectual property rights of others, there can be no assurance that such a claim will not be asserted against the Company. In the event any third party made a valid claim against the Company and a license was not made available to the Company on commercially reasonable terms, this could have a material adverse effect on the Company's results of operations. GOVERNMENT REGULATIONS Many of the Company's operations are subject to compliance with regulatory requirements of federal, state and municipal authorities, including regulations concerning employment obligations and affirmative action, workplace safety, and protection of the environment. While compliance with applicable regulations has not adversely affected the Company's operations in the past, there can be no assurance that the Company will continue to be in compliance in the future or that these regulations will not change. In particular, the company must comply with detailed government procurement and contracting regulations and with United States Government security regulations, certain of which carry substantial penalty provisions for nonperformance or misrepresentation in the course of negotiations. Failure of the Company to comply with its government procurements or contracting obligations or security obligations could result in penalties or suspension of the Company form government contracting, which would have a material adverse effect on the Company's results of operations. (see Item 1 - Business: "Customers, Contracts, and Marketing.") EMPLOYEES As of January 3, 2000, the Company had approximately 642 full- time employees, 160 of whom hold advanced technical degrees (master and/or doctoral degrees), including 19 with doctoral degrees. The Company's business requires that a large number of its technical employees obtain security clearances from the United States Government, which limits the available pool of eligible candidates for such positions to those who can satisfy the prerequisites to obtaining these clearances. In particular, the personnel involved in signal reconnaissance marketing require the appropriate clearances to meet with government technical representatives and discuss the government's needs. The Company has a United States Government-sanctioned security program that allows staff members to obtain appropriate clearances. Approximately 45% of the Company's staff have security clearances. The success of the Company is dependent on attracting, retaining, and motivating qualified key management and technical personnel, the loss of whom, could adversely affect the Company's business. Such personnel are in great demand and limited supply. The Company believes its employees are its most valuable resource and that its workforce possesses a strong feeling of dedication to and pride in the Company. This dedication is reinforced through incentive compensation arrangements based on Company performance. The Company's employees are not represented by any collective bargaining agreements, and the Company has never experienced a work stoppage. SUMMARY OF BUSINESS CONSIDERATIONS AND CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS AND/OR STOCK PRICE The Company's future operating results and stock price may be subject to volatility, particularly on a quarterly basis, due to the following: Customer Concentration: Historically, defense and intelligence agencies of the United States Government have accounted for almost all of the Company's revenues. Future reductions in United States Government spending on signal reconnaissance and communications equipment or future changes in the kind of signal reconnaissance and communications products or services required by the United States Government agencies could limit demand for the Company's products which would have a material adverse effect on the Company's operating results and financial condition. In addition, as a supplier of these agencies, the Company must comply with numerous regulations, including regulations governing security and contracting practices. Failure to comply with these regulations could disqualify the Company as a supplier of these agencies, which would have a material adverse effect on the Company's operating results and financial condition. Revenue Concentration: Due to the award of certain larger contracts the Company has experienced a significant concentration of revenues from a single contract in recent periods. Revenue related to a single contract comprised of 21% of revenue for fiscal 1999. This compares to 18% and 22% attributable to the same contract in fiscal 1998 and 1997, respectively. This contract may be terminated at the sole discretion of the United States Government. If this contract or other larger contracts of the Company were terminated, this could have a material adverse effect on the Company's operating results and financial condition. Competition: The telecommunication signal processing market is highly competitive and the Company expects that competition will increase in the future. Some of the Company's current and potential competitors have significantly greater technical, manufacturing, financial, and marketing resources than the Company. Substantial competition could have a material adverse effect on the Company's operating results 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 few years, the Company has experienced difficulty in attracting new talent due to an increasingly competitive market for qualified personnel. Management believes this effect continues to be 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 due to the difficulty in recruiting new staff capable of obtaining the necessary security clearance. (See "Employees.") The Company has taken step to bolster its ability to attract and retain staff by opening additional offices in Salt Lake City, Utah and in Hillsboro, Oregon. The Company believes these new offices, in addition to the increased investment made in the Company's human resources activities during fiscal 1999, should allow it to successfully attract and retain qualified employees. Failure to do so could have a material adverse effect on the Company's 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 and financial condition. In addition, almost all of the Company's contracts contain termination clauses which permit contract termination upon the Company's default or for the convenience of the other contracting party. In either case, termination could adversely affect the Company's operating results. Although the Company has not experienced any material contract terminations to date, there can be no assurance that such terminations will not occur in the future. Potential Fluctuations in Quarterly Results and Market Volatility: The Company has experienced significant fluctuations in operating results from quarter to quarter and expects that it will continue to experience such fluctuations in the future. These fluctuations are caused by, among other factors, conditions inherent in government contracting and the Company's business, such as the timing of cost and expense recognition for contracts and the United States Government contracting and budget cycles. Fluctuations in quarterly results, shortfalls in revenues or earnings from levels forecast by securities analysts, changes in estimates by analysts, competition, or announcements of extraordinary events such as acquisitions or litigation may cause the price of the Company's common stock to fluctuate substantially. In addition, there can be assurance that an active trading market will be sustained for the Company's common stock. The sock market in recent years has experienced extreme price and volume fluctuations that have particularly affected the market prices of many technology 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 certain signal reconnaissance and industrial marketplace 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 develop and market new products successfully in the future or respond effectively to technological changes, such as data encryption technology, network intrusion detection 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 product contain critical components like single board computers available solely from Motorola and Force Computers and field programmable gate arrays available solely from Xilinx, 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 and financial condition. Business Disruption: The Company's corporate headquarters, including most of its research and development operations and production facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant earthquake could materially affect operating results. The Company is not insured for most losses and business interruptions of this kind. Year 2000 Y2K Risks: The Company has implemented a program over the last two and a half years to define and minimize risks related to transitioning to the year 2000 and beyond. The program and associated risk assessment was segregated into three main areas: 1)Product Readiness Program, 2)Internal Infrastructure Readiness Program and, 3) Business Partners Readiness Program. For each of the three areas, the Company systematically performed risk assessments, conducted tests and implemented remediation activities. The Company's efforts in this area have been successful to date. The Company has transitioned all of its systems to the new millennium without experiencing significant problems in any of its product, infrastructure or business partner programs. Further, the Company believes it has identified, tested and developed a plan to handle all known Year 2000 concerns in accordance with its contractual obligations and operational requirements. Thus, management believes that the risk related to future exposure of Year 2000 issues is minimal. All costs related to Year 2000 readiness have been borne by the Company and recovered in the product prices and therefore, have not had a material impact on its operating results. ITEM 2: PROPERTIES The Company's corporate offices that also serve as its primary research and development, engineering, production, marketing, and administrative offices are located in Sunnyvale, California. The Company leases and occupies six buildings of approximately 273,000 square feet whose term expires in March 2012. Under the terms of the lease, the Company has options to lease three additional buildings. The first option was exercised in July 1998 for which the construction of a 69,000 square foot building started in January 2000; occupancy is anticipated in November 2000. The second option for a 58,000 square foot building was exercised in September 1999; occupancy is targeted for November 2001. The third option for another 58,000 square foot building can be exercised anytime through February 2001; the Company has not taken any action on this option. In addition, the Company maintains four offices within the United States for small development, marketing and administrative functions. The Company leases: 29,121 square feet of a 90,000 square foot building in Annapolis Junction, Maryland that expires in April 2004; a 15,520 square foot building in Herndon, Virginia that expires in January 2006; 11,000 square feet of a 40,000 square foot building in Hillsboro, Oregon that expires in October 2004; and 9,500 square feet of a 28,000 square foot building in Salt Lake City, Utah that expires in April 2004. 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 or 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 The Company from time to time is engaged in various legal actions including but not limited to wrongful termination allegations, governmental agency investigations and employee discrimination allegations. The Company, believes that these legal actions will not, either individually or in aggregate, have a material adverse effect on the operating results or financial condition of the Company. EXECUTIVE OFFICERS OF THE REGISTRANT As of January 3, 2000, set forth below is certain information with respect to age and background for each of the executive officers of the Company:
NAME AGE POSITION ---- --- ------- Gary L. Yancey 54 President, CEO and Chairman of the Board Brian M. Offi 46 Vice President-- Finance, Chief Financial Officer and Secretary Bani M. Scribner, Jr. 55 Executive Vice President, General Manager-- Technical Operations Group Richard Gooch 43 Vice President-- Personal Communications Systems Division Al Ovadia 59 Vice President-- Multichannel Systems Division Ken Snow 59 Vice President-- Operations Division Kenway Wong 50 Vice President-- Communication System Division
Gary L. Yancey, a co-founder of the Company, has served the Company as President, CEO and Chairman of the Board since the Company's incorporation in January 1984. Prior to co-founding the Company, he was employed for 10 years by ARGOSystems, a manufacturer of electronic reconnaissance systems. Brian M. Offi joined the Company in October 1990 as Chief Financial Officer and was elected Vice President-Finance in May 1991. From May 1987 to October 1990, he served as Chief Financial Officer of S-Tron, Inc., a manufacturer of life-support equipment worn by military personnel. 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. Richard Gooch joined the Company in May 1985 as an Engineer. He was promoted to Department Manager in 1989. In November 1999, he was elected Vice President of Personal Communications System Division. Al Ovadia joined the Company in April 1993 as a Senior Engineer and was promoted to Department Manager in October 1994. In November 1999, he elected Vice President of Multichannel 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 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 SHAREHOLDER MATTERS Selected Common Stock Data: Applied Signal Technology, Inc. Common Stock was first offered to the public on March 26, 1993. Since the initial public offering, the stock has been traded on The Nasdaq National Market under the symbol "APSG". As of January 5, 1999, the Company had approximately 570 shareholders of record. The following table sets forth the range of high, low and closing sale prices for the Company's Common Stock over the last eight quarters ending October 31, 1998. The "last" price per share in the table represents the closing price on the last trading day of the quarter. The quotations represent inter-dealer quotations, without retail markups, markdowns, or commissions and may not necessarily represent actual transactions. The Company's line of credit agreement prohibits the Company from making dividend payments without the lender's approval which has been granted.
Share Volume High Low Last (in 000'S) -------- -------- -------- ---------- Fiscal year ended October 31, 1998 First quarter $13.63 $13.38 $13.50 5,647.1 Second quarter $11.75 $11.06 $11.50 10,255.8 Third quarter $12.88 $11.63 $11.63 3,765.6 Fourth quarter $11.88 $11.25 $11.31 2,080.0 Fiscal year ended October 31, 1999 First quarter $14.18 $9.00 $9.50 2,757.8 Second quarter $9.75 $5.00 $6.50 3,686.8 Third quarter $11.00 $6.38 $10.31 1,743.1 Fourth quarter $10.63 $8.75 $9.81 1,063.7
In the third quarter of fiscal 1999, the Board of Directors declared a $0.25 per share dividend, payable over four quarters at the rate of $0.625 per share per quarter. Payments are made to shareholders of record at July 30, 1999; October 31, 1999; January 28, 2000; and April 28, 2000 during the month following the record date. The Company plans to continue its dividend program; however, dividend payments beyond those authorized by the Board of Directors are contingent upon future earnings, capital investment requirements, strategic initiatives and the Company's financial condition. Nasdaq Market Makers: As of December 31, 1999, the following firms were registered market makers of the Company's Common Stock on the Nasdaq National Market: SG Cowen Securities; Mayer & Schweitzer Inc.; Sherwood Securities Corp.; Herzog, Heine, Geduld, Inc.; Knight Securities L.P.; Weeden and Co., Inc.; Spear, Leads & Kellogg; and Riley & Co. Item 6. SELECTED FINANCIAL DATA All data is in thousands except per common share data.
Summary of Operations: Year Ended October 31, 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- Revenues from contracts $115,541 $110,087 $96,259 $77,410 $67,664 Operating expenses: Contract costs 70,109 67,840 60,404 53,333 45,418 Research and development 12,913 12,208 10,137 9,380 9,873 General and administrative 17,245 14,262 13,642 11,954 11,221 --------- --------- --------- --------- --------- Total operating expenses 100,267 94,310 84,183 74,667 66,512 --------- --------- --------- --------- --------- Operating income 15,274 15,777 12,076 2,743 1,152 Interest income/(expense), net 672 584 190 49 187 --------- --------- --------- --------- --------- Income before provision for income taxes 15,946 16,361 12,266 2,792 1,339 Provision for income taxes 6,059 6,217 4,600 977 435 --------- --------- --------- --------- --------- Net income $9,887 $10,144 $7,666 $1,815 $904 ========= ========= ========= ========= ========= Earnings per Share: Basic $1.17 $1.20 $0.94 $0.23 $0.12 Diluted $1.14 $1.15 $0.91 $0.23 $0.12 Average Shares: Basic 8,433 8,468 8,128 7,754 7,754 Diluted 8,696 8,859 8,438 7,919 7,635 Financial Position at End of Fiscal Year: 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- Working capital $45,009 $39,716 $34,936 $26,477 $24,269 Total assets 84,034 72,463 64,161 52,103 49,030 Retained earnings 46,504 37,711 27,569 19,866 18,052 Shareholders' equity 64,433 56,866 49,766 39,965 36,947 Book value per common share $7.63 $6.77 $5.96 $5.08 $4.90
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Applied signal Technology, Inc. designs, develops, and manufactures signal processing equipment to collect and process a wide range of telecommunication signals for reconnaissance and industrial application. Signal reconnaissance equipment is used for the monitoring of foreign telecommunications, predominantly by the United States Government and allied foreign governments. Industrial applications include spectrum monitoring equipment for commercial communication satellite systems, and data intrusion detection equipment for data network protection. Signal reconnaissance systems are composed of collection equipment and processing equipment. Signal collection equipment consist of sophisticated receivers that can scan the radio frequency (RF) spectrum (cellular telephone, microwave, ship-to-shore, military transmissions, etc.) to collect certain signals from potentially thousands of signals within the RF spectrum. Process equipment, using sophisticated software and hardware, evaluates the characteristics of collected signals and selects those signals likely to contain relevant information. Spectrum monitoring equipment evaluate a communication satellite's frequency spectrum usage to detect any misuse that could cause substandard service. Data intrusion detection equipment monitor commercial data networks to detect unauthorized system entry for the purpose of altering or pirating data. Since inception, the Company has focused its efforts primarily on processing equipment, but also provides specialized collection equipment, as well as complete signal processing systems. The Company's business involves risks and uncertainties, including, without limitation, those contained in this report in "Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Prices." The Company's revenues are primarily generated from sales of its products and services to two agencies of the United States Government. The two agencies accounted for 42% and 34%, respectively, of revenues in fiscal 1999. In fiscal 1998, the two agencies accounted for 39% and 34%, respectively, of revenues and in fiscal 1997, the percentages of revenues derived from these two agencies were 57% and 29%, 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 1999, approximately 45% of the Company's revenues were derived from fixed price contracts, and approximately 55% of the Company's revenues were derived from cost plus reimbursement contracts. In fiscal 1998, approximately 46% of the Company's revenues were derived from fixed price contracts, and approximately 54% of the Company's revenues were derived from cost plus reimbursement contracts. In fiscal 1997, approximately 50% of the Company's revenues were derived from fixed price contracts, and approximately 50% of the Company's revenues were derived from cost plus reimbursement contracts. 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, -------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Revenues from contracts 100.0% 100.0% 100.0% Operating expenses: Contract costs 60.7% 61.6% 62.8% Research and development 11.2% 11.1% 10.5% General and administrative 14.9% 13.0% 14.2% ------------ ------------ ------------ Total operating expenses 86.8% 85.7% 87.5% ------------ ------------ ------------ Operating income 13.2% 14.3% 12.5% Interest income/(expense), net 0.6% 0.6% 0.2% ------------ ------------ ------------ Income before provision for income taxes 13.8% 14.9% 12.7% Provision for income taxes 5.2% 5.7% 4.7% ------------ ------------ ------------ Net income 8.6% 9.2% 8.0% ============ ============ ============ Backlog (thousands of dollars) $64,905 $49,380 $83,268
Revenues Revenues from contracts increased by 5% from approximately $110,087,000 in fiscal 1998 to approximately $115,541,000 in fiscal 1999. Revenues increased by 14% from approximately $96,259,000 in fiscal 1997 to approximately $110,087,000 in fiscal 1998. The increase in revenues during fiscal 1999 is primarily due to an increase in revenue generated by the Company's development and engineering services contracts generated by the Company's development and engineering services contracts which were partially offset by a decrease in sales of off-the shelf products. Management believes the decrease in revenues resulting from lower off-the- shelf product sales has adversely impacted the fiscal 1999 revenue growth. The revenue increase in fiscal 1998 is due, in part, to increased contract activity experienced in the military marketplace and, in part, due to an increasing demand from the intelligence agencies for development contracts. The following table identifies the source of the Company's revenues for fiscal years 1999, 1998 and 1997 by major market:
FY99 FY98 FY97 ----- ----- ----- Intelligence Agencies 80% 81% 91% Military 12% 9% 7% Foreign 5% 9% 2% Commercial 3% 1% --%
Backlog The Company's backlog, which consists of anticipated revenues from the uncompleted portions of existing contracts (excluding unexercised options), was approximately $64,905,000 at the end of fiscal 1999. This represents an increase of 31.4% from the prior year's ending backlog of approximately $49,380,000. The increase in orders in fiscal 1999 is in part due to receiving orders delayed from the previous year and, in part, to a resurgence in the need for signal reconnaissance capabilities by the United States Government. The decrease in backlog between fiscal 1997 and fiscal 1998 was due in part to a delay in specific contract awards from the United States Government and, in part, due to a reduced number of awards for the Company's off-the-shelf products. While management believes that the demand for global intelligence and tactical communications systems should continue, there can be no assurances that the Company will continue to experience growth in its backlog or its revenues. Contract Costs Contract costs consist of direct costs on contracts, such as labor, materials and manufacturing overhead costs. Contract costs, as a percentage of revenues, decreased to 60.7% in fiscal year 1999 from 61.6% in fiscal year 1998. As a percentage of revenues, contract costs in fiscal year 1998 were lower than contract costs of 62.8% of revenues in fiscal year 1997. The decrease in contract costs as a percentage of revenues in fiscal year 1999 compared to fiscal year 1998 is in part attributable to lowering of reserves related to a government investigation which commenced during fiscal 1994 and in part, due to a reduction in estimated losses on certain fixed price contracts. Both reductions reflect management's belief that the risk of loss has been mitigated. The reserve reduction recorded during fiscal 1999 totaled approximately $595,000. The decrease in contract costs as a percentage of revenues in fiscal year 1998, compared to fiscal year 1997, is attributable, in part, to higher contract fees and, in part due to the lower manufacturing overhead applied to contracts during fiscal 1998 compared to fiscal 1997. Research and Development Expenses Company directed investment in research and development consists of expenditures recoverable from customers through the Company's billing rates and expenditures funded by the Company from earnings. Research and development expenses as a percentage of revenues were 11.2%, 11.1% and 10.5% for fiscal years 1999, 1998, and 1997, respectively. Research and development expenses increased by approximately $706,000 in fiscal 1999 from $12,208,000 in fiscal 1998, and grew as a percentage of revenues in fiscal 1999 when compared to the percentage of revenue in fiscal 1998. The increase in research and development spending during both fiscal year 1999 and fiscal year 1998 are due to management's decision to increase research and development activities for the benefit of future business. As a percentage of revenues, research and development spending was low in fiscal year 1997 primarily due to the greater demand of contract work which limited the availability of staff to work on research and development contracts. General and Administrative Expenses General and administrative expenses include administrative salaries, costs related to the Company's marketing and proposal activities, and other administrative costs. General and administrative expenses were approximately $17,245,000 or 14.9% of revenues in fiscal 1999 compared to approximately $14,262,000 or 13.0% of revenues in fiscal 1998 and approximately $13,642,000 or 14.2% of revenues in fiscal 1997. The increase from fiscal 1998 to fiscal 1999 in general and administrative expenses of approximately $2,982,000, and as a percentage of revenues is primarily attributable to increased efforts in marketing, and bid and proposal activity. In recent years, management has continued to emphasize the marketing component of general and administrative expenses in an effort to generate revenues in future periods. The decrease in general and administrative expenses as a percentage of revenues in fiscal 1998 relative to fiscal 1997 is primarily attributable to the higher profit recognized on contracts during fiscal 1998 compared to fiscal 1997. Interest Income/Expense (Net) Net interest income/(expense) for fiscal 1999 increased approximately $88,000 to approximately $672,000 from approximately of $584,000 net interest income in fiscal 1998. Net interest income in fiscal 1998 increased approximately $394,000 over net interest income in fiscal 1997 of approximately $190,000. The continued increase in interest income during the fiscal years 1999 and 1998 is due primarily to investing higher cash balances generated from operations. Provision for Income Taxes Income taxes as a percentage of income before provision for income taxes have been provided for at a combined federal and state rate of 38% for both fiscal years 1999 and 1998 and 37.5% for fiscal year 1997. The 1999 and 1998 effective tax rates are lower than the combined federal and state statutory income tax rates primarily due to the benefit derived from federal and state income tax credits. The increase in the effective tax rate from fiscal 1997 to fiscal 1998 is primarily a result of the increase in federal and state tax liabilities as a result of the lower impact of federal and state tax credits on increased profitability. Analysis of Liquidity and Capital Resources The Company's primary source of liquidity has been the cash flow generated from operations, as well as the issuance of common stock through its employee stock plans. The Company has a $3,000,000 unsecured, revolving line of credit for short-term cash requirements bearing interest at the bank's reference rate (8.25% as of October 31, 1999). Outstanding amounts on the line of credit were zero at October 31, 1999 and 1998. The line expires on March 15, 2001. Net cash from operating activities: Net cash provided by operating activities has varied significantly from year to year. For fiscal years 1999, 1998 and 1997, cash provided by operating activities was approximately $10,316,000, $16,035,000, and $9,806,000, respectively. The year-to-year variances are primarily the result of changes in net income, changes in accounts receivable, changes in the level of accrued liabilities and the change in inventories held by the Company. During fiscal year 1999 net income was approximately $9,887,000, a decrease from approximately $10,144,000 in fiscal year 1998. The decrease in net income for fiscal year 1999 was primarily due to the application of a higher general and administrative rate in fiscal year 1999 as compared to fiscal year 1998. The improvement in net income for fiscal year 1998 over fiscal year 1997 is primarily due to an increase in the average gross margin profitability recorded on contracts during the year, and, in part, due to a reduction in general and administrative expenses recorded as a percentage of revenue for the fiscal year. During fiscal 1999, accounts receivable increased by approximately $6,158,000 when compared to a decrease of approximately $2,068,000 for fiscal year 1998. The increase in accounts receivable in fiscal year 1999 is primarily due to the strong revenues and associated billings in the fourth quarter. The decrease in accounts receivable in fiscal 1998 is due, in part to greater collection efforts and, in part, due to collections received from a one-time billing modification authorized by the United States Government in the fourth quarter of fiscal 1997. Cash used by the increased levels of inventories, prepaid expenses and other current assets of approximately $1,472,000 in fiscal year 1999 is primarily due to the increase in purchases for anticipated future production contracts. Cash used by the increased levels of inventories, prepaid expenses and other current assets of approximately $1,589,000 in fiscal 1998 is primarily due to the increase in work-in-progress for engineering and production contracts and, in part, due to the increase in prepaid income taxes related to higher profits. Cash provided by the increased levels of liabilities for fiscal year 1999 approximated $3,372,000 and was primarily due to an increase in accrued employee related benefits, the accrual for the fourth quarter dividend payment, and an increase in trade accounts payable resulting from the higher revenue volume recorded during the last quarter of fiscal 1999. This increase in accrued liabilities was partially offset by a reduction in the reserves recorded for previously anticipated losses (see Management Discussion and Analysis - Contract Costs). Cash provided by the increased levels of liabilities for fiscal 1998 approximated $1,203,000 and was primarily due to increased tax liabilities associated with higher profit margins. Net cash from investing activities: Net cash used in investing activities was approximately $5,867,000, $5,925,000 and $5,822,000 during fiscal years 1999,1998 and 1997, respectively. The use of cash for investing activities in each of the last three fiscal years was primarily for additions to property and equipment. The Company's capital investment continues to be driven by an increase in the number of new employees and by the level of development-type contracts that have required test and computing equipment. Cash provided by investing activities throughout fiscal year 1999 was due to the maturity of short-term investments, primarily in U.S. Government treasuries and was approximately $1,000,000. Cash provided by investing activities was approximately $300,000 during fiscal year 1998 related to net the purchases and maturities of short-term investments in U.S. Government treasuries. Net cash from financing activities: Net cash used in financing activities was approximately $1,854,000 during fiscal year 1999 compared to approximately $3,429,000 used in financing activities during fiscal year 1998 and approximately $1,860,000 provided by financing activities during fiscal year 1997. During fiscal year 1999, the $1,854,000 used in financing activities is primarily attributable to approximately $3,773,000 repurchases of common stock and an approximately $534,000 dividend payment partially offset by the issuance of approximately $2,453,000 of common stock under the employee stock purchase plan and stock option plan. During fiscal 1998, the $3,429,000 used in financing activities is attributable to approximately $6,207,000 of common stock repurchases initiated under the Company's stock repurchase program offset by the issuance of approximately $2,778,000 of common stock under the employee stock purchase plan and stock option plan. The cash provided by financing activities of approximately $1,860,000 in fiscal year 1997 was predominately due to the issuance of common stock under the Company's employee stock purchase plan and stock option plan. The Company believes that the funds generated from operations, existing working capital, and amounts available under existing lines of credit will be sufficient to meet its cash needs for at least the next 12 months. Year 2000 Risks A complete discussion of the impact of Year 2000 issues on the Company and the Company's Year 2000 readiness programs is set forth in Item 1: Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price. Quarterly Results The following table sets forth certain unaudited quarterly financial data for the eight quarters ending October 31, 1998. In the opinion of the Company's management, the unaudited information set forth below has been prepared on the same basis as the audited information and includes all adjustments necessary to present fairly the information set forth herein. The operating results for any quarter are not indicative of results for any future period. All data is in thousands except per common share data.
FISCAL YEAR 1998 FISCAL YEAR 1999 ---------------------------------------------- ------------------------------------------ Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 ---------- ---------- ---------- ---------- --------- --------- --------- --------- Revenues from contracts $24,361 $27,732 $27,373 $30,621 $22,848 $27,590 $27,555 $37,548 Operating expenses Contract costs 15,095 17,327 16,695 18,723 14,628 16,500 17,410 21,571 Research and development 2,137 3,114 3,050 3,907 2,728 3,477 2,554 4,154 General and administrative 3,661 3,233 3,296 4,072 3,401 3,247 4,535 6,062 ---------- ---------- ---------- ---------- --------- --------- --------- --------- Total operating expenses 20,893 23,674 23,041 26,702 20,757 23,224 24,499 31,787 ---------- ---------- ---------- ---------- --------- --------- --------- --------- Operating income 3,468 4,058 4,332 3,919 2,091 4,366 3,056 5,761 Interest income/(expense) net 147 145 140 152 202 123 152 195 ---------- ---------- ---------- ---------- --------- --------- --------- --------- Income before provision for income taxes 3,615 4,203 4,472 4,071 2,293 4,489 3,208 5,956 Provision for income taxes 1,410 1,639 1,621 1,547 871 1,706 1,219 2,263 ---------- ---------- ---------- ---------- --------- --------- --------- --------- Net income $2,205 $2,564 $2,851 $2,524 $1,422 $2,783 $1,989 $3,693 ========== ========== ========== ========== ========= ========= ========= ========= Net income per common share Basic $0.26 $0.30 $0.34 $0.30 $0.17 $0.33 $0.24 $0.44 Diluted $0.25 $0.28 $0.32 $0.29 $0.16 $0.32 $0.23 $0.42 Average share outstanding Basic 8,480 8,580 8,429 8,388 8,480 8,439 8,446 8,462 Diluted 8,954 9,000 8,776 8,708 8,793 8,640 8,707 8,714
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. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 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, 1999 and 1998, and the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended October 31, 1999. 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, 1999 and 1998 and the results of its operations and its cash flows for each of the three years in the period ended October 31, 1999 in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP San Jose, California December 8, 1999 STATEMENTS OF INCOME
Year Ended October 31, ---------------------------------------- 1999 1998 1997 ------------- ------------- ------------ Revenues from contracts $115,541,283 $110,087,178 $96,258,831 Operating expenses: Contract costs 70,109,422 67,840,318 60,403,961 Research and development 12,913,212 12,207,696 10,137,304 General and administrative 17,244,475 14,261,998 13,641,613 ------------- ------------- ------------ Total operating expenses 100,267,109 94,310,012 84,182,878 ------------- ------------- ------------ Operating income 15,274,174 15,777,166 12,075,953 Interest income/(expense), net 672,206 583,863 189,953 ------------- ------------- ------------ Income before provision for income taxes 15,946,380 16,361,029 12,265,906 Provision for income taxes 6,059,624 6,217,191 4,599,715 ------------- ------------- ------------ Net income $9,886,756 $10,143,838 $7,666,191 ============= ============= ============ Net income per common share Basic $1.17 $1.20 $0.94 Diluted $1.14 $1.15 $0.91 Number of shares used in calculating net income per common share Basic 8,433,447 8,468,463 8,128,062 Diluted 8,696,010 8,858,662 8,435,191
See accompanying notes. BALANCE SHEETS
October 31, ------------------------- 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $16,680,178 $14,084,727 Short term investments -- 1,029,223 Accounts receivable: Billed 19,746,085 14,298,029 Unbilled 16,992,047 16,282,067 ------------ ------------ Total accounts receivable 36,738,132 30,580,096 Inventory 6,746,209 5,551,312 Prepaid expensesand other current assets 3,311,784 3,034,544 ------------ ------------ Total current assets 63,476,303 54,279,902 Property and equipment, at cost: Machinery and equipment 37,719,084 31,653,925 Furniture and fixtures 4,418,532 4,010,924 Leasehold improvements 7,316,492 5,812,967 Construction in process 328,712 1,438,036 ------------ ------------ 49,782,820 42,915,852 Accumulated depreciation and amortization (29,268,448) (24,775,359) ------------ ------------ Net property and equipment 20,514,372 18,140,493 Other assets 43,143 42,221 ------------ ------------ Total Assets $84,033,818 $72,462,616 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $4,838,273 $3,841,929 Accrued payroll and related benefits 7,505,059 6,330,405 Other accrued liabilities 2,293,324 2,091,566 Income taxes payable 3,830,993 2,300,098 ------------ ------------ Total current liabilities 18,467,649 14,563,998 Deferred income taxes 1,132,831 1,032,910 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 - 8,442,239 at October 31, 1999 and 8,393,526 at October 31, 1998 17,929,157 19,154,309 Retained earnings 46,504,181 37,711,399 ------------ ------------ Total shareholders' equity 64,433,338 56,865,708 ------------ ------------ Total Liabilities and Shareholders' Equity $84,033,818 $72,462,616 ============ ============
See accompanying notes. STATEMENTS OF CASH FLOWS
Year Ended October 31, ------------------------------------- 1999 1998 1997 ------------ ------------ ----------- Operating activities: Net income $9,886,756 $10,143,838 $7,666,191 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 4,493,089 3,795,512 3,781,431 Tax benefit related to stock plans 95,308 385,895 238,114 Changes in: Accounts receivable (6,158,036) 2,068,310 (2,630,098) Inventory, prepaid expenses and other current assets (1,472,137) (1,589,228) (1,553,618) Other assets (922) 28,352 47,560 Accounts payable, taxes payable and accrued expenses 3,372,436 1,120,964 2,132,001 Deferred income taxes 99,921 81,538 123,944 ------------ ------------ ----------- Net cash provided by (used in) operating activities 10,316,415 16,035,181 9,805,525 Investing activities: Purchases of available-for-sale securities -- (6,000,000) -- Maturity of available-for-sale securities 1,000,000 6,300,000 800,000 Additions to property and equipment (6,866,968) (6,224,829) (6,621,535) ------------ ------------ ----------- Net cash provided by (used in) investing activities (5,866,968) (5,924,829) (5,821,535) Financing activities: Issuance of common stock 2,452,728 2,777,870 1,866,925 Repurchase of common stock (3,773,188) (6,206,623) (6,999) Dividends paid (533,536) -- -- ------------ ------------ ----------- Net cash provided by financing activities (1,853,996) (3,428,753) 1,859,926 ------------ ------------ ----------- Net increase (decrease) in cash and cash equivalents 2,595,451 6,681,599 5,843,916 Cash and cash equivalents at beginning of year 14,084,727 7,403,128 1,559,212 ------------ ------------ ----------- Cash and cash equivalents at end of year $16,680,178 $14,084,727 $7,403,128 ============ ============ =========== Supplemental disclosures of cash flow information: Interest paid $31,814 $33,509 $49,089 Taxes paid $4,424,400 $5,574,000 $4,374,800 ============ ============ ===========
See accompanying notes.
Total Common Retained Shareholders' Stock Earnings Equity ------------ ------------ ------------ Balance at October 31, 1996 $20,099,127 $19,865,625 $39,964,752 Issuance of 483,259 common shares to employees under stock purchase agreements and stock option plan 1,866,925 -- 1,866,925 Repurchase of 4,977 common shares (6,999) -- (6,999) Tax benefit related to stock plans 238,114 -- 238,114 Net change in unrealized loss on securities available for sale -- 37,177 37,177 Net income -- 7,666,191 7,666,191 ------------ ------------ ------------ Balance at October 31, 1997 22,197,167 27,568,993 49,766,160 Issuance of 529,397 common shares to employees under stock purchase agreements and stock option plan 2,777,870 -- 2,777,870 Repurchase of 487,500 common shares (6,206,623) -- (6,206,623) Tax benefit related to stock plans 385,895 -- 385,895 Net change in unrealized loss on securities available for sale -- (1,432) (1,432) Net income -- 10,143,838 10,143,838 ------------ ------------ ------------ Balance at October 31, 1998 19,154,309 37,711,399 56,865,708 Issuance of 414,213 common shares to employees under stock purchase agreements and stock option plan 2,452,728 -- 2,452,728 Repurchase of 365,500 common shares (3,773,188) -- (3,773,188) Cash dividends declared ($.0625 per share) -- (1,064,632) (1,064,632) Tax benefit related to stock plans 95,308 -- 95,308 Net change in unrealized loss on securities available for sale -- (29,342) (29,342) Net income -- 9,886,756 9,886,756 ------------ ------------ ------------ Balance at October 31, 1999 $17,929,157 $46,504,181 $64,433,338 ============ ============ ============
See accompanying notes. NOTES TO FINANCIAL STATEMENTS OCTOBER 31, 1999 NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization Applied Signal Technology, Inc. (the Company) was incorporated in California on January 12, 1984. The Company designs, develops, manufactures signal processing equipment to collect and process a wide range of telecommunication signals. This equipment is used for reconnaissance of foreign telecommunications predominantly by the United States Government and allied foreign governments, for certain industrial applications and for defense communications systems. For the three years ended October 31, 1999, substantially all of the Company's revenues were from contracts with the U.S. Government, its agencies, or prime contractors for the U.S. Government. The Company currently operates in only one business segment. 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 55% of contract revenues in fiscal year 1999 (54% in fiscal year 1998 and 50% in fiscal year 1997) 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 45% of contract revenues in fiscal year 1999 (46% in fiscal year 1998 and 50% in fiscal year 1997) 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 fro at the time they become known. A significant portion of the company's revenues is derived from fixed price contracts. Under fixed price contracts, unexpected increases in the cost to develop or manufacture a product, whether due to inaccurate estimates in the bidding process, unanticipated increases in material costs, inefficiencies or other factors, are borne by the Company, and could have a material adverse effect on the Company's results of operations. Accounts receivable are segregated between billed and unbilled accounts. The Company bills incurred costs and ratable portions of fees regularly under its cost reimbursement type contracts. Under fixed price contracts, the Company either regularly progress bills 90% of incurred costs or bills contract costs on a milestone or unit of delivery basis. Unbilled amounts result from recognition of contract revenue in advance of contractual billing or progress billing terms. The Company regards the credit risk of its business to be minimal. Price Redetermination As a government contractor, the Company is subject to price redetermination on certain fixed price contracts if it is determined that the Company did not price its products and services consistent with the requirements of the Federal Acquisition Regulations. Cash Equivalents and Short-Term Investments The Company considers all highly liquid debt investment purchased with a maturity of three months or less to be cash equivalents. Short- term investments, when acquired, are comprised of U.S. Government treasury bills and notes. 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 be 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, 1999. Realized gains and losses on available-for-sale securities have not bee 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 up to five years. Leasehold improvements are amortized using the straight-line method over the lesser of the useful of the assets or the lease term. Per Share Data Basic earnings per share is based on the weighted effect of all common shares issued and outstanding, and is calculated by dividing net income available to common stockholders by the weighted average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares used in the basic earnings per share calculation, plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities outstanding using the treasury stock method. Per Share Data
(in thousands, except per share amounts) Year Ended October 31, -------------------------------------- 1999 1998 1997 ------------- ----------- ----------- Numerator: Net Income $9,887 $10,144 $7,666 ============= =========== =========== Denominator: Share used to compute net income per common share - basic 8,433 8,468 8,128 Effect of dilutive stock options 263 391 307 ------------- ----------- ----------- Share used to compute net income per common share - diluted 8,696 8,859 8,435 ------------- ----------- ----------- Net income per common share - basic $1.17 $1.20 $094 ------------- ----------- ----------- Net income per common share - diluted $1.14 $1.15 $0.91 ------------- ----------- -----------
COMPREHENSIVE INCOME As of October 31, 1999, the Company adopted Statement of Financial Accountin Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." FAS 130 establishes new rules for the reporting and display of comprehensive income its' components, however, it has no material impact on the Company's net inc or shareholders' equity. SFAS 130 requires changes in fair value for available-for-sale securities and foreign currency translation adjustments, prior to adoption were reported in shareholders' equity, to be included in comprehensive income. The components of comprehensive income, net of tax, are as follows:
Year Ended October 31, ------------------------------------- 1999 1998 1997 ----- ----- ----- Net income $9,886,756 $10,143,838 $7,666,191 Unrealized gain (loss) on securities (29,342) (1,432) 37,177 ------------ ------------------------ Comprehensive income $9,857,414 $10,142,406 $7,703,368 ============ ========================
Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. 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, -------------------------- 1999 1998 ----------- ----------- Raw materials $ 1,261,628 $ 1,101,992 Work-in-process 4,327,879 4,113,729 Finished goods 927,207 244,869 ----------- ----------- 6,516,714 5,460,590 Precontract costs 229,495 90,722 ----------- ----------- $ 6,746,209 $ 5,551,312 =========== ===========
Precontract costs represent costs incurred in connection with ongoing level-of-effort type contracts for which contract modifications have not been definitized ($225,897 at October 31, 1999 and $87,424 at October 31, 1998) 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, 1999, the company has a $3,000,000 revolving line of credit available with a bank. Borrowings under the line of credit bear interest at the bank's reference rate (8.25% at October 31, 1999), payable monthly and expires on March 15, 2001; the Company intends to renew this line of credit. At both October 31, 1999 and 1998 this facility was unused. Under this credit facility, the Company is subject to certain commitment and utilization fees on the unused portion of the committed amount. Fees incurred were not material during the last three fiscal years. The line of credit agreement requires compliance with certain financial covenants and restricts dividend payments, stock repurchases and any loans or advances made to any third parties without the prior written consent of the lender. At both October 31, 1999 and 1998, the Company was in compliance with the Bank's required covenants and restrictions. NOTE 4: COMMITMENTS Facility Commitment The Company leases its facilities under noncancelable lease agreements which expire at various dates between fiscal years 2000 and 2012. Certain of the leases contain escalation clauses and requirements for the payment of property taxes, insurance and maintenance expenses. The aggregate minimum annual lease commitments at October 31, 1999 under long-term operating leases are as follows: Fiscal Year: ----------- 2000 $ 4,150,117 2001 4,277,132 2002 4,313,977 2003 4,348,379 2004 4,284,120 Thereafter 27,464,244 ----------- $48,837,969 ===========
Rent expense under operating leases was $4,313,166 in fiscal 1999 ($4,013,335 in fiscal 1998; $3,296,185 in fiscal 1997). The Company had outstanding letters of credit at October 31, 1999 of $1,000,000 of which $218,250 and $11,755 are used as security deposits for its leased operating facilities. The Company had no noncancelable purchase commitments for materials as of October 31, 1999 and as of October 31, 1998. 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, 1999, 512,985 shares remain eligible for purchase under the 1993 Plan. Stock Option Plan The Company's 1991 Stock Option Plan ("1991 Plan") provides for the granting of incentive stock options and non-qualified stock options to employees, directors, and consultants of the Company at prices ranging from 85% to 110% (depending on the type of grant) of the fair market value of the common stock on the date of grant. Some options are only exercisable at the end of a two-year vesting period and some options are exercisable at the rate of 1/5 per year over five years. A summary of the option activity under the 1991 Plan is as follows:
Options Outstanding -------------------------------------------------- Options Available Weighted for Number of Aggregate Average Grant Shares Price Exercise Price ------------- ----------- ----------- ------------ Balance at October 31, 1996 197,497 1,086,739 $4,803,057 $4.42 Additional Authorizatio 500,000 Granted (20,000) 20,000 90,000 $4.50 Exercised -- (179,173) (800,821) $4.47 Canceled 203,183 (203,183) (997,799) $4.91 ------------- ----------- ----------- Balance at October 31, 1997 880,680 724,383 3,094,437 $4.27 Granted (295,900) 295,900 4,593,950 $15.53 Exercised -- (229,985) (1,119,663) $4.87 Canceled 10,168 (10,168) (135,860) $13.36 ------------- ----------- ----------- Balance at October 31, 1998 594,948 780,130 6,432,864 $8.25 Granted (275,938) 275,938 3,345,748 $12.13 Exercised -- (60,492) (240,339) $3.97 Canceled 29,850 (29,850) (428,419) $14.35 ------------- ----------- ----------- Balance at October 31, 1999 348,860 965,726 $9,109,854 $9.43 ============= =========== ===========
Accounting for Stock-Based Compensation The following table summarizes information about options outstanding at October 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------- ------------------------ Weighted Average Weighted Weighted Number Remaining Average Number Average Range of of Shares Contractual Exercise of Shares Exercise Exercise Prices Outstanding Life(years) Price Exercisable Price - ------------- ----------------------- ----------- ----------- ------------ $2.50 126,905 1.46 $2.50 126,905 $2.50 $4.50 159,583 1.61 $4.50 159,583 $4.50 $4.63 125,500 0.97 $4.63 125,500 $4.63 $5.50 20,000 1.35 $5.50 20,000 $5.50 $12.13 265,788 7.10 $12.13 - $15.50 261,950 6.05 $15.50 7,840 $15.50 $16.75 6,000 7.35 $16.75 1,200 16.75 -------- ------------- ----------- ----------- ------------ $2.50 - $16.75 965,726 4.25 $9.43 441,028 $4.23
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 Stock-Based Compensation" (SFAS 123") to disclose its stock-based compensation with no financial statement 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:
Year Endend October 31, ------------------------------------------ 1999 1998 1997 ------- ------- ------- Net income As reported $9,886,756 $10,143,838 $7,666,191 Pro forma 7,649,852 8,416,194 5,984,637 Net income per share Basic -As reporte $1.17 $1.20 $0.94 -Pro forma 0.91 0.99 0.74 Diluted-As report $1.14 $1.15 $0.91 -Pro forma 0.88 0.95 0.71
The weighted average fair value of the options granted during fiscal years 1999, 1998 and 1997 were $6.26, $8.78, and $3.17 per option, respectively. The weighted average fair value at date of grant for shares purchased through the employee stock purchas plans during fiscal year 1999, 1998, and 1997 were $3.89, $4.01, and $2.51 per share, respectively. The fair value of options at the date of grant was estimated using Black Scholes model with the following weighted average assumptions:
Employee Stock Employee Stock Option Plans Purchase Plan ---------------------------- ---------------------- 1999 1998 1997 1999 1998 1997 -------- -------- -------- -------- -------- -------- Risk-free interest rate 6.7% 4.9% 6.0% 5.3% 4.0% 6.0% Expected lives (in years) 5.5 4.7 2.5 .5 .5 .5 Expected volatility .62 .63 .84 .62 .63 .84 Expected dividends 2% 0% 0% 2% 0% 0%
NOTE 6: INCOME TAXES The provision for income taxes for the years ended October 31, 1999, 1998 and 1997 consists of the following:
Year Ended October 31, ------------------------------------------ 1999 1998 1997 ------------- ----------- ----------- Federal: $5,205,608 $5,759,182 $3,921,838 Current (2,980) (515,097) 44,731 Deferred (prepaid) ------------- ----------- ----------- 5,202,628 5,244,085 3,966,569 State: 844,995 933,639 218,788 Current 12,001 39,467 414,358 Deferred (prepaid) ------------- ----------- ----------- 856,996 973,106 633,146 ------------- ----------- ----------- $6,059,624 $6,217,191 $4,599,715 ============= =========== ===========
The tax benefits associated with disqualifying dispositions of stock options or employee stock purchase plan shares reduce taxes currently payable as shown by $95,308; $385,895; and $238,114 for fiscal 1999, 1998, and 1997, 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 statutory federal income tax rate of 35% to income before provison for income taxes as follows:
Year Ended October 31, ------------------------------------- 1999 1998 1997 ------------- ----------- ----------- Computed expected tax provision $5,581,233 $5,726,360 $4,293,067 State income tax, net of federal benefit 557,047 632,519 411,545 Other individually immaterial items (78,656) (141,688) (104,897) ------------- ----------- ----------- $6,059,624 $6,217,191 $4,599,715 ------------- ----------- ----------- Effective Tax Rate 38.0% 38.0% 37.5% ============= =========== ===========
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, ----------------------- 1999 1998 ----------- ----------- Deferred tax assets: Accrued expenses and reserves $1,842,302 $1,694,481 Deferred revenue 19,825 32,906 State taxes and other 178,977 222,817 ----------- ----------- $2,041,104 $1,950,204 =========== =========== Deferred tax liabilities: Tax over book depreciation (1,132,831) (1,032,910) ----------- ----------- $908,273 $917,294 =========== ===========
During fiscal 1999, the Company made total cash payments, net of refunds, of approximately $4,424,000 ($5,574,000 during fiscal 1998 and $4,375,000 during fiscal 1997) 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 ("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 $160,000. The Company accrues for the accumulated contributions which are payable bi-weekly to the Retirement Plan's administrator. The Company has expensed approximately $2,006,000 in fiscal 1999 ($1,655,000 in fiscal 1998 and $1,524,000 in fiscal 1997), which is included in general and administrative expenses. NOTE 8: SEGMENT REPORTING The Company adopted SFAS 131, "Disclosure about Segments of an Enterprise and Related Information," at October 31, 1999. SFAS 131 establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. The Company's operations are treated as one operating segment - the design, development and manufacturing of signal processing equipment - as it only reports profit and loss information on an aggregate basis to chief operating decision makers of the Company. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 of Form 10-K with respect to identification of directors is incorporated by reference from the information contained in Applied Signal Technology, Inc.'s Proxy Statement for the Annual Meeting of Stockholders to be held March 9, 2000 (the "Proxy Statement"), a copy of which will be filed with the Securities and Exchange Commission before the meeting date. For information with respect to the executive officers of the Registrant, see "Executive Officers of Registrant" at the end of Part 1 of this report. ITEM 11: EXECUTIVE COMPENSATION The information required by Item 11 of Form 10-K is incorporated by reference from the information contained in the section captioned "Executive Compensation and Other Matters" in the Proxy Statement. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 of Form 10-K is incorporated by reference from the information contained in the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. 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 documents of Applied Signal Technology, Inc. are filed as part of this report under Item 8. Balance Sheets -- October 31, 1999 and 1998 Statements of Income -- Years ended October 31, 1999, 1998, and 1997 Statement of Shareholders' Equity -- Years ended October 31, 1999, 1998, and 1997 Statements of Cash Flows -- Years ended October 31, 1999, 1998, and 1997 Notes to Financial Statements -- October 31, 1999 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 57 of this Report on Form 10-K. (b) Reports on Form 8-K filed in the Company's fiscal year ended October 31, 1999: 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 28, 1998 /s/ Gary L. Yancey ------------------------------ Gary L. Yancey, President, Chief Executive Officer and Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE DATE TITLE --------- ---- ----- /s/ Gary L. Yancey ____________ President, Chief Executive Officer and - ----------------------------- Chairman of the Board (Principal Executive Officer) /s/ Brian M. Offi ____________ Vice President of Finance and Chief - ----------------------------- Financial Officer (Principal Financial and Accounting Officer), Secretary /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. 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. EX-23.1 2 CONSENT OF ERNST & YOUNG LLP APPLIED SIGNAL TECHNOLOGY, INC. EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-21236) pertaining to the Applied Signal Technology, Inc. Non-Incentive Stock Option Plan of our report dated December 8, 1999, with respect to the financial statements of Applied Signal Technology, Inc. included in this Annual Report (Form 10-K) for the year ended October 31, 1999. /s/ Ernst & Young LLP San Jose, California January 28, 2000 EX-27 3 ARTICLE 5 FIN. DATA SCHEDULE FOR 10-K
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheet and Consolidated Statement of Income included in the Company's Form 10-K for the period ended October 31, 1997 and is qualified in its entirety by reference to such Financial Statements. 1,000 U.S. DOLLARS 1 Oct-31-1999 Nov-01-1998 Oct-31-1999 12-MOS 16,680 0 36,738 0 6,746 63,476 49,783 29,268 84,034 18,468 0 0 0 17,929 46,504 84,034 115,541 115,541 70,109 100,267 30,158 0 (672) 15,946 6,060 9,887 0 0 0 9,887 $1.17 $1.14
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