The Company's United States government customers consist of five defense and intelligence agencies with signal reconnaissance needs. Within these five agencies, the Company has contracts with approximately 20 different offices, each with separate budgets and contracting authority. Although concentration of revenue sources is significant for the United States government, no single contract accounted for more than 5% of the Company's revenues in fiscal years 1993 and 1994, or more than 3% in fiscal year 1995.
Two intelligence agencies accounted for approximately 82% and 11%, respectively, of revenues in fiscal year 1993; 78% and 12%, respectively, of revenues in fiscal year 1994; and 69% and 17%, respectively, of revenues in fiscal year 1995.
The Company believes that other federal government agencies and their numerous offices are potential customers of the Company, particularly law enforcement agencies (that is, FBI, Drug Enforcement Agency, Secret Service, United States Coast Guard, and Naval Investigative Service). The Company believes that other offices within current customer agencies are also potential customers. The Company conducts regular marketing programs designed to make potential customers aware of its capabilities and products. See "--Marketing."
In recent years, the United States defense budget has been reduced, causing customers and potential customers of the Company's products to reevaluate their needs. The Company believes that budget reductions have caused agencies increasingly to favor standard products similar to the Company's products rather than custom products that generally are more expensive, take longer to deliver, and provide solutions to a narrower range of signal reconnaissance problems. Future reductions in United States government spending on signal reconnaissance equipment or future changes in the kinds of signal reconnaissance products or services required by United States government agencies, however, could limit demand for the Company's products, which would have a material adverse effect on the Company's operating results.
Sole source contracts are let by the United States government when a single contractor is deemed to have an expertise or technology that is superior to that of competing contractors. Potential suppliers compete informally for sole source contracts through R&D investment and marketing efforts. This competition requires a contractor to identify the United States government's requirements early and invest in developing potential solutions so that the contractor can demonstrate a distinguishing expertise or technology promptly after the United States government has identified a signal reconnaissance requirement.
Competitive bid contracts are awarded after a formal bid and proposal competition among suppliers and sole source contracts are awarded without a formal competition. During fiscal years 1993, 1994, and 1995, approximately 95%, 99%, and 95%, respectively, of the Company's revenues were from sole source contracts, and 5%, 1%, and 5%, respectively, were from competitive bid contracts.
As a government contractor, the Company is subject to price redetermination on certain fixed-price contracts if it is determined that the Company did not price its products and services consistent with the requirements of the Federal Acquisition Regulations. As of October 31, 1995, the Company has not had a material claim sustained against it for noncompliance.
In April 1994 the Company was served with a subpoena by the Department of Defense Office of Inspector General (OIG) in connection with approximately six contracts. Shortly thereafter, a second agency issued a request for information related to nine additional contracts. To date, the Company has not received any allegation of wrongdoing from the OIG or the other agency. Through its internal review of the contracts in question, the Company has provided voluntary disclosure to the government which is expected to result in a downward price adjustment on certain contracts. In anticipation of a settlement, the Company recorded a charge of $1.2 million to third quarter 1995 operating results. While management believes this charge is adequate to cover all related risks, the government has not concluded its investigation or agreed to a settlement with the Company. (See Item 3 -- "Legal Proceedings.")
Competitive bid contracts are awarded based on objective proposal evaluation criteria established by the procuring agency. Interested contractors prepare a bid and proposal that responds to the agency's request for proposal. A bid and proposal is usually prepared in a short period of time (for example, 45 days) in response to a deadline and requires the extensive involvement of numerous technical and administrative personnel.
Competitive bid or sole source contracts can be either fixed-price contracts, pursuant to which the Company agrees to deliver equipment for a fixed price and assumes the risk of cost overruns, or cost-plus contracts, pursuant to which the Company is reimbursed for its direct and indirect costs and paid a negotiated profit. During each of the last three fiscal years ending 1993, 1994, and 1995, approximately 65% of the Company's revenues were from fixed-price contracts and 35% were from cost-plus contracts.
Most of the Company's fixed-price contracts are for the manufacture of multiple units of its products, rather than the development of new products. The Company believes that the risk of cost overruns is much less in the case of fixed-price manufacturing contracts, where the product already has been developed and at least a prototype made, than in the case of fixed-price development contracts.
Almost all of the Company's contracts contain termination clauses that permit contract termination upon the Company's default or for the convenience of the other contracting party. In either case, termination could adversely affect the Company's operating results. Although the Company has not experienced any material cancellations in the past, there can be no assurance such cancellations will not occur in the future.
Commercial Contracts. During fiscal years 1993 and 1994, commercial contracts have accounted for 0.3% and 1.2% of the Company's yearly revenue, respectively. In 1995, commercial contracts accounted for 2.9% of the Company's revenue. The commercial contracts are typically fixed-price for development or manufacturing and often require R&D investments by the Company. Commercial contracting is a maturing business area for the Company and due to the highly competitive nature of these commercial endeavors, there is risk that the Company's investments may not produce income and that the fixed-price contracts may experience cost overruns. Losses on any individual contracts are provided for at the time they become known.
The Company's marketing occurs at three levels. The top level of marketing involves contact between the Company's senior management and officials of the United States government responsible for signal reconnaissance policy. The purpose of these contacts is to understand national level requirements in future years (five to ten years out), obtain guidance for direction of the Company's R&D, and keep the United States government community informed about the Company, its technology, and its products.
The intermediate level of marketing is performed by the Company's systems engineers contacting government officials responsible for allocating budgets. These engineers seek to identify new requirements that will result in projects within the next six to 18 months and work with government technical representatives to develop system concepts. The Company invests in R&D to address these requirements and to obtain potential projects. To assist with this level of marketing, the Company's technical staff often constructs a theoretical model of the problem and tests processing solutions so that the Company and the customer can determine whether a product can be developed or modified to meet the customer's requirements. At this stage of marketing, the customer often awards a sole source contract to the Company.
The final level of marketing involves establishing precise cost estimates and detailed specifications. This level of marketing is performed by development engineers who are involved in the actual development or modification of the product.
In addition to its primary technical marketing, the Company also conducts marketing activities designed to increase its visibility with existing and potential customers. Each year the Company conducts two equipment shows in the Washington, D.C. area demonstrating the operation of many of its products. The Company uses direct mail and magazine advertising from time to time to inform potential customers of available products. The Company mails in excess of 1,500 copies of its quarterly technical newsletter, which includes any new data sheets, to existing and potential new customers. The Company also produces a product summary catalog that is updated every six months and included with the quarterly newsletter mailing. The Company's mailing list includes contacts at private sector companies that may purchase the Company's products for their own use or for inclusion in systems they are developing for United States government customers, as well as contacts at United States government agencies that buy products but do not contract for development efforts.
Commercial Marketing. The Company's approach to marketing of commercial products is to form strategic alliances with other companies that have had experience in a particular commercial marketplace. The Company will rely on the marketing techniques of these strategic partners to attempt penetration of the new commercial marketplaces. Further, the Company intends to license its technology which the Company believes should minimize the risk of lost investment in these new marketplaces.
The Company seeks to develop technology capable of addressing new signal reconnaissance requirements before its competitors. In addition, the Company focuses its R&D on developing products that can be used, with or without further modification, to satisfy various needs of a variety of customers, thereby permitting the Company to offer a solution promptly. The Company attempts to direct its R&D funds among projects intended to yield revenues within one to two years, projects intended to yield revenues in two to five years, and projects intended to yield revenues in more than five years. Most of the Company's R&D expenditures are for projects intended to yield revenues within one to two years.
An important aspect of the Company's R&D efforts is understanding telecommunication trends to anticipate the future signal reconnaissance needs of its customers. Not only does this allow the Company to direct its R&D engineering efforts to produce solutions promptly once a customer expresses a need, but it often allows the Company to educate the customer about its potential needs and simultaneously present a conceptual solution to those needs.
Another important aspect of the Company's R&D is the development of components or products utilizing advanced technology. This enables the Company to develop products superior to competing products in size, power consumption, delivery time, and cost. The Company has developed an in-house capability to design very large scale integration (VLSI) circuits (custom CMOS, 0.8 micron process). Using its VLSI capabilities, the Company has designed proprietary application specific integrated circuits that enhance the processing power of many of its signal processing products.
The Company's commercial endeavors attempt to apply technology developed for signal reconnaissance to commercial areas of telecommunications. The Company intends to identify opportunities where it believes it has technology that commercial companies have not developed and can form strategic alliances with other commercial companies in an attempt to exploit these opportunities.
Engineering. The engineering divisions are responsible for the Company's R&D. The Company's R&D activities include both United States government R&D contracts and the Company's R&D projects. The engineering division activities are directed toward developing products that will ultimately be produced by the Operations Division. The engineering divisions work in conjunction with the Operations Division to assure that the development efforts will culminate in a product able to be manufactured efficiently in quantity.
The Company has offices which also support the Company's marketing activities, in Herndon, Virginia and Jessup, Maryland. As of January 19, 1996, there were 17 employees in the Virginia office and 11 employees in the Maryland office. Most of the personnel staffing these offices are technical personnel and, in addition to marketing activities, are involved in research and development and customer support (for example, installation, training and troubleshooting).
Operations. The Operations Division is responsible for completing final product development and manufacturing multiple units of products. By combining engineering and production expertise within the Operations Division, the Company believes it is able to maximize manufacturing efficiency and, therefore, reduce overall production costs. Operations manufactures products using batch production methods. The division achieves labor efficiency by extensive cross-training of its personnel, which permits these personnel to participate in the production of all of the Company's products. The division is also responsible for managing the Company's purchases of goods and services, including third party manufacturing and assembly services. See "--Suppliers."
Although the Company procures most of its parts and components from multiple sources or believes that these components are readily available from numerous other sources, certain components are available only from sole sources or from a limited number of sources. A number of the Company's products contain critical components like single board computers available solely from Motorola and Force Computers and digital signal processing integrated circuits available solely from Texas Instruments. While the Company believes that substitute components or assemblies could be obtained, use of substitutes would require development of new suppliers or would require the Company to re-engineer its products, or both, which could delay the Company's shipment of its products and could have a material adverse effect on the Company's operating results.
Many of the Company's products currently use application specific integrated circuits (ASICs) designed by the Company but manufactured by third parties. The Company purchases these ASICs on a purchase order basis and is required to pay for all ASICs produced, whether or not they perform correctly. The Company has experienced unanticipated low yields of working ASICs from time to time, causing the cost of products using these ASICs to be higher than expected. In addition, as chip manufacturing technology evolves, the Company may be forced to redesign certain cards as cards produced with older technology may no longer be manufactured. The Company may be required to bear the cost of redesign. To date, these have not had a material adverse impact on the Company's results. The Company is likely to design and use ASICs in new products in the future. There can be no assurance that the Company will not continue to experience unanticipated low yields of working ASICs and therefore higher product costs, which could have a material adverse effect on the Company's results of operations.
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