Item 1: Business (Continued)

Competition

Signal Reconnaissance

The signal reconnaissance equipment market is highly competitive and the Company expects that competition will increase in the future. Some of the Company's current and potential competitors have significantly greater technical, manufacturing, financial and marketing resources than the Company. The Company's current competitors include Adams-Russell, Inc. (a subsidiary of M/A-Com, Inc.); ARGOSystems, Inc. (a subsidiary of The Boeing Company); E-Systems, Inc. (a subsidiary of Raytheon Corporation); GTE Government Systems Corporation; Harris Corporation; Lockheed Martin Corporation; Motorola Government Electronics Group (a subsidiary of Motorola, Inc.); and TRW, Inc. Substantial competition could have a material adverse effect on the Company's results of operations.

The competition for competitive bid contracts differs from the competition for sole source contracts. Companies competing for competitive bid contracts prepare bids and proposals in response to government request for proposals. Potential suppliers compete informally for sole source contracts through R&D investment and marketing efforts. Companies competing for sole source contracts attempt to identify the United States government's requirements early and invest in solutions so that they can demonstrate a distinguishing expertise or technology promptly after the United States government has identified a signal reconnaissance requirement. The Company competes primarily for sole source contracts and conducts its operations accordingly. The principal factors of competition for sole source contracts include investments in R&D, the ability to respond to government needs promptly, product price relative to performance, quality, and customer support. The Company believes that it competes favorably on each of these factors.

Commercial

The commercial marketplace is relatively new for the Company and the competition can be worldwide. The Company feels that competition can be the highest risk area in commercial ventures. The Company believes that these risks can be minimized by striving to achieve funded development (as in, funded with the customer) and by making strategic alliances for the majority of commercial investments. The Company continues to employ a cautious, measured approach to commercial investments which should help minimize the risk and, at the same time, the Company continues to nurture business relationships which are expected to result in maturing this segment of the Company's business.

Proprietary Rights

The United States government has rights to most of the technology developed by the Company under government contracts, including rights to permit other companies, including the Company's competitors, to use this technology to develop products for the United States government. The Company is not aware that the United States government has exercised these rights.

The Company has filed limited patent applications for its technology. As of October 31, 1995, one patent has been granted to the Company for the QAMalyzer(TM), two other patents were submitted and a fourth is pending. The Company believes that given the rapidly changing nature of signal collection and processing technology, its future success will depend primarily upon the technical competence and creative skills of its personnel. The Company attempts to protect its trade secrets and other proprietary information through agreements with customers, employees, and consultants and other security measures. There can be no assurance that the measures adopted by the Company for the protection of its intellectual property will be adequate.

Although the Company does not believe and has not received notice that it is infringing upon the intellectual property rights of others, there can be no assurance that such a claim will not be asserted against the Company. In the event any third party made a valid claim against the Company and a license was not made available to the Company on commercially reasonable terms, this could have a material adverse effect on the Company's results of operations.

Government Regulations

Many of the Company's operations are subject to compliance with regulatory requirements of federal, state and municipal authorities, including regulations concerning employment obligations and affirmative action, workplace safety and protection of the environment. While compliance with applicable regulations has not adversely affected the Company's operations in the past, there can be no assurance that the Company will continue to be in compliance in the future or that these regulations will not change.

In particular, the Company must comply with detailed government procurement and contracting regulations and with United States government security regulations, certain of which carry substantial penalty provisions for nonperformance or misrepresentation in the course of negotiations. Failure of the Company to comply with its government procurement or contracting obligations or security obligations could result in penalties or suspension of the Company from government contracting, which would have a material adverse effect on the Company's results of operations. See "Business -- Customers, Contracts, and Marketing -- Contracts" and Item 3, "Legal Proceedings".

Employees

As of January 19, 1996, the Company had approximately 493 full-time employees, 143 of whom hold advanced technical degrees (master and/or doctoral degrees), including 17 with doctoral degrees.

The Company's business requires that a large number of its technical employees obtain security clearances from the United States government which limits the available pool of eligible candidates for such positions to those who can satisfy the prerequisites to obtaining these clearances. In particular, the personnel involved in marketing require the appropriate clearances to meet with government technical representatives and discuss the government's signal reconnaissance needs. The Company has a United States government-sanctioned security program that allows staff members to obtain appropriate clearances. Approximately 55% of the Company's current technical 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, by one or more, 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.

During the most recent year, the Company has experienced increased turnover among its staff. The Company believes that this is primarily due to a much more favorable economic environment in Silicon Valley and to the explosive growth of the telecommunications industry creating a preponderance of new opportunities for the staff. The challenge confronting the Company in 1996 will be to attract and retain qualified staff in support of the Company's growth objectives. There can be no assurance that the Company will be successful in this area.