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 July 30, 2006
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 No. 0-5411
Herley Industries, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 23-2413500
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State or other jurisdiction (I.R.S. Employer
of incorporation or organization Identification No.)
101 North Pointe Blvd., Lancaster, Pennsylvania 17601
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (717) 735-8117
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $ .10 par value The NASDAQ Stock Market LLC
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(Title of Class) Name of each exchange on which registered
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark 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 period 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 check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
[ ] Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the Registrant's voting Common Stock held by
non-affiliates of the Registrant, based on the closing sale price of the Common
Stock of $16.96 as reported on The Nasdaq Global Market as of January 29, 2006,
the last business day of the Registrant's most recently completed second fiscal
quarter, was approximately $224,984,000.
The number of shares outstanding of Registrant's Common Stock, $ .10 par value
on October 18, 2006 was 13,862,149.
Documents incorporated by reference: None
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HERLEY INDUSTRIES, INC.
TABLE OF CONTENTS
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Page
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PART I
Item 1. Business. 3
Item 1A. Risk Factors. 11
Item 2. Properties. 16
Item 3. Legal Proceedings. 16
Item 4. Submission of Matters to a Vote of Security Holders. 17
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities. 17
Item 6. Selected Financial Data. 18
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 19
Item 7A. Quantitative and Qualitative Disclosures about Market Risk. 28
Item 8. Financial Statements and Supplementary Data. 29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure. 29
Item 9A. Controls and Procedures. 29
Item 9B. Other Information. 32
PART III
Item 10. Directors and Executive Officers of the Registrant. 32
Item 11. Executive Compensation. 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters. 37
Item 13. Certain Relationships and Related Transactions. 39
Item 14. Principal Accounting Fees and Services 40
PART IV
Item 15. Exhibits and Financial Statement Schedules. 41
SIGNATURES 43
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS F-1
2
PART I
Item 1. Business
FORWARD-LOOKING STATEMENTS
All statements other than statements of historical fact included in this Annual
Report, including without limitation statements under, "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business,"
regarding our financial position, business strategy and our plans and objectives
of management for future operations, are forward-looking statements.
Forward-looking statements involve various important assumptions, risks,
uncertainties and other factors which could cause our actual results to differ
materially from those expressed in such forward-looking statements.
Forward-looking statements in this Annual Report can be identified by words such
as "anticipate," "believe," "could," "estimate," "expect," "plan," "intend,"
"may," "should" or the negative of these terms or similar expressions. Although
we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, performance or achievement.
Actual results could differ materially from those contemplated by the
forward-looking statements as a result of certain factors including but not
limited to, competitive factors and pricing pressures, changes in legal and
regulatory requirements, cancellation or deferral of customer orders,
technological change or difficulties, difficulties in the timely development of
new products, difficulties in manufacturing, commercialization and trade
difficulties, the effects of the recently announced indictment of the Company
and general economic conditions as well as the factors set forth in our public
filings with the Securities and Exchange Commission.
You are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date of this Annual Report or the date of any
document incorporated by reference, in this Annual Report. We are under no
obligation, and expressly disclaim any obligation, to update or alter any
forward-looking statements, whether as a result of new information, future
events or otherwise.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in Section 21E of the Securities Exchange
Act of 1934.
GENERAL
The Company's corporate offices are located at 101 North Pointe Boulevard,
Lancaster, Pennsylvania 17601. The telephone number of the Company at that
location is (717) 735-8117. The Company's web site is located at www.herley.com.
The Company makes its periodic and current reports available, free of charge, on
its web site as soon as reasonably practicable after such material is
electronically filed with, or furnished to, the Securities and Exchange
Commission. The Company's Common Stock is listed on The Nasdaq Global Market
under the symbol "HRLY."
BACKGROUND
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including Northrop Grumman, Lockheed Martin, Raytheon and Boeing),
the U.S. Government (including the Department of Defense, NASA and other U.S.
Government agencies) and international customers (including the Egyptian,
German, Japanese and South Korean militaries and suppliers to international
militaries). We are a leading provider of microwave technologies for use in
command and control systems, flight instrumentation, weapons sensors and
electronic warfare systems. We have served the defense industry since 1965 by
designing and manufacturing microwave devices for use in high technology defense
electronics applications. Our products and systems are currently deployed on a
wide range of high profile military platforms, including the F-16 Falcon, the
F/A-18E/F Super Hornet, the RC-135 Rivet Joint, the E-2C Hawkeye, the AEGIS
class surface combatants, the EA-6B Prowler, the AMRAAM air to air missile, and
unmanned aerial vehicles, or UAVs, as well as high priority national security
programs such as National Missile Defense and the Trident II D-5.
ACQUISITIONS
We have grown internally and through strategic acquisitions and have evolved
from a component manufacturer to a systems and service provider. We have
successfully integrated these acquisitions by targeting microwave technology
companies and focusing their strengths into our existing operations. Since July
1995 our acquisitions have included the following:
- - In July 1995, we acquired Stewart Warner Electronics Corp. of Chicago,
Illinois, a manufacturer of high frequency radio and IFF interrogator systems.
- - In August 1997, we acquired Metraplex Corporation of Frederick, Maryland, a
manufacturer of airborne PCM and FM telemetry and data acquisition systems.
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- - In January 1999, we acquired General Microwave Corporation of Farmingdale, New
York, a manufacturer of microwave components and electronic systems.
- - In January 2000, we acquired Robinson Laboratories, Inc. of Nashua, New
Hampshire, a designer, developer and manufacturer of microwave components and
assemblies primarily for defense applications.
- - In September 2000, we acquired American Microwave Technology, Inc. of Anaheim,
California, a manufacturer of high power, solid state amplifiers for the
scientific and medical markets, which enabled us to enter these markets.
- - In September 2002, we acquired EW Simulation Technology, Limited ("EWST"), a
company located in Farnborough, in the United Kingdom. EWST designs, develops
and produces electronic warfare simulator systems for prime defense contractors
and countries worldwide.
- - In March 2004, we acquired Communication Techniques, Inc. ("CTI"), of
Whippany, New Jersey. CTI designs, develops and produces state-of-the-art signal
generation components and integrated assemblies for digital radio, SONET,
SatCom, test and instrumentation, datacom, and wired and wireless applications
to 45 Gigahertz ("GHz") and 45 Gigabits Per Second ("Gb/s").
- - In September 2004, we acquired Reliable System Services Corporation ("RSS"),
of Melbourne, Florida, a manufacturer of satellite based command and control
systems for defense customers. The RSS Iridium based command and control system
provides secure (encryption, anti-spoof) global service coverage, allowing
multiple target operations, and is complementary with the Company's MAGIC2
command and control systems.
- - In February 2005, we acquired Micro Systems, Inc. ("MSI"), Fort Walton Beach,
Florida, a market leader in the design and manufacturing of command and control
systems for operation of unmanned aerial, seaborne and ground targets and
missiles.
- - In April 2005, we acquired Innovative Concepts, Inc. ("ICI"), McLean,
Virginia, which has a successful history of developing and providing wireless
communications technology and real-time embedded systems, software, hardware and
high-speed processing in support of the defense industry.
BUSINESS STRATEGY
Our goal is to continue to leverage our proprietary technology, microwave
expertise and manufacturing capabilities to further expand our penetration in
our market. Our strategies to achieve our objectives include:
- - INCREASE LEVELS OF COMPONENT INTEGRATION AND VALUE ADDED CONTENT. Due to
growth of engineering expertise, new product development, and acquisitions, we
have increased our capability to provide more component integration. Management
believes component integration adds value and will enable us to increase content
in defense platforms and systems, thereby increasing our revenue and
profitability.
- - MAINTAIN LEADERSHIP IN MICROWAVE TECHNOLOGY. We intend to pursue further
technological advances through continued investment in internally-funded and
customer-funded research and product development.
- - STRENGTHEN AND EXPAND CUSTOMER RELATIONSHIPS. We have developed mutually
beneficial relationships with various agencies of the U.S. Government and
defense and commercial companies. We expect to continue to build and strengthen
these relationships with industry leaders by anticipating and recognizing their
needs and providing them with on-time and cost-effective solutions.
- - CAPITALIZE ON OUTSOURCING DYNAMICS IN THE AEROSPACE AND DEFENSE INDUSTRY.
Microwave technology has traditionally been an in-house resource of the prime
contractors. However, the prime contractors are beginning to outsource the
design and manufacture of this specialized engineering work to system
sub-contractors. We are well positioned to generate more business as prime
contractors continue to focus primarily on integration of defense electronics.
- - PURSUE STRATEGIC ACQUISITIONS. We intend to continue to augment our existing
technological base by acquiring specialized companies that complement or expand
our product offerings and market strategies. We believe that expansion of our
core competencies through the acquisition of such specialized technology
companies, when combined with our current technological and manufacturing
skills, will provide us with improved levels of horizontal and vertical
integration, leading to the creation of subsystems and complete system products.
- - ENHANCE MANUFACTURING CAPABILITIES. We intend to continue to implement process
manufacturing automation, and believe that our ability to develop a high level
of automated production and test capability will help to further improve our
cost effectiveness and time to market.
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- - PURSUE SELECTIVE COMMERCIAL OPPORTUNITIES. We seek to identify and pursue
selected commercial applications for our products and technologies where we can
add value based on our microwave expertise.
COMPETITIVE STRENGTHS
Our competitive strengths include:
- - TECHNICAL EXPERTISE. We have developed a leading position in the field of
microwave technology through more than 40 years of focus on research and
development and through our state-of-the-art design and production capabilities.
In fiscal 2002 we completed the expansion of our facilities in Lancaster,
Pennsylvania, including state-of-the-art manufacturing capacity, where we now
have a full range of capabilities including long and short run production,
hardware assembly and full-service engineering. In addition, we have highly
capable manufacturing facilities located in Woburn, Massachusetts; Farmingdale,
New York; Whippany, New Jersey; Fort Walton Beach, Florida; Farnborough,
England; and Jerusalem, Israel. We continue to develop and reward our engineers
in order to maintain our expertise in-house.
- - HIGH PROPORTION OF LONG-TERM SOLE-PROVIDER PRODUCTION PROGRAMS. We generate a
significant proportion of our revenue from continuing, long-term programs, both
in the production and upgrade phases, and continue to target high growth, high
priority defense programs. Typically, on such long-term defense programs we are
the sole provider of microwave equipment.
- - DIVERSE PRODUCT AND CUSTOMER BASE. We have a diverse product and customer
base. The U.S. Government accounted for approximately 22% of our fiscal 2006
revenues. No other customer accounted for 10% or more of our revenues in fiscal
2006. We are a first-tier supplier to all of the prime defense contractors, as
well as a direct supplier to all of the service branches of the U.S. military,
including products found on over 120 individual platforms. Foreign customers
accounted for approximately 24% of our revenues in fiscal 2006.
- - LONG-STANDING INDUSTRY RELATIONSHIPS. We have established long-standing
relationships with the U.S. Government and other key organizations in the
aerospace and defense industry after more than 40 years in the defense
electronic industry. Over this period, we have become recognized for our ability
to develop new technologies and meet stringent program requirements.
- - SUCCESSFUL ACQUISITION TRACK RECORD. We have demonstrated that we can
successfully integrate acquired companies. We are experienced at evaluating
prospective operations in order to increase efficiencies and capitalize on
market and technological synergies.
- - EMPHASIS ON RESEARCH AND DEVELOPMENT. In fiscal year 2006, we spent
approximately $30.3 million on new product development, of which our customers
funded approximately $21.2 million. Our emphasis on new product development
enables us to maintain our technological leadership in current products and to
develop new capabilities. This spending helps solidify and strengthen our
position on different programs and may serve as a barrier to entry for
competitors.
- - EXPERIENCED MANAGEMENT TEAM. Our senior management team averages over 25 years
of experience in the defense electronics industry.
PRODUCTS AND SERVICES
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. We design and manufacture microwave components and
subassemblies which are embedded in a variety of radars, flight instrumentation,
weapons sensors, electronic warfare systems and guidance systems. Our microwave
devices are used on our subassemblies and integrated systems (e.g. command and
control systems, telemetry systems, transponders, flight termination receivers
and identification friend or foe, or IFF, interrogators), in addition to being
sold on a component basis.
The following are descriptions of our major systems and products:
Telemetry Systems. Telemetry systems provide wireless data transmission between
two or more sites for recording and analysis. Missile, UAV, or target testing on
domestic and international test ranges requires flight safety and performance
data transmission to maximize flight safety during the test operation.
Surveillance and intelligence gathering UAVs also require a data transmission
downlink and a command and control systems uplink to accomplish their mission.
We have developed a telemetry system capability that can be configured to meet
individual customers' needs. Various components of the system include data
encoders, transmitters and flight termination receivers. Each has a distinctive
role and each is the key to the success of the mission.
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We are a leading manufacturer of Pulse Code Modulation, or PCM, and Frequency
Modulation, or FM, telemetry and data acquisition systems for severe environment
applications, and our products are used worldwide for testing space launch
vehicle instrumentation, aircraft flight testing, and amphibian, industrial and
automotive vehicle testing. The product portfolio ranges in size and complexity
from miniature encoders to completely programmable data acquisition systems.
We offer a complete airborne data link system. With our digital capability in
data encoding and acquisition elements combined with our radio frequency
capability in providing telemetry transmitters and flight termination receivers,
we offer a full line of narrow and wide-band airborne telemetry systems to meet
a wide variety of industrial needs, both domestically and internationally.
Command and Control Systems. Our command and control ("C2") systems principally
are used to fly remotely a large variety of unmanned aerial vehicles, or UAVs,
typically aircraft used as target drones or Remotely Piloted Vehicles, or RPVs.
Our C2 systems also control surface targets. Operations have been conducted by
users on the open ocean, remote land masses, and instrumented test and training
ranges. Our C2 systems are currently in service throughout the world. C2 systems
permit a ground operator to fly a target or a UAV through a pre-planned mission.
The mission may be for reconnaissance, where the vehicle is equipped with high
definition TV sensors and the necessary data links to send information back to
its C2 systems ground station. The UAV may also be used as a decoy, since the
operator can direct the flight operations that will make the small drone appear
to be a larger combat aircraft.
Our MONTAGE system affords over-the-horizon C2 using GPS guidance and control of
multiple targets from a single ground station. The ability to control multiple
targets at increased distances represents a significant product improvement. The
MONTAGE is a highly flexible, multiple processor design with high resolution
graphics, which can be field-configured within minutes to fly or control any
selected vehicle for which it is equipped. The MONTAGE is used in support of
missile, aircraft and other weapons systems development and testing. The system
meets a growing requirement to test against multiple threats with the automated
defense capabilities of ships like the AEGIS cruiser and the E-2C aircraft.
In September 2004, we closed on the purchase of Reliable System Services
Corporation ("RSS"). In addition to complementing and adding to our capabilities
in Telemetry, Electronic Warfare ("EW") Simulation Equipment, EW Jamming
Equipment and Range Safety Commanding applications, RSS significantly enhanced
our C2 capabilities for UAV platforms, in that RSS provides a C2 system for UAVs
that operates through the Iridium satellite system. The RSS Iridium based C2
system provides secure (encryption, anti-spoof) global service coverage,
allowing multiple target operations. The addition of this RSS Iridium based
alternate for UAV C2 systems enables us to provide a broader array of systems
configuration solutions to our defense industry customers.
Transponders. We manufacture a variety of expendable transponders, including
range safety, IFF, command and control, and range scoring systems. Transponders
are small, expendable, electronic systems consisting of a transmitter, sensitive
receiver and internal signal processing equipment comprised of active and
passive components, including microwave subassemblies such as amplifiers,
oscillators and circulators. The transponder receives signals from radars,
changes and amplifies the frequency of the signals, and transmits back a reply
on a different frequency and signal level. This reply is a strong, noise-free
signal upon which the tracking radar can "lock," and one which is far superior
to skin reflection tracking, particularly under adverse weather conditions after
the launch.
In range safety applications, transponders enable accurate tracking of space
launch and unmanned aerial vehicles, missiles, and target drones so that
position and direction are known throughout its flight. In the case of several
defense and commercial space launch vehicles (i.e., Delta, Atlas, Titan and
Pegasus), our transponder is tracked by the ground launch team all the way to
space orbit, and in certain instances through several orbits, as a reference
location point in space to assure that the launch payload has been properly
placed in orbit.
IFF transponders, which are used in conjunction with the Federal Aviation
Authority Air Traffic Control System, enable ground controllers to identify the
unmanned targets, drones and cruise missiles on which these units fly and to
vector other manned aircraft safely away from the flight path of the unmanned
aerial vehicle.
Command and control transponders provide the link through the telemetry system
for relaying ground signals to direct the vehicle's flight. The uplink from the
ground control station, a series of coded pulse groups, carries the signals that
command the flight control guidance system of the vehicle. The downlink to the
ground provides both tracking signals for range safety, as well as
acknowledgment and status of the uplink commands and their implementation in the
vehicle. The transponder is therefore the means to fly the vehicle. Scoring
systems are mounted on both airborne and sea targets. Scoring systems enable
test and evaluation engineers to determine the "miss-distance" between a
projectile and the target at which it has been launched.
Flight Termination Receiver. A flight termination receiver, or FTR, is installed
in a test missile, UAV, target or space launch vehicle as a safety device. The
FTR has a built-in decoder that enables it to receive a complex series of audio
tones which, when appropriate, will set off an explosive charge that will
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destroy the vehicle. A Range Safety Officer, or RSO, using the range safety
transponder will track the vehicle in flight to determine if it is performing as
required. If the RSO detects a malfunction in the test or launch vehicle that
causes it to veer from a planned trajectory in a manner that may endanger
personnel or facilities, the RSO will transmit a coded signal to the onboard FTR
to explode the vehicle.
HF Communications and IFF Interrogators. We design and manufacture high
frequency radio and IFF interrogators. This high frequency communications
equipment is used by the U.S. Navy and foreign navies that conduct joint
military exercises with the U.S. Navy. The IFF interrogators are used as part of
shipboard equipment and are also placed on coastlines, where they are employed
as silent sentries. We have been a significant supplier to the Republic of Korea
for over twenty years and have a large, established installed base of equipment.
We have been, and continue to be, a supplier to the Republic of Korea DDX, LPX
and KDX destroyer programs.
High Power Amplifier. We design and manufacture high power amplifier systems
with frequencies ranging from 1.5 Megahertz ("MHz") to 12 GHz with power levels
from multi-kilowatts up to 15W, depending on the frequency. Our high power
amplifier applications include but are not limited to defense communication,
electronic warfare, radar and avionics.
Microwave Integrated Circuits. We design and manufacture complex microwave
integrated circuits, or MICs, which consist of sophisticated assemblies that
perform many functions, primarily involving switching of microwave signals. Our
MICs are employed in many defense electronics systems and missile programs.
High/Low Power Integrated Assembly. Our high power microwave devices are used in
radar system transmitters and in long-range missiles. High power devices
frequently use small amounts of nuclear material to enhance breakdown of high
energy pulses, and we are one of very few companies with an active nuclear
license that permits the handling of these trace amounts of nuclear materials.
There are relatively few companies with the expertise or facilities to design,
manufacture and test high power devices. We also produce lower power, broad band
microwave integrated assemblies for the defense electronics industry. These
complex assemblies combine microwave functions such as amplification,
attenuation, switching of multiple signals, and phase and amplitude control.
Their applications include Rear Warning Receivers, or RWRs, Electronics
Countermeasure, or ECM, systems and highly sensitive receiver systems.
Solid State Receiver Protector. We have become a preeminent supplier of
solid-state receiver protector devices that are able to withstand high energy
pulses without the use of nuclear materials. These high power devices protect a
radar receiver from transient bursts of microwave energy and are employed in
almost every military and commercial radar system. For our engineering efforts
in designing solid-state receiver protectors for the F-16, we received cash
awards from the United States Air Force as part of the government's value
engineering program.
Digitally Tuned Oscillators (DTO's). We produce microwave sources, which
generate signals that are used in microwave oscillators. Our microwave sources
are sold to the U.S. defense industry and to various foreign governments. We
specialize in digitally tuned oscillators, or DTOs, a critical component in many
ECM systems.
Simulation Equipment. EW Simulation Technology Limited ("EWST"), a U.K. company
and wholly owned subsidiary, designs and manufactures radar threat and
electronic countermeasures simulation equipment for electronic warfare training
and test and evaluation applications. Radar threat and countermeasures simulator
products include but are not limited to the following:
CHAMELEON is a real time electronic countermeasures ("ECM") jamming simulator.
It uses a variety of ECM techniques and radar target modeling for training and
testing of both radar and EW operators and systems. The system offers a fully
programmable ECM capability using Digital RF Memories ("DRFM") technology; and
offers fully coherent jamming in both range and velocity through the use of
8-bit DRFM technology together with GUI software. The CHAMELEON is suited for
ground-based and airborne ECM test and training systems.
The RSS8000 Series Radar Threat Simulator generates real-time user programmable
radar threats and provides output configurations in digital (On-board
trainer-OBT) and RF (RSS series) formats. The system can be used for EW system
test and evaluation as well as for EW operator training in laboratory and more
rugged environments. The RSS8000 equipment covers the 100MHz to 40 GHz range and
can be configured to suit any application from a portable single RF source unit
to a multiple RF source and multiple port DF system. The DF systems are
available in amplitude, DTOA and/or phase formats with the ports being capable
of angular rotation.
Mobile EW and Radar Test Systems ("MERTS") is a mobile EW and radar test system
providing complete jamming and radar threat test facility for field use. It
provides a turnkey test and evaluation equipment for field applications and
includes both the CHAMELEON and RSS8000 systems integrated into one operational
unit. The MERTS equipment is housed within an air-conditioned ISO container
mounted on a four-wheel drive truck that allows on-site test and evaluation of
radar and EW systems as well as operator training.
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Scientific Products. Our scientific products are used extensively in Nuclear
Magnetic Resonance (NMR) systems. These amplifiers, which have dual mode
capability and can be operated in either a pulsed or continuous wave, cover the
frequency ranges of 6 MHz to 950 MHz, with power levels as high as 2.0KW peak
power at 10% duty cycle. Scientific customers include Original Equipment
Manufacturers ("OEM"), system manufacturers and research centers.
Medical Products. Our medical products vary in complexity from single modules,
to rack mounted amplifiers, to complete systems. The rack-mounted amplifiers and
complete systems typically include detection/protection circuitry, built-in
power supplies, front panel metering and digital and/or analog interface
controls. Both forced air and/or water cooling are used, depending on the
customer's requirements. Our medical products are used in Magnetic Resonance
Imaging, or MRI, systems. All amplifiers have dual mode capability and can be
operated in either a pulsed or continuous wave mode, and cover the frequency
ranges of 10 MHz to 200 MHz with power levels as high as 12.0KW peak power at
10% duty cycle. Medical customers include OEM, as well as universities and
research centers.
All products feature highly reliable technical solutions designed for improved
production and reliability. Producibility is enhanced through the use of surface
mount components and circuit designs which eliminate the need for excessive
alignment during the production cycle. High reliability is achieved through the
implementation of conservative thermal and RF circuit design and sophisticated
self-protection schemes. Reliability is further enhanced during the design phase
by employing detailed environmental testing.
CUSTOMERS
During the fiscal years ended July 30, 2006 and July 31, 2005, approximately 22%
and 25% of our net sales respectively, were attributable to contracts with
offices and agencies of the U.S. Government. During the fiscal year ended July
31, 2005, Northrop Grumman accounted for approximately 11% of net sales. No
other customers accounted for shipments of 10% or more of net sales in fiscal
2006 or 2005.
We provide defense electronics equipment to major defense prime contractors for
integration into larger platforms and systems. Some of our customers for defense
electronics equipment include:
The Boeing Company BAE Systems Harris Corporation
Lockheed Martin Corporation Northrop Grumman Corporation Raytheon Company
During fiscal 2006, sales to foreign customers accounted for approximately 24%
of our net sales. Sales to foreign customers from our domestic locations
accounted for 12% of net sales. Sales from England were 4%, and Israel 8% of net
sales to foreign customers. The governments of Egypt, Japan, South Korea, Taiwan
and the United Kingdom are all significant customers of ours. All of our
domestic contracts with foreign customers are payable in U.S. dollars. Contracts
with customers originating in Israel and England are either in U.S. dollars or
the local functional currency. International sales are subject to numerous
risks, including political and economic instability in foreign markets, currency
and economic difficulties in the Pacific Rim, restrictive trade policies of
foreign governments, inconsistent product regulation by foreign agencies or
governments, imposition of product tariffs and burdens and costs of complying
with a wide variety of international and U.S. export laws and regulatory
requirements. Our international sales also are subject to us obtaining export
licenses for certain products and systems.
SALES AND MARKETING
We market our products worldwide to the United States Government, prime
contractors and various countries in defense markets, and to OEM, research
institutions and universities in commercial markets. Sales are primarily through
a sales force generally organized by geographic territory and markets. In
addition, we have contracts with manufacturers' representatives in the United
States and international representatives who are located in Western Europe, the
Middle East and Asia. As part of our marketing efforts, we advertise in major
trade publications and attend major industrial shows in the commercial, medical,
satellite communications and defense markets.
After we have identified key potential customers, we make sales calls with our
own sales, management and engineering personnel. In order to promote widespread
acceptance of our products and provide customers with support, our sales and
engineering teams work closely with our customers to develop tailored solutions
to their requirements. We believe that our customer engineering support provides
us with a key competitive advantage.
We also produce microwave components that are sold through our catalog, which
for more than forty years has been an industry leader, and sell attenuating
devices and IQ modulation and phase shifters through the microwave engineer's
handbook.
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MANUFACTURING
We manufacture our products from standard components, as well as from items that
are manufactured by vendors to our specifications. A majority of our defense
electronics and commercial assemblies and subsystems contain proprietary
technology which is designed and tested by our engineers and technicians and is
manufactured at our own facilities.
We continue to invest in improving our proprietary manufacturing processes and
the automation of the manufacturing processes. Automation is critical in meeting
our customers' demands for price competitiveness, world class quality and
on-time delivery. We are also investing to enhance our responsiveness to the
production demands of our customers.
We purchase electronic components and other raw materials used in our products
from a large number of suppliers and all such materials are readily available
from alternate sources.
We maintain minimal levels of finished products inventory, principally to meet
the needs of our medical products customers. We generally purchase raw materials
for specific contracts, and we purchase common components for stock based on our
firm fixed backlog.
There are no significant environmental control procedures required concerning
the discharge of materials into the environment that require us to invest in any
significant capital equipment or that would have a material effect on our
earnings or our competitive position.
Quality assurance checks are performed on manufacturing processes, purchased
items, work-in-process and finished products. Due to the complexity of our
products, final tests are performed on some products by highly skilled engineers
and technicians.
Our primary manufacturing facilities have earned the ISO 9001 Registration. The
ISO 9000 series standards are internationally recognized quality management
system requirements. ISO 9001, the most comprehensive Standard in the ISO 9000
Series, covers design, manufacturing, installation, and servicing systems.
Assembly, test, package and shipment of products are done at our manufacturing
facilities located in the following cities:
Lancaster, Pennsylvania
Farmingdale, New York
Woburn, Massachusetts
Whippany, New Jersey
Fort Walton Beach, Florida
McLean, Virginia
Jerusalem, Israel
Farnborough, England
BACKLOG
Our total funded backlog of orders was approximately $125 million on July 30,
2006 which are orders covered by funded signed contracts or purchase orders. The
funded backlog on July 31, 2005 was approximately $145 million. There was no
"unfunded" backlog at July 30, 2006 or July 31, 2005. Of our total backlog at
July 30, 2006, $89 million (71%) is attributable to domestic orders and $36
million (29%) is attributable to foreign orders.
Backlog is not directly indicative of future sales. Accordingly, we do not
believe that our backlog as of any particular date is representative of actual
sales for any succeeding period. Management anticipates that approximately 84%
of the backlog at July 30, 2006 will be shipped during the fiscal year ending
July 29, 2007.
Approximately 94% of our contracts are firm fixed price contracts, some of which
require delivery over time periods in excess of one year. With this type of
contract we agree to deliver products at a fixed price, subject to adjustment,
for costs incurred because of change orders issued by the customer. The
remaining contracts are cost plus type contracts.
In accordance with Department of Defense procedures, all contracts involving
government programs may be terminated by the government, in whole or in part, at
the government's discretion for cause or convenience. In the event of a
termination for convenience, prime contractors on such contracts are required to
terminate their subcontracts on the program, and the government or the prime
contractor is obligated to pay the costs incurred by us under the contract to
the date of termination plus a fee based on the work completed.
9
PRODUCT DEVELOPMENT
We believe that our growth depends, in part, on our ability to renew and expand
our technology, products, and design and manufacturing processes with an
emphasis on cost effectiveness. We focus our primary efforts on engineering
design and product development activities rather than pure research. Our policy
is to assign the required engineering and support people, on an ad hoc basis, to
new product development as needs require and budgets permit. The cost of these
development activities, including employees' time and prototype development, was
approximately $30.3 million in fiscal 2006 (of which $14.2 million is
attributable to the acquisitions of MSI and ICI), $10.3 million in fiscal 2005
and $11.1 million in fiscal 2004. The portion of these costs not reimbursed by
customers was approximately $9.1 million in fiscal 2006, $5.0 million in fiscal
2005 and $5.4 million in 2004. These increases in development spending were
undertaken to continue to provide future business opportunities for the Company.
Future product development costs will depend on the availability of appropriate
development opportunities within the markets served by the Company.
COMPETITION
The microwave component and subsystems industry is highly competitive and we
compete against many companies, both foreign and domestic. Many of these
companies are larger, have greater financial resources and are better known. As
a supplier, we also experience significant competition from the in-house
capabilities of our customers.
Competition is generally based upon technology, design, past performance and
price. Our ability to compete depends, in part, on our ability to offer better
design and performance than our competitors and our readiness in facilities,
equipment and personnel to complete the programs. Many of the programs in which
we participate are long standing programs in which we are the sole provider of
our product.
GOVERNMENT REGULATION
Because of our participation in the defense industry, we are subject to audits
by various government agencies for our compliance with government regulations.
We are also subject to a variety of local, state and federal government
regulations relating to, among other things, the storage, discharge, handling,
omission, generation, manufacture and disposal of toxic or other hazardous
substances used to manufacture our products. We believe that we operate our
business in material compliance with applicable laws and regulations. However,
any failure to comply with existing or future laws or regulations could have a
material adverse impact on our business, financial condition and results of
operations.
INTELLECTUAL PROPERTY
We rely primarily on a combination of trade secrets and employee and third-party
non-disclosure agreements to protect our intellectual property, as well as
limiting access to the distribution of proprietary information. We cannot
provide assurance that the steps taken to protect our intellectual property
rights will be adequate to prevent misappropriation of our technology or to
preclude competitors from independently developing such technology. Furthermore,
we cannot provide assurance that, in the future, third parties will not assert
infringement claims against us with respect to our products. Asserting our
rights or defending against third party claims could involve substantial costs
and diversion of resources, thus materially and adversely affecting our
business, financial condition and results of operations. In the event a third
party were successful in a claim that one of our products infringed its
proprietary rights, we may have to pay substantial royalties or damages, remove
that product from the marketplace or expend substantial amounts in order to
modify the product so that it no longer infringes on such proprietary rights,
any of which could have a material adverse effect on our business, financial
condition and results of operations.
EMPLOYEES
As of July 30, 2006 we had 1,014 employees. We believe that our employee
relations are satisfactory. None of our approximately 871 U.S. based employees
are represented by a labor union. Employment by functional area as of July 30,
2006 is as follows:
Executive 16
Administration 59
Manufacturing 647
Engineering 225
Sales and Marketing 67
-----
Total 1,014
=====
We believe that our future success will depend, in part, on our continued
ability to recruit and retain highly skilled technical, managerial and marketing
personnel, including microwave engineers. To assist in recruiting and retaining
such personnel, we have established competitive benefits programs, including a
401(k) employee savings plan for our U.S. employees, and stock option plans.
10
OFFICERS OF THE REGISTRANT
Name Age Served as Officer Since Position(s) and Offices
- ---- --- ----------------------- -----------------------
Myron Levy 66 1988 Chairman of the Board,
Chief Executive Officer,
and Director
John M. Kelley 53 1998 President
Kevin J. Purcell 48 2006 Vice President and
Chief Financial Officer
Charles L. Pourciau, Jr. 58 2006 Vice President - Administration
and Governance
Andy Feldstein 55 2006 Vice President and Chief
Technology Officer
Rozalie Schachter 60 2000 Vice President - Business
Development
Anello C. Garefino 59 1993 Vice President - Finance
John A. Carroll 55 2003 Vice President - Human
Resources
Richard Poirier 41 2003 Vice President
Item 1A. Risk Factors
You should carefully consider the factors described below and other information
contained in this report. The risks and uncertainties described below are not
the only ones we face. Additional risks and uncertainties not presently known to
us, which we currently deem immaterial or which are similar to those faced by
other companies in our industry or business in general, may also impair our
business operations. If any of the following risks actually occurs, our
business, financial condition or results of operations could be materially and
adversely affected. In such case, the trading price of our common stock could
decline, and you may lose all or part of your investment. This report also
contains forward-looking statements that involve risks and uncertainties. Please
refer to "Forward-Looking Statements" included elsewhere in this report.
Risks Related to Recent Legal Proceedings
A finding of criminal liability against us in connection with the recent
indictment by the U.S. Attorney's office could have a material adverse effect on
our business and operating results.
On June 6, 2006 an indictment was returned against Herley Industries, Inc. and
Lee Blatt, our former Chairman by the U.S. Attorney's Office for the Eastern
District of Pennsylvania in connection with three government contracts completed
in October 2002 aggregating revenue of approximately $3.9 million. No other
officer, director or employee of ours was named in the indictment. The
indictment is on multiple charges in connection with purported activities
resulting in alleged excessive profits by us on three contracts with the U.S.
Government. We and Mr. Blatt could be fined up to approximately $13 million each
and we could be required to forfeit monies paid under the contracts. Under the
terms of an indemnification agreement with Mr. Blatt, the Company has agreed to
provide indemnification with regard to certain legal proceedings so long as he
has acted in good faith and in a manner believed to be in, or not opposed to,
the Company's best interest with respect to any criminal proceeding and had no
reasonable cause to believe his conduct was unlawful. We believe we have
substantial defenses to the charges alleged in the indictment and intend to
vigorously defend against these allegations; however, there can be no assurance
that we will be successful.
A further suspension of certain of our facilities from receiving new contract
awards could have a material adverse effect on our business.
On June 13, 2006, we were notified that as a consequence of the indictment,
certain of our operations had been suspended from receiving new contract awards
from the U. S. Government. The affected operations include facilities in
Lancaster, Pennsylvania, Woburn, Massachusetts, Chicago, Illinois and our
subsidiary in Farmingdale, New York. The Chicago, Illinois location is a
two-person marketing office. The result of this suspension was that these
facilities could not be solicited for or awarded new contracts or contract
extensions without special exceptions, pending the outcome of the criminal
proceeding. The suspended facilities could receive contract awards or
subcontracts from the Federal Government if the head of the agency states in
writing the compelling reason to do so.
11
Effective October 12, 2006, we entered into an Administrative Agreement with the
Department of the Navy, on behalf of the Department of the Defense that required
us, among other things, to implement a comprehensive program of compliance
reviews, audits and reports for a period of three years or until settlement or
adjudication of the legal matter referenced above, whichever is later, unless
shortened or extended by written agreement of the parties. In addition, we were
required to sever our relationship with Mr. Lee N. Blatt, former Chairman of the
Board of Directors, as our employee or consultant. In return, the Navy, on
behalf of the Department of Defense has terminated the suspension and debarment
of our operations from receiving new contract awards from the U.S. Government.
Our failure to comply with this Administrative Order or an unfavorable outcome
of the recent indictment could lead to a further suspension.
The recent class-action complaints against us could result in costly litigation
and payment of damages.
Since June 6, 2006, we have been served with several class-action complaints
against us and certain of our officers and directors in the United States
District Court for the Eastern District of Pennsylvania. The claims arise out of
the criminal indictment and are made under Section 10(b) and 20(a) of the
Securities Exchange act of 1934 and Rule 10b-5 thereunder. While we intend to
vigorously defend against these actions, their ultimate outcome is presently not
determinable as they are in the preliminary phase. Thus, we cannot at this time
determine the likelihood of an adverse judgment or a likely range of damages in
the event of an adverse judgment. If a class were ultimately certified, any
settlement of or judgment arising from such lawsuit could be material, and we
cannot give any assurance that we would have resources available to pay such
settlement or judgment. Additionally, any litigation to which we are subject may
be costly and could require significant involvement of our senior management and
may divert management's attention from our business and operations.
Risks Related to Our Business
A significant percentage of our sales are under government contracts which are
only partially funded initially and may lose funding or be terminated in future
years.
Approximately 67% of our net sales for fiscal 2006 and 65% of our net sales for
fiscal 2005 were made to United States government agencies and their contractors
and subcontractors for defense programs. Over its lifetime, a government program
may be implemented by the award of many different individual contracts and
subcontracts. The funding of government programs is subject to congressional
appropriations. Although multi-year contracts may be authorized in connection
with major procurements, Congress generally appropriates funds on a fiscal year
basis even though a program may continue for several years. Consequently,
programs are often only partially funded initially and additional funds are
committed only as Congress makes further appropriations. The termination of
funding for a government program would result in a loss of anticipated future
revenues attributable to that program which could have a negative impact on our
operations.
Generally, government contracts contain provisions permitting the government
agency to terminate the contract at its convenience, in whole or in part,
without prior notice, and to provide for payment of compensation only for work
done and commitments made at the time of termination. We cannot guarantee that
one or more of our government contracts will not be terminated under these
circumstances. Also, we cannot guarantee that we would be able to procure new
government contracts to offset the revenues lost as a result of termination of
any contracts. Because a substantial part of our revenues are dependent on our
procurement, performance and payment under our contracts, our failure to replace
sales attributable to a significant defense program or contract at its
termination, whether due to cancellation, spending cuts, budgetary constraints
or otherwise, could have a material adverse effect upon our business, financial
condition and results of operations.
Fixed-price contracts are common in all of our markets and may increase risks of
cost overruns and product non-performance.
Our customers set demanding specifications for product performance, reliability
and cost. Most of our customer contracts are firm, fixed price contracts,
providing for a predetermined fixed price for the products that we make,
regardless of the costs we incur. Thus, we must make pricing commitments to our
customers based on our expectation that we will achieve more cost effective
product designs and automate more of our manufacturing operations. The
manufacture of our products requires a complex integration of demanding
processes involving unique technical skill sets. We face risks of cost overruns
or order cancellations if we fail to achieve forecasted product design and
manufacturing efficiencies or if products cost more to produce than expected.
The expense of producing products can rise due to increased cost of materials,
components, labor, capital equipment or other factors. We may have cost overruns
or problems with the performance or reliability of our products in the future.
12
If we fail to win competitively awarded contracts in the future, we may
experience a reduction in our sales, which could negatively affect our
profitability.
We obtain many of our U.S. Government contracts through a competitive bidding
process. We cannot provide assurance that we will continue to win competitively
awarded contracts or that awarded contracts will generate sales sufficient to
result in our profitability. We are also subject to risks associated with the
following:
o the frequent need to bid on programs in advance of the completion of
their design (which may result in unforeseen technological
difficulties and cost overruns);
o the substantial time and effort, including the relatively unproductive
design and development required to prepare bids and proposals, spent
for competitively awarded contracts that may not be awarded to us;
o design complexity and rapid technological obsolescence; and
o the constant need for design improvement
Our government contracts may be subject to protest or challenge by unsuccessful
bidders or to termination, reduction or modification in the event of changes in
government requirements, reductions in federal spending or other factors. In
addition, failure to obtain a renewal or follow-on contract with U.S. Government
or foreign governments would result in a loss of revenues. If revenues from the
award of new contracts fail to offset this loss, it could have a material
adverse effect on our results of operations and financial position.
Our international sales are subject to risks related to doing business in
foreign countries.
In fiscal 2006 and 2005, international sales comprised approximately 24% and
27%, respectively, of our net sales, and we expect our international business to
continue to account for a significant part of our revenues. We currently
maintain significant manufacturing facilities in the United Kingdom and Israel.
International sales are subject to numerous risks, including political and
economic instability in foreign markets, currency and economic difficulties in
the Pacific Rim, restrictive trade policies of foreign governments, inconsistent
product regulation by foreign agencies or governments, imposition of product
tariffs and burdens and costs of complying with a wide variety of international
and U.S. export laws and regulatory requirements. The governments of Japan,
South Korea, Taiwan and the United Kingdom are all significant customers. Our
international sales also are subject to us obtaining export licenses for certain
products and systems. We cannot provide assurance that we will be able to
continue to compete successfully in international markets or that our
international sales will be profitable. Substantially all of our revenues in
fiscal 2006 at our domestic locations and our operation in Israel were
denominated in U.S. dollars, and we intend to continue to enter only into U.S.
dollar-denominated contracts. Revenues reported at our EWST (U.K.) facility are
primarily denominated in Pound Sterling and accounts for approximately 4% to 8%
of our consolidated net sales in U.S. dollars over the last three fiscal years.
In addition, fluctuations in currency could adversely affect our customers,
which may lead to delays in the timing and execution of orders.
We rely on a small number of significant customers.
A significant part of our sales have historically come mainly from contracts
with agencies of, and prime contractors to, the U.S. government. Net sales
directly to the U.S. government accounted for 22% of fiscal year 2006 net sales.
Additionally, approximately 38% of our net sales were attributable to our next
five largest customers for fiscal year 2006. Variations in the demand for our
products by any of these direct and indirect customers could have a serious,
adverse impact on our performance. If we were to lose any of these or any other
major customers, or if orders by any major customer were otherwise to be delayed
or reduced, including reductions due to market or competitive conditions in
commercial markets or further decreases in government defense spending, then our
business, financial condition and results of operations would be harmed.
We have limited intellectual property rights.
Our success is dependent upon our proprietary technology. We do not currently
have any material patents. We rely principally on trade secret and copyright
laws, certain employee and third-party non-disclosure agreements, as well as
limited access to and distribution of proprietary information, in order to
protect our technology. Trade secret laws afford us limited protection because
they cannot be used to prevent third parties from reverse engineering and
reproducing our products. Similarly, copyright laws afford us limited protection
because copyright protection extends only to how an idea is expressed and does
not protect the idea itself. Moreover, third parties could independently develop
technologies that compete with our technologies. We cannot provide assurance
that the obligations on the part of our employees and business partners to
maintain the confidentiality of our proprietary technology will prevent
13
disclosure of such information by our employees or third parties. Litigation may
be necessary for us to defend against claims of infringement or protect our
proprietary technology, which could result in substantial cost to us and
diversion of our efforts. We cannot provide assurance that we would prevail in
any such litigation. Our inability to protect our proprietary technology could
have a material adverse effect on our business, financial condition and results
of operations. Although we believe that our products and proprietary rights do
not infringe on the patents and proprietary rights of third parties, we cannot
provide assurance that infringement claims, regardless of merit, will not be
asserted against us. In addition, effective copyright and trade secret
protection of our proprietary technology may be unavailable or limited in
certain foreign countries.
We are subject to environmental laws and regulations and our ongoing operations
may expose us to environmental liabilities.
Our operations are subject to federal, state, foreign and local environmental
laws and regulations. As a result, we may be involved from time to time in
administrative or legal proceedings relating to environmental matters. We cannot
provide assurance that the aggregate amount of future clean-up costs and other
environmental liabilities will not be material. We cannot predict what
environmental legislation or regulations will be enacted in the future, how
existing or future laws or regulations will be administered or interpreted or
what environmental conditions may be found to exist. Enactment of more stringent
laws or regulations or more strict interpretations of existing laws and
regulations may require us to make additional expenditures, some of which could
be material.
A failure to attract and retain technical personnel could reduce our revenues
and our operational effectiveness.
There is a continuing demand for qualified technical personnel. We believe that
our future growth and success will depend upon our ability to attract, train and
retain such personnel. Competition for personnel in the defense industry is
intense and there are a limited number of persons, especially engineers, with
knowledge of and experience in microwave technology. Our design and development
efforts depend on hiring and retaining qualified technical personnel. Although
we currently experience relatively low rates of turnover for our technical
personnel, the rate of turnover may increase in the future. An inability to
attract or maintain a sufficient number of technical personnel could have a
material adverse effect on our contract performance or on our ability to
capitalize on market opportunities.
The markets in which we operate are competitive.
Our historical defense markets and our more recent commercial markets are
characterized by rapid technological change as new products are generally
developed quickly and industry standards are constantly evolving. Thus, our
products can become obsolete over a short period of time unless we succeed in
remaining technologically innovative and in anticipating new market demands.
The defense industry in particular has experienced substantial consolidation
due, among other things, to increasing pressures for cost reductions. This has
substantially increased competitive pressures and introduced delays in contract
funding and awards into our historical markets in the defense industry. Many of
our competitors are larger than us and have substantially greater financial and
other resources than we have. As a supplier, we also experience significant
competition from the in-house capabilities of our customers. Our ability to
compete for defense contracts largely depends on the following factors:
o our ability to offer better performance than our competitors;
o the readiness of our facilities, equipment and personnel to undertake
the programs for which we compete; and
o the effectiveness and innovations of our research and development
programs.
We may encounter difficulties in effectively integrating acquired businesses.
As part of our business strategy, we have augmented our technology base by
acquiring companies with compatible or related products. Historically, we have
acquired a number of such companies and products and have integrated those
companies into our business. These and any future acquisitions we make will be
accompanied by the risks commonly encountered in acquisitions of companies,
which include, among other things:
o potential exposure to unknown liabilities of acquired companies;
o higher than anticipated acquisition costs and expenses;
o difficulty and expense of assimilating the operations and personnel of
the companies, especially if the acquired operations are
geographically distant;
o potential disruption of our ongoing business and diversion of
management time and attention;
o failure to maximize our financial and strategic position by the
successful incorporation of acquired technology;
o difficulties in adopting and maintaining uniform standards, controls,
procedures and policies;
14
o loss of key employees and customers as a result of changes in
management; and
o possible dilution to our shareholders.
We may not be successful in overcoming these risks or any other problems
encountered in connection with any of our acquisitions. We may make a strategic
acquisition knowing that the transaction may adversely affect our short-term
profitability, perhaps because the acquisition candidate may be experiencing
operating losses. We may believe that acquiring such a company outweighs the
operating losses the candidate is experiencing and the losses that we expect to
experience before being able to make the acquisition candidate profitable. The
completion of such an acquisition in the future would negatively affect our
profitability and may cause a decline in our stock price.
Our backlog is subject to reduction and cancellation.
Backlog represents products or services that our customers have committed by
contract to purchase from us. Our backlog as of July 30, 2006, was approximately
$125 million. Typically, the majority of our backlog is filled within 12 months.
Our backlog is subject to fluctuations and is not necessarily indicative of
future backlog or sales. Moreover, cancellations of purchase orders or
reductions of product quantities in existing contracts could substantially and
materially reduce our backlog and, consequently, future revenues. Our failure to
replace canceled or reduced backlog could result in lower revenues.
Risks Related to Our Securities
Our stock price has fluctuated significantly and may continue to do so.
A number of factors could cause the market price of our common stock to
fluctuate significantly, including:
o our quarterly operating results or those of other defense companies;
o the public's reaction to our press releases, announcements and our
filings with the Securities and Exchange Commission, including
developments with respect to the recent indictment and suspension;
o changes in earnings estimates or recommendations by research analysts;
o changes in general conditions in the U.S. economy, financial markets
or defense industry;
o natural disasters, terrorist attacks or acts of war; and
o other developments affecting us or our competitors.
In recent years, the stock market has experienced extreme price and volume
fluctuations. This volatility has had a significant effect on the market price
of securities issued by many companies for reasons unrelated to the operating
performance of these companies.
Delaware law and our charter documents may impede or discourage a takeover,
which could cause the market price of our shares to decline.
We are a Delaware corporation and the anti-takeover provisions of Delaware law
impose various impediments to the ability of a third party to acquire control of
us, even if a change in control would be beneficial to our existing
shareholders. Our certificate of incorporation and by-laws provide, among other
things, for a classified board of directors serving staggered three-year terms.
Our incorporation under Delaware law, the acceleration of the vesting of
outstanding stock options including options that we have granted upon a change
in control, and certain provisions of our certificate of incorporation and
by-laws could impede a merger, takeover or other business combination involving
us or discourage a potential acquirer from making a tender offer for our common
stock, which, under certain circumstances, could reduce the market value of our
common stock.
15
Item 2. Properties
Our facilities are as follows:
Owned
Or
Location Purpose of Property Area Leased
- -------- ------------------- ------- ------
Lancaster, PA Corporate headquarters 3,300 sq. ft. Leased
Lancaster, PA Production, engineering and administration 86,200 sq. ft. Owned
Woburn, MA Production, engineering and administration 60,000 sq. ft. Owned
Farmingdale, NY (1) Production, engineering and administration 46,000 sq. ft. Leased
14,000 sq. ft. Leased
Whippany, NJ (2) Production, engineering and administration 23,000 sq. ft. Leased
Fort Walton Beach, FL Production, engineering and administration 20,000 sq. ft. Owned
Fort Walton Beach, FL (4) Production, engineering and administration 31,500 sq. ft. Leased
McLean, VA (5) Production, engineering and administration 43,260 sq. ft. Leased
Jerusalem, Israel Production, engineering and administration 29,580 sq. ft. Leased
Farnborough, England (3) Production, engineering and administration 7,570 sq. ft. Leased
Chicago, IL Engineering and administration 3,000 sq. ft. Leased
Lancaster, PA Land held for expansion 37 Acres Owned
- --------------
<FN>
(1) On September 23, 1999 we closed on the sale of its prior owned facility
in Amityville, NY and relocated the plant to this leased facility in
Farmingdale, NY. The Company entered into two 10 year lease agreements with a
partnership owned by the children of Messrs Blatt and Levy. The leases provide
for initial minimum annual rent of approximately $312,000 and $92,000,
respectively, in each case subject to escalation of approximately 4% annually
throughout the 10 year term.
(2) We entered into an agreement as of March 29, 2004 to acquire certain
assets and the business of Communication Techniques, Inc. as discussed in Note B
of the financial statements.
(3) As of September 1, 2002, we entered into an agreement to acquire all of
the issued and outstanding common stock of EW Simulation Technology, Limited.
(4) As of February 1, 2005, we entered into an agreement to acquire all of
the issued and outstanding common stock of Micro Systems, Inc. as discussed in
Note B of the financial statements. Prior to the acquisition of MSI, MSI had
leased one of its two buildings in Fort Walton Beach, Florida from MSI
Investments, a Florida General Partnership. MSI Investments is owned by four
individuals, three of whom are currently employees of MSI. This lease has an
original term of 15 years, ending December 31, 2012. The lease costs currently
are approximately $287,000 on an annual basis, including the tenant's obligation
to pay for insurance and property taxes. The base lease rate is adjusted every
January for changes in the consumer price index, using 1997 as the base year.
(5) As of April 1, 2005, we entered into an agreement to acquire all of the
issued and outstanding common stock of Innovative Concepts, Inc., including its
wholly owned subsidiary Stapor in Chantilly, VA as discussed in Note B of the
financial statements.
</FN>
We believe that these facilities are adequate for our current and presently
anticipated future needs.
Item 3. Legal Proceedings
As previously reported, there has been a continuing investigation by the U.S.
Attorneys' Office in Pennsylvania which, inter alia, involves pricing under
contracts with the U.S. Department of Defense relating to voltage control
oscillators and powerheads. The contracts aggregate approximately $3.9 million
in total revenue.
On June 6, 2006 an indictment was returned against the Company and Lee Blatt,
its former Chairman. No other officer or director of the Company was named in
the indictment. The indictment alleges 29 counts of violations of the wire fraud
statute (18 U.S.C. Section 1343); 2 counts of violations of the obstruction of a
federal audit statute (18 U.S.C. Section 1516); 1 count of violating the major
fraud against the United States statute (18 U.S.C. Section 1031); 3 counts of
violating the false statements to the government statute (18 U.S.C. Section
1001) and a notice of forfeiture. The Company believes that no criminal conduct
has occurred and will vigorously contest the charges. If convicted, Mr. Blatt
and the Company could be fined up to approximately $13 million each and the
Company could be required to forfeit approximately $2.9 million paid under the
contracts. Under the terms of an indemnification agreement with Mr. Blatt, the
Company has agreed to provide indemnification with regard to certain legal
proceedings so long as he has acted in good faith and in a manner believed to be
in, or not opposed to, the Company's best interest with respect to any criminal
proceeding and had no reasonable cause to believe his conduct was unlawful.
16
In June and July 2006, the Company was served with several class-action
complaints against the Company and certain of its officers in the United States
District Court for the Eastern District of Pennsylvania. The claims are made
under Section 10(b) and 20(a) of the Securities Exchange act of 1934 and Rule
10b-5 thereunder. In July 2006, the Company and its directors were also served
with a derivative complaint for breach of fiduciary duty brought pursuant to
Rule 23.1 of the Federal Rules of Civil Procedure. The complaints relate to the
Company's indictment in the matter discussed above. In addition, in June 2006
the Company was notified by representatives of the United States Attorney's
Office for the Eastern District of Pennsylvania, Civil Division, that they
intended to file a civil lawsuit against the Company pursuant to inter alia, the
False Claims Act, 31 U.S.C. ss. 3729 et. seq. The Company entered into a Tolling
Agreement on June 21, 2006, and does not anticipate any further activity related
to this potential claim until after the trial of the criminal matter mentioned
above.
The Company believes it has substantial defenses to the charges alleged in the
indictment and intends to vigorously defend against these allegations.
In connection with the Robinson Laboratories, Inc. ("RLI") litigation settled in
2005, by Order Dated February 17, 2005, the Company was awarded $2.1 million for
attorneys' fees. The judgment has not been paid by RLI and the receivable for
this award has not been recorded in the Company's consolidated financial
statements because RLI has no assets.
The Company is involved in various other legal proceedings and claims which
arise in the ordinary course of its business. While any litigation contains an
element of uncertainty, management believes that the outcome of such litigation
will not have a material adverse effect on the Company's financial position or
results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and
Issuer Purchases of Equity Securities.
(a) Our Common Stock is traded in The Nasdaq Global Market under the symbol
HRLY. The following table sets forth the high and low closing sales price
as reported by The Nasdaq Global Market for our Common Stock for the
periods indicated.
Common Stock
High Low
---- ---
Fiscal Year 2004
First Quarter............................................. 20.55 17.50
Second Quarter............................................ 22.85 18.24
Third Quarter............................................. 21.90 18.88
Fourth Quarter............................................ 21.92 18.50
Fiscal Year 2005
First Quarter ............................................ 19.77 17.32
Second Quarter............................................ 20.60 18.04
Third Quarter............................................. 20.27 16.40
Fourth Quarter............................................ 19.82 17.38
Fiscal Year 2006
First Quarter............................................. 21.54 16.45
Second Quarter ........................................... 17.80 15.74
Third Quarter ............................................ 21.38 16.98
Fourth Quarter ........................................... 20.77 9.21
The closing price on October 18, 2006 was $15.52.
As of October 18, 2006, there were approximately 190 holders of record and
approximately 2,400 beneficial holders of our Common Stock.
There have been no cash dividends declared or paid by us on our Common
Stock during the past two fiscal years.
(b) Not applicable.
17
Item 6. Selected Financial Data (in thousands except per share data):
53 weeks 52 weeks
52 weeks ended ended ended
----------------------------- -------- --------
July 30, July 31, August 1, August 3, July 28,
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Net sales (3) $ 176,268 151,415 122,154 110,223 92,881
Income from continuing operations $ 10,354 10,781 13,673 13,937 10,730
Loss from discontinued operations $ - - - - (921)
Cumulative effect of adopting SFAS 142 $ - - - - (4,637)
Net income $ 10,354 10,781 13,673 13,937 5,172
Per share data from continuing operations (1) (2)
Basic $ 0.72 0.75 0.97 0.97 0.89
Assuming Dilution $ 0.69 0.72 0.92 0.93 0.83
Total Assets $ 251,450 242,023 220,971 197,564 190,202
Total Current Liabilities $ 33,351 32,090 23,846 18,125 14,557
Long-Term Debt net of current portion $ 5,948 5,000 5,845 6,403 5,684
Other Long-Term Liabilities $ 1,265 1,042 932 849 706
<FN>
(1) Earnings per share from continuing operations are presented and calculated
before discontinued operations and cumulative effect of accounting change
in 2002.
(2) No cash dividends have been distributed in any of the years presented.
(3) See "Acquisitions" under Item 1. "Business".
</FN>
18
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements and notes thereto included in Item 8 of Part II of this
Annual Report on Form 10-K.
Business Summary
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including Northrop Grumman, Lockheed Martin, Raytheon and Boeing),
the U.S. Government (including the Department of Defense, NASA and other U.S.
Government agencies) and international customers (including the Egyptian,
German, Japanese and South Korean militaries and suppliers to international
militaries). We are a leading provider of microwave technologies for use in
command and control systems, flight instrumentation, weapons sensors and
electronic warfare systems. We have served the defense industry since 1965 by
designing and manufacturing microwave devices for use in high technology defense
electronics applications. Our products and systems are currently deployed on a
wide range of high profile military platforms, including the F-16 Falcon, the
F/A-18E/F Super Hornet, the RC-135 Rivet Joint, the E-2C Hawkeye, the AEGIS
class surface combatants, the EA-6B Prowler, the AMRAAM air to air missile, and
unmanned aerial vehicles ("UAVs"), as well as high priority national security
programs such as National Missile Defense and the Trident II D-5.
Significant Events
In connection with the legal matter discussed in Part I, Item 3. "Legal
Proceedings," we were notified on June 9, 2006 that certain of our operations
were suspended from receiving new contract awards from the U.S. Government. The
affected operations include facilities in Lancaster, Pennsylvania; Woburn,
Massachusetts; Chicago, Illinois and our subsidiary in Farmingdale, New York.
The Chicago, Illinois location is a two-person marketing office. The result of
this suspension was that these facilities could not be solicited for or awarded
new contracts or contract extensions without special exceptions, pending the
outcome of the legal proceedings. The suspended facilities could receive
contract awards or subcontracts from the Federal Government if the head of the
agency stated in writing the compelling reason to do so. A significant portion
of our business is received where we are the only qualified supplier on critical
defense programs.
Effective October 12, 2006, we entered into an Administrative Agreement with the
Department of the Navy, on behalf of the Department of the Defense that required
us, among other things, to implement a comprehensive program of compliance
reviews, audits and reports for a period of three years or until settlement or
adjudication of the legal matter referenced above, whichever is later, unless
shortened or extended by written agreement of the parties. In addition, we were
required to sever our relationship with Mr. Lee N. Blatt, former Chairman of the
Board of Directors, as our employee or consultant. In return, the Navy, on
behalf of the Department of Defense has terminated our suspension and debarment
from receiving new contract awards from the U.S. Government.
Our facilities which were not included in the action and who were at all times
free to contract with the U.S. Government are our facilities in Whippany, New
Jersey (Herley-CTI); Jerusalem (Herley-Israel); McLean, Virginia (Innovative
Concepts, Inc.); Fort Walton Beach, Florida (Micro Systems, Inc. and Herley-RSS)
and Farnborough, U.K. (EW Simulation Technology, Limited).
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy noted above, we entered
into an agreement (the "Agreement") with Lee N. Blatt to terminate his
Employment Agreement with us dated as of July 29, 2002 and modified on December
9, 2003. Under the terms of the Agreement Mr. Blatt will receive payments
totaling $9,461,528 payable $3,000,000 upon the effective date of the Agreement
and sixty-four (64) consecutive monthly payments of $100,000 commencing on
January 1, 2007 and a final payment of $61,528 on May 1, 2012 as evidenced by a
non-interest bearing Promissory Note dated effective October 12, 2006
("Promissory Note"). In addition Mr. Blatt will receive his bonus of $636,503
for fiscal year 2006, and shall be entitled to receive medical care
reimbursement and insurance, including life insurance, in accordance with the
original terms of his Employment Agreement. The Agreement also provides that all
outstanding stock options previously issued to Mr. Blatt which are all vested
and fully exercisable shall continue to be exercisable by him or, following his
death, by his designated beneficiaries, on or before the expiration date of the
specific option. On September 26, 2006, as required under the terms of the
Administrative Agreement with the Department of the Navy, Mr Blatt entered into
a voting trust agreement wherein sole voting power to 1,301,000 shares under
stock options held by Mr. Blatt and 28,799 shares held in his IRA was granted to
our Chairman, Myron Levy. In the event of a "change of control" as defined in
the Employment Agreement all remaining payments due under the Promissory Note
become immediately due and payable. Costs in connection with the Agreement will
be recorded in our consolidated financial statements in the first quarter ended
October 29, 2006.
In June 2006, in connection with the legal matter noted above, we were advised
by BDO SEIDMAN, LLP ("BDO"), our then independent registered public accountants,
that, due to their need to conduct an independent investigation of the
allegations in the indictment by outside counsel, BDO was unable to complete its
review of the interim consolidated financial statements for the quarter ended
April 30, 2006 by the due date of our Form 10-Q in accordance with established
professional standards and procedures for conducting such reviews. BDO
subsequently on July 27, 2006 informed us that they had resigned as our
auditors. In addition, by letter dated August 14, 2006 BDO informed us that it
19
was withdrawing its opinion on our financial statements for the fiscal year
ended July 31, 2005.
At a meeting held on July 27, 2006, our Audit Committee accepted the resignation
of BDO and approved the engagement of Marcum & Kliegman LLP as our independent
registered public accountants. In addition, on August 16, 2006 the Audit
Committee approved the engagement of Marcum & Kliegman LLP to also act as its
independent auditors for the fiscal years ended July 31, 2005 and August 1,
2004.
By letter dated June 16, 2006, we received written notification from Nasdaq that
since the Form 10-Q filed by us on June 14, 2006 had not been reviewed by our
accountants and did not include the required certifications, we were not in
compliance with Marketplace Rule 4310(c) (14). Accordingly, we were informed
that our securities would be delisted from The Nasdaq Stock Market. On June 22,
2006, we requested a hearing which was held on August 3, 2006. By letter dated
August 16, 2006, we received written notification from Nasdaq that our request
for continued listing on The Nasdaq Stock Market had been granted, subject to
our filing of a complete amended Form 10-Q by September 15, 2006. We filed the
required amended Form 10-Q on September 14, 2006. On September 18, 2006 we
received written notification from Nasdaq that since we had demonstrated
compliance with all Nasdaq Marketplace Rules our securities would continue to be
listed on The Nasdaq Global Market.
On June 15, 2006 we announced a resumption of the stock repurchase program
initially announced in October 2002 covering 1,000,000 shares of our common
stock and subsequently expanded on May 30, 2003 to cover 2,000,000 shares of
common stock. As of October 13, 2006 we had acquired approximately 1,898,000
shares of common stock under this program of which 798,567 shares were acquired
during the fourth quarter of fiscal 2006 at an aggregate cost of approximately
$9,044,000.
Results of Operations
The following table sets forth for the periods indicated certain financial
information derived from our consolidated statements of income expressed as a
percentage of net sales. There can be no assurance that trends in sales growth
or operating results will continue in the future.
52 weeks ended
--------------------------------------
July 30, July 31, August 1,
2006 2005 2004
------- ------- --------
Net sales 100.0% 100.0% 100.0%
Cost of products sold 72.6% 70.3% 65.1%
------- ------- --------
Gross profit 27.4% 29.7% 34.9%
Selling and administrative expenses 19.8% 20.0% 18.9%
------- ------- --------
Income from operations 7.6% 9.7% 16.0%
------- ------- --------
Other income (expense), net:
Investment income 0.5% 0.6% 0.6%
Interest expense (0.2%) (0.2%) (0.3%)
Foreign exchange gain (loss) 0.2% (0.2%) (0.1%)
------- ------- --------
0.5% 0.2% 0.2%
------- ------- --------
Income before income taxes 8.1% 9.9% 16.2%
Provision for income taxes 2.3% 2.8% 5.0%
------- ------- --------
Net income 5.8% 7.1% 11.2%
======= ======= ========
Fiscal 2006 Compared to Fiscal 2005
Net sales for the fifty-two weeks ended July 30, 2006 were approximately $176.3
million compared to $151.4 million for fiscal 2005, an increase of approximately
$24.9 million (16%). Net sales attributable to the acquisitions of MSI and ICI
completed in the third quarter of fiscal 2005 accounted for an increase of
approximately $21.3 million (14%) in net sales. We also experienced an
approximate $3.6 million (2%) net increase in sales at our other operations,
most significantly as follows:
o An increase in sales at our Lancaster operation of $1.9 million, which
includes $2.2 million in revenue in connection with a claim due to customer
20
delays and changes in specifications and designs under a major program, as
well as an increase of $3.0 million in the sales of Herley-Medical
products. These increases were offset by reduced sales caused by a
reduction in scheduled requirements of F18, IFF, AMRAAM and Meteor
programs.
o A net increase in sales at our Herley-Israel operation of approximately
$1.7 million, primarily driven by an increase in development and production
of sophisticated microwave integrated assemblies for military use to
various international customers.
Our level of intercompany sales, which are eliminated in consolidation,
increased to $10.0 million in fiscal 2006 from approximately $7.3 million in
fiscal 2005.
The gross profit margin for the fifty-two weeks ended July 30, 2006 was 27.4% as
compared to the margin of 29.7% in fiscal 2005, a decline of 2.3%. The decrease
in gross profit margins is primarily attributable to the following:
o Development costs on certain contracts in excess of billings to customers.
o Engineering costs related to penetration into new military markets.
o The transition of several new programs from engineering development to the
early stage of production, with startup costs not yet offset by production
revenues.
o The cumulative effects of changes in contract cost estimates on certain
programs accounted for under the percentage completion method of
accounting.
Offset by
o Higher gross margins contributed by our foreign operations and at recently
acquired businesses (MSI and ICI) from improved pricing, cost efficiencies,
and product mix.
Selling and administrative expenses for the fifty-two weeks ended July 30, 2006
were 19.8% of net sales as compared to 20.0% in fiscal 2005, or an increase of
$4.7 million. Significant increases during the period included:
o An increase of approximately $4.1 million attributable to selling and
administrative expenses related to the two acquisitions completed in the
third quarter of fiscal 2005 (MSI and ICI).
o Stock compensation costs of $0.5 million in connection with the adoption of
SFAS 123R as of August 1, 2005.
Legal expenses in fiscal 2006 were $2.3 million and were primarily attributable
to legal costs associated with the investigation and subsequent indictment by
the U.S. Attorneys' office in Pennsylvania. During fiscal 2005, legal costs
incurred were $2.7 million of which $1.8 million relates to the investigation
and the balance relates primarily to the litigation and settlement costs
involving Robinson Laboratories, Inc. and Ben Robinson which was settled in
fiscal 2005.
We spent approximately $17,000 in out-of-pocket consulting fees in fiscal 2006
versus $658,000 in out-of-pocket consulting fees in fiscal 2005 in connection
with our Sarbanes-Oxley Section 404 compliance program. The reduction in fees is
attributable to our establishment of an internal audit department and the use of
internal resources for compliance testing activities.
As a result of the above trends, our operating income for fiscal year 2006 was
$13,381,100 or 7.6% of net sales, as compared to $14,669,000 or 9.7% of net
sales in fiscal 2005. Our foreign operations contributed $2,748,000 in operating
income for the year as compared to $872,000 in fiscal 2005. Revenues from our
foreign operations increased by $1,550,000 as compared to fiscal 2005. The
increase in revenue and operating income within our foreign operations was
primarily driven by improved performance at Herley-Israel.
Investment income decreased by $95,000 in fiscal 2006 as a result of a decrease
on average of approximately $27 million in excess cash reserves invested,
attributable to cash used to fund the acquisitions in fiscal 2005 (see Note B);
offset by an increase of 65% in the rate of interest earned on the investment of
excess cash reserves and increased operating cash balances during the 2006
fiscal year as compared to fiscal 2005.
The effective income tax rate for both fiscal 2006 and 2005 was 28%. The
effective tax rate is lower than the statutory income tax rate of 35% primarily
due to net favorable tax benefits. The largest benefit in 2006 was due to a
lower effective tax rate on foreign source income, and in 2005 due to the
recognition of multi-year research and development tax credits realized. Other
benefits included research and development credits (prior to December 31, 2005),
tax benefits attributable to extra territorial income (i.e. export sales), the
Section 199 manufacturing deduction and tax exempt interest income.
21
Fiscal 2005 Compared to Fiscal 2004
Net sales for the fifty-two weeks ended July 31, 2005 were approximately
$151,415,000 compared to $122,154,000 for fiscal 2004, an increase of
approximately $29.3 million (24%). Net sales at our three acquisitions completed
in fiscal 2005 (RSS, MSI and ICI), accounted for an increase of approximately
$22.3 million, or approximately three quarters of the increase for the fifty-two
weeks ended July 31, 2005. Approximately $11.2 million of net sales increase is
attributable to CTI, which was consolidated into our results for only 4 months
in fiscal 2004, versus a full 12 months in fiscal 2005. In addition to this
impact of a full year results for CTI, CTI has experienced growth of greater
than 20% in sales in the fourth quarter of fiscal 2005 as compared to the fourth
quarter of fiscal 2004, principally due to growth at CTI in sales of military
products in CTI's direct synthesizer products.
Other than these acquisition driven impacts, our other divisions experienced a
net decline in sales for the year. The largest decline occurred in our Lancaster
operation with the decline in 2005 versus 2004 net sales being primarily
attributable to a reduction in revenues from the Automatic Carrier Landing
System ("ACLS") program of $1.7 million and a reduction of $1.3 million in
foreign sales.
The ACLS program was awarded in August 2001 and included three options over
three years. The third and final option was awarded in June 2005. The decline in
fiscal year 2005 revenue versus fiscal year 2004 is attributable to the
completion of the second year option in fiscal 2005 prior to the award of the
third year option which is currently in production.
Our UK subsidiary, EWST, experienced a reduction in revenue of approximately
$1.8 million in fiscal 2005 versus fiscal 2004, principally due to revisions to
(and increases in) estimated costs to complete certain contracts, which resulted
in a reduction in revenue recognized on these contracts. EWST began to
experience technical difficulties under two contracts in 2004 which continued
into fiscal 2005 causing delays in completion of the contracts and costs to
increase. In both cases, the primary reasons for costs increasing were changes
in the system design to meet customer specifications which resulted in
unanticipated labor and material costs and subsequent adjustments in the costs
to complete the projects. There are no specific market trends or other customer
related issues accounting for the fluctuation in foreign revenues other than the
timing of orders. There are no significant changes in the customer base or
products sold in fiscal 2005 versus fiscal 2004. Fifty percent of the foreign
revenue in fiscal 2004 came from three customers. Those same customers accounted
for twenty-eight percent of foreign revenue in fiscal 2005.
Our level of intercompany sales, which are eliminated in consolidation,
increased from approximately $6.1 million in fiscal 2004 to $7.3 million in
fiscal 2005.
The gross profit margin for the fifty-two weeks ended July 31, 2005 was 30% as
compared to the margin of 35% in fiscal 2004 a decline of 5%. Excluding the
impact of our three acquisitions completed in fiscal 2005 (RSS, MSI and ICI),
the decline in gross profit margins would have been larger. The decrease in
gross profit margins is primarily attributable to:
o The transition of several new programs from engineering development to the
early stage of production, with higher engineering costs not yet offset by
production revenues.
o Decreases of gross margins at EWST, principally due to changes in contract
cost estimates at that operation versus contract cost estimates in the
prior fiscal year for the same projects. The changes in contract cost
estimates were principally due to unanticipated delays in meeting technical
requirements and delivery dates on certain EWST contracts.
Offset by:
o Higher margins contributed by signal generation components and direct
sources, principally due to the fact that the prior year included only four
months of results for CTI, which was acquired effective as of March 29,
2004.
Selling and administrative expenses for the fifty-two weeks ended July 31, 2005
were 20% of net sales as compared to 17% in fiscal 2004, or an increase of $7.3
million. Large increases during the period included:
o Increases of approximately $4.0 million attributable to our three
acquisitions completed in fiscal 2005 (RSS, MSI and ICI).
o An increase of approximately $2.0 million due to the fact that the prior
year only included four months of results for CTI, which was acquired
effective as of March 29, 2004.
o An increase of approximately $935,000 in legal costs associated with
Robinson Laboratories and the continuing investigation and subsequent
indictment by the U.S. Attorneys' office in Pennsylvania.
22
We spent approximately $658,000 in out of pocket consulting fees in fiscal 2005
in connection with our Sarbanes-Oxley Section 404 compliance program.
As a result of the above trends, our Operating Income for fiscal year 2005 was
$14,669,000 or 10% of net sales, as compared to $19,602,000 or 16% of net sales
in fiscal 2004. Our foreign operations contributed $872,000 in operating income
for the year as compared to $3,017,000 in fiscal 2004. Revenues from our foreign
operations decreased by $1,319,000 as compared to fiscal 2004. The drop in
revenue and operating income within our foreign operations was due to revisions
in total cost estimates at our EWST subsidiary in the UK.
Investment income increased by $260,000 in fiscal 2005 as a result of an 89%
increase in the rate of interest earned on the investment of excess cash
reserves during the 2005 fiscal year as compared to interest rates in fiscal
2004, and a decrease on average of approximately $27.5 million in funds
invested.
The effective income tax rate for fiscal 2005 was 28% as compared to 31% in
fiscal 2004. The effective tax rate is lower than the statutory income tax rate
of 35% in fiscal 2005 due to various favorable tax benefits. The largest benefit
was from the recognition of multi year research and development tax credits now
being realized. Other benefits included a lower effective tax rate on
foreign-source income, the US tax benefits attributable to extra territorial
income (i.e. - export sales) and tax exempt interest income.
Liquidity and Capital Resources
As of July 30, 2006 and July 31, 2005, working capital was $92,088,000 and
$88,343,000 respectively, and the ratio of current assets to current liabilities
was 3.8 to 1 for each period.
As is customary in the defense industry, inventory is partially financed by
progress payments. In addition, it is customary for us to receive advanced
payments from customers on major contracts at the time a contract is entered
into. The un-liquidated balance of the progress payments was approximately
$2,573,000 at July 30, 2006, and $4,060,000 at July 31, 2005. The balance of
advanced payments was approximately $3,323,000 at July 30, 2006, and $1,888,000
at July 31, 2005.
Net cash provided by operating activities was approximately $15,319,000 in
fiscal 2006 as compared to $12,968,000 in 2005, an increase of approximately
$2.4 million. Income from operations (adjusted for depreciation and
amortization) was $17,450,000 in fiscal 2006 as compared to $16,464,000 in
fiscal 2005, an increase of approximately $1.0 million. Significant items
contributing to the net increase in cash provided by operating activities
include the following:
o A reduction of approximately $3.8 million in the amount of cash invested in
"Costs incurred and income recognized in excess of billings on uncompleted
contracts." The largest impact comes from milestone billings at our EWST
facility in 2006.
o A reduction of approximately $0.4 million in the amount of cash invested in
inventories during fiscal 2006 versus fiscal 2005.
o An increase of approximately $6.3 million in cash generated through advance
payments from customers on contracts during the course of fiscal 2006.
o An increase of approximately $1.6 million in cash generated from billings
to customers in excess of costs incurred and income recognized on
uncompleted contracts during the course of fiscal 2006.
Offset primarily by
o A decrease of approximately $5.9 million in cash generated from collection
of accounts receivable during fiscal 2006 versus fiscal 2005. The increase
in cash collections in fiscal 2005 resulted from collections for shipments
under a major contract at our Lancaster facility in connection with an
upgrade for US Navy aircraft. This job was largely shipped during fiscal
2004 and early in fiscal 2005, which resulted in increased collections of
accounts receivable in the first quarter of fiscal 2005. Trade receivables
increased in fiscal 2006 generally in relationship to the increase in sales
volume.
o A decrease of approximately $2.9 million resulting from payments to vendors
and reductions in accrued expenses.
o A reduction in income taxes payable of approximately $1 million.
23
Net cash used in investing activities includes:
o Additional payments of $1.3 million in connection with the Xytrans license
of certain technology to be used in missile and millimeter wave products.
(See Note A-8.)
o Capital expenditures of $6.2 million including approximately $3.8 million
invested in new equipment to further automate and upgrade our product test
facilities.
Net cash used in financing activities of $6.0 million results from the
following:
o Proceeds from the exercise of stock options for $3.2 million.
o The income tax benefit of $0.7 million in connection with the exercise of
stock options.
Offset by
o The purchase of 798,567 shares of treasury stock in the fourth quarter of
fiscal 2006 for approximately $9.0 million under a stock repurchase program
initially announced in October 2002 covering 1,000,000 shares of common
stock and subsequently expanded on May 30, 2003 to cover 2,000,000 shares
of common stock.
In June 2002, we entered into a new $50,000,000 Revolving Credit Loan Agreement
with two banks on an unsecured basis which may be used for general corporate
purposes, including business acquisitions. The revolving credit facility
requires the payment of interest only on a monthly basis and payment of the
outstanding principal balance on March 31, 2008 (as amended). We may elect to
borrow up to a maximum of $5,000,000 with interest based on the Federal Funds
Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum of $45,000,000
with interest based on LIBOR plus a margin of 1.35% to 1.65%. The applicable
incremental margin is based on the ratio of total liabilities to tangible net
worth, as those terms are defined in the agreement. The Federal Funds Target
Rate and the LIBOR rate was 5.25% and 5.40%, respectively, at July 30, 2006.
There is a fee of 15 basis points per annum on the unused portion of the
$45,000,000 LIBOR based portion of the credit facility payable quarterly. During
fiscal 2006, we utilized the credit facility for short term working capital
needs to the extent of $16.5 million. There were no borrowings outstanding under
the line at July 30, 2006 and July 31, 2005. Stand-by letters of credit were
outstanding in the amount of $10,285,000 under the credit facility at July 30,
2006.
We believe that presently anticipated future cash requirements will be provided
by internally generated funds, our existing unsecured credit facility and
existing cash reserves. A significant portion of our revenue for fiscal 2006
will be generated from our existing backlog of sales orders. The funded backlog
of orders at July 30, 2006 was approximately $125 million. All orders included
in backlog are covered by signed contracts or purchase orders. Nevertheless,
contracts involving government programs may be terminated at the discretion of
the government. In the event of the cancellation of a significant amount of
government contracts included in our backlog, we will be required to rely more
heavily on cash reserves and our existing credit facility to fund our
operations. We are not aware of any events which are reasonably likely to result
in any cancellation of our government contracts. We have approximately
$39,715,000 available under our bank credit facility, net of outstanding
stand-by letters of credit of approximately $10,285,000, and cash reserves at
July 30, 2006 of approximately $22,303,000.
Contractual Obligations and Commitments
Our obligations and commitments to make future payments under contracts, such as
purchase orders, and debt and lease agreements, and under contingent
commitments, such as stand-by letters of credit are as follows:
We have outstanding an aggregate of approximately $23,048,000 in open purchase
orders as of July 30, 2006. These open purchase orders represent executory
contracts for the purchase of goods and services which will be substantially
fulfilled in the next six months.
24
The following table summarizes the Company's contractual obligations and other
contingent commitments, including interest, at July 30, 2006 (in thousands):
Within 2-3 4-5 After 5
Obligations Total 1 Year Years Years Years
----------- ----- ------ ----- ----- -----
Mortgage Note $ 2,470 $ 131 $ 2,339 $ - $ -
Industrial Revenue Bonds 3,590 220 442 441 2,487
Operating Lease Obligations 15,742 3,244 5,972 4,293 2,233
Purchase Obligations 23,048 22,284 740 24 -
------ ------ ------ ------ ------
44,850 25,879 9,493 4,758 4,720
Standby Letters of Credit 10,284 8,067 592 - 1,625
------ ------ ------ ------ ------
Total Contractual Obligations $ 55,134 $ 33,946 $ 10,085 $ 4,758 $ 6,345
====== ====== ====== ====== ======
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy discussed earlier, we
entered into an agreement (the "Agreement") with Lee N. Blatt to terminate the
Employment Agreement between us and Mr. Blatt dated as of July 29, 2002 and
modified on December 9, 2003. Under the terms of the Agreement Mr. Blatt will
receive a total payment of $9,461,528 payable $3,000,000 upon the effective date
of the Agreement and sixty-four (64) consecutive monthly payments of $100,000
commencing on January 1, 2007 and a final payment of $61,528 on May 1, 2012 as
evidenced by a non-interest bearing Promissory Note dated effective October 12,
2006. In addition Mr. Blatt will receive his bonus of $636,503 for fiscal year
2006, and shall be entitled to receive medical care reimbursement and insurance,
including life insurance, in accordance with the original terms of his
Employment Agreement. The Agreement also provides that all outstanding stock
options previously issued to Mr. Blatt which are all vested and fully
exercisable shall continue to be exercisable by him or, following his death, by
his designated beneficiaries, on or before the expiration date of the specific
option. In the event of a "change of control" as defined in the Employment
Agreement all remaining payments due under the Promissory Note become
immediately due and payable.
We have an employment agreement with our Chairman/Chief Executive Officer (the
"Executive") which expires December 31, 2011, subject to extension for
additional one-year periods annually each January 1 with a final expiration date
of December 31, 2015. The agreement provides for an annual salary as of July 30,
2006 of $685,758 and provides for a semi-annual cost of living adjustment based
on the consumer price index. The agreement also provides for incentive
compensation at 3% in the aggregate of our pretax income.
The agreement also provides that, in the event there is a change in control, the
Executive has the option to terminate the agreement and receive a lump-sum
payment equal to the sum of the salary payable for the remainder of the
employment term, plus the annual bonuses (based on the average of the three
highest annual bonuses awarded during the ten preceding years) for the remainder
of the employment term. As of July 30, 2006, the amount payable in the event of
such termination would be approximately $7,592,000.
In addition, the agreement provides for a consulting period of ten years at the
end of the employment period at an annual compensation equivalent to one-half of
the executive's annual salary at the end of the employment period, subject to
annual cost of living adjustments.
In addition, certain of our executive officers have employment agreements which
expire June 6, 2009 providing for aggregate annual salaries as of July 30, 2006
of $590,000.
An employment contract of a retired executive provides for a consulting period
which became effective October 1, 1998, and terminates December 31, 2010 at the
annual rate of compensation of $100,000.
Several of our officers and key employees have severance agreements providing
for an aggregate lump-sum payment of approximately $3,320,000 through September
30, 2008 in the event of a change of control as defined in the agreements.
Several other employees have severance agreements, in the event of termination
of employment except for cause, expiring at various dates from December 2006
through February 2008, providing for an aggregate payment as of July 30, 2006 of
$1,910,000.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value
Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. It codifies the definitions
25
of fair value included in other authoritative literature; clarifies and, in some
cases, expands on the guidance for implementing fair value measurements; and
increases the level of disclosure required for fair value measurements. Although
SFAS 157 applies to (and amends) the provisions of existing authoritative
literature, it does not, of itself, require any new fair value measurements, nor
does it establish valuation standards. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. This statement will be effective for
our fiscal year beginning August 2008. We will evaluate the impact of adopting
SFAS 157 but do not expect that it will have a material impact on our
consolidated financial position, results of operations or cash flows.
In September 2006, the staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 108 ("SAB 108") which provides interpretive
guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year misstatement.
SAB 108 becomes effective in fiscal 2007. Adoption of SAB 108 is not expected to
have a material impact on our consolidated financial position, results of
operations or cash flows.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes (as amended) - an interpretation of FASB Statement No. 109"
("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with SFAS No.
109, "Accounting for Income Taxes," and prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is effective
for fiscal years beginning after December 15, 2006. We are in the process of
analyzing the impact of FIN 48, which is required to be adopted by the first
quarter of fiscal 2008.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets, an amendment of FASB Statements No. 140" ("SFAS 156"). SFAS
156 requires that servicing assets and servicing liabilities be recognized at
fair value, if practicable, when the Company enters into a servicing agreement.
This new standard will be effective as of the start of our first fiscal year
that begins after September 15, 2006. We do not expect the adoption of SFAS 156
to have a material impact on our consolidated financial position, results of
operations or cash flows.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments" ("SFAS 155"), an amendment of SFAS Nos. 133 and 140. SFAS
155 permits a fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation;
clarifies which interest-only strips and principal-only strips are not subject
to the requirements of Statement 133; establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation; clarifies that concentrations of
credit risk in the form of subordination are not embedded derivatives; and
amends Statement 140 to eliminate the prohibition on a qualifying
special-purpose entity from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative financial
instrument. This new standard will be effective for all financial instruments
acquired or issued after the beginning of our first fiscal year that begins
after September 15, 2006. We do not expect the adoption of SFAS 155 to have a
material impact on our consolidated financial position, results of operations or
cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20 "Accounting
Changes" and SFAS No. 3 "Reporting Accounting Changes in Interim Financial
Statements." SFAS 154 requires that a voluntary change in accounting principle
be applied retrospectively with all prior period financial statements presented
on the new accounting principle, unless it is impracticable to do so. SFAS 154
also provides that a correction of errors in previously issued financial
statements should be termed a "restatement." This new standard will be effective
for accounting changes and correction of errors for fiscal years beginning after
December 15, 2005. We do not expect that the adoption of SFAS 154 will have a
material impact on our consolidated financial position, results of operations or
cash flows.
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - An Interpretation of SFAS No. 143."
This Interpretation provides additional guidance as to when companies should
record the fair value of a liability for a conditional asset retirement
obligation when there is uncertainty about the timing and/or method of
settlement of the obligation. This Interpretation is effective no later than the
end of fiscal years ending after December 15, 2005. Management adopted this
Interpretation effective July 30, 2006. Adoption of FASB Interpretation No. 47
did not have a material impact on our consolidated financial position, results
of operations or cash flows.
In March of 2005, the SEC issued Staff Accounting Bulletin No. 107, "Share-Based
Payment" ("SAB 107"), which provides interpretive guidance related to the
interaction between SFAS 123(R) and certain SEC rules and regulations, as well
as provides the SEC staff's views regarding the valuation of share-based payment
arrangements. We have incorporated SAB 107 in the implementation and adoption of
SFAS 123(R).
26
In December 2004, the FASB issued SFAS No. 123(R), "Share Based Payment," which
is a revision of SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS
123(R)"). SFAS 123(R) is effective for publicly traded companies for annual
periods beginning after June 15, 2005, supersedes Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and amends SFAS No.
95, "Statement of Cash Flows." Management adopted this standard on August 1,
2005. See Note A-14 for a discussion of the impact on our consolidated financial
position, result of operations and cash flows upon adoption of SFAS 123(R).
Critical Accounting Policies and Estimates
Our established policies are outlined in the footnotes to the Consolidated
Financial Statements entitled "Summary of Significant Accounting Policies"
(contained in Part II, Item 8 of this Form 10-K). As part of our oversight
responsibilities, we continually evaluate the propriety of our accounting
methods as new events occur. We believe that our policies are applied in a
manner which is intended to provide the user of our financial statements a
current, accurate and complete presentation of information in accordance with
accounting principles generally accepted in the United States of America.
Important accounting practices that require the use of assumptions and judgments
are outlined below.
We generally recognize revenue when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the relevant receivable is
probable, persuasive evidence of an arrangement exists and the sales price is
fixed or determinable. Payments received from customers in advance of products
delivered are recorded as customer advance payments until earned. Approximately
94% of our customer contracts are firm, fixed price contracts, providing for a
predetermined fixed price for the products sold, regardless of the costs
incurred. Approximately 11% to 14% of revenues over the last three fiscal years
were derived from long-term, fixed price contracts for which revenues and
estimated profits are recognized using the percentage of completion method of
accounting based on estimated completion to date (the total contract amount
multiplied by the percentage of performance, based on total costs incurred in
relation to total estimated cost at completion). Contract costs include all
direct material and labor costs and those indirect costs related to contract
performance. Selling, general and administrative costs are charged to expense as
incurred. Risks and uncertainties inherent in the estimation process could
affect the amounts reported in our financial statements. The key assumptions
used in the estimate of costs to complete relate to labor costs and indirect
costs required to complete the contract. The estimate of rates and hours as well
as the application of overhead costs is reviewed on a regular basis. If our
business conditions were different, or if we used different assumptions in the
application of this and other accounting policies, it is likely that materially
different amounts would be reported on our financial statements.
Prospective losses on long-term contracts are based upon the anticipated excess
of costs over the selling price of the remaining units to be delivered and are
recorded in the period when first determinable. Actual losses could differ from
those estimated due to changes in the ultimate costs and contract terms.
Inventories are stated at lower of cost (principally first-in, first-out) or
market. A valuation allowance for obsolete and slow-moving inventory is
established based upon an aging of raw material components. Current requirements
for raw materials are evaluated based on current backlog of orders for products
in which the components are used and anticipated future orders.
Goodwill is tested for impairment in accordance with SFAS No. 142 using a fair
value approach applied to our one reporting unit. Impairment charges are
recognized for amounts where the reporting unit's goodwill exceeds its fair
value. An annual impairment test is performed in the fourth quarter of each
fiscal year. Any future impairment of goodwill will be charged to operations. We
amortize the cost of other intangibles over their estimated useful lives.
Amortizable intangible assets may also be tested for impairment if indications
of impairment exist.
We obtained a fair market value appraisal of the Company by an independent
investment banking firm. Based on this appraisal, we have determined that no
impairment in the carrying value of goodwill and intangible assets has occurred
at July 30, 2006.
Provisions for federal, foreign, state and local income taxes are calculated on
reported financial statement pretax income based on current tax law and also
include the cumulative effect of any changes in tax rates from those used
previously in determining deferred tax assets and liabilities. Such provisions
differ from the amounts currently payable because certain items of income and
27
expense are recognized in different time periods for financial reporting
purposes than for income tax purposes.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risk associated with foreign currency exchange and
changes in interest rates. We have not entered into any market risk sensitive
instruments for trading purposes.
Since the acquisitions of General Microwave Corporation and EWST, we are subject
to movements in foreign currency rate changes related to our operations in
Israel and in the U.K. The movements in the Israeli Shekel versus the U.S.
Dollar have not been significant. Movements in Pounds Sterling (the functional
currency at EWST) have been more significant.
For the fiscal years 2006, 2005 and 2004, EWST accounts for approximately 4% to
8% of our consolidated net sales, based in part on the rate at which EWST's
Sterling denominated financial statements have been converted into U.S. dollars.
Having a portion of our future revenue and income denominated in Sterling
exposes us to market risk with respect to fluctuations in the U.S. dollar value
of future Sterling denominated revenue and earnings. A 10% decline in the
average value of Sterling in fiscal 2006, for example, would have reduced sales
by approximately $680,000, and would have increased our consolidated operating
income by approximately $146,000 due to the reduction in the U.S. dollar value
of EWST's sales and operating loss. The average, high and low foreign currency
exchange rates during fiscal year 2006 were 1.79, 1.87 and 1.73 respectively. A
10% decline in the average value of Sterling in fiscal 2005, for example, would
have reduced sales by approximately $735,000, and would have increased our
consolidated operating income by approximately $193,000 due to the reduction in
the U.S. dollar value of EWST's sales and operating loss. The average, high and
low foreign currency exchange rates during fiscal year 2005 were 1.85, 1.93 and
1.76 respectively.
We have made inter-company advances to EWST in the aggregate amount of
approximately $7.6 million at July 30, 2006 that were previously considered
long-term advances. Since the advances are denominated in U.S. Dollars and EWST
anticipates reducing the amount of advances during fiscal year 2007, the amount
outstanding is subject to foreign exchange rate fluctuations.
In October 2001, we entered into an interest rate swap with a bank pursuant to
which it exchanged floating rate interest in connection with the Bonds discussed
in Note H of the financial statements on a notional amount of $3,000,000 for a
fixed rate of 4.07% for a ten-year period ending October 1, 2011. The notional
amount reduces each year in tandem with the annual installments due on the
Bonds. The fixing of the interest rate for this period offsets our exposure to
the uncertainty of floating interest rates on the Bonds, and as such has been
designated as a cash flow hedge. The hedge is deemed to be highly effective and
any ineffectiveness will be recognized in interest expense in the reporting
period. The fair value of the interest rate swap was a liability of
approximately $30,000 as of July 30, 2006. There was no material hedge
ineffectiveness related to cash flow hedges during the fiscal years presented to
be recognized in earnings.
We also have a $50 million Revolving Credit Loan Agreement with two banks on an
unsecured basis which may be used for general corporate purposes, including
business acquisitions. The revolving credit facility requires the payment of
interest only on a monthly basis and payment of the outstanding principal
balance on March 31, 2008. We may elect to borrow up to a maximum of $5 million
with interest based on the Federal Funds Target Rate plus a margin of 1.50% to
1.80%, or up to a maximum of $45 million with interest based on LIBOR plus a
margin of 1.35% to 1.65%. The applicable incremental margin is based on the
ratio of total liabilities to tangible net worth, as those terms are defined in
the Agreement. The Federal Funds Target Rate and the LIBOR rate was 5.25% and
5.40%, respectively, at July 30, 2006. The credit line is reviewed on an annual
basis.
There were no borrowings outstanding under our revolving credit facility as of
July 30, 2006.
The table below provides information about our debt that is sensitive to changes
in interest rates. Future principal payment cash flows by maturity date as
required under the industrial revenue bonds, and corresponding fair value is as
follows (in thousands):
Fiscal year ending Bonds
------------------ -----
2006 $ 115
2007 120
2008 125
2009 130
2010 135
2011 and later 1,965
-------
$ 2,590
=======
Fair value $ 2,622
=======
28
We do not anticipate any other material changes in our primary market risk
exposures in fiscal 2006.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data listed in the Index on Page F-1
are filed as a part of this report.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
I. Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our management,
including our principal executive officer (Chairman of the Board/Chief
Executive Officer) and principal financial officer (Vice President and
Chief Financial Officer), we have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) as of July 30, 2006 (the "Evaluation Date").
Based on such evaluation, the principal executive officer and the principal
financial officer have concluded that, as of the Evaluation Date, our
disclosure controls and procedures are effective, and are reasonably
designed to ensure that all material information (including our
consolidated subsidiaries) required to be included in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
Our review of our internal controls was made within the context of the
relevant professional auditing standards defining "internal controls,"
"significant deficiencies" and "material weaknesses." "Internal controls"
are processes designed to provide reasonable assurance that our
transactions are properly authorized, our assets are safeguarded against
unauthorized or improper use, and our transactions are properly recorded
and reported, all to permit the preparation of our consolidated financial
statements in conformity with accounting principles generally accepted in
the United States. "Significant deficiencies" are control issues that could
have a significant adverse effect on our ability to properly authorize
transactions; safeguard our assets; or record, process, summarize or report
financial data in the consolidated financial statements. A "material
weakness" is a particularly serious reportable condition where the internal
control does not reduce to a relatively low level the risk that
misstatements caused by error or fraud may occur in amounts that would be
material in relation to the consolidated financial statements and not be
detected within a timely period by employees in the normal course of
performing their assigned functions. As part of our internal controls
procedures, we also address other, less significant control matters that we
identify, and we determine what revision or improvement to make, if any, in
accordance with our on-going procedures.
II. Changes in Internal Control over Financial Reporting.
During the quarter ended July 30, 2006, there were certain changes in our
internal control over financial reporting which resulted from control
improvement and remediation efforts. These changes have not materially
affected, and are not likely to materially affect, such internal control
over financial reporting.
III. Management's Annual Report on Internal Control over Financial Reporting.
We are responsible for establishing and maintaining an adequate internal
control structure and procedures over financial reporting. We have assessed
the effectiveness of internal control over financial reporting as of July
30, 2006. Our assessment was based on criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO) Internal
Control-Integrated Framework.
Our internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. Our internal
control over financial reporting includes those policies and procedures
that:
29
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect our transactions and dispositions of our
assets;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles in the United States,
and that our receipts and expenditures are being made only in
accordance with authorizations of our management and board of
directors; and
(3) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of our assets that
could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect all misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may
deteriorate.
Based on the COSO criteria, we believe our internal control over financial
reporting as of July 30, 2006 was effective.
Our management's assessment of the effectiveness of our internal control
over financial reporting as of July 30, 2006 has been audited by Marcum &
Kliegman LLP, independent registered public accounting firm, as stated in
their report which is included below.
Important Considerations
The effectiveness of our disclosure controls and procedures and our
internal control over financial reporting is subject to various inherent
limitations, including cost limitations, judgments used in decision making,
assumptions about the likelihood of future events, the soundness of our
systems, the possibility of human error and the risk of fraud. Moreover,
projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes
in conditions and the risk that the degree of compliance with policies or
procedures may deteriorate over time. Because of these limitations, there
can be no assurance that any system of disclosure controls and procedures
or internal control over financial reporting will be successful in
preventing all errors or fraud or in making all material information known
in a timely manner to the appropriate levels of management.
30
Report of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting
To the Audit Committee of the
Board of Directors and Shareholders of
Herley Industries, Inc.
We have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control over Financial Reporting, that
Herley Industries, Inc. and Subsidiaries (the "Company") maintained effective
internal controls over financial reporting as of July 30, 2006, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and effectiveness of internal control, and performing other
procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that the receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention and
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of July 30, 2006 is fairly stated,
in all material respects, based on the criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Also in our opinion, the Company maintained, in all
material respects, effective internal controls over financial reporting as of
July 30, 2006, based on the criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of July 30, 2006 and July 31, 2005 and the related consolidated statements of
income, shareholders' equity, and cash flows and the related financial statement
schedule for the fifty-two (52) weeks ended July 30, 2006, July 31, 2005 and
August 1, 2004 of the Company and our report dated October 27, 2006 expressed an
unqualified opinion on those financial statements and financial statement
schedule.
/s/ Marcum & Kliegman LLP
- -------------------------
Marcum & Kliegman LLP
Melville, New York
October 27, 2006
31
Item 9B. Other Information
Not applicable
PART III
Item 10. Directors and Executive Officers of the Registrant
Directors of the Registrant
Director
--------
Name of Director Age Principal Occupation Since
---------------- --- -------------------- --------
Myron Levy 66 Chairman of the Board
and Chief Executive Officer 1992
Rear Admiral Edward K. Walker, Jr. (Ret.) 73 Vice Chairman of the Board 1997
(1)(2)(3)
Dr. Edward A. Bogucz (1) (3) 50 Executive Director of the New York Center 2003
of Excellence in Environmental Systems
Rear Admiral Robert M. Moore (Ret.) (1) (2) 67 Business and Financial Management Consultant 2003
John A Thonet 56 President of Thonet Associates 1991
Carlos C. Campbell (2) (3) 69 Business and Financial Management Consultant 2005
- --------------------
(1) Member of Compensation and Audit Committees
(2) Member of Corporate Governance Committee
(3) Member of Nominating Committee
Mr. Myron Levy was appointed Chairman of the Board in June 2006 after serving as
Vice Chairman of the Board since August 2003, and has been our Chief Executive
Officer since August 2001. Prior thereto, Mr. Levy served as President since
June 1993, as Executive Vice President and Treasurer since May 1991, and as Vice
President for Business Operations and Treasurer since October 1988. For more
than ten years prior to joining the Company, Mr. Levy, a certified public
accountant, was employed in various executive capacities, including
Vice-President, by Griffon Corporation. Mr Levy also serves as a Director of
NetWolves Corporation.
Rear Admiral Edward K. Walker, Jr. (Ret.) was appointed Vice Chairman of the
Board in June 2006. Rear Admiral Walker served as the Director of Corporate
Strategy for Resource Consultants, Inc., a privately held corporation supporting
the Department of Defense and other government agencies, after his retirement
from the United States Navy in 1988 until 2000. Prior to his retirement from the
United States Navy, Rear Admiral Walker served for 34 years in various naval
officer positions, including Commander of the Naval Supply Systems Command, and
Chief of Supply Corps. He holds a Bachelor's Degree from the United States Naval
Academy and Master's Degree in Business Administration from The George
Washington University.
Dr. Edward A. Bogucz is currently Executive Director of the New York Center of
Excellence in Environmental Systems, a university-industry consortium that
includes 12 universities and research institutions. Previously, Dr. Bogucz
served as Dean of Engineering and Computer Science at Syracuse University from
1995 through 2003. Dean Bogucz earned his bachelor's and doctoral degrees in
mechanical engineering from Lehigh University and a Master's Degree from
Imperial College, University of London. His teaching and research expertise
includes fluid dynamics, energy systems, computational methods, and
multidisciplinary analysis and design. As Dean, he led the strengthening of the
College of Engineering and Computer Science in selected areas, including RF and
microwave devices, information fusion, systems assurance, and environmental
technologies.
Rear Admiral Robert M. Moore (Ret.) is a consultant in business and financial
management. He is a retired Rear Admiral, U.S. Navy. His 35-year career in the
Navy culminated in his last assignment in charge of the Navy's worldwide supply
system. He holds a Bachelor's Degree from the University of Texas and a Master's
Degree in Business Administration from Harvard University.
Mr. John A. Thonet has been Secretary since January 2003, and is President of
Thonet Associates, an environmental consulting firm specializing in land
planning and zoning matters, for the past ten years. Mr. Thonet is the
son-in-law of Mr. Blatt.
Carlos C. Campbell operates a consulting business in Reston, Virginia and serves
on the Board of Directors for Resource America, Inc, NetWolves Corporation, and
Pico Holdings, Inc., all publicly traded companies. He is a veteran of nine
years as a Naval Flight Officer and served in the Administration of President
Reagan as the Assistant Secretary for Economic Development, U.S. Department of
Commerce.
32
Executive Officers of the Registrant
Name Age Position
---- --- ---------
Myron Levy 66 Chairman of the Board, Chief Executive Officer,
and Director
John M. Kelley 53 President
Kevin J. Purcell 48 Vice President and Chief Financial Officer
- -------------
John M. Kelley was appointed President in August 2003, and served as Executive
Vice President since July 2002. Prior thereto, Mr. Kelley served as Senior Vice
President since July 2000 and as Vice President/Director of Corporate
Communications since March 2000. Mr. Kelley joined us in December 1998 as
Director of Investor Relations. Prior to joining Herley, Mr. Kelley had fifteen
years of banking experience, most recently serving as Vice President at First
Capital Bank. Mr. Kelley earned his Bachelor of Science Degree in Business
Administration from the University of Arizona, Tucson, Arizona with Graduate
Degree Studies at UCLA.
Kevin J. Purcell was appointed Vice President and Chief Financial Officer in
June 2006. Prior to joining Herley, Mr. Purcell served as Vice President
Finance, Contracts and Compliance for Smiths Aerospace LLC, Customer Services
Americas. Previously, Mr. Purcell served other companies in senior financial
positions including Vice President and CFO, Controller and Director. In
addition, he worked for a number of years in the Government Contractor Advisory
Services group of KPMG. Mr. Purcell received his B.B.A. degree in financial
accounting from Iona College and his M.B.A. degree from Pepperdine University.
He is a Certified Public Accountant and a Certified Management Accountant.
Committees of the Board of Directors
Audit Committee and Audit Committee Financial Expert
The Board has a standing Audit Committee. The Board has affirmatively determined
that each director who serves on the Audit Committee is independent, as the term
is defined by applicable Nasdaq and Securities and Exchange Commission ("SEC")
rules. During 2006, the Audit Committee of the Board of Directors of the Company
consisted of Edward K. Walker (Chairman), Robert M. Moore, and Edward A. Bogucz.
The members of the audit committee have substantial experience in assessing the
performance of companies, gained as members of the Company's board of directors
and audit committee, as well as by serving in various capacities in other
companies or governmental agencies. As a result, they each have an understanding
of financial statements. However, none of them keep current on all aspects of
generally accepted accounting principles. Accordingly, the board of directors
does not consider any of them to be a financial expert as that term is defined
in applicable regulations. Nevertheless, the board of directors believes that
they competently perform the functions required of them as members of the audit
committee and, given their backgrounds, it would not be in the best interest of
the Company to replace any of them with another person to qualify a member of
the audit committee as a financial expert.
The Audit Committee regularly meets with our independent registered public
accounting firm outside the presence of management.
Compensation Committee
Our Compensation Committee annually establishes, subject to the approval of the
Board of Directors and any applicable employment agreements, the salaries which
will be paid to our executive officers during the coming year, and administers
our stock-based benefit plans. The Compensation Committee currently consists of
Edward A. Bogucz, Chairman, Edward K. Walker and Robert M. Moore. Each member of
the Compensation Committee is a director who is not employed by us or any of our
affiliates, and our independent directors under NASDAQ listing standards.
Nominating Committee
Our Nominating Committee currently consisting of Carlos Campbell, Chairman,
Edward K. Walker, and Edward A. Bogucz, each of whom is an independent director,
identifies individuals qualified to become Board members, recommends to the
Board nominees to fill vacancies in membership of the Board as they occur and,
prior to each Annual Meeting of Shareholders, recommends a slate of nominees for
election as Directors at such meeting.
Corporate Governance Committee
Our Corporate Governance Committee, currently consisting of Robert M. Moore,
Chairman, Edward K. Walker and Carlos Campbell, each of whom is an independent
33
director, monitors developments in corporate governance principles and other
corporate governance matters and makes recommendations to the Board of Directors
regarding the adoption of additional corporate governance principles.
Compliance with Section 16(a) of The Securities Exchange Act of 1934 -
Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires directors,
executive officers and persons who beneficially own more than 10% of our common
stock (collectively, "Reporting Persons") to file initial reports of ownership
and reports of changes in ownership of our common stock with the Securities and
Exchange Commission. Reporting Persons are required by SEC regulations to
furnish us with copies of all Section 16(a) reports they file. To our knowledge,
based solely on our review of the copies of such reports received or written
representations from certain Reporting Persons that no other reports were
required, we believe that during fiscal 2006, all Reporting Persons timely
complied with all applicable filing requirements.
Corporate Governance - Code of Ethics
We have adopted a Corporate Code of Business Ethics (the "Code") that applies to
all employees, including our principal executive officer, principal financial
officer, and directors of the Company. The Code is broad in scope and is
intended to foster honest and ethical conduct, including accurate financial
reporting, compliance with laws and the like. If any substantive amendments are
make to the Code or if there is any grant of waiver, including any implicit
waiver, from a provision of the Code to our Chief Executive Officer or Chief
Financial Officer, we will disclose the nature of such amendment or waiver in a
report on Form 8-K.
Item 11. Executive Compensation
The following table sets forth the annual and long-term compensation with
respect to our Chairman, Chief Executive Officer, and our other most highly
compensated executive officers other than the Chief Executive Officer who were
serving as executive officers at the end of the last completed fiscal year, and
certain former executive officers as required under SEC rules (collectively, the
"Named Executive Officers") for services rendered for the fiscal years ended
July 30, 2006, July 31, 2005 and August 1, 2004.
Summary Compensation Table
Annual Compensation (1) Long-Term Compensation
-------------------------------------------- -----------------------------------
Name and Securities
Principal Fiscal Underlying All Other
Position Year Salary (2) Bonus (3) Options Compensation
- -------- ------ ---------- --------- ---------- ------------
Lee N. Blatt 2006 $ 856,544 $ 636,503 $ 8,400 (5)
Former Chairman of 2005 824,830 650,131 200,000 (4) 6,150
the Board (6) 2004 787,950 1,207,680 6,500
Myron Levy 2006 $ 685,755 $ 477,377 $ 12,972 (5)
Chairman of 2005 660,363 487,598 200,000 (4) 10,722
the Board and 2004 630,851 987,010 11,072
Chief Executive
Officer (6)
John M. Kelley 2006 $ 250,016 $ 25,000 $ 9,228 (5)
President 2005 250,016 - 50,000 (4) 6,836
2004 227,884 35,000 6,741
William R. Wilson 2006 $ 240,011 $ - $ 9,948 (5)
Former Chief 2005 240,011 - 25,000 (4) 7,698
Operating Officer (7) 2004 214,528 80,000 8,048
Kevin J. Purcell 2006 $ 29,616 $ - 25,000 (4) $ -
Chief Financial
Officer (8)
- --------
<FN>
(1) Does not include Other Annual Compensation because amounts of certain
perquisites and other non-cash benefits provided by us do not exceed the
lesser of $50,000 or 10% of the total annual compensation disclosed in this
table for the respective officer.
(2) Amounts set forth herein include cost of living adjustments for Messrs.
Blatt and Levy under employment contracts.
34
(3) Represents for Messrs. Blatt and Levy incentive compensation under
employment agreements. Bonuses for all other employees are discretionary
bonuses.
(4) Consisting of the following options issued in June 2006 for the right to
purchase our Common Stock at a price of $19.38 to Kevin J. Purcell -
25,000; options issued in May 2005 for the right to purchase our Common
Stock at a price of $17.98: Lee N. Blatt - 200,000, Myron Levy - 200,000,
John M. Kelley - 40,000, and William Wilson - 20,000; and options issued in
December 2004 for the right to purchase our Common Stock at a price of
$19.83: John M. Kelley - 10,000, and William R. Wilson - 5,000.
(5) All Other Compensation includes: (a) group term life insurance as follows:
$4,572 for Mr. Levy, $828 for Mr. Kelley, and $1,548 for Mr. Wilson, and
(b) contributions to our 401(k) Plan as a pre-tax salary deferral of $8,400
for each of Messrs. Blatt, Levy, Wilson, and Kelley.
(6) Lee N. Blatt served as Chairman of the Board until his resignation on June
8, 2006. On October 12, 2006 Mr. Blatt accepted the terms of an agreement
with us terminating his employment agreement. Following Mr. Blatt's
resignation as Chairman of the Board, Myron Levy, former Vice Chairman, was
elected Chairman and Adm. Edward K. Walker was named Vice Chairman.
(7) Mr. Wilson served as Chief Operating Officer and Vice President from August
2003 until February 2006. On February 23, 2006 Mr. Wilson entered into a
consulting agreement with us effective March 1, 2006 and terminating on
December 31, 2006.
(8) Kevin Purcell was appointed Vice President and Chief Financial Officer on
June 5, 2006 at an annual rate of compensation of $220,000.
</FN>
Option Grants in Last Fiscal Year
The following table sets forth certain information concerning stock options
granted to the named executive officers during fiscal 2006.
Individual Grants
----------------------------------------------------------------------------------------------
Number of Potential Realized Value at
Securities % of Total Assumed Annual Rates of
Underlying Options Issued Exercise Stock Price Appreciation
Options to Employees in Price Expiration Option Term (3)
Name Granted(1) Fiscal Year(2) ($/Sh) Date 0% 5% 10%
- ---- ---------- -------------- ------ ---- -- -- ---
Kevin J. Purcell 25,000 32 $ 19.38 9/02/11 $ 0.00 $141,510 $314,764
- --------
<FN>
(1) Options issued in fiscal 2006 were at 100% of the closing price of our
common stock on the date of issue and vest as follows: one fifth of the
options vest one year from date of grant and one fifth each year
thereafter.
(2) Total options issued in fiscal 2006 to all employees were for 79,000 shares
of common stock.
(3) The amounts under the columns labeled "5%" and "10%" are included by us
pursuant to certain rules promulgated by the Commission and are not
intended to forecast future appreciation, if any, in the price of the
common stock. Such amounts are based on the assumption that the named
persons hold the options for the full term of the options. The actual value
of the options will vary in accordance with the market price of the common
stock. The column headed "0%" is included to demonstrate that the options
were issued with an exercise price greater than or equal to the trading
price of the Common Stock so that the holders of the options will not
recognize any gain without an increase in the stock price, which increase
benefits all stockholders commensurately.
</FN>
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
The following table sets forth stock options exercised during fiscal 2006
and all unexercised stock options held by the named executive officers as of
July 30, 2006.
Value of Unexercised
Number of Unexercised In the-Money
Shares Options at Fiscal Options at Fiscal
Acquired on Value Year-End Year-End (2)
Name Exercise(#) Realized($)(1) Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- -------------- ----------- ------------- ----------- -------------
Lee N. Blatt - - 1,301,000 - $ 869,198 -
Myron Levy - - 1,075,000 - 466,748 -
John M. Kelley 12,000 $ 131,708 87,000 - 27,150 -
William R. Wilson - - 45,000 - - -
Kevin J. Purcell - - - 25,000 - -
35
- -------
<FN>
(1) Values are calculated by subtracting the exercise price from the trading
price of the common stock as of the exercise date.
(2) Based upon the closing price of the common stock of $10.87 on July 30,
2006.
</FN>
Employment Agreements
Lee N. Blatt entered into an employment agreement with us, dated as of July
29, 2002 which was to expire December 31, 2011, subject to extension for
additional one-year periods annually each January 1 with a final expiration date
of December 31, 2015 (as amended December 9, 2003). The agreement provided for
an annual salary as of July 30, 2006 at the rate of $856,542 and for a
semi-annual cost of living adjustment based on the consumer price index. The
agreement also provided for incentive compensation at 4% in the aggregate of our
pretax income. Incentive compensation earned for fiscal year ended July 30, 2006
was $636,503. At the end of the employment period, the agreement provided for a
five-year consulting period at an annual compensation rate equivalent to
one-half of Mr. Blatt's annual salary in effect at the end of the employment
period, subject to annual cost of living adjustments. Mr. Blatt's employment
agreement was terminated effective October 12, 2006 as a condition to entering
into an administrative agreement with the Department of the Navy.
Myron Levy entered into an employment agreement with us, dated as of July
29, 2002 which expires December 31, 2011, subject to extension for additional
one-year periods annually each January 1 with a final expiration date of
December 31, 2015 (as amended December 9, 2003). The agreement provides for an
annual salary as of July 30, 2006 at the rate of $685,758 and provides for a
semi-annual cost of living adjustment based on the consumer price index. The
agreement also provides for incentive compensation at 3% in the aggregate of our
pretax income. Incentive compensation earned for fiscal year ended July 30, 2006
was $477,377. At the end of the employment period, the agreement provides for a
ten-year consulting period at an annual compensation rate equivalent to one-half
of Mr. Levy's annual salary in effect at the end of the employment period,
subject to annual cost of living adjustments.
The employment agreement with Mr. Levy provides for certain payments
following death or disability, and also provides that, in the event there is a
change in control, as defined, he has the option to terminate the agreement and
receive a lump-sum payment equal to the sum of the salary payable for the
remainder of the employment term, plus the annual incentive (based on the
average of the three highest annual incentive awarded during the ten preceding
years) for the remainder of the employment term. As of July 30, 2006, the amount
payable in the event of such termination would be approximately $7,592,000.
John M. Kelley entered into an employment agreement with us, dated as of
June 7, 2006 which expires June 6, 2009. The agreement provides for an annual
salary as of July 30, 2006 at the rate of $250,000, subject to review by the
Board of Directors, plus an annual bonus at the discretion of the Board of
Directors. In addition, Mr. Kelley has entered into a severance agreement with
us which provides that in the event of a change in our control, as defined,
prior to September 30, 2008, he is entitled to two years' base salary.
Kevin J. Purcell entered into an employment agreement with us, dated as of
June 7, 2006 which expires June 6, 2009. The agreement provides for an annual
salary as of July 30, 2006 at the rate of $220,000, subject to review by the
Board of Directors, plus an annual bonus at the discretion of the Board of
Directors. In addition, Mr. Purcell has entered into a severance agreement with
us which provides that in the event of a change in our control, as defined,
prior to June 10, 2008, he is entitled to two years' base salary.
Six other officers have severance agreements providing for an aggregate
lump sum payment of $1,980,000 through September 30, 2008 in the event of a
change of control as defined in the agreements.
Directors' Compensation
Directors who are our employees receive no additional compensation for
serving as Directors. Directors who are not our employees receive an annual fee
of $15,000 and a fee of $1,500 for each interim board of directors meeting
attended. The Corporate Governance Committee Chairman receives an annual fee of
$12,500, and other members of the Corporate Governance Committee receive $5,000
annually. The Audit Committee Chairman receives an annual fee of $25,000, and
other members of the Audit Committee receive $10,000 annually. The Compensation
Committee Chairman receives an annual fee of $7,500, and other members of the
Compensation Committee receive $5,000 annually. The Nominating Committee
Chairman receives an annual fee of $7,500, and other members of the Nominating
Committee receive $5,000 annually. We also reimburse each Director for the
reasonable expenses incurred in attending meetings of the Board of Directors and
committee meetings.
36
Board of Directors Interlocks and Insider Participation
In fiscal 2006, our Compensation Committee consisted of Dr. Edward A.
Bogucz, and Messrs. Edward K. Walker, Jr., and Robert M. Moore. None of these
persons were our officers or employees during fiscal 2006 nor had any
relationship requiring disclosures in this Annual Report.
Indemnification Agreements
We have entered into separate indemnification agreements with our officers
and directors. We have agreed to provide indemnification with regard to certain
legal proceedings so long as the indemnified officer or director has acted in
good faith and in a manner he or she reasonably believed to be in, or not
opposed to, our best interests and with respect to any criminal proceeding, had
no reasonable cause to believe his or her conduct was unlawful. We only provide
indemnification for expenses, judgments, fines and amounts paid in settlement
actually incurred by the relevant officer or director, or on his or her behalf,
arising out of proceedings brought against such officer or director by reason of
his or her corporate status.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth the beneficial ownership of shares of our
common stock as of September 30, 2006 of (i) each person known by us to
beneficially own 5% or more of the shares of outstanding common stock, based
solely on filings with the Securities and Exchange Commission, (ii) each of our
executive officers and directors, and (iii) all of our executive officers and
directors as a group. Except as otherwise indicated, all shares are beneficially
owned, and investment and voting power is held by the persons named as owners.
Common Stock % of Outstanding
Name of Beneficial Owner Beneficially Owned (1) (2) Shares
- ------------------------ -------------------------- -----------------------
Myron Levy 1,531,615 10.3%
John M. Kelley 104,423 *
Kevin J. Purcell (3) - *
Carlos C. Campbell 25,000 *
John A. Thonet (4) 118,038 *
Adm. Edward K. Walker, Jr. (Ret.) 58,500 *
Dr. Edward A. Bogucz 25,075 *
Adm. Robert M. Moore (Ret.) 25,000 *
Lee N. Blatt (5) 1,598,898 10.5%
Dimensional Fund Advisors, Inc. (6) 1,206,050 8.7%
Lotsoff Capital Management (7) 880,707 6.4%
Third Avenue Management, Inc. (8) 1,774,147 12.8%
Directors and executive
officers as a group
(8 persons) 1,887,651 12.4%
<FN>
- ---------
* Indicates ownership of less than one percent.
(1) No officer or director owns more than one percent of the outstanding shares
of common stock unless otherwise indicated. Ownership represents sole
voting and investment power.
(2) Includes beneficial ownership of the following number of shares that may be
acquired within 60 days of September 30, 2006 pursuant to stock options
awarded under our stock option plans:
</FN>
Myron Levy 1,075,000 Adm. Edward K. Walker, Jr. 57,000
John M. Kelley 87,000 Dr. Edward A. Bogucz 25,000
Carlos C. Campbell 25,000 Adm. Robert M. Moore 25,000
John A. Thonet 97,500 Directors and executive
officers as a group 1,391,500
(3) Mr. Purcell was appointed Vice President and Chief Financial Officer in
June 2006.
(4) Does not include 155,998 shares, owned by Mr. Thonet's children, Hannah and
Rebecca Thonet, and 31,287 shares owned by his wife, Kathi Thonet. Mr.
Thonet disclaims beneficial ownership of these shares.
(5) Includes beneficial ownership of 1,301,000 shares that may be acquired
within 60 days of September 30, 2006 pursuant to stock options awarded
under our stock option plans, 172,300 shares held in the name of Mrs.
Blatt, 96,799 shares held in the Blatt Family Charitable Trust and 28,799
shares held in Mr. Blatt's individual retirement account ("IRA"). On
September 26, 2006, as required under the terms of the Administrative
Agreement with the Department of the Navy, Mr Blatt entered into a voting
37
trust agreement wherein sole voting power to the 1,301,000 shares under
stock options held by Mr. Blatt and the 28,799 shares held in his IRA was
granted to our Chairman, Myron Levy. Does not include an aggregate of
431,773 shares owned by family members, including Hannah Thonet, Rebecca
Thonet, Kathi Thonet, Randi Rossignol, Max Rossignol, Henry Rossignol and
Allyson Brenner, of which Mr. Blatt disclaims beneficial ownership.
(6) Address is 1299 Ocean Avenue, Santa Monica, CA 90401.
(7) Address is 20 North Clark Street, 34th Floor, Chicago, IL 60602.
(8) Address is 622 Third Avenue, New York, NY 10017
Equity Compensation Plan Information
The following table sets forth the indicated information as of July 30,
2006 with respect to our equity compensation plans:
(c)
(a) Number of securities
Number Remaining available
of securities (b) for future issuance
to be issued upon Weighted-average under equity
exercise of exercise price of compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
- ------------- ------------------- ------------------- ------------------------
Equity compensation
Plans approved by
security holders 2,481,273 13.19 25,779
Equity compensation
plans not approved
by security holders 1,008,807 18.24 218,700
Total 3,490,080 14.65 244,479
The following information is provided about our stock option plans:
2006 New Employee Stock Option Plan. The 2006 New Employee Stock Option
Plan covers 250,000 shares of common stock. Options granted under the plan are
non-qualified stock options. Under the terms of the plan, the exercise price for
options granted under the plan will be the fair market value at the date of
grant. The nature and terms of the options to be granted are determined at the
time of grant by the compensation committee or the board of directors. The
options expire no later than ten years from the date of grant, subject to
certain restrictions. Options for 33,000 shares were granted during the fiscal
year ended July 30, 2006 and are outstanding at July 30, 2006.
2003 Stock Option Plan. The 2003 Stock Option Plan covers 1,000,000 shares
of common stock. Options granted under the plan are non-qualified stock options.
Under the terms of the plan, the exercise price of options granted under the
plan will be the fair market value at the date of grant. The nature and terms of
the options to be granted are determined at the time of grant by the
compensation committee or the board of directors. If not specified, 100% of the
shares can be exercised one year after the date of grant. The options expire not
later than ten years from the date of grant, subject to certain restrictions.
Options for 16,300 shares were granted under this plan during the fiscal year
ended July 30, 2006. At July 30, 2006, options to purchase 968,600 shares of
common stock were outstanding under this plan.
2000 Stock Option Plan. The 2000 Stock Option Plan covers 1,500,000 shares
of common stock. Options granted under the plan are non-qualified stock options.
Under the terms of the plan, the exercise price of options granted under the
plan will be the fair market value at the date of grant. The nature and terms of
the options to be granted are determined at the time of grant by the
compensation committee or the board of directors. If not specified, 100% of the
shares can be exercised one year after the date of grant. The options expire not
later than ten years from the date of grant, subject to certain restrictions.
Options for 18,000 shares were granted under this plan during the fiscal year
ended July 30, 2006. At July 30, 2006, options to purchase 1,290,900 shares of
common stock were outstanding under this plan.
1998 Stock Option Plan. The 1998 Stock Option Plan covers 2,250,000 shares
of common stock. Options granted under the plan may be incentive stock options
qualified under Section 422 of the Internal Revenue Code of 1986, as amended, or
non-qualified stock options. Under the terms of the plan, the exercise price of
options granted under the plan will be the fair market value at the date of
grant. Prices for incentive stock options granted to employees who own 10% or
more of our stock are at least 110% of market value at the date of grant. The
38
nature and terms of the options to be granted are determined at the time of
grant by the compensation committee or the board of directors. If not specified,
100% of the shares can be exercised one year after the date of grant. The
options expire not later than ten years from the date of grant, subject to
certain restrictions. Non-qualified stock options for 9,000 shares were granted
under this plan during the fiscal year ended July 30, 2006. At July 30, 2006,
options to purchase 1,032,292 shares of common stock were outstanding under this
plan.
1997 Stock Option Plan. The 1997 Stock Option Plan covers 2,500,000 shares
of common stock. Options granted under the plan may be incentive stock options
qualified under Section 422 of the Internal Revenue Code of 1986, as amended, or
non-qualified stock options. Under the terms of the plan, the exercise price of
options granted under the plan will be the fair market value at the date of
grant. Prices for incentive stock options granted to employees who own 10% or
more of our stock are at least 110% of market value at the date of grant. The
nature and terms of the options to be granted are determined at the time of
grant by the compensation committee or the board of directors. If not specified,
100% of the shares can be exercised one year after the date of grant. The
options expire not later than ten years from the date of grant, subject to
certain restrictions. Non-qualified stock options for 2,700 shares were granted
under this plan during the fiscal year ended July 30, 2006. At July 30, 2006,
options to purchase 158,081 shares of common stock were outstanding under this
plan.
1996 Stock Option Plan. The 1996 Stock Option Plan which has now expired
with respect to the granting of new options covers 1,000,000 shares of common
stock. Options which have been granted under the plan are non-qualified stock
options. Under the terms of the plan, the exercise prices of the options granted
under the plan were at the fair market value at the date of grant. The options
expire not later than ten years from the date of grant. At July 30, 2006,
non-qualified options to purchase 7,007 shares of common stock were outstanding
under this plan.
Employee Savings Plan
We maintain an Employee Savings Plan ("Plan") which qualified as a thrift
plan under Section 401(k) of the Internal Revenue Code. This Plan, as amended
and restated, allows employees to contribute between 2% and 30% of their
salaries to the Plan. For the Plan year beginning August 1, 2005, the Plan was
amended to be considered a "Safe Harbor" plan, where a contribution will be made
to eligible participants in an amount equal to 100% of the amount of each
participant's elective deferral that does not exceed 3% of compensation, plus
50% of the amount of the elective deferral that exceeds 3% of compensation up to
a maximum contribution of 5% of compensation. Under the Safe Harbor provision,
all contributions are 100% vested when made. Additional contributions can be
made by us, depending on profits. The aggregate benefit payable to an employee
is dependent upon the employee's rate of contribution, the earnings of the fund,
and the length of time such employee continues as a participant. We recognized
expenses of approximately $1,773,000 (including approximately $727,000 related
to the acquisitions of MSI, ICI, and RSS), $1,038,000 (including approximately
$268,000 related to the acquisitions of MSI, ICI, and RSS), and $618,000 under
the Plan for the 52 weeks ended July 30, 2006, July 31, 2005 and August 1, 2004,
respectively. For the year ended July 30, 2006, $8,400 was contributed by us to
this plan for each of Messrs. Blatt, Levy, Wilson, and for Mr. Kelley. A total
of $72,601 was contributed for all officers and directors as a group.
Item 13. Certain Relationships and Related Transactions.
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy (see Note A.1), the
Company entered into an agreement (the "Agreement") with Lee N. Blatt to
terminate the Employment Agreement between the Company and Mr. Blatt dated as of
July 29, 2002 and modified on December 9, 2003. Under the terms of the Agreement
Mr. Blatt will receive a lump sum payment of $9,461,528 payable $3,000,000 upon
the effective date of the Agreement and sixty-four (64) consecutive monthly
payments of $100,000 commencing on January 1, 2007 and a final payment of
$61,528 on May 1, 2012 as evidenced by a Promissory Note dated effective October
12, 2006. In addition Mr. Blatt will receive his bonus of $636,503 for fiscal
year 2006, and shall be entitled to receive medical care reimbursement and
insurance, including life insurance, in accordance with the original terms of
his Employment Agreement. The Agreement also provides that all outstanding stock
options previously issued to Mr. Blatt which are all vested and fully
exercisable shall continue to be exercisable by him or, following his death, by
his designated beneficiaries, on or before the expiration date of the specific
option. In the event of a "change of control" of the Company as defined in the
Employment Agreement all remaining payments due under the Promissory Note become
immediately due and payable.
In connection with the move of the Amityville facilities of GMC in fiscal
1999, the Company entered into a 10 year lease agreement with a partnership
owned by the children of certain officers of the Company. The lease provides for
initial minimum annual rent of $312,000 subject to escalation of approximately
4% annually throughout the 10 year term. Additionally, in March 2000, The
Company entered into another 10 year lease with the same partnership for
additional space. The initial minimum annual rent of $92,000 is subject to
escalation of approximately 4% annually.
39
Item 14. Principal Accountant Fees and Services.
Marcum & Kliegman LLP is our independent registered public accounting firm and
performed the audit of our consolidated financial statements for fiscal years
2006, 2005 and 2004. BDO SEIDMAN, LLP, our former independent registered public
accounting firm, informed us on July 27, 2006 that they had resigned as our
auditors. In addition, by letter dated August 14, 2006 BDO informed us that they
were withdrawing their opinion on our financial statements for the fiscal year
ended July 31, 2005. The following table sets forth estimated fees for the
audits of the fiscal years ended July 30, 2006 and July 31, 2005 performed by
Marcum & Kliegman LLP:
2006 2005
---- ----
Audit Fees (1) $ 475,000 $ 225,000
<FN>
- ---------------
(1) Audit Fees includes fees for professional services provided in connection
with the audits of our financial statements, the review of our quarterly
financial statements, Sarbanes-Oxley 404 related services, consents, and
audit services provided in connection with other statutory or regulatory
filings. All such services were pre-approved by the Audit Committee.
</FN>
Marcum & Kliegman LLP was engaged on July 27, 2006, and accordingly, did not
render any other services during either 2006 or 2005. Fees for the audit of the
fiscal year ended August 1, 2004, which was performed subsequent to July 27,
2006, are estimated at $200,000.
The Audit Committee has sole authority to appoint, determine funding for, retain
and oversee our independent auditors and to pre-approve all audit services and
permissible non-audit services. The Audit Committee has delegated to Adm. Walker
the authority to pre-approve audit-related and non-audit services not prohibited
by law to be performed by our independent registered public accounting firm and
associated fees, provided that he reports any pre-approval of audit-related or
non-audit related services and fees to the full Audit Committee at its next
regular meeting.
Marcum & Kliegman LLP did not render any services related to financial
information systems design and implementation during fiscal years 2006 and 2005.
40
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1
Registration Statement No. 2-87160).
3.2 By-Laws, as amended August 7, 2001 (Exhibit 3.2 of Annual Report on Form
10-K for the fiscal year ended July 29, 2001).
10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the
fiscal year ended July 28, 1996).
10.2 1997 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 10,
1997).
10.3 1998 Stock Option Plan (Exhibit 10.3 of Annual Report on Form 10-K for the
fiscal year ended August 1, 1999).
10.4 2000 Stock Option Plan (Exhibit 4.1 of Report on Form S-8 dated October 12,
2001).
10.5 2003 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 11,
2003).
10.6 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated
as of July 29, 2002. (Exhibit 10.5 of Annual Report on Form 10-K for the
fiscal year ended July 28, 2002).
10.7 Employment Agreement between Herley Industries, Inc. and Myron Levy dated
as of July 29, 2002. (Exhibit 10.6 of Annual Report on Form 10-K for the
fiscal year ended July 28, 2002).
10.8 Agreement and Plan of Reorganization dated as of July 8, 1997 among the
Company, Metraplex Acquisition Corporation and Metraplex Corporation
(Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997).
10.9 Agreement and Plan of Merger dated as of August 21, 1998 among General
Microwave Corp., Eleven General Microwave Corp., Shareholders, GMC
Acquisition Corporation and Registrant (Exhibit 1 of Schedule 13D dated
August 28, 1998).
10.10 Lease Agreement dated September 1, 1999 between Registrant and RSK Realty
LTD. (Exhibit 10.8 of Annual Report on Form 10-K for the fiscal year ended
August 1, 1999).
10.11 Loan Agreement dated June 19, 2002 among the Registrant, Allfirst Bank and
Fulton Bank. (Exhibit 10.10 of Annual Report on Form 10-K for the fiscal
year ended July 28, 2002).
10.12 Amendment (dated May 2, 2003) to Loan Agreement dated June 19, 2002 among
the Registrant, Manufacturers and Traders Trust Company, successor in
interest to Allfirst Bank, and Fulton Bank. (Exhibit 10.12 of Annual Report
on Form 10-K for the fiscal year ended August 3, 2003).
10.13 Asset Purchase Agreement dated as of February 1, 2000 between Registrant
and Robinson Laboratories, Inc. (Exhibit 10.2 of Form 10-Q dated March 13,
2000).
10.14 Asset Purchase Agreement dated as of October 12, 2000 between Registrant
and American Microwave Technology Inc. (Exhibit 10.1 of Form 10-Q dated
December 12, 2000).
10.15 Asset Purchase Agreement dated as of March 29, 2004 between Registrant and
Communication Techniques, Inc. (Exhibit 10.15 of Annual Report on Form 10-K
for the fiscal year ended August 1, 2004).
10.16 Lease Agreement dated March 1, 2000 between Registrant and RSK Realty LTD
(Exhibit 10.13 of Annual Report on Form 10-K for the fiscal year ended July
30, 2000).
10.17 Common Stock Purchase Agreement dated as of September 20, 2002 between
Registrant and EW Simulation Technology, Limited. (Exhibit 10.17 of Annual
Report on Form 10-K for the fiscal year ended July 28, 2002).
10.18 Trust Indenture dated as of October 19, 2001 between Registrant, and East
Hempfield Township Industrial Development Authority and Allfirst Bank, as
Trustee. (Exhibit 10.18 of Annual Report on Form 10-K for the fiscal year
ended July 28, 2002).
10.19 Amendment (dated April 2, 2004) to Loan Agreement dated June 19, 2002
among the Registrant, Manufacturers and Traders Trust Company, successor in
interest to Allfirst Bank, and Fulton Bank. (Exhibit 10.19 of Annual Report
on Form 10-K for the fiscal year ended August 1, 2004).
10.20 Asset Purchase Agreement dated as of September 1, 2004 between Registrant
and Reliable System Services Corp. (Exhibit 10.20 of Annual Report on Form
10-K for the fiscal year ended August 1, 2004).
10.21 Amendment dated December 9, 2003 to Employment Agreement between Herley
Industries, Inc. and Myron Levy dated as of July 29, 2002. (Exhibit 10.21
of Annual Report on Form 10-K for the fiscal year ended August 1, 2004).
10.22 Amendment dated December 9, 2003 to Employment Agreement between Herley
Industries, Inc. and Lee N. Blatt dated as of July 29, 2002. (Exhibit 10.22
of Annual Report on Form 10-K for the fiscal year ended August 1, 2004).
10.23 Common Stock Purchase Agreement dated as of February 1, 2005 between
Registrant and Micro Systems, Inc. (Exhibit 2.1 of Form 8K dated February
7, 2005).
10.24 Common Stock Purchase Agreement dated as of April 12, 2005 between
Registrant and Innovative Concepts, Inc. (Exhibit 2.1 of Form 8K dated
April 18, 2005).
10.25 Amendment (dated June 9, 2005) to Loan Agreement dated June 19, 2002 among
the Registrant, Manufacturers and Traders Trust Company, successor in
interest to AllFirst Bank, and Fulton Bank. (Exhibit 10.1 of Form 10-Q
dated June 10, 2005).
10.26 2006 New Employee Stock Option Plan.
10.27 Employment Agreement between Herley Industries, Inc. and John Kelley dated
as of June 7, 2006.
41
10.28 Employment Agreement between Herley Industries, Inc. and Kevin J. Purcell
dated as of June 7, 2006. (Form 8-K dated June 8, 2006).
10.29 Amendment (dated March 9, 2006) to Loan Agreement dated June 19, 2002
among the Registrant, Manufacturers and Traders Trust Company, successor in
interest to AllFirst Bank, and Fulton Bank.
10.30 Administrative Agreement between the Department of the Navy, on hehalf of
the Department of Defense, and Herley Industries, Inc. (Exhibit 10.1 of
Form 8K dated October 12, 2006).
10.31 Agreement between Herley Industries, Inc. and Lee N. Blatt effective
October 12, 2006. (Exhibit 10.2 of Form 8K dated October 12, 2006).
23.1 Consent of Marcum & Kliegman LLP.
31.1 Certifications pursuant to Rules 13a-14(a) as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Financial Statements
(1) See Index to Consolidated Financial Statements at Page F-1.
(2) Schedule II - Valuation and Qualifying Accounts filed as part of this
Form 10-K at page 44.
42
SIGNATURES:
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on October 30, 2006.
HERLEY INDUSTRIES, INC.
By: /S/ Myron Levy
------------------------------------
Myron Levy, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on October 30, 2006 by the following persons in the
capacities indicated:
By: /S/ Myron Levy Chairman of the Board,
-----------------------------
Myron Levy Chief Executive Officer and Director
(Principal Executive Officer)
By: /S/ Kevin J. Purcell Vice President and
-----------------------------
Kevin J. Purcell Chief Financial Officer
(Principal Financial Officer)
By: /S/ John A. Thonet Secretary and Director
-----------------------------
John A. Thonet
By: /S/ Carlos C. Campbell Director
-----------------------------
Carlos C. Campbell
By: /S/ Edward K. Walker, Jr. Director
-----------------------------
Edward K. Walker, Jr.
By: /S/ Robert M. Moore Director
-----------------------------
Robert M. Moore
By: /S/ Edward A. Bogucz Director
-----------------------------
Edward A. Bogucz
43
Schedule II - Valuation and Qualifying Accounts (in thousands)
Column A Column B Column C Column D Column E
-------- -------- Additions Amount ----------
------------------------- written
Balance at Charged to off Balance at
beginning costs and against end of
Description of period expenses Other reserve period
----------- ---------- ---------- ----- ------- ----------
Valuation accounts deducted
from assets to which they
apply:
July 30, 2006:
Inventory $ 4,492 $ 1,475 $ - $ 1,391 $ 4,576
July 31, 2005:
Inventory $ 3,938 $ 804 $ - $ 250 $ 4,492
August 1, 2004:
Inventory $ 2,739 $ 859 $ 1,241 (1) $ 901 $ 3,938
<FN>
(1) Represents valuation reserves acquired through the acquisition of CTI of
$715 and a reclassification of $526 previously included as an offset in raw
material inventory.
</FN>
All other Schedules have been omitted since they are either not required, not
applicable, or the information is otherwise included in this Annual Report on
Form 10-K.
44
Item 8. Financial Statements and Supplementary Data
HERLEY INDUSTRIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-2
FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of July 30, 2006 and July 31, 2005 F-3
Consolidated Statements of Income for the fifty-two weeks ended
July 30, 2006, July 31, 2005 and August 1, 2004 F-4
Consolidated Statements of Shareholders' Equity for the fifty-two weeks
ended July 30, 2006, July 31, 2005 and August 1, 2004 F-5
Consolidated Statements of Cash Flows for the fifty-two weeks ended
July 30, 2006, July 31, 2005 and August 1, 2004 F-6
Notes to Consolidated Financial Statements F-7
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of the
Board of Directors and Shareholders of
Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley
Industries, Inc. and Subsidiaries (the "Company") as of July 30, 2006 and July
31, 2005, and the related consolidated statements of income, shareholders'
equity and cash flows for the fifty-two (52) weeks ended July 30, 2006, July 31,
2005 and August 1, 2004. Our audits also included the financial statement
schedule as of and for the fifty-two (52) weeks ended July 30, 2006, July 31,
2005 and August 1, 2004 listed in the index at Item 15. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
also includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Herley
Industries, Inc. and Subsidiaries as of July 30, 2006 and July 31, 2005, and the
consolidated results of its operations and its cash flows for the fifty-two (52)
weeks ended July 30, 2006, July 31, 2005 and August 1, 2004 in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole
presents fairly, in all material aspects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of July 30, 2006, based on the
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated, October 27, 2006, expressed an unqualified opinion on management's
assessment of the effectiveness of the Company's internal control over financial
reporting and an unqualified opinion on the effectiveness of the Company's
internal control over financial reporting.
/s/ Marcum & Kliegman LLP
- -------------------------
Marcum & Kliegman LLP
Melville, New York
October 27, 2006
F-2
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
July 30, July 31,
2006 2005
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 22,303 $ 20,331
Trade accounts receivable 30,600 27,258
Costs incurred and income recognized in excess
of billings on uncompleted contracts 13,926 16,058
Other receivables 769 1,414
Inventories, net 52,909 51,590
Deferred income taxes and other 4,932 3,782
------------ ------------
Total Current Assets 125,439 120,433
Property, Plant and Equipment, net 30,478 29,461
Goodwill 73,612 70,831
Intangibles, net of accumulated amortization of $3,468
in 2006 and $1,680 in 2005 19,989 20,554
Other Assets 1,932 744
------------ ------------
$ 251,450 $ 242,023
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 630 $ 797
Accounts payable and accrued expenses 21,503 23,678
Billings in excess of costs incurred and
income recognized on uncompleted contracts 555 538
Income taxes payable 3,395 3,760
Accrual for contract losses 2,959 630
Accrual for warranty costs 986 799
Advance payments on contracts 3,323 1,888
------------ ------------
Total Current Liabilities 33,351 32,090
Long-term Debt 5,948 5,000
Other Long-term Liabilities 1,265 1,042
Deferred Income Taxes 7,416 6,254
------------ ------------
47,980 44,386
------------ ------------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized 20,000,000 shares;
issued 14,660,716 and outstanding 13,862,149 in 2006
and issued and outstanding 14,389,625 in 2005 1,466 1,439
Additional paid-in capital 113,418 109,118
Retained earnings 96,286 85,932
Treasury stock, 798,567 common shares, at cost (9,044) -
Accumulated other comprehensive income 1,344 1,148
------------ ------------
Total Shareholders' Equity 203,470 197,637
------------ ------------
$ 251,450 $ 242,023
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data)
Fifty-two weeks ended
---------------------------------------------------------
July 30, July 31, August 1,
2006 2005 2004
----------------- ---------------- ----------------
Net sales $ 176,268 $ 151,415 $ 122,154
----------------- ---------------- ----------------
Cost and expenses:
Cost of products sold 127,921 106,441 79,505
Selling and administrative expenses 34,966 30,305 23,047
----------------- ---------------- ----------------
162,887 136,746 102,552
----------------- ---------------- ----------------
Income from operations 13,381 14,669 19,602
----------------- ---------------- ----------------
Other income (expense), net:
Investment income 840 934 674
Interest expense (319) (286) (326)
Foreign exchange gain (loss) 431 (291) (194)
----------------- ---------------- ----------------
952 357 154
----------------- ---------------- ----------------
Income before income taxes 14,333 15,026 19,756
Provision for income taxes 3,979 4,245 6,083
----------------- ---------------- ----------------
Net income $ 10,354 $ 10,781 $ 13,673
================= ================ ================
Earnings per common share - Basic $ .72 $ .75 $ .97
================= ================ ================
Basic weighted average shares 14,463 14,310 14,105
================= ================ ================
Earnings per common share - Diluted $ .69 $ .72 $ .92
================= ================ ================
Diluted weighted average shares 15,097 14,969 14,896
================= ================ ================
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Fifty-two weeks ended July 30, 2006 and July 31, 2005, and August 1, 2004
(In thousands except share data)
Accumulated
Additional Other
Common Stock Paid-in Retained Treasury Comprehensive
Shares Amount Capital Earnings Stock Income (loss) Total
------------ ---------- ---------- ---------- ---------- ------------- --------
Balance at August 3, 2003 13,969,151 $ 1,397 104,551 61,478 - (184) $ 167,242
Exercise of stock options 251,357 25 2,433 2,458
Tax benefit upon exercise of stock options 687 687
------------ ---------- ---------- ---------- ---------- ---------- ----------
Subtotal 14,220,508 1,422 107,671 61,478 - (184) 170,387
----------
Net income 13,673 13,673
Other comprehensive income (loss), net of tax:
Unrealized gain on
available-for-sale securities 49 49
Unrealized (loss) on interest rate swap (23) (23)
Foreign currency translation gain 1,414 1,414
----------
Comprehensive income 15,113
------------ ---------- ---------- ---------- ---------- ---------- ----------
Balance at August 1, 2004 14,220,508 $ 1,422 107,671 75,151 - 1,256 $ 185,500
Exercise of stock options 329,349 33 3,501 3,534
Tax benefit upon exercise of stock options 658 658
Purchase of 160,232 shares of treasury stock (2,728) (2,728)
Retirement of treasury shares (160,232) (16) (2,712) 2,728 -
------------ ---------- ---------- ---------- ---------- ---------- ----------
Subtotal 14,389,625 1,439 109,118 75,151 - 1,256 186,964
----------
Net income 10,781 10,781
Other comprehensive income (loss), net of tax:
Unrealized (loss) on
available-for-sale securities (1) (1)
Unrealized gain on interest rate swap 18 18
Foreign currency translation (loss) (125) (125)
----------
Comprehensive income 10,673
------------ ---------- ---------- ---------- ---------- ---------- ----------
Balance at July 31, 2005 14,389,625 $ 1,439 109,118 85,932 - 1,148 $ 197,637
Exercise of stock options 271,091 27 3,144 3,171
Stock option compensation 453 453
Tax benefit upon exercise of stock options 703 703
Purchase of 798,567 shares of treasury stock (9,044) (9,044)
------------ ---------- ---------- ---------- ---------- ---------- ----------
Subtotal 14,660,716 1,466 113,418 85,932 (9,044) 1,148 192,920
----------
Net income 10,354 10,354
Other comprehensive income, net of tax:
Unrealized gain on interest rate swap 33 33
Foreign currency translation gain 163 163
----------
Comprehensive income 10,550
------------ ---------- ---------- ---------- ---------- ---------- ----------
Balance at July 30, 2006 14,660,716 $ 1,466 113,418 96,286 (9,044) 1,344 $ 203,470
============ ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Fifty-two weeks ended
---------------------
July 30, July 31, August 1,
2006 2005 2004
--------- ---------- ----------
Cash flows from operating activities:
Net Income $ 10,354 $ 10,781 $ 13,673
--------- ---------- ----------
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 7,096 5,683 4,244
Stock-based compensation expense 453 - -
Excess tax benefit from exercises of
stock options (703) - -
Foreign exchange (gain) loss (74) (20) 753
Inventory valuation reserve charges 1,475 804 859
Gain on sale of marketable securities - (22) -
Gain on sale of fixed assets - (8) -
Equity in income of limited partnership (52) (54) (10)
(Increase) decrease in deferred tax assets (959) 403 (316)
Increase (decrease) in deferred tax liabilities 1,147 1,397 (109)
Changes in operating assets and liabilities:
Trade accounts receivable (3,342) 2,590 (6,923)
Costs incurred and income recognized
in excess of billings on uncompleted
contracts 2,132 (1,626) (7,250)
Other receivables 645 (576) 251
Inventories, net (2,794) (2,515) (6,665)
Deferred income taxes and other 157 (430) 31
Accounts payable and accrued expenses (1,988) 925 3,431
Billings in excess of costs incurred and
income recognized on uncompleted contracts 17 (1,596) 1,303
Income taxes payable 338 2,306 108
Accrual for contract losses (175) (500) (240)
Advance payments on contracts 1,435 (4,827) 324
Other, net 157 253 146
--------- ---------- ----------
Total adjustments 4,965 2,187 (10,063)
--------- ---------- ----------
Net cash provided by operating activities 15,319 12,968 3,610
--------- ---------- ----------
Cash flows from investing activities:
Acquisition of businesses, net of cash acquired - (51,407) (14,914)
Acquisition of technology license (1,256) (2,300) -
Proceeds from sale of securities - 165 -
Proceeds from sale of fixed assets - 17 19
Partial distribution from limited partnership 111 109 55
Capital expenditures (6,227) (5,404) (5,884)
--------- ---------- ----------
Net cash used in investing activities (7,372) (58,820) (20,724)
--------- ---------- ----------
Cash flows from financing activities:
Borrowings under bank line of credit 16,500 - -
Proceeds from exercise of stock options, net 3,171 3,534 2,458
Excess tax benefit from exercises of stock options 703 - -
Payments of long-term debt (805) (804) (686)
Payments under bank line of credit (16,500) - -
Purchase of treasury stock (9,044) (2,728) -
--------- ---------- ----------
Net cash (used in) provided by financing activities (5,975) 2 1,772
--------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 1,972 (45,850) (15,342)
Cash and cash equivalents at beginning of period 20,331 66,181 81,523
--------- ---------- ----------
Cash and cash equivalents at end of period $ 22,303 $ 20,331 $ 66,181
========= ========== ==========
Supplemental cash flow information:
Financing of computer software and maintenance $ 1,627
=========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Nature of Operations and Recent Events
--------------------------------------
The Company, a Delaware corporation, is engaged in research, engineering,
product development, and manufacturing of complex microwave radio frequency
(RF) and millimeter wave components and subsystems for defense and
commercial customers worldwide.
In connection with the legal matter discussed in Note F "Litigation," the
Company was notified that certain of its operations had been suspended from
receiving new contract awards from the U. S. Government. The affected
operations included facilities in Lancaster, Pennsylvania; Woburn,
Massachusetts; Chicago, Illinois and the Company's subsidiary in
Farmingdale, New York. The Chicago, Illinois location is a two-person
marketing office. The result of this suspension was that these facilities
were not solicited for or awarded new contracts or contract extensions
without special exceptions, pending the outcome of the legal proceedings.
The suspended facilities were permitted to receive contract awards or
subcontracts from the Federal Government if the head of the agency stated
in writing the compelling reason to do so. A significant portion of the
Company's business is received under contracts where the Company is the
only qualified supplier on critical defense programs.
Effective October 12, 2006, the Company entered into an Administrative
Agreement with the Department of the Navy, on behalf of the Department of
the Defense that requires the Company, among other things, to implement a
comprehensive program of compliance reviews, audits and reports for a
period of three years or until settlement or adjudication of the legal
matter referenced above, whichever is later, unless shortened or extended
by written agreement of the parties. In addition, the Company is required
to sever its relationship with Mr. Lee N. Blatt, former Chairman of the
Board of Directors, as an employee or consultant to the Company. In return,
the Navy, on behalf of the Department of Defense has terminated the
suspension and debarment of the Company from receiving new contract awards
from the U.S. Government.
The Company's facilities which were not included in the action and who were
free at all times to contract with the U.S. Government are our facilities
in Whippany, New Jersey (Herley-CTI); Jerusalem (Herley-Israel); McLean,
Virginia (Innovative Concepts, Inc.); Fort Walton Beach, Florida (Micro
Systems, Inc. and Herley-RSS) and Farnborough, U.K. (EW Simulation
Technology, Limited).
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy noted above, the
Company entered into an agreement (the "Agreement") with Lee N. Blatt to
terminate the Employment Agreement between the Company and Mr. Blatt dated
as of July 29, 2002 and modified on December 9, 2003. Under the terms of
the Agreement Mr. Blatt will receive payments totaling $9,461,528 payable
$3,000,000 upon the effective date of the Agreement and sixty-four (64)
consecutive monthly payments of $100,000 commencing on January 1, 2007 and
a final payment of $61,528 on May 1, 2012 as evidenced by a non-interest
bearing Promissory Note dated effective October 12, 2006 (the "Promissory
Note"). In addition Mr. Blatt will receive his bonus of $636,503 for fiscal
year 2006, and shall be entitled to receive medical care reimbursement and
insurance, including life insurance, in accordance with the original terms
of his Employment Agreement. The Agreement also provides that all
outstanding stock options previously issued to Mr. Blatt which are all
vested and fully exercisable shall continue to be exercisable by him or,
following his death, by his designated beneficiaries, on or before the
expiration date of the specific option. On September 26, 2006, as required
under the terms of the Administrative Agreement with the Department of the
Navy, Mr Blatt entered into a voting trust agreement wherein sole voting
power to 1,301,000 shares under stock options held by Mr. Blatt and 28,799
shares held in his IRA was granted to the Company's Chairman, Myron Levy .
In the event of a "change of control" of the Company as defined in the
Employment Agreement all remaining payments due under the Promissory Note
become immediately due and payable. Costs in connection with the Agreement
will be recorded in the Company's consolidated financial statements in the
first quarter ended October 29, 2006.
The Company had been advised by BDO SEIDMAN, LLP ("BDO"), the Company's
former independent registered public accountants, that, due to their need
to complete review procedures in connection with an independent
investigation of the allegations by outside counsel, BDO was unable to
complete its review of the interim consolidated financial statements for
the quarter ended April 30, 2006 by the due date of the Company's Form 10-Q
F-7
in accordance with established professional standards and procedures for
conducting such reviews, which review is required by Rule 10-01(d) of
Regulation S-X. BDO subsequently on July 27, 2006 informed the Company that
they had resigned as the Company's auditors. In addition, by letter dated
August 14, 2006 BDO informed the Company that it was withdrawing its
opinion on the Company's financial statements for the fiscal year ended
July 31, 2005.
At a meeting held on July 27, 2006, the Company's Audit Committee accepted
the resignation of BDO and approved the engagement of Marcum & Kliegman LLP
as the Company's independent registered public accountants. In addition, on
August 16, 2006, the Audit Committee approved the engagement of Marcum &
Kliegman LLP to also act as its independent auditors for the fiscal years
ended July 31, 2005 and August 1, 2004. The interim consolidated financial
statements for the quarter ended April 30, 2006 were reviewed by Marcum &
Kliegman LLP, and the Company's Form 10-Q was filed on September 14, 2006.
By letter dated June 16, 2006, the Company received written notification
from Nasdaq that since the Form 10-Q filed by the Company on June 14, 2006
had not been reviewed by its accountants and did not include the required
certifications, the Company was not in compliance with Marketplace Rule
4310(c) (14). Accordingly, the Company was informed that its securities
would be delisted from The Nasdaq Stock Market. On June 22, 2006, the
Company requested a hearing which was held on August 3, 2006. By letter
dated August 16, 2006, the Company received written notification from
Nasdaq that the Company's request for continued listing on The Nasdaq Stock
Market had been granted, subject to the Company's filing of a complete
amended Form 10-Q by September 15, 2006. The Company filed the amended Form
10-Q on September 14, 2006 and received written notification on September
18, 2006 from Nasdaq that since it has demonstrated compliance with all
Nasdaq Marketplace Rules, the Nasdaq Listing Qualification Panel has
determined to continue the listing of the Company's securities on The
Nasdaq Global Market.
On June 15, 2006, the Company announced a resumption of the stock
repurchase program initially announced in October 2002 covering 1,000,000
shares of common stock of the Company and subsequently expanded on May 30,
2003 to cover 2,000,000 shares of common stock. As of July 30, 2006 the
Company has acquired an aggregate of approximately 1,898,000 shares of
common stock under this program of which 798,567 and 160,232 shares were
acquired during fiscal 2006 and 2005 at an aggregate cost of approximately
$9,044,000 and $2,728,000, respectively.
2. Fiscal Year
-----------
The Company's fiscal year ends on the Sunday closest to July 31. Normally
each fiscal year consists of fifty-two weeks, but every five or six years
the fiscal year will consist of fifty-three weeks.
3. Basis of Financial Statement Presentation
-----------------------------------------
The consolidated financial statements include the accounts of Herley
Industries, Inc. and its subsidiaries, all of which are wholly-owned. All
significant intercompany accounts and transactions have been eliminated in
consolidation. The presentation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements as well as revenues
and expenses during the period. Actual results could differ from those
estimates.
4. Cash and Cash Equivalents
-------------------------
The Company considers all liquid investments with an original maturity of
three months or less at the date of acquisition to be cash equivalents.
Short-term investments are recorded at the amortized cost plus accrued
interest which approximates market value. The Company limits its credit
risk to an acceptable level by evaluating the financial strength of
institutions at which significant investments are made and based upon
credit ratings.
5. Concentration of Credit Risk/Trade Accounts Receivable
------------------------------------------------------
Financial instruments which potentially subject the Company to credit risk
consist primarily of trade accounts receivable. Accounts receivable are
principally from the U.S. Government, major U.S. Government contractors,
several foreign governments, and domestic customers in the defense,
aerospace and medical industries. Credit is extended based on an evaluation
of the customer's financial condition and generally collateral is not
required. In many cases, irrevocable letters of credit accompanied by
advanced payments are received from foreign customers, and progress
payments are received from domestic customers. The Company performs
periodic credit evaluations of its customers and maintains reserves for
potential credit losses. As of July 30, 2006 and July 31, 2005, a reserve
for doubtful accounts of $283,000 and $130,000, respectively are reflected
in the consolidated balance sheets as a deduction from trade accounts
F-8
receivable. The write off of uncollectible accounts receivable over the
years has been immaterial.
6. Inventories
-----------
Inventories, other than inventory costs relating to long-term contracts and
programs, are stated at lower of cost (principally first-in, first-out) or
market. Inventory costs relating to long-term contracts and programs are
stated at the actual production costs, including factory overhead, reduced
by amounts identified with revenue recognized on units delivered or
progress completed. Inventory costs relating to long-term contracts and
programs are reduced by any amounts in excess of estimated realizable
value.
7. Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost. Depreciation and
amortization are provided principally by the straight-line method over the
estimated useful lives of the related assets. Leasehold improvements are
amortized over the shorter of their economic lives or the lease term, as
defined in paragraph 5(f) of Statement of Financial Accounting Standards
("SFAS") No.13, "Accounting for Leases." Rent holidays and scheduled rent
increases under operating leases are recognized on a straight-line basis
over the lease term, including the rent holiday period, in accordance with
paragraph 2 of Financial Accounting Standards Board ("FASB") Technical
Bulletin 85-3 (as amended). Gains and losses arising from the sale or
disposition of property, plant and equipment are included in income from
operations.
8. Goodwill and Other Intangible Assets
-------------------------------------
Goodwill is tested for impairment in accordance with SFAS No. 142 using a
fair value approach applied to the Company's one reporting unit. Impairment
charges are recognized for amounts where the reporting unit's goodwill
exceeds its fair value. An annual impairment test is performed in the
fourth quarter of each fiscal year. Any future impairment of goodwill will
be charged to operations. The Company amortizes the cost of other
intangibles over their estimated useful lives. Amortizable intangible
assets may also be tested for impairment if indications of impairment
exist.
The Company obtained a fair market value appraisal of the Company by an
independent investment banking firm. Based on this appraisal, the Company
has determined that no impairment in the carrying value of goodwill has
occurred at July 30, 2006.
The change in the carrying amount of goodwill for the years ended July 30,
2006 and July 31, 2005, is principally based upon the fair value of assets
acquired and liabilities assumed related to the acquisitions of RSS, MSI
and ICI (as defined in Note B) in fiscal 2005, as follows (in thousands):
Balance at August 1, 2004 $ 35,165
Goodwill acquired during the period (2) 35,793
Foreign currency translation adjustment (1) (155)
Other adjustments 28
---------
Balance at July 31, 2005 $ 70,831
Change in fair value of liabilities assumed
in connection with the ICI acquisition (Note B) 2,504
Foreign currency translation adjustment (1) 277
--------
Balance at July 30, 2006 $ 73,612
========
---------
<FN>
(1) Related to the acquisition of EWST in fiscal 2003 (See Note B).
(2) Related to the acquisitions of RSS, MSI and ICI in fiscal 2005 (See Note
B).
</FN>
F-9
Intangibles consist of the following (in thousands):
July 30, July 31, Estimated
2006 2005 useful life
---- ---- -----------
Trademarks (acquired with MSI and ICI) $2,800 $2,800 Indefinite
Technology (acquired with EWST, MSI and ICI) 12,421 12,421 10-15 years
Technology license acquired from Xytrans 3,556 2,300 (see below)
Drawings 800 800 15 years
Patents 568 568 14 years
Backlog 3,125 3,125 2-5 years
Non-compete agreement 31 31 5 years
Foreign currency translation adjustment 156 189
------- -------
23,457 22,234
Accumulated amortization 3,468 1,680
------- -------
$ 19,989 $ 20,554
======== ========
The Company entered into a license and development agreement ("agreement")
on April 7, 2005 to license millimeter wave technology for military
applications from Xytrans, Inc. Xytrans focuses on providing high-frequency
transceiver and outdoor unit design for the wireless broadband network
market. The technology acquired includes exclusive access to a portfolio of
patents and trade secrets that improve the cost and performance of
millimeter wave subsystems that are used in weapons and radar systems.
In January 2005, the Company had made a deposit payment of $1,000,000 in
connection with this proposed transaction. The deposit payment was secured
by a note receivable, which was cancelled upon execution of the agreement.
The agreement provided for an additional payment on execution of
$1,000,000, and for certain additional contingent payments, of up to
$4,500,000. These contingent payments are subject to achievement of a
series of development milestones on a U.S. Government missile program, and
/or receipt by the Company of a single contract award using millimeter wave
technology valued at a minimum of $6,000,000, amongst other requirements.
The agreement also provides for the payment of royalties ranging from 1% to
4% of sales of products including relevant millimeter wave technology,
starting at the earliest January 1, 2006, and generally ending 4 years
later. No royalties have been earned or paid as of July 30, 2006.
Xytrans achieved several of the development milestones on the missile
program discussed above and the Company made additional contingent payments
totaling $1,500,000. Additional development costs as a result of a scope
change were paid in the net amount of $56,000. A final milestone payment of
$178,700 was made in August 2006. No further contingent payments are due
under the agreement. At the commencement of sales of products using the
millimeter wave technology, the Company will begin to amortize the costs
associated with this agreement over the estimated economic life of
approximately eight years.
Amortization expense related to Intangibles for the fifty-two weeks ended
July 30, 2006, July 31, 2005 and August 1, 2004, was approximately
$1,788,000, $928,000 and $349,000, respectively.
Estimated aggregate amortization expense for each of the next five fiscal
years is as follows (in thousands):
2007 1,828
2008 1,822
2009 1,821
2010 1,540
2011 1,260
F-10
9. Marketable Securities
---------------------
The Company accounts for its investments in marketable securities in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." Management determines the appropriate
classification of debt securities at the time of purchase and reevaluates
such designation as of each balance sheet date. Debt securities are
classified as held-to-maturity when the Company has the positive intent and
ability to hold the securities to maturity. Marketable equity securities
and debt securities not classified as held-to-maturity are classified as
available-for-sale. Available-for-sale securities are carried at fair
market value with net unrealized holding gains or losses, net of income
taxes, reported as a separate component of other comprehensive income or
loss. Realized gains and losses and declines in value judged to be
other-than-temporary are included in other income (expense), net. The cost
of securities sold is based on the specific identification method. Interest
and dividends on securities are included in other income.
10. Other Investments
-----------------
The Company is a limited partner in a non-marketable limited partnership in
which it owns approximately a 10% interest. The investment is accounted for
under the equity method (See Note D).
11. Revenue and Cost Recognition
----------------------------
The Company generally recognizes revenue when products are shipped and the
customer takes ownership and assumes risk of loss, collection of the
relevant receivable is probable, persuasive evidence of an arrangement
exists and the sales price is fixed or determinable. It is the policy of
the U.S. Government to ensure that (a) its contracts include inspection and
other quality requirements, including warranty clauses when appropriate,
that are determined necessary to protect the Government's interest; (b)
supplies tendered by contractors meet contract requirements; and (c)
Government contract quality assurance is conducted before acceptance
(except as otherwise provided in the Federal Acquisition Regulations), by
or under the direction of Government personnel. The Company, as a U.S.
Government contractor, is required to control the quality of its products
and to tender to the Government only those products that meet the contract
requirements. Accordingly, the Company's Government contracts include
provisions that require its products to pass quality inspection prior to
acceptance by the Government. Except for contracts that are accounted for
using the percentage of completion method of accounting, revenue is not
recognized until the products pass quality inspection and generally not
until customer acceptance. In the event the Government's acceptance occurs
at destination, revenue is recognized at shipment if it can be demonstrated
that the delivered products meet all of the specified criteria prior to
customer acceptance. Payments received from customers in advance of
products delivered are recorded as advance payments on contracts until
earned. Most of our customer contracts are firm, fixed price contracts,
providing for a predetermined fixed price for the products sold, regardless
of the costs incurred. A certain percentage of revenues are derived from
long-term, fixed price contracts. Revenues and estimated profits are
recognized on these contracts using the percentage of completion method of
accounting and are based on estimated completion to date (the total
contract amount multiplied by the percentage of performance, based on total
costs incurred in relation to total estimated cost at completion).
Prospective losses on long-term contracts are based upon the anticipated
excess of manufacturing costs over the selling price of the remaining units
to be delivered and are recorded in the period when first determinable.
Actual losses could differ from those estimated due to changes in the
ultimate manufacturing costs and contract terms.
Contract costs include all direct material and labor costs and those
indirect costs related to contract performance. Selling, general and
administrative costs are charged to expense as incurred.
12. Product Development
-------------------
The Company's primary efforts are focused on engineering design and product
development activities rather than pure research. The cost of these
development activities, including employees' time and prototype
development, net of amounts paid by customers, was approximately $9.1, $5.0
and $5.4 million in fiscal 2006, 2005, and 2004, respectively, and are
included in cost of products sold. The amounts paid by customers are
included in net sales and was approximately $21.2, 5.3 and $5.7 million in
fiscal 2006, 2005 and 2004, respectively.
F-11
13. Income Taxes
------------
Income taxes are accounted for by the asset/liability approach in
accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred taxes
represent the expected future tax consequences when the reported amounts of
assets and liabilities are recovered or paid. They arise from temporary
differences between the financial reporting and tax bases of assets and
liabilities and are adjusted for changes in tax laws and tax rates when
those changes are enacted. The provision for income taxes represents the
total of income taxes paid or payable for the current year, plus the change
in deferred taxes during the year.
14. Stock-Based Compensation
------------------------
The Company has various fixed stock option plans which are described in
Note M that provide for the grant of stock options to eligible employees
and directors.
Effective August 1, 2005, the Company adopted the fair value recognition
provisions of SFAS No. 123(R), "Share-Based Payment" ("SFAS 123(R)") using
the modified prospective application method. This standard requires the
Company to measure the cost of employee services received in exchange for
equity share options granted based on the grant-date fair value of the
options. The cost is recognized as compensation expense over the requisite
service period for each separately vesting portion of the options. Under
the modified prospective application method, compensation cost included in
operating expenses in the fifty-two weeks ended July 30, 2006 is
approximately $453,000 and includes: (a) compensation cost of stock options
granted prior to but not yet vested as of August 1, 2005 (based on
grant-date fair value estimated in accordance with the provisions of SFAS
123) and (b) compensation cost for all options granted subsequent to July
31, 2005 (based on grant-date fair value estimated in accordance with the
new provisions of SFAS 123(R)). Operating income and income before taxes
for the fiscal year 2006 were reduced by approximately $453,000 while net
income was reduced by approximately $322,000 or approximately $0.02 per
basic and diluted share.
Income tax benefits relating to the exercise of stock options during the
fifty-two weeks ended July 30, 2006, July 31, 2005 and August 1, 2004
amounted to approximately $703,000, $658,000 and $687,000, respectively.
Commencing in fiscal 2006, the income tax benefits are classified as a
financing cash inflow in the Company's Consolidated Statements of Cash
Flows. Prior to the adoption of SFAS 123(R), the Company presented all
income tax benefits related to stock-based compensation as an operating
cash inflow.
As of July 30, 2006, there were 3,490,080 stock options outstanding. The
aggregate value of unvested options, as determined using a Black-Scholes
option valuation model was approximately $812,000 (net of estimated
forfeitures). During the fifty-two weeks ended July 30, 2006, the Company
granted 79,000 non-qualified stock options, with a fair value of
approximately $568,000. Options for 272,429 shares of common stock were
exercised, and 52,021 options were forfeited during the year. New option
grants made after July 31, 2005, as well as option grants issued on or
prior to that date, have been valued using a Black-Scholes option valuation
model.
In April 2005, the Company's Board of Directors, upon recommendation of the
Board's Compensation Committee, approved the accelerated vesting of all
unvested and "out-of-the-money" stock options outstanding as of May 2,
2005. As a result of this action, options to purchase approximately 307,000
shares of the Company's common stock that would otherwise have vested at
various times within the next four years became fully vested. The decision
to accelerate the vesting, which the Company believes to be in the best
interest of the Company and its shareholders, was made in lieu of certain
discretionary cash bonuses, and to reduce compensation expense that would
be recorded in future periods following the Company's adoption of SFAS
123(R). The Board of Directors further believes that the acceleration is
consistent with the Company's overall equity compensation approach which
includes a reduced use of stock options. The SFAS 123 pro forma stock-based
compensation costs of approximately $2,770,000 (net of taxes) for the year
ended July 31, 2005 in the table below includes a charge of approximately
$540,000 (net of taxes) as a result of the acceleration.
Prior to adopting SFAS 123(R) on August 1, 2005, the Company's equity based
employee compensation expense under the various stock option plans was
accounted for under the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. Under the modified prospective application method, results
for prior periods have not been restated to reflect the effects of
implementing SFAS 123(R). Therefore, for the fiscal years 2005 and 2004, no
option based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the
underlying common stock price on the date of grant. The following table
which is presented for comparative purposes, provides the pro forma
information as required by SFAS No. 148, "Accounting for Stock-Based
F-12
Compensation-Transition and Disclosure, an amendment of FASB Statement No.
123," and illustrates the effect on net income and earnings per common
share for the periods presented as if the Company had applied the fair
value recognition provisions of SFAS No. 123 to stock based employee
compensation prior to August 1, 2005:
2005 2004
----------- -----------
Net income - as reported $ 10,781 $ 13,673
Deduct: total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (2,770) (570)
--------- -----------
Net income - pro forma $ 8,011 $ 13,103
========= ===========
Earnings per share - as reported
Basic $0.75 $0.97
Diluted 0.72 0.92
Earnings per share - pro forma
Basic $0.56 $0.93
Diluted 0.54 0.88
The weighted average fair value of stock options on the date of grant, and
the assumptions used to estimate the fair value of stock options issued
during the periods presented using the Black-Scholes option valuation model
are as follows:
2006 2005 2004
---- ---- ----
Weighted average fair value of options granted $ 7.19 $ 4.00 $ 7.87
Expected life (years) 3.53 3.69 4.14
Expected volatility .44 .44 .48
Risk-free interest rate 4.3% 3.8% 2.8%
Expected dividend yield zero zero zero
The expected life of options granted during the periods presented above is
based on the Company's historical share option exercise experience using
the historical expected term from vest date. The expected volatility of the
options granted is determined using historical volatilities based on
historical stock prices. The risk-free interest rate is determined using
the yield available for zero-coupon U.S. Government issues with a remaining
term equal to the expected life of the options. The Company has never paid
a dividend, and as such the dividend yield is zero.
15. Foreign Currency Translation
----------------------------
Financial statements of foreign subsidiaries are prepared in their
respective functional currencies and translated into United States dollars
at the current exchange rates for assets and liabilities and a monthly
average rate during the year for revenues, costs and expenses. Net gains or
losses resulting from the translation of foreign financial statements are
charged or credited directly to the 'Foreign currency translation'
component of "Accumulated other comprehensive income" in the accompanying
consolidated statements of shareholders' equity. Transaction gains and
losses resulting from transactions entered into under contracts in a
currency other than the subsidiary's functional currency are accounted for
on a transactional basis as a credit or charge to operations.
16. Derivatives
-----------
The Company recognizes all derivatives on the balance sheet at fair value.
On the date the derivative instrument is entered into, the Company
generally designates the derivative as either (1) a hedge of the fair value
of a recognized asset or liability, or of an unrecognized firm commitment
("fair value hedge") or (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized
asset or liability ("cash flow hedge"). The Company entered into an
interest rate swap in October 2001 with a bank, which it recognized as a
cash flow hedge. Changes in the fair value of a derivative that is
designated as, and meets all the required criteria for, a cash flow hedge
are recorded in accumulated other comprehensive income (loss) and
reclassified into earnings as the underlying hedged item affects earnings.
F-13
17. Comprehensive Income
--------------------
The Company reports comprehensive income in the Consolidated Statements of
Shareholders' Equity, which includes net income, unrealized gain (loss) on
available-for-sale securities, unrealized gain (loss) on interest rate
swap, and foreign currency translation gain (loss), net of related income
taxes. Substantially all the amount included in other comprehensive income
relates to the effects of foreign exchange translation gains and losses.
18. New Accounting Pronouncements
-----------------------------
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. It codifies the
definitions of fair value included in other authoritative literature;
clarifies and, in some cases, expands on the guidance for implementing fair
value measurements; and increases the level of disclosure required for fair
value measurements. Although SFAS 157 applies to (and amends) the
provisions of existing authoritative literature, it does not, of itself,
require any new fair value measurements, nor does it establish valuation
standards. SFAS 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those
fiscal years. This statement will be effective for the Company's fiscal
year beginning August 2008. We will evaluate the impact of adopting SFAS
157 but do not expect that it will have a material impact on the Company's
consolidated financial position, results of operations or cash flows.
In September 2006, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 108 ("SAB 108") which provides
interpretive guidance on how the effects of the carryover or reversal of
prior year misstatements should be considered in quantifying a current year
misstatement. SAB 108 becomes effective in fiscal 2007. Adoption of SAB 108
is not expected to have a material impact on the Company's consolidated
financial position, results of operations or cash flows.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes (as amended) - an interpretation of FASB
Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise's financial
statements in accordance with SFAS No. 109, "Accounting for Income Taxes",
and prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company is in the process of
analyzing the impact of FIN 48, which is required to be adopted by the
first quarter of fiscal 2008.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets, an amendment of FASB Statements No. 140" ("SFAS 156").
SFAS 156 requires that servicing assets and servicing liabilities be
recognized at fair value, if practicable, when the Company enters into a
servicing agreement. This new standard will be effective as of the start of
the Company's first fiscal year that begins after September 15, 2006. The
Company does not expect the adoption of SFAS 156 to have a material impact
on its consolidated financial position, results of operations or cash
flows.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments" ("SFAS 155"), an amendment of SFAS Nos. 133
and 140. SFAS 155 permits a fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise
would require bifurcation; clarifies which interest-only strips and
principal-only strips are not subject to the requirements of Statement 133;
establishes a requirement to evaluate interests in securitized financial
assets to identify interests that are freestanding derivatives or that are
hybrid financial instruments that contain an embedded derivative requiring
bifurcation; clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives; and amends Statement 140 to
eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains to a beneficial
interest other than another derivative financial instrument. This new
standard will be effective for all financial instruments acquired or issued
after the beginning of the Company's first fiscal year that begins after
September 15, 2006. The Company does not expect the adoption of SFAS 155 to
have a material impact on its consolidated financial position, results of
operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20 "Accounting
Changes" and SFAS No. 3 "Reporting Accounting Changes in Interim Financial
Statements." SFAS 154 requires that a voluntary change in accounting
F-14
principle be applied retrospectively with all prior period financial
statements presented on the new accounting principle, unless it is
impracticable to do so. SFAS 154 also provides that a correction of errors
in previously issued financial statements should be termed a "restatement."
This new standard will be effective for accounting changes and correction
of errors for fiscal years beginning after December 15, 2005. The Company
does not expect that the adoption of SFAS 154 will have a material impact
on its consolidated financial position, results of operations or cash
flows.
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - An Interpretation of SFAS No.
143." This Interpretation provides additional guidance as to when companies
should record the fair value of a liability for a conditional asset
retirement obligation when there is uncertainty about the timing and/or
method of settlement of the obligation. This Interpretation is effective no
later than the end of fiscal years ending after December 15, 2005.
Management adopted this Interpretation effective July 30, 2006. Adoption of
FASB Interpretation No. 47 did not have a material impact on the Company's
consolidated financial position, results of operations or cash flows.
In March of 2005, the SEC issued Staff Accounting Bulletin No. 107,
"Share-Based Payment" ("SAB 107"), which provides interpretive guidance
related to the interaction between SFAS 123(R) and certain SEC rules and
regulations, as well as provides the SEC staff's views regarding the
valuation of share-based payment arrangements. The Company has incorporated
SAB 107 in the implementation and adoption of SFAS 123(R).
In December 2004, the FASB issued SFAS No. 123(R), "Share Based Payment,"
which is a revision of SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123(R)"). SFAS 123(R) is effective for publicly traded
companies for annual periods beginning after June 15, 2005, supersedes
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and amends SFAS No. 95, "Statement of Cash Flows." Management
adopted this standard on August 1, 2005. See Note A-14 for a discussion of
the impact on the consolidated financial position, results of operations
and cash flows of the Company upon adoption of SFAS 123(R).
NOTE B - ACQUISITIONS
The Company entered into an agreement as of March 29, 2004 to acquire
certain assets and the business, subject to the assumption of certain
liabilities, of Communication Techniques, Inc. for $14,914,000 in cash. The
business operates as a wholly-owned subsidiary of the Company, Herley-CTI,
Inc. ("CTI"). The results of operations of CTI are included in the
consolidated financial statements from March 29, 2004. CTI designs,
develops and produces signal generation components and integrated
assemblies for digital radio, satellite communications, test and
instrumentation and datacom applications. CTI also recently developed a
fast frequency changing direct synthesizer which, when combined with the
capabilities of Herley-Israel, puts the Company at the forefront of
producing broadband microwave sources for radar, communication, electronic
warfare and microwave test systems.
The Company entered into an agreement as of September 1, 2004 to purchase
the majority of the assets and assume the majority of the liabilities of
Reliable System Services Corporation of Melbourne, Florida for $3,725,000
in cash, plus acquisition costs of approximately $28,000. The results of
operations are included in the consolidated financial statements from
September 1, 2004. The Company operates the business as a wholly-owned
subsidiary under the name Herley-RSS, Inc. ("RSS"). RSS was acquired by the
Company in order to capitalize on its synergies with the Company's other
product lines, particularly in "over the horizon" command and control
(C(2)) systems for drones and targets. RSS designs, develops and produces
satellite-based command and control systems for prime defense contractors
and entities worldwide. The Company closed the facility in Melbourne,
Florida in August 2006, and moved the RSS operations into the Fort Walton
Beach facility.
The Company entered into an agreement as of February 1, 2005 to acquire all
of the capital stock of Micro Systems, Inc. ("MSI"), Fort Walton Beach,
Florida for payments of $21,473,328 in cash, plus acquisition costs accrued
of approximately $16,000, and the assumption of certain liabilities. The
results of operation of MSI are included in the consolidated financial
statements from February 1, 2005. MSI was acquired by the Company in order
to capitalize on its synergies with the Company's legacy product lines,
consolidate operations, add additional engineers and increase its
capabilities in the area of control avionics and target control systems.
MSI is a market leader in the design and manufacturing of command and
control systems for operation of unmanned aerial, seaborne and ground
targets and missiles.
The Company entered into an agreement as of April 1, 2005 to acquire all of
the capital stock of Innovative Concepts, Inc. ("ICI"), McLean, Virginia
for cash payments of $24,378,330, the assumption of certain liabilities,
and a cash advance of $3,250,000 for the repayment of debt assumed. The
F-15
results of operations of ICI are included in the consolidated financial
statements from April 1, 2005. ICI was acquired by the Company in order to
capitalize on its tactical data link technology for exchange of digital
information. ICI has a successful history of developing and providing
wireless communications technology and real-time embedded systems,
software, hardware and high-speed processing in support of the defense
industry.
All of the acquisitions completed by the Company are accounted for in
accordance with the provisions of SFAS No. 141, "Business Combinations,"
which requires that all business combinations be accounted for using the
purchase method.
For the four acquisitions outlined above, the allocation of the aggregate
purchase price (net of cash acquired of approximately $1,463,000), based on
a review of the fair value of the assets acquired and liabilities assumed,
is as follows (in thousands):
Company acquired: CTI RSS MSI ICI
-----------------
Effective Date: March 29, September 1, February 1, April 1,
-------------- 2004 2004 2005 2005
---- ---- ---- ----
Current assets $ 2,861 $ 483 $1,534 $8,759
Property, plant and equipment 1,492 72 2,038 681
Other assets - - 1 -
Intangible assets 3,200 - 4,400 10,200
Goodwill 8,753 3,456 15,148 19,693
Current liabilities (1,392) (258) (2,436) (12,364)
------ ----- ------ ------
Aggregate purchase price $ 14,914 $ 3,753 $ 20,685 $ 26,969
====== ===== ====== ======
The Company adjusted its valuation of the assets acquired and liabilities
assumed in the acquisition of ICI in accordance with the provisions of SFAS
No. 141 during the second quarter of fiscal 2006. Accordingly, the
Company's consolidated financial statements reflect an adjustment of
$2,504,000 to the reserve for contract losses relating to a contract in
ICI's backlog at the date of acquisition that consisted of an initial
production order and four additional options exercisable unilaterally by
the customer. Although the customer had not exercised any options as of the
date of acquisition, the Company had a contractual obligation to honor the
terms and conditions of the contract including the discounted pricing in
the contract options, with a high probability of the options being
exercised, resulting in the estimated losses under the contract. Two of the
options have been exercised to date.
Goodwill resulting from these acquisitions is based on the excess of the
amounts paid over the estimated fair value of the net assets acquired, and
is tax deductible.
Unaudited pro forma financial information for the three acquisitions
completed by the Company in fiscal 2005 as if the acquisitions had occurred
on August 4, 2003 is as follows (in thousands except per share amounts):
2005 2004
---- ----
Net sales $ 173,223 $ 158,584
Net income 10,374 13,654
Net income per common share:
Basic $ 0.72 $ 0.97
Diluted $ 0.69 $ 0.92
Weighted shares outstanding
Basic 14,310 14,105
Diluted 14,969 14,896
F-16
NOTE C - INVENTORIES
The major components of inventories are as follows (in thousands):
July 30, July 31,
2006 2005
---- ----
Purchased parts and raw materials $ 27,191 $ 23,695
Work in process 29,597 34,151
Finished products 3,270 2,296
------- -------
60,058 60,142
Less:
Allowance for obsolete and slow moving inventory 4,576 4,492
Unliquidated progress payments 2,573 4,060
------- -------
$ 52,909 $ 51,590
====== ======
NOTE D - OTHER INVESTMENTS
In July 1994, the Company invested $1,000,000 for a limited partnership
interest in M.D. Sass Municipal Finance Partners-I, a Delaware limited
partnership. The objectives of the partnership are the preservation and
protection of its capital and the earning of income through the purchase of
certificates or other documentation that evidence liens for unpaid local
taxes on parcels of real property. At July 30, 2006 and July 31, 2005, the
percentage of ownership was approximately 10%. The Company's interest in
the partnership may be transferred to a substitute limited partner, upon
written notice to the managing general partners, only with the unanimous
consent of both general partners at their sole discretion. The partnership
is in the process of being liquidated and accordingly the Company received
partial distributions of approximately $111,000 and $109,000 from the
partnership in fiscal 2006 and 2005, respectively. The net annualized pre
tax return on investment in the partnership since inception is
approximately 9.9%. As of July 30, 2006, the Company's limited partnership
interest had a carrying value of approximately $3,200 based on the equity
method of accounting.
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following (in
thousands):
July 30, July 31, Estimated
2006 2005 Useful Life
------- -------- -----------
Land $ 4,006 $ 4,006
Building and building improvements 12,221 12,011 10-40 years
Machinery and equipment 51,827 46,402 5-8 years
Furniture and fixtures 3,199 2,962 5-10 years
Automobiles 18 18 3 years
Leasehold improvements 2,988 2,649 5-10 years
-------------- -------------
74,259 68,048
Less accumulated depreciation 43,781 38,587
-------------- -------------
$30,478 $ 29,461
============== =============
Depreciation charges totaled approximately $5,208,000, $4,655,000 and
$3,796,000 in fiscal 2006, 2005 and 2004, respectively.
F-17
NOTE F - COMMITMENTS AND CONTINGENCIES
Leases
------
The Company leases office, production and warehouse space as well as
computer equipment and automobiles under non-cancelable operating leases.
Rent expense for the fifty-two weeks ended July 30, 2006, July 31, 2005 and
August 1, 2004, was approximately $3,960,000, $2,834,000 and $1,749,000,
respectively. Minimum annual rentals under non-cancelable operating leases
are as follows (in thousands):
Amount
------
Year ending fiscal 2007 $ 3,244
2008 3,197
2009 2,775
2010 2,129
2011 2,164
Future 2,233
-----
$ 15,742
======
Employment and Severance Agreements
-----------------------------------
The Company has employment agreements with the Chairman/Chief Executive
Officer and former Chairman of the Company which expire December 31, 2011,
subject to extension for additional one-year periods annually each January
1 with a final expiration date of December 31, 2015 (as amended December 9,
2003). The agreements provide for aggregate annual salaries as of July 31,
2006 of $1,542,300 and provide for a semi-annual cost of living adjustment
based on the consumer price index. The agreements also provide for
incentive compensation at 7% in the aggregate of pretax income of the
Company. Incentive compensation in the amount of $1,114,000, $1,138,000 and
$2,214,000 was charged to expense in fiscal years 2006, 2005 and 2004,
respectively. The agreement with the Company's former Chairman was
terminated as discussed below.
The agreements also provide that, in the event there is a change in control
of the Company, as defined, the executives have the option to terminate the
agreements and receive a lump-sum payment equal to the sum of the salary
payable for the remainder of the employment term, plus the annual bonuses
(based on the average of the three highest annual bonuses awarded during
the ten preceding years) for the remainder of the employment term. As of
July 31, 2006, the amount payable in the event of such termination would be
approximately $17,243,000. The agreements also provide for consulting
periods, one for five and one for ten years, at the end of the employment
period at an annual compensation equivalent to one-half of the executive's
annual salary at the end of the employment period, subject to annual cost
of living adjustments.
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy, the Company
entered into an agreement with Lee N. Blatt, former Chairman of the
Company, to terminate the Employment Agreement between the Company and Mr.
Blatt dated as of July 29, 2002 and modified on December 9, 2003 (see Note
A.1).
In addition, certain executive officers of the Company have employment
agreements which expire June 6, 2009 providing for aggregate annual
salaries as of July 30, 2006 of $590,000.
An employment contract of a retired executive provides for a consulting
period which became effective October 1, 1998, and terminates December 31,
2010 at the annual rate of compensation of $100,000.
Several officers and key employees of the Company have severance agreements
providing for an aggregate lump-sum payment of approximately $3,320,000
through September 30, 2008 in the event of a change in control of the
Company as defined in the agreements. Several other employees have
severance agreements, in the event of termination of employment except for
cause, expiring at various dates from December 2006 through February 2008,
providing for an aggregate payment as of July 30, 2006 of $1,910,000.
Litigation
----------
As previously reported, there has been a continuing investigation by the
U.S. Attorneys' Office in Pennsylvania which, inter alia, involves pricing
under contracts with the U.S. Department of Defense relating to voltage
control oscillators and powerheads. The contracts aggregate approximately
$3.9 million in total revenue.
F-18
On June 6, 2006, an indictment was returned against the Company and Lee
Blatt, its former Chairman. No other officer or director of the Company was
named in the indictment. The indictment alleges 29 counts of violations of
the wire fraud statute (18 U.S.C. Section 1343), 2 counts of violations of
the obstruction of a federal audit statute (18 U.S.C. Section 1516), 1
count of violating the major fraud against the United States statute (18
U.S.C. Section 1031), 3 counts of violating the false statements to the
government statute (18 U.S.C. Section 1001) and a notice of forfeiture. The
Company believes that no criminal conduct has occurred and will vigorously
contest the charges. If convicted, Mr. Blatt and the Company could be fined
up to approximately $13 million each and the Company could be required to
forfeit approximately $2.9 million paid under the contracts. Under the
terms of an indemnification agreement with Mr. Blatt, the Company has
agreed to provide indemnification with regard to certain legal proceedings
so long as he has acted in good faith and in a manner believed to be in, or
not opposed to, the Company's best interest with respect to any criminal
proceeding and had no reasonable cause to believe his conduct was unlawful.
In June and July 2006, the Company was served with several class-action
complaints against the Company and certain of its officers in the United
States District Court for the Eastern District of Pennsylvania. The claims
are made under Section 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 thereunder. In July 2006, the Company and its directors
were also served with a derivative complaint for breach of fiduciary duty
brought pursuant to Rule 23.1 of the Federal Rules of Civil Procedure. The
complaints relate to the Company's indictment in the matter discussed
above. In addition, in June 2006, the Company was notified by
representatives of the United States Attorney's Office for the Eastern
District of Pennsylvania, Civil Division, that they intended to file a
civil lawsuit against the Company pursuant to inter alia, the False Claims
Act, 31 U.S.C. Section 3729 et. seq. The Company entered into a Tolling
Agreement on June 21, 2006, and does not anticipate any further activity
related to this potential claim until after the trial of the criminal
matter mentioned above.
The Company believes it has substantial defenses to the charges alleged in
the indictment and intends to vigorously defend against these allegations.
In accordance with SFAS No. 5, "Accounting for Contingencies," the Company
determines whether an estimated loss from a loss contingency should be
accrued by assessing whether a loss is deemed probable and can be
reasonably estimated. Litigation is inherently unpredictable and due to the
uncertainty of the outcome of the matters discussed above, the Company has
concluded that it is currently not probable that a loss has been incurred.
Accordingly, no accrual has been recorded in the accompanying consolidated
financial statements. If an unfavorable ruling were to occur in any
specific period, there exists the possibility of a material adverse impact
on the results of operations for that period.
In connection with the Robinson Laboratories, Inc. ("RLI") litigation
settled in 2005, by Order Dated February 17, 2005, the Company was awarded
$2.1 million for attorneys' fees. The judgment has not been paid by RLI and
the receivable for this award has not been recorded in the Company's
consolidated financial statements because RLI has no assets.
The Company is involved in various other legal proceedings and claims which
arise in the ordinary course of its business. While any litigation contains
an element of uncertainty, management believes that the outcome of such
litigation will not have a material adverse effect on the Company's
financial position or results of operations.
Stand-by Letters of Credit
--------------------------
The Company maintains a letter of credit facility in connection with the
revolving credit agreement with two banks that provides for the issuance of
stand-by letters of credit and requires the payment of a fee of 1.0% per
annum of the amounts outstanding under the facility. The facility expires
March 31, 2008. At July 30, 2006, stand-by letters of credit aggregating
approximately $10,285,000 were outstanding under this facility (See Note
H).
F-19
NOTE G - INCOME TAXES
Income tax expense consisted of the following (in thousands):
52 weeks ended
-------------------------------------
July 30, July 31, August 1,
2006 2005 2004
---- ---- ----
Current
Federal $ 3,036 $ 2,772 $ 5,514
State 350 344 549
Foreign 375 30 431
--------- -------- ----------
3,761 3,146 6,494
Deferred
Federal 225 992 (372)
State 24 94 (44)
Foreign (31) 13 5
--------- -------- ----------
218 1,099 (411)
--------- -------- ----------
$ 3,979 $ 4,245 $ 6,083
========= ======== ==========
The Company paid income taxes of approximately $3,407,000, $546,000, and
$5,496,000 in fiscal 2006, 2005, and 2004, respectively. The following is a
reconciliation of the U. S. statutory income tax rate and the effective tax
rate on pretax income:
52 weeks ended
-----------------------------
July 30, July 31, August 1,
2006 2005 2004
---- ---- ----
Statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of
Federal income tax benefit 1.8 1.9 1.7
Benefit of extra territorial income (1.4) (1.1) (1.4)
Non-deductible expenses 0.9 0.7 0.6
Benefit of foreign and
foreign-source income (4.5) (1.0) (3.9)
Research and development credits (1.3) (5.7) (1.0)
Tax exempt interest (1.2) (1.3) -
Manufacturing deduction (0.6) - -
Other, net (0.9) (0.2) (0.2)
--------- --------- ---------
Effective tax rate 27.8% 28.3% 30.8%
========= ========= =========
Income taxes have not been provided on undistributed earnings of foreign
subsidiaries. If remitted as dividends, these earnings could become subject
to additional tax. The Company's intention is to reinvest non-remitted
earnings of subsidiaries outside the United States permanently. The U.S.
research and development credit expired on December 31, 2005 and has not
been extended by Congress. The credit taken in fiscal 2006 is based on
qualified research expenditures through December 31, 2005.
F-20
The tax effects of significant items comprising deferred income taxes are
as follows (in thousands):
July 30, 2006 July 31, 2005
------------------------ -----------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
----------- ----------- ----- -----------
Intangibles $ - $ 4,393 $ - $ 3,060
Accrued vacation pay 562 - 396 -
Accrued bonus 201 - 318 -
Warranty costs 476 - 279 -
Inventory 1,668 - 1,348 -
Depreciation - 3,023 - 3,194
Contract losses 95 - 69 -
Net operating loss
carry-forwards 628 - 230 -
Other 115 - 146 -
------------- ------------ ------------ ------------
$ 3,745 $ 7,416 $ 2,786 $ 6,254
============= ============ ============ ============
As of July 30, 2006, the Company has available net operating loss
carry-forwards for state income tax purposes of approximately $5,917,000
with expiration dates from 2022 through 2026.
NOTE H- LONG-TERM DEBT
Long-term debt is summarized as follows (in thousands):
July 30, July 31,
Rate 2006 2005
--------------- ---- ----
Revolving loan facility (a) 6.75% and 7.20% $ - $ -
Mortgage note (b) 7.43% 2,330 2,431
Industrial Revenue Bonds (c) 4.07% 2,590 2,700
Note payable (d) 6.75% 1,626 -
Note for acquired business (e) 1.80% - 586
Other 32 80
---------- -------------
6,578 5,797
Less current portion 630 797
---------- -------------
$5,948 $5,000
========== =============
(a) In June 2002, the Company entered into a new $50 million Revolving Credit
Loan Agreement, which includes provision for the issuance of stand-by
letters of credit, with two banks on an unsecured basis which may be used
for general corporate purposes, including business acquisitions. The
revolving credit facility requires the payment of interest only on a
monthly basis and payment of the outstanding principal balance on March 31,
2008 (as amended). The Company may elect to borrow up to a maximum of $5
million with interest based on the Federal Funds Target Rate plus a margin
of 1.50% to 1.80%, or up to a maximum of $45 million with interest based on
LIBOR plus a margin of 1.35% to 1.65%. The applicable incremental margin is
based on the ratio of total liabilities to tangible net worth, as those
terms are defined in the agreement. The Federal Funds Target Rate and the
LIBOR rate was 5.25% and 5.40%, respectively, at July 30, 2006. There is a
fee of 15 basis points per annum on the unused portion of the $45,000,000
LIBOR based portion of the credit facility payable quarterly. There are no
borrowings under the line at July 30, 2006 and July 31, 2005.
The agreement contains various financial covenants, including, among other
matters, minimum tangible net worth, total liabilities to tangible net
worth, debt service coverage and restrictions on other borrowings. The
Company is in compliance with all such financial covenants at July 30,
2006.
F-21
(b) The mortgage loan is for a term of ten years commencing February 16, 1999
with fixed monthly principal and interest installments of $23,359 including
interest at a fixed rate of 7.43%, and is based upon a twenty-year
amortization. The loan is secured by a mortgage on the Company's land and
building in Lancaster, Pennsylvania having a net book value of
approximately $1,764,000.
The mortgage note agreement contains various financial covenants,
including, among other matters, the maintenance of specific amounts of
tangible net worth, debt to tangible net worth, debt service coverage and
restrictions on other borrowings. The Company is in compliance with all
such financial covenants at July 30, 2006. In connection with this loan,
the Company paid approximately $45,000 in financing costs. Such costs are
included in Other Assets in the accompanying consolidated balance sheets at
July 30, 2006 and July 31, 2005, and are being amortized over the term of
the loan (10 years).
(c) On October 19, 2001, the Company received $3,000,000 in proceeds from the
East Hempfield Township Industrial Development Authority Variable Rate
Demand/Fixed Rate Revenue Bonds Series of 2001 (the "Bonds"). The Bonds are
due in varying annual installments through October 1, 2021. The initial
installment of $95,000 was paid October 1, 2002 and increases each year
until the final payment of $225,000 in 2021. The interest rate on the Bonds
is reset weekly at the prevailing market rate of the BMA Municipal Index.
The initial rate of interest was 2.1%, which, after giving effect to a ten
year interest rate swap agreement (See Note O) becomes a fixed rate of
4.07%. The interest rate at July 30, 2006 was 3.71%. The bond agreement
requires a sinking fund payment on a monthly basis to fund the annual Bonds
redemption installment. Proceeds from the Bonds were used for the
construction of a 15,000 square foot expansion of the Company's facilities
in Lancaster, Pennsylvania, and for manufacturing equipment.
The Bonds are secured by a letter of credit expiring October 18, 2011 and a
mortgage on the related properties pledged as collateral. The net book
value of the land and building covered by the mortgage is approximately
$1,697,000 at July 30, 2006.
(d) In June 2006, the Company entered into a loan agreement with DeLage Landen
Financial Services, Inc. through Microsoft Capital Corporation for the
principal sum of $1,626,501. The note is payable in thirty-six monthly
payments of approximately $45,181 including imputed interest at 6.75% per
annum. Proceeds of the loan were used to license certain software and
related maintenance fees from Microsoft Corporation.
(e) In connection with the acquisition of EWST as of September 1, 2002, the
Company issued a note for 1,000,000 Pounds Sterling, including interest at
1.8%, payable in annual installments of 333,334 Pounds Sterling beginning
October 1, 2003. The note was paid in full on October 1, 2005.
The Company paid interest in 2006, 2005 and 2004 of approximately $291,000,
$304,000 and $314,000, respectively.
Future payments required on long-term debt are as follows (in thousands):
Fiscal year ending during: Amount
2007 $ 630
2008 779
2009 2,772
2010 265
2011 135
Future 1,997
-----
$ 6,578
=====
F-22
NOTE I - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following (in thousands):
July 30, July 31,
2006 2005
Accounts payable $ 10,039 $ 13,756
Accrued payroll, bonuses and related costs 5,563 5,010
Accrued commissions 1,525 1,643
Accrued royalties 46 37
Accrued legal and accounting fees 639 533
Accrued rent expense 1,448 996
Unearned income 38 56
Other accrued expenses 2,205 1,647
--------- ---------
$ 21,503 $ 23,678
========= =========
NOTE J - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan
("Plan") which qualified as a thrift plan under Section 401(k) of the
Internal Revenue Code. This Plan, as amended and restated, allows employees
to contribute between 2% and 30% of their salaries to the Plan. For the
Plan year beginning August 1, 2005, the Plan was amended to be considered a
"Safe Harbor" plan, where a contribution will be made to eligible
participants in an amount equal to 100% of the amount of each participant's
elective deferral that does not exceed 3% of compensation, plus 50% of the
amount of the elective deferral that exceeds 3% of compensation up to a
maximum contribution of 5% of compensation. Under the Safe Harbor
provision, all contributions are 100% vested when made. Additional Company
contributions can be made depending on profits. The aggregate benefit
payable to an employee is dependent upon his rate of contribution, the
earnings of the fund, and the length of time such employee continues as a
participant. The Company has recognized expenses of approximately
$1,773,000 (including approximately $727,000 related to the acquisitions of
MSI, ICI and RSS), $1,038,000 (including approximately $268,000 related to
the acquisitions of MSI, ICI and RSS), and $618,000 under the Plan for the
fifty-two weeks ended July 30, 2006, July 31, 2005 and August 1, 2004,
respectively. The Company also contributed to a similar plan through EWST
whereby the Company matches employee elective contributions up to a maximum
of 5% of compensation. Expenses recognized for 2006, 2005 and 2004 were
approximately $55,900, $60,600 and $72,000, respectively.
The Company's Israeli subsidiary provides for employee severance
liabilities pursuant to the Israeli severance pay law and labor agreements.
The Company's liability is fully provided for by monthly payments deposited
with insurers and by a reserve established by the Company to cover the
portion of this liability not covered by the Company's deposits. In
addition to recognizing an expense for the funding to the insurance
programs for this severance obligation, the Company also records as expense
the net increase in its unfunded severance liability. The liability for
this unfunded severance obligation is carried in Other Long-Term
Liabilities on the accompanying Consolidated Balance Sheets and was
$1,265,000 and $1,042,000 at July 30, 2006 and July 31, 2005, respectively.
The total expense recognized for employee severance programs in Israel
(both the funded and unfunded portion of the program) was approximately
$223,000, $110,000 and $313,000 for fiscal years 2006, 2005 and 2004,
respectively.
NOTE K - RELATED PARTY TRANSACTIONS
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy, the Company
entered into an agreement with Lee N. Blatt to terminate the Employment
Agreement between the Company and Mr. Blatt dated as of July 29, 2002 and
modified on December 9, 2003 (See Note A.1).
In connection with the move of the Amityville facilities of General
Microwave Corporation in fiscal 1999, the Company entered into a 10 year
lease agreement with a partnership owned by the children of certain
officers of the Company. The lease provides for initial minimum annual rent
of $312,000 subject to escalation of approximately 4% annually throughout
the 10 year term. Additionally, in March 2000, the Company entered into
another 10 year lease with the same partnership for additional space. The
initial minimum annual rent of $92,000 is subject to escalation of
approximately 4% annually.
F-23
NOTE L - COMPUTATION OF PER SHARE EARNINGS
The following table shows the components used in the calculation of basic
earnings per share and earnings per share assuming dilution (in thousands
except per share data):
Fifty-two weeks ended
--------------------------------------------
July 30, July 31, August 1,
2006 2005 2004
------------- ------------- -------------
Numerator:
Net Income $10,354 $10,781 $13,673
============= ============= =============
Denominator:
Basic weighted-average shares 14,463 14,310 14,105
Effect of dilutive securities:
Employee stock options 634 659 791
------------- ------------- -------------
Diluted weighted-average shares 15,097 14,969 14,896
============= ============= =============
Stock options not included in computation 1,722 807 4
============= ============= =============
The number of stock options not included in the computation of diluted EPS
relates to stock options having exercise prices which are greater than the
average market price of the common shares during the period, and therefore,
are anti-dilutive. The options, which were outstanding as of July 30, 2006,
expire at various dates through February 4, 2015.
NOTE M - SHAREHOLDERS' EQUITY
The authorized shares of Common Stock of the Company are 20,000,000 shares.
Summary of Stock Option Plans
In August 2006, the Board of Directors ratified and approved the 2006 New
Employee Stock Option Plan which covers 250,000 shares of the Company's
common stock. Options granted under the plan are non-qualified stock
options. Under the terms of the plan, the exercise price for options
granted under the plan will be the fair market value at the date of grant.
The nature and terms of the options to be granted are determined at the
time of grant by the Compensation Committee or the Board of Directors. The
options expire no later than ten years from the date of grant, subject to
certain restrictions. Options for 33,000 shares were granted under the plan
during the fiscal year ended July 30, 2006. Options for 217,000 shares of
common stock are available for grant under the plan as of July 30, 2006.
In March 2003, the Board of Directors approved the 2003 Stock Option Plan
which covers 1,000,000 shares of the Company's common stock. Options
granted under the plan are non-qualified stock options. Under the terms of
the plan, the exercise price for options granted under the plan will be the
fair market value at the date of grant. The nature and terms of the options
to be granted are determined at the time of grant by the Compensation
Committee or the Board of Directors. The options expire no later than ten
years from the date of grant, subject to certain restrictions. Options for
16,300 and 993,500 shares were granted under the plan during the fiscal
years ended July 30, 2006 and July 31, 2005, respectively. No options were
granted under this plan during fiscal year ended August 1, 2004. Options
for 1,700 shares of common stock are available for grant under the plan as
of July 30, 2006.
In September 2000, the Board of Directors approved the 2000 Stock Option
Plan which covers 1,500,000 shares of the Company's common stock. Options
granted under the plan are non-qualified stock options. Under the terms of
the plan, the exercise price for options granted under the plan will be the
fair market value at the date of grant. The nature and terms of the options
to be granted are determined at the time of grant by the Compensation
Committee or the Board of Directors. The options expire no later than ten
years from the date of grant, subject to certain restrictions. Options for
18,000 and 53,000 shares were granted under the plan during the fiscal
years ended July 30, 2006 and July 31, 2005, respectively. No options were
granted under this plan during fiscal year ended August 1, 2004. Options
for 4,250 shares of common stock are available for grant under the plan as
of July 30, 2006.
F-24
In April 1998, the Board of Directors approved the 1998 Stock Option Plan
which covers 2,250,000 shares of the Company's common stock. Options
granted under the plan may be incentive stock options qualified under
Section 422 of the Internal Revenue Code of 1986 or non-qualified stock
options. Under the terms of the plan, the exercise price for options
granted under the plan will be the fair market value at the date of grant.
Prices for incentive stock options granted to employees who own 10% or more
of the Company's stock are at least 110% of market value at date of grant.
The nature and terms of the options to be granted are determined at the
time of grant by the Compensation Committee or the Board of Directors. The
options expire no later than ten years from the date of grant, subject to
certain restrictions. Non-qualified stock options for 9,000, 29,500 and
40,000 shares were granted under this plan during the fiscal years ended
July 30, 2006, July 31, 2005 and August 1, 2004, respectively. Options for
21,529 shares of common stock are available for grant under the plan as of
July 30, 2006.
In May 1997, the Board of Directors approved the 1997 Stock Option Plan
which covers 2,500,000 shares of the Company's common stock. Options
granted under the plan may be incentive stock options qualified under
Section 422 of the Internal Revenue Code of 1986 or non-qualified stock
options. Under the terms of the plan, the exercise price for options
granted under the plan will be the fair market value at the date of grant.
Prices for incentive stock options granted to employees who own 10% or more
of the Company's stock are at least 110% of market value at date of grant.
The nature and terms of the options to be granted are determined at the
time of grant by the Compensation Committee or the Board of Directors. The
options expire no later than ten years from the date of grant, subject to
certain restrictions. Non-qualified stock options for 2,700, 5,000 and
7,500 shares were granted under this plan during the fiscal years ended
July 30, 2006, July 31, 2005 and August 1, 2004, respectively. There are no
options available for grant under the plan.
A summary of stock option activity under all plans for the fifty-two weeks
ended July 30, 2006, July 31, 2005 and August 1, 2004 is as follows:
Non-Qualified Stock Options Weighted Aggregate
Average Intrinsic
Number Price Range Exercise Value (1)
of shares per share Price (in thousands)
--------- --------- ----- --------------
Outstanding August 3, 2003 3,298,227 $ 4.06 - 19.52 $ 12.33
Granted 53,500 17.32 - 20.45 $ 19.38
Exercised (253,598) 4.06 - 19.52 $ 9.88
Cancelled (77,200) 8.38 - 17.67 $ 11.91
--------------- ---------------- ---------------
Outstanding August 1, 2004 3,020,929 $ 4.06 - 19.52 $ 12.33
Granted 1,081,000 17.98 - 19.94 $ 18.29
Exercised (329,349) 16.54 - 20.60 $ 18.55
Cancelled (37,050) 8.38 - 19.83 $ 17.08
--------------- ---------------- ---------------
Outstanding July 31, 2005 3,735,530 $ 4.06 - 20.45 $ 14.41
Granted 79,000 16.61 - 21.18 $ 19.11
Exercised (272,429) 4.31 - 19.83 $ 11.73
Cancelled (52,021) 17.98 - 20.45 $ 19.64
--------------- ---------------- ---------------
Outstanding July 30, 2006 3,490,080 $ 4.06 - 21.18 $ 14.65 $1,802
=============== =============
Exercisable July 30, 2006 3,275,880 $ 14.41 $1,802
=============== =============
Vested and expected to vest July 30, 2006 3,456,375 $ 14.62 $1,802
=============== =============
<FN>
(1) There are 2,143,900 vested options with exercise prices greater than the
closing stock price of $10.87 as of July 30, 2006.
</FN>
F-25
Options outstanding and exercisable by price range as of July 30, 2006,
with expiration dates ranging from January 3, 2007 to May 2, 2015 are as
follows:
Average Weighted Weighted
Range of Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
----------------- ----------- ---------------- -------------- ----------- --------------
$ 4.06 - 10.46 1,124,980 3.64 $ 9.27 1,124,980 $ 9.27
10.50 - 17.50 680,100 4.68 $ 13.35 663,100 $ 13.25
17.98 - 17.98 844,000 6.15 $ 17.98 708,800 $ 17.98
18.57 - 19.66 714,500 5.00 $ 19.49 677,000 $ 19.51
19.83 - 21.18 126,500 4.04 $ 19.98 102,000 $ 19.84
--------------- -------------- -------------- ----------------
$ 4.06 - 21.18 3,490,080 4.74 $ 14.65 3,275,880 $ 14.41
=============== ==============
In April 2005, the Company's Board of Directors, upon recommendation of the
Board's Compensation Committee, approved the accelerated vesting of all
unvested and "out-of-the-money" stock options outstanding as of May 2,
2005. See Note A-14 of Notes to Consolidated Financial Statements.
NOTE N - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, EXPORT SALES AND GEOGRAPHIC
INFORMATION
The Company's chief operating decision makers are considered to be the
Chairman/Chief Executive Officer and the President. The Company's
Chairman/Chief Executive Officer and President evaluate both consolidated
and disaggregated financial information, primarily gross revenues, in
deciding how to allocate resources and assess performance. The
Chairman/Chief Executive Officer and President also use certain
disaggregated financial information for the Company's product groups. The
Company does not determine a measure of operating income or loss by product
group. The Company's product groups have similar long-term economic
characteristics, such as application, and are similar in regards to (a)
nature of products and production processes, (b) type of customers and (c)
method used to distribute products. Accordingly, the Company operates as a
single integrated business and as such has one operating segment as a
provider of complex microwave radio frequency (RF) and millimeter wave
components and subsystems for defense and commercial customers worldwide.
All of the Company's revenues result from sales of its products.
Revenues for fiscal years 2006, 2005 and 2004 were as follows: defense
electronics, $159,717,000, $138,071,000 and $113,172,000, respectively; and
commercial technologies, $16,551,000, $13,344,000, and $8,982,000,
respectively. Defense electronics revenues in fiscal 2006 include revenues
of $43,386,000 attributable to the acquisitions of RSS, MSI and ICI during
fiscal 2005, compared to revenues of $25,769,000 in fiscal 2005. Also in
fiscal 2006, defense electronics includes revenues of $6,660,000, and
commercial technologies includes revenue of $8,798,000 attributable to the
CTI acquisition in fiscal 2004. In fiscal 2005, defense electronics
includes revenues of $6,660,000, and commercial technologies includes
revenue of $8,633,000 attributable to the CTI acquisition (See Note B).
Net sales directly to the U.S. Government in fiscal 2006, 2005 and 2004
accounted for approximately 22%, 25% and 17% of net sales, respectively.
Approximately 67% of our net sales for fiscal 2006 and 65% of our net sales
for fiscal 2005 were made to United States government agencies and their
contractors and subcontractors for defense programs. Northrop Grumman
accounted for approximately 11% of net sales in fiscal 2005. No other
customer accounted for shipments of 10% or more of consolidated net sales
during the periods presented. Foreign sales amounted to approximately
$41,817,000 (24%), $40,460,000 (27%) and $39,716,000 (33%) in fiscal 2006,
2005 and 2004, respectively.
F-26
Geographic net sales based on place of contract performance were as follows
(in thousands):
2006 2005 2004
---- ---- ----
United States $ 155,057 $ 131,326 $ 100,746
Israel 14,048 12,738 12,305
England 7,163 7,351 9,103
--------- --------- ---------
$ 176,268 $ 151,415 $ 122,154
======= ======= =======
F-27
Net property, plant and equipment by geographic area was as follows (in
thousands):
2006 2005
---- ----
United States $ 25,243 $ 24,318
Israel 4,654 4,376
England 581 767
-------- --------
$ 30,478 $ 29,461
====== ======
NOTE O - DERIVATIVE FINANCIAL INSTRUMENTS
In October 2001, the Company entered into an interest rate swap with a bank
pursuant to which it exchanged floating rate interest in connection with
the Bonds discussed in Note H on a notional amount of $3,000,000 for a
fixed rate of 4.07% for a 10 year period ending October 1, 2011. The
notional amount reduces each year in tandem with the annual installments
due on the Bonds. The fixing of the interest rate for this period offsets
the Company's exposure to the uncertainty of floating interest rates on the
Bonds, and as such has been designated as a cash flow hedge. The hedge is
deemed to be highly effective and any ineffectiveness will be recognized in
interest expense in the reporting period. The fair value of the interest
rate swap was a liability of $30,000 as of July 30, 2006. There was no
material hedge ineffectiveness related to cash flow hedges during the
period to be recognized in earnings. There was no gain or loss reclassified
from accumulated other comprehensive income into earnings during the fiscal
year ended July 30, 2006 as a result of the discontinuance of a cash flow
hedge due to the probability of the original forecasted transaction not
occurring.
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance
sheet for cash and cash equivalents approximated its fair value.
Long-term debt: The fair value of the mortgage note and industrial
revenue bonds (including the related interest rate swap) was estimated
using discounted cash flow analyses, based on the Company's current
incremental borrowing rate for similar types of borrowing
arrangements.
The carrying amounts and fair values of the Company's financial instruments
are presented below (in thousands):
July 30, 2006
---------------------------------------
Carrying Amount Fair Value
-------------------- ---------------
Cash and cash equivalents $ 22,303 $ 22,303
Long-term debt 5,948 6,029
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NOTE Q - QUARTERLY RESULTS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
for the fifty-two weeks ended July 30, 2006 and July 31, 2005 (in
thousands, except for per share data).
2006 October 30, January 29, April 30, July 30,
2005 2006 2006 2006
----------- ----------- --------- ----------
Net sales $ 41,938 45,839 45,689 42,802
Gross profit 14,125 13,488 10,953 9,781
Net income $ 3,975 3,964 1,702 713
===== ===== ===== ===
Earnings per common share - Basic $ 0.28 0.27 0.12 0.05
==== ==== ==== ====
Basic weighted average shares 14,446 14,474 14,569 14,363
====== ====== ====== ======
Earnings per common share - Diluted $ 0.26 0.26 0.11 0.05
==== ==== ==== ====
Diluted weighted average shares 15,240 15,091 15,398 14,828
====== ====== ====== ======
2005 October 31, January 30, May 1, July 31,
2004 2005 2005 2005
----------- ----------- --------- ----------
Net sales $ 33,590 33,754 41,266 42,805
Gross profit 10,806 9,349 13,421 11,398
Net income $ 3,553 2,077 3,627 1,524
===== ===== ===== =====
Earnings per common share - Basic $ 0.25 0.14 0.25 0.11
==== ==== ==== ====
Basic weighted average shares 14,252 14,335 14,313 14,340
====== ====== ====== ======
Earnings per common share - Diluted $ 0.24 0.14 0.24 0.10
==== ==== ==== ====
Diluted weighted average shares 14,936 15,044 14,936 14,952
====== ====== ====== ======
The gross profit margin in the third quarter of 2006 was 24.0%.
Contributing to the reduction versus previous quarters were (a) development
cost overruns on certain contracts in excess of billings to customers, (b)
startup production costs on certain programs, (c) the cumulative effects of
changes in contract costs estimates on certain programs accounted for under
the percentage completion method of accounting and (d) engineering
development costs in connection with the Xytrans license agreement.
During the fourth quarter of 2006 the gross profit margin was 22.9%. The
margin was impacted by (a) high development costs on certain key programs,
(b) startup production costs on certain programs, (c) an increase in lower
margin cost reimbursable contracts at one of our facilities and (d)
billable costs under a cost reimbursable contract that provided no margin.
The third and fourth quarters of fiscal 2005 includes revenue attributable
to the acquisitions of MSI of $5,294,000 and $2,824,000, respectively, and
ICI of $3,401,000 and $8,389,000, respectively.
F-29
The gross margin percentage in the fourth quarter of 2005 was negatively
impacted due to revisions in total cost estimates on certain long term
contracts at our EWST subsidiary which resulted in negative gross profit.
In addition, the gross profit margin also varies from quarter to quarter
due to changes in product mix.
Included in the results of the third quarter of fiscal 2005 is an accrual
of $260,000, which was paid in the fourth quarter of 2005 in connection
with the Robinson Labs litigation.
**********
F-30