UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: January 28, 2007
----------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-5411
HERLEY INDUSTRIES, INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE #23-2413500
-------- -----------
(State or other jurisdiction (I.R.S. Employer Identification
of incorporation or organization) Number)
101 North Pointe Boulevard, Lancaster, Pennsylvania 17601
- --------------------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (717) 735-8117
-------------
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.
X Yes No
--- ---
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 X No
--- ---
As of February 28, 2007 - 13,962,799 shares of Common Stock are outstanding.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets -
January 28, 2007 (Unaudited) and July 30, 2006 2
Condensed Consolidated Statements of Operations (Unaudited) -
For the thirteen and twenty-six weeks ended January 28, 2007
and January 29, 2006 3
Condensed Consolidated Statement of Shareholders' Equity (Unaudited) -
For the twenty-six weeks ended January 28, 2007 4
Condensed Consolidated Statements of Cash Flows (Unaudited) -
For the twenty-six weeks ended January 28, 2007
and January 29, 2006 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 17
Item 4 - Controls and Procedures 17
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 18
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 18
Item 3 - Defaults Upon Senior Securities 18
Item 4 - Submission of Matters to a Vote of Security Holders 18
Item 5 - Other Information 19
Item 6 - Exhibits 19
Signatures 20
Part I - Financial Information
Item 1 - Financial Statements
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
January 28,
2007 July 30,
(Unaudited) 2006
---------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 24,124 $ 22,303
Trade accounts receivable 28,438 30,600
Costs incurred and income recognized in excess
of billings on uncompleted contracts and claims 13,006 13,926
Other receivables 1,657 769
Inventories, net 53,984 52,909
Deferred income taxes and other 5,705 4,932
---------- -----------
Total Current Assets 126,914 125,439
Property, Plant and Equipment, net 30,027 30,478
Goodwill 73,862 73,612
Intangibles, net of accumulated amortization of $4,362
at January 28, 2007 and $3,468 at July 30, 2006 19,485 19,989
Other Assets 1,725 1,932
---------- -----------
$ 252,013 $ 251,450
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 1,321 $ 630
Current portion of employment settlement agreement -
(net of imputed interest of $331) (Note 2) 1,027 -
Accounts payable and accrued expenses 16,707 21,503
Billings in excess of costs incurred and
income recognized on uncompleted contracts 701 555
Income taxes payable 4,957 3,395
Accrual for contract losses 1,974 2,959
Accrual for warranty costs 1,150 986
Advance payments on contracts 4,840 3,323
---------- -----------
Total Current Liabilities 32,677 33,351
Long-term Debt 6,577 5,948
Long-term Portion of Employment Settlement Agreement -
(net of imputed interest of $665) (Note 2) 4,672 -
Other Long-term Liabilities 1,439 1,265
Deferred Income Taxes 5,390 7,416
---------- -----------
50,755 47,980
---------- -----------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized 20,000,000 shares;
issued 14,761,366 and outstanding 13,962,799 in 2007
issued 14,660,716 and outstanding 13,862,149 in 2006 1,476 1,466
Additional paid-in capital 115,128 113,418
Retained earnings 91,948 96,286
Treasury stock, 798,567 common shares at cost (9,044) (9,044)
Accumulated other comprehensive income 1,750 1,344
---------- -----------
Total Shareholders' Equity 201,258 203,470
---------- -----------
$ 252,013 $ 251,450
========== ===========
See notes to condensed consolidated financial statements.
2
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except per share data)
(Unaudited)
Thirteen weeks ended Twenty-six weeks ended
-------------------- ----------------------
January 28, January 29, January 28, January 29,
2007 2006 2007 2006
----------- ---------- ---------- -----------
Net sales $ 37,997 $ 45,839 $ 78,113 $ 87,777
----------- ---------- ---------- -----------
Cost and expenses:
Cost of products sold 28,010 32,351 57,841 60,164
Selling and administrative expenses 7,398 8,238 16,420 16,825
Employment contract settlement costs (Note 2) - - 8,914 -
----------- ---------- ---------- -----------
35,408 40,589 83,175 76,989
----------- ---------- ---------- -----------
Income (loss) from operations 2,589 5,250 (5,062) 10,788
----------- ---------- ---------- -----------
Other income (expense), net:
Investment income 263 199 479 309
Interest expense (222) (91) (365) (174)
Foreign exchange gain (loss) 266 (10) 283 103
----------- ---------- ---------- -----------
307 98 397 238
----------- ---------- ---------- -----------
Income (loss) before income taxes 2,896 5,348 (4,665) 11,026
Provision (benefit) for income taxes 1,223 1,384 (327) 3,087
----------- ---------- ---------- -----------
Net income (loss) $ 1,673 $ 3,964 $ (4,338) $ 7,939
=========== ========== ========== ===========
Earnings (loss) per common share - Basic $ .12 $ .27 $ (.31) $ .55
=========== ========== ========== ===========
Basic weighted average shares 13,902 14,474 13,882 14,460
=========== ========== ========== ===========
Earnings (loss) per common share - Diluted $ .12 $ .26 $ (.31) $ .52
=========== ========== ========== ===========
Diluted weighted average shares 14,405 15,091 13,882 15,173
=========== ========== ========== ===========
See notes to condensed consolidated financial statements.
3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Twenty-six weeks ended January 28, 2007
(In thousands except share data)
(Unaudited)
Accumulated
Additional Other
Common Stock Paid-in Retained Treasury Comprehensive
Shares Amount Capital Earnings Stock Income Total
---------- -------- --------- --------- -------- ------------- --------
Balance at July 30, 2006 14,660,716 $ 1,466 $ 113,418 $ 96,286 $ (9,044) $ 1,344 $ 203,470
Exercise of stock options 100,650 10 1,077 1,087
Tax benefit upon exercise of
stock options 212 212
Stock option compensation 225 225
Stock option modification
(Note 2) 196 196
---------- -------- --------- --------- -------- ------------- --------
Subtotal 14,761,366 1,476 115,128 96,286 (9,044) 1,344 205,190
--------
Net loss (4,338) (4,338)
Other comprehensive (loss), net of tax:
Unrealized loss on interest rate swap (9) (9)
Foreign currency translation gain 415 415
--------
Comprehensive loss (3,932)
---------- -------- --------- --------- -------- ------------- --------
Balance at January 28, 2007 14,761,366 $ 1,476 $ 115,128 $ 91,948 $ (9,044) $ 1,750 $ 201,258
========== ======== ========= ========= ======== ============= ========
See notes to condensed consolidated financial statements.
4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Twenty-six weeks ended
January 28, January 29,
2007 2006
--------------- ---------------
Cash flows from operating activities:
Net (loss) income $ (4,338) $ 7,939
--------------- ---------------
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization 3,507 3,466
Stock-based compensation expense 225 213
Excess tax benefit from exercise of stock options (212) (244)
Employment contract settlement costs (includes $196 of
stock option modification costs) 5,914 -
Imputed interest related to employment settlement liability 111 -
Deferred taxes (2,307) (81)
Gain on sale of equipment (107) -
Foreign exchange gain (68) (36)
Inventory valuation reserve charges 424 488
Reduction in accrual for contract losses (664) -
Warranty reserve charges 634 167
Changes in operating assets and liabilities:
Trade accounts receivable 2,162 (1,291)
Costs incurred and income
recognized in excess of billings on
uncompleted contracts and claims 920 (2,865)
Other receivables (888) (228)
Inventories (1,499) (3,491)
Other current assets (315) (71)
Accounts payable and accrued expenses (5,266) (3,121)
Billings in excess of costs incurred and
income recognized on uncompleted contracts 146 457
Income taxes payable 1,774 1,174
Accrual for contract losses (321) 85
Advance payments on contracts 1,517 1,738
Other, net 209 259
--------------- ---------------
Total adjustments 5,896 (3,381)
--------------- ---------------
Net cash provided by operating activities 1,558 4,558
--------------- ---------------
Cash flows from investing activities:
Acquisition of technology license (179) (825)
Proceeds from sale of equipment 202 -
Capital expenditures (2,235) (2,785)
--------------- ---------------
Net cash used in investing activities (2,212) (3,610)
--------------- ---------------
Cash flows from financing activities:
Borrowings under bank line of credit 8,500 8,000
Borrowings - other 1,746 -
Proceeds from exercise of stock options 1,087 999
Excess tax benefit from exercises of stock options 212 244
Payments under employment contract settlement (130) -
Payments of long-term debt (440) (753)
Payments under bank line of credit (8,500) (8,000)
--------------- ---------------
Net cash provided by financing activities 2,475 490
--------------- ---------------
Net increase in cash and cash equivalents 1,821 1,438
Cash and cash equivalents at beginning of period 22,303 20,331
--------------- ---------------
Cash and cash equivalents at end of period $ 24,124 $ 21,769
=============== ===============
See notes to condensed consolidated financial statements.
5
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (UNAUDITED)
1. Principles of Consolidation and Basis of Presentation
The unaudited condensed consolidated financial statements include the
accounts of Herley Industries, Inc. and its wholly-owned subsidiaries,
collectively referred to as the "Company". All significant intercompany
accounts and transactions have been eliminated.
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with instructions to Form 10-Q and Article 10
of Regulation S-X and do not include all of the information and note
disclosures normally included in annual financial statements as required by
accounting principles generally accepted in the United States of America
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring items, as well as the recording
of the employment contract settlement costs discussed in Note 2) considered
necessary for a fair presentation have been included in the accompanying
condensed consolidated financial statements. Operating results for interim
periods are not necessarily indicative of the results of operations that
may be expected for a full year. These statements should be read in
conjunction with the consolidated financial statements and notes thereto,
and the Company's description of critical accounting policies, included in
the Company's 2006 Annual Report on Form 10-K for the fiscal year ended
July 30, 2006, as filed with the Securities and Exchange Commission
("SEC"). The consolidated balance sheet at July 30, 2006 has been derived
from the audited consolidated financial statements at that date but does
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results
could differ from those estimates. The accrual for contract losses
associated with the ICI acquisition (more fully described in Note B of Form
10-K for the fiscal year ended July 30, 2006), was reduced by $664,000 in
the thirteen weeks ended January 28, 2007 (which is included as a reduction
of costs of products sold) as a result of management changing its estimated
liability for expected losses under the first two options of the contract.
The accrual for contract losses includes an estimate of approximately
$1,569,000 relating to the remaining two contract options not yet exercised
by the customer. It is at least reasonably possible that a change in the
estimate will occur in the near term.
Certain prior period balances have been reclassified to conform to the
current period's financial statement presentation.
2. Significant Events
In connection with the legal matter discussed in Note 7 "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 contracting 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.
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 the 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, the Company entered into an Administrative
Agreement with the Department of the Navy, on behalf of the Department of
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 was 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 terminated the suspension
of the Company from receiving new contract awards from the U.S. Government.
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 approximately
$9,462,000; 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 "Note"). The Note, which has been discounted at 6.75%, has a balance
at January 28, 2007 of approximately $5,365,000. Of this amount, $969,000
is included in "Current portion of employment settlement agreement" net of
imputed interest of $231,000 and $4,396,000 is included in "Long-term
Portion of Employment Settlement Agreement" net of imputed interest of
$765,000 in the accompanying balance sheet. In addition, Mr. Blatt received
6
his bonus of $636,503 in January 2007 for fiscal year 2006, and shall be
entitled to receive reimbursement for medical care and life insurance, in
accordance with the original terms of his Employment Agreement. The current
portion of the medical care and life insurance is estimated at $57,000 and
is included in Current portion of employment settlement agreement" and the
long-term portion is estimated at $276,000 as of January 28, 2007 and is
included in "Long-term Portion of Employment Settlement Agreement" in the
accompanying balance sheet.
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.
Aggregate costs of approximately $8,914,000 under the Agreement, including
cash payments of $3,000,000, payments due under the Note of approximately
$5,354,000, medical and life insurance benefits of approximately $364,000
(both discounted at an imputed interest rate of 6.75%) and the fair value
of the modification of the stock options of approximately $196,000 (using
the Black-Scholes option valuation model), have been recorded in the
Company's condensed consolidated financial statements in the six months
ended January 28, 2007.
3. Inventories
The major components of inventories are as follows (in thousands):
January 28, 2007 July 30, 2006
---------------- -------------
Purchased parts and raw materials $ 29,889 $ 27,191
Work in process 28,663 29,597
Finished products 2,448 3,270
---------------- -------------
61,000 60,058
Less:
Allowance for obsolete and slow moving inventory 4,750 4,576
Unliquidated progress payments 2,266 2,573
---------------- -------------
$ 53,984 $ 52,909
================ =============
4. Income taxes
The net deferred income tax asset balance at January 28, 2007 was
approximately $4,203,000, an increase of approximately $458,000 from July
30, 2006. The increase is due to the tax effect on the timing of the
deductions for future payments of approximately $5,254,000 under a
promissory note and approximately $334,000 for estimated medical and life
insurance benefits due under the employment contract settlement discussed
in Note 2.
The income tax provision recognized in the second quarter of fiscal 2007
was $1.2 million as compared to a provision for income taxes of $1.4
million in the prior year's second quarter. As of the end of the second
quarter of fiscal 2007, the effective income tax rate for the full year
2007 is now estimated at 7%, versus the rate of approximately 21% that was
estimated in the first quarter. The decline in the estimated effective
income tax rate for fiscal 2007 is primarily attributable to (a) the
extension of the R&D tax credit by Congress in December 2006 retroactive to
January 1, 2006 and (b) an increase in the proportion of overall earnings
expected to be generated through the Company's foreign operations where
earnings are taxed at lower rates than domestically. The extension of the
R&D tax credit reduced the statutory income tax rate of 35% by an estimated
8% for fiscal 2007. As a result of lower domestic earnings, due primarily
to the employment contract settlement costs which significantly affects
domestic profitability, foreign earnings are a greater percentage of total
earnings. The Company's foreign earnings are attributable primarily to our
Israeli subsidiary which is taxed at an estimated rate of 12% for fiscal
2007 thereby reducing the effective income tax rate by approximately 20%.
5. Product Warranties
The Company warrants its products generally for a period of one year.
Product warranty costs are accrued based on historical claims expense.
Accrued warranty costs are reduced as warranty repair costs are incurred.
The following table presents the change in the accrual for product warranty
costs for the thirteen and twenty-six weeks ended January 28, 2007 and
January 29, 2006 (in thousands):
7
Thirteen weeks ended Twenty-six weeks ended
January 28, January 29, January 28, January 29,
2007 2006 2007 2006
Balance at beginning of period $ 1,068 $ 776 $ 986 799
Provision for warranty obligations 368 28 634 167
Warranty costs charged to the reserve (286) (58) (470) (220)
------------ ------------ ------------ ------------
Balance at end of period $ 1,150 $ 746 1,150 $ 746
============ ============ ============ ============
6. Long Term Debt
In connection with the implementation of an ERP software package, the
Company entered into an additional financing agreement in August 2006 with
De Lage Landen Financial Services, Inc. through Microsoft Capital
Corporation providing for loans not to exceed an aggregate of $2,000,000.
Amounts borrowed under the agreement are payable in thirty-six equal
monthly installments with interest at 5.354% per annum. The Company has
borrowed an aggregate of $1,400,000 as of January 28, 2007 with monthly
payments totaling approximately $42,750. In addition, we financed the
purchase of capital equipment in the amount of $346,000 in connection with
a major long-term contract.
7. Litigation
On June 6, 2006, in connection with 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, 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 contracts aggregate approximately
$3.9 million in total revenue. 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 and August 2006, the Company and
certain of its current and former officers and directors were also served
with two separate derivative complaints 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.
The Company believes it is entitled to recovery of certain legal fees
associated with the above matters under its D&O insurance policy.
Accordingly, as of January 28, 2007, the Company has recorded a receivable
of $951,000 (net of a deductible of $500,000) in anticipation of
recoveries. The amount is included in other receivables in the accompanying
consolidated balance sheet at January 28, 2007. The insurance carrier may
contest the claim in whole or in part. In addition, the Company has entered
into an agreement dated January 11, 2007 with the insurance carrier whereby
if it is determined by final decision of an arbitration panel, or by final
judgment of a court, or other final decision of a tribunal having
jurisdiction thereof, that any amount paid by the insurance carrier was not
a loss, as that term is defined in the policy, the Company shall repay to
the insurance carrier any such uncovered sums previously advanced to the
Company. No payments have been received from the insurance carrier as of
January 28, 2007.
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
other litigation will not have a material adverse effect on the Company's
financial position or results of operations.
8
8. Comprehensive Income (Loss), net of income taxes
Comprehensive income (loss) for the periods presented is as follows (in
thousands):
Thirteen weeks ended Twenty-six weeks ended
-------------------- ----------------------
January 28, January 29, January 28, January 29,
2007 2006 2007 2006
---- ---- ---- ----
Net income (loss) $ 1,673 $ 3,964 $ (4,338) $ 7,939
Unrealized (loss) gain on interest rate swap 12 6 (9) 18
Foreign currency translation (loss) gain 436 (21) 415 6
----------- ----------- ------------ ------------
Comprehensive income (loss) $ 2,121 $ 3,949 $ (3,932) 7,963
=========== =========== ============ ============
The foreign currency translation (loss) gain relates to the Company's
investment in its U.K. subsidiary and fluctuations in exchange rates
between its local currency and the U.S. dollar.
The components of accumulated other comprehensive income are as follows (in
thousands):
January 28, 2007 July 30, 2006
---------------- -------------
Unrealized loss on interest rate swap $ (31) $ (22)
Foreign currency translation gain 1,781 1,366
-------- ---------
Accumulated other comprehensive income $ 1,750 $ 1,344
======== =========
9. Stock-Based Compensation
The Company has various fixed stock option plans which are described in
Note M of the Company's July 30, 2006 Annual Report on Form 10-K that
provide for the grant of stock options to eligible employees and directors.
As of January 28, 2007, there were 3,386,930 stock options outstanding. No
stock options were issued during the quarter or six months ended January
28, 2007. The aggregate value of unvested options as of January 28, 2007,
as determined using a Black-Scholes option valuation model was
approximately $592,000 (net of estimated forfeitures).
Options for 100,650 shares of common stock were exercised during the
thirteen weeks ended January 28, 2007 at an average exercise price of
$10.80 per share and options for 2,500 shares of common stock were
cancelled.
10. Earnings (Loss) Per Share ("EPS")
The following table shows the components used in the calculation of basic
earnings (loss) per share and earnings (loss) per share assuming dilution
(in thousands):
Thirteen weeks ended Twenty-six weeks ended
-------------------- ----------------------
January 28, January 29, January 28, January 29,
2007 2006 2007 2006
-------------- -------------- --------------- --------------
Numerator:
Net Income (Loss) $ 1,673 $ 3,964 $ (4,338) $ 7,939
============== ============== =============== ==============
Denominator:
Basic weighted-average shares 13,902 14,474 13,882 14,460
Effect of dilutive securities:
Employee stock options 503 617 - 713
-------------- -------------- --------------- --------------
Diluted weighted-average shares 14,405 15,091 13,882 15,173
============== ============== =============== ==============
Stock options not included in computation 1,730 1,762 3,387 1,041
============== ============== =============== ==============
Exercise price range per share $15.78 - $21.18 $17.11 - $20.85 $4.31 - $21.18 $17.11 - $20.85
9
The number of stock options not included in the computation of diluted EPS
for the thirteen weeks ended January 28, 2007 and the thirteen and
twenty-six weeks ended January 29, 2006 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. No
employee stock options were considered in the computation of diluted net
loss per share for the twenty-six weeks ended January 28, 2007 as their
effect is anti-dilutive. The options which were outstanding as of January
28, 2007 and excluded from the computation in the table above expire at
various dates through May 2, 2015.
11. Geographic Information
Net sales to the U.S. Government in the twenty-six weeks ended January 28,
2007 and January 29, 2006 accounted for approximately 21% and 24% of net
sales, respectively. Lockheed Martin accounted for approximately 11% of net
sales in 2006. No other customer accounted for 10% or more of net sales
during the periods presented.
The Company operates as a single integrated business and as such has one
operating segment. Geographic net sales for the first quarter, based on
place of contract performance, were as follows (in thousands):
Thirteen weeks ended Twenty-six weeks ended
-------------------- ----------------------
January 28, January 29, January 28, January 29,
2007 2006 2007 2006
---- ---- ---- ----
United States $ 31,653 $ 39,754 $ 65,238 $ 77,608
Israel 5,125 3,309 9,500 6,420
England 1,219 2,776 3,375 3,749
----------- ----------- ----------- ------------
$ 37,997 $ 45,839 $ 78,113 $ 87,777
=========== =========== =========== ============
Net property, plant and equipment by geographic area was as follows (in
thousands):
January 28, 2007 July 30, 2006
---------------- -------------
United States $ 24,629 $ 25,243
Israel 4,988 4,654
England 410 581
-------- --------
$ 30,027 $ 30,478
======== ========
12. Supplemental cash flow information is as follows (in thousands):
Twenty-six weeks ended
----------------------
January 28, 2007 January 29, 2006
---------------- ----------------
Net cash paid during the period for:
Interest $ 247 $ 148
Income taxes - 1,832
13. New Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Post Retirement Plans, an
amendment of FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS
158 requires an entity to recognize in its statement of financial position
an asset for a defined benefit pension or postretirement plan's overfunded
status or a liability for a plan's underfunded status and to recognize
changes in that funded status through comprehensive income in the year in
which the changes occur. SFAS 158 will not change the amount of net
periodic benefit expense recognized in an entity's results of operations.
SFAS 158 is effective for fiscal years ending after December 15, 2006. The
Company will evaluate the impact of adopting SFAS 158 but does not expect
that it will have a material impact on the Company's consolidated financial
position, results of operations or cash flows.
10
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. The Company will evaluate the impact of
adopting SFAS 157 but does 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.
11
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Certain statements contained in this report are "forward-looking statements"
that involve various important assumptions, risks, uncertainties and other
factors which could cause the Company's actual results to differ materially from
those expressed in such forward-looking statements. Forward-looking statements
can be identified by terminology such as "may", "will", "should" , "expects",
"intends", "anticipates", "believes", "estimates", "predicts", "continue", or
the negative of these terms or other comparable terminology. These important
factors include, without limitation, a large percentage of sales are under
government contracts, cost overruns under fixed price contracts, doing business
in foreign markets, customer concentration, competitive factors and pricing
pressures, effective integration of acquired businesses, management of future
growth, recruiting and retaining qualified technical personnel, general economic
conditions, as well as other risks previously disclosed in the Company's
securities filings and press releases. Although the Company believes that the
expectations reflected in the forward-looking statements are reasonable, it
cannot guarantee future results, performance or achievements. Further, the
Company is under no duty to update any of the forward-looking statements after
the date of this quarterly report to conform such statements to actual results.
Explanatory Note
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited condensed
consolidated financial statements, the notes thereto and the other unaudited
financial data included elsewhere in this 10-Q.
Significant Events
In connection with the legal matter discussed in Note 7 "Litigation", we were
notified that certain of our 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 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 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 our business is
received under contracts where we are the only qualified supplier on critical
defense programs.
Our facilities which were not included in the action and who were free at all
times to contract with the U.S. Government are the 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, we entered into an Administrative Agreement with the
Department of the Navy, on behalf of the Department of Defense that requires 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 an employee or consultant to the Company. In return, the
Navy, on behalf of the Department of Defense terminated the suspension of the
Company from receiving new contract awards from the U.S. Government.
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 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 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 "Note"). In addition Mr. Blatt was paid his bonus of $636,503 in
January 2007 for fiscal year 2006, and shall be entitled to receive
reimbursement for medical care and 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" of the Company
as defined in the Employment Agreement all remaining payments due under the Note
become immediately due and payable.
Aggregate costs of approximately $8,914,000 under the Agreement, including cash
payments of $3,000,000, payments due under the Note of approximately $5,354,000,
medical and life insurance benefits of approximately $364,000 (both discounted
at an imputed interest rate of 6.75%) and the fair value of the modification of
the stock options of approximately $196,000 (using the Black-Scholes option
valuation model), have been recorded in our condensed consolidated financial
statements in the six months ended January 28, 2007.
12
Business Overview
We are a leader in the design, development and manufacture of microwave
technology solutions for the defense, aerospace and medical industries
worldwide. Our primary customers include large defense prime contractors
(including Raytheon, Northrop Grumman, General Dynamics, Lockheed Martin and
Boeing), the U.S. Government (including the Department of Defense, NASA and
other U.S. Government agencies), international customers (including the German,
Japanese, Turkish, British, Norwegian, Finnish and South Korean militaries, and
suppliers to international militaries) and commercial medical customers
(including Siemens Medical Solutions, Varian NMR System and G E Healthcare.) We
are a leading provider of microwave technologies for use in command and control
systems, flight instrumentation, weapons sensors, high power amplifiers,
electronic warfare systems, wireless data communications products and services,
and radar threat and electronic countermeasure simulation systems. We have
served the defense industry since 1965 by designing and manufacturing microwave
devices and systems 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
EA-6B Prowler, the EA-18 Growler, the AH-64D Apache Longbow, AEGIS class
destroyers, the AMRAAM missile, unmanned aerial vehicles (UAVs), as well as high
priority national security programs such as National Missile Defense, the
Trident II D-5 missile, ICAPIII, and Sensor Fuzed Weapon.
Results of Operations
Twenty-six weeks ended January 28, 2007 and January 29, 2006
- ------------------------------------------------------------
The suspension from receiving new contract awards from the U.S. Government in
June 2006 caused disruption in our business in several respects which cannot be
easily measured, but certainly had an impact on the results of operations in
fiscal 2007 both in terms of sales and profitability. While the effects of the
suspension were evident during the first quarter, they continued during the
second quarter as the delays in bookings affected the timing of certain
shipments.
Net sales for the twenty-six weeks ended January 28, 2007 were approximately
$78.1 million compared to $87.8 million in the first six months of fiscal 2006,
a decrease of $9.7 million (11%). The decrease in net sales is partly related to
the recording of a $2.2 million claim receivable on a major program during the
first quarter of the prior year. In addition, there was a decline in microwave
systems and assemblies primarily due to the completion of certain contracts and
the timing of shipments, some of which was due to the delays in bookings during
the suspension period. Offsetting these decreases were higher sales related
primarily to sales of both microwave systems and microwave products at
Herley-Israel.
Domestic and foreign sales were 70% and 30% respectively of net sales in the
twenty-six weeks ended January 28, 2007, versus 78% and 22% respectively in the
prior year comparable period.
The gross profit margin in the twenty-six weeks ended January 28, 2007 was 26.0%
compared to 31.5% in the first half of fiscal 2006, a decrease of 5.5%.
Contributing to the reduction in gross profit during the first six months of
fiscal 2007 are the following items:
o The booking of the $2.2 million claim receivable in fiscal 2006.
o Disruption caused by the suspension.
o Engineering development costs overruns on certain contracts in excess of
billings to customers.
o Startup production costs on certain programs.
o Product mix of contracts.
Offset by
o Revisions in the accrual for contract losses on existing contracts based on
current estimates.
Selling and administrative expenses for the twenty-six weeks ended January 28,
2007 were 21% of net sales as compared to 19% in the first six months of fiscal
2006.
We believe we are entitled to recovery of certain legal fees associated with the
recent indictment and class-action complaints under our D&O insurance policy.
Accordingly, as of January 28, 2007, we have recorded a receivable of $951,000
(net of a deductible of $500,000) in anticipation of recoveries. The amount is
included in other receivables in the accompanying consolidated balance sheet at
January 28, 2007. The insurance carrier may contest the claim in whole or in
13
part. In addition, we have entered into an agreement dated January 11, 2007 with
the insurance carrier whereby if it is determined by final decision of an
arbitration panel, or by final judgment of a court, or other final decision of a
tribunal having jurisdiction thereof, that any amount paid by the insurance
carrier was not a loss, as that term is defined in the policy, we shall repay to
the insurance carrier any such uncovered sums previously advanced to us.
Employment contract settlement costs of approximately $8.9 million relate to an
agreement effective October 12, 2006 with Lee N. Blatt our co-founder and former
Chairman, to terminate his employment agreement with us after 41 years of
service. Settlement costs include a cash payment of $3.0 million paid upon the
effective date of the settlement agreement, payments due under a Promissory Note
and estimated medical and life insurance benefits discounted at an imputed
interest rate of 6.75%, plus the fair value of a modification to the stock
options held by Mr. Blatt using the Black-Scholes option valuation model.
We had an operating loss for the first six months of fiscal 2007 of $5.1 million
compared to operating income of $10.8 million in the comparable period of fiscal
2006. Excluding the employment contract settlement costs of $8.9 million
recorded in the first quarter of fiscal 2007, operating income for the first six
months of fiscal 2007 was $3.9 million or 4.9% of net sales, as compared to
$10.8 million or 12.3% of net sales in the first six months of fiscal 2006. The
decrease in operating income as a percentage of net sales is primarily
attributable to the 5.5% decrease in gross margin percentage as discussed above
and the increase in selling and administrative expenses as a percentage of net
sales due to the lower sales volume. Our foreign operations contributed
approximately $2.2 million in operating income for the six months as compared to
$1.1 million in fiscal 2006.
Investment income was $479,000, an increase of $170,000 in the first six months
of fiscal 2007 because of interest earned on higher cash balances.
Interest expense was $365,000, an increase in the first half of $191,000
primarily due to the imputed interest expense related to the employment
settlement agreement as well as interest expense relating to financing the
implementation of the ERP software package.
We recognized a net foreign exchange gain of $283,000 through the second quarter
of fiscal 2007, versus a gain of $103,000 in the prior year period. The foreign
exchange gains are attributable to fluctuations in exchange rates between the
U.S. dollar and the local currency of our U.K. subsidiary primarily in
connection with temporary advances we have made to them in U.S. dollars.
The benefit for income taxes for the first six months of fiscal 2007 was
$327,000 representing an effective tax rate of 7%, as compared to an effective
tax rate of 28% in the first six months of fiscal 2006. The decline in the
estimated effective income tax rate for fiscal 2007 is primarily attributable to
(a) the extension of the R&D tax credit by Congress in December 2006 retroactive
to January 1, 2006 and (b) an increase in the proportion of overall earnings
expected to be generated through the Company's foreign operations where earnings
are taxed at lower rates than domestically. The extension of the R&D tax credit
reduced the statutory income tax rate of 35% by an estimated 8% for fiscal 2007.
As a result of lower domestic earnings, due primarily to the employment contract
settlement costs which significantly affects domestic profitability, foreign
earnings are a greater percentage of total earnings. The Company's foreign
earnings are attributable primarily to our Israeli subsidiary which is taxed at
an estimated rate of 12% for fiscal 2007 thereby reducing the effective income
tax rate by approximately 20%.
Basic and diluted loss per common share for the twenty-six weeks ended January
28, 2007 were $.31 per common share each as compared to basic and diluted
earnings per common share of $.55 and $.52, respectively for the twenty-six
weeks ended January 29, 2006. Excluding the impact of the employment contract
settlement costs, basic and diluted earnings per common share would have been
$.23 for the twenty-six weeks ended January 28, 2007 as compared to basic and
diluted earnings per common share of $.55 and $.52, respectively for the
twenty-six weeks ended January 29, 2006. A reconciliation of the Non-GAAP
earnings per common share calculation is as follows (in thousands except share
data):
Twenty-six weeks ended
----------------------
Non-GAAP As Reported Under GAAP
Measure ----------------------
January 28, January 28, January 29,
2007 2007 2006
---- ---- ----
(Loss) income before income taxes $ (4,665) $ (4,665) $ 11,026
Employment contract settlement costs 8,914 - -
-------- -------- --------
Income before income taxes 4,249 (4,665) 11,026
Provision (benefit) for income taxes 1,003 (327) 3,087
-------- -------- --------
Net income (loss) $ 3,246 $ (4,338) $ 7,939
======== ======== =======
Earnings (loss) per common share - Basic $ 0.23 $ (0.31) $ 0.55
======== ======== =======
Basic weighted average shares 13,882 13,882 14,460
======== ======== =======
Earnings (loss) per common share - Diluted $ 0.23 $ (0.31) $ 0.52
======== ======== =======
Basic weighted average shares 14,306 13,882 15,173
======== ======== =======
Thirteen weeks ended January 28, 2007 and January 29, 2006
- ----------------------------------------------------------
Net sales for the thirteen weeks ended January 28, 2007 were approximately $38.0
million, as compared to $45.8 million in the thirteen weeks ended January 29,
14
2006, a decrease of $7.8 million (17.1%). Increases in sales related primarily
to sales of both microwave systems and microwave products through Israel.
Offsetting these increases was a decline in microwave systems and assemblies
primarily due to the completion of certain contracts and the timing of
shipments, some of which was due to the delays in bookings during the suspension
period.
Domestic and foreign sales were 70% and 30% respectively of net sales in the
quarter, versus 79% and 21% respectively in the prior year comparable quarter.
The gross profit margin in the thirteen weeks ended January 28, 2007 was 26.3%
compared to 29.4% in the second quarter of fiscal 2006, a decrease of 3.1%.
Contributing to the reduction in gross profit for the quarter are the following
items:
o Startup production costs on certain programs.
o Product mix of contracts.
Offset by
o Revisions in the accrual for contract losses on existing contracts based on
current estimates.
Selling and administrative expenses for the thirteen weeks ended January 28,
2007 decreased approximately $0.8 million from the prior year comparable quarter
and were 19.5% of net sales as compared to 18.0% of net sales in the second
quarter of fiscal 2007 and 2006, respectively. Significant changes during the
period included:
o An approximate reduction of $200,000 in personnel and facility costs at
EWST as a result of streamlining the operations.
o A $255,000 reduction in net legal fees due to the booking of anticipated
insurance recoveries.
Operating income for the second quarter of fiscal 2007 was $2.6 million or 6.8%
of net sales, as compared to $5.2 million or 11.5% of net sales in the prior
year. The decrease in operating income as a percentage of net sales is primarily
attributable to the reduction in gross margins discussed above.
In the thirteen weeks ended January 28, 2007, we recognized a foreign exchange
gain of $266,000 versus a loss of $10,000 in the second quarter of fiscal 2006.
The foreign exchange gains are attributable to fluctuations in exchange rates
between the U.S. dollar and the local currency of our U.K. subsidiary primarily
in connection with temporary advances we have made to them in U.S. dollars.
The income tax provision recognized in the second quarter of fiscal 2007 was
$1.2 million as compared to a provision for income taxes of $1.4 million in the
prior year's second quarter. As of the end of the second quarter of fiscal 2007,
the effective income tax rate for the full year 2007 is now estimated at 7%,
versus the rate of approximately 21% that was estimated in the first quarter.
The decline in the estimated effective income tax rate for fiscal 2007 is
primarily attributable to (a) the extension of the R&D tax credit by Congress in
December 2006 retroactive to January 1, 2006 and (b) an increase in the
proportion of overall earnings expected to be generated through our foreign
operations where earnings are taxed at lower rates than domestically. The
extension of the R&D tax credit reduced the statutory income tax rate of 35% by
an estimated 8% for fiscal 2007. As a result of lower domestic earnings, due
primarily to the employment contract settlement costs which significantly
affects domestic profitability, foreign earnings are a greater percentage of
total earnings. Our foreign earnings are attributable primarily to our Israeli
subsidiary which is taxed at an estimated rate of 12% for fiscal 2007 thereby
reducing the effective income tax rate by approximately 20%.
Liquidity and Capital Resources
- -------------------------------
As of January 28, 2007 and July 30, 2006, working capital was $94.2 million and
$92.1 million, respectively, and the ratio of current assets to current
liabilities was 3.9 to 1 and 3.8 to 1, respectively.
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. The un-liquidated balance of
progress payments was approximately $2.3 million at January 28, 2007 and $2.6
million at July 30, 2006. The balance of advanced payments was approximately
$4.8 million at January 28, 2007 and $3.3 million at July 30, 2006.
15
Net cash provided by operating activities during the twenty-six weeks ended
January 28, 2007 was approximately $1.6 million as compared to $4.6 million
during the comparable period in the prior year; a net decrease of approximately
$2.8 million. Net (loss) income (adjusted for the following non-cash items:
depreciation and amortization, employment contract settlement costs and foreign
exchange gain) was $5.0 million in the first six months of the current fiscal
year versus $11.4 million in the prior year, a decrease of approximately $6.4
million.
Significant items offsetting this decrease include the following sources of
cash:
1. A decrease in accounts receivable of $2.2 million versus an increase of
$1.3 million in fiscal 2006 resulting in an improvement in cash flow of
approximately $3.5 million.
2. A reversal in the level of growth in inventory as compared to fiscal 2006
resulting in an improvement in cash flow of approximately $2.0 million.
3. 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 which included $2.2 million of estimated costs incurred and
income recognized in connection with a claim due to customer delays and
changes in specification and designs under a major program in fiscal 2006.
4. An increase in income taxes payable of approximately $.6 million.
Offset primarily by the following uses of cash:
1. An increase in deferred tax assets of $2.5 million related to the timing of
the deduction for tax purposes of the non-cash portion of the employment
contract settlement costs.
2. A decrease of approximately $2.1 million generated through amounts due to
vendors and accrued expenses.
3. The reduction of $1.1 million in the accrual for contract losses related to
product shipped during the six months of fiscal 2007, as well as revisions
to estimated loss reserves on existing contracts.
Net cash used in investing activities includes capital expenditures of $2.2
million and a final milestone payment of $.2 million in connection with the
Xytrans license agreement for millimeter wave technology for military
applications. Proceeds from the sale of demonstration equipment in the United
Kingdom amounted to $.2 million.
In connection with the implementation of an ERP software package, we entered
into an additional financing agreement in August 2006 with De Lage Landen
Financial Services, Inc. through Microsoft Capital Corporation providing for
loans not to exceed an aggregate of $2.0 million. Amounts borrowed under the
agreement are payable in thirty-six equal monthly installments with interest at
5.354% per annum. We have borrowed an aggregate of $1.4 million as of January
28, 2007 with monthly payments totaling approximately $42,750. In addition, we
financed the purchase of capital equipment in the amount of $.3 million in
connection with a major long-term contract.
The proceeds from the exercises of stock options during the six months of fiscal
2007 were $1.1 million.
In June 2002, we entered into a new $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 (as amended). 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 were 5.25% and 5.32%, respectively, at January 28, 2007.
There is a fee of 15 basis points per annum on the unused portion of the $45
million LIBOR based portion of the credit facility payable quarterly. During the
quarter ended January 28, 2007, we utilized the credit facility for short-term
working capital needs to the extent of $8.5 million. There are no borrowings
under the credit line at January 28, 2007 and July 30, 2006. Stand-by letters of
credit were outstanding in the amount of approximately $9.3 million under the
credit facility at January 28, 2007, and $10.3 million at July 30, 2006.
The agreement contains various financial covenants, including, among other
matters, minimum tangible net worth, total liabilities to tangible net worth,
debt services coverage, and restrictions on other borrowings. We are in
compliance with all covenants at January 28, 2007.
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 2007
will be generated from our existing backlog of sales orders. The backlog of
orders at January 28, 2007 was approximately $136 million. 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 operations. We are not aware of any events
which are reasonably likely to result in any cancellation of our government
16
contracts. As of January 28, 2007, we have approximately $40.7 million available
under our bank credit facility, net of outstanding stand-by letters of credit of
approximately $9.3 million and cash reserves of approximately $24.1 million.
New Accounting Pronouncements
- -----------------------------
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Post Retirement Plans, an
amendment of FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158
requires an entity to recognize in its statement of financial position an asset
for a defined benefit pension or postretirement plan's overfunded status or a
liability for a plan's underfunded status and to recognize changes in that
funded status through comprehensive income in the year in which the changes
occur. SFAS 158 will not change the amount of net periodic benefit expense
recognized in an entity's results of operations. SFAS 158 is effective for
fiscal years ending after December 15, 2006. The Company will evaluate the
impact of adopting SFAS 158 but does 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 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. The Company will evaluate the impact of
adopting SFAS 157 but does 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.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
The Company's exposures to market risk have not changed significantly since July
30, 2006.
Item 4: Controls and Procedures
(a) Evaluation of disclosure controls and procedures. The term "disclosure
controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934 as amended (the "Exchange Act"). These rules
refer to the controls and other procedures of a company that are designed to
ensure that information required to be disclosed by the company in the reports
that it files under the Exchange Act is recorded, processed, summarized and
reported within the required time periods. The Company's management, with
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the design, operation and effectiveness of the Company's
disclosure controls and procedures and have concluded, based on such evaluation,
that such controls and procedures were effective at providing reasonable
assurance that required information will be disclosed in the Company's reports
filed under the Exchange Act as of January 28, 2007.
(b) Changes in internal controls. There were no changes in the Company's
internal controls over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended
January 28, 2007 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
17
PART II - OTHER INFORMATION
Item 1 - 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.
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 and August 2006, the Company and certain of its
current and former officers and directors were also served with two separate
derivative complaints 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.
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 other
litigation will not have a material adverse effect on the Company's financial
position or results of operations.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
None
Item 3 - Defaults Upon Senior Securities:
None
Item 4 - Submission of Matters to a Vote of Security Holders:
(1) The Registrant held its Annual Meeting of Stockholders on February 21,
2007.
(2) Two directors were elected at the Annual Meeting of Stockholders as
follows:
Class I - To hold office until the 2009 Annual Meeting of
Stockholders.
Name Votes For Votes Withheld
---- --------- --------------
Rear Adm. Robert M. Moore (Ret.) 11,211,943 1,032,008
Rear Adm. Edward K. Walker, Jr. (Ret.) 11,198,243 1,045,708
(3) The appointment of Marcum & Kliegman, LLP as our independent
registered public accountants for the year ending July 29, 2007 was
approved as follows:
Votes For Votes Against Abstained
--------- ------------- ---------
12,186,723 54,713 2,513
18
Item 5 - Other Information:
None
Item 6 - Exhibits
31. Certifications pursuant to Rules 13a-14(a) as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32. Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
19
FORM 10-Q
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HERLEY INDUSTRIES, INC.
-----------------------
Registrant
BY: /S/ Myron Levy
-----------------------------------
Myron Levy, Chief Executive Officer
BY: /S/ Kevin J. Purcell
-----------------------------------------
Kevin J. Purcell, Chief Financial Officer
DATE: March 7, 2007
20