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: April 29, 2007
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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.
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(Exact name of registrant as specified in its charter)
DELAWARE #23-2413500
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
101 North Pointe Boulevard, Lancaster, Pennsylvania 17601
- --------------------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (717) 735-8117
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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 May 28, 2007 - 13,977,115 shares of Common Stock are outstanding.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets -
April 29, 2007 (Unaudited) and July 30, 2006 2
Condensed Consolidated Statements of Operations (Unaudited) - For the
thirteen and thirty-nine weeks ended April 29, 2007
and April 30, 2006 3
Condensed Consolidated Statement of Shareholders' Equity (Unaudited) -
For the thirty-nine weeks ended April 29, 2007 4
Condensed Consolidated Statements of Cash Flows (Unaudited) - For the
thirty-nine weeks ended April 29, 2007
and April 30, 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 1A- Risk Factors 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)
April 29,
2007 July 30,
(Unaudited) 2006
---------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 31,562 $ 22,303
Trade accounts receivable 30,843 30,600
Costs incurred and income recognized in excess
of billings on uncompleted contracts and claims 13,592 13,926
Other receivables 2,079 769
Inventories, net 52,196 52,909
Deferred income taxes and other 5,815 4,932
---------- -----------
Total Current Assets 136,087 125,439
Property, Plant and Equipment, net 30,001 30,478
Goodwill 73,964 73,612
Intangibles, net of accumulated amortization of $4,809
at April 29, 2007 and $3,468 at July 30, 2006 19,072 19,989
Other Assets 1,702 1,932
---------- -----------
$ 260,826 $ 251,450
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 1,335 $ 630
Current portion of employment settlement agreement -
(net of imputed interest of $287) (Note 2) 1,070 -
Accounts payable and accrued expenses 19,039 21,503
Billings in excess of costs incurred and
income recognized on uncompleted contracts 606 555
Income taxes payable 4,956 3,395
Accrual for contract losses 1,960 2,959
Accrual for warranty costs 1,129 986
Advance payments on contracts 7,525 3,323
---------- -----------
Total Current Liabilities 37,620 33,351
Long-term Debt 6,327 5,948
Long-term Portion of Employment Settlement Agreement -
(net of imputed interest of $622) (Note 2) 4,404 -
Other Long-term Liabilities 1,493 1,265
Deferred Income Taxes 5,538 7,416
---------- -----------
55,382 47,980
---------- -----------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized 20,000,000 shares;
issued and outstanding 13,971,715 in 2007,
issued 14,660,716 and outstanding 13,862,149 in 2006 1,397 1,466
Additional paid-in capital 106,364 113,418
Retained earnings 95,826 96,286
Treasury stock, 798,567 common shares at cost - (9,044)
Accumulated other comprehensive income 1,857 1,344
---------- -----------
Total Shareholders' Equity 205,444 203,470
---------- -----------
$ 260,826 $ 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 Thirty-nine weeks ended
-------------------- -----------------------
April 29, April 30, April 29, April 30,
2007 2006 2007 2006
----------- ---------- ---------- -----------
Net sales $ 44,401 $ 45,689 $ 122,514 $ 133,466
----------- ---------- ---------- -----------
Costs and expenses:
Costs of products sold 31,687 34,736 89,528 94,900
Selling and administrative expenses 8,895 8,960 25,315 25,785
Employment contract settlement costs (Note 2) - - 8,914 -
----------- ---------- ---------- -----------
40,582 43,696 123,757 120,685
----------- ---------- ---------- -----------
Income (loss) from operations 3,819 1,993 (1,243) 12,781
----------- ---------- ---------- -----------
Other income (expense), net:
Investment income 375 269 854 578
Interest expense (213) (68) (578) (242)
Foreign exchange gain 195 170 478 273
----------- ---------- ---------- -----------
357 371 754 609
----------- ---------- ---------- -----------
Income (loss) before income taxes 4,176 2,364 (489) 13,390
Provision (benefit) for income taxes 298 662 (29) 3,749
----------- ---------- ---------- -----------
Net income (loss) $ 3,878 $ 1,702 $ (460) $ 9,641
=========== ========== ========== ===========
Earnings (loss) per common share - Basic $ .28 $ .12 $ (.03) $ .67
=========== ========== ========== ===========
Basic weighted average shares 13,969 14,569 13,911 14,497
=========== ========== ========== ===========
Earnings (loss) per common share - Diluted $ .27 $ .11 $ (.03) $ .63
=========== ========== ========== ===========
Diluted weighted average shares 14,449 15,398 13,911 15,230
=========== ========== ========== ===========
See notes to condensed consolidated financial statements.
3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Thirty-nine weeks ended April 29, 2007
(In thousands except share date)
(Unaudited)
Accumulated
Common Stock Additional Other
------------ 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 111,230 11 1,179 1,190
Purchase of 1,664 shares of
treasury stock (26) (26)
Tax benefit upon exercise
of stock options 235 235
Stock option compensation 326 326
Stock option modification (Note 2) 196 196
Retirement of treasury stock (800,231) (80) (8,990) 9,070 -
--------- ------- -------- -------- --------- -------------- ---------
Subtotal 13,971,715 1,397 106,364 96,286 - 1,344 205,391
---------
Net loss (460) (460)
Other comprehensive income, net of tax:
Unrealized loss on interest rate swap (20) (20)
Foreign currency translation gain 533 533
---------
Comprehensive income 53
--------- ------- -------- -------- --------- -------------- ---------
Balance at April 29, 2007 13,971,715 $ 1,397 $ 106,364 $ 95,826 $ - $ 1,857 $ 205,444
========= ======= ======== ======== ========= ============== =========
See notes to condensed consolidated financial statements.
4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Thirty-nine weeks ended
-----------------------
April 29, April 30,
2007 2006
--------------- ---------------
Cash flows from operating activities:
Net (loss) income $ (460) $ 9,641
--------------- ---------------
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization 5,271 5,266
Stock-based compensation expense 326 333
Excess tax benefit from exercise of stock options (235) (674)
Employment contract settlement costs (includes $196 of
stock option modification costs) 5,914 -
Imputed interest related to employment settlement liability 199 -
Deferred taxes (2,314) 786
Gain on sale of equipment (107) -
Equity in income of limited partnership - (49)
Foreign exchange gain (96) (55)
Inventory valuation reserve charges 1,102 924
Reduction in accrual for contract losses (699) -
Warranty reserve charges 976 345
Changes in operating assets and liabilities:
Trade accounts receivable (243) (2,890)
Costs incurred and income
recognized in excess of billings on
uncompleted contracts and claims 334 (2,436)
Other receivables (1,310) 283
Inventories (389) (895)
Other current assets (438) (535)
Accounts payable and accrued expenses (3,297) (1,146)
Billings in excess of costs incurred and
income recognized on uncompleted contracts 51 (128)
Income taxes payable 1,796 (133)
Accrual for contract losses (300) 24
Advance payments on contracts 4,202 1,143
Other, net 457 205
--------------- ---------------
Total adjustments 11,200 368
--------------- ---------------
Net cash provided by operating activities 10,740 10,009
--------------- ---------------
Cash flows from investing activities:
Acquisition of technology license (179) (1,256)
Proceeds from sale of equipment 202 -
Partial distribution from limited partnership - 111
Capital expenditures (3,516) (4,525)
--------------- ---------------
Net cash used in investing activities (3,493) (5,670)
--------------- ---------------
Cash flows from financing activities:
Borrowings under bank line of credit 13,000 12,000
Borrowings - other 1,746 -
Proceeds from exercise of stock options 1,164 2,799
Excess tax benefit from exercises of stock options 235 674
Payments under employment contract settlement (443) -
Payments of long-term debt (690) (779)
Payments under bank line of credit (13,000) (12,000)
--------------- ---------------
Net cash provided by financing activities 2,012 2,694
--------------- ---------------
Net increase in cash and cash equivalents 9,259 7,033
Cash and cash equivalents at beginning of period 22,303 20,331
--------------- ---------------
Cash and cash equivalents at end of period $ 31,562 $ 27,364
=============== ===============
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 of America requires that
management of the Company make certain estimates and assumptions that
affect the reported amounts of assets, liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements
and reported amounts of revenues and expenses during the reporting periods.
These judgments can be subjective and complex, and consequently actual
results could differ from those estimates and assumptions. The most
significant estimates include: valuation and recoverability of long-lived
assets; income taxes; recognition of revenue and costs on production
contracts and the valuation of inventory. Each of these areas requires the
Company to make use of reasoned estimates including estimating the cost to
complete a contract, the net realizable value of its inventory and the
market value of its products. Changes in estimates can have a material
impact on the Company's financial position and results of operations. 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 $699,000 in the thirty-nine weeks ended April 29, 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
On June 13, 2006, 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
6
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 April 29, 2007 of approximately $5,153,000. Of this amount, $1,013,000
is included in "Current portion of employment settlement agreement" net of
imputed interest of $287,000 and $4,140,000 is included in "Long-term
Portion of Employment Settlement Agreement" net of imputed interest of
$622,000 in the accompanying balance sheet. In addition, Mr. Blatt received
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 $264,000 as of April 29, 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 thirty-nine
weeks ended April 29, 2007.
3. Inventories
The major components of inventories are as follows (in thousands):
April 29, 2007 July 30, 2006
-------------- -------------
Purchased parts and raw materials $ 28,498 $ 27,191
Work in process 28,336 29,597
Finished products 2,563 3,270
------- -------
59,397 60,058
Less:
Allowance for obsolete and slow moving inventory 5,099 4,576
Unliquidated progress payments 2,102 2,573
------- -------
$ 52,196 $ 52,909
====== ======
4. Income taxes
The net deferred income tax asset balance at April 29, 2007 was
approximately $4,189,000, an increase of approximately $444,000 from July
30, 2006. The increase is primarily due to the tax effect on the timing of
the deductions for future payments of approximately $5,153,000 as of April
29, 2007 under a promissory note and approximately $321,000 as of April 29,
2007 for estimated medical and life insurance benefits due under the
employment contract settlement discussed in Note 2.
The income tax provision recognized in the third quarter of fiscal 2007 was
$298,000 as compared to a provision for income taxes of $662,000 in the
prior year's third quarter. As of the end of the third quarter of fiscal
2007, the effective income tax rate for the full year 2007 is now estimated
at 6%, versus the rate of approximately 7% that was estimated through the
first six months of fiscal 2007. 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
9% 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 18%.
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 thirty-nine weeks ended April 29, 2007 and April
30, 2006 (in thousands):
7
Thirteen weeks ended Thirty-nine weeks ended
-------------------- -----------------------
April 29, April 30, April 29, April 30,
2007 2006 2007 2006
------------ ------------ ------------ ------------
Balance at beginning of period $ 1,150 $ 746 $ 986 $ 799
Provision for warranty obligations 342 98 976 347
Warranty costs charged to the reserve (363) (129) (833) (431)
------------ ------------ ------------ ------------
Balance at end of period $ 1,129 $ 715 $ 1,129 $ 715
============ ============ ============ ============
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 April 29, 2007 with monthly
payments totaling approximately $42,750. No additional amounts will be
borrowed under this agreement. In addition, the Company financed the
purchase of capital equipment through its bank 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. All defendants in the class-action
complaints filed motions to dismiss on April 6, 2007. Oral arguments on the
motions to dismiss have been scheduled for June 19, 2007. 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. All defendants in the derivative complaints
filed motions to dismiss on February 26, 2007. Oral arguments on the
motions to dismiss have been scheduled for June 6, 2007. 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 which is currently scheduled for
January 2008.
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 April 29, 2007, the Company has recorded a receivable of
$1,556,000 (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 April 29, 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. The Company received a partial payment of approximately $684,000
on June 1, 2007.
On April 10, 2007, EADS Deutschland GmbH ("EADS"), a German corporation,
filed a lawsuit against Herley Industries, Inc., General Microwave
Corporation and General Microwave Export Corporation d/b/a Herley Power
Amplifier Systems (collectively the "Company") in the United States
District Court for the Eastern District of New York. EADS claims that the
Company breached a Transfer of Technology Agreement entered into on May 30,
2001 under which the Company was granted the right to use certain
technology owned by EADS in performing under an exclusive sales and
marketing agreement entered into on May 30, 2001. EADS has asserted claims
for breach of contract and conversion, claiming that the Company is
wrongfully in possession of the intellectual property that was transferred
to the Company. EADS also seeks a preliminary injunction. The Company has
denied any wrongdoing and filed counterclaims against EADS. The parties are
now engaging in expedited discovery and awaiting a hearing date from the
court relating to the request for a preliminary injunction.
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, net of income taxes
Comprehensive income for the periods presented is as follows (in
thousands):
Thirteen weeks ended Thirty-nine weeks ended
------------------------ ---------------------------
April 29, April 30, April 29, April 30,
2007 2006 2007 2006
----------- ----------- ------------ ------------
Net income (loss) $ 3,878 $ 1,702 $ (460) $ 9,641
Unrealized (loss) gain on interest rate swap (11) 15 (20) 33
Foreign currency translation gain 118 152 533 158
----------- ----------- ------------ ------------
Comprehensive income $ 3,985 $ 1,869 $ 53 $ 9,832
=========== =========== ============ ============
The foreign currency translation 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):
April 29, 2007 July 30, 2006
-------------- -------------
Unrealized loss on interest rate swap $ (42) $ (22)
Foreign currency translation gain 1,899 1,366
-------------- -------------
Accumulated other comprehensive income $ 1,857 $ 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 April 29, 2007, there were 3,241,350 stock options outstanding. No
stock options were issued during the thirteen or thirty-nine weeks ended
April 29, 2007. The aggregate value of unvested options as of April 29,
2007, as determined using a Black-Scholes option valuation model was
approximately $490,000 (net of estimated forfeitures).
Options for 111,230 shares of common stock were exercised during the
thirty-nine weeks ended April 29, 2007 at an average exercise price of
$10.70 per share and options for 137,500 shares of common stock were
cancelled.
10. Earnings (Loss) Per Common 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 Thirty-nine weeks ended
------------------------------ -------------------------------
April 29, April 30, April 29, April 30,
2007 2006 2007 2006
-------------- -------------- --------------- --------------
Numerator:
Net Income (Loss) $ 3,878 $ 1,702 $ (460) $ 9,641
============== ============== =============== ==============
Denominator:
Basic weighted-average shares 13,969 14,569 13,911 14,497
Effect of dilutive securities:
Employee stock options 480 829 - 733
-------------- -------------- --------------- --------------
Diluted weighted-average shares 14,449 15,398 13,911 15,230
============== ============== =============== ==============
Stock options not included in computation 1,673 376 3,241 1,015
============== ============== =============== ==============
Exercise price range per share $15.78 - $21.18 $17.11 - $20.85 $4.31 - $21.18 $17.11 - $20.85
The number of stock options not included in the computation of diluted EPS
for the thirteen weeks ended April 29, 2007 and the thirteen and
thirty-nine weeks ended April 30, 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 thirty-nine weeks ended April 29, 2007 as their
effect is anti-dilutive. The options which were outstanding as of April 29,
2007 and excluded from the computation in the table above expire at various
dates through May 2, 2015.
9
11. Geographic Information
Net sales to the U.S. Government in the thirty-nine weeks ended April 29,
2007 and April 30, 2006 accounted for approximately 22% of net sales. No
other customer accounted for 10% or more of net sales.
The Company operates as a single integrated business and as such has one
operating segment. Geographic net sales for the third quarter and year to
date, based on place of contract performance, were as follows (in
thousands):
Thirteen weeks ended Thirty-nine weeks ended
------------------------- -------------------------
April 29, April 30, April 29, April 30,
2007 2006 2007 2006
----------- ----------- ----------- ------------
United States $ 38,252 $ 40,069 $ 103,490 $ 117,677
Israel 5,132 3,887 15,040 10,307
England 1,017 1,733 3,984 5,482
----------- ----------- ----------- ------------
$ 44,401 $ 45,689 $ 122,514 $ 133,466
=========== =========== =========== ============
Net property, plant and equipment by geographic area was as follows (in
thousands):
April 29, 2007 July 30, 2006
-------------- -------------
United States $ 24,600 $ 25,243
Israel 5,058 4,654
England 343 581
-------- --------
$ 30,001 $ 30,478
====== ======
12. Supplemental cash flow information is as follows (in thousands):
Thirty-nine weeks ended
-----------------------
April 29, 2007 April 30, 2006
-------------- --------------
Net cash paid during the period for:
Interest $ 357 $ 219
Income taxes - 2,960
13. New Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 159, "The Fair
Value Option for Financial Assets and Financial Liabilities" ("SFAS 159").
SFAS 159 provides companies with an option to report selected financial
assets and financial liabilities at fair value. Unrealized gains and losses
on items for which the fair value option has been elected are reported in
earnings at each subsequent reporting date. SFAS 159 is effective for
fiscal years beginning after November 15, 2007 (the Company's 2009 fiscal
year). The Company will evaluate the impact of adopting SFAS 159 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. 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.
10
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 for 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.
14. Subsequent Events
On April 30, 2007, the Company replaced its existing credit facility with a
new $40 million Revolving Credit Loan Agreement with two banks on an
unsecured basis which may be used for general corporate purposes, including
business acquisitions and stand-by letters of credit. The revolving credit
facility requires the payment of interest only on a monthly basis and
payment of the outstanding principal balance on March 31, 2009. The Company
may elect to borrow with interest based on the bank's prime rate of
interest minus 0.50% or 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. There is a
fee of 20 basis points per annum on the unused portion of the credit
facility payable quarterly. Stand-by letters of credit were outstanding in
the amount of approximately $11.7 million at April 29, 2007. If at any time
the Company's backlog of orders falls below $50 million, the bank may
obtain a security interest in eligible accounts receivable, as defined, and
if the outstanding advances are greater than 100% of eligible receivables,
a lien on all inventory.
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 April 29,
2007.
The Company entered into an employment agreement with Jeffrey L. Markel
dated as of May 30, 2007 (the "Employment Agreement") pursuant to which Mr.
Markel has been appointed Chief Operating Officer. The Employment Agreement
has an initial term through July 31, 2010 and provides for (i) a base
salary at the rate of $350,000 per annum together with cost of living
increases; (ii) an annual bonus at the discretion of the Board of
Directors, with a minimum first year bonus of $300,000; (iii) a ten-year
consulting period at the end of the employment term at an annual rate of
$100,000; (iv) certain perquisites including an automobile allowance and
medical benefits; and (v) certain rights in the event of a change in
control of the Company, as defined in the Employment Agreement.
To induce Mr. Markel to enter into the Employment Agreement, the Company
also granted him options (the "Options") to purchase 250,000 shares of its
common stock at a price of $15.77 per share, which was the closing price of
its common stock on the day prior to execution of the Employment Agreement.
Twenty percent (20%) of the options vest immediately with the remaining
options vesting at the rate of twenty percent (20%) per year over a four
year period.
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, the other unaudited
financial data included elsewhere in this 10-Q and our 2006 Form 10-K.
Critical Accounting Policies
Our significant accounting policies are described in Note A of the Notes to
Consolidated Financial Statements included in our Annual Report on Form 10-K for
the fiscal year ended July 30, 2006. A discussion of our critical accounting
policies and estimates are included in Management's Discussion and Analysis of
Results of Operations and Financial Condition in our Annual Report on Form 10-K
for the fiscal year ended July 30, 2006. Management has discussed the
development and selection of these policies with the Audit Committee of the
Company's Board of Directors, and the Audit Committee of the Board of Directors
has reviewed the Company's disclosures of these policies. There have been no
material changes to the critical accounting policies or estimates reported in
Management's Discussion and Analysis section of the audited financial statements
for the fiscal year ended July 30, 2006 as filed with the Securities and
Exchange Commission.
Significant Events
On June 13, 2006, 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, Ltd.).
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
12
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 nine months ended April 29, 2007.
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
Thirty-nine weeks ended April 29, 2007 and April 30, 2006
- ---------------------------------------------------------
The four-month suspension (June-October 2006) from receiving new contract awards
from the U.S. Government at some of our operations caused disruption in our
business in several respects which cannot be easily measured, but certainly has
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 and in the third quarter
to a lesser degree due to delays in bookings.
Net sales for the thirty-nine weeks ended April 29, 2007 were approximately
$122.5 million compared to $133.5 million in the first nine months of fiscal
2006, a decrease of $11 million (8.2%). 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 72% and 28% respectively of net sales in the
thirty-nine weeks ended April 29, 2007, versus 77% and 23% respectively in the
prior year comparable period.
The gross profit margin in the thirty-nine weeks ended April 29, 2007 was 26.9%
compared to 28.9% in the first nine months of fiscal 2006, a decrease of 2%.
Contributing to the reduction in gross profit during the first nine months of
fiscal 2007 are the following items:
o The booking of the $2.2 million claim receivable in fiscal 2006.
o Disruptions caused by the four-month suspension from receiving new contract
awards from the U. S. Government at some of our operations.
o Startup production costs on certain programs.
o Product mix of contracts domestically and internationally.
Offset by
o Revisions in the accrual for contract losses on existing contracts based on
current 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 $699,000 in the thirty-nine weeks
ended April 29, 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.
13
Selling and administrative expenses for the thirty-nine weeks ended April 29,
2007 were 21% of net sales as compared to 19% in the first nine months of fiscal
2006. The increase in costs as a percentage of sales is due to the lower net
sales in fiscal 2007.
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 April 29, 2007, we have recorded a receivable of $1,556,000
(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
April 29, 2007. The insurance carrier may contest the claim in whole or in 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. The
Company received a partial payment of approximately $684,000 on June 1, 2007.
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 nine months of fiscal 2007 of $1.2
million compared to operating income of $12.8 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 nine months of fiscal 2007 would have been $7.7 million or 6.3% of net
sales, as compared to $12.8 million or 9.6% of net sales in the first nine
months of fiscal 2006. The decrease in operating income as a percentage of net
sales is primarily attributable to the 2% 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 $3.3 million in operating income for the first nine
months of fiscal 2007 as compared to $2.4 million in fiscal 2006.
Investment income was $854,000, an increase of $276,000 in the first nine months
of fiscal 2007 as compared to the comparable prior year period because of
interest earned on higher cash balances.
Interest expense was $578,000, an increase in the first three quarters of
$336,000 as compared to the comparable prior year period 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 $478,000 through the third quarter
of fiscal 2007, versus a gain of $273,000 in the prior fiscal year comparable
period. These 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 nine months of fiscal 2007 was
$29,000 representing an effective tax rate of 6%, as compared to an effective
tax rate of 28% in the first nine 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 9% 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 18%.
Basic and diluted loss per common share for the thirty-nine weeks ended April
29, 2007 were $.03 per common share each as compared to basic and diluted
earnings per common share of $.67 and $.63, respectively, for the thirty-nine
weeks ended April 30, 2006. Excluding the impact of the employment contract
settlement costs, basic and diluted earnings per common share would have been
$.46 and $.44, respectively, for the thirty-nine weeks ended April 29, 2007 as
compared to basic and diluted earnings per common share of $.67 and $.63,
respectively, for the thirty-nine weeks ended April 30, 2006. A reconciliation
of the Non-GAAP earnings per common share calculation is as follows (in
thousands except share data):
14
Thirty-nine weeks ended
-----------------------
Non-GAAP
Measure As Reported Under GAAP
April 29, April 29, April 30,
2007 2007 2006
------ ------ -------
(Loss) income before income taxes $ (489) $ (489) $13,390
Employment contract settlement costs 8,914 - -
------ ------ -------
Income (loss) before income taxes 8,425 (489) 13,390
Provision (benefit) for income taxes 2,081 (29) 3,749
------ ------ -------
Net income (loss) $6,344 $ (460) $ 9,641
====== ====== =======
Earnings (loss) per common share - Basic $ 0.46 $ (0.03) $ 0.67
====== ====== =======
Basic weighted average shares 13,911 13,911 14,497
====== ====== =======
Earnings (loss) per common share - Diluted $ 0.44 $ (0.03) $ 0.63
====== ====== =======
Diluted weighted average shares 14,369 13,911 15,230
====== ====== =======
Thirteen weeks ended April 29, 2007 and April 30, 2006
Net sales for the thirteen weeks ended April 29, 2007 were approximately $44.4
million, as compared to $45.7 million in the thirteen weeks ended April 30,
2006, a decrease of $1.3 million (2.8%). The net decrease in sales is
attributable to a decline in domestic shipments of microwave systems and
assemblies primarily due to the completion of certain contracts and the timing
of shipments, some of which was due to delays in bookings during the four-month
suspension from receiving new contract awards from the U. S. Government at some
of our operations. Offsetting this were increased shipments of both microwave
systems and microwave products through our Israeli subsidiary.
Domestic and foreign sales were 77% and 23% respectively of net sales in the
quarter, versus 75% and 25% respectively in the prior year comparable quarter.
The gross profit margin in the thirteen weeks ended April 29, 2007 was 28.6%
compared to 24.0% in the third quarter of fiscal 2006, an increase of 4.6%.
Contributing to the improvements in gross profit for the quarter are (a) the
non-recurrence of startup production costs on certain programs from the prior
year and (b) the product mix of contracts.
Selling and administrative expenses for the thirteen weeks ended April 29, 2007
was nearly equal to the prior year comparable quarter and were 20.0% of net
sales as compared to 19.6% of net sales in the third quarter of fiscal 2007 and
2006, respectively.
Operating income for the third quarter of fiscal 2007 was $3.8 million or 8.6%
of net sales, as compared to $2.0 million or 4.4% of net sales in the prior
year. The improvement in operating income as a percentage of net sales is
primarily attributable to the increase in gross margins discussed above.
In the thirteen weeks ended April 29, 2007, we recognized a foreign exchange
gain of $195,000 versus a gain of $170,000 in the third quarter of fiscal 2006.
These 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 third quarter of fiscal 2007 was $0.3
million as compared to a provision for income taxes of $0.7 million in the prior
year's third quarter. As of the end of the third quarter of fiscal 2007, the
effective income tax rate for the full year 2007 is now estimated at 6%, versus
the rate of approximately 7% that was estimated in the second quarter.
Liquidity and Capital Resources
- -------------------------------
As of April 29, 2007 and July 30, 2006, working capital was $98.5 million and
$92.1 million, respectively, and the ratio of current assets to current
liabilities was 3.6 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 unliquidated balance of progress
payments was approximately $2.1 million at April 29, 2007 and $2.6 million at
July 30, 2006. The balance of advanced payments was approximately $7.5 million
at April 29, 2007 and $3.3 million at July 30, 2006.
15
Net cash provided by operating activities during the thirty-nine weeks ended
April 29, 2007 was approximately $10.7 million as compared to $10.0 million
during the comparable period in the prior year; a net increase of approximately
$0.7 million. Net income (Net (loss) income adjusted for the following non-cash
items: depreciation and amortization, employment contract settlement costs,
including imputed interest, and foreign exchange gain) was $10.9 million in the
first nine months of the current fiscal year versus $14.9 million in the prior
year, a decrease of approximately $4.0 million.
Significant changes in sources and uses of cash include the following offsetting
items:
Sources:
1. An increase in accounts receivable of $0.2 million versus an increase of
$2.9 million in fiscal 2006 resulting in an improvement in cash flow of
approximately $2.7 million.
2. An increase in advanced payments on contracts of $3.1 million including
$2.5 million on a new foreign contract.
3. A reduction of approximately $2.8 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 $1.9 million.
Offset primarily by the following uses of cash:
1. An increase in deferred tax assets of $2.0 million related to the timing of
the deduction for tax purposes of the non-cash portion of the employment
contract settlement costs.
2. An increase in other receivables of $1.6 million for an insurance claim for
legal fees incurred in connection with the matter previously discussed
under "Significant Events."
3. A decrease of approximately $2.1 million generated through amounts due to
vendors and accrued expenses.
4. The reduction of $1.0 million in the accrual for contract losses related to
product shipped during the nine 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 $3.5
million and a final milestone payment of $0.2 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 $0.2 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 April 29,
2007 with monthly payments totaling approximately $42,750. No additional amounts
will be borrowed under this agreement. In addition, we financed the purchase of
capital equipment through our bank in the amount of $0.3 million in connection
with a major long-term contract.
The proceeds from the exercises of stock options during the first nine months of
fiscal 2007 were $1.2 million.
During the first nine months of fiscal 2007, we borrowed and we paid $13.0
million under our current revolving credit facility for short-term working
capital needs.
On April 30, 2007, we replaced our existing credit facility with a new $40
million Revolving Credit Loan Agreement with two banks on an unsecured basis
which may be used for general corporate purposes, including business
acquisitions and stand-by letters of credit. The revolving credit facility
requires the payment of interest only on a monthly basis and payment of the
outstanding principal balance on March 31, 2009. We may elect to borrow with
interest based on the bank's prime rate of interest minus 0.50% or 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. There is a fee of 20 basis points per annum on the
unused portion of the credit facility payable quarterly. Stand-by letters of
credit were outstanding in the amount of approximately $11.7 million at April
29, 2007. If at any time our backlog of orders falls below $50 million, the bank
may obtain a security interest in eligible accounts receivable, as defined, and
if the outstanding advances are greater than 100% of eligible receivables, a
lien on all inventory. Funded backlog as of April 29, 2007 was approximately
$145 million.
The agreement contains various financial covenants, including, among other
matters, minimum tangible net worth, total liabilities to tangible net worth,
16
debt services coverage, and restrictions on other borrowings. We are in
compliance with all covenants at April 29, 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 funded backlog
of orders at April 29, 2007 was approximately $145 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
contracts. As of April 29, 2007, we have approximately $28.3 million available
under our new credit facility, net of outstanding stand-by letters of credit of
approximately $11.7 million, and cash reserves of approximately $31.6 million.
New Accounting Pronouncements
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In February 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159
provides companies with an option to report selected financial assets and
financial liabilities at fair value. Unrealized gains and losses on items for
which the fair value option has been elected are reported in earnings at each
subsequent reporting date. SFAS 159 is effective for fiscal years beginning
after November 15, 2007 (our 2009 fiscal year). We will evaluate the impact of
adopting SFAS 159 but we 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 FASB issued 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. We will evaluate the impact of adopting SFAS 158 but we 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 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 our fiscal year
beginning August 2008. We will evaluate the impact of adopting SFAS 157 but we
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 for 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.
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 April 29, 2007.
17
(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
April 29, 2007 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
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. All defendants in the class-action complaints filed motions to
dismiss on April 6, 2007. Oral arguments on the motions to dismiss have been
scheduled for June 19, 2007. 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. All defendants in the derivative
complaints filed motions to dismiss on February 26, 2007. Oral arguments on the
motions to dismiss have been scheduled for June 6, 2007. 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 which is currently scheduled for January 2008 .
The Company believes it has substantial defenses to the charges alleged in the
indictment and intends to vigorously defend against these allegations.
On April 10, 2007, EADS Deutschland GmbH ("EADS"), a German corporation, filed a
lawsuit against Herley Industries, Inc., General Microwave Corporation and
General Microwave Export Corporation d/b/a Herley Power Amplifier Systems
(collectively the "Company") in the United States District Court for the Eastern
District of New York. EADS claims that the Company breached a Transfer of
Technology Agreement entered into on May 30, 2001 under which the Company was
granted the right to use certain technology owned by EADS in performing under an
exclusive sales and marketing agreement entered into on May 30, 2001. EADS has
asserted claims for breach of contract and conversion, claiming that the Company
is wrongfully in possession of the intellectual property that was transferred to
the Company. EADS also seeks a preliminary injunction. The Company has denied
any wrongdoing and filed counterclaims against EADS. The parties are now
engaging in expedited discovery and awaiting a hearing date from the court
relating to the request for a preliminary injunction.
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 1A - Risk Factors
In addition to the other information set forth in this report, you should
carefully consider the risk factors disclosed under Part 1 -"Item 1A. Risk
Factors" in our Annual Report on Form 10-K for the year ended July 30, 2006,
which could materially adversely affect our business, financial condition,
operating results and cash flows. The risks and uncertainties described in our
Form 10-K for the year ended July 30, 2006 are not the only ones we face. Risks
and uncertainties not currently known to us or that we currently deem immaterial
also may materially adversely affect our business, financial condition,
operating results or cash flows.
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:
None
18
Item 5 - Other Information:
None
Item 6 - Exhibits
10.1 Revolving Credit Loan Agreement dated April 30, 2007 among the
Registrant, Manufacturers and Traders Trust Company and Bank of
Lancaster County, N.A.
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: June 7, 2007