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: May 4, 2008
-----------
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 of (I.R.S. Employer
incorporation or organization) Identification 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 June 6, 2008 - 13,510,177 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:
Condensed Consolidated Balance Sheets -
May 4, 2008 (Unaudited) and July 29, 2007 2
Condensed Consolidated Statements of Operations (Unaudited) - For the
thirteen and forty weeks ended May 4, 2008
and for the thirteen and thirty-nine weeks ended April 29, 2007 3
Condensed Consolidated Statement of Shareholders' Equity (Unaudited) -
For the forty weeks ended May 4, 2008 4
Condensed Consolidated Statements of Cash Flows (Unaudited) - For the
forty weeks ended May 4, 2008
and for the thirty-nine weeks ended April 29, 2007 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 22
Item 4 - Controls and Procedures 22
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 22
Item 1A- Risk Factors 24
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 3 - Defaults Upon Senior Securities 24
Item 4 - Submission of Matters to a Vote of Security Holders 24
Item 5 - Other Information 24
Item 6 - Exhibits 25
Signatures 26
Part I - Financial Information
Item 1 - Financial Statements
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
May 4,
2008 July 29,
(Unaudited) 2007
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 20,583 $ 35,181
Trade accounts receivable, net 23,548 28,058
Income Taxes Receivable 2,056 819
Costs incurred and income recognized in excess
of billings on uncompleted contracts and claims 19,833 14,448
Other receivables 3,837 2,816
Inventories, net 60,321 51,815
Deferred income taxes 11,340 4,254
Other current assets 1,546 1,069
------------ ------------
Total Current Assets 143,064 138,460
Property, Plant and Equipment, net 30,957 29,996
Goodwill 73,903 74,044
Intangibles, net of accumulated amortization of $6,943 at May 4,
2008 and $5,256 at July 29, 2007 16,624 18,431
Other Assets 551 1,662
------------ ------------
Total Assets $ 265,099 $ 262,593
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 1,387 $ 1,346
Current portion of employment settlement agreement -
(net of imputed interest of $124 at May 4, 2008 and $245
at July 29, 2007) 1,234 1,113
Current portion of litigation settlements (net of imputed interest of $62) 10,438 -
Accounts payable, accrued expenses and other 30,903 21,719
Billings in excess of costs incurred and
income recognized on uncompleted contracts 527 99
Income taxes payable 411 3,518
Advance payments on contracts 7,111 7,163
------------ ------------
Total Current Liabilities 52,011 34,958
Long-term Debt 4,927 5,951
Long-term Portion of Employment Settlement Agreement -
(net of imputed interest of $471 at May 4, 2008 and $580
at July 29, 2007) 3,192 4,117
Long-term portion of litigation settlement (net of imputed interest of $122) 878 -
Other Long-term Liabilities 1,598 1,311
Deferred Income Taxes 8,675 6,615
Accrued Income Taxes Payable 507 -
------------ ------------
Total Liabilities 71,788 52,952
------------ ------------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized 20,000,000 shares;
issued and outstanding 13,510,177 at May 4, 2008, and
13,977,115 at July 29, 2007 1,351 1,398
Additional paid-in capital 101,085 107,094
Retained earnings 89,381 99,404
Accumulated other comprehensive income 1,494 1,745
------------ ------------
Total Shareholders' Equity 193,311 209,641
------------ ------------
Total Liabilities and Shareholders' Equity $ 265,099 $ 262,593
============ ============
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)
Forty Thirty-Nine
Weeks Weeks
Thirteen weeks ended Ended Ended
May 4, April 29, May 4, April 29,
2008 2007 2008 2007
----------- ---------- ---------- -----------
Net sales $ 38,549 $ 44,401 $ 108,343 $ 122,514
----------- ---------- ---------- -----------
Cost and expenses:
Cost of products sold 29,982 31,687 84,790 89,528
Selling and administrative expenses 9,951 8,895 27,869 25,315
Litigation settlements (Notes 2 and 6) 9,500 - 15,542 -
Employment contract settlement costs (Note 2) - - - 8,914
----------- ---------- ---------- -----------
49,433 40,582 128,201 123,757
----------- ---------- ---------- -----------
(Loss) income from operations (10,884) 3,819 (19,858) (1,243)
----------- ---------- ---------- -----------
Other income (expense):
Investment income 147 375 955 854
Interest expense (164) (213) (427) (578)
Foreign exchange transactions gain (loss) 42 195 (6) 478
----------- ---------- ---------- -----------
25 357 522 754
----------- ---------- ---------- -----------
(Loss) income before income taxes (10,859) 4,176 (19,336) (489)
(Benefit) provision for income taxes (7,267) 298 (9,313) (29)
----------- ---------- ---------- -----------
Net (loss) income $ (3,592) $ 3,878 $ (10,023) $ (460)
=========== ========== ========== ===========
(Loss) earnings per common share - Basic $ (.27) $ .28 $ (.73) $ (.03)
=========== ========== ========== ===========
Basic weighted average shares 13,507 13,969 13,696 13,911
=========== ========== ========== ===========
(Loss) earnings per common share - Diluted $ (.27) $ .27 $ (.73) $ (.03)
=========== ========== ========== ===========
Diluted weighted average shares 13,507 14,449 13,696 13,911
=========== ========== ========== ===========
See notes to condensed consolidated financial statements.
3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
Forty weeks ended May 4, 2008
(In thousands, except share data)
Accumulated
Additional Other
Common Stock Paid-in Retained Treasury Comprehensive
Shares Amount Capital Earnings Stock Income (Loss) Total
------------- -------- ----------- --------- --------- --------------- ---------
Balance at July 29, 2007 13,977,115 $ 1,398 $ 107,094 $ 99,404 $ - $ 1,745 $ 209,641
Exercise of stock options 27,000 1 224 225
Purchases of 493,938 shares of
treasury stock (7,138) (7,138)
Tax benefit upon exercise of
stock options 57 57
Stock-based compensation costs 800 800
Retirement of treasury stock (493,938) (48) (7,090) 7,138 -
------------- -------- ----------- --------- --------- --------------- ---------
Subtotal 13,510,177 1,351 101,085 99,404 - 1,745 203,585
---------
Net loss (10,023) (10,023)
Other comprehensive loss:
Unrealized loss on interest rate swap (34) (34)
Foreign currency translation loss (217) (217)
---------
Comprehensive loss (10,274)
------------- -------- ----------- --------- --------- --------------- ---------
Balance at May 4, 2008 13,510,177 $ 1,351 $ 101,085 $ 89,381 $ - $ 1,494 $ 193,311
============= ======== =========== ========= ========= =============== =========
See notes to condensed consolidated financial statements.
4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Forty Thirty-nine
weeks weeks
ended ended
May 4, April 29,
2008 2007
--------- ----------
Cash flows from operating activities:
Net Loss $ (10,023) $ (460)
--------- ----------
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities:
Depreciation and amortization 5,573 5,271
Stock-based compensation costs 800 326
Excess tax benefit from exercises of stock options (57) (235)
Employment contract settlement costs (includes $196 of
stock option modification costs) - 5,914
Litigation settlement costs 15,442 -
Imputed interest 347 199
Deferred tax benefit (4,999) (2,314)
Loss (gain) on sale of fixed assets 8 (107)
Foreign exchange transaction losses (gains) 48 (96)
Inventory valuation reserve charges 1,287 1,102
Reduction in accrual for contract losses (826) (699)
Warranty reserve charges 848 976
Changes in operating assets and liabilities:
Trade accounts receivable 4,416 (243)
Income taxes receivable (1,237) -
Costs incurred and income recognized in excess
of billings on uncompleted contracts and claims (5,385) 334
Other receivables (1,021) (1,310)
Inventories (9,876) (389)
Other current assets (477) (438)
Accounts payable, accrued expenses and other 10,079 (3,597)
Billings in excess of costs incurred and
income recognized on uncompleted contracts 428 51
Income taxes payable (2,543) 1,796
Employment settlement payments (1,034) (443)
Litigation settlement payments (4,000) -
Advance payments on contracts (52) 4,202
Other, net (531) 449
--------- ----------
Total adjustments 7,238 10,749
--------- ----------
Net cash (used in) provided by operating activities (2,785) 10,289
--------- ----------
Cash flows from investing activities:
Acquisition of technology license - (179)
Proceeds from sale of fixed assets - 202
Capital expenditures (3,912) (3,516)
--------- ----------
Net cash used in investing activities (3,912) (3,493)
--------- ----------
Cash flows from financing activities:
Borrowings under bank line of credit 13,900 13,000
Borrowings - other 1,746
Proceeds from exercise of stock options 225 1,164
Excess tax benefit from exercises of stock options 57 235
Payments of long-term debt (1,044) (690)
Payments under bank line of credit (13,900) (13,000)
Purchase of treasury stock (7,138) -
--------- ----------
Net cash (used in) provided by financing activities (7,900) 2,455
--------- ----------
Effect of exchange rate changes on cash (1) 8
--------- ----------
Net (decrease) increase in cash and cash equivalent (14,598) 9,259
Cash and cash equivalents at beginning of period 35,181 22,303
--------- ----------
Cash and cash equivalents at end of period $ 20,583 $ 31,562
========= ==========
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 litigation settlement costs and employment contract settlement costs
discussed in Note 2 and Note 6) considered necessary for a fair
presentation have been included in the accompanying condensed consolidated
financial statements. Operating results for this quarter are not
necessarily indicative of the results of operations that may be expected
for any other interim period or for the 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 2007 Annual Report on Form 10-K/A Amendment No. 1
for the fiscal year ended July 29, 2007, as filed with the Securities and
Exchange Commission ("SEC"). The accounting policies used in preparing
these unaudited condensed interim financial statements are consistent with
those described in the July 29, 2007 audited financial statements except
for the adoption of Financial Accounting Standards Board ("FASB")
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109" ("FIN 48"), which is discussed in
Note 4. The consolidated balance sheet at July 29, 2007 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; estimated claims and unpriced change orders under contracts; the
valuation of inventory; and stock-based compensation costs valued in
accordance with FAS 123(R). Each of these areas requires the Company to
make use of reasoned estimates including estimating the cost to complete a
contract, the recoverability of contractual claims, 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 remaining accrual for contract losses
associated with the ICI acquisition (more fully described in Note A-3 and
Note B of Form 10-K/A Amendment No. 1 for the fiscal year ended July 29,
2007), in the amount of $826,000 was eliminated in the forty weeks ended
May 4, 2008 (which is included as a reduction of costs of products sold) as
a result of the customer not exercising the remaining two contract options
under the contract. Shipments under the contract were completed during the
first quarter of fiscal 2008 and the remaining options under the contract
expired. In the forty weeks ended May 4, 2008, the Company recognized a
loss of approximately $1,200,000 on a development contract due to cost
overruns and a change in management's estimate of the recoverability of the
costs on future contracts; and a loss of approximately $1,000,000 due to
cost overruns on two other development contract.
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 matters discussed in Note 6 "Litigation," to
avoid the delay, expense, inconvenience and uncertainty of protracted
litigation, the Company entered into an agreement with the Office of the
United States Attorney for the Eastern District of Pennsylvania to settle
all existing criminal claims. Under the terms of the agreement dated May 5,
2008 the Company agreed to pay a fine of $3,500,000. In addition, the
Company entered into an agreement to settle all existing civil claims with
the Civil Division of the Office of the United States Attorney for the
Eastern District of Pennsylvania which requires the payment of $6,000,000.
These payments were made on May 5, 2008 and are included in "Current
portion of litigation settlements" in the accompanying Condensed
Consolidated Balance Sheet at May 4, 2008.
The Company anticipated that the trial of the criminal matter would have
been between two to three months and the trial of the Justice Department's
civil action would have been a similar time period. The legal fees for both
trials have been estimated to be in excess of the settlement amounts.
The Company has advised the Department of the Navy, Acquisition Integrity
6
Office about the terms and conditions of the criminal and civil settlement
agreements and the Company has been advised that no action will be taken to
suspend or debar the Company based on these settlements.
Various actions leading up to these settlements are discussed below.
On June 27, 2007, the Company was notified by the Office of the General
Counsel, Acquisition Integrity Office, Department of Navy (the "Navy"),
that certain of its operations had been suspended from receiving new
contract awards from the U.S. Government as discussed in Note A-1 in the
Company's 2007 Annual Report on Form 10-K/A Amendment No. 1 for the fiscal
year ended July 29, 2007. The affected operations included facilities in
Lancaster, Pennsylvania; Woburn, Massachusetts and Chicago, Illinois. The
Chicago, Illinois location is a two-person marketing office. On August 15,
2007 the suspension was lifted following an amendment to the Administrative
Agreement (originally signed on October 12, 2006) with the Navy as
discussed below. While the suspension was in place, these facilities could
not be solicited for or awarded new contracts or contract extensions
without special exceptions. 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.
On June 13, 2006, in connection with the legal matter discussed in Note 6
"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 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 four years (as amended August 15, 2007) 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 its
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 its former
Chairman to terminate the Employment Agreement between him and the Company
dated as of July 29, 2002 and modified on December 9, 2003. Aggregate costs
of approximately $8,914,000 under the Agreement, including a cash payment
of $3,000,000, payments due under a Promissory 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 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.
In connection with a lawsuit filed on April 10, 2007, by EADS Deutschland
GmbH ("EADS"), a German corporation, against the Company (see Note 6), the
parties have entered into an agreement effective December 5, 2007 providing
for a mutual release and dismissal, with prejudice and without costs or
attorney's fees to either party, of all claims and counterclaims filed. To
avoid further dilution of management's time and energies, as well as legal
costs on a long and protracted legal dispute, the Company agreed to pay to
EADS the sum of $6,000,000. A payment of $2,500,000 was made on December 5,
2007; a payment of $1,500,000 was made on March 31, 2008; and payments of
$1,000,000 are due on March 31, 2009 and March 31, 2010, respectively. The
agreement further provides for the transfer to EADS of all drawings in the
Company's possession, custody or control for the equipment supplied in
conjunction with a contract between the parties; providing EADS with the
use of such drawings for the exclusive purpose of fulfilling its
obligations towards its own customers under the contract. As security for
the payments due in March of 2008, 2009 and 2010, the Company issued an
irrevocable stand-by letter of credit in the amount of $3,500,000 under its
existing credit facility. The letter of credit was reduced to $2,000,000 in
connection with the payment made in March 2008. The Company recorded a
charge to operations in the forty weeks ended May 4, 2008 of approximately
$6,042,000 consisting of payments due under the agreement of approximately
$5,699,000, net of imputed interest of approximately $301,000 discounted at
an imputed interest rate of 7.25%, plus costs and other direct settlement
expenses of approximately $343,000.
7
3. Inventories
The major components of inventories are as follows (in thousands):
May 4, July 29,
2008 2007
---- ----
Purchased parts and raw materials $ 31,092 $ 28,526
Work in process 34,358 27,797
Finished products 2,236 2,576
------ ------
$ 67,686 $ 58,899
Less:
Allowance for obsolete and slow moving inventory 6,093 5,163
Unliquidated progress payments 1,272 1,921
------ ------
$ 60,321 $ 51,815
====== ======
4. Income Taxes
On July 30, 2007, the Company adopted Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes (as amended) - an interpretation of FASB
Statement No. 109" ("FIN 48"). The cumulative effect of applying the
provisions of FIN 48 resulted in a reclassification of $3,139,000 of tax
liabilities (including interest and penalties of $ 734,000) from current to
non-current and did not require an adjustment to retained earnings. The
total amount of unrecognized tax benefits could increase or decrease within
the next twelve months for a number of reasons including audit settlements,
tax examination activities and the recognition and measurement
considerations under FIN 48. As of May 4, 2008, the Company's unrecognized
tax benefits, that if recognized would affect the Company's effective tax
rate were $507,000. During the quarter ended May 4, 2008 the Company
recognized a tax benefit of $2,737,000, including interest and penalties of
$806,000, due to the expiration of the statute of limitations in April
2008, for a deduction taken for an impaired investment on a prior year's
income tax return. The ultimate timing of the tax consequences of the other
tax benefits is uncertain. The Company has elected to retain its existing
accounting policy with respect to the treatment of interest and penalties
attributable to income taxes in accordance with FIN 48, and continues to
reflect interest and penalties attributable to income taxes, to the extent
they arise, as a component of its income tax provision or benefit as well
as its outstanding income tax assets and liabilities. At May 4, 2008, the
Company had $33,000 of accrued interest and penalties which is included as
"Accrued Income Taxes Payable" under long-term liabilities in the
accompanying Condensed Consolidated Balance Sheet.
The Company has identified its federal tax return and its state tax return
in Pennsylvania as major tax jurisdictions. The Company is also subject to
multiple other state and foreign jurisdictions. The Company's evaluation of
FIN 48 tax matters was performed for tax years ended 2002 through 2007, the
only periods subject to examination. The Company believes that its income
tax positions and deductions would be sustained on audit and does not
anticipate any adjustments, other than those identified above that would
result in a material change to its financial position.
The income tax benefit recognized in the first nine months of fiscal 2008
was $9,313,000 (an effective income tax benefit rate of 48.2%) compared to
a benefit of $29,000 (an effective rate of 6.0%) in the first nine months
of the prior fiscal year. The estimated effective tax benefit rate for
fiscal year 2008 is 48.8%, which is greater than the statutory rate of 35%
primarily due to the reversal of a FIN 48 liability offset by the
non-deductible penalty paid as part of the litigation settlement. Other
non-recurring items contributing to the tax benefit in the first nine
months of fiscal 2008 include a research and development credit carryover
and a lower than expected tax rate in Israel for fiscal 2007 which
increased the income tax benefit for the first nine months of fiscal 2008
by approximately 3.6% resulting in an overall effective rate for the first
nine months of 48.2%.
The Company incurred an estimated net operating loss in the forty weeks
ended May 4, 2008 of approximately $16,800,000 for Federal and state income
tax purposes of which approximately $7,930,000 would be available to carry
back two years for Federal income taxes; and approximately $8,870,000 would
be available to carry forward for Federal and state income taxes which will
expire in 2028.
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 forty weeks ended May 4, 2008 and the thirteen
and thirty-nine weeks ended April 29, 2007 (in thousands):
8
Thirty-
Forty nine
Thirteen weeks ended weeks weeks
-------------------- ended ended
May 4, April 29, May 4, April 29,
2008 2007 2008 2007
---- ---- ---- ----
Balance at beginning of period $ 1,017 $ 1,150 $ 1,106 $ 986
Provision for warranty obligations 282 342 848 976
Warranty costs charged to the reserve (262) (363) (917) (833)
----- ----- ----- -----
Balance at end of period $ 1,037 $ 1,129 $ 1,037 $ 1,129
===== ===== ===== =====
6. 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 as superseded on January 30,
2007 alleges 27 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); aiding and abetting (18 U.S.C. Section 2); and a notice of
forfeiture. The Company moved to dismiss the indictment and that motion was
denied on November 5, 2007. A trial was scheduled for May 5, 2008.
On May 5, 2008, the Company entered into an agreement with the United
States Attorney's Office for the Eastern District of Pennsylvania in which
(a) the Company agreed to plead guilty to two counts of obstructing an
audit relating solely to the powerheads; (b) the Company agreed to pay a
fine of $3.5 million; and (c) the Government agreed to dismiss all other
counts of the Superseding Indictment. The agreement was presented to the
Court on May 5, 2008, and the Court accepted the agreement and sentenced
the Company to the agreed-upon fine.
With respect to Mr. Blatt, the Court, at the Government's request,
dismissed all of the charges against him in the indictment and the
Government filed a Superseding Information charging Mr. Blatt with a
misdemeanor violation of the tax code in a single count, and Mr. Blatt has
entered a guilty plea for failing to keep Company records of the allocation
of an $18,000 corporate research expense. Mr. Blatt has been fined $25,000,
has received a term of probation of one year and is required to perform
some community service. 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.
Shortly before the indictment mentioned above, Company counsel were
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, deferring any further activity related
to this potential claim until after the trial of the criminal matter
mentioned above. By agreement dated May 5, 2008, the United States
Attorney's Office for the Eastern District of Pennsylvania and the Company
entered into an agreement to resolve the potential issues arising from the
lawsuit threatened against the Company pursuant to, among other things, the
False Claims Act, 31 U.S.C. Section 3729 et. seq. for the matters alleged
in the Superseding Indictment. The Company agreed to pay $6 million in
exchange for, among other things, a release.
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.
On July 17, 2007, the Court issued an order denying the Company's and Mr.
Blatt's motion to dismiss and granted, in part, the other defendants'
motion to dismiss. Specifically, the Court dismissed the Section 10(b)
claim against the other defendants and denied the motion to dismiss the
Section 20(a) claim against them. On July 18, 2007, the Court granted
defendant's motion to stay these actions until after the trial of the
criminal matter referenced above. On February 8, 2008, the Court issued an
Order allowing for certain document discovery to commence. On May 9, 2008,
the Court lifted the stay. A Scheduling Order has now been entered
requiring the parties to complete discovery by January 2009. At this stage
of the proceedings, it is not possible to predict what, if any, liability
the Company may have from the Securities Class Actions.
In July and August 2006, the Company and certain of its current and former
9
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 and were consolidated
into one action on March 9, 2006. All defendants in the derivative
complaints filed motions to dismiss on February 26, 2007. On July 20, 2007,
the Court issued an order denying defendants' motions in part and granting
them in part. Specifically, the Court dismissed the claim that the named
officers and directors failed to oversee Mr. Blatt and denied the motions
with respect to the other alleged claims. The Court also granted
defendants' motion to stay the action until after the trial of the criminal
matter. On February 8, 2008, the Court issued an Order allowing for certain
document discovery to commence. On May 9, 2008, the Court lifted the stay.
A Scheduling Order has now been entered requiring the parties to complete
discovery by January 2009. At this stage of the proceedings, it is not
possible to predict what, if any, liability the Company may have from the
Derivative Actions.
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 May 4, 2008, the Company recorded claims of
approximately $4,802,000 (net of a deductible of $500,000) in anticipation
of recoveries. As of May 4, 2008, partial payments of approximately
$1,997,000 have been received leaving a receivable balance of $2,805,000.
The amount is included in other receivables in the accompanying condensed
consolidated balance sheet at May 4, 2008. Subsequent to May 4, 2008, the
Company received an additional payment of approximately $238,000. 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 term "Loss" is defined in the policy as follows:
"Loss means the amount that any Insured becomes legally obligated to pay on
account of any covered Claim, including but not limited to damages
(including punitive or exemplary damages, or the multiple portion of any
multiplied damage award, if and to the extent such damages are insurable
under the law of the jurisdiction most favorable to the insurability of
such damages provided such jurisdiction has a substantial relationship to
the relevant Insureds, to the Company, or to the Claim giving rise to the
damages), judgments, settlements, pre-judgment and post-judgment interest,
Defense Costs and, solely with respect to Insuring Clause 2, Settlement
fees."
Further, the policy defines "Defense Costs" as follows:
"Defense Costs means that part of Loss consisting of reasonable costs,
charges, fees (including but not limited to attorneys' fees and experts'
fees) and expenses (other than regular or overtime wages, salaries, fees or
benefits of the directors, officers or employees of the Organization)
incurred in defending any Claim and the premium for appeal, attachment or
similar bonds."
In establishing the receivable for legal recoveries, the Company identified
and segregated defense costs related to the defense of the class action
lawsuits and the defense of the former Chairman and officer of the Company
in the criminal case. The Company believes such costs represent a "loss"
under its D&O policy and are recoverable. The Company excluded all defense
costs related to the defense of the Company pertaining to the criminal case
as such costs may not be recoverable under the D&O policy.
On June 27, 2007, the Company was notified by the Office of the General
Counsel, Acquisition Integrity Office, Department of Navy (the "Navy"),
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 and Chicago,
Illinois. The Chicago, Illinois location is a two-person marketing office.
On August 15, 2007 the suspension was lifted following an amendment to the
Administrative Agreement with the Navy (originally signed on October 12,
2006) extending the term of the agreement for one additional year. While
the suspension was in place, these facilities could not be solicited for or
awarded new contracts or contract extensions without special exceptions.
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.
Prior to May 5, 2008, counsel for the Company met with representatives of
the Department of Navy, Suspension and Debarment Office, Acquisition
Integrity Office to discuss (a) the possible agreement between the United
States Attorney's Office for the Eastern District of Pennsylvania and the
Company, as such is set forth above, and (b) the possible agreement with
the Civil Division of the U.S. Attorney's Office and the Company, as is
mentioned above. Representatives from the Navy advised that no action would
be taken to suspend or debar the Company based upon these agreements, and
no action was in fact taken or is expected to be taken.
On April 10, 2007, EADS Deutschland GmbH ("EADS"), a German corporation,
filed a lawsuit against Herley Industries, Inc., General Microwave
10
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 asserted claims for
breach of contract and conversion, claiming that the Company was wrongfully
in possession of the intellectual property that was transferred to the
Company. EADS also sought a preliminary injunction. The Company denied any
wrongdoing and filed counterclaims against EADS. On August 2, 2007, the
Company and EADS entered into a settlement of this motion, which was
reduced to a written consent decree entered by the Court on August 29,
2007. EADS's claims for breach of contract and for conversion remained
pending, as did the Company's counterclaims. Pursuant to the consent
decree, the parties agreed to a mediation/settlement conference of all
their respective claims with the Court, and further agreed to stay all
proceedings pending the outcome of that mediation/settlement conference on
October 17, 2007. In November 2007, the Company reached a comprehensive
settlement agreement with EADS effective December 5, 2007, as discussed in
Note 2.
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.
7. Comprehensive (Loss) Income
Comprehensive (loss) income for the periods presented is as follows (in
thousands):
Thirty-
Forty nine
weeks weeks
Thirteen weeks ended ended ended
May 4, April 29, May 4, April 29,
2008 2007 2008 2007
---- ---- ---- ----
Net (loss) income $ (3,592) $ 3,878 $ (10,023) $ (460)
Unrealized (loss) income on interest rate swap 18 (10) (34) (20)
Foreign currency translation (loss) gain (71) 118 (217) 534
------------ ------------ ------------ ------------
Comprehensive (loss) income $ (3,645) $ 3,986 $ (10,274) $ 54
============ ============ ============ ============
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 is as follows (in
thousands):
May 4, July 29,
2008 2007
---- ----
Unrealized loss on interest rate swap $ (63) $ (29)
Foreign currency translation gain 1,557 1,774
----- -----
Accumulated other comprehensive income $ 1,494 $ 1,745
===== =====
8. Share-Based Compensation
The Company has various fixed stock option plans which are described in
Note N of the Company's July 29, 2007 Annual Report on Form 10-K/A
Amendment No. 1 that provide for the grant of stock options to eligible
employees and directors.
The Company recorded total share-based costs related to stock options,
included as compensation costs in operating expenses, of approximately
$287,000 and $800,000 for the thirteen and forty weeks ended May 4, 2008
and approximately $101,000 and $326,000 for the thirteen and thirty-nine
weeks ended April 29, 2007, respectively.
As of May 4, 2008, there were 3,528,950 stock options outstanding. Options
for 4,000 shares of common stock were issued at an average price of $13.87
during the forty weeks ended May 4, 2008. The aggregate fair value of the
options issued, as determined using a Black-Scholes option valuation model,
is approximately $23,000. No stock options were granted during the
thirty-nine weeks ended April 29, 2007. The aggregate value of unvested
options as of May 4, 2008, as determined using a Black-Scholes option
valuation model, was approximately $1,076,000 (net of estimated
forfeitures) which is expected to be recognized over a weighted-average
period of 1.7 years.
Options for 27,000 shares of common stock were exercised during the forty
weeks ended May 4, 2008 at an average exercise price of $8.35 per share for
11
total proceeds of $225,000 and options for 88,500 shares of common stock
expired or were forfeited during the period.
The total intrinsic value of options exercised during the forty weeks ended
May 4, 2008, based on the difference between the Company's stock price at
the time of exercise and the related exercise price, was approximately
$150,000.
A summary of stock option activity under all plans for the forty weeks
ended May 4, 2008 is as follows:
Non-Qualified Stock Options
---------------------------
Weighted Aggregate
Average Intrinsic
Number Price Range Exercise Value
of shares per share Price (in thousands)
--------- --------- ----- --------------
Outstanding July 29, 2007 3,640,450 $ 7.25 - 21.18 $ 14.84
Granted 4,000 $ 12.58 - 15.16 $ 13.87
Exercised (27,000) $ 7.25 - 9.13 $ 8.35
Cancelled (88,500) $ 17.98 - 20.09 $ 19.21
--------- ------------- -----
Outstanding May 4, 2008 3,528,950 $ 7.62 - 21.18 $ 14.78 $ 2,730
========= ----- -----
Exercisable May 4, 2008 (1) 3,149,750 $ 14.53 $ 2,730
--------- ----- -----
Vested and expected to vest May 4, 2008 3,491,422 $ 14.75 $ 2,730
--------- ----- -----
<FN>
(1) There are 2,052,800 vested options with exercise prices greater than the
closing stock price of $12.00 as of May 4, 2008.
</FN>
9. (Loss) earnings per Common Share ("EPS")
The following table shows the components used in the calculation of basic
loss per common share and loss per common share assuming dilution (in
thousands):
Thirty-
Forty nine
weeks weeks
Thirteen weeks ended ended ended
May 4, April 29, May 4, April 29,
2008 2007 2008 2007
---- ---- ---- ----
Numerator:
Net (loss) income $ (3,592) $ 3,878 $ (10,023) $ (460)
===== ===== ====== ===
Denominator:
Basic weighted-average shares 13,507 13,969 13,696 13,911
Effect of dilutive securities:
Employee stock options - 480 - -
------ ------ ------ ------
Diluted weighted-average shares 13,507 14,449 13,696 13,911
====== ====== ====== ======
Stock options not included in computation 3,529 1,673 3,529 3,241
====== ====== ====== ======
Exercise price range per share $7.62 - $21.18 $15.78 - $21.18 $7.62 - $21.18 $4.31 - $21.18
============= ============== ============= =============
No employee stock options were considered in the computation of diluted net
loss per share for the thirteen and forty weeks ended May 4, 2008 and for
the thirty-nine weeks ended April 29, 2007 as their effect is
anti-dilutive. The options which were outstanding as of May 4, 2008 and
excluded from the computation in the table above expire at various dates
through June 8, 2017.
10. Stock Buyback Program
On October 12, 2007, the Company announced that its Board of Directors had
approved an expansion of its existing stock buyback program to make
additional purchases of up to 1,000,000 shares of its common stock in the
open market or private transactions, in accordance with applicable SEC
rules. During the forty weeks ended May 4, 2008 the Company repurchased and
retired 493,938 shares of its common stock, pursuant to this program at an
aggregate cost of approximately $7,138,000 including transaction costs.
12
Funds to acquire the shares came from excess cash reserves. Common stock at
par value and additional paid-in capital were reduced by approximately
$48,000 and $7,090,000, respectively. The timing, actual number and value
of any additional shares that may be repurchased under this program will
depend on a number of factors, including the Company's future financial
performance, the Company's available cash resources and competing uses for
the cash, prevailing market prices of the Company's common stock and the
number of shares that become available for sale at prices that the Company
believes are attractive. As of May 4, 2008, approximately 614,000 shares
are eligible for future purchase under the Company's buyback program.
11. Geographic Information and Major Customers
The Company's chief operating decision makers are considered to be the
Chairman/Chief Executive Officer and the Chief Operating Officer. These
individuals evaluate both consolidated and disaggregated financial
information, primarily gross revenues, in deciding how to allocate
resources and assess performance. They also use certain disaggregated
financial information for the Company's product groups. The Company does
not determine a measure of operating income or loss by product group. The
Company's product groups have similar long-term economic characteristics,
such as application, and are similar in regards to (a) nature of products
and production processes, (b) type of customers and (c) method used to
distribute products. Accordingly, the Company operates as a single
integrated business and as such has one operating segment as a provider of
complex microwave technology solutions for the defense, aerospace and
medical industries worldwide. All of the Company's revenues result from
sales of its products.
Net sales for defense electronics and commercial technologies were as
follows:
Thirty-
Forty nine
weeks weeks
Thirteen weeks ended ended ended
May 4, April 29, May 4, April 29,
2008 2007 2008 2007
---- ---- ---- ----
Defense electronics $ 35,866 $ 41,199 $ 100,461 $ 110,442
Commercial technologies 2,683 3,202 7,882 12,072
---------- --------- ---------- --------
Net sales $ 38,549 $ 44,401 $ 108,343 $ 122,514
========== ========= ========== ========
Net sales directly to the U.S. Government in the forty and thirty-nine
weeks ended May 4, 2008 and April 29, 2007 accounted for approximately 16%
and 22% of net sales, respectively, and in the thirteen and thirteen weeks
ended May 4, 2008 and April 29, 2007 net sales directly to the U.S.
Government accounted for approximately 21% and 24% of net sales. Lockheed
Martin and Northrop Grumman each accounted for approximately 12% and 11% of
net sales, respectively in the forty weeks ended May 4, 2008. No other
customer accounted for 10% or more of consolidated net sales in the periods
presented. Foreign sales amounted to approximately $34,434,000 (32%) and
$33,803,000 (28%) in the forty and thirty-nine weeks ended May 4, 2008 and
April 29, 2007, respectively; and in the thirteen and thirteen weeks ended
May 4, 2008 and April 29, 2007 foreign sales amounted to approximately
$11,448,000 (30%) and $10,157,000 (23%), respectively.
Geographic net sales based on place of contract performance, were as
follows (in thousands):
Thirty-
Forty nine
weeks weeks
Thirteen weeks ended ended ended
May 4, April 29, May 4, April 29,
2008 2007 2008 2007
---- ---- ---- ----
United States $ 33,715 $ 38,214 $ 91,745 $ 103,476
Israel 4,380 5,170 14,388 15,054
England 454 1,017 2,210 3,984
----------- ----------- ------------ -----------
Net sales $ 38,549 $ 44,401 $ 108,343 $ 122,514
=========== =========== ============ ===========
Net property, plant and equipment by geographic area were as follows (in
thousands):
May 4, July 29,
2008 2007
---- ----
United States $ 26,291 $ 24,904
Israel 4,458 4,844
England 208 248
------- -------
$ 30,957 $ 29,996
======= =======
13
12. Supplemental Cash Flow information is as follows (in thousands):
Forty Thirty-nine
weeks ended weeks ended
May 4, 2008 April 29, 2007
----------- --------------
Net cash paid during the period for:
Interest $ 323 $ 357
Income taxes $ 324 $ -
Non-cash financing transactions:
Retirement of 493,938 shares of treasury stock $ 7,138 $ -
13. New Accounting Pronouncements
In March 2008, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 161 ("SFAS 161"),
Disclosures about Derivative Instruments and Hedging Activities--an
amendment of FASB Statement No.133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS No. 133"). SFAS No. 161 requires companies to
provide enhanced disclosures regarding derivative instruments and hedging
activities in order to better convey the purpose of derivative use in terms
of risk management. Disclosures about (i) how and why an entity uses
derivative instruments, (ii) how derivative instruments and related hedged
items are accounted for under SFAS No. 133 and its related interpretations,
and (iii) how derivative instruments and related hedged items affect a
company's financial position, financial performance, and cash flows, are
required. This Statement retains the same scope as SFAS No. 133 and is
effective for fiscal years and interim periods beginning after November 15,
2008. The Company is currently evaluating the impact, if any, that the
adoption of SFAS No. 161 will have on its consolidated financial position,
cash flows and results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS No. 157 (i) establishes a single definition of fair
value and a framework for measuring fair value, (ii) sets out a fair value
hierarchy to be used to classify the source of information used in fair
value measurements, and (iii) requires new disclosures of assets and
liabilities measured at fair value based on their level in the hierarchy.
This statement applies under other accounting pronouncements that require
or permit fair value measurements. In February 2008, the FASB issued Staff
Positions (FSPs) No. 157-1 and No. 157-2, which, respectively, remove
leasing transactions from the scope of SFAS No. 157 and defer its effective
date for one year relative to certain nonfinancial assets and liabilities.
As a result, the application of the definition of fair value and related
disclosures of SFAS No. 157 (as impacted by these two FSPs) will be
effective for the Company's fiscal year beginning August, 2008 on a
prospective basis with respect to fair value measurements of (a)
nonfinancial assets and liabilities that are recognized or disclosed at
fair value in the Company's financial statements on a recurring basis (at
least annually) and (b) all financial assets and liabilities. The remaining
aspects of SFAS No. 157 for which the effective date was deferred under FSP
No. 157-2 are currently being evaluated by the Company and will be
effective for the Company's fiscal year beginning August, 2009. Areas
impacted by the deferral relate to nonfinancial assets and liabilities that
are measured at fair value, but are recognized or disclosed at fair value
on a nonrecurring basis. This deferral applies to such items as
nonfinancial assets and liabilities initially measured at fair value in a
business combination (but not measured at fair value in subsequent periods)
or nonfinancial long-lived asset groups measured at fair value for an
impairment assessment. The effects of SFAS No. 157 and FSPs No. 157-1 and
No. 157-2 are currently being evaluated by the Company but are not expected
to have a material impact on its consolidated results of operations, cash
flows or financial condition.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" (SFAS 141(R)). The objective of this Statement is to improve
the relevance, representational faithfulness, and comparability of the
information that a reporting entity provides in its financial reports about
a business combination. Specifically, it establishes principles and
requirements over how the acquirer (1) recognizes and measures the
identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree; (2) recognizes and measures
goodwill acquired in the business combination or a gain from a bargain
purchase, and; (3) determines what information to disclose to enable users
of the financial statements to evaluate the nature and financial effects of
the business combination. SFAS 141(R) also requires acquisition-related
transaction expenses and restructuring costs be expensed as incurred rather
than capitalized as a component of the business combination. This Statement
is effective for fiscal years beginning after December 15, 2008 (the
Company's 2010 fiscal year). The Company does not believe this Statement
will have a material impact on the financial statements. SFAS 141(R) would
have an impact on accounting for any businesses acquired after the
effective date of this pronouncement.
In December 2007, the FASB issued Statement of Financial Accounting
Standard No. 160, "Noncontrolling Interests in Consolidated Financial
Statements an amendment of ARB No. 51" (SFAS 160). The objective of this
Statement is to improve the relevance, comparability, and transparency of
the financial information that a reporting entity provides in its
consolidated financial statements by establishing accounting and reporting
standards for the noncontrolling interest in a subsidiary (minority
interests) and for the deconsolidation of a subsidiary. SFAS 160 also
requires that a retained noncontrolling interest upon the deconsolidation
14
of a subsidiary be initially measured at its fair value. Upon adoption of
SFAS 160, the Company would be required to report any noncontrolling
interests as a separate component of stockholders' equity. The Company
would also be required to present any net income allocable to
noncontrolling interests and net income attributable to the stockholders of
the Company separately in its consolidated statements of income. This
Statement is effective for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2008 (the Company's 2010 fiscal
year). SFAS 160 requires retroactive adoption of the presentation and
disclosure requirements for existing minority interests, and would have an
impact on the presentation and disclosure of the noncontrolling interest of
any non wholly-owned businesses acquired in the future.
14. Related Party Transactions
The Company leases one of its buildings in Fort Walton Beach, Florida from
MSI Investments, a Florida General Partnership which is owned by four
individuals, two of whom are currently employees of MSI and one who serves
as a consultant. Rent expense in the thirteen and forty weeks ended May 4,
2008 was approximately $71,000 and $213,000, respectively, and for the
thirteen and thirty-nine weeks ended April 29, 2007 was approximately
$69,000 and $204,000, respectively.
The Company leases its facilities in Farmingdale, New York from a
partnership partially owned by the children of an officer of the Company.
Rent expense in the thirteen and forty weeks ended May 4, 2008 was
approximately $208,000 and $506,000, respectively, and for the thirteen and
thirty-nine weeks ended April 29, 2007 was approximately $173,000 and
$515,000, respectively.
15. Line of Credit and Stand-by Letters of Credit
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, 2010 (as amended
May 2, 2008.) 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 1.65% (as amended May 2, 2008.) There is a fee of 20 basis points per
annum on the unused portion of the credit facility payable quarterly. 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. Our backlog as of May 4, 2008 was approximately $158
million. During the forty weeks ended May 4, 2008, the Company utilized the
credit facility for short-term working capital needs to the extent of $13.9
million. There are no borrowings under the credit line at May 4, 2008 and
July 29, 2007. The Company borrowed $1.5 million under the credit line on
May 5, 2008.
The Company maintains a letter of credit facility in connection with its
revolving credit agreement with two banks that provides for the issuance of
stand-by letters of credit, subject to a maximum of loans and letters of
credit outstanding of $40,000,000, and requires the payment of a fee of
1.0% per annum of the amounts outstanding under the facility. The facility
expires March 31, 2010 as amended. At May 4, 2008 and July 29, 2007,
stand-by letters of credit aggregating approximately $17,420,000 and
$11,535,000, respectively were outstanding under this facility.
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. The
Company was in compliance with all covenants (as amended May 2, 2008) at
May 4, 2008.
16. Subsequent Event
On May 6, 2008 the Company announced a plan to significantly downsize its
manufacturing facility in Farmingdale, New York and transfer the bulk of
its workload to its other facilities in Whippany, New Jersey; Woburn,
Massachusetts; Lancaster, Pennsylvania; and Jerusalem, Israel.
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
15
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
We begin Management's Discussion and Analysis of Financial Condition and Results
of Operations ("MD&A") of Herley Industries, Inc. with a business overview. This
is followed by a discussion of the critical accounting estimates that we believe
are important to understanding the assumptions and judgments incorporated in our
reported financial results, which we discuss under "Results of Operations." We
then provide an analysis of cash flows under "Liquidity and Capital Resources."
This MD&A 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 2007 Form 10-K/A
Amendment No. 1.
Business Overview
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including Northrop Grumman Corporation, Lockheed Martin
Corporation, Raytheon Company, The Boeing Company, BAE Systems and Harris
Corporation), the U.S. Government (including the Department of Defense, NASA and
other U.S. Government agencies) and international customers (including the
Egyptian, German, Japanese and South Korean militaries and suppliers to
international militaries). We are a leading provider of microwave technologies
for use in command and control systems, flight instrumentation, weapons sensors
and electronic warfare systems. We have served the defense industry since 1965
by designing and manufacturing microwave devices for use in high technology
defense electronics applications. Our products and systems are currently
deployed on a wide range of high profile military platforms, including the F-16
Falcon, the F/A-18E/F Super Hornet, the E-2C/D Hawkeye, EA-18G Growler, the
AEGIS class surface combatants, the EA-6B Prowler, the AMRAAM air to air
missile, CALCM (Conventional Air Launch Cruise Missile), Multi-mission Maritime
Aircraft and unmanned aerial vehicles, or UAVs, as well as high priority
national security programs such as National Missile Defense and the Trident II
D-5.
Critical Accounting Policies and Estimates
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/A
Amendment No. 1 for the fiscal year ended July 29, 2007. 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/A Amendment No. 1 for the fiscal year ended July 29,
2007. 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.
We adopted the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 48 (FIN 48) effective July 30, 2007. 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. We had no cumulative effect adjustment
related to the adoption. However, certain amounts have been reclassified in the
consolidated balance sheet in order to comply with the requirements of the
statement.
Other than the adoption of FIN 48, 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 29, 2007 as filed with the Securities and Exchange Commission.
Results of Operations
Our Company's senior management regularly reviews the performance of our
operations including reviews of key performance metrics as well as the status of
operating initiatives. We review information on the financial performance of the
operations, new business opportunities, customer relationships and initiatives,
IR&D activities, human resources, manufacturing effectiveness, cost reduction
activities, as well as other subjects. We compare performance against budget,
against prior comparable periods, and against our most recent internal
forecasts. The following table presents a financial summary comparison (in
thousands) of the key performance metrics.
16
Third Quarter Nine Months Year to Date
------------------------------------ ------------------------------------
2008 2007 % Change 2008 2007 % Change
------------------------------------ ------------------------------------
Key performance metrics:
Net sales $38,549 $44,401 (13)% $108,343 $122,514 (12)%
Gross profit $8,567 $12,714 (33)% $23,553 $32,986 (29)%
Gross profit percentage 22.2% 28.6% 21.7% 26.9%
Operating (loss) income ($10,884) $3,819 (385)% ($19,858) ($1,243) (1,498)%
Bookings $49,159 $58,731 (16)% $131,132 $146,927 (11)%
Backlog $158,089 $150,496 5 % $158,089 $150,496 5 %
The results of operations for the Company in our third quarter included a $9.5
million charge for the settlement of the Department of Justice litigation
matters. Our gross profit in the quarter improved versus the second quarter of
fiscal 2008 and we believe this improvement will continue. In our discussion
below, we will explain the key performance metrics and provide an analysis of
the performance of the Company in the third quarter. While the results of the
third quarter did not meet expectations, we believe the underlying strength of
the business is continuing to show operational improvement and we believe we
will return to profitability in the fourth quarter. However, there can be no
assurance that we will achieve our expectations.
We believe the overall prospects for our financial performance continues to be
promising. Our backlog remains at high levels while our proposal activity
continues to be very active. The poor financial performance year to date, and
particularly in the second quarter, is driven largely by engineering and
manufacturing difficulties on a number of significant and important contracts,
including development contracts. We understand the various technical problems we
are facing and are progressing with action plans to resolve them. In addition,
the operational issues are being carefully, but aggressively addressed, as
evidenced in part by the recently announced restructuring of our Farmingdale
facility. Although there can be no assurance that we will succeed, we are
confident that we will successfully work through these challenges.
During recent months, a number of operational improvement initiatives have been
undertaken at our operating facilities. We expect many of these initiatives to
provide operational performance improvement in the near term and, in fact, we
are already seeing some of their impact on the businesses. We have established
four improvement objectives across all locations. They are: improve cycle time,
reduce defects, improve customer satisfaction, and increase Herley pride. We
motivated our employees to actively engage in this program. Across our eight
locations we have more than 100 active teams addressing company specific
improvement objectives aligned with these four corporate objectives. Each of
these teams has a quantifiable improvement objective targeted for completion on
or before the end of our fiscal year. We are also emphasizing a culture of
honoring our commitments in everything we do. We are seeing this process
improvement culture beginning to take root in our operations. Although we
believe that our expectations for the success of these initiatives are
reasonable, there are no guarantees that future results, performance or
achievements may be realized.
Similarly, we formed five Councils which are: Technology, Operations, Business
Development, Finance, and Contracts. Each Council has a representative from each
of our locations and is chartered with the objective of implementing process
improvements in their respective discipline that crosses all locations as well
as sharing of best practices across Herley. Each Council has identified
specific, measurable objectives which are expected to be achieved on or before
the end of this fiscal year. Approximately thirty different issues are being
addressed by the Councils, each of which we believe will improve the performance
of the Company.
In addition, we are identifying and implementing specific and substantive
actions immediately to control costs and focus the resources of the Company
directly on the operational performance issues which are designed to bring about
measurable improvement in a short period of time.
Accordingly, we believe we are taking appropriate and aggressive actions to meet
the challenges facing our Company and we remain optimistic that the Company's
performance issues will be short-lived.
Thirteen weeks ended May 4, 2008 and April 29, 2007
- ---------------------------------------------------
Net sales for the thirteen weeks ended May 4, 2008 were approximately $38.5
million, as compared to $44.4 million in the thirteen weeks ended April 29,
2007, a decrease of $5.9 million (13%). This decrease is primarily attributable
to:
o A decrease of $1.9 million due to the completion of a contract for radio
communications equipment in a prior period at ICI;
o A decrease of more than $1.6 million at Herley Farmingdale as the result of
delays in certain microwave development programs;
o A decrease of $0.8 million at Herley Israel due to the timing of shipments
on a particular contract;
o A decrease of approximately $0.5 million at EWST due to cost overruns on a
percentage completion contract for a simulation system for an international
customer;
o A decrease of $0.5 million in activity on various cost plus fixed fee
contracts at ICI due to contract mix and timing;
o A decrease at Herley Medical Products of approximately $0.5 million in
medical equipment sales due to timing of key customer capital purchasing
requirements;
17
o A decrease of $0.4 million at Herley New England due to a temporary decline
in production output resulting from turnover of certain key technicians;
and
o A decrease of $0.2 million versus the prior year quarter as certain
commercial programs ended and the transition towards military business
progressed at Herley CTI.
Offsetting these decreases was:
o An increase of $0.6 million at Micro Systems, Inc. across several
contracts.
Domestic and foreign sales from all locations were 70% and 30% respectively of
total net sales in the quarter, versus 77% and 23% respectively in the prior
year quarter. Bookings in the third quarter were approximately $49.2 million,
and were 85% domestic and 15% foreign. This compares to bookings of
approximately $58.7 million in the prior year third quarter which were 69%
domestic and 31% foreign, and included a large $8.3 million order at Herley
Israel for an Airborne Electronic Warfare program.
Gross profit in the thirteen weeks ended May 4, 2008 was $8.6 million (22.2% of
net sales) compared to $12.7 million (28.6% of net sales) in the third quarter
of fiscal 2007, a decrease of approximately $4.1 million. Contributing to the
decrease in gross profit for the quarter are the following items:
o Reduced volume of revenues across several Herley operations affected gross
margin by approximately $1.7 million;
o Loss provisions of approximately $0.8 million were established for two
development contracts at Herley Farmingdale due to changes in management's
estimate of the costs required to complete the contract requirements;
o Gross profit at our EWST operation decreased by $0.5 million due to changes
in management's estimate of the costs required to complete the contract
requirements of a development contract for an international customer;
o We incurred higher independent research and development costs of
approximately $0.6 million on investments in certain strategic
opportunities at multiple Herley operations;
o Higher costs at our Israeli subsidiary of approximately $0.4 million due to
the unfavorable exchange rate of the U.S. Dollar versus the Israeli Shekel;
and
o Products mix both domestically and internationally.
Offset by
o Gross profit improvement within certain operations due to reduced overhead
spending, product mix, or performance improvement.
Selling and administrative expenses for the thirteen weeks ended May 4, 2008
increased approximately $1.1 million over the third quarter of fiscal 2007 and
was 26% of net sales as compared to 20% in fiscal 2007. Significant expenses
during the period included:
o An increase in legal fees, net of accrued insurance recoveries, over the
prior year third quarter of approximately $1.0 million. During the thirteen
weeks ended May 4, 2008, gross legal costs were approximately $2.4 million,
while legal costs net of accrued insurance recoveries were approximately
$1.2 million as compared to $0.2 million in thirteen weeks ended April 29,
2007. Legal costs in both periods are primarily attributable to the
indictment by the Department of Justice and the subsequent class action
lawsuits;
o An increase in sales commissions of approximately $0.4 million over the
prior year third quarter;
o An increase in stock compensation costs recorded per SFAS 123(R) of
approximately $0.2 million; and
o An increase in amortization of intangibles of approximately $0.1 million.
Offset by
o A net decrease in general expenses at various locations of approximately
$0.6 million.
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 May 4, 2008, we have recorded a claim of approximately $4.8
million (net of a deductible of $0.5 million) and have received partial payments
of approximately $2.0 million leaving a receivable balance of $2.8 million. The
amount is included in other receivables in the accompanying condensed
consolidated balance sheet at May 4, 2008. 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.
18
The term "Loss" is defined in the policy as follows:
"Loss means the amount that any Insured becomes legally obligated to pay on
account of any covered Claim, including but not limited to damages (including
punitive or exemplary damages, or the multiple portion of any multiplied damage
award, if and to the extent such damages are insurable under the law of the
jurisdiction most favorable to the insurability of such damages provided such
jurisdiction has a substantial relationship to the relevant Insureds, to the
Company, or to the Claim giving rise to the damages), judgments, settlements,
pre-judgment and post-judgment interest, Defense Costs and, solely with respect
to Insuring Clause 2, Settlement fees."
Further, the policy defines "Defense Costs" as follows:
"Defense Costs means that part of Loss consisting of reasonable costs, charges,
fees (including but not limited to attorneys' fees and experts' fees) and
expenses (other than regular or overtime wages, salaries, fees or benefits of
the directors, officers or employees of the Organization) incurred in defending
any Claim and the premium for appeal, attachment or similar bonds."
In establishing the receivable for legal recoveries, the Company identified and
segregated defense costs related to the defense of the class action lawsuits and
the defense of the former Chairman and officer of the Company in the criminal
case. The Company believes such costs represent a "loss" under its D&O policy
and are recoverable. The Company excluded all defense costs related to the
defense of the Company pertaining to the criminal case as such costs may not be
recoverable under the D&O policy.
Loss from operations for the third quarter of fiscal 2008 was $10.9 million or
28.2% of net sales, as compared to income from operations of $3.8 million or
8.6% of net sales in the prior year. The loss from operations for the third
quarter of fiscal 2008 included the $9.5 million litigation settlement costs and
was also impacted by the shortfall in gross margin as well as the increased
general and administrative costs as described above.
Other income (expense) decreased in the third quarter of fiscal 2008 over the
prior year by approximately $0.3 million primarily due to reduced investment
income on lower cash balances and foreign currency exchange fluctuations. The
foreign exchange gains and losses 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 benefit recognized in the third quarter of fiscal 2008 was $7.3
million as compared to a provision of $0.3 million in the prior year's third
quarter. The benefit in fiscal 2008 consists primarily of the tax benefit of
$4.7 million attributable to the loss in the quarter (adjusted for the
non-deductible fine of $3.5 million paid as part of the litigation settlement);
plus the recognition of a tax benefit of $2.7 million due to the expiration of
the statute of limitations in April 2008. This benefit primarily relates to a
deduction taken for an impaired investment on the Company's fiscal year 2004
income tax return.
Forty weeks ended May 4, 2008 and thirty-nine weeks ended April 29, 2007
- ------------------------------------------------------------------------
Net sales for the forty weeks ended May 4, 2008 were approximately $108.3
million compared to $122.5 million in the first nine months of fiscal 2007, a
decrease of $14.2 million (12%). The decrease in net sales is primarily related
to:
o a decrease of approximately $5.5 million due to delays in booking and
reduction in scope for certain cost plus fixed fee contracts for software
development at ICI;
o a decrease of approximately $3.0 million in deliveries due to the
completion of a contract for radio communications equipment at ICI;
o delays in key microwave development and production programs at Herley
Farmingdale of approximately $3.9 million;
o a decrease at Herley Medical Products of approximately $1.9 million in
equipment sales to two key commercial customers due to timing of their
capital purchasing requirements;
o a decrease of approximately $1.8 million at EWST due to cost overruns on a
percentage completion contract for a simulation system for an international
customer and timing of other contract activity;
o disruptions across several production programs due to supplier quality
issues, primarily affecting the second quarter; and
o a decrease in revenues of approximately $2.2 million versus the first nine
months of the prior year as certain commercial programs ended and the
transition towards military business progressed at Herley CTI.
Offsetting these decreases was:
o an increase of $4.1 million of simulation systems and other product sales
through Micro Systems, Inc.; and
o an increase of approximately $0.4 million at Herley New England due to
volume of certain key second generation production programs.
Domestic and foreign sales were 68% and 32% respectively of net sales in the
forty weeks ended May 4, 2008, versus 72% and 28% respectively in the prior year
comparable period. Bookings were approximately $131.1 million, and were 79%
domestic and 21% foreign. This compares to bookings of approximately $146.9
million in the prior year period which were 66% domestic and 34% foreign.
19
Gross profit in the forty weeks ended May 4, 2008 was $23.6 million (21.7% of
net sales) compared to $33.0 million (26.9% of net sales) in the first nine
months of fiscal 2007, a decrease of $9.4 million. The decrease was
approximately $0.3 million during the first quarter, $5.0 million during the
second quarter, and $4.1 million during the third quarter. Contributing to the
reduction in gross profit during the first nine months of fiscal 2008 are the
following items:
o Reduced volume of revenues across several Herley operations affected gross
margin by approximately $3.7 million;
o Higher independent research and development costs of approximately $2.7
million on investments in certain strategic opportunities at several Herley
operations.
o Approximately $1.0 million at Herley Farmingdale due to cost overruns and a
change in management's estimate of the recoverability of the costs on
future contracts.
o Higher costs at our Israeli subsidiary due to the unfavorable exchange rate
of the U.S. Dollar versus the Israeli Shekel reduced gross margins by
approximately $0.9 million; and
o Product mix of contracts both domestically and internationally.
Selling and administrative expenses for the forty weeks ended May 4, 2008 were
26% of net sales as compared to 21% in the first nine months of fiscal 2007. The
$2.6 million increase in selling and administrative expenses is attributable to
an increase in legal costs; an increase in commissions related primarily to our
international business, an increase in stock compensation costs recorded per
SFAS 123(R); and an increase in amortization expense.
We had an operating loss for the first nine months of fiscal 2008 of $19.9
million compared to an operating loss of $1.2 million in the comparable period
of fiscal 2007 which includes the $9.5 million settlement of the Department of
Justice litigation and the $6.0 million settlement of the EADS litigation as
discussed in Note 2 to the condensed consolidated financial statements.
Excluding both the litigation settlement costs in the first and third quarters
of fiscal 2008 and the employment contract settlement costs recorded in the
first quarter of fiscal 2007, operating loss for the first nine months of fiscal
2008 was $4.4 million or 4.1% of net sales, as compared to operating income of
$7.7 million or 6.3% of net sales in the first nine months of fiscal 2007. The
decrease in operating income is primarily attributable to the 12% reduction in
sales volume, the 5.2% decrease in gross margin percentage as discussed above,
and the increase in selling and administrative expenses.
Investment income was $1.0 million, an increase of $0.1 million in the first
nine months of fiscal 2008 because of higher interest rates earned on higher
average cash balances through a portion of the year. Interest expense was $0.4
million, a decrease of $0.2 million versus the prior year comparable period.
We recognized a net foreign exchange loss of $0.5 million through the third
quarter of fiscal 2007. The foreign exchange losses and 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 benefit recognized in the first nine months of fiscal 2008 was
$9.3 million (an effective income tax benefit rate of 48.2%.) The estimated
effective tax benefit rate for fiscal year 2008 is 48.8%, which is greater than
the statutory rate of 35% primarily due to the recognition of the FIN 48
liability that could now be recognized offset by the non-deductible penalty paid
as part of the litigation settlement. Other non-recurring items contributing to
the tax benefit in the first nine months of fiscal 2008 include a research and
development credit carryover and a lower than expected tax rate in Israel for
fiscal 2007 which increased the income tax benefit for the first nine months of
fiscal 2008 by approximately 3.6% resulting in an overall effective rate for the
first nine months of 48.2%.
Liquidity and Capital Resources
- -------------------------------
As of May 4, 2008 and July 29, 2007, working capital was $91.1 million and
$103.5 million, respectively, and the ratio of current assets to current
liabilities was 2.8 to 1 and 4.0 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 at the time a contract is entered
into. The un-liquidated balance of progress payments was approximately $1.3
million at May 4, 2008 and $1.9 million at July 29, 2007. The balance of
advanced payments was approximately $7.1 million at May 4, 2008 and $7.2 million
at July 29, 2007.
Net cash used in operations during the forty weeks ended May 4, 2008 was
approximately $2.8 million as compared to net cash provided by operations of
$1.4 million during the first three quarters of the prior year, a net decrease
of approximately $4.2 million. We had a net loss in the first three quarters of
the current fiscal year of $10.0 million versus a loss of $4.3 million in the
prior year first three quarters, an increase in the loss of approximately $5.7
million. The first three quarters of fiscal 2008 was impacted by the settlement
costs of various litigation and related expenses of approximately $15.5 million
and the first three quarters of fiscal 2007 included employment settlement costs
of approximately $8.9 million, including a cash payment of $3.0 million (as
discussed in Note 2 to the condensed consolidated financial statements).
20
Significant increases in cash provided by operating activities during the forty
weeks ended May 4, 2008 include the following:
1. A decrease in trade accounts receivable of $4.4 million, and
2. an increase of approximately $9.3 million generated through amounts due to
vendors and accrued expenses.
Offset primarily by the following decreases in cash provided by operating
activities:
1. An increase of approximately $5.4 million in the amount of cash invested in
costs incurred and income recognized in excess of billings on uncompleted
contracts and claims,
2. an increase in inventory of approximately $9.9 million partially due to
delays in shipping certain contracts due to technical issues,
3. payments of $4.0 million in connection with the EADS litigation settlement,
4. payments of $1.0 million in connection with the employment settlement
agreement in 2007, and
5. an increase in refundable income taxes of $1.2 million.
On May 5, 2008, the Company paid $9.5 million in fines and settlement costs in
connection with the settlement of litigation (see Note 6 to the condensed
consolidated financial statements).
Net cash used in investing activities relates to capital expenditures of
approximately $3.9 million.
Net cash used in financing activities includes:
1. The purchase and retirement of 493,938 shares of our common stock at an
aggregate cost of approximately $7.1 million, including transaction costs,
pursuant to an expansion of a stock buyback program to make additional
purchases of up to 1,000,000 shares of our common stock in the open market
or private transactions. As of May 4, 2008, approximately 614,000 shares
are available for purchase under the buyback program, and
2. payments of $1.0 million related to our long-term debt.
During the forty weeks ended May 4, 2008 we borrowed and repaid $13.9 million
under our revolving credit facility for short-term working capital needs. On May
5, 2008 we borrowed $1.5 million under our credit facility in connection with
the litigation settlement payment.
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, 2010 (as amended May 2, 2008). 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 1.65% (as amended May 2, 2008). There
is a fee of 20 basis points per annum on the unused portion of the credit
facility payable quarterly. 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. Our backlog as of May 4, 2008 was
approximately $158 million. During the forty weeks ended May 4, 2008, we
utilized the credit facility for short-term working capital needs to the extent
of $13.9 million. There are no borrowings under the credit line at May 4, 2008
and July 29, 2007. Stand-by letters of credit were outstanding in the amount of
approximately $17.4 million under the credit facility at May 4, 2008, and $11.5
million at July 29, 2007. As indicated above, we borrowed $1.5 million under the
credit line on May 5, 2008.
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 (as amended May 2, 2008) at May 4, 2008.
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 2008
will be generated from our existing backlog of sales orders. Our backlog at May
4, 2008 was approximately $158 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 May 4, 2008, we
have approximately $22.6 million available under our bank credit facility, net
of outstanding stand-by letters of credit of approximately $17.4 million and
operating cash of approximately $20.6 million.
21
Contractual Financial Obligations, Commitments and Off-Balance Sheet
Arrangements
Our financial obligations and commitments to make future payments under
contracts include purchase orders, debt and lease agreements, and contingent
commitments such as stand-by letters of credit. These financial obligations are
recorded in accordance with accounting rules applicable to the underlying
transaction, with the result that some are recorded as liabilities on the
Condensed Consolidated Balance Sheet, while others are required to be disclosed
in the Notes to Consolidated Financial Statements and Management's Discussion
and Analysis. The Company's contractual financial obligations and other
contingent commitments are disclosed in our Annual Report on Form 10-K/A
Amendment No. 1 for the fiscal year ended July 29, 2007 under Management's
Discussion and Analysis.
In addition to the financial obligations contained therein, the following
payments (including imputed interest), and a stand-by letter of credit, are
required under the terms of the litigation settlement discussed in Note 2 to the
condensed consolidated financial statements (in thousands):
Stand-by Letters of Credit
--------------------------
Payments Litigation Other
-------- ---------- -----
Within one year $1,000 $1,000 $3,960
2 years 1,000 1,000 -
------- ------- ------
Total $2,000 $2,000 $3,960
======= ======= =======
Upon the adoption of FIN 48, the Company reclassified to long term its
liabilities for unrecognized tax benefits in the amount of approximately $3.1
million, as discussed in Note 4 to the Condensed Consolidated Financial
Statements. Approximately $2.7 million of the unrecognized tax benefit was
realized in the quarter ended May 4, 2008 due to the expiration of the statute
of limitations in April 2008. The Company is unable to make reasonable estimates
as to the period(s) in which cash will be paid for the remaining liabilities.
New Accounting Pronouncements
- -----------------------------
For a discussion of new accounting standards, see Note 13 to our Condensed
Consolidated Financial Statements - (Unaudited) in Item 1.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
The Company's exposures to market risk have not changed significantly since
July 29, 2007.
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
May 4, 2008.
(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 May 4, 2008 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:
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 as superseded on January 30,
2007 alleges 27 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); aiding and abetting (18 U.S.C. Section 2); and a notice of
forfeiture. The Company moved to dismiss the indictment and that motion was
denied on November 5, 2007. A trial was scheduled for May 5, 2008.
22
On May 5, 2008, the Company entered into an agreement with the United
States Attorney's Office for the Eastern District of Pennsylvania in which
(a) the Company agreed to plead guilty to two counts of obstructing an
audit relating solely to the powerheads; (b) the Company agreed to pay a
fine of $3.5 million; and (c) the Government agreed to dismiss all other
counts of the Superseding Indictment. The agreement was presented to the
Court on May 5, 2008, and the Court accepted the agreement and sentenced
the Company to the agreed-upon fine.
With respect to Mr. Blatt, the Court, at the Government's request,
dismissed all of the charges against him in the indictment and the
Government filed a Superseding Information charging Mr. Blatt with a
misdemeanor violation of the tax code in a single count, and Mr. Blatt has
entered a guilty plea for failing to keep Company records of the allocation
of an $18,000 corporate research expense. Mr. Blatt has been fined $25,000,
has received a term of probation of one year and is required to perform
some community service. 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.
Shortly before the indictment mentioned above, Company counsel were
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, deferring any further activity related
to this potential claim until after the trial of the criminal matter
mentioned above. By agreement dated May 5, 2008, the United States
Attorney's Office for the Eastern District of Pennsylvania and the Company
entered into an agreement to resolve the potential issues arising from the
lawsuit threatened against the Company pursuant to, among other things, the
False Claims Act, 31 U.S.C. Section 3729 et. seq. for the matters alleged
in the Superseding Indictment. The Company agreed to pay $6 million in
exchange for, among other things, a release.
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.
On July 17, 2007, the Court issued an order denying the Company's and Mr.
Blatt's motion to dismiss and granted, in part, the other defendants'
motion to dismiss. Specifically, the Court dismissed the Section 10(b)
claim against the other defendants and denied the motion to dismiss the
Section 20(a) claim against them. On July 18, 2007, the Court granted
defendant's motion to stay these actions until after the trial of the
criminal matter referenced above. On February 8, 2008, the Court issued an
Order allowing for certain document discovery to commence. On May 9, 2008,
the Court lifted the stay. A Scheduling Order has now been entered
requiring the parties to complete discovery by January 2009. At this stage
of the proceedings, it is not possible to predict what, if any, liability
the Company may have from the Securities Class Actions.
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 and were consolidated
into one action on March 9, 2006. All defendants in the derivative
complaints filed motions to dismiss on February 26, 2007. On July 20, 2007,
the Court issued an order denying defendants' motions in part and granting
them in part. Specifically, the Court dismissed the claim that the named
officers and directors failed to oversee Mr. Blatt and denied the motions
with respect to the other alleged claims. The Court also granted
defendants' motion to stay the action until after the trial of the criminal
matter. On February 8, 2008, the Court issued an Order allowing for certain
document discovery to commence. On May 9, 2008, the Court lifted the stay.
A Scheduling Order has now been entered requiring the parties to complete
discovery by January 2009. At this stage of the proceedings, it is not
possible to predict what, if any, liability the Company may have from the
Derivative Actions.
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 May 4, 2008, the Company recorded claims of
approximately $4,802,000 (net of a deductible of $500,000) in anticipation
of recoveries. As of May 4, 2008, partial payments of approximately
$1,997,251 have been received leaving a receivable balance of $2,805,000.
The amount is included in other receivables in the accompanying condensed
consolidated balance sheet at May 4, 2008. Subsequent to May 4, 2008, the
Company received an additional payment of approximately $238,000. 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 term "Loss" is defined in the policy as follows:
"Loss means the amount that any Insured becomes legally obligated to pay on
account of any covered Claim, including but not limited to damages
23
(including punitive or exemplary damages, or the multiple portion of any
multiplied damage award, if and to the extent such damages are insurable
under the law of the jurisdiction most favorable to the insurability of
such damages provided such jurisdiction has a substantial relationship to
the relevant Insureds, to the Company, or to the Claim giving rise to the
damages), judgments, settlements, pre-judgment and post-judgment interest,
Defense Costs and, solely with respect to Insuring Clause 2, Settlement
fees."
Further, the policy defines "Defense Costs" as follows:
"Defense Costs means that part of Loss consisting of reasonable costs,
charges, fees (including but not limited to attorneys' fees and experts'
fees) and expenses (other than regular or overtime wages, salaries, fees or
benefits of the directors, officers or employees of the Organization)
incurred in defending any Claim and the premium for appeal, attachment or
similar bonds."
In establishing the receivable for legal recoveries, the Company identified
and segregated defense costs related to the defense of the class action
lawsuits and the defense of the former Chairman and officer of the Company
in the criminal case. The Company believes such costs represent a "loss"
under its D&O policy and are recoverable. The Company excluded all defense
costs related to the defense of the Company pertaining to the criminal case
as such costs may not be recoverable under the D&O policy.
On June 27, 2007, the Company was notified by the Office of the General
Counsel, Acquisition Integrity Office, Department of Navy (the "Navy"),
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 and Chicago,
Illinois. The Chicago, Illinois location is a two-person marketing office.
On August 15, 2007 the suspension was lifted following an amendment to the
Administrative Agreement with the Navy (originally signed on October 12,
2006) extending the term of the agreement for one additional year. While
the suspension was in place, these facilities could not be solicited for or
awarded new contracts or contract extensions without special exceptions.
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.
Prior to May 5, 2008, counsel for the Company met with representatives of
the Department of Navy, Suspension and Debarment Office, Acquisition
Integrity Office to discuss (a) the possible agreement between the United
States Attorney's Office for the Eastern District of Pennsylvania and the
Company, as such is set forth above, and (b) the possible agreement with
the Civil Division of the U.S. Attorney's Office and the Company, as is
mentioned above. Representatives from the Navy advised that no action would
be taken to suspend or debar the Company based upon these agreements, and
no action was in fact taken or is expected to be taken.
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 asserted claims for
breach of contract and conversion, claiming that the Company was wrongfully
in possession of the intellectual property that was transferred to the
Company. EADS also sought a preliminary injunction. The Company denied any
wrongdoing and filed counterclaims against EADS. On August 2, 2007, the
Company and EADS entered into a settlement of this motion, which was
reduced to a written consent decree entered by the Court on August 29,
2007. EADS's claims for breach of contract and for conversion remained
pending, as did the Company's counterclaims. Pursuant to the consent
decree, the parties agreed to a mediation/settlement conference of all
their respective claims with the Court, and further agreed to stay all
proceedings pending the outcome of that mediation/settlement conference on
October 17, 2007. In November 2007, the Company reached a comprehensive
settlement agreement with EADS effective December 5, 2007, as discussed in
Note 2 to the condensed consolidated financial statements.
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/A Amendment No. 1 for the year
ended July 29, 2007, which could materially adversely affect our business,
financial condition, operating results and cash flows. The risks and
uncertainties described in our Form 10-K/A Amendment No. 1 for the year
ended July 29, 2007 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.
24
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:
Information relating to the Annual Meeting of the Company held on February
26, 2008 was included in the Company's Form 10-Q for the quarter ended
February 3, 2008 filed on March 12, 2008.
Item 5 - Other Information:
None
25
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.
26
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 12, 2008