UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended August 3, 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 No. 0-5411
Herley Industries, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 23-2413500
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State or other jurisdiction (I.R.S. Employer
of incorporation or organization Identification No.)
101 North Pointe Blvd., Lancaster, Pennsylvania 17601
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (717) 735-8117
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.10 par value the NASDAQ Stock Market LLC
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(Title of Class) Name of each exchange on which registered
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
[ ] Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
The aggregate market value of the Registrant's voting Common Stock held by
non-affiliates of the Registrant, based on the closing sale price of the Common
Stock of $12.97 as reported on The Nasdaq Global Market as of February 1, 2008,
the last business day of the Registrant's most recently completed second fiscal
quarter, was approximately $166,514,000.
The number of shares outstanding of Registrant's Common Stock, $ .10 par value
on October 3, 2008 was 13,526,402.
Documents incorporated by reference: Portions of the Registrant's definitive
proxy statement in connection with its Annual Meeting of Stockholders to be held
in January 2009, to be filed pursuant to Regulation 14A of the Securities
Exchange Act of 1934, are incorporated by reference into Part III of this Annual
Report on Form 10-K.
HERLEY INDUSTRIES, INC.
TABLE OF CONTENTS
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Page
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PART I
Item 1. Business. 3
Item 1A. Risk Factors. 11
Item 1B. Unresolved Staff Comments. 15
Item 2. Properties. 15
Item 3. Legal Proceedings. 16
Item 4. Submission of Matters to a Vote of Security Holders. 18
PART II
Item 5. Market for Registrant's Common Equity, Related Shareholder
Matters and Issuer Purchases of Equity Securities. 18
Item 6. Selected Financial Data. 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 20
Item 7A. Quantitative and Qualitative Disclosures about Market Risk. 32
Item 8. Financial Statements and Supplementary Data. 33
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure. 33
Item 9A. Controls and Procedures. 33
Item 9B. Other Information. 37
PART III
Item 10. Directors, Executive Officers and Corporate Governance. 37
Item 11. Executive Compensation. 37
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Shareholder Matters. 37
Item 13. Certain Relationships and Related Transactions, and Director
Independence. 37
Item 14. Principal Accountant Fees and Services. 37
PART IV
Item 15. Exhibits and Financial Statement Schedules. 37
SIGNATURES 39
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS F-1
2
PART I
Item 1. Business
FORWARD-LOOKING STATEMENTS
All statements other than statements of historical fact included in this Annual
Report, including without limitation statements under, "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business,"
regarding our financial position, business strategy and our plans and objectives
of management for future operations, are forward-looking statements.
Forward-looking statements involve various important assumptions, risks,
uncertainties and other factors which could cause our actual results to differ
materially from those expressed in such forward-looking statements.
Forward-looking statements in this Annual Report can be identified by words such
as "anticipate," "believe," "could," "estimate," "expect," "plan," "intend,"
"may," "should" or the negative of these terms or similar expressions. Although
we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, performance or achievement.
Actual results could differ materially from those contemplated by the
forward-looking statements as a result of certain factors including but not
limited to, competitive factors and pricing pressures, changes in legal and
regulatory requirements, cancellation or deferral of customer orders,
technological change or difficulties, difficulties in the timely development of
new products, difficulties in manufacturing, commercialization and trade
difficulties and general economic conditions as well as the factors set forth in
our public filings with the Securities and Exchange Commission.
You are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date of this Annual Report or the date of any
document incorporated by reference, in this Annual Report. We are under no
obligation, and expressly disclaim any obligation, to update or alter any
forward-looking statements, whether as a result of new information, future
events or otherwise.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in Section 21E of the Securities Exchange
Act of 1934.
GENERAL
The Company's corporate offices are located at 101 North Pointe Boulevard,
Lancaster, Pennsylvania 17601. The telephone number of the Company at that
location is (717) 735-8117. The Company's web site is located at www.herley.com.
The Company makes its periodic and current reports available, free of charge, on
its web site as soon as reasonably practicable after such material is
electronically filed with, or furnished to, the Securities and Exchange
Commission. The Company's Common Stock is listed on The Nasdaq Global Market
under the symbol "HRLY."
BACKGROUND
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including Northrop Grumman 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.
ACQUISITIONS
We have grown internally and through strategic acquisitions and have evolved
from a component manufacturer to a systems and service provider. We have
successfully integrated these acquisitions by targeting microwave technology
companies and focusing their strengths into our existing operations. Since July
1995 our acquisitions have included the following:
- - In July 1995, we acquired Stewart Warner Electronics Corp. of Chicago,
Illinois, a manufacturer of high frequency radio and IFF interrogator systems.
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- - In August 1997, we acquired Metraplex Corporation of Frederick, Maryland, a
manufacturer of airborne PCM and FM telemetry and data acquisition systems.
- - In January 1999, we acquired General Microwave Corporation of Farmingdale, New
York, a manufacturer of microwave components and electronic systems. During the
fourth quarter of fiscal 2008 we decided to significantly downsize our
manufacturing facility in Farmingdale, NY and transfer its contracts and assets
to our other facilities in Whippany, New Jersey; Woburn, Massachusetts;
Lancaster, Pennsylvania; and Jerusalem, Israel. It is expected that the
restructuring will be substantially completed by the end of December 2008.
- - In January 2000, we acquired Robinson Laboratories, Inc. of Nashua, New
Hampshire, a designer, developer and manufacturer of microwave components and
assemblies primarily for defense applications.
- - In September 2000, we acquired American Microwave Technology, Inc. of Anaheim,
California, a manufacturer of high power, solid state amplifiers for the
scientific and medical markets, which enabled us to enter these markets.
- - In September 2002, we acquired EW Simulation Technology, Limited ("EWST"), a
company located in Farnborough, in the United Kingdom. EWST designs, develops
and produces electronic warfare simulator systems for prime defense contractors
and countries worldwide.
- - In March 2004, we acquired Communication Techniques, Inc. ("CTI"), of
Whippany, New Jersey. CTI designs, develops and produces state-of-the-art signal
generation components and integrated assemblies for digital radio, SONET,
SatCom, test and instrumentation, datacom, and wired and wireless applications
to 45 Gigahertz ("GHz") and 45 Gigabits Per Second ("Gb/s").
- - In September 2004, we acquired Reliable System Services Corporation ("RSS"),
of Melbourne, Florida, a manufacturer of satellite based command and control
systems for defense customers. The RSS Iridium based command and control system
provides secure (encryption, anti-spoof) global service coverage, allowing
multiple target operations, and is complementary with the Company's MONTAGE
command and control systems.
- - In February 2005, we acquired Micro Systems, Inc. ("MSI"), Fort Walton Beach,
Florida, a market leader in the design and manufacturing of command and control
systems for operation of unmanned aerial, seaborne and ground targets and
missiles.
- - In April 2005, we acquired Innovative Concepts, Inc. ("ICI"), McLean,
Virginia, which has a successful history of developing and providing wireless
communications technology and real-time embedded systems, software, hardware and
high-speed processing in support of the defense industry. On September 18, 2008,
the Company executed an agreement (the "Agreement") with a foreign defense
company to divest ICI. The Agreement provides for an all cash transaction valued
at approximately $15 million and includes a significant contingency requiring
U.S. Government approval on or before November 5, 2008 or the Agreement will be
void. The Company believes it is reasonably possible that the U.S. Government
approval will be granted and the transaction will be completed.
- - In September 2008, we acquired Eyal Microwave Industries ("EMI"), Kibbutz
Eyal, Israel, a privately held Israeli company. EMI is a leading supplier of a
broad range of innovative, high-reliability, RF, microwave and millimeter wave
components and customized subsystems for the global defense industry.
BUSINESS STRATEGY
Our goal is to continue to leverage our proprietary technology, microwave
expertise and manufacturing capabilities to further expand our penetration in
our market. Our strategies to achieve our objectives include:
- - INCREASE LEVELS OF COMPONENT INTEGRATION AND VALUE ADDED CONTENT. Due to
growth of engineering expertise, new product development, and acquisitions, we
have increased our capability to provide more component integration. Management
believes component integration adds value and will enable us to increase content
in defense platforms and systems, thereby increasing our revenue and
profitability.
- - MAINTAIN LEADERSHIP IN MICROWAVE TECHNOLOGY. We intend to pursue further
technological advances through continued investment in internally-funded and
customer-funded research and product development.
- - STRENGTHEN AND EXPAND CUSTOMER RELATIONSHIPS. We have developed mutually
beneficial relationships with various agencies of the U.S. Government and
defense and commercial companies. We expect to continue to build and strengthen
these relationships with industry leaders by anticipating and recognizing their
needs and providing them with on-time and cost-effective solutions.
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- - CAPITALIZE ON OUTSOURCING DYNAMICS IN THE AEROSPACE AND DEFENSE INDUSTRY.
Microwave technology has traditionally been an in-house resource of the prime
contractors. However, the prime contractors are beginning to outsource the
design and manufacture of this specialized engineering work to system
sub-contractors. We are well positioned to generate more business as prime
contractors continue to focus primarily on integration of defense electronics.
- - PURSUE STRATEGIC ACQUISITIONS. We intend to continue to augment our existing
technological base by acquiring specialized companies that complement or expand
our product offerings and market strategies. We believe that expansion of our
core competencies through the acquisition of such specialized technology
companies, when combined with our current technological and manufacturing
skills, will provide us with improved levels of horizontal and vertical
integration, leading to the creation of subsystems and complete system products.
- - ENHANCE MANUFACTURING CAPABILITIES. We intend to continue to implement process
manufacturing automation, and believe that our ability to develop a high level
of automated production and test capability will help to further improve our
cost effectiveness and time to market.
- - PURSUE SELECTIVE COMMERCIAL OPPORTUNITIES. We seek to identify and pursue
selected commercial applications for our products and technologies where we can
add value based on our microwave expertise.
COMPETITIVE STRENGTHS
Our competitive strengths include:
- - TECHNICAL EXPERTISE. We have developed a leading position in the field of
microwave technology through more than 40 years of focus on research and
development and through our state-of-the-art design and production capabilities.
We have a full range of capabilities including long and short run production,
hardware assembly and full-service engineering at our facilities located in
Lancaster, Pennsylvania; Woburn, Massachusetts; Whippany, New Jersey; McLean,
Virginia; Fort Walton Beach, Florida; Farnborough, England; and Jerusalem,
Israel.
- - HIGH PROPORTION OF LONG-TERM SOLE-PROVIDER PRODUCTION PROGRAMS. We generate a
significant proportion of our revenue from continuing, long-term programs, both
in the production and upgrade phases, and continue to target high growth, high
priority defense programs. Typically, on such long-term defense programs we are
the sole provider of microwave equipment.
- - DIVERSE PRODUCT AND CUSTOMER BASE. We have a diverse product and customer
base. The U.S. Government accounted for approximately 19% of our fiscal 2008
revenues. Lockheed Martin Corporation and Northrop Grumman Corporation accounted
for approximately 12% each of net sales in fiscal 2008. No other customer
accounted for 10% or more of consolidated net sales during the periods
presented. We are a first-tier supplier to all of the prime defense contractors,
as well as a direct supplier to all of the service branches of the U.S.
military, including products found on over 120 individual platforms. Foreign
customers accounted for approximately 32% of our revenues in fiscal 2008.
- - LONG-STANDING INDUSTRY RELATIONSHIPS. We have established long-standing
relationships with the U.S. Government and other key organizations in the
aerospace and defense industry after more than 40 years in the defense
electronic industry. Over this period, we have become recognized for our ability
to develop new technologies and meet stringent program requirements.
- - SUCCESSFUL ACQUISITION TRACK RECORD. We have demonstrated that we can
successfully integrate acquired companies. We are experienced at evaluating
prospective operations in order to increase efficiencies and capitalize on
market and technological synergies.
- - EMPHASIS ON RESEARCH AND DEVELOPMENT. In fiscal year 2008, we spent
approximately $28.8 million on new product development, of which our customers
funded approximately $9.6 million. Our emphasis on new product development
enables us to maintain our technological leadership in current products and to
develop new capabilities. This spending helps solidify and strengthen our
position on different programs and may serve as a barrier to entry for
competitors.
- - EXPERIENCED MANAGEMENT TEAM. Our senior management team averages over 25 years
of experience in the defense electronics industry.
PRODUCTS AND SERVICES
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. We design and manufacture microwave components and
subassemblies which are embedded in a variety of radars, flight instrumentation,
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weapons sensors, electronic warfare systems and guidance systems. Our microwave
devices are used on our subassemblies and integrated systems (e.g. command and
control systems, telemetry systems, transponders, flight termination receivers
and identification friend or foe, or IFF, interrogators), in addition to being
sold on a component basis.
The following are descriptions of our major systems and products:
Telemetry Systems. Telemetry systems provide wireless data transmission between
two or more sites for recording and analysis. Missile, UAV, or target testing on
domestic and international test ranges requires flight safety and performance
data transmission to maximize flight safety during the test operation.
Surveillance and intelligence gathering UAVs also require a data transmission
downlink and a command and control systems uplink to accomplish their mission.
We have developed a telemetry system capability that can be configured to meet
individual customers' needs. Various components of the system include data
encoders, transmitters and flight termination receivers. Each has a distinctive
role and each is the key to the success of the mission.
We are a leading manufacturer of Pulse Code Modulation, or PCM, and Frequency
Modulation, or FM, telemetry and data acquisition systems for severe environment
applications, and our products are used worldwide for testing space launch
vehicle instrumentation, aircraft flight testing, and amphibian, industrial and
automotive vehicle testing. The product portfolio ranges in size and complexity
from miniature encoders to completely programmable data acquisition systems.
We offer a complete airborne data link system. With our digital capability in
data encoding and acquisition elements combined with our radio frequency
capability in providing telemetry transmitters and flight termination receivers,
we offer a full line of narrow and wide-band airborne telemetry systems to meet
a wide variety of industrial needs, both domestically and internationally.
Command and Control Systems. Our command and control ("C2") systems principally
are used to fly remotely a large variety of unmanned aerial vehicles, or UAVs,
typically aircraft used as target drones or Remotely Piloted Vehicles, or RPVs.
Our C2 systems also control surface targets. Operations have been conducted by
users on the open ocean, remote land masses, and instrumented test and training
ranges. Our C2 systems are currently in service throughout the world. C2 systems
permit a ground operator to fly a target or a UAV through a pre-planned mission.
The mission may be for reconnaissance, where the vehicle is equipped with high
definition TV sensors and the necessary data links to send information back to
its C2 systems ground station. The UAV may also be used as a decoy, since the
operator can direct the flight operations that will make the small drone appear
to be a larger combat aircraft.
Our MONTAGE system affords over-the-horizon C2 using GPS guidance and control of
multiple targets from a single ground station. The ability to control multiple
targets at increased distances represents a significant product improvement. The
MONTAGE is a highly flexible, multiple processor design with high resolution
graphics, which can be field-configured within minutes to fly or control any
selected vehicle for which it is equipped. The MONTAGE is used in support of
missile, aircraft and other weapons systems development and testing. The system
meets a growing requirement to test against multiple threats with the automated
defense capabilities of ships like the AEGIS cruiser and the E-2C aircraft.
In September 2004, we closed on the purchase of Reliable System Services
Corporation ("RSS"). In addition to complementing and adding to our capabilities
in Telemetry, Electronic Warfare ("EW") Simulation Equipment, EW Jamming
Equipment and Range Safety Commanding applications, RSS significantly enhanced
our C2 capabilities for UAV platforms, in that RSS provides a C2 system for UAVs
that operates through the Iridium satellite system. The RSS Iridium based C2
system provides secure (encryption, anti-spoof) global service coverage,
allowing multiple target operations. The addition of this RSS Iridium based
alternate for UAV C2 systems enables us to provide a broader array of systems
configuration solutions to our defense industry customers. We closed these
facilities in Melbourne, Florida in August 2006 and moved the RSS operations
into the Fort Walton Beach facility.
Transponders. We manufacture a variety of expendable transponders, including
range safety, IFF, command and control, and range scoring systems. Transponders
are small, expendable, electronic systems consisting of a transmitter, sensitive
receiver and internal signal processing equipment comprised of active and
passive components, including microwave subassemblies such as amplifiers,
oscillators and circulators. The transponder receives signals from radars,
changes and amplifies the frequency of the signals, and transmits back a reply
on a different frequency and signal level. This reply is a strong, noise-free
signal upon which the tracking radar can "lock," and one which is far superior
to skin reflection tracking, particularly under adverse weather conditions after
the launch.
In range safety applications, transponders enable accurate tracking of space
launch and unmanned aerial vehicles, missiles, and target drones so that
position and direction are known throughout its flight. In the case of several
defense and commercial space launch vehicles (i.e., Delta, Atlas, Titan and
Pegasus), our transponder is tracked by the ground launch team all the way to
space orbit, and in certain instances through several orbits, as a reference
location point in space to assure that the launch payload has been properly
placed in orbit.
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IFF transponders, which are used in conjunction with the Federal Aviation
Authority Air Traffic Control System, enable ground controllers to identify the
unmanned targets, drones and cruise missiles on which these units fly and to
vector other manned aircraft safely away from the flight path of the unmanned
aerial vehicle.
Command and control transponders provide the link through the telemetry system
for relaying ground signals to direct the vehicle's flight. The uplink from the
ground control station, a series of coded pulse groups, carries the signals that
command the flight control guidance system of the vehicle. The downlink to the
ground provides both tracking signals for range safety, as well as
acknowledgment and status of the uplink commands and their implementation in the
vehicle. The transponder is therefore the means to fly the vehicle. Scoring
systems are mounted on both airborne and sea targets. Scoring systems enable
test and evaluation engineers to determine the "miss-distance" between a
projectile and the target at which it has been launched.
Flight Termination Receiver. A flight termination receiver, or FTR, is installed
in a test missile, UAV, target or space launch vehicle as a safety device. The
FTR has a built-in decoder that enables it to receive a complex series of audio
tones which, when appropriate, will set off an explosive charge that will
destroy the vehicle. A Range Safety Officer, or RSO, using the range safety
transponder will track the vehicle in flight to determine if it is performing as
required. If the RSO detects a malfunction in the test or launch vehicle that
causes it to veer from a planned trajectory in a manner that may endanger
personnel or facilities, the RSO will transmit a coded signal to the onboard FTR
to explode the vehicle.
HF Communications and IFF Interrogators. We design and manufacture high
frequency radio and IFF interrogators. This high frequency communications
equipment is used by the U.S. Navy and foreign navies that conduct joint
military exercises with the U.S. Navy. The IFF interrogators are used as part of
shipboard equipment and are also placed on coastlines, where they are employed
as silent sentries. We have been a significant supplier to the Republic of Korea
for over twenty years and have a large, established installed base of equipment.
We have been, and continue to be, a supplier to the Republic of Korea DDX, LPX
and KDX destroyer programs.
High Power Amplifier. We design and manufacture high power amplifier systems
with frequencies ranging from 1.5 Megahertz ("MHz") to 12 Gigahertz ("GHz") with
power levels from multi-kilowatts up to 15W, depending on the frequency. Our
high power amplifier applications include but are not limited to defense
communication, electronic warfare, radar and avionics.
Microwave Integrated Circuits. We design and manufacture complex microwave
integrated circuits, or MICs, which consist of sophisticated assemblies that
perform many functions, primarily involving switching of microwave signals. Our
MICs are employed in many defense electronics systems and missile programs.
High/Low Power Integrated Assembly. Our high power microwave devices are used in
radar system transmitters and in long-range missiles. High power devices
frequently use small amounts of nuclear material to enhance breakdown of high
energy pulses, and we are one of very few companies with an active nuclear
license that permits the handling of these trace amounts of nuclear materials.
There are relatively few companies with the expertise or facilities to design,
manufacture and test high power devices. We also produce lower power, broad band
microwave integrated assemblies for the defense electronics industry. These
complex assemblies combine microwave functions such as amplification,
attenuation, switching of multiple signals, and phase and amplitude control.
Their applications include Rear Warning Receivers, or RWRs, Electronics
Countermeasure, or ECM, systems and highly sensitive receiver systems.
Solid State Receiver Protector. We have become a preeminent supplier of
solid-state receiver protector devices that are able to withstand high energy
pulses without the use of nuclear materials. These high power devices protect a
radar receiver from transient bursts of microwave energy and are employed in
almost every military and commercial radar system.
Digitally Tuned Oscillators (DTO's). We produce microwave sources, which
generate signals that are used in microwave oscillators. Our microwave sources
are sold to the U.S. defense industry and to various foreign governments. We
specialize in digitally tuned oscillators, or DTOs, a critical component in many
ECM systems.
Simulation Equipment. EW Simulation Technology Limited ("EWST"), a U.K. company
and wholly owned subsidiary, designs and manufactures radar threat and
electronic countermeasures simulation equipment for electronic warfare training
and test and evaluation applications. Radar threat and countermeasures simulator
products include but are not limited to the following:
- - CHAMELEON is a real time electronic countermeasures ("ECM") jamming simulator.
It uses a variety of ECM techniques and radar target modeling for training and
testing of both radar and EW operators and systems. The system offers a fully
programmable ECM capability using Digital RF Memories ("DRFM") technology; and
offers fully coherent jamming in both range and velocity through the use of
8-bit DRFM technology together with GUI software. The CHAMELEON is suited for
ground-based and airborne ECM test and training systems.
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- - The RSS8000 Series Radar Threat Simulator generates real-time user
programmable radar threats and provides output configurations in digital
(On-board trainer-OBT) and RF (RSS series) formats. The system can be used for
EW system test and evaluation as well as for EW operator training in laboratory
and more rugged environments. The RSS8000 equipment covers the 100MHz to 40 GHz
range and can be configured to suit any application from a portable single RF
source unit to a multiple RF source and multiple port DF system. The DF systems
are available in amplitude, DTOA and/or phase formats with the ports being
capable of angular rotation.
- - Mobile EW and Radar Test Systems ("MERTS") is a mobile EW and radar test
system providing complete jamming and radar threat test facility for field use.
It provides a turnkey test and evaluation equipment for field applications and
includes both the CHAMELEON and RSS8000 systems integrated into one operational
unit. The MERTS equipment is housed within an air-conditioned ISO container
mounted on a four-wheel drive truck that allows on-site test and evaluation of
radar and EW systems as well as operator training.
RF Simulation Equipment. Micro Systems Inc. ("MSI"), a Florida based company and
wholly owned subsidiary, designs and manufactures Digital RF Memories ("DRFM"s),
Radar Target Simulators, and Radar Environment Simulators for operator training
and critical testing of a variety of electronic warfare systems including
Radars, Jammers, and ELINT/SIGINT systems. DRFM technology is also incorporated
into Electronic Counter Measure (ECM) systems worldwide. These simulator
products include but are not limited to the following:
- - Digital RF Memories are subsystems that digitize RF waveforms, stores, delays,
modulates and eventually replays the RF waveform. These items are used in
ECM/Jamming systems, Radar Target Simulators and ECM Simulators.
- - Radar Target Generators capture/replay or generate radar waveforms and
transmits signals back to the radar to simulate what the radar would see in an
operational environment. Aircraft, missiles, ships, buildings, weather, clutter
and ECM can be generated for radar operator training and comprehensive radar
system testing.
- - Radar Environment Simulators ("RES") also capture/replay or generate radar
waveforms and injects them directly into the radar under test. These simulators
use either DRFM or Synthesizer/Digital Signal Processing technology to generate
the waveforms. Complex graphical user interfaces are provided for the simulator
operator to aide in the development of complex environments for the radar. These
RES systems are similar to Radar Target Generators, but are typically more
complex due to the level of fidelity and processing required by the simulator.
Scientific Products. Our scientific products are used extensively in Nuclear
Magnetic Resonance (NMR) systems. These amplifiers, which have dual mode
capability and can be operated in either a pulsed or continuous wave, cover the
frequency ranges of 6 MHz to 950 MHz, with power levels as high as 2.0KW peak
power at 10% duty cycle. Scientific customers include Original Equipment
Manufacturers ("OEM"), system manufacturers and research centers.
Medical Products. Our medical products vary in complexity from single modules,
to rack-mounted amplifiers, to complete systems. The rack-mounted amplifiers and
complete systems typically include detection/protection circuitry, built-in
power supplies, front panel metering and digital and/or analog interface
controls. Both forced air and/or water cooling are used, depending on the
customer's requirements. Our medical products are used in Magnetic Resonance
Imaging, or MRI, systems. All amplifiers have dual mode capability and can be
operated in either a pulsed or continuous wave mode, and cover the frequency
ranges of 10 MHz to 200 MHz with power levels as high as 12.0KW peak power at
10% duty cycle. Medical customers include OEM, as well as universities and
research centers.
All products feature highly reliable technical solutions designed for improved
production and reliability. Producibility is enhanced through the use of surface
mount components and circuit designs which eliminate the need for excessive
alignment during the production cycle. High reliability is achieved through the
implementation of conservative thermal and RF circuit design and sophisticated
self-protection schemes. Reliability is further enhanced during the design phase
by employing detailed environmental testing.
CUSTOMERS
During the fiscal years ended August 3, 2008 and July 29, 2007, approximately
19% and 20% of our net sales respectively, were attributable to contracts
directly with offices and agencies of the U.S. Government. Lockheed Martin
Corporation and Northrop Grumman Corporation accounted for approximately 12%
each of net sales in fiscal 2008. No other customer accounted for 10% or more of
consolidated net sales during fiscal 2008 or 2007.
We provide defense electronics equipment to major defense prime contractors for
integration into larger platforms and systems. Some of our customers for defense
electronics equipment include:
The Boeing Company BAE Systems Harris Corporation
Lockheed Martin Corporation Northrop Grumman Corporation Raytheon Company
8
During fiscal 2008, sales to foreign customers accounted for approximately 32%
of our net sales. Sales to foreign customers from our domestic locations
accounted for 17% of net sales with the remaining sales generated from England
(2%) and Israel (13%). The governments of Egypt, Japan, South Korea, Taiwan and
the United Kingdom are all significant customers of ours. All of our domestic
contracts with foreign customers are payable in U.S. dollars. Contracts with
customers originating in Israel and England are either in U.S. dollars or the
local functional currency. International sales are subject to numerous risks,
including political and economic instability in foreign markets, currency and
economic difficulties in the Pacific Rim, restrictive trade policies of foreign
governments, inconsistent product regulation by foreign agencies or governments,
imposition of product tariffs and burdens and costs of complying with a wide
variety of international and U.S. export laws and regulatory requirements. Our
international sales are also subject to our obtaining export licenses for
certain products and systems.
SALES AND MARKETING
We market our products worldwide to the United States Government, prime
contractors and various countries in defense markets, and to OEM, research
institutions and universities in commercial markets. Sales are primarily through
a sales force generally organized by geographic territory and markets. In
addition, we have contracts with manufacturers' representatives in the United
States and international representatives who are located in Western Europe, the
Middle East and Asia. As part of our marketing efforts, we advertise in major
trade publications and attend major industrial shows in the commercial, medical,
satellite communications and defense markets.
After we have identified key potential customers, we make sales calls with our
own sales, management and engineering personnel. In order to promote widespread
acceptance of our products and provide customers with support, our sales and
engineering teams work closely with our customers to develop tailored solutions
to their requirements. We believe that our customer engineering support provides
us with a key competitive advantage.
We also produce microwave components that are sold through our catalog, which
for more than forty years has been an industry leader, and sell attenuating
devices and IQ modulation and phase shifters through the Microwave Engineer's
Handbook.
MANUFACTURING
We manufacture our products from standard components, as well as from items that
are manufactured by vendors to our specifications. A majority of our defense
electronics and commercial assemblies and subsystems contain proprietary
technology which is designed and tested by our engineers and technicians and is
manufactured at our own facilities.
We continue to invest in improving our proprietary manufacturing processes and
the automation of the manufacturing processes. Automation is critical in meeting
our customers' demands for price competitiveness, world class quality and
on-time delivery. We are also investing to enhance our responsiveness to the
production demands of our customers.
We purchase electronic components and other raw materials used in our products
from a large number of suppliers and all such materials are readily available
from alternate sources.
We maintain minimal levels of finished products inventory, principally to meet
the needs of our medical products customers. We generally purchase raw materials
for specific contracts, and we purchase common components for stock based on our
firm fixed backlog.
There are no significant environmental control procedures required concerning
the discharge of materials into the environment that require us to invest in any
significant capital equipment or that would have a material effect on our
earnings or our competitive position.
Quality assurance checks are performed on manufacturing processes, purchased
items, work-in-process and finished products. Due to the complexity of our
products, final tests are performed on some products by highly skilled engineers
and technicians.
9
Our primary manufacturing facilities have earned the ISO 9001 Registration. The
ISO 9000 series standards are internationally recognized quality management
system requirements. ISO 9001, the most comprehensive Standard in the ISO 9000
Series, covers design, manufacturing, installation, and servicing systems.
Assembly, test, package and shipment of products are done at our manufacturing
facilities located in the following cities:
Lancaster, Pennsylvania
Woburn, Massachusetts
Whippany, New Jersey
Fort Walton Beach, Florida
McLean, Virginia
Jerusalem, Israel
Kibbutz Eyal, Israel
Farnborough, England
BACKLOG
Our funded backlog of orders was approximately $157 million on August 3, 2008
which are orders covered by funded signed contracts or purchase orders. There
was no unfunded backlog at August 3, 2008. Of our total backlog at August 3,
2008, $114 million (73%) is attributable to domestic orders and $43 million
(27%) is attributable to foreign orders.
Our backlog of orders is subject to change including possible cancellation of
orders, change orders to the contract and other factors which may be beyond our
control. Accordingly, our backlog is not necessarily indicative of the revenues
and earnings which may be realized when the results of such contracts are
reported in the financial statements. Management anticipates that approximately
78% of the backlog at August 3, 2008 will be shipped during the fiscal year
ending August 2, 2009.
Approximately 92% of our backlog consists of firm fixed price contracts, some of
which require delivery over time periods in excess of one year. With this type
of contract we agree to deliver products at a fixed price, subject to
adjustment, for costs incurred because of change orders issued by the customer.
The remaining contracts are primarily cost reimbursement type contracts.
In accordance with Department of Defense procedures, all contracts involving
government programs may be terminated by the government, in whole or in part, at
the government's discretion for cause or convenience. In the event of a
termination for convenience, prime contractors on such contracts are required to
terminate their subcontracts on the program, and the government or the prime
contractor is obligated to pay the costs incurred by us under the contract to
the date of termination plus a fee based on the work completed.
PRODUCT DEVELOPMENT
We believe that our growth depends, in part, on our ability to renew and expand
our technology, products, and design and manufacturing processes with an
emphasis on cost effectiveness. We focus our primary efforts on engineering
design and product development activities rather than pure research. Our policy
is to assign the required engineering and support people, on an ad hoc basis, to
new product development as needs require and budgets permit. The cost of these
development activities, including employees' time and prototype development, was
approximately $28.8 million in fiscal 2008, $33.4 million in fiscal 2007 and
$33.3 million in fiscal 2006. The portion of these costs not reimbursed by
customers was approximately $19.1 million in fiscal 2008, $13.1 million in
fiscal 2007 and $12.4 million in fiscal 2006. These increases in development
spending were undertaken to continue to provide future business opportunities
for the Company. Future product development costs will depend on the
availability of appropriate development opportunities within the markets served
by the Company.
COMPETITION
The microwave component and subsystems industry is highly competitive and we
compete against many companies, both foreign and domestic. Many of these
companies are larger, have greater financial resources and are better known. As
a supplier, we also experience significant competition from the in-house
capabilities of our customers.
Competition is generally based upon technology, design, past performance and
price. Our ability to compete depends, in part, on our ability to offer better
design and performance than our competitors and our readiness in facilities,
equipment and personnel to complete the programs. Many of the programs in which
we participate are long standing programs in which we are the sole provider of
our product.
10
GOVERNMENT REGULATION
Because of our participation in the defense industry, we are subject to audits
by various government agencies for our compliance with government regulations.
We are also subject to a variety of local, state and federal government
regulations relating to, among other things, the storage, discharge, handling,
omission, generation, manufacture and disposal of toxic or other hazardous
substances used to manufacture our products. We believe that we operate our
business in material compliance with applicable laws and regulations. However,
any failure to comply with existing or future laws or regulations could have a
material adverse impact on our business, financial condition and results of
operations.
INTELLECTUAL PROPERTY
We rely primarily on a combination of trade secrets, employee and third-party
non-disclosure agreements to protect our intellectual property, as well as
limiting access to the distribution of proprietary information. We cannot
provide assurance that the steps taken to protect our intellectual property
rights will be adequate to prevent misappropriation of our technology or to
preclude competitors from independently developing such technology. Furthermore,
we cannot provide assurance that, in the future, third parties will not assert
infringement claims against us with respect to our products. Asserting our
rights or defending against third party claims could involve substantial costs
and diversion of resources, thus materially and adversely affecting our
business, financial condition and results of operations. In the event a third
party were successful in a claim that one of our products infringed its
proprietary rights, we may have to pay substantial royalties or damages, remove
that product from the marketplace or expend substantial amounts in order to
modify the product so that it no longer infringes on such proprietary rights,
any of which could have a material adverse effect on our business, financial
condition and results of operations.
EMPLOYEES
As of August 3, 2008 we had 903 full-time employees, none of whom are
represented by a labor union as follows:
Executive 13
Administration 50
Manufacturing 605
Engineering 192
Sales and Marketing 43
---
Total 903
===
We believe that our future success will depend, in part, on our continued
ability to recruit and retain highly skilled technical, managerial and marketing
personnel, including microwave engineers. To assist in recruiting and retaining
such personnel, we have established competitive benefits programs, including a
401(k) employee savings plan for our U.S. employees, and stock option plans.
Item 1A. Risk Factors
You should carefully consider the factors described below and other information
contained in this report. The risks and uncertainties described below are not
the only ones we face. Additional risks and uncertainties not presently known to
us, which we currently deem immaterial or which are similar to those faced by
other companies in our industry or business in general, may also impair our
business operations. If any of the following risks actually occurs, our
business, financial condition or results of operations could be materially and
adversely affected. In such case, the trading price of our common stock could
decline, and you may lose all or part of your investment. This report also
contains forward-looking statements that involve risks and uncertainties. Please
refer to "Forward-Looking Statements" included elsewhere in this report.
11
Risks Related to Recent Legal Proceedings
Class-action complaints against us could result in costly litigation and payment
of damages.
In 2006, we were served with several class-action complaints against us and
certain of our officers and directors in the United States District Court for
the Eastern District of Pennsylvania. The claims arise out of a criminal
indictment by the U.S. Attorney's Office for the Eastern District of
Pennsylvania in connection with certain government contracts and are made under
Section 10(b) and 20(a) of the Securities Exchange act of 1934 and Rule 10b-5
thereunder. While we intend to vigorously defend against these actions, their
ultimate outcome is presently not determinable as they are in the preliminary
phase. Thus, we cannot at this time determine the likelihood of an adverse
judgment or a likely range of damages in the event of an adverse judgment. If a
class were ultimately certified, any settlement of or judgment arising from such
lawsuit could be material, and we cannot give any assurance that we would have
resources available to pay such settlement or judgment. Additionally, any
litigation to which we are subject may be costly and could require significant
involvement of our senior management and may divert management's attention from
our business and operations.
Risks Related to Our Business
A significant percentage of our sales are under government contracts which are
only partially funded initially and may lose funding or may be terminated in
future years.
Approximately 62% of our net sales in fiscal 2008 and 64% of our net sales in
fiscal 2007 were made to United States government agencies and their contractors
and subcontractors for defense programs. Over its lifetime, a government program
may be implemented by the award of many different individual contracts and
subcontracts. The funding of government programs is subject to congressional
appropriations. Although multi-year contracts may be authorized in connection
with major procurements, Congress generally appropriates funds on a fiscal year
basis even though a program may continue for several years. Consequently,
programs are often only partially funded initially and additional funds are
committed only as Congress makes further appropriations. The termination of
funding for a government program would result in a loss of anticipated future
revenues attributable to that program which could have a negative impact on our
operations.
Generally, government contracts contain provisions permitting the government
agency to terminate the contract at its convenience, in whole or in part,
without prior notice, and to provide for payment of compensation only for work
done and commitments made at the time of termination. We cannot guarantee that
one or more of our government contracts will not be terminated under these
circumstances. Also, we cannot guarantee that we would be able to procure new
government contracts to offset the revenues lost as a result of termination of
any contracts. Because a substantial part of our revenues are dependent on our
procurement, performance and payment under our contracts, our failure to replace
sales attributable to a significant defense program or contract at its
termination, whether due to cancellation, spending cuts, budgetary constraints
or otherwise, could have a material adverse effect upon our business, financial
condition and results of operations.
Fixed-price contracts are common in all of our markets and may increase risks of
cost overruns and product non-performance.
Our customers set demanding specifications for product performance, reliability
and cost. Most of our customer contracts are firm, fixed price contracts,
providing for a predetermined fixed price for the products that we make,
regardless of the costs we incur. Thus, we must make pricing commitments to our
customers based on our expectation that we will achieve more cost effective
product designs and automate more of our manufacturing operations. The
manufacture of our products requires a complex integration of demanding
processes involving unique technical skill sets. We face risks of cost overruns
or order cancellations if we fail to achieve forecasted product design and
manufacturing efficiencies or if products cost more to produce than expected.
The expense of producing products can rise due to increased cost of materials,
components, labor, capital equipment or other factors. We may have cost overruns
or problems with the performance or reliability of our products in the future.
If we fail to win competitively awarded contracts in the future, we may
experience a reduction in our sales, which could negatively affect our
profitability.
We obtain many of our U.S. Government contracts through a competitive bidding
process. We cannot provide assurance that we will continue to win competitively
awarded contracts or that awarded contracts will generate sales sufficient to
result in our profitability. We are also subject to risks associated with the
following:
o the frequent need to bid on programs in advance of the completion of
their design (which may result in unforeseen technological
difficulties and cost overruns);
o the substantial time and effort, including the relatively unproductive
design and development required to prepare bids and proposals, spent
12
for competitively awarded contracts that may not be awarded to us;
o design complexity and rapid technological obsolescence; and
o the constant need for design improvement
Our government contracts may be subject to protest or challenge by unsuccessful
bidders or to termination, reduction or modification in the event of changes in
government requirements, reductions in federal spending or other factors. In
addition, failure to obtain a renewal or follow-on contract with U.S. Government
or foreign governments would result in a loss of revenues. If revenues from the
award of new contracts fail to offset this loss, it could have a material
adverse effect on our results of operations and financial position.
Our international sales are subject to risks related to doing business in
foreign countries.
In fiscal 2008 and 2007, sales to international customers comprised
approximately 32% and 27%, respectively, of our net sales, and we expect our
international business to continue to account for a significant part of our
revenues. We currently maintain manufacturing facilities in the United Kingdom
and Israel. International sales are subject to numerous risks, including
political and economic instability in foreign markets, currency and economic
difficulties in the Pacific Rim, restrictive trade policies of foreign
governments, inconsistent product regulation by foreign agencies or governments,
imposition of product tariffs and burdens and costs of complying with a wide
variety of international and U.S. export laws and regulatory requirements. The
governments of Japan, South Korea, Taiwan and the United Kingdom are all
significant customers. Our international sales also are subject to us obtaining
export licenses for certain products and systems. We cannot provide assurance
that we will be able to continue to compete successfully in international
markets or that our international sales will be profitable. Substantially all of
our revenues in fiscal 2008 at our domestic locations and our operation in
Israel were denominated in U.S. dollars, and we intend to continue to enter only
into U.S. dollar-denominated contracts. Revenues reported at our EWST (U.K.)
facility are primarily denominated in Pound Sterling and accounts for
approximately 2% to 4% of our consolidated net sales in U.S. dollars over the
last three fiscal years. In addition, fluctuations in currency could adversely
affect our customers, which may lead to delays in the timing and execution of
orders.
We rely on a small number of significant customers.
A significant part of our sales have historically come mainly from contracts
with agencies of, and prime contractors to, the U.S. government. Net sales
directly to the U.S. government accounted for 19% of fiscal year 2008 net sales.
Additionally, approximately 36% of our net sales were attributable to our next
five largest customers for fiscal year 2008. Variations in the demand for our
products by any of these direct and indirect customers could have a serious,
adverse impact on our performance. If we were to lose any of these or any other
major customers, or if orders by any major customer were otherwise to be delayed
or reduced, including reductions due to market or competitive conditions in
commercial markets or further decreases in government defense spending, then our
business, financial condition and results of operations would be harmed.
We have limited intellectual property rights.
Our success is dependent upon our proprietary technology. We do not currently
have any material patents. We rely principally on trade secret and copyright
laws, certain employee and third-party non-disclosure agreements, as well as
limited access to and distribution of proprietary information, in order to
protect our technology. Trade secret laws afford us limited protection because
they cannot be used to prevent third parties from reverse engineering and
reproducing our products. Similarly, copyright laws afford us limited protection
because copyright protection extends only to how an idea is expressed and does
not protect the idea itself. Moreover, third parties could independently develop
technologies that compete with our technologies. We cannot provide assurance
that the obligations on the part of our employees and business partners to
maintain the confidentiality of our proprietary technology will prevent
disclosure of such information by our employees or third parties. Litigation may
be necessary for us to defend against claims of infringement or protect our
proprietary technology, which could result in substantial cost to us and
diversion of our efforts. We cannot provide assurance that we would prevail in
any such litigation. Our inability to protect our proprietary technology could
have a material adverse effect on our business, financial condition and results
of operations. Although we believe that our products and proprietary rights do
not infringe on the patents and proprietary rights of third parties, we cannot
provide assurance that infringement claims, regardless of merit, will not be
asserted against us. In addition, effective copyright and trade secret
protection of our proprietary technology may be unavailable or limited in
certain foreign countries.
We are subject to environmental laws and regulations and our ongoing operations
may expose us to environmental liabilities.
Our operations are subject to federal, state, foreign and local environmental
laws and regulations. As a result, we may be involved from time to time in
administrative or legal proceedings relating to environmental matters. We cannot
13
provide assurance that the aggregate amount of future clean-up costs and other
environmental liabilities will not be material. We cannot predict what
environmental legislation or regulations will be enacted in the future, how
existing or future laws or regulations will be administered or interpreted or
what environmental conditions may be found to exist. Enactment of more stringent
laws or regulations or more strict interpretations of existing laws and
regulations may require us to make additional expenditures, some of which could
be material.
A failure to attract and retain technical personnel could reduce our revenues
and our operational effectiveness.
There is a continuing demand for qualified technical personnel. We believe that
our future growth and success will depend upon our ability to attract, train and
retain such personnel. Competition for personnel in the defense industry is
intense and there are a limited number of persons, especially engineers, with
knowledge of and experience in microwave technology. Our design and development
efforts depend on hiring and retaining qualified technical personnel. Although
we currently experience relatively low rates of turnover for our technical
personnel, the rate of turnover may increase in the future. An inability to
attract or maintain a sufficient number of technical personnel could have a
material adverse effect on our contract performance or on our ability to
capitalize on market opportunities.
The markets in which we operate are competitive.
Our historical defense markets and our more recent commercial markets are
characterized by rapid technological change as new products are generally
developed quickly and industry standards are constantly evolving. Thus, our
products can become obsolete over a short period of time unless we succeed in
remaining technologically innovative and in anticipating new market demands.
The defense industry in particular has experienced substantial consolidation
due, among other things, to increasing pressures for cost reductions. This has
substantially increased competitive pressures and introduced delays in contract
funding and awards into our historical markets in the defense industry. Many of
our competitors are larger than us and have substantially greater financial and
other resources than we have. As a supplier, we also experience significant
competition from the in-house capabilities of our customers. Our ability to
compete for defense contracts largely depends on the following factors:
o our ability to offer better performance than our competitors;
o the readiness of our facilities, equipment and personnel to undertake
the programs for which we compete; and
o the effectiveness and innovations of our research and development
programs.
We may encounter difficulties in effectively integrating acquired businesses.
As part of our business strategy, we have augmented our technology base by
acquiring companies with compatible or related products. Historically, we have
acquired a number of such companies and products and have integrated those
companies into our business. These and any future acquisitions we make will be
accompanied by the risks commonly encountered in acquisitions of companies,
which include, among other things:
o potential exposure to unknown liabilities of acquired companies;
o higher than anticipated acquisition costs and expenses;
o difficulty and expense of assimilating the operations and personnel of
the companies, especially if the acquired operations are
geographically distant;
o potential disruption of our ongoing business and diversion of
management time and attention;
o failure to maximize our financial and strategic position by the
successful incorporation of acquired technology;
o difficulties in adopting and maintaining uniform standards, controls,
procedures and policies;
o loss of key employees and customers as a result of changes in
management; and
o possible dilution to our shareholders.
We may not be successful in overcoming these risks or any other problems
encountered in connection with any of our acquisitions. We may make a strategic
acquisition knowing that the transaction may adversely affect our short-term
profitability, perhaps because the acquisition candidate may be experiencing
operating losses. We may believe that acquiring such a company outweighs the
operating losses the candidate is experiencing and the losses that we expect to
experience before being able to make the acquisition candidate profitable. The
completion of such an acquisition in the future would negatively affect our
profitability and may cause a decline in our stock price.
Our backlog is subject to reduction and cancellation.
Backlog represents products or services that our customers have committed by
contract to purchase from us. Our backlog as of August 3, 2008, was
approximately $157 million. Approximately 78% of this backlog is expected to be
filled within twelve months. Our backlog is subject to fluctuations and is not
necessarily indicative of future backlog or sales. Moreover, cancellations of
14
purchase orders or reductions of product quantities in existing contracts could
substantially and materially reduce our backlog and, consequently, future
revenues. Our failure to replace canceled or reduced backlog could result in
lower revenues.
Risks Related to Our Securities
Our stock price has fluctuated significantly and may continue to do so.
A number of factors could cause the market price of our common stock to
fluctuate significantly, including:
o our quarterly operating results or those of other defense companies;
o the public's reaction to our press releases, announcements and our
filings with the Securities and Exchange Commission, including
developments with respect to the recent indictment and suspension;
o changes in earnings estimates or recommendations by research analysts;
o changes in general conditions in the U.S. economy, financial markets
or defense industry;
o natural disasters, terrorist attacks or acts of war; and
o other developments affecting us or our competitors.
In recent years, the stock market has experienced extreme price and volume
fluctuations. This volatility has had a significant effect on the market price
of securities issued by many companies for reasons unrelated to the operating
performance of these companies.
Delaware law and our charter documents may impede or discourage a takeover,
which could cause the market price of our shares to decline.
We are a Delaware corporation and the anti-takeover provisions of Delaware law
impose various impediments to the ability of a third party to acquire control of
us, even if a change in control would be beneficial to our existing
shareholders. Our certificate of incorporation and by-laws provide, among other
things, for a classified board of directors serving staggered three-year terms.
Our incorporation under Delaware law, the acceleration of the vesting of
outstanding stock options including options that we have granted upon a change
in control, and certain provisions of our certificate of incorporation and
by-laws could impede a merger, takeover or other business combination involving
us or discourage a potential acquirer from making a tender offer for our common
stock, which, under certain circumstances, could reduce the market value of our
common stock.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties
Our facilities are as follows:
Owned
Or
Location Purpose of Property Area Leased
- -------- ------------------- ------- ------
Lancaster, PA Corporate headquarters 5,200 sq. ft. Leased
Lancaster, PA Production, engineering and administration 86,200 sq. ft. Owned
Woburn, MA Production, engineering and administration 60,000 sq. ft. Owned
Farmingdale, NY (1) Production, engineering and administration 62,300 sq. ft. Leased
Whippany, NJ Production, engineering and administration 23,000 sq. ft. Leased
Fort Walton Beach, FL Production, engineering and administration 20,000 sq. ft. Owned
Fort Walton Beach, FL (2) Production, engineering and administration 31,500 sq. ft. Leased
McLean, VA Production, engineering and administration 43,260 sq. ft. Leased
Jerusalem, Israel Production, engineering and administration 23,700 sq. ft. Leased
Kibbutz Eyal, Israel (3) Production, engineering and administration 40,000 sq. ft. Leased
Farnborough, England Production, engineering and administration 7,570 sq. ft. Leased
Chicago, IL Engineering and administration 3,000 sq. ft. Leased
Tustin, CA Engineering and administration 2,020 sq. ft. Leased
Lancaster, PA Land held for expansion 37 Acres Owned
- --------------
<FN>
(1) On August 24, 2005 we amended our lease agreements with a partnership
partially owned by the children of our Chairman. The original two 10 year lease
agreements provided for initial minimum annual rents of approximately $312,000
and $92,000, respectively, in each case subject to escalation of approximately
15
4% annually throughout the 10 year term. The two individual leases were combined
into a single lease with the same rent provisions and with the term extended to
August 31, 2010. During the fourth quarter of fiscal 2008 we decided to close
our manufacturing facility in Farmingdale, NY and transfer its contracts and
assets to our other facilities in Whippany, New Jersey; Woburn, Massachusetts;
Lancaster, Pennsylvania; and Jerusalem, Israel. It is expected that the closure
of the facility will be substantially completed by the end of December 2008.
(2) As of February 1, 2005, we entered into an agreement to acquire all of
the issued and outstanding common stock of Micro Systems, Inc. Prior to the
acquisition of MSI, MSI had leased one of its two buildings in Fort Walton
Beach, Florida from MSI Investments, a Florida General Partnership. MSI
Investments is owned by four individuals, two of whom are currently employees of
MSI and one serves as a consultant. This lease has an original term of 15 years,
ending December 31, 2012. The lease costs currently are approximately $287,000
on an annual basis, including the tenant's obligation to pay for insurance and
property taxes. The base lease rate is adjusted every January for changes in the
consumer price index, using 1997 as the base year.
(3) As of August 1, 2008 we entered into an agreement to acquire the
business and certain assets subject to the assumption of certain liabilities of
Eyal Microwave Industries ("EMI") a privately held Israeli company. EMI has an
existing lease with a term expiring December 31, 2019 at an annual cost of
approximately $324,000.
</FN>
We believe that these facilities are adequate for our current and presently
anticipated future needs.
Item 3. Legal Proceedings
On June 6, 2006, in connection with an investigation by the U.S. Attorney's
Office in Pennsylvania which, inter alia, involved pricing under contracts with
the U.S. Department of Defense relating to voltage control oscillators and
powerheads, an indictment was returned against us and Lee Blatt, our 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.
On May 5, 2008, we entered into an agreement with the United States Attorney's
Office for the Eastern District of Pennsylvania in which (a) we agreed to plead
guilty to two counts of obstructing an audit relating solely to the powerheads;
(b) we agreed to pay a fine of $3.5 million; and (c) the Government agreed to
dismiss all other counts of the indictment. The agreement was presented to the
Court on May 5, 2008, and the Court accepted the agreement and sentenced us 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 entered a guilty plea for failing to
keep Company records of the allocation of an $18,000 corporate research expense.
Mr. Blatt was fined $25,000, received a term of probation of one year and was
required to perform some community service which has been completed.
Under the terms of an indemnification agreement with Mr. Blatt, we have 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,
our 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 us pursuant to inter alia, the False Claims Act, 31 U.S.C. Section 3729
et. seq. We 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 entered into
an agreement with us to resolve the potential issues arising from the lawsuit
threatened against us 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. We agreed to pay $6 million in exchange for, among other things, a
release.
In June and July 2006, we were served with several class-action complaints
against us and certain of our 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 we may have from the Securities Class Actions.
In July and August 2006, we and certain of our 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 our indictment in the matter discussed above
16
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 we may have from the Derivative Actions.
We believe we are entitled to recovery of certain legal fees associated with the
above matters under our Directors and Officers ("D&O") insurance policy. As of
August 3, 2008, we have aggregate claims of approximately $7,151,000 (net of a
deductible of $500,000) and have received partial payments of approximately
$2,236,000. 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.
Subsequent to the end of fiscal 2008, the insurance carrier asserted in a letter
their determination that they are not liable for certain of the legal costs
incurred by us. We have responded with a letter, supported by court case
citations, that all the submitted costs represent valid claims under the policy
and that the insurance company is liable. However, based on the insurance
company's position and generally accepted accounting principles, we are not
permitted to record any potential claim for recovery under our insurance policy.
Accordingly, the previously recorded receivable of $2,803,000 as of May 4, 2008
has been eliminated in the fourth quarter of fiscal 2008. While there are no
assurances, we believe such costs represent a "loss" under our D&O policy and
such costs are recoverable.
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."
On June 27, 2007, we were notified by the Office of the General Counsel,
Acquisition Integrity Office, Department of Navy (the "Navy"), that certain of
our operations had been suspended from receiving new contract awards from the
U.S. Government. The affected operations included facilities in Lancaster,
Pennsylvania; Woburn, Massachusetts 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, our counsel 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 us, as such is set forth above, and (b) the
possible agreement with the Civil Division of the U.S. Attorney's Office and us,
as is mentioned above. Representatives from the Navy advised that no action
would be taken to suspend or debar us 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 "we" or "us") in the United States District Court for the Eastern
District of New York. EADS claims that we breached a Transfer of Technology
Agreement entered into on May 30, 2001 under which we were 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 we were wrongfully in
possession of the intellectual property that was transferred to us. EADS also
sought a preliminary injunction. We denied any wrongdoing and filed
counterclaims against EADS. On August 2, 2007, we and EADS entered into a
17
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 our 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, we reached a comprehensive settlement agreement with EADS
effective December 5, 2007, as discussed in Note A-1.
We are involved in various other legal proceedings and claims which arise in the
ordinary course of its business. While any litigation contains an element of
uncertainty, management believes that the outcome of such litigation will not
have a material adverse effect on our financial position or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Shareholder Matters, and
Issuer Purchases of Equity Securities.
(a) Our Common Stock is traded in The Nasdaq Global Market under the symbol
"HRLY". The following table sets forth the high and low closing sales price
as reported by The Nasdaq Global Market for our Common Stock for the
periods indicated.
Common Stock
High Low
---- ---
Fiscal Year 2007
First Quarter............................................. 15.55 10.50
Second Quarter ........................................... 16.99 14.60
Third Quarter ............................................ 16.66 14.85
Fourth Quarter ........................................... 18.28 15.20
Fiscal Year 2008
First Quarter............................................. 15.90 12.86
Second Quarter............................................ 15.29 12.37
Third Quarter ............................................ 13.36 9.69
Fourth Quarter ........................................... 16.17 12.93
The closing price on October 3, 2008 was $16.02.
As of October 3, 2008, there were approximately 163 holders of record and
approximately 2,600 beneficial holders of our Common Stock.
There have been no cash dividends declared or paid by us on our Common
Stock during the past two fiscal years.
We did not repurchase any equity securities during the fourth quarter of
fiscal 2008.
18
The following table sets forth the indicated information as of August 3,
2008 with respect to our equity compensation plans:
(c)
number
(a) of securities
Number remaining available
of securities (b) for future issuance
to be issued upon Weighted-average under equity
exercise of exercise price of compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
- ------------- ------------------- ------------------- ------------------------
Equity compensation
plans approved by
security holders 2,263,418 $ 13.23 32,250
Equity compensation
plans not approved
by security holders 1,248,807 $ 17.64 228,700
--------- -------
Total 3,512,225 $ 14.80 260,950
========= =======
<FN>
(b) Not applicable.
</FN>
Item 6. Selected Financial Data (in thousands except per share data):
Consolidated Statements of Operations Data:
- ------------------------------------------
53 weeks
ended 52 weeks ended
August 3, July 29, July 30, July 31, August 1,
2008 2007 2006 2005 2004
---- ---- ---- ---- ----
Net sales (1) $ 152,511 163,140 176,268 151,415 122,154
======= ======= ======= ======= =======
Cost and expenses:
Cost of products sold $ 118,311 118,834 127,921 106,441 79,505
======= ======= ======= ======= =======
Selling and administrative expenses $ 33,735 32,516 32,736 27,599 21,123
======= ======= ======= ======= =======
Litigation costs $ 5,550 1,674 2,230 2,706 1,924
======= ======= ======= ======= =======
Litigation settlements (3) $ 15,542 - - - -
======= ======= ======= ======= =======
Employment contract settlement costs (2) $ - 8,914 - - -
======= ======= ======= ======= =======
Operating (loss) income $ (20,627) 1,202 13,381 14,669 19,602
======= ======= ======= ======= =======
Net (loss) income $ (10,346) 3,118 10,354 10,781 13,673
======= ======= ======= ======= =======
(Loss) earnings per common share (4):
Basic $ (.76) .22 .72 .75 .97
Assuming Dilution $ (.76) .22 .69 .72 .92
Consolidated Balance Sheet Data:
- -------------------------------
Total Assets $ 259,418 262,593 251,450 242,023 220,971
Total Current Liabilities $ 43,925 34,958 33,351 32,090 23,846
Long-Term Debt net of current portion $ 7,092 5,951 5,948 5,000 5,845
Long-Term Portion of Litigation Settlement (3) $ 892 - - - -
Agreement (2) $ 3,074 4,117 - - -
Other Long-Term Liabilities $ 1,652 1,311 1,265 1,042 932
<FN>
Notes to Selected Financial Data:
- --------------------------------
(1) See "Acquisitions" under Item 1. "Business".
(2) See Note H of Notes to Consolidated Financial Statements.
(3) See Note E of Notes to Consolidated Financial Statements.
(4) No cash dividends have been distributed in any of the years presented.
</FN>
19
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements and notes thereto included in Item 8 of Part II of this
Annual Report on Form 10-K.
FORWARD-LOOKING STATEMENTS
All statements other than statements of historical fact included in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" which follows, are forward-looking statements. Forward-looking
statements involve various important assumptions, risks, uncertainties and other
factors which could cause our actual results to differ materially from those
expressed in such forward-looking statements. Forward-looking statements in this
discussion can be identified by words such as "anticipate," "believe," "could,"
"estimate," "expect," "plan," "intend," "may," "should" or the negative of these
terms or similar expressions. Although we believe that the expectations
reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, performance or achievement. Actual results could differ
materially from those contemplated by the forward-looking statements as a result
of certain factors including but not limited to, competitive factors and pricing
pressures, changes in legal and regulatory requirements, cancellation or
deferral of customer orders, technological change or difficulties, difficulties
in the timely development of new products, difficulties in manufacturing,
commercialization and trade difficulties and general economic conditions as well
as the factors set forth in our public filings with the Securities and Exchange
Commission.
You are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date of this Annual Report or the date of any
document incorporated by reference, in this Annual Report. We are under no
obligation, and expressly disclaim any obligation, to update or alter any
forward-looking statements, whether as a result of new information, future
events or otherwise.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in Section 21E of the Securities Exchange
Act of 1934.
Business Summary
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including Northrop Grumman, Lockheed Martin, Raytheon and Boeing),
the U.S. Government (including the Department of Defense, NASA and other U.S.
Government agencies) and international customers (including the Egyptian,
German, Japanese and South Korean militaries and suppliers to international
militaries). We are a leading provider of microwave technologies for use in
command and control systems, flight instrumentation, weapons sensors and
electronic warfare systems. We have served the defense industry since 1965 by
designing and manufacturing microwave devices for use in high technology defense
electronics applications. Our products and systems are currently deployed on a
wide range of high profile military platforms, including the F-16 Falcon, the
F/A-18E/F Super Hornet, the 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.
Significant Events
In connection with the legal matters discussed in Note E "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.
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 advised the Department of the Navy, Acquisition Integrity Office
about the terms and conditions of the criminal and civil settlement agreements
and the Company was advised that no action would be taken to suspend or debar
the Company based on these settlements.
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
20
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 (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 E
"Litigation" to the consolidated financial statements, 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.
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 fifty-two weeks ended July 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 E), 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 fifty-three weeks ended August 3, 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.
On May 5, 2008, the employees of General Microwave Corp. (GMC) which does
business as Herley Farmingdale, were notified of the Company's intent to close
the Herley Farmingdale facility. Despite our efforts to update and improve the
Farmingdale operations, the facility has continued to report losses and has been
the single largest contributor to our poor operating performance. Accordingly,
management decided to close our manufacturing facility in Farmingdale, New York
as quickly as possible and transfer the bulk of its workload to our other
facilities in Whippany, New Jersey; Woburn, Massachusetts; Lancaster,
Pennsylvania; and Jerusalem, Israel. A transition plan is well underway which
transfers contract activity and assets to other Herley businesses and also
21
reduces the workforce as the activity at Farmingdale decreases. It is expected
that the closure of the facility will be substantially completed by the end of
December 2008. The lease obligations at the facility extend to August 2010. The
major cost associated with the restructuring are one-time termination benefits
which are estimated at approximately $1.1 million. The costs are being accrued
evenly from May 2008 through December 2008. Costs accrued during the fourth
quarter approximated $377,000 and charges against the liability for one-time
termination benefits paid approximated $30,000. The liability for the one-time
termination benefits was approximately $347,000 as of August 3, 2008.
The Company entered into an Asset Purchase Agreement ("Asset Agreement") dated
as of August 1, 2008 to acquire the business and certain assets subject to the
assumption of certain liabilities of Eyal Microwave Industries ("EMI") a
privately held Israeli company for cash of $30,000,000. EMI is a leading
supplier of a broad range of innovative, high reliability RF, microwave and
millimeter wave components and customized subsystems for the global defense
industry. Based in Kibbutz Eyal, Israel, the company has approximately 175
employees. EMI includes Eyal Microwave Ltd. and its wholly-owned subsidiary,
Eyal Mag Ltd. Funding for the purchase was provided through a $20 million loan
under the Company's existing credit facility through its current bank and a term
loan in the amount of $10 million for a period of 10 years through the Company's
bank in Israel. The new loan is payable in quarterly installments over a period
of 10 years with interest at LIBOR plus 1.5%. The acquisition will be accounted
for under the provisions of SFAS 141.
In September 2008, management executed an agreement (the "Agreement") with a
foreign defense company to divest our ICI subsidiary located in McLean,
Virginia. ICI is a communications technology development firm specializing in
research, design, development, production, and support of wireless data
communications products and services. The Agreement provides for an all cash
transaction valued at approximately $15 million and includes a significant
contingency requiring U.S. Government approval on or before November 5, 2008 or
the Agreement will be void. We believe it is reasonably possible that the U.S.
Government approval will be granted and the transaction will be completed. In
the event the transaction is completed, ICI will be reported as a discontinued
operation and a non-cash charge to earnings of approximately $1.0 million would
be recorded to reflect the difference between the sale price pursuant to the
Agreement and the net carrying value of the assets held for sale. In fiscal
2008, ICI reported revenues of approximately $19 million and operating income of
approximately $0.6 million. The ICI balance sheet includes total assets of
approximately $21.7 million, including approximately $4.1 million of allocated
goodwill, and liabilities of approximately $5.7 million. There can be no
assurance that the U.S. Government will grant approval so that the transaction
will be completed.
Results of Operations
The following table sets forth for the periods indicated certain financial
information derived from our consolidated statements of operations expressed as
a percentage of net sales. There can be no assurance that trends in sales growth
or operating results will continue in the future.
53 weeks 52 weeks ended
ended --------------
August 3, July 29, July 30,
2008 2007 2006
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of products sold 77.6% 72.8% 72.6%
----- ----- -----
Gross profit 22.4% 27.2% 27.4%
Selling and administrative expenses 22.1% 19.9% 18.6%
Litigation costs 3.6% 1.1% 1.2%
Litigation settlements 10.2% 0.0% 0.0%
Employment contract settlement costs 0.0% 5.5% 0.0%
----- ----- -----
Operating (loss) income (13.5%) 0.7% 7.6%
----- ----- -----
Other (expense) income, net:
Investment income 0.7% 0.7% 0.5%
Interest expense (0.4%) (0.4%) (0.2%)
Foreign exchange (loss) gain (0.1%) 0.3% 0.2%
----- ----- -----
0.2% 0.6% 0.5%
----- ----- -----
(Loss) income before income taxes (13.3%) 1.3% 8.1%
(Benefit) provision for income taxes (6.5%) (0.6%) 2.3%
----- ----- -----
Net (loss) income (6.8%) 1.9% 5.8%
====== ===== =====
22
Fiscal 2008 Compared to Fiscal 2007
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 key performance metrics.
Fourth Quarter Fiscal Year to Date
------------------------------------- ----------------------------------------
2008 2007 % Change 2008 2007 % Change
-------------------------------------- ----------------------------------------
Key performance metrics:
Net sales $44,168 $40,626 9 % $152,511 $163,140 (7)%
Gross profit $10,647 $11,320 (6)% $34,200 $44,306 (23)%
Gross profit percentage 24.1% 27.9% 22.4% 27.2%
Selling and administrative $8,127 $8,427 (4)% $33,835 $32,516 4 %
Litigation costs $3,289 $448 634 % $5,550 $1,674 232 %
Litigation settlement costs - - n/a $15,442 - n/a
Employment settlement costs - - n/a - $8,914 n/a
Operating (loss) income ($769) $2,445 n/a ($20,627) $1,202 n/a
Bookings $40,068 $28,058 43 % $171,200 $174,985 (2)%
Backlog $156,559 $136,717 15 % $156,559 $136,717 15 %
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 in fiscal 2008 was
driven largely by engineering and manufacturing difficulties on a number of
significant and important contracts, including development contracts, as well as
litigation settlement costs. 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 closing of our Farmingdale manufacturing facility. Although there
can be no assurance that we will succeed, we believe the business is showing
improvement and we are confident that we will continue to successfully work
through these challenges.
During fiscal 2008, a number of operational improvement initiatives have been
undertaken at our operating facilities which have demonstrated operational
performance improvement which is expected to continue into future periods. We
established four improvement objectives across all locations: improve cycle
time, reduce defects, improve customer satisfaction, and increase Herley pride.
We motivated our employees to actively engage in this program. Across all our
locations, we have more than 100 active teams addressing specific improvement
objectives aligned with these four corporate objectives. We are also emphasizing
a culture of honoring our commitments in everything we do. We continue to see
this process improvement culture taking 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. Significant accomplishments were
achieved by the Councils during fiscal 2008 and efforts are underway on their
initiatives for fiscal 2009.
In addition, we continue to identify and implement specific and substantive
actions to control costs and focus the resources of the Company directly on
operational performance issues designed to bring about measurable and
sustainable improvement. 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 experienced during fiscal 2008
will be short-lived.
Fifty-three weeks ended August 3, 2008 and fifty-two weeks ended July 29, 2007
- ------------------------------------------------------------------------------
Net sales for the fifty-three weeks ended August 3, 2008 were approximately
$152.5 million compared to $163.1 million in fiscal 2007, a decrease of $10.6
million (7%). The decrease in net sales is primarily related to:
o a decrease of approximately $6.4 million at Innovative Concepts primarily
due to (a) delays in booking and a reduction in scope for certain cost plus
fixed fee contracts for software development and (b) a decrease in
deliveries due to the completion of a contract for radio communication
equipment;
o delays in key microwave development and production programs at Herley
Farmingdale of approximately $6.3 million;
23
o a decrease in revenue of approximately $2.4 million versus the prior year
as certain commercial programs ended and the transition towards military
business progressed at Herley CTI;
o a decrease at Herley Medical Products of approximately $2.1 million in
sales to two key commercial customers due to timing of their customers'
capital purchasing requirements; and
o disruptions across several production programs due to supplier quality
issues.
Offsetting these decreases was:
o an increase of $5.7 million of simulation systems and other product sales
through Micro Systems, Inc.;
o an increase of approximately $0.8 million at Herley New England due to
volume of certain key second generation production programs; and
o an increase in revenue on various programs and products across multiple
sites.
Domestic and foreign sales were 68% and 32% respectively of net sales in fiscal
2008 versus 73% and 27% respectively in the prior fiscal year. Bookings were
approximately $171.2 million, and were 77% domestic and 23% foreign. This
compares to bookings of approximately $175.0 million in the prior year period
which were 65% domestic and 35% foreign.
Gross profit in the fifty-three weeks ended August 3, 2008 was $34.2 million
(22.4% of net sales) compared to $44.3 million (27.2% of net sales) in fiscal
2007, a decrease of $10.1 million. Contributing to the reduction in gross profit
during fiscal 2008 are the following items:
o Higher independent research and development costs of approximately $3.3
million on investments in certain strategic opportunities at several Herley
operations;
o Approximately $2.6 million in contract losses recognized on two development
and production contracts at Herley Farmingdale;
o Higher costs at our Israeli subsidiary due to the unfavorable exchange rate
of the U.S. Dollar versus the New Israeli Shekel reduced gross margins by
approximately $1.6 million;
o Reduced volume of revenues across several Herley operations affected gross
margin by approximately $1.2 million;
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 Disruptions across several production programs due to supplier quality
issues, increased costs of production; and
o Product mix of contracts both domestically and internationally.
Selling and administrative expenses for the fifty-three weeks ended August 3,
2008 were $33.8 million as compared to $32.5 million in fiscal 2007. The $1.3
million increase in selling and administrative expenses is primarily
attributable to an increase in representative commissions related largely to our
international business.
We believe we are entitled to recovery of certain legal fees under our D&O
insurance policy associated with the matters discussed in Part 1, Item 3, "Legal
Proceedings". As of August 3, 2008, we have aggregate claims of approximately
$7,151,000 (net of a deductible of $500,000) and have received partial payments
of approximately $2,236,000. 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.
Subsequent to the end of fiscal 2008, the insurance carrier asserted in a letter
their determination that they are not liable for certain of the legal costs
incurred by us. We have responded with a letter, supported by court case
citations, that all the submitted costs represent valid claims under the policy
and that the insurance company is liable. However, based on the insurance
company's position and generally accepted accounting principles we are not
permitted to record any potential claim for recovery under our insurance policy.
Accordingly, the previously recorded receivable of $2,803,000 as of May 4, 2008
has been eliminated in the fourth quarter of fiscal 2008. While there are no
assurances, we believe such costs represent a "loss" under our D&O policy and
such costs are recoverable.
We had an operating loss during fiscal 2008 of $20.6 million compared to
operating income of $1.2 million in fiscal 2007. The results of fiscal 2008
include both 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 A to
the consolidated financial statements as well as related legal expenses of $5.6
million. The decrease in operating income before the legal expenses, litigation
settlements and employment contract settlement costs is attributable to the
reduction in sales volume, the decrease in gross margin as discussed above, and
the increase in selling and administrative.
Investment income was $1.1 million, a decrease of $0.1 million in fiscal 2008
because of lower average cash balances through portions of the year. Interest
expense was $0.7 million, a decrease of $0.1 million versus the prior year
comparable period.
24
We recognized a net foreign exchange loss of $0.1 million in fiscal year 2008
compared to a foreign exchange transaction gain of $0.5 million in 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 benefit for income taxes for fiscal 2008 was $10.0 million representing an
effective income tax benefit rate of 49.2%, as compared to an effective income
tax benefit rate of 48.5% in fiscal 2007. The increase in the effective income
tax rate for fiscal 2008 is primarily attributable to the net operating loss for
the company for fiscal year 2008 as compared to overall income for the company
for fiscal year 2007. The 49.2% benefit exceeds the statutory rate of 35%
primarily due to the reversal of FIN 48 liabilities of approximately $2.7
million that are no longer needed due to the expiration of the statute of
limitations for an earlier tax year in which an uncertain tax position had been
taken. Another major component to the benefit was the tax on the non-deductible
penalty paid as part of the litigation settlement, which reduced the benefit by
6.0%.
Basic and diluted loss per common share for the fifty-three weeks ended August
3, 2008 were $(.76) each as compared to basic and diluted earnings per common
share of $.22 each for the fifty-two weeks ended July 29, 2007.
Fiscal 2007 Compared to Fiscal 2006
The four-month suspension (June-October 2006) from receiving new contract awards
from the U.S. Government at some of our operations caused disruption in our
business in several respects which cannot be easily measured, but certainly had
an impact on the results of operations in fiscal 2007 both in terms of sales and
profitability. While the effects of the suspension were evident during the first
quarter, they continued during the second quarter and to a lesser degree in the
third quarter due to delays in bookings. The fourth quarter was affected by the
second suspension on June 26, 2007 but the impact on the fourth quarter
performance was not significant.
Net sales for the fifty-two weeks ended July 29, 2007 were approximately $163.1
million compared to $176.3 million for fiscal 2006, a decrease of $13.2 million
(7.5%). The decrease in net sales is partly related to the recording of a $2.2
million claim receivable on a major program during the first quarter of the
prior year. In addition, there was a net decline of $11.7 million in microwave
systems and assemblies in our domestic operations primarily due to the
completion of certain contracts and the timing of shipments, some of which was
due to the delays in bookings during the suspension period. Sales of simulation
systems at EWST declined $2.3 million due to the completion of certain contracts
and the cyclical nature of its business. Commercial sales of medical products
were slightly higher, while commercial sales at Herley-CTI decreased $1.8
million as certain commercial programs ended and the transition towards military
business progressed. Offsetting these decreases were $4.7 million of increased
sales at Herley-Israel of both microwave systems and microwave products.
Domestic and foreign sales were 73% and 27% respectively of net sales in fiscal
2007, versus 76% and 24% respectively in fiscal 2006.
The gross profit margin in the fifty-two weeks ended July 29, 2007 was 27.2%
compared to 27.4% in fiscal 2006, a decline of 0.2%. Contributing to the
reduction in the gross profit percentage during fiscal 2007 are the following
items:
o The booking of the $2.2 million claim receivable in fiscal 2006.
o Disruptions caused by the four-month suspension from receiving new contract
awards from the U. S. Government at some of our operations.
o Startup production costs on certain programs.
o Product mix of contracts domestically and internationally.
Offset by
o Revisions in the accrual for contract losses on existing contracts based on
current estimates. The accrual for contract losses associated with the ICI
acquisition (more fully described in Note B of Form 10-K for the fiscal
year ended July 30, 2006) was reduced by $1,144,000 in the fifty-two weeks
ended July 29, 2007 (which is included as a reduction of costs of products
sold) as a result of changes in the estimated liability for expected losses
under the contract.
Selling and administrative expenses for the fifty-two weeks ended July 29, 2007
were 21% of net sales as compared to 19.8% in fiscal 2006. The increase in costs
as a percentage of sales is due to the lower net sales in fiscal 2007. Selling
and administrative costs declined year to year by $776,000. Increases and
decreases are as follows:
25
o Stock compensation costs recorded in fiscal 2007 per SFAS 123(R) of $1.0
million, of which approximately $0.3 million was related to the employment
contract for the Chief Operating Officer. This is an increase of $0.5
million versus fiscal 2006 where the stock compensation costs were $0.5
million.
Offset by
o Legal costs, net of estimated insurance recoveries, were $1.8 million in
fiscal 2007, a decrease of $0.5 million versus fiscal 2006. The majority of
the legal costs relate to the defense of the Company associated with the
recent indictment.
o A net decrease of approximately $0.8 million in commission costs across
several businesses due to the mix and timing of specific orders.
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 July 29, 2007, we have a receivable of $1,778,000 (net of a
deductible of $500,000 and a payment received of $684,000 on June 1, 2007) in
anticipation of recoveries and the amount is included in other receivables in
the accompanying consolidated balance sheet at July 29, 2007. The insurance
carrier may contest the claim in whole or in part. In addition, we have entered
into an agreement dated January 11, 2007 with the insurance carrier whereby if
it is determined by final decision of an arbitration panel, or by final judgment
of a court, or other final decision of a tribunal having jurisdiction thereof,
that any amount paid by the insurance carrier was not a loss, as that term is
defined in the policy, we shall repay to the insurance carrier any such
uncovered sums previously advanced to us.
Employment contract settlement costs of approximately $8.9 million relate to an
agreement effective October 12, 2006 with the Company's co-founder and former
Chairman, to terminate his employment agreement with us after 41 years of
service. Settlement costs include a cash payment of $3.0 million paid upon the
effective date of the settlement agreement, payments due under a Promissory Note
and estimated medical and life insurance benefits discounted at an imputed
interest rate of 6.75%, plus the fair value of a modification to the stock
options held by him using the Black-Scholes option valuation model.
We had operating income for fiscal 2007 of $1.2 million compared to operating
income of $13.4 million in fiscal 2006. Excluding the employment contract
settlement costs of $8.9 million recorded in the first quarter of fiscal 2007,
operating income for fiscal 2007 would have been $10.1 million or 6.2% of net
sales, as compared to $13.4 million or 7.6% of net sales in fiscal 2006. The
decrease in operating income as a percentage of net sales is primarily
attributable to the increase in selling and administrative expenses as a
percentage of net sales due to the lower sales volume. Our foreign operations
contributed approximately $3.3 million in operating income for fiscal 2007 as
compared to $2.7 million in fiscal 2006.
Investment income was $1,186,000, an increase of $346,000 in fiscal 2007 as
compared to fiscal 2006 because of interest earned on higher cash balances.
Interest expense was $790,000, an increase of $471,000 as compared to the prior
year primarily due to the imputed interest expense related to the employment
settlement agreement, as well as interest expense relating to financing the
implementation of the ERP software package.
We recognized a net foreign exchange gain of $501,000 in fiscal 2007, versus a
gain of $431,000 in fiscal 2006. These foreign exchange gains are attributable
to fluctuations in exchange rates between the U.S. dollar and the local currency
of our U.K. subsidiary primarily in connection with temporary advances we have
made to them in U.S. dollars.
The benefit for income taxes for fiscal 2007 was $1,019,000 representing a
negative effective tax rate of 48.5%, as compared to an effective tax rate of
27.8% in fiscal 2006. The decline in the effective income tax rate for fiscal
2007 is primarily attributable to (a) the extension of the R&D tax credit by
Congress in December 2006 retroactive to January 1, 2006, (b) an increase in the
proportion of overall earnings generated through the Company's foreign
operations where earnings are taxed at lower rates than domestically, and (c)
the elimination of certain tax accruals that are no longer deemed necessary. The
extension of the R&D tax credit reduced the statutory income tax rate of 35% by
an estimated 5% for fiscal 2007. As a result of lower domestic earnings, due
primarily to the employment contract settlement costs which significantly
affects domestic profitability, foreign earnings are a greater percentage of
total earnings. The Company's foreign earnings are attributable primarily to our
Israeli subsidiary which is taxed at an estimated rate of 11% for fiscal 2007
thereby reducing the effective income tax rate by approximately 49%. The
elimination of certain tax reserves that are no longer deemed necessary reduced
the effective tax rate by approximately 11%. Other benefits included research
and development credits (prior to December 31, 2005), tax benefits attributable
to extra territorial income (i.e. export sales), the Section 199 manufacturing
deduction, the benefit of stock compensation costs, and tax exempt interest
income.
Basic and diluted earnings per common share for the fifty-two weeks ended July
29, 2007 were $.22 per common share each as compared to basic and diluted
earnings per common share of $.72 and $.69, respectively, for fiscal 2006.
26
Liquidity and Capital Resources
We believe that presently anticipated future cash requirements will be provided
by internally generated funds, our existing unsecured credit facility and
existing cash balances. A significant portion of our revenue for fiscal 2009
will be generated from our existing backlog of sales orders. The funded backlog
of orders at August 3, 2008 was approximately $157 million of which
approximately 78% is expected to ship in fiscal 2009. All orders included in
this backlog are covered by signed contracts or purchase orders. Nevertheless,
contracts involving government programs may be terminated at the discretion of
the government. In the event of the cancellation of a significant amount of
government contracts included in our backlog, we will be required to rely more
heavily on cash balances and our existing credit facility to fund our
operations. We are not aware of any events which are reasonably likely to result
in any cancellation of our government contracts. We have approximately $24.1
million available under our bank credit facility as of August 3, 2008, net of
outstanding stand-by letters of credit of approximately $15.9 million, and cash
of approximately $14.3 million. On September 12, 2008, in connection with the
acquisition of Eyal Microwave Industries ("Eyal") (See Note S of Notes to
Consolidated Financial Statements) we borrowed $20.0 million under the line of
credit. We also entered into a new term loan in the amount of $10 million for a
period of 10 years through our bank in Israel. The new loan is payable in
quarterly installments over a period of 10 years with interest at LIBOR plus
1.5%. Proceeds of this loan were also used to fund the acquisition of Eyal.
As of August 3, 2008 and July 29, 2007, working capital was $94.4 million and
$103.5 million, respectively, and the ratio of current assets to current
liabilities was 3.1 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 $0.7
million at August 3, 2008 and $1.9 million at July 29, 2007. The balance of
advanced payments was approximately $8.1 million at August 3, 2008 and $7.2
million at July 29, 2007.
Net cash used in operations during the fifty-three weeks ended August 3, 2008
was approximately $10.6 million as compared to net cash provided by operations
of $15.7 million in the prior year, a net decrease of approximately $26.3
million. We had a net loss in the current fiscal year of $10.3 million versus
net income of $3.1 million in the prior year, a negative change in profitability
of approximately $13.5 million. Fiscal 2008 was impacted by the settlement costs
of various litigation and related expenses of approximately $15.5, including
cash payments of $13.5 million (as discussed in Note E to the Consolidated
Financial Statements) and fiscal 2007 included employment settlement costs of
approximately $8.9 million, including a cash payment of $3.0 million (as
discussed in Note H to the Consolidated Financial Statements).
Significant decreases in cash provided by operating activities during the
fifty-three weeks ended August 3, 2008 include the following:
1. An increase of approximately $5.0 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 $11.3 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. payment of $3.5 million in fines and $6.0 million in settlement of
litigation relating to contracts with the U. S. Department of Defense,
5. payments of $1.3 million in connection with the employment settlement
agreement, and
6. an increase in refundable income taxes of $1.2 million.
Offset primarily by:
An increase of approximately $6.9 million generated through amounts due to
vendors and accrued expenses.
Net cash used in investing activities relates to capital expenditures of
approximately $4.6 million.
27
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 August 3, 2008, approximately 608,000 shares
are available for purchase under the buyback program, and
2. payments of $1.4 million related to our long-term debt.
During the fifty-three weeks ended August 3, 2008 we borrowed $20.4 million
under our revolving credit facility for short-term working capital needs and
repaid $17.9 million. On September 16, 2008 we borrowed $20.0 million under our
credit facility in connection with the acquisition of Eyal Microwave Industries
(See Note S of Notes to the Consolidated Financial Statements).
Dividend Policy
We have not paid cash dividends in the Company's history. Our board of directors
evaluates our dividend policy based on our financial condition, profitability,
cash flow, capital requirements, and the outlook of our business. We currently
intend to retain any earnings for use in the business, including for investment
in acquisitions, and consequently we do not anticipate paying any cash dividends
on our common stock in the foreseeable future.
Bank Line of Credit
On April 30, 2007, we replaced our existing credit facility with a new $40
million Revolving Credit Loan Agreement ("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 Agreement requires the
payment of interest only on a monthly basis and payment of the outstanding
principal balance on March 31, 2010. The Agreement was modified as of September
12, 2008. Under the terms of the modification, 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 2.0% effective September 12, 2008 (the margin was 1.65%
at August 3, 2008). In addition, if in the event the sale of ICI (See Note S of
Notes to the Consolidated Financial Statements) is not consummated by November
30, 2008, we will grant the bank a security interest in our domestic accounts
receivable, inventory and all other non-real estate domestic assets. There is a
fee of 20 basis points per annum on the unused portion of the credit facility
payable quarterly. Stand-by letters of credit were outstanding in the amount of
approximately $15.9 million at August 3, 2008 (See Note E to the Consolidated
Financial Statements). 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 inventories. Funded backlog as of August 3,
2008 was approximately $157 million. A loan of $2.5 million was outstanding
under the line at August 3, 2008. There were no borrowings under the line at
July 29, 2007.
On September 16, 2008, in connection with the acquisition of Eyal as discussed
in Note S of Notes to Consolidated Financial Statements, we borrowed $20 million
under our bank line of credit and we entered into a new term loan in the amount
of $10 million for a period of 10 years through our bank in Israel. The new loan
is payable in quarterly installments over a period of 10 years with interest at
LIBOR plus 1.5%. Proceeds of this loan were also used to fund the acquisition of
Eyal.
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
Balance Sheet, while others are required to be disclosed in the Notes to
Consolidated Financial Statements and Management's Discussion and Analysis.
We have outstanding an aggregate of approximately $23.2 million in open purchase
orders as of August 3, 2008. These open purchase orders represent executory
contracts for the purchase of goods and services which will be substantially
fulfilled in the next six months.
We utilized off-balance sheet arrangements to provide performance guarantees to
certain customers in case of our default in performance of certain contracts
under which advance payments have been received. These arrangements consist of
standby letters of credit. Off-balance sheet arrangements are not considered to
be a source of liquidity or capital resources and do not expose us to material
risks or material unfavorable financial impacts.
28
The following table summarizes the Company's contractual financial obligations
and other contingent commitments, including interest, at August 3, 2008 (in
thousands):
Within 2-3 4-5 After 5
Obligations Total 1 Year Years Years Years
----------- ----- ------ ----- ----- -----
Mortgage Note $ 2,908 280 560 560 1,508
Industrial Revenue Bonds 2,928 221 440 443 1,824
Notes Payable - bank 2,500 - 2,500 - -
Notes Payable 1,314 1,019 295 - -
Litigation settlement 2,000 1,000 1,000 - -
Employment Settlement Agreement 4,718 1,357 2,426 935 -
Operating Lease Obligations 11,679 3,552 6,317 1,646 164
Purchase Obligations 23,174 22,862 309 3 -
------ ------ ------ ----- -----
51,221 30,291 13,847 3,587 3,496
Standby Letters of Credit 18,268 8,355 9,851 62 -
------ ------ ------ ----- -----
Total Contractual Obligations $ 69,489 38,646 23,698 3,649 3,496
====== ====== ====== ===== =====
Upon the adoption of FIN 48, we reclassified to long term our liabilities for
unrecognized tax benefits in the amount of approximately $3.1 million, as
discussed in Note F to the 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
balance of the long-term liability at August 3, 2008 is approximately $0.5
million. We are unable to make reasonable estimates as to the period(s) in which
cash will be paid for the remaining liabilities.
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy discussed earlier, we
entered into an agreement (the "Agreement") with Lee N. Blatt to terminate the
Employment Agreement between us and him dated as of July 29, 2002 and modified
on December 9, 2003. Under the terms of the Agreement he will receive a total
payment of $9,461,528 payable $3,000,000 upon the effective date of the
Agreement and sixty-four (64) consecutive monthly payments of $100,000
commencing on January 1, 2007 and a final payment of $61,528 on May 1, 2012 as
evidenced by a non-interest bearing Promissory Note dated effective October 12,
2006. In addition he received his bonus of $636,503 for fiscal year 2006, and
shall be entitled to receive medical care reimbursement and insurance, including
life insurance, in accordance with the original terms of his Employment
Agreement. The Agreement also provides that all outstanding stock options
previously issued to him which are all vested and fully exercisable shall
continue to be exercisable by him or, following his death, by his designated
beneficiaries, on or before the expiration date of the specific option. In the
event of a "change of control" as defined in the Employment Agreement all
remaining payments due under the Promissory Note become immediately due and
payable.
We have an employment agreement with our Chairman/Chief Executive Officer (the
"Executive") which expires December 31, 2013, subject to extension for
additional one-year periods annually each January 1 with a final expiration date
of December 31, 2015 (as amended December 9, 2003). The agreement provides for
an annual salary as of August 3, 2008 of $739,300 and provides for a semi-annual
cost of living adjustment based on the consumer price index. The agreement also
provides for incentive compensation at 3% in the aggregate of our pretax income.
The agreement also provides that, in the event there is a change in control, the
Executive has the option to terminate the agreement and receive a lump-sum
payment equal to the sum of the salary payable for the remainder of the
employment term, plus the annual bonuses (based on the average of the three
highest annual bonuses awarded during the ten preceding years) for the remainder
of the employment term. As of August 3, 2008, the amount payable in the event of
such termination would be approximately $8,357,000.
In addition, the agreement provides for a consulting period of ten years at the
end of the employment period at an annual compensation equivalent to one-half of
the executive's annual salary at the end of the employment period, subject to
annual cost of living adjustments.
We entered into an employment agreement with our Chief Operating Officer as of
June 4, 2007 which expires July 31, 2011, subject to extension for additional
one-year periods annually beginning July 31, 2008 with a final expiration date
of July 31, 2012. The agreement provides for an initial annual salary of
$365,800 (subject to a semi-annual cost of living adjustment based on the
consumer price index), and an initial award of 250,000 non-qualified stock
options at the closing stock price on the date prior to execution of the
agreement of $15.77 per share. The options vest 20% upon award and 20% annually
over the next four years. The agreement also provides for incentive compensation
to be paid at the discretion of the Board of Directors, however, incentive
compensation for the fiscal year ended August 3, 2008 is at a minimum of
$300,000. The agreement also provides for a consulting period of ten years at
the end of the employment period at an annual compensation of $100,000. In the
event there is a change in control of the Company, as defined, the executive has
29
the option to terminate the agreement at any time after July 31, 2010 and
receive a lump-sum payment equal to the sum of: (1) his salary payable for the
remainder of the employment term, (2) the annual bonuses (based on the average
of the annual bonuses awarded during the term of the employment agreement) for
the remainder of the employment term, and (3) a lump sum payment of $500,000
representing full consideration under the consulting period.
Certain other executive officers have employment agreements which expire June 6,
2009 providing for aggregate annual salaries as of August 3, 2008 of $395,500.
An employment contract of a retired executive provides for a consulting period
which became effective October 1, 1998, and terminates December 31, 2010 at the
annual rate of compensation of $100,000.
Several officers and key employees have severance agreements providing for an
aggregate lump-sum payment of approximately $2,533,000 in the event of a change
of control as defined in the agreements. The agreements expire from one to two
years from the date of a change of control.
Recent Accounting Pronouncements
In April 2008, the Financial Accounting Standards Board ("FASB") issued Staff
Position No. FAS 142-3, "Determination of the Useful Life of Intangible Assets",
which amends the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized
intangible asset under FASB Statement No. 142, "Goodwill and Other Intangible
Assets." The intent of FAS 142-3 is to improve the consistency between the
useful life of a recognized intangible asset under Statement 142 and the period
of expected cash flows used to measure the fair value of the asset under FASB
Statement No. 141 (revised 2007), "Business Combinations", and other generally
accepted accounting principles. FAS 142-3 is effective for fiscal years
beginning after December 15, 2008 and only applies prospectively to intangible
assets acquired after the effective date. Early adoption is not permitted. We
are currently evaluating the impact, if any, that this statement will have on
our consolidated financial position, cash flows and results of operations.
In March 2008, the 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. We are currently evaluating
the impact, if any, that the adoption of SFAS No. 161 will have on our
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 our 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 our 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 us and
will be effective for our 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 us but
are not expected to have a material impact on our consolidated financial
position, cash flows and results of operations.
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
30
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
(our 2010 fiscal year). 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 of a subsidiary be initially measured at its fair value.
Upon adoption of SFAS 160, we would be required to report any noncontrolling
interests as a separate component of shareholders' equity. We would also be
required to present any net income allocable to noncontrolling interests and net
income attributable to our shareholders separately in our consolidated
statements of income. This Statement is effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2008 (our 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.
Critical Accounting Policies and Estimates
Our established policies are outlined in the footnotes to the Consolidated
Financial Statements entitled "Summary of Significant Accounting Policies"
(contained in Part II, Item 8 of this Form 10-K). As part of our oversight
responsibilities, we continually evaluate the propriety of our accounting
methods as new events occur. We believe that our policies are applied in a
manner which is intended to provide the user of our financial statements a
current, accurate and complete presentation of information in accordance with
accounting principles generally accepted in the United States of America.
Important accounting practices that require the use of assumptions and judgments
are outlined below.
We recognize revenue when products are shipped and the customer takes ownership
and assumes risk of loss, collection of the relevant receivable is probable,
persuasive evidence of an arrangement exists and the sales price is fixed or
determinable. Payments received from customers in advance of products delivered
are recorded as customer advance payments until earned. Approximately 92% of our
contracts are firm, fixed price contracts, providing for a predetermined fixed
price for the products sold, regardless of the costs incurred. Approximately 10%
to 11% of revenues over the last three fiscal years were derived from long-term,
fixed price contracts for which revenues and estimated profits are recognized
using the percentage of completion method of accounting on the cost to cost
method. Under this method, revenue is recorded based upon the ratio that
incurred costs to date bear to total estimated contract costs at completion with
related cost of sales recorded as costs are incurred. Contract costs include all
direct material and labor costs and those indirect costs related to contract
performance. Selling, general and administrative costs are charged to expense as
incurred. Risks and uncertainties inherent in the estimation process could
affect the amounts reported in our financial statements. The key assumptions
used in the estimate of costs to complete relate to labor costs and indirect
costs required to complete the contract. The estimate of rates and hours as well
as the application of overhead costs is reviewed on a regular basis. If our
business conditions were different, or if we used different assumptions in the
application of this and other accounting policies, it is likely that materially
different amounts would be reported on our financial statements.
The effect of any change in the estimated gross margin percentage for a contract
is reflected in the period in which the change is known. Prospective losses on
long-term contracts are based upon the anticipated excess of costs over the
selling price of the remaining units to be delivered and are recorded in the
period when first determinable. Actual losses could differ from those estimated
due to changes in the final costs and contract terms.
Inventories are stated at lower of cost (principally first-in, first-out) or
market. A valuation allowance for obsolete and slow-moving inventory is
established based upon an aging of raw material components. Current requirements
for raw materials are evaluated based on current backlog of orders for products
in which the components are used and anticipated future orders.
Goodwill is tested for impairment in accordance with SFAS No. 142 using a fair
value approach applied to our single reporting unit. Impairment charges are
recognized for amounts where the reporting unit's goodwill exceeds its fair
value. An annual impairment test is performed in the fourth quarter of each
fiscal year. Any future impairment of goodwill will be charged to operations. We
amortize the cost of other intangibles over their estimated useful lives.
Amortizable intangible assets may also be tested for impairment if indications
of impairment exist.
An impairment test based on a single reporting unit was performed in the fourth
quarter of fiscal 2008 using our current market capitalization, which in an
31
active market for our common stock, we consider a reasonable indication of
implied fair value. Based on this initial step in the test for impairment, we
concluded that there was no impairment of goodwill as of August 3, 2008.
Effective August 1, 2005, the Company adopted the fair value recognition
provisions of SFAS No. 123(R), "Share-Based Payment" ("SFAS 123(R)") using the
modified prospective application method. This standard requires the Company to
measure the cost of employee services received in exchange for equity share
options granted based on the grant-date fair value of the options. The cost is
recognized as compensation expense over the requisite service period for each
separately vesting portion of the options. Under the modified prospective
application method, compensation costs includes: (a) compensation cost of stock
options granted prior to but not yet vested as of August 1, 2005 (based on
grant-date fair value estimated in accordance with the provisions of SFAS 123)
and (b) compensation cost for all options granted subsequent to July 31, 2005
(based on grant-date fair value estimated in accordance with the new provisions
of SFAS 123(R)). Determining the fair value of share-based awards at the grant
date requires judgment, including estimating our stock price volatility and
employee stock option exercise behaviors. Our expected volatility is based upon
the historical volatility of our stock. The expected life of share-based awards
is based on observed historical exercise patterns for our employees. As
share-based compensation expense recognized in the consolidated statement of
income is based on awards ultimately expected to vest, the amount of expense has
been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates.
Provisions for federal, foreign, state and local income taxes are calculated on
reported financial statement pretax income based on current tax law and also
include the cumulative effect of any changes in tax rates from those used
previously in determining deferred tax assets and liabilities. Such provisions
differ from the amounts currently payable because certain items of income and
expense are recognized in different time periods for financial reporting
purposes than for income tax purposes.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risk associated with foreign currency exchange and
changes in interest rates. We have not entered into any market risk sensitive
instruments for trading purposes.
Since the acquisitions of General Microwave Corporation and EWST, we are subject
to movements in foreign currency rate changes related to our operations in
Israel and in the U.K. Prior to fiscal 2008, the movements in the New Israeli
Shekel versus the U.S. Dollar have not been significant. Movements in Pounds
Sterling (the functional currency at EWST) have been more significant.
For fiscal years 2008, 2007, and 2006, Herley Israel accounts for approximately
8% to 13% of our consolidated net sales. A significant portion of the revenues
are derived from dollar denominated contracts, however costs at Herley Israel
are largely based in New Israeli Shekels which exposes us to market risk with
respect to fluctuations in the U.S. dollar value of future New Israeli Shekel
denominated costs and earnings. A 10% strengthening in the average value of New
Israeli Shekels in fiscal 2008, for example, would have increased costs by
approximately $1,736,000, and would have increased our consolidated loss before
income taxes by approximately $1,736,000. The average, high and low foreign
currency exchange rates during fiscal year 2008 were 0.2688, 0.3096, and 0.2304
respectively. A 10% strengthening in the average value of New Israeli Shekels in
fiscal 2007, for example, would have increased costs by approximately
$1,565,000, and would have decreased our consolidated income from operations
before income taxes by approximately $1,565,000. The average, high and low
foreign currency exchange rates during fiscal year 2007 were 0.2370, 0.2545, and
0.2268 respectively.
For fiscal years 2008, 2007 and 2006, EWST accounts for approximately 2% to 4%
of our consolidated net sales based in part on the rate at which EWST's Sterling
denominated financial statements have been converted into U.S. dollars. Having a
portion of our future revenue and income denominated in Sterling exposes us to
market risk with respect to fluctuations in the U.S. dollar value of future
Sterling denominated revenue and earnings. A 10% decline in the average value of
Sterling in fiscal 2008, for example, would have reduced sales by approximately
$437,000, and would have decreased our consolidated loss from operations before
income taxes by approximately $161,000 due to the reduction in the U.S. dollar
value of EWST's sales and operating loss. The average, high and low foreign
currency exchange rates during fiscal year 2008 were 2.00, 2.07 and 1.96
respectively. A 10% decline in the average value of Sterling in fiscal 2007, for
example, would have reduced sales by approximately $473,000, and would have
increased our consolidated operating income by approximately $63,000 due to the
reduction in the U.S. dollar value of EWST's sales and operating loss. The
average, high and low foreign currency exchange rates during fiscal year 2007
were 1.95, 2.03 and 1.88 respectively.
We have made inter-company advances to EWST in the aggregate amount of
approximately $8.6 million at August 3, 2008 and $7.6 million at July 29, 2007.
Since the advances are denominated in U.S. Dollars and EWST anticipates reducing
the amount of advances during fiscal year 2009, the amount outstanding is
subject to foreign exchange rate fluctuations.
32
In October 2001, we entered into an interest rate swap with a bank pursuant to
which it exchanged floating rate interest in connection with the Bonds discussed
in Note G of the financial statements on a notional amount of $3,000,000 for a
fixed rate of 4.07% for a ten-year period ending October 1, 2011. The notional
amount reduces each year in tandem with the annual installments due on the
Bonds. The fixing of the interest rate for this period offsets our exposure to
the uncertainty of floating interest rates on the Bonds, and as such has been
designated as a cash flow hedge. The hedge is deemed to be highly effective and
any ineffectiveness will be recognized in interest expense in the reporting
period. The fair value of the interest rate swap was a liability of
approximately $87,200 as of August 3, 2008. There was no material hedge
ineffectiveness related to cash flow hedges during the fiscal years presented to
be recognized in earnings.
On April 30, 2007, the Company replaced its existing credit facility with a new
$40 million Revolving Credit Loan Agreement ("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 Agreement requires the
payment of interest only on a monthly basis and payment of the outstanding
principal balance on March 31, 2010. The Agreement was modified as of September
12, 2008. Under the terms of the modification, 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 2.0% effective September 12, 2008 (the margin was 1.65%
at August 3, 2008). In addition, if in the event the sale of ICI (See Note S of
Notes to the Consolidated Financial Statements) is not consummated by November
30, 2008, we will grant the bank a security interest in our domestic accounts
receivable, inventory and all other non-real estate domestic assets. There is a
fee of 20 basis points per annum on the unused portion of the credit facility
payable quarterly. Stand-by letters of credit were outstanding in the amount of
approximately $15.9 million at August 3, 2008 (See Note E). If at any time the
Company's backlog of orders falls below $50 million, the bank may obtain a
security interest in eligible accounts receivable, as defined, and if the
outstanding advances are greater than 100% of eligible receivables, a lien on
all inventories. Funded backlog as of August 3, 2008 was approximately $157
million. A loan of $2,500,000 was outstanding under the line at August 3, 2008.
There were no borrowings under the line at July 29, 2007.
The table below provides information about our debt that is sensitive to changes
in interest rates. Future principal payment cash flows by maturity date as
required under the industrial revenue bonds, and corresponding fair value is as
follows (in thousands):
Fiscal year ending Bonds
------------------ -----
2009 $ 125
2010 130
2011 135
2012 140
2013 145
2014 and later 1,680
-----
$ 2,355
=====
Fair value $ 2,317
=====
On September 16, 2008, the Company entered into a new term loan in the amount of
$10 million for a period of 10 years through the Company's bank in Israel. The
new loan is payable in quarterly installments over a period of 10 years with
interest at LIBOR plus 1.5%. We do not anticipate any other material changes in
our primary market risk exposures in fiscal 2009.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data listed in the Index on Page F-1
are filed as a part of this report.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
I. Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our management,
including our principal executive officer (Chairman of the Board/Chief
Executive Officer) and principal financial officer (Vice President and
Chief Financial Officer), we have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) as of August 3, 2008 (the "Evaluation Date").
Based on such evaluation, the principal executive officer and the principal
financial officer have concluded that, as of the Evaluation Date, our
33
disclosure controls and procedures are effective, and are reasonably
designed to ensure that all material information (including our
consolidated subsidiaries) required to be included in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
Our review of our internal controls was made within the context of the
relevant professional auditing standards defining "internal controls,"
"significant deficiencies" and "material weaknesses." "Internal controls"
are processes designed to provide reasonable assurance that our
transactions are properly authorized, our assets are safeguarded against
unauthorized or improper use, and our transactions are properly recorded
and reported, all to permit the preparation of our consolidated financial
statements in conformity with accounting principles generally accepted in
the United States. "Significant deficiencies" are control issues that could
have a significant adverse effect on our ability to properly authorize
transactions; safeguard our assets; or record, process, summarize or report
financial data in the consolidated financial statements. A "material
weakness" is a particularly serious reportable condition where the internal
control does not reduce to a relatively low level the risk that
misstatements caused by error or fraud may occur in amounts that would be
material in relation to the consolidated financial statements and not be
detected within a timely period by employees in the normal course of
performing their assigned functions. As part of our internal controls
procedures, we also address other, less significant control matters that we
identify, and we determine what revision or improvement to make, if any, in
accordance with our on-going procedures.
II. Changes in Internal Control over Financial Reporting.
During the quarter ended August 3, 2008, there were certain insignificant
changes in our internal control over financial reporting which resulted
from control improvement and remediation efforts. These changes have not
materially affected, and are not likely to materially affect, such internal
control over financial reporting.
III. Management's Annual Report on Internal Control over Financial Reporting.
We are responsible for establishing and maintaining an adequate internal
control structure and procedures over financial reporting. We have assessed
the effectiveness of internal control over financial reporting as of August
3, 2008. Our assessment was based on criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) Internal
Control-Integrated Framework.
Our internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. Our internal
control over financial reporting includes those policies and procedures
that:
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect our transactions and dispositions
of our assets;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles in the
United States, and that our receipts and expenditures are being
made only in accordance with authorizations of our management and
board of directors; and
(3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our
assets that could have a material effect on our financial
statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect all misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may
deteriorate.
Based on the COSO criteria, we believe our internal control over financial
reporting as of August 3, 2008 was effective.
Our internal control over financial reporting as of August 3, 2008 has been
audited by Marcum & Kliegman LLP, independent registered public accounting
firm, as stated in their report which is included below.
Important Considerations
The effectiveness of our disclosure controls and procedures and our
internal control over financial reporting is subject to various inherent
34
limitations, including cost limitations, judgments used in decision making,
assumptions about the likelihood of future events, the soundness of our
systems, the possibility of human error and the risk of fraud. Moreover,
projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes
in conditions and the risk that the degree of compliance with policies or
procedures may deteriorate over time. Because of these limitations, there
can be no assurance that any system of disclosure controls and procedures
or internal control over financial reporting will be successful in
preventing all errors or fraud or in making all material information known
in a timely manner to the appropriate levels of management.
35
Report of Independent Registered Public Accounting Firm on Internal Control over
Financial Reporting
To the Audit Committee of the
Board of Directors and Shareholders of
Herley Industries, Inc.
We have audited Herley Industries, Inc. and Subsidiaries' (the "Company")
internal control over financial reporting as of August 3, 2008, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company's management is responsible for maintaining effective internal control
over financial reporting, and for its assessment of the effectiveness of
internal control over financial reporting, included in the accompanying
"Management Annual Report on Internal Control over Financial Reporting". Our
responsibility is to express an opinion on the Company's internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that degree of compliance with
the policies or procedures may deteriorate.
In our opinion, Herley Industries, Inc. and Subsidiaries maintained, in all
material aspects, effective internal control over financial reporting as of
August 3, 2008, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of August 3, 2008 and July 29, 2007 and the related consolidated statements of
operations, shareholders' equity, and cash flows and the related financial
statement schedule for the fifty-three (53) weeks ended August 3, 2008 and the
fifty-two (52) weeks ended July 29, 2007 and July 30, 2006 of the Company, and
our report dated October 21, 2008 expressed an unqualified opinion on those
financial statements and financial statement schedule.
/s/ Marcum & Kliegman LLP
- -------------------------
Marcum & Kliegman LLP
Melville, New York
October 21, 2008
36
Item 9B. Other Information
Not applicable
PART III
The information required by Part III is incorporated by reference to the
Company's definitive proxy statement in connection with its Annual Meeting of
Stockholders scheduled to be held in January 2009, to be filed with the
Securities and Exchange Commission within 120 days following the end of the
Company's fiscal year ended August 3, 2008.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1
Registration Statement No. 2-87160).
3.2 By-Laws, as amended August 7, 2001 (Exhibit 3.2 of Annual Report on Form
10-K for the fiscal year ended July 29, 2001).
10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the
fiscal year ended July 28, 1996).
10.2 1997 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 10,
1997).
10.3 1998 Stock Option Plan (Exhibit 10.3 of Annual Report on Form 10-K for the
fiscal year ended August 1, 1999).
10.4 2000 Stock Option Plan (Exhibit 4.1 of Report on Form S-8 dated October
12, 2001).
10.5 2003 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 11,
2003).
10.6 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt
dated as of July 29, 2002. (Exhibit 10.5 of Annual Report on Form 10-K for
the fiscal year ended July 28, 2002).
10.7 Employment Agreement between Herley Industries, Inc. and Myron Levy dated
as of July 29, 2002. (Exhibit 10.6 of Annual Report on Form 10-K for the
fiscal year ended July 28, 2002).
10.8 Agreement and Plan of Reorganization dated as of July 8, 1997 among the
Company, Metraplex Acquisition Corporation and Metraplex Corporation
(Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997).
10.9 Agreement and Plan of Merger dated as of August 21, 1998 among General
Microwave Corp., Eleven General Microwave Corp., Shareholders, GMC
Acquisition Corporation and Registrant (Exhibit 1 of Schedule 13D dated
August 28, 1998).
10.10 Lease Agreement dated September 1, 1999 between Registrant and RSK Realty
LTD. (Exhibit 10.8 of Annual Report on Form 10-K for the fiscal year ended
August 1, 1999).
10.11 Asset Purchase Agreement dated as of February 1, 2000 between Registrant
and Robinson Laboratories, Inc. (Exhibit 10.2 of Form 10-Q dated March 13,
2000).
10.12 Asset Purchase Agreement dated as of October 12, 2000 between Registrant
and American Microwave Technology Inc. (Exhibit 10.1 of Form 10-Q dated
December 12, 2000).
10.13 Asset Purchase Agreement dated as of March 29, 2004 between Registrant and
Communication Techniques, Inc. (Exhibit 10.15 of Annual Report on Form
10-K for the fiscal year ended August 1, 2004).
10.14 Lease Agreement dated March 1, 2000 between Registrant and RSK Realty LTD
(Exhibit 10.13 of Annual Report on Form 10-K for the fiscal year ended
July 30, 2000).
10.15 Common Stock Purchase Agreement dated as of September 20, 2002 between
Registrant and EW Simulation Technology, Limited. (Exhibit 10.17 of Annual
Report on Form 10-K for the fiscal year ended July 28, 2002).
10.16 Trust Indenture dated as of October 19, 2001 between Registrant, and East
Hempfield Township Industrial Development Authority and Allfirst Bank, as
Trustee. (Exhibit 10.18 of Annual Report on Form 10-K for the fiscal year
ended July 28, 2002).
10.17 Asset Purchase Agreement dated as of September 1, 2004 between Registrant
and Reliable System Services Corp. (Exhibit 10.20 of Annual Report on Form
10-K for the fiscal year ended August 1, 2004).
10.18 Amendment dated December 9, 2003 to Employment Agreement between Herley
Industries, Inc. and Myron Levy dated as of July 29, 2002. (Exhibit 10.21
of Annual Report on Form 10-K for the fiscal year ended August 1, 2004).
10.19 Amendment dated December 9, 2003 to Employment Agreement between Herley
Industries, Inc. and Lee N. Blatt dated as of July 29, 2002. (Exhibit
10.22 of Annual Report on Form 10-K for the fiscal year ended August 1,
2004).
10.20 Common Stock Purchase Agreement dated as of February 1, 2005 between
Registrant and Micro Systems, Inc. (Exhibit 2.1 of Form 8-K dated February
7, 2005).
10.21 Common Stock Purchase Agreement dated as of April 12, 2005 between
Registrant and Innovative Concepts, Inc. (Exhibit 2.1 of Form 8-K dated
April 18, 2005).
10.22 2006 New Employee Stock Option Plan. (Exhibit 10.26 of Annual Report on
Form 10-K for the fiscal year ended July 30, 2006).
37
10.23 Employment Agreement between Herley Industries, Inc. and John Kelley dated
as of June 7, 2006. (Exhibit 10.27 of Annual Report on Form 10-K for the
fiscal year ended July 30, 2006).
10.24 Employment Agreement between Herley Industries, Inc. and Kevin J. Purcell
dated as of June 7, 2006. (Form 8-K dated June 8, 2006).
10.25 Administrative Agreement between the Department of the Navy, on behalf of
the Department of Defense, and Herley Industries, Inc. (Exhibit 10.1 of
Form 8-K dated October 12, 2006).
10.26 Agreement between Herley Industries, Inc. and Lee N. Blatt effective
October 12, 2006. (Exhibit 10.2 of Form 8-K dated October 12, 2006).
10.27 Employment Agreement dated as of May 30, 2007 between Herley Industries,
Inc. and Jeffrey L. Markel. (Exhibit 10.1 of Form 8-K dated May 30, 2007).
10.28 Revolving Credit Loan Agreement dated April 30, 2007 among the Registrant,
Manufacturers and Traders Trust Company and Bank of Lancaster County, N.A.
(Exhibit 10.1 of Form 8-K dated June 7, 2007).
10.29 Amendment No. 1 to Agreement between Herley Industries, Inc. and the
Department of the Navy. (Exhibit 10 of Form 8-K dated August 15, 2007).
10.30 Asset Purchase Agreement dated as of August 1, 2008 by and between General
Microwave Israel Acquisition (2008) Ltd. and Eyal Microwave Ltd. and Eyal
Mag Ltd. (Exhibit 10.1 of Form 8-K dated September 22, 2008).
10.31 Addendum to the Asset Purchase Agreement dated as of September 16, 2008 by
and between Herley GMI Eyal Ltd. (formerly called General Microwave Israel
Acquisition (2008) Ltd.), Eyal Microwave Ltd. and Eyal Mag Ltd. (Exhibit
10.2 of Form 8-K dated September 22, 2008).
23.1 Consent of Marcum & Kliegman LLP.
31.1 Certifications pursuant to Rules 13a-14(a) as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Financial Statements
(1) See Index to Consolidated Financial Statements at Page F-1.
(2) Schedule II - Valuation and Qualifying Accounts filed as part of this
Form 10-K at page 40.
38
SIGNATURES:
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on October 21, 2008.
HERLEY INDUSTRIES, INC.
By: /S/ Myron Levy
-------------------------------------
Myron Levy, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on October 21, 2008 by the following persons in the
capacities indicated:
By: /S/ Myron Levy
--------------------------------- Chairman of the Board,
Myron Levy Chief Executive Officer and Director
(Principal Executive Officer)
By: /S/ Kevin J. Purcell Vice President and
--------------------------------- Chief Financial Officer
Kevin J. Purcell (Principal Financial Officer
By: /S/ John A. Thonet Secretary and Director
---------------------------------
John A. Thonet
By: /S/ Carlos C. Campbell Director
---------------------------------
Carlos C. Campbell
By: /S/ Edward K. Walker, Jr. Director
---------------------------------
Edward K. Walker, Jr.
By: /S/ Robert M. Moore Director
---------------------------------
Robert M. Moore
By: /S/ Edward A. Bogucz Director
---------------------------------
Edward A. Bogucz
Schedule II - Valuation and Qualifying Accounts (in thousands)
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions Amount
------------------- written
Balance at Charged to off Balance at
beginning costs and against end of
Description of period expenses Other reserve period
----------- ---------- ---------- ----- ------- ----------
Valuation accounts deducted
from assets to which they
apply:
August 3, 2008:
Inventories $ 5,163 $ 1,678 $ - $ 365 $ 6,476
July 29, 2007:
Inventories $ 4,576 $ 1,277 $ - $ 690 $ 5,163
July 30, 2006:
Inventories $ 4,492 $ 1,475 $ - $ 1,391 $ 4,576
All other Schedules have been omitted since they are either not required, not
applicable, or the information is otherwise included in this Annual Report on
Form 10-K.
40
Item 8. Financial Statements and Supplementary Data
HERLEY INDUSTRIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-2
FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of August 3, 2008 and July 29, 2007 F-3
Consolidated Statements of Operations for the fifty-three weeks ended August 3, 2008
and the fifty-two weeks ended July 29, 2007 and July 30, 2006 F-4
Consolidated Statements of Shareholders' Equity for the fifty-three weeks
ended August 3, 2008 and the fifty-two weeks ended July 29, 2007 and July
30, 2006 F-5
Consolidated Statements of Cash Flows for the fifty-three weeks ended August 3, 2008
and the fifty-two weeks ended July 29, 2007 and July 30, 2006 F-6
Notes to Consolidated Financial Statements F-7
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of the
Board of Directors and Shareholders of
Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley
Industries, Inc. and Subsidiaries (the "Company") as of August 3, 2008 and July
29, 2007, and the related consolidated statements of operations, shareholders'
equity and cash flows for the fifty-three (53) weeks ended August 3, 2008 and
the fifty-two (52) weeks ended July 29, 2007 and July 30, 2006. Our audits also
included the financial statement schedule as of and for the fifty-three (53)
weeks ended August 3, 2008 and the fifty-two (52) weeks ended July 29, 2007 and
July 30, 2006 listed in the index at Item 15. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Herley
Industries, Inc. and Subsidiaries, as of August 3, 2008 and July 29, 2007, and
the consolidated results of its operations and its cash flows for the
fifty-three (53) weeks ended August 3, 2008 and the fifty-two (52) weeks ended
July 29, 2007 and July 30, 2006 in conformity with United States generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole presents fairly, in all material aspects,
the information set forth therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Herley Industries, Inc. and
Subsidiaries' internal control over financial reporting as of August 3, 2008,
based on the criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated, October 21, 2008, expressed an unqualified opinion on the
effectiveness of the Company's internal control over financial reporting.
/s/ Marcum & Kliegman LLP
- -------------------------
Marcum & Kliegman LLP
Melville, New York
October 21, 2008
F-2
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
August 3, July 29,
2008 2007
--------- --------
ASSETS
Current Assets:
Cash and cash equivalents $ 14,347 $ 35,181
Trade accounts receivable, net 27,003 28,058
Income Taxes Receivable 2,056 819
Costs incurred and income recognized in excess
of billings on uncompleted contracts and claims 19,490 14,448
Other receivables 1,286 2,816
Inventories, net 61,559 51,815
Deferred income taxes 11,263 4,254
Other current assets 1,276 1,069
--------- --------
Total Current Assets 138,280 138,460
Property, Plant and Equipment, net 30,552 29,996
Goodwill 73,900 74,044
Intangibles, net of accumulated amortization of $7,505
in 2008 and $5,256 in 2007 16,145 18,431
Other Assets 541 1,662
-------- --------
Total Assets $ 259,418 $ 262,593
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 1,394 $ 1,346
Current portion of employment settlement
agreement - (net of imputed interest of
$238 in 2008 and $245 in 2007)(Note H) 1,119 1,113
Current portion of litigation settlements -
(net of imputed interest of $46) 954 -
Accounts payable and accrued expenses 27,546 19,453
Billings in excess of costs incurred and
income recognized on uncompleted contracts 613 99
Income taxes payable 43 3,518
Accrual for contract losses 2,994 1,160
Accrual for warranty costs 1,142 1,106
Advance payments on contracts 8,120 7,163
-------- --------
Total Current Liabilities 43,925 34,958
Long-term Debt, net of current portion 7,092 5,951
Long-term Portion of Employment Settlement Agreement -
(net of imputed interest of $287 in 2008
and $580 in 2007)(Note H) 3,074 4,117
Long-term Portion of litigation settlement -
(net of imputed interest of $108) 892 -
Other Long-term Liabilities 1,652 1,311
Deferred Income Taxes 8,839 6,615
Accrued Income Taxes Payable 509 -
-------- --------
Total Liabilities 65,983 52,952
-------- --------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized 20,000,000
shares; issued and outstanding 13,521,902 in 2008,
and 13,977,115 in 2007 1,352 1,398
Additional paid-in capital 101,403 107,094
Retained earnings 89,058 99,404
Accumulated other comprehensive income 1,622 1,745
-------- --------
Total Shareholders' Equity 193,435 209,641
-------- --------
Total Liabilities and Shareholders'
Equity $ 259,418 $ 262,593
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except per share data)
Fifty-three Fifty-two weeks ended
weeks ended ---------------------
August 3, July 29, July 30,
2008 2007 2006
----------- ----------- -----------
Net sales $ 152,511 $ 163,140 $ 176,268
----------- ----------- -----------
Cost and expenses:
Cost of products sold 118,311 118,834 127,921
Selling and administrative expenses 33,835 32,516 32,736
Litigation costs 5,550 1,674 2,230
Litigation settlements (Notes A-1 and E) 15,442 - -
Employment contract settlement costs (Note H) - 8,914 -
----------- ----------- -----------
173,138 161,938 162,887
----------- ----------- -----------
Operating (loss) income (20,627) 1,202 13,381
----------- ----------- -----------
Other income (expense):
Investment income 1,061 1,186 840
Interest expense (661) (790) (319)
Foreign exchange transaction (losses) gains (122) 501 431
----------- ----------- -----------
278 897 952
----------- ----------- -----------
(Loss) income before income taxes (20,349) 2,099 14,333
(Benefit) provision for income taxes (10,003) (1,019) 3,979
----------- ----------- -----------
Net (loss) income $ (10,346) $ 3,118 $ 10,354
=========== =========== ===========
(Loss) earnings per common share - Basic $ (.76) $ .22 $ .72
=========== =========== ===========
Basic weighted average shares 13,652 13,927 14,463
=========== =========== ===========
(Loss) earnings per common share - Diluted $ (.76) $ .22 $ .69
=========== =========== ===========
Diluted weighted average shares 13,652 14,395 15,097
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Fifty-three weeks ended August 3, 2008 and
Fifty-two weeks ended July 29, 2007 and July 30, 2006
(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 31, 2005 14,389,625 $ 1,439 $ 109,118 $ 85,932 $ - $ 1,148 $ 197,637
Exercise of stock options 271,091 27 3,144 3,171
Stock option compensation 453 453
Tax benefit upon exercise of stock options 703 703
Purchase of 798,567 shares of treasury
stock (9,044) (9,044)
----------- -------- --------- --------- --------- ------------ -----------
Subtotal 14,660,716 1,466 113,418 85,932 (9,044) 1,148 192,920
-----------
Net income 10,354 10,354
Other comprehensive income
Unrealized gain on interest rate swap 33 33
Foreign currency translation gain 163 163
-----------
Comprehensive income 10,550
----------- -------- --------- --------- --------- ------------ -----------
Balance at July 30, 2006 14,660,716 $ 1,466 $ 113,418 $ 96,286 $ (9,044)$ 1,344 $ 203,470
Exercise of stock options 116,630 12 1,207 1,219
Purchase of 1,664 shares of treasury stock (26) (26)
Stock option compensation 1,007 1,007
Stock option modification (Note H) 196 196
Tax benefit upon exercise of stock options 256 256
Retirement of treasury shares (800,231) (80) (8,990) 9,070 -
----------- -------- --------- --------- --------- ------------ -----------
Subtotal 13,977,115 1,398 107,094 96,286 - 1,344 206,122
Net income 3,118 3,118
Other comprehensive (loss) income
Unrealized loss on interest rate swap (7) (7)
Foreign currency translation gain 408 408
-----------
Comprehensive income 3,519
----------- -------- --------- --------- --------- ------------ -----------
Balance at July 29, 2007 13,977,115 $ 1,398 $ 107,094 $ 99,404 $ - $ 1,745 $ 209,641
Exercise of stock options 38,725 3 318 321
Purchase of 493,938 shares of treasury
stock (7,139) (7,139)
Stock option compensation 990 990
Tax benefit upon exercise of stock options 91 91
Retirement of treasury shares (493,938) (49) (7,090) 7,139 -
----------- -------- --------- --------- --------- ------------ -----------
Subtotal 13,521,902 1,352 101,403 99,404 - 1,745 203,904
Net loss (10,346) (10,346)
Other comprehensive loss
Unrealized loss on interest rate swap (25) (25)
Foreign currency translation loss (98) (98)
-----------
Comprehensive loss (10,469)
----------- -------- --------- --------- --------- ------------ -----------
Balance at August 3, 2008 13,521,902 $ 1,352 $ 101,403 $ 89,058 $ - $ 1,622 $ 193,435
=========== ======== ========= ========= ========= ============ ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Fifty-three Fifty-two weeks ended
weeks ended ---------------------
August 3 July 29, July 30,
2008 2007 2006
------------ ----------- --------
Cash flows from operating activities:
Net (loss) income $ (10,346) $ 3,118 $ 10,354
------------ ----------- ------------
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization 7,266 7,177 7,096
Stock-based compensation costs 990 1,007 453
Excess tax benefit from exercises of stock options (91) (256) (703)
Litigation settlements 15,442
Employment contract settlement costs (includes $196
of stock option modification costs) - 8,914 -
Imputed interest on employment and litigation
settlement liabilities 446 283 -
Foreign exchange transaction losses (gains) 122 (501) (431)
Inventory valuation reserve charges 1,515 1,283 1,475
Reduction in accrual for contract losses (826) (1,144)
Warranty reserve charges 1,260 1,304 726
Deferred tax provision (4,275) (1,310) 218
Changes in operating assets and liabilities:
Trade accounts receivable 961 2,542 (3,342)
Income Taxes Receivable (1,237) (819)
Costs incurred and income recognized in excess
of billings on uncompleted contracts and claims (5,042) (522) 2,132
Other receivables 1,530 (2,047) 645
Inventories, net (11,342) (189) (2,794)
Other current assets (207) 118 157
Accounts payable and accrued expenses 6,869 (3,246) (2,357)
Billings in excess of costs incurred and
income recognized on uncompleted contracts 514 (456) 17
Income taxes payable (3,384) 379 338
Accrual for contract losses 2,660 (251) (175)
Litigation settlements (13,500) - -
Employment settlement agreement (1,336) (3,771) -
Advance payments on contracts 957 3,840 1,435
Other, net 438 222 84
------------ ----------- ------------
Total adjustments (270) 12,557 4,974
------------ ----------- ------------
Net cash (used in) provided by operating activities (10,616) 15,675 15,328
------------ ----------- ------------
Cash flows from investing activities:
Acquisition of technology license - (179) (1,256)
Other 3 204 111
Capital expenditures (4,637) (4,972) (6,227)
------------ ----------- ------------
Net cash used in investing activities (4,634) (4,947) (7,372)
------------ ----------- ------------
Cash flows from financing activities:
Borrowings under bank line of credit 20,400 17,900 16,500
Borrowings - other - 1,746 -
Proceeds from exercise of stock options 321 1,219 3,171
Excess tax benefit from exercises of stock options 91 256 703
Payments of long-term debt (1,357) (1,038) (805)
Payments under bank line of credit (17,900) (17,900) (16,500)
Purchase of treasury stock (7,139) (26) (9,044)
------------ ----------- ------------
Net cash (used in) provided by financing activities (5,584) 2,157 (5,975)
------------ ----------- ------------
Effect of exchange rate changes on cash - (7) (9)
------------ ----------- ------------
Net (decrease) increase in cash and cash
equivalents (20,834) 12,878 1,972
Cash and cash equivalents at beginning of period 35,181 22,303 20,331
------------ ----------- ------------
Cash and cash equivalents at end of period $ 14,347 $ 35,181 $ 22,303
============ =========== ============
Supplemental cash flow information:
Financing of computer software and maintenance $ 1,627
============
Retirement of 493,938 (800,231 in 2007) shares of
treasury stock $ 7,139 $ 9,070
=========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Nature of Operations and Recent Events
--------------------------------------
Herley Industries, Inc. ("Herley"), a Delaware corporation, and its
wholly-owned subsidiaries (collectively the "Company") are engaged in the
design, development and manufacture of microwave technology solutions for
the defense, aerospace and medical industries worldwide with four domestic
and three foreign manufacturing facilities and two engineering offices in
the US. Herley's corporate office is in Lancaster, Pennsylvania.
During the fourth quarter of fiscal 2008 the Company decided to close its
manufacturing facility in Farmingdale, NY and transfer its contracts and
assets to its other facilities in Whippany, New Jersey; Woburn,
Massachusetts; Lancaster, Pennsylvania; and Jerusalem, Israel. Management
expects that the closure of the facility will be substantially completed by
the end of December 2008. The major costs associated with the restructuring
are one-time termination benefits which are estimated at approximately $1.1
million. The costs are being accrued evenly from May 2008 through December
2008. Costs accrued during the fourth quarter approximated $377,000 and
charges against the liability for one-time termination benefits paid
approximated $30,000. The liability for the one-time termination benefits
was approximately $347,000 as of August 3, 2008.
In connection with the legal matters discussed in Note E "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. The Company advised the Department
of the Navy, Acquisition Integrity Office about the terms and conditions of
the criminal and civil settlement agreements and the Company was advised
that no action would be taken to suspend or debar the Company based on
these settlements.
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 (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 E
"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.
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.) ("ICI"); Fort Walton Beach, Florida
(Micro Systems, Inc. and Herley-RSS) ("MSI"); 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
F-7
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
consolidated financial statements in the fifty-two weeks ended July 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 E), 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 fifty-three weeks ended August 3, 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.
2. Fiscal Year
-----------
The Company's fiscal year ends on the Sunday closest to July 31. Normally
each fiscal year consists of fifty-two weeks, but every five or six years
the fiscal year will consist of fifty-three weeks. Fiscal year 2008
consists of fifty-three weeks ended August 3, 2008 ("fiscal 2008"); and
fiscal years 2007 and 2006 consist of fifty-two weeks ended July 29, 2007
("fiscal 2007") and July 30, 2006 ("fiscal 2006"), respectively.
3. Basis of Financial Statement Presentation and Accounting Estimates
------------------------------------------------------------------
The consolidated financial statements include the accounts of Herley
Industries, Inc. and its subsidiaries, all of which are wholly-owned. All
significant inter-company accounts and transactions have been eliminated in
consolidation. The presentation of financial statements in conformity with
accounting principles generally accepted in the United States of America
("U.S. GAAP") requires management to make certain estimates and assumptions
that affect the reported amounts of assets, liabilities and disclosure of
contingent assets and liabilities as of the date of the financial
statements and reported amounts of revenues and expenses during the
reporting periods.
These judgments can be subjective and complex, and consequently actual
results could differ from those estimates and assumptions. The most
significant estimates include: valuation and recoverability of long-lived
assets; income taxes; recognition of revenue and costs on production
contracts; and the valuation of inventory and stock-based compensation
costs valued in accordance with FAS 123R. Each of these areas requires the
Company to make use of reasoned estimates including estimating the cost to
complete a contract, the net realizable value of its inventory and the
market value of its products. Changes in estimates can have a material
impact on the Company's financial position and results of operations. The
accrual for contract losses associated with the ICI acquisition (more fully
described in Note B), was reduced by $1.1 million for the fifty-two weeks
ended July 29, 2007 (which is included as a reduction of costs of products
sold) as a result of management changing its estimated liability for
expected losses under the contract. The remaining accrual for contract
losses of approximately $826,000 relating to the remaining two contract
options was eliminated in the fifty-three weeks ended August 3, 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 fifty-three weeks ended August 3, 2008, the Company recognized a
loss of approximately $1.0 million 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 losses of approximately $2.6 million due to
cost overruns on two other development contracts.
Certain prior year amounts were reclassified to conform to the 2008
presentation. The reclassifications had no effect on previously reported
net income.
F-8
4. Cash and Cash Equivalents
-------------------------
The Company considers all liquid investments with an original maturity of
three months or less at the date of acquisition to be cash equivalents.
Short-term investments are recorded at the amortized cost plus accrued
interest which approximates market value. The Company limits its credit
risk to an acceptable level by evaluating the financial strength of
institutions at which significant investments are made and based upon
credit ratings. The Company has cash balances in excess of amounts insured
by the FDIC as of August 3, 2008 and July 29, 2007. In addition, the
Company has cash balances in foreign countries of approximately $9,089,000
and $6,364,000 as of August 3, 2008 and July 29, 2007, respectively.
5. Concentration of Credit Risk/Trade Accounts Receivable and Related Accounts
---------------------------------------------------------------------------
Financial instruments which potentially subject the Company to credit risk
consist primarily of trade accounts receivable. Accounts receivable are
principally from the U.S. Government, major U.S. Government contractors,
several foreign governments, and domestic customers in the defense,
aerospace and medical industries. Credit is extended based on an evaluation
of the customer's financial condition and generally collateral is not
required. In many cases, irrevocable letters of credit accompanied by
advanced payments are received from foreign customers, and progress
payments are received from domestic customers. The Company performs
periodic credit evaluations of its customers and maintains reserves for
potential credit losses. As of August 3, 2008 and July 29, 2007, a reserve
for doubtful accounts of approximately $122,000 and $138,000, respectively
are reflected in the consolidated balance sheets as a deduction from trade
accounts receivable. Historically, the write off of uncollectible accounts
receivable has been immaterial.
The asset "Costs incurred and income recognized in excess of billings on
uncompleted contracts" represents revenues recognized in excess of amounts
billed. The liability "Billings in excess of costs incurred and income
recognized on uncompleted contracts" represents amounts billed in excess of
revenues earned. Included in these two categories are unbilled amounts
which are recorded under the percentage of completion method and are
recoverable from the customer upon shipment of the product, presentation of
billings or completion of the contract. Unbilled amounts are expected to be
collected inside of one year.
6. Inventories
-----------
Inventories, other than inventory costs relating to long-term contracts and
programs, are stated at lower of cost (principally first-in, first-out) or
market. Inventory costs relating to long-term contracts and programs are
stated at the actual production costs, including factory overhead, reduced
by amounts identified with revenue recognized on units delivered or
progress completed. Inventory costs relating to long-term contracts and
programs are reduced by any amounts in excess of estimated realizable
value. As is customary in the defense industry, inventory is partially
financed by progress payments. The un-liquidated balance of the progress
payments is shown as a reduction in the carrying amount of inventory. An
estimate for obsolete and excess inventory is also provided as a reduction
of the carrying value of inventory.
7. Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are provided
principally by the straight-line method over the estimated useful lives of
the related assets. Leasehold improvements are amortized over the shorter
of their economic lives or the lease term, as defined in paragraph 5(f) of
Statement of Financial Accounting Standards ("SFAS") No.13, "Accounting for
Leases." Rent holidays and scheduled rent increases under operating leases
are recognized on a straight-line basis over the lease term, including the
rent holiday period, in accordance with paragraph 2 of Financial Accounting
Standards Board ("FASB") Technical Bulletin 85-3 (as amended). Gains and
losses arising from the sale or disposition of property, plant and
equipment are included in income from operations.
8. Computer Software
-----------------
Internal use software, which consists primarily of an integrated
manufacturing and financial reporting package is stated at cost less
accumulated amortization and is amortized using the straight-line method
over its estimated useful life, generally eight years.
9. Goodwill and Intangible Assets
------------------------------
The Company accounts for its goodwill in accordance with SFAS 141,
"Business Combinations", and SFAS 142, "Goodwill and Other Intangible
Assets". These statements established accounting and reporting standards
for acquired goodwill and other intangible assets. Specifically, the
standards address how acquired intangible assets should be accounted for
both at the time of acquisition and after they have been recognized in the
financial statements. In accordance with SFAS No. 142, purchased goodwill
must be evaluated for impairment on an annual basis. Those intangible
assets that are classified as goodwill or as other intangibles with
indefinite lives are not amortized.
F-9
Impairment testing is performed in two steps: (i) the Company determines
impairment by comparing the fair value of a reporting unit with its
carrying value, and (ii) if there is impairment, the Company measures the
amount of impairment loss by comparing the implied fair value of goodwill
with the carrying amount of that goodwill. The Company has performed its
annual impairment evaluation required by this standard and determined that
the goodwill and other intangibles with indefinite lives are not impaired.
Any future impairment of goodwill will be charged to operations. The
Company amortizes the cost of other intangibles over their estimated useful
lives. Amortizable intangible assets may also be tested for impairment if
indications of impairment exist.
The change in the carrying amount of goodwill for the fifty-three weeks
ended August 3, 2008 is as follows (in thousands):
Balance at July 30, 2006 $ 73,612
Fluctuations in foreign currency (1) 432
-------------
Balance at July 29, 2007 $ 74,044
Fluctuations in foreign currency (1) (144)
-------------
Balance at August 3, 2008 $ 73,900
=============
The carrying amounts of intangible assets as of August 3, 2008 and July 29, 2007
are as follows (in thousands):
August 3, July 29,
2008 2007
----------------------- --------------------------------------
Gross Gross
carrying Accumulated carrying Accumulated Amortization
amount amortization amount amortization period (years)
-------- ------------ -------- ------------ --------------
Definite lived intangible assets:
- --------------------------------
Technology (1) $ 12,592 4,103 $ 12,629 3,324 10-15
Backlog 3,125 2,285 3,125 1,375 2-5
Drawings 800 231 800 178 15
Non-compete agreement 31 31 31 31 5
Xytrans license 3,734 467 3,734 - 8
Patents 568 388 568 348 14
---------- ----- --------- -----
$ 20,850 7,505 $ 20,887 5,256
---------- ----- --------- -----
Indefinite lived intangible assets:
- ----------------------------------
Trademarks $ 2,800 $ 2,800
========== =========
Total intangible assets $ 23,650 7,505 $ 23,687 5,256
========== ===== ========= =====
<FN>
- ---------
(1) Adjusted to reflect fluctuations in foreign currency related to EWST.
</FN>
The Company entered into a license and development agreement ("agreement") on
April 7, 2005 to license millimeter wave technology for military applications
from Xytrans, Inc. ("Xytrans"). Xytrans focuses on providing high-frequency
transceiver and outdoor unit design for the wireless broadband network market.
The technology acquired includes exclusive access to a portfolio of patents and
trade secrets that improve the cost and performance of millimeter wave
subsystems that are used in weapons and radar systems. The agreement also
provides for the payment of royalties ranging from 1% to 4% of sales of products
including relevant millimeter wave technology, starting at the earliest January
1, 2006, and generally ending 4 years later. No royalties have been earned or
paid as of August 3, 2008. The Company began to amortize the costs associated
with this agreement starting July 30, 2007 over the estimated economic life of
approximately eight years.
Amortization expense related to Intangibles for the fifty-three weeks ended
August 3, 2008 and the fifty-two weeks ended July 29, 2007 and July 30, 2006 was
approximately $2,249,000, $1,788,000 and $1,788,000, respectively.
Estimated aggregate amortization expense for each of the next five fiscal years
is as follows (in thousands):
2009 $2,208
2010 $1,928
2011 $1,648
2012 $1,648
2013 $1,648
F-10
10. Long-Lived Assets
-----------------
The Company accounts for long-lived assets in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." This
statement applies to long-lived assets other than goodwill, and prescribes
a probability weighted cash flow estimation approach to evaluate the
recoverability of the carrying amount of long-lived assets such as a
component of an entity. The Company considers a business to be held for
sale when management approves and commits to a formal plan to actively
market a business for sale. Upon designation as held for sale, the carrying
value of the assets of the business are recorded at the lower of their
carrying value or their estimated fair value, less cost to sell. Results of
operations of a business classified as held for sale are reported as
discontinued operations when (a) the operations and cash flows of the
business will be eliminated from ongoing operations as a result of the sale
and (b) the Company will not have any significant continuing involvement in
the operations of the business after the sale.
11. Advance Payments and Billings in Excess of Costs Incurred
---------------------------------------------------------
The Company receives advances, performance-based payments and progress
payments from customers which may exceed costs incurred on certain
contracts.
12. Revenue and Cost Recognition
----------------------------
The Company recognizes revenue when products are shipped and the customer
takes ownership and assumes risk of loss, collection of the relevant
receivable is probable, persuasive evidence of an arrangement exists and
the sales price is fixed or determinable. It is the policy of the U.S.
Government to ensure that (a) its contracts include inspection and other
quality requirements, including warranty clauses when appropriate, that are
determined necessary to protect the Government's interest; (b) supplies
tendered by contractors meet contract requirements; and (c) Government
contract quality assurance is conducted before acceptance (except as
otherwise provided in the Federal Acquisition Regulations), by or under the
direction of Government personnel. The Company, as a U.S. Government
contractor, is required to control the quality of its products and to
tender to the Government only those products that meet the contract
requirements. Accordingly, the Company's Government contracts include
provisions that require its products to pass quality inspection prior to
acceptance by the Government. Revenue is not recognized until the products
pass quality inspection and accepted by the customer. In the event the
Government's acceptance occurs at destination, revenue is recognized at
shipment if it can be demonstrated that the delivered products meet all of
the specified criteria prior to customer acceptance. Payments received from
customers in advance of products delivered are recorded as advance payments
on contracts until earned.
Most of our customer contracts are firm, fixed price contracts, providing
for a predetermined fixed price for the products sold, regardless of the
costs incurred. A certain percentage of revenues are derived from
long-term, fixed price contracts. Revenues and estimated profits, including
contract claims and unpriced change orders, are recognized on these
contracts using the percentage of completion method of accounting and are
based on estimated completion to date (the total contract amount multiplied
by the percentage of performance, based on total costs incurred in relation
to total estimated cost at completion). The amount of claims and unpriced
change orders relating to changes in scope issues on a contract, which is
included in "Costs incurred and income recognized in excess of billings on
uncompleted contracts and claims" as of August 3, 2008 and July 29, 2007 is
approximately $4.3 million.
Prospective losses on long-term contracts are based upon the anticipated
excess of manufacturing costs over the selling price of the remaining units
to be delivered and are recorded in the period when first determinable.
Actual losses could differ from those estimated due to changes in the
ultimate manufacturing costs and contract terms.
Contract costs include all direct material and labor costs and those
indirect costs related to contract performance. Selling, general and
administrative costs are charged to expense as incurred.
13. Product Development
-------------------
The Company's primary efforts are focused on engineering design and product
development activities rather than pure research. The cost of these
development activities, including employees' time and prototype
development, was approximately $28.7, $33.4 and $33.3 million in fiscal
2008, 2007, and 2006, respectively, and are included in cost of products
sold. Amounts paid by customers toward these product development activities
were approximately $9.6, $20.3 and $20.9 million in fiscal 2008, 2007 and
2006, respectively and are included in net sales.
Expenditures for Company-sponsored research and development projects and
bid and proposal costs are expensed as incurred. Customer-sponsored
research and development projects performed under contracts are accounted
for as contract costs as the work is performed.
14. Income Taxes
------------
Income taxes are accounted for by the asset/liability approach in
accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred taxes
F-11
represent the expected future tax consequences when the reported amounts of
assets and liabilities are recovered or paid. They arise from temporary
differences between the financial reporting and tax bases of assets and
liabilities and are adjusted for changes in tax laws and tax rates when
those changes are enacted. The (benefit) provision for income taxes
represents the total of income taxes paid or payable for the current year,
plus the change in deferred taxes during the year.
Deferred tax assets pertaining to windfall tax benefits on exercise of
stock options and the corresponding credit to additional paid-in capital
are recorded if the related tax deduction reduces taxes payable. The
Company has elected the "With-and-without approach" regarding ordering of
windfall tax benefits to determine whether the windfall tax benefit did
reduce taxes payable in the current year. Under this approach, the windfall
tax benefits would be recognized in additional paid-in capital only if an
incremental tax benefit is realized after considering all other tax
benefits presently available to the Company.
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. 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.
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 2005 through 2008, 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.
15. Stock-Based Compensation
------------------------
The Company has various fixed stock option plans which are described in
Note N that provide for the grant of stock options to eligible employees
and directors.
Effective August 1, 2005, the Company adopted the fair value recognition
provisions of SFAS No. 123(R), "Share-Based Payment" ("SFAS 123(R)") using
the modified prospective application method. This standard requires the
Company to measure the cost of employee services received in exchange for
equity share options granted based on the grant-date fair value of the
options. The cost is recognized as compensation expense over the requisite
service period for each separately vesting portion of the options. Under
the modified prospective application method, compensation costs included in
operating expenses in the fifty-three weeks ended August 3, 2008 and the
fifty-two weeks ended July 29, 2007 and July 30, 2006 was approximately
$990,000, $1,007,000 and $453,000, respectively and includes: (a)
compensation cost of stock options granted prior to but not yet vested as
of August 1, 2005 (based on grant-date fair value estimated in accordance
with the provisions of SFAS 123) and (b) compensation cost for all options
granted subsequent to July 31, 2005 (based on grant-date fair value
estimated in accordance with the new provisions of SFAS 123(R)). New option
grants made after July 31, 2005, as well as option grants issued on or
prior to that date, have been valued using a Black-Scholes option valuation
model.
Income tax benefits relating to the exercise of stock options during the
fifty-three weeks ended August 3, 2008 and the fifty-two weeks ended July
29, 2007 and July 30, 2006 amounted to approximately $91,000, $256,000 and
$703,000, respectively. Commencing in fiscal 2006 income tax benefits
relating to the exercise of stock options are classified as a financing
cash inflow in the Company's Consolidated Statements of Cash Flows.
As of August 3, 2008, there were 3,512,225 stock options outstanding. The
aggregate value of unrecognized compensation costs related to unvested
options, as determined using a Black-Scholes option valuation model was
approximately $910,000 (net of estimated forfeitures) which is expected to
be recognized over a weighted-average period of 1.77 years. During the
fifty-three weeks ended August 3, 2008, the Company granted 4,000
non-qualified stock options, with a fair value of approximately $23,000.
Options for 38,725 shares of common stock were exercised at an average
price of $8.30 per share, and 93,500 options were forfeited during the
year.
The total intrinsic value of options exercised during the years ended
August 3, 2008, July 29, 2007 and July 30, 2006 was approximately $237,000,
$685,000 and $2,085,000, respectively.
F-12
The weighted average fair value of stock options on the date of grant, and
the assumptions used to estimate the fair value of stock options issued
during the periods presented using the Black-Scholes option valuation model
are as follows:
2008 2007 2006
---- ---- ----
Weighted average fair value of options granted $5.72 $5.72 $7.19
Expected life (years) 2.73 2.93 3.53
Expected volatility .47 .47 .44
Risk-free interest rate 5.1% 5.1% 4.3%
Expected dividend yield zero zero zero
Forfeiture rate 6.19 6.19 7.45
The expected life of options granted during the periods presented above is
based on the Company's historical share option exercise experience using
the historical expected term from vest date. The expected volatility of the
options granted is determined using historical volatilities based on
historical stock prices. The risk-free interest rate is determined using
the yield available for zero-coupon U.S. Government issues with a remaining
term equal to the expected life of the options. The Company has never paid
a dividend, and as such the dividend yield is zero. The forfeiture rate is
based on the Company's historical experience.
16. Foreign Currency Translation
----------------------------
Financial statements of foreign subsidiaries are prepared in their
respective functional currencies and translated into United States dollars
using exchange rates at the balance sheet date for assets and liabilities
and a monthly average rate during the year for revenues, costs and
expenses. Net gains or losses resulting from the translation of foreign
financial statements are charged or credited directly to the foreign
currency translation component of "Accumulated other comprehensive income"
in the accompanying consolidated statements of shareholders' equity.
Transaction gains and losses resulting from transactions entered into under
contracts in a currency other than the subsidiary's functional currency are
accounted for on a transactional basis as a credit or charge to operations.
17. Derivatives
-----------
The Company recognizes all derivatives on the consolidated balance sheet at
fair value. On the date the derivative instrument is entered into, the
Company generally designates the derivative as either (1) a hedge of the
fair value of a recognized asset or liability, or of an unrecognized firm
commitment ("fair value hedge") or (2) a hedge of a forecasted transaction
or of the variability of cash flows to be received or paid related to a
recognized asset or liability ("cash flow hedge"). The Company entered into
an interest rate swap in October 2001 with a bank, which it recognized as a
cash flow hedge. Changes in the fair value of a derivative that is
designated as, and meets all the required criteria for, a cash flow hedge
are recorded in accumulated other comprehensive income (loss) and
reclassified into earnings as the underlying hedged item affects earnings.
18. Comprehensive Income
--------------------
The Company reports comprehensive income in the Consolidated Statements of
Shareholders' Equity which includes net income, unrealized gain (loss) on
an interest rate swap, net of related income taxes; and foreign currency
translation gain (loss). Substantially all the amount included in other
comprehensive income relates to the effects of foreign exchange translation
gains and losses. No adjustment has been made for income taxes since
substantially all translation gains and losses relate to the permanent
investment in the foreign subsidiary.
19. Dividend Policy
---------------
The Company has not paid cash dividends in the Company's history. The
Company's board of directors evaluates its dividend policy based on its
financial condition, profitability, cash flow, capital requirements, and
the outlook of its business.
20. Advertising Costs
-----------------
The Company expenses advertising costs as incurred. Advertising costs in
fiscal 2008, 2007 and 2006 were $233,000, $315,000 and $262,000,
respectively.
21. New Accounting Pronouncements
-----------------------------
In April 2008, the FASB issued Staff Position ("SFP") No. FAS 142-3,
"Determination of the Useful Life of Intangible Assets", which amends the
factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible
F-13
asset under SFAS No. 142, "Goodwill and Other Intangible Assets." The
intent of FAS 142-3 is to improve the consistency between the useful life
of a recognized intangible asset under SFAS No. 142 and the period of
expected cash flows used to measure the fair value of the asset under SFAS
No. 141 (revised 2007), "Business Combinations", and other U.S. generally
accepted accounting principles. FAS 142-3 is effective for fiscal years
beginning after December 15, 2008 and only applies prospectively to
intangible assets acquired after the effective date. Early adoption is not
permitted. The Company is currently evaluating the impact this statement
will have on its consolidated financial position, cash flows and results of
operations.
In March 2008, the FASB issued SFAS No. 161 ("SFAS 161"), "Disclosures
about Derivative Instruments and Hedging Activities--an amendment of FASB
Statement 133, Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 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 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 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 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 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 FSP
No. 157-1 and No. 157-2, which, respectively, remove leasing transactions
from the scope of SFAS 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
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 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 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 financial
position, cash flows and results of operations.
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). 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 SFAS 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 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
shareholders' equity. The Company would also be required to present any net
income allocable to noncontrolling interests and net income attributable to
the shareholders 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.
F-14
Note B - ACQUISITIONS
The Company adjusted its valuation of the assets acquired and liabilities
assumed in the acquisition of ICI in accordance with the provisions of SFAS
No. 141 during the second quarter of fiscal 2006. Accordingly, the
Company's consolidated financial statements reflect an adjustment of
$2,504,000 to the reserve for contract losses relating to a contract in
ICI's backlog at the date of acquisition that consisted of an initial
production order and four additional options exercisable unilaterally by
the customer. Although the customer had not exercised any options as of the
date of acquisition, the Company had a contractual obligation to honor the
terms and conditions of the contract including the discounted pricing in
the contract options, with a high probability of the options being
exercised, resulting in the estimated losses under the contract. Two of the
four options were exercised. The accrual for contract losses was reduced by
$1.1 million in the fifty-two weeks ended July 29, 2007 (which is included
as a reduction of costs of products sold) as a result of management
changing its estimated liability for expected losses under the contract.
The balance of the accrual for contract losses of approximately $826,000
relating to the remaining two contract options was eliminated in the
fifty-three weeks ended August 3, 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.
NOTE C - INVENTORIES
The major components of inventories are as follows (in thousands):
August 3, July 29,
2008 2007
--------- --------
Purchased parts and raw materials $ 32,439 $ 28,526
Work in process 33,663 27,797
Finished products 2,623 2,576
------------- ----------
68,725 58,899
Less:
Allowance for obsolete and slow moving inventory 6,476 5,163
Unliquidated progress payments 690 1,921
------------- ----------
$ 61,559 $ 51,815
============= ==========
NOTE D - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following (in
thousands):
August 3, July 29, Estimated
2008 2007 Useful Life
---- ---- -----------
Land $ 4,006 $ 4,006
Building and building improvements 13,894 12,229 10-40 years
Machinery, equipment and software 60,594 56,128 3- 8 years
Furniture and fixtures 2,888 3,285 5-10 years
Leasehold improvements 2,073 3,242 5-10 years
----------- ----------- -----------
83,455 78,890
Less accumulated depreciation and amortization 52,903 48,894
----------- -----------
$ 30,552 $ 29,996
=========== ===========
Depreciation and amortization charges totaled approximately $5,017,000,
$5,389,000 and $5,208,000 in fiscal 2008, 2007 and 2006, respectively.
F-15
NOTE E - COMMITMENTS AND CONTINGENCIES
Leases
------
The Company leases office, production and warehouse space as well as
computer equipment and automobiles under non-cancelable operating leases.
Rent expense for the fifty-three weeks ended August 3, 2008 and the
fifty-two weeks ended July 29, 2007 and July 30, 2006, was approximately
$4,036,000, $3,812,000 and $3,960,000, respectively. Minimum annual rentals
under non-cancelable operating leases are as follows (in thousands):
Fiscal year ending Amount
------------------ ------
2009 $ 3,552
2010 3,460
2011 2,857
2012 1,472
2013 174
Thereafter 164
------
$11,679
======
Purchase Commitments
--------------------
The Company was committed to make future purchases primarily for inventory
related items under various purchase arrangements with fixed purchase
provisions aggregating approximately $23 million at August 3, 2008.
Employment and Severance Agreements
The Company has an employment agreement with the Chairman/Chief Executive
Officer of the Company which expires December 31, 2013, subject to
extension for additional one-year periods annually each January 1 with a
final expiration date of December 31, 2015 (as amended December 9, 2003).
The agreement provides for an annual salary as of August 3, 2008 of
$739,300 as adjusted under the agreement for a semi-annual cost of living
adjustment based on the consumer price index. The agreement also provides
for incentive compensation at 3% of pretax income of the Company. No
incentive compensation has been provided under the agreement for fiscal
2008. A discretionary bonus of $381,000 was paid and charged to expense in
fiscal 2008. Incentive compensation in the amount of approximately $369,000
and $477,000 was charged to expense in fiscal years 2007 and 2006,
respectively.
The agreement also provides that, in the event there is a change in control
of the Company, as defined, the executive has the option to terminate the
agreement and receive a lump-sum payment equal to the sum of his salary
payable for the remainder of the employment term, plus the annual bonus
(based on the average of the three highest annual bonuses awarded during
the ten preceding years) for the remainder of the employment term. As of
August 3, 2008, the amount payable in the event of such termination would
be approximately $8,357,000. The agreement also provides for a consulting
period of ten years at the end of the employment period at an annual
compensation equivalent to one-half of the executive's annual salary at the
end of the employment period, subject to annual cost of living adjustments.
Under the terms of an employment agreement with the Company's former
Chairman, incentive compensation in the amount of approximately $637,000
was charged to expense in fiscal 2006.
The Company entered into an employment agreement with the Chief Operating
Officer of the Company as of May 30, 2007 which expires July 31, 2011,
subject to extension for additional one-year periods annually beginning
July 31, 2008 with a final expiration date of July 31, 2012. The agreement
provides for an annual salary of $365,800 (adjusted for a semi-annual cost
of living adjustment based on the consumer price index), and an initial
award of 250,000 non-qualified stock options at the closing stock price on
the date prior to execution of the agreement of $15.77 per share. The
options vest 20% upon award and 20% annually over the next four years. The
agreement also provides for incentive compensation to be paid at the
discretion of the Board of Directors, however, incentive compensation for
the fiscal year ended August 3, 2008 is a minimum of $300,000 which has
been accrued in the financial statements as of August 3, 2008. The
agreement also provides for a consulting period of ten years at the end of
the employment period at an annual compensation of $100,000. In the event
there is a change in control of the Company, as defined, the executive has
the option to terminate the agreement at any time after July 31, 2010 and
receive a lump-sum payment equal to the sum of: (1) his salary payable for
the remainder of the employment term, (2) the annual bonuses (based on the
average of the annual bonuses awarded during the term of the employment
agreement) for the remainder of the employment term, and (3) a lump-sum
payment of $500,000 representing full consideration under the consulting
period.
Certain other executive officers of the Company have employment agreements
which expire June 6, 2009 providing for aggregate annual salaries as of
August 3, 2008 of $396,500.
An employment contract of a retired executive provides for a consulting
period which became effective October 1, 1998, and terminates December 31,
2010 at the annual rate of compensation of $100,000.
F-16
Several officers and key employees have severance agreements providing for
an aggregate lump-sum payment of approximately $2,533,000 in the event of a
change of control as defined in the agreements. The agreements expire from
one to two years from the date of a change of control.
Litigation
----------
On June 6, 2006, in connection with an investigation by the U.S. Attorneys'
Office in Pennsylvania which, inter alia, involved 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. 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 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
entered a guilty plea for failing to keep Company records of the allocation
of an $18,000 corporate research expense. Mr. Blatt was fined $25,000,
received a term of probation of one year and was required to perform some
community service which has been completed.
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 our Directors and Officers ("D&O")
insurance policy. As of August 3, 2008, the Company has aggregate claims of
approximately $7,151,000 (net of a deductible of $500,000) and has received
F-17
partial payments of approximately $2,236,000. 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, we shall repay to the
insurance carrier any such uncovered sums previously advanced to us.
Subsequent to the end of fiscal 2008, the insurance carrier asserted in a
letter their determination that they are not liable for certain of the
legal costs incurred by the Company. The Company has responded with a
letter, supported by court case citations, that all the submitted costs
represent valid claims under the policy and that the insurance company is
liable. The Company believes such costs represent a "loss" under its D&O
policy. However, based on the insurance company's position and in
accordance with the guidance in AICPA Statement of Position 96-1,
"Environmental Remediation Liabilities" and Securities and Exchange
Commission Staff Accounting Bulletin No. 92 "Accounting and Disclosures
Relating to Loss Contingencies", the Company is not permitted to record a
potential claim for recovery under its insurance policy. Accordingly, the
previously recorded receivable of $2,803,000 as of May 4, 2008 has been
eliminated in the fourth quarter of fiscal 2008.
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."
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 the
Company's business is received under contracts where it is 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 filed a lawsuit against 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 A-1.
F-18
In accordance with SFAS No. 5, "Accounting for Contingencies," the Company
determines whether an estimated loss from a loss contingency should be
accrued by assessing whether a loss is deemed probable and can be
reasonably estimated. Litigation is inherently unpredictable and due to the
uncertainty of the outcome of the matters discussed above, the Company has
concluded that it is currently not probable that a loss has been incurred.
Accordingly, no accrual has been recorded in the accompanying consolidated
financial statements. If an unfavorable ruling were to occur in any
specific period, there exists the possibility of a material adverse impact
on the results of operations for that period.
The Company is involved in various other legal proceedings and claims which
arise in the ordinary course of its business. While any litigation contains
an element of uncertainty, management believes that the outcome of such
litigation will not have a material adverse effect on the Company's
consolidated financial position, cash flows and results of operations.
Stand-by Letters of Credit
--------------------------
The Company maintains a letter of credit facility in connection with the
revolving credit agreement with two banks that provides for the issuance of
stand-by letters of credit and requires the payment of a fee of 1.0% per
annum of the amounts outstanding under the facility. The facility expires
March 31, 2010. At August 3, 2008, stand-by letters of credit aggregating
approximately $15,878,000 were outstanding under this facility (See Note
G).
NOTE F - INCOME TAXES
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.
As of August 3, 2008, the Company's unrecognized tax benefits, that if
recognized would affect the Company's effective tax rate, were $509,000. A
reconciliation of the beginning and ending amount of unrecognized tax
benefits is as follows:
Balance at July 30, 2007 upon adoption $ 3,139,000
Lapse of statute of limitations (2,737,000)
Accrued interest 107,000
--------------
$ 509,000
==============
The unrecognized tax benefits are included as "Accrued Income Taxes
Payable" under long-term liabilities in the accompanying Consolidated
Balance Sheets.
(Loss) income before income taxes consists of the following (in thousands):
Fifty-three
weeks ended Fifty-two weeks ended
August 3, July 29, July 30,
2008 2007 2006
---- ---- ----
(Loss) income before income taxes:
Domestic (loss) income $ (21,089) $ (2,124) $ 11,514
Foreign income 740 4,223 2,819
------------ --------- -------------
Total (loss) income $ (20,349) $ 2,099 $ 14,333
============ ========= =============
F-19
(Benefit) provision for income tax consists of the following (in
thousands):
Fifty-three
Weeks ended Fifty-two weeks ended
August 3, July 29, July 30,
2008 2007 2006
---- ---- ----
Current:
Federal $ (4,968)$ 283 $ 3,036
State (531) (448) 350
Foreign (229) 456 375
-------------- ----------- -----------
(5,728) 291 3,761
-------------- ----------- -----------
Deferred:
Federal (4,170) (1,196) 225
State (22) (114) 24
Foreign (83) - (31)
-------------- ----------- -----------
(4,275) (1,310) 218
-------------- ----------- -----------
$ (10,003)$ (1,019) $ 3,979
============== =========== ===========
The Company (received refunds) paid income taxes of approximately
($1,217,000), $225,000 and $3,407,000 in fiscal 2008, 2007 and 2006,
respectively.
The benefit for income taxes for fiscal 2008 was $10,003,000 representing
an effective income tax benefit rate of 49.2%, as compared to an effective
income tax benefit rate of (48.5)% in fiscal 2007. The 49.2% benefit
exceeds the statutory rate of 35% primarily due to the reversal of FIN 48
liabilities that are no longer needed due to the expiration of the statute
of limitations for an earlier tax year in which an uncertain tax position
had been taken offset by the tax on the non-deductible penalty paid as part
of the litigation settlement, which reduced the benefit by 6.0%.
The following is a reconciliation of the U. S. Federal statutory income tax
rate and the effective tax rate on pretax income:
Fifty-three
weeks ended Fifty-two weeks ended
August 3, July 29, July 30,
2008 2007 2006
----------- -------- --------
Tax (benefit) provision at
Federal statutory rate 35.0 % 35.0 % 35.0 %
State income taxes, net of
Federal income tax benefit 2.0 (1.8) 1.8
Benefit of extra territorial income - (7.7) (1.4)
Non-deductible expenses (0.5) 1.0 0.9
Benefit of foreign and
foreign-source income 1.3 (48.6) (4.5)
Research and development credits 0.6 (5.1) (1.3)
Tax exempt interest - (3.4) (1.2)
Adjustment of prior year accrual 3.3 (8.3) -
Non-Deductible Fine (6.0) - -
Reversal of unrecognized tax benefits 13.4 (10.7) -
Other, net 0.1 1.1 (1.5)
-------------- --------- -----------
Effective tax rate 49.2 % (48.5) % 27.8 %
============== ========= ===========
In the fifty-three weeks ended August 3, 2008, the Company recorded
benefits from accrual adjustments from the previous year consisting of: (1)
a benefit relating to the research and development credit carryover from
fiscal year 2007; and (2) the final rate adjustment for the Israel income
tax provision of 5% as compared to an estimated rate of 11% for fiscal year
2007. These items were included in the tax benefit recorded in fiscal 2008.
In the fifty-two weeks ended July 30, 2006, the Company recorded $453,000
of stock compensation costs related to various stock options outstanding in
accordance with SFAS 123(R). For tax purposes, these costs are not
deductible until the stock options are actually exercised. This temporary
difference should have increased the balance of the deferred tax asset on
the balance sheet as of July 30, 2006 by $173,000. The Company's tax return
for fiscal year 2006 properly accounted for these costs. However, the
related deferred tax asset was not properly recorded on the balance sheet
at July 30, 2006. The deferred tax asset of $173,000 was corrected in
fiscal 2007 as an adjustment of the prior year's accrual resulting in a
benefit reflected in the above table as (8.3) %. The amount was deemed not
F-20
to be material to the balance sheet under the "iron curtain" approach and
not considered material to the statement of operations under the "rollover"
approach in accordance with the provisions of Securities and Exchange
Commission Staff Accounting Bulletin No. 108.
Income taxes have not been provided on undistributed earnings of foreign
subsidiaries. If remitted as dividends, these earnings could become subject
to additional tax. The Company's intention is to reinvest non-remitted
earnings of subsidiaries outside the United States permanently.
The tax effects of significant items comprising deferred income taxes are
as follows (in thousands):
August 3, 2008 July 29, 2007
---------------------------------- ---------------------------------
Deferred Tax Assets Long-term Deferred Tax Assets Long-term
Long Deferred Tax Long Deferred Tax
Current Term Liabilities Current Term Liabilities
------- ---- ----------- ------- ---- -----------
Intangibles $ - $ - $ 7,334 $ - $ - $ 5,598
Accrued vacation pay 959 - - 534 - -
Accrued bonus 179 - - 286 - -
Accrued warranty and other costs 388 - - 219 - -
Inventory 2,538 - - 1,719 - -
Depreciation - - 3,420 - - 3,006
Accrual for contract losses 899 - - 44 - -
Net operating loss carry-forwards 5,488 - - 912 - -
Accrued employment settlement costs 458 959 - 458 1,432 -
Plant closing costs 133 - - - - -
Stock compensation costs - 936 - - 557 -
Other 221 20 - 82 - -
-------- ------ -------- ------ ------ -------
$ 11,263 $1,915 $ 10,754 $ 4,254 $1,989 $ 8,604
======== ===== ======== ======= ====== =======
As of August 3, 2008, the Company has available net operating loss
carry-forwards for state income tax purposes of approximately $10,113,000
and $8,657,000, net of carryback, for Federal income tax purposes with
expiration dates through 2028. Unused research and development credits of
approximately $128,000, which expire in 2028, are available for Federal
income tax purposes. There is also an AMT credit of $163,000 available.
NOTE G- LONG-TERM DEBT
Long-term debt is summarized as follows (in thousands):
August 3, July 29,
Rate 2008 2007
-------------------- ---- ----
Revolving loan facility (a) 4.11% and 4.50% $ 2,500 $ -
Mortgage note (b) 7.43% 2,105 2,222
Industrial Revenue Bonds (c) 4.07% 2,355 2,475
Note payable (d) 6.75% 633 1,175
Note payable (e) 5.35% 681 1,144
Other 212 281
------------ ----------
8,486 7,297
Less current portion 1,394 1,346
------------ ----------
$ 7,092 $ 5,951
============ ==========
(a) On April 30, 2007, the Company replaced its existing credit facility with a
new $40 million Revolving Credit Loan Agreement ("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 Agreement requires the payment of interest only on a monthly basis and
payment of the outstanding principal balance on March 31, 2010. The
Agreement was modified as of September 12, 2008. Under the terms of the
modification, 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 2.0% effective September 12, 2008 (the margin was 1.65% at August 3,
2008). In addition, if in the event the sale of ICI (see Note S) is not
consummated by November 30, 2008, the Company will grant the bank a
security interest in its domestic accounts receivable, inventory and all
other non-real estate domestic assets. There is a fee of 20 basis points
per annum on the unused portion of the credit facility payable quarterly.
Stand-by letters of credit were outstanding in the amount of approximately
$15.9 million at August 3, 2008 (See Note E). If at any time the Company's
backlog of orders falls below $50 million, the bank may obtain a security
F-21
interest in eligible accounts receivable, as defined, and if the
outstanding advances are greater than 100% of eligible receivables, a lien
on all inventories. Funded backlog relating to continuing operations as of
August 3, 2008 was approximately $157 million. A loan of $2,500,000 was
outstanding under the line at August 3, 2008. There were no borrowings
under the line at July 29, 2007.
The agreement contains various financial covenants, including, among other
matters, minimum tangible net worth, total liabilities to tangible net
worth, debt service coverage and restrictions on other borrowings. The
Company was in compliance with all such financial covenants at August 3,
2008. In connection with the acquisition of Eyal Microwave Ltd. discussed
in Note T, the Company received a waiver of the tangible net worth
covenant.
(b) The mortgage loan is for a term of ten years commencing February 16, 1999
(with an extended maturity as modified to March 1, 2014) with fixed monthly
principal and interest installments of $23,359 based upon a twenty-year
amortization including interest at a fixed rate of 7.43% through March 1,
2009 and at LIBOR plus 1.75% thereafter. The loan is secured by a mortgage
on the Company's land and building in Lancaster, Pennsylvania having a net
book value of approximately $1,810,000 at August 3, 2008.
The mortgage note agreement contains various financial covenants,
including, among other matters, the maintenance of specific amounts of
tangible net worth, debt to tangible net worth, debt service coverage and
restrictions on other borrowings. The Company is in compliance with all
such financial covenants at August 3, 2008. In connection with this loan,
the Company paid approximately $45,000 in financing costs. Such costs are
included in Other Assets in the accompanying consolidated balance sheets
and are being amortized over the term of the loan (10 years).
(c) On October 19, 2001, the Company received $3,000,000 in proceeds from the
East Hempfield Township Industrial Development Authority Variable Rate
Demand/Fixed Rate Revenue Bonds Series of 2001 (the "Bonds"). The Bonds are
due in varying annual installments through October 1, 2021. The initial
installment of $95,000 was paid October 1, 2002 and increases each year
until the final payment of $225,000 in 2021. The interest rate on the Bonds
is reset weekly at the prevailing market rate of the BMA Municipal Index.
The initial rate of interest was 2.1%, which, after giving effect to a ten
year interest rate swap agreement (See Note P) becomes a fixed rate of
4.07%. The interest rate at August 3, 2008 was 2.39%. The bond agreement
requires a sinking fund payment on a monthly basis to fund the annual Bonds
redemption installment. Proceeds from the Bonds were used for the
construction of a 15,000 square foot expansion of the Company's facilities
in Lancaster, Pennsylvania, and for manufacturing equipment.
The Bonds are secured by a letter of credit in the amount of approximately
$2,390,000 expiring October 18, 2011 and a mortgage on the related
properties pledged as collateral. The net book value of the land and
building covered by the mortgage was approximately $1,644,000 at August 3,
2008.
(d) In June 2006, the Company entered into a loan agreement with DeLage Landen
Financial Services, Inc. through Microsoft Capital Corporation for the
principal sum of $1,626,501. The note is payable in thirty-six monthly
payments of approximately $45,181 including imputed interest at 6.75% per
annum. Proceeds of the loan were used to license certain software and
related maintenance fees from Microsoft Corporation.
(e) In connection with the implementation of an integrated manufacturing and
financial accounting and reporting software package, the Company entered
into an additional financing agreement in August 2006 with DeLage Landen
Financial Services, Inc. through Microsoft Capital Corporation providing
for loans not to exceed an aggregate of $2.0 million. Amounts borrowed
under the agreement are payable in thirty-six equal monthly installments
with interest at 5.354% per annum. The Company borrowed an aggregate of
$1.4 million with monthly payments totaling approximately $42,750.
The Company paid interest in fiscal 2008, 2007 and 2006 of approximately
$406,000, $469,000 and $291,000, respectively.
Future payments required on long-term debt are as follows (in thousands):
Fiscal year ending during: Amount
------------------------- ------
2009 $ 1,394
2010 3,061
2011 281
2012 297
2013 320
Thereafter 3,133
-------
$ 8,486
=======
F-22
NOTE H - EMPLOYMENT SETTLEMENT AGREEMENT
Effective October 12, 2006 and as a condition to entering into the
Administrative Agreement with the Department of the Navy discussed in Note
A-1, the Company entered into an agreement (the "Agreement") with Lee N.
Blatt to terminate the Employment Agreement between the Company and him
dated as of July 29, 2002 and modified on December 9, 2003. Under the terms
of the Agreement he will receive payments totaling $9,461,528 payable
$3,000,000 upon the effective date of the Agreement and sixty-four (64)
consecutive monthly payments of $100,000 commencing on January 1, 2007 and
a final payment of $61,528 on May 1, 2012 as evidenced by a non-interest
bearing Promissory Note dated effective October 12, 2006 (the "Promissory
Note"). In addition, he received his bonus of $636,503 for fiscal year
2006, and shall be entitled to receive medical care reimbursement and
insurance, including life insurance, in accordance with the original terms
of his Employment Agreement. The Agreement also provides that all
outstanding stock options previously issued to him which are all vested and
fully exercisable shall continue to be exercisable by him or, following his
death, by his designated beneficiaries, on or before the expiration date of
the specific option. On September 26, 2006, as required under the terms of
the Administrative Agreement with the Department of the Navy, Mr. Blatt
entered into a voting trust agreement wherein sole voting power to
1,301,000 shares under stock options held by him and 28,799 shares held in
his IRA was granted to the Company's Chairman, Myron Levy. In the event of
a "change of control" of the Company as defined in the Employment Agreement
all remaining payments due under the Promissory Note become immediately due
and payable.
Aggregate costs of approximately $8,914,000 under the Agreement, including
an initial cash payment of $3,000,000, payments due under the Note of
approximately $5,354,000, medical and life insurance benefits of
approximately $364,000 (both discounted at an imputed interest rate of
6.75%) and the fair value of the modification of the stock options of
approximately $196,000 (using the Black-Scholes option valuation model),
have been recorded in the consolidated financial statements for the
fifty-two weeks ended July 29, 2007.
The current portion of the settlement agreement payments, net of imputed
interest of $238,000, as of August 3, 2008 is approximately $1,119,000 and
the long-term portion, net of imputed interest of $287,000, is
approximately $3,074,000.
The principal portion of the payments due under the promissory note in each
fiscal year is approximately $961,700 in 2009, $1,028,700 in 2010,
$1,100,300 in 2011 and $875,200 in 2012.
NOTE I - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND WARRANTY COSTS
Accounts payable and accrued expenses include the following (in thousands):
August 3, July 29,
2008 2007
---- ----
Accounts payable $ 15,502 $ 8,407
Accrued payroll, bonuses and related costs 6,761 5,812
Accrued commissions 1,254 1,088
Accrued legal and accounting fees 1,302 1,117
Accrued rent expense 1,123 1,332
Accrued contract penalties 733 404
Other accrued expenses 871 1,293
------ ------
$ 27,546 $ 19,453
====== ======
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 fifty-three and fifty-two weeks ended August 3, 2008 and July
29, 2007, respectively (in thousands):
Fifty-three Fifty-two
weeks ended weeks ended
August 3, July 29,
2008 2007
---- ----
Balance at beginning of period $ 1,106 $ 986
Provision for warranty obligations 1,260 1,338
Warranty costs charged to the reserve (1,224) (1,218)
----- -----
Balance at end of period $ 1,142 $ 1,106
===== =====
F-23
NOTE J - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan
("Plan") which qualified as a thrift plan under Section 401(k) of the
Internal Revenue Code ("Code"). Effective August 1, 2006, the Plan was
amended to allow employees to elect salary deferrals up to the maximum
dollar amounts permissible under Code Section 402(g) not to exceed the
limits of Code Section 401(k), 404 and 415. For the Plan year beginning
August 1, 2005, the Plan was amended to be considered a "Safe Harbor" plan,
where a contribution will be made to eligible participants in an amount
equal to 100% of the amount of each participant's elective deferral that
does not exceed 3% of compensation, plus 50% of the amount of the elective
deferral that exceeds 3% of compensation up to a maximum contribution of 5%
of compensation. Under the Safe Harbor provision, all contributions are
100% vested when made. Additional Company contributions can be made
depending on profits. The aggregate benefit payable to an employee is
dependent upon his rate of contribution, the earnings of the fund, and the
length of time such employee continues as a participant. ICI also has a
"Safe Harbor" plan, where a contribution will be made to eligible
participants in an amount equal to 100% of the amount of each participant's
elective deferral that does not exceed 6% of compensation, subject to the
Code limitations discussed above. The Company has recognized expenses of
approximately $1,765,000, $1,766,000 and $1,773,000 under the plans for the
fifty-three weeks ended August 3, 2008 and the fifty-two weeks ended July
29, 2007 and July 30, 2006, respectively. The Company also contributed to a
similar plan through EWST whereby the Company matches employee elective
contributions up to a maximum of 5% of compensation. Expenses recognized
for 2008, 2007 and 2006 were approximately $86,000, $75,200 and $55,900,
respectively.
The Company's Israeli subsidiary provides for employee severance
liabilities pursuant to the Israeli severance pay law and labor agreements.
The Company's liability is fully provided for by monthly payments deposited
with insurers and by a reserve established by the Company to cover the
portion of this liability not covered by the Company's deposits. In
addition to recognizing an expense for the funding to the insurance
programs for this severance obligation, the Company also records as expense
the net increase in its unfunded severance liability. The liability for
this unfunded severance obligation is carried in Other Long-Term
Liabilities on the accompanying Consolidated Balance Sheets and was
$1,652,000 and $1,311,000 at August 3, 2008 and July 29, 2007,
respectively. The total expense recognized for employee severance programs
in Israel (both the funded and unfunded portion of the program) was
approximately $458,000, $228,000 and $223,000 for fiscal years 2008, 2007
and 2006, respectively.
NOTE K - RELATED PARTY TRANSACTIONS
Prior to the acquisition of MSI, MSI had leased one of its two buildings in
Fort Walton Beach, Florida from MSI Investments, a Florida General
Partnership. MSI Investments is owned by four individuals, two of whom are
currently employees of MSI and one serves as a consultant. Lease costs paid
in fiscal years 2008, 2007 and 2006 were $281,000, $273,000 and $265,000,
respectively.
The Company entered into a 10 year lease agreement with a partnership
partially owned by the children of the Company's Chairman. The lease
provides for initial minimum annual rent of $312,000 subject to escalation
of approximately 4% annually throughout the 10 year term. Additionally, in
March 2000, the Company entered into another 10 year lease with the same
partnership for additional space. The initial minimum annual rent of
$92,000 is subject to escalation of approximately 4% annually. On August
24, 2005, the Company amended the agreement to incorporate the two
individual leases into a single lease and extended the term of the lease to
August 31, 2010. The Company incurred rent expense of approximately
$478,000, $487,000 and $485,000 in fiscal 2008, 2007 and 2006,
respectively. During the fourth quarter of fiscal 2008 the Company decided
to close its manufacturing facility in Farmingdale, NY and transfer its
contracts and assets to its other facilities in Whippany, New Jersey;
Woburn, Massachusetts; Lancaster, Pennsylvania; and Jerusalem, Israel. The
major costs associated with the restructuring are one-time termination
benefits which are estimated at approximately $1.1 million. The costs are
being accrued evenly from May 2008 through December 2008. Costs accrued
during the fourth quarter approximated $377,000, of which $313,000 is
included in cost of products sold and $64,000 is included in selling and
administrative expenses. Charges against the liability for amounts paid
during the fourth quarter approximated $30,000 leaving a liability at
August 3, 2008 of $347,000.
NOTE L - COMPUTATION OF PER SHARE EARNINGS
The Company follows the provisions of SFAS No. 128, Earnings Per Share.
Basic earnings per common share (Basic EPS) are computed by dividing net
income by the weighted average number of common shares outstanding. Diluted
earnings per common share (Diluted EPS) are computed by dividing net income
by the weighted average number of common shares and dilutive common share
equivalents and convertible securities then outstanding. SFAS No. 128
requires the presentation of both Basic EPS and Diluted EPS on the face of
the consolidated statements of operations.
The following provides a reconciliation of the shares used in calculating
the per share amounts for the fiscal years ended August 3, 2008, July 29,
2007 and July 30, 2006 (in thousands):
F-24
Fifty-three Fifty-two weeks ended
weeks ended ---------------------
August 3, July 29, July 30,
2008 2007 2006
-------------- --------- ----------
Numerator:
Net (Loss) Income ($ 10,346) $ 3,118 $ 10,354
============== ========= ==========
Denominator:
Basic weighted-average shares 13,652 13,927 14,463
Effect of dilutive securities:
Employee stock options - 468 634
-------------- --------- ----------
Diluted weighted-average shares 13,652 14,395 15,097
============== ========= ==========
Stock options not included in computation 3,512 1,757 1,722
============== ========= ==========
Employee stock options for 3,512,225 shares were not considered in the
computation of diluted loss per share calculations for fiscal 2008 as their
effect is anti-dilutive. The number of stock options not included in the
computation of diluted EPS for the fiscal years 2007 and 2006 relates to
stock options having exercise prices which are greater than the average
market price of the common shares during the period, and therefore, are
anti-dilutive. The options, which were outstanding as of August 3, 2008,
expire at various dates through June 8, 2017 (See Note N).
NOTE M - COMPREHENSIVE INCOME
The foreign currency translation gain relates to the Company's investment
in its U.K. subsidiary and fluctuations in exchange rates between its local
currency and the U.S. dollar.
As of the fiscal years ended August 3, 2008 and July 29, 2007, the
components of accumulated other comprehensive income is as follows (in
thousands):
August 3, July 29,
2008 2007
---- ----
Unrealized loss on interest rate swap, net of taxes $ (54) (29)
Foreign currency translation gain 1,676 1,774
----- -----
$ 1,622 1,745
===== =====
NOTE N - SHAREHOLDERS' EQUITY
On June 15, 2006, the Company announced a resumption of the stock
repurchase program initially announced in October 2002 covering 1,000,000
shares of common stock of the Company and subsequently expanded on May 30,
2003 to cover up to 2,000,000 shares of common stock and again increased on
October 12, 2007 to purchase up to 3,000,000 shares in the open market. As
of August 3, 2008 the Company has acquired an aggregate of approximately
2,392,000 shares of common stock under this program of which 493,938 and
798,567 shares were acquired during fiscal years 2008 and 2006 at an
aggregate cost of approximately $7,139,000 and $9,044,000, respectively.
Summary of Stock Option Plans:
In August 2006, the Board of Directors ratified and approved the 2006 New
Employee Stock Option Plan which covers 500,000 shares (as amended June 8,
2007) of the Company's common stock. Options granted under the plan are
non-qualified stock options. Under the terms of the plan, the exercise
price for options granted under the plan will be the fair market value at
the date of grant. The nature and terms of the options to be granted are
determined at the time of grant by the Compensation Committee or the Board
of Directors. The options expire no later than ten years from the date of
grant, subject to certain restrictions. Options for 4,000 and 250,000
shares were granted under the plan during the fiscal years ended August 3,
2008 and July 29, 2007, respectively. Options for 213,000 shares of common
stock are available for grant under the plan as of August 3, 2008.
In March 2003, the Board of Directors approved the 2003 Stock Option Plan
which covers 1,000,000 shares of the Company's common stock. Options
granted under the plan are non-qualified stock options. Under the terms of
the plan, the exercise price for options granted under the plan will be the
fair market value at the date of grant. The nature and terms of the options
to be granted are determined at the time of grant by the Compensation
Committee or the Board of Directors. The options expire no later than ten
years from the date of grant, subject to certain restrictions. No options
were granted under the plan the fiscal year ended August 3, 2008. Options
F-25
for 97,000 shares were granted under the plan during the fiscal year ended
July 29, 2007. Options for 12,000 shares were cancelled in fiscal 2008 and
options for 15,700 shares of common stock are available for grant under the
plan as of August 3, 2008.
In September 2000, the Board of Directors approved the 2000 Stock Option
Plan which covers 1,500,000 shares of the Company's common stock. Options
granted under the plan are non-qualified stock options. Under the terms of
the plan, the exercise price for options granted under the plan will be the
fair market value at the date of grant. The nature and terms of the options
to be granted are determined at the time of grant by the Compensation
Committee or the Board of Directors. The options expire no later than ten
years from the date of grant, subject to certain restrictions. No options
were granted under the plan the fiscal year ended August 3, 2008. Options
for 26,000 shares were granted under the plan during the fiscal year ended
July 29, 2007. Options for 30,500 shares were cancelled in fiscal 2008 and
options for 32,250 shares of common stock are available for grant under the
plan as of August 3, 2008.
In April 1998, the Board of Directors approved the 1998 Stock Option Plan
which covers 2,250,000 shares of the Company's common stock. The plan has
expired with respect to the granting of new options. Options which have
been granted under the plan are non-qualified stock options. Under the
terms of the plan, the exercise price for options granted under the plan
will be the fair market value at the date of grant. Prices for incentive
stock options granted to employees who own 10% or more of the Company's
stock are at least 110% of market value at date of grant. The nature and
terms of the options to be granted are determined at the time of grant by
the Compensation Committee or the Board of Directors. The options expire no
later than ten years from the date of grant, subject to certain
restrictions. No options were granted under the plan the fiscal year ended
August 3, 2008. Non-qualified stock options for 33,500 shares were granted
under this plan during the fiscal year ended July 29, 2007. Options for
51,000 shares were cancelled in fiscal 2008. There are no options available
for grant under the plan.
In May 1997, the Board of Directors approved the 1997 Stock Option Plan
which covers 2,500,000 shares of the Company's common stock. The plan has
expired with respect to the granting of new options. Options which have
been granted under the plan are non-qualified stock options. Under the
terms of the plan, the exercise price for options granted under the plan
will be the fair market value at the date of grant. Prices for incentive
stock options granted to employees who own 10% or more of the Company's
stock are at least 110% of market value at date of grant. The nature and
terms of the options to be granted are determined at the time of grant by
the Compensation Committee or the Board of Directors. The options expire no
later than ten years from the date of grant, subject to certain
restrictions. There are no options available for grant under the plan.
In October 1995, the Board of Directors approved the 1996 Stock Option Plan
which covers 1,000,000 shares of the Company's common stock. The plan has
expired with respect to the granting of new options. Options which have
been granted under the plan are non-qualified stock options. Under the
terms of the plan, the exercise prices of the options granted under the
plan were at the fair market value at the date of grant. The options expire
not later than ten years from the date of grant. At August 3, 2008,
non-qualified options to purchase 7,007 shares of common stock were
outstanding under this plan.
A summary of stock option activity under all plans for the fifty-three
weeks ended August 3, 2008 and the fifty-two weeks ended July 29, 2007 and
July 30, 2006 is as follows:
Non-Qualified Stock Options Weighted Aggregate
- --------------------------- Average Intrinsic
Number Price Range Exercise Value (1)
of shares per share Price (in thousands)
--------- ----------- -------- ------------
Outstanding July 31, 2005 3,735,530 $ 4.06 - 19.52 $ 12.33
Granted 79,000 16.61 - 21.18 19.11
Exercised (272,429) 4.31 - 19.83 11.73
Cancelled (52,021) 17.98 - 20.45 19.64
--------- ------------------------------
Outstanding July 30, 2006 3,490,080 $ 4.06 - 20.45 $ 14.41
Granted 406,500 15.77 - 17.82 16.56
Exercised (116,630) 4.06 - 13.10 10.45
Cancelled (139,500) 13.10 - 20.09 18.86
--------- ------------------------------
Outstanding July 29, 2007 3,640,450 $ 7.25 - 21.18 $ 14.84
Granted 4,000 12.58 - 15.16 13.87
Exercised (38,725) 7.25 - 13.10 8.30
Cancelled (93,500) 14.50 - 20.09 18.95
--------- ------------------------------
Outstanding August 3, 2008 3,512,225 $ 7.63 - 21.18 $ 14.80 $ 8,566
=========
Exercisable August 3, 2008 3,201,825 $ 14.59 $ 8,520
Vested and expected to vest August 3, 2008 3,479,433 $ 14.78 $ 8,561
<FN>
(1) There are 1,494,600 vested options with exercise prices greater than the
closing stock price of $16.02 as of August 3, 2008.
</FN>
F-26
Options outstanding and exercisable by price range as of August 3, 2008,
with expiration dates ranging from November 22, 2008 to June 8, 2017 are as
follows:
Options Outstanding Options Exercisable
------------------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Range of Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
----------------- ----------- ---------------- -------------- ----------- --------------
$ 7.63 - 10.46 1,053,025 1.78 $ 9.45 1,053,025 $ 9.45
10.97 - 15.77 798,200 5.04 13.96 644,200 13.53
15.78 - 17.82 183,500 5.66 17.63 118,100 17.60
17.98 - 17.98 796,000 4.27 17.98 735,600 17.98
18.57 - 21.18 681,500 3.46 19.57 650,900 19.57
--------- ---- ----- --------- -----
$ 7.62 - 21.18 3,512,225 3.61 $ 14.80 3,201,825 $ 14.59
========= =========
NOTE O - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, EXPORT SALES AND GEOGRAPHIC
INFORMATION
The Company's chief operating decision makers are considered to be the
Chairman/Chief Executive Officer and the Chief Operating Officer ("Chief
Executive Officers"). The Company's Chief Executive Officers evaluate both
consolidated and disaggregated financial information, primarily gross
revenues, in deciding how to allocate resources and assess performance. The
Chief Executive Officers 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.
Revenues for fiscal years 2008, 2007 and 2006 were as follows: defense
electronics, $142,296,000, $148,314,000 and $159,717,000, respectively; and
commercial technologies, $10,215,000, $14,826,000 and $16,551,000,
respectively.
Approximately 62%, 64% and 67% of our net sales for fiscal 2008, 2007 and
2006 were made to United States government agencies and their contractors
and subcontractors for defense programs. Net sales directly to the U.S.
Government in fiscal 2008, 2007 and 2006 accounted for approximately 19%,
20% and 22% of net sales, respectively. Lockheed Martin Corporation and
Northrop Grumman Corporation accounted for approximately 12% each of net
sales in fiscal 2008. No other customer accounted for 10% or more of
consolidated net sales during the periods presented. Sales to foreign
customers amounted to approximately $48,490,000 (32%), $44,857,000 (27%)
and $41,817,000 (24%) in fiscal 2008, 2007 and 2006, respectively.
Geographic net sales based on place of contract performance were as follows
(in thousands):
2008 2007 2006
----- ---- ----
United States $ 129,546 $ 139,349 $ 155,057
Israel 19,166 19,207 14,048
England 3,799 4,584 7,163
---------- ---------- ----------
$ 152,511 $ 163,140 $ 176,268
========== ========== ==========
Net property, plant and equipment by geographic area were as follows (in
thousands):
2008 2007
----- ----
United States $ 25,864 $ 24,904
Israel 4,495 4,844
England 193 248
---------- ----------
$ 30,552 29,996
========== ==========
Total assets of foreign subsidiaries accounted for approximately 12% and
11% of total consolidated assets in fiscal 2008 and 2007, respectively; and
total foreign liabilities accounted for approximately 8% of total
consolidated liabilities in each of fiscal 2008 and 2007.
F-27
NOTE P - DERIVATIVE FINANCIAL INSTRUMENTS
In October 2001, the Company entered into an interest rate swap with a bank
pursuant to which it exchanged floating rate interest in connection with
the Bonds discussed in Note H on a notional amount of $3,000,000 for a
fixed rate of 4.07% for a 10 year period ending October 1, 2011. The
notional amount reduces each year in tandem with the annual installments
due on the Bonds. The fixing of the interest rate for the ten year period
offsets the Company's exposure to the uncertainty of floating interest
rates on the Bonds, and as such has been designated as a cash flow hedge.
The hedge is deemed to be highly effective and any ineffectiveness will be
recognized in interest expense in the reporting period. The fair value of
the interest rate swap was a liability of $87,200 and $42,300 as of August
3, 2008 and July 29, 2007, respectively. There was no material hedge
ineffectiveness related to cash flow hedges during the period to be
recognized in earnings. There was no gain or loss reclassified from
accumulated other comprehensive income into earnings during the fiscal year
ended August 3, 2008 as a result of the discontinuance of a cash flow hedge
due to the probability of the original forecasted transaction not
occurring.
NOTE Q - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance
sheet for cash and cash equivalents approximates fair value because of the
short-term maturity of those instruments.
Accounts receivable and accounts payable: The carrying amounts reported in
the balance sheet for accounts receivable and accounts payable approximates
fair value because of the short-term maturity of those instruments.
Long-term debt: The fair value of the mortgage note and industrial revenue
bonds (including the related interest rate swap) was estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rate for similar types of borrowing arrangements.
The carrying amounts and fair values of the Company's financial instruments
are presented below (in thousands):
August 3, 2008
---------------------------------------
Carrying Amount Fair Value
-------------------- ---------------
Cash and cash equivalents $ 14,347 $ 14,347
Long-term debt 7,092 7,414
F-28
NOTE R - QUARTERLY RESULTS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
for the fifty-three weeks and fifty-two weeks ended August 3, 2008 and July
29, 2007, respectively (in thousands, except for per share data). The
quarter ended February 3, 2008 consisted of fourteen weeks.
2008 October 28, February 3, May 4, August 3,
---- 2007 2008 2008 2008
---- ---- ---- ----
Net sales $ 35,133 34,661 38,549 44,168
Gross profit $ 9,993 4,993 8,567 10,648
Net loss $ (2,591) (3,840) (3,592) (323)
======= ======= ======= =======
Loss per common share:
Basic $ (0.19) (0.28) (0.27) (0.02)
======= ======= ======= =======
Diluted $ (0.19) (0.28) (0.27) (0.02)
======= ======= ======= =======
Basic weighted average shares 13,965 13,617 13,507 13,518
======= ======= ======= =======
Diluted weighted average shares 13,965 13,617 13,507 13,518
======= ======= ======= =======
2007 October 29, January 28, April 29, July 29,
---- 2006 2007 2007 2007
---- ---- ---- ----
Net sales $ 40,116 37,997 44,401 40,626
Gross profit $ 10,285 9,987 12,714 11,320
Net (loss) income $ (6,011) 1,673 3,878 3,578
======= ======= ======= =======
(Loss) earnings per common share:
Basic $ (0.43) 0.12 0.28 0.26
======= ======= ======= =======
Diluted $ (0.43) 0.12 0.27 0.25
======= ======= ======= =======
Basic weighted average shares 13,862 13,902 13,969 13,977
======= ======= ======= =======
Diluted weighted average shares 13,862 14,405 14,449 14,480
======= ======= ======= =======
In the first quarter ended October 28, 2007 the Company recorded a charge
of $6.0 million in connection with a litigation settlement.
In the third quarter ended May 4, 2008 the Company recorded a $9.5 million
charge in connection with a litigation settlement. The income tax benefit
in the third quarter included the recognition of a tax benefit of $2.7
million due to the expiration of the statute of limitations relating to a
deduction taken for an impaired investment on a prior year tax return.
In the fourth quarter ended August 3, 2008 gross margin was negatively
affected by approximately $2.1 million of contract loss provisions for two
development contracts at Herley Farmingdale. The fourth quarter also
includes an adjustment of $2.8 million for legal fees receivable at the end
of the third quarter which, in accordance with generally accepted
accounting standards, has been eliminated in the fourth quarter of fiscal
2008.
During the quarter ended July 29, 2007, the cost of sales was reduced by
approximately $475,000 due to revisions in the estimated liability for
expected losses under the last two options of a contract associated with
the ICI acquisition.
NOTE S - SUBSEQUENT EVENTS
The Company entered into an Asset Purchase Agreement ("Asset Agreement")
dated as of August 1, 2008 to acquire the business and certain assets
subject to the assumption of certain liabilities of Eyal Microwave
Industries ("EMI") a privately held Israeli company for cash of
$30,000,000. The transaction closed on September 16, 2008. EMI is a leading
supplier of a broad range of innovative, high reliability RF, microwave and
millimeter wave components and customized subsystems for the global defense
industry. Based in Kibbutz Eyal, Israel, the company has approximately 175
employees. EMI includes Eyal Microwave Ltd. and its wholly-owned
subsidiary, Eyal Mag Ltd. Funding for the purchase was provided through a
$20 million loan under the Company's existing credit facility through its
current bank and a new term loan in the amount of $10 million for a period
of 10 years through the Company's bank in Israel. The new loan is payable
in quarterly installments over a period of 10 years with interest at LIBOR
plus 1.5%. The acquisition will be accounted for under the provisions of
SFAS 141.
On September 18, 2008, the Company executed an agreement (the "Agreement")
with a foreign defense company to divest its ICI subsidiary located in
McLean, Virginia. ICI is a communications technology development firm
F-29
specializing in research, design, development, production, and support of
wireless data communications products and services. The Agreement provides
for an all cash transaction valued at approximately $15 million and
includes a significant contingency requiring U.S. Government approval on or
before November 5, 2008 or the Agreement will be void. The Company believes
it is reasonably possible that the U.S. Government approval will be granted
and the transaction will be completed. In the event the transaction is
completed, ICI will be reported as a discontinued operation and a non-cash
charge to earnings of approximately $1.0 million would be recorded to
reflect the difference between the sale price pursuant to the Agreement and
the net carrying value of the assets held for sale. In fiscal 2008, ICI
reported revenues of approximately $19 million and operating income of
approximately $0.6 million. The ICI balance sheet includes total assets of
approximately $21.7 million, including approximately $4.1 million of
allocated goodwill, and liabilities of approximately $5.7 million. There
can be no assurance that the U.S. Government will grant approval so that
the transaction will be completed.
As of September 12, 2008 the Company entered into a modification of its
existing credit facility. Under the terms of the modification, 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 2.0% effective
September 12, 2008 (the margin was 1.65% at August 3, 2008). In addition,
if in the event the sale of ICI (see Note S) is not consummated by November
30, 2008, the Company will grant the bank a security interest in its
domestic accounts receivable, inventory and all other non-real estate
domestic assets.
**********