UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended July 28, 2002
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.)
3061 Industry Drive, Lancaster, Pennsylvania 17603
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(Address of Principal Executive Offices ) (Zip Code)
Registrant's telephone number, including area code: (717) 397-2777
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Exchange on which registered
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None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $ .10 par value
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(Title of Class)
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]
Based on the closing sale price of $16.47 as of October 21, 2002 the aggregate
market value of the voting stock held by non- affiliates of the registrant was
$242,503,605.
The number of shares outstanding of registrant's common stock, $ .10 par value
as of October 21, 2002 was 14,723,959.
Documents incorporated by reference:
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Registrant's definitive proxy statement to be filed pursuant to Regulation 14A
of the Securities Exchange Act of 1934.
HERLEY INDUSTRIES, INC.
TABLE OF CONTENTS
Page
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PART I
Item 1 Business 1
Item 2 Properties 10
Item 3 Legal Proceedings 11
Item 4 Submission of Matters to a Vote of Security Holders 11
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 11
Item 6 Selected Financial Data 11
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 7A Quantitative and Qualitative Disclosures About Market Risk 21
Item 8 Financial Statements and Supplementary Data 22
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 22
PART III
Item 10 Directors and Executive Officers of the Registrant 22
Item 11 Executive Compensation 22
Item 12 Security Ownership of Certain Beneficial
Owners and Management 22
Item 13 Certain Relationships and Related Transactions 22
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports
on Form 8K 23
SIGNATURES 25
CERTIFICATION PURSUANT TO SECTION 302(a) OF THE SARBANES-OXLEY
ACT OF 2002 26
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES F-1
PART I
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," "estimate," "expect," "plan," "intend" 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, technological change or difficulties, product development risks,
commercialization and trade difficulties and general economic conditions.
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.
Item 1. Business
BACKGROUND
Herley is a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including Raytheon, Northrop Grumman, Lockheed Martin and Boeing),
the U.S. government (including the Department of Defense, NASA and other U.S.
government agencies) and international customers (including the Egyptian,
German, Japanese and South Korean militaries and suppliers to international
militaries). We are a leading provider of microwave technologies for use in
command and control systems, flight instrumentation, weapons sensors and
electronic warfare systems. We have served the defense industry since 1965 by
designing and manufacturing microwave devices for use in high technology defense
electronics applications. Our products and systems are currently deployed on a
wide range of high profile military platforms, including the F-16 Falcon, the
F/A-18E/F Super Hornet, the RC-135 Rivet Joint, the E-2C Hawkeye, the AEGIS
class surface combatants, the EA-6B Prowler 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 through internal growth and strategic acquisitions over the past
ten years 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.
- - In September 1992, we acquired Micro-Dynamics, Inc. of Woburn, Massachusetts,
a microwave subsystem designer and manufacturer.
- - In June 1993, we acquired Vega Precision Laboratories, Inc. of Vienna,
Virginia, a manufacturer of flight instrumentation products.
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- - In July 1995, we acquired Stewart Warner Electronics Corp. of Chicago,
Illinois, a manufacturer of high frequency radio and IFF interrogator systems.
- - In August 1997, we acquired Metraplex Corporation of Frederick, Maryland, a
manufacturer of airborne PCM and FM telemetry and data acquisition systems.
- - In January 1999, we acquired General Microwave Corporation of Farmingdale, New
York, a manufacturer of microwave components and electronic systems.
- - In January 2000, we acquired Robinson Laboratories, Inc. of Nashua, New
Hampshire, a designer, developer and manufacturer of microwave components and
assemblies primarily for defense applications.
- - In September 2000, we acquired American Microwave Technology, Inc. of Anaheim,
California, a manufacturer of high power, solid state amplifiers for the
scientific and medical markets, which enabled us to enter these markets.
- - In September 2002, we acquired EW Simulation Technology, Limited ("EWST"), a
British company of Aldershot, UK. EWST designs, develops and produces electronic
warfare simulator systems for prime defense contractors and countries worldwide.
BUSINESS STRATEGY
Our goal is to continue to leverage our proprietary technology, microwave
expertise and manufacturing capabilities to further expand our penetration in
our market. Our strategies to achieve our objectives include:
- - INCREASE LEVELS OF COMPONENT INTEGRATION AND VALUE ADDED CONTENT. Due to
growth of engineering expertise, new product development, and acquisitions, we
have increased our capability to provide more component integration. Management
believes component integration adds value and will enable us to increase content
in defense platforms and systems, thereby increasing our revenue and
profitability.
- - MAINTAIN LEADERSHIP IN MICROWAVE TECHNOLOGY. We intend to pursue further
technological advances through continued investment in internally-funded and
customer-funded research and product development.
- - STRENGTHEN AND EXPAND CUSTOMER RELATIONSHIPS. We have developed mutually
beneficial relationships with various agencies of the U.S. government and
defense and commercial companies. We expect to continue to build and strengthen
these relationships with industry leaders by anticipating and recognizing their
needs and providing them with on-time and cost-effective solutions.
- - CAPITALIZE ON OUTSOURCING DYNAMICS IN THE AEROSPACE AND DEFENSE INDUSTRY.
Microwave technology has traditionally been an in-house resource of the prime
contractors. However, the prime contractors are beginning to outsource the
design and manufacture of this specialized engineering work to system
sub-contractors. We are well positioned to generate more business as prime
contractors continue to focus primarily on integration of defense electronics.
- - PURSUE STRATEGIC ACQUISITIONS. We intend to continue to augment our existing
technological base by acquiring specialized companies that complement or expand
our product offerings and market strategies. We believe that expansion of our
core competencies through the acquisition of such specialized technology
companies, when combined with our current technological and manufacturing
skills, will provide us with improved levels of horizontal and vertical
integration, leading to the creation of subsystems and complete system products.
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- - 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 our 35 year focus on research and development and
our state-of-the-art design and production capabilities. We have recently
completed construction of state-of-the-art manufacturing facilities in
Lancaster, Pennsylvania, where we have a full range of capabilities including
long and short run production, hardware assembly and full-service engineering.
In addition, we have highly capable manufacturing facilities located in Woburn,
Massachusetts; Farmingdale, New York; and Jerusalem, Israel. We have developed
and rewarded our engineers in order to maintain our expertise in-house.
- - HIGH PROPORTION OF LONG-TERM SOLE-PROVIDER PRODUCTION PROGRAMS. We generate a
significant proportion of our revenue from continuing, long-term programs, both
in the production and upgrade phases, and continue to target high growth, high
priority defense programs. Typically, on such long-term defense programs we are
the sole provider of microwave equipment.
- - DIVERSE PRODUCT AND CUSTOMER BASE. We have a diverse product and customer
base, with only the U.S. government, at approximately 17%, representing more
than 10% of our fiscal 2002 revenues. 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 2002.
- - 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 35 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 2002, we spent over $5.6
million on new product development, of which our customers funded approximately
$3.3 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 21 years
of experience in the defense electronics industry.
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PRODUCTS AND SERVICES
We operate in two markets: defense electronics and commercial technologies.
DEFENSE ELECTRONICS
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. We design and manufacture microwave components and
subassemblies which are embedded in a variety of radars, flight instrumentation,
weapons sensors, electronic warfare systems and guidance systems. Our microwave
devices are used on our subassemblies and integrated systems (e.g. command and
control systems, telemetry systems, transponders, flight termination receivers
and identification friend or foe, or IFF, interrogators), in addition to being
sold on a component basis.
The following are descriptions of our major systems and products:
Telemetry Systems. Telemetry systems provide wireless data transmission between
two or more sites for recording and analysis. Missile, UAV, or target testing on
domestic and international test ranges requires flight safety and performance
data transmission to maximize flight safety during the test operation.
Surveillance and intelligence gathering UAVs also require a data transmission
downlink and a command and control systems uplink to accomplish their mission.
We have developed a telemetry system capability that can be configured to meet
individual customers' needs. Various components of the system include data
encoders, transmitters and flight termination receivers. Each has a distinctive
role and each is 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 systems have been 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
command and control 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 command and control systems are currently in service
throughout the world. Command and control 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 command and control
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 MAGIC2 system affords over-the-horizon command and control 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 MAGIC2 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 MAGIC2 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.
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Transponders. We manufacture a variety of expendable transponders, including
range safety, IFF, command and control, and range scoring systems. Transponders
are small, expendable, electronic systems consisting of a transmitter, sensitive
receiver and internal signal processing equipment comprised of active and
passive components, including microwave subassemblies such as amplifiers,
oscillators and circulators. The transponder receives signals from radars,
changes and amplifies the frequency of the signals, and transmits back a reply
on a different frequency and signal level. This reply is a strong, noise-free
signal upon which the tracking radar can "lock," and one which is far superior
to skin reflection tracking, particularly under adverse weather conditions after
the launch.
In range safety applications, transponders enable accurate tracking of space
launch and unmanned aerial vehicles, missiles, and target drones so that
position and direction are known throughout its flight. In the case of several
defense and commercial space launch vehicles (i.e., Delta, Atlas, Titan and
Pegasus), our transponder is tracked by the ground launch team all the way to
space orbit, and in certain instances through several orbits, as a reference
location point in space to assure that the launch payload has been properly
placed in orbit.
IFF transponders, which are used in conjunction with the Federal Aviation
Authority Air Traffic Control System, enable ground controllers to identify the
unmanned targets, drones and cruise missiles on which these units fly and to
vector other manned aircraft safely away from the flight path of the unmanned
aerial vehicle.
Command and control transponders provide the link through the telemetry system
for relaying ground signals to direct the vehicle's flight. The uplink from the
ground control station, a series of coded pulse groups, carries the signals that
command the flight control guidance system of the vehicle. The downlink to the
ground provides both tracking signals for range safety, as well as
acknowledgment and status of the uplink commands and their implementation in the
vehicle. The transponder is therefore the means to fly the vehicle. Scoring
systems are mounted on both airborne and sea targets. Scoring systems enable
test and evaluation engineers to determine the "miss-distance" between a
projectile and the target at which it has been launched.
Flight Termination Receiver. A flight termination receiver, or FTR, is installed
in a test missile, UAV, target or space launch vehicle as a safety device. The
FTR has a built-in decoder that enables it to receive a complex series of audio
tones which, when appropriate, will set off an explosive charge that will
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 KDX
destroyer program.
High Power Amplifier. We design and manufacture high power amplifier systems
with frequencies ranging from 1.5 MHz to 12GHz 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. We have an exclusive sales and marketing agreement
with EADS ewation, Grintek Ewation, Sysdel Close Corporation and Teleplan AS
regarding high power amplifiers for monitoring reconnaissance and
countermeasures.
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. We
also manufacture magnetrons, which are the power source utilized in the
production of our transponders.
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High/Low Power Integrated Assembly. Our high power microwave devices are used in
radar system transmitters and in long-range missiles. High power devices
frequently use small amounts of nuclear material to enhance breakdown of high
energy pulses, and we are one of very few companies with an active nuclear
license that permits the handling of these trace amounts of nuclear materials.
There are relatively few companies with the expertise or facilities to design,
manufacture and test high power devices. We also produce lower power, broad band
microwave integrated assemblies for the defense electronics industry. These
complex assemblies combine microwave functions such as amplification,
attenuation, switching of multiple signals, and phase and amplitude control.
Their applications include Rear Warning Receivers, or RWRs, Electronics
Countermeasure, or ECM, systems and highly sensitive receiver systems.
Solid State Receiver Protector. We have become a preeminent supplier of
solid-state receiver protector devices that are able to withstand high energy
pulses without the use of nuclear materials. These high power devices protect a
radar receiver from transient bursts of microwave energy and are employed in
almost every military and commercial radar system. For our engineering efforts
in designing solid-state receiver protectors for the F- 16, we received cash
awards from the United States Air Force as part of the government's value
engineering program.
Digitally Tuned Oscillators (DTO's). We produce microwave sources, which
generate signals that are used in microwave oscillators. Our microwave sources
are sold to the U.S. defense industry and to various foreign governments. We
specialize in digitally tuned oscillators, or DTOs, a critical component in many
ECM systems.
COMMERCIAL TECHNOLOGIES
Our commercial technologies are comprised of scientific products and medical
products.
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 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 both original equipment and systems
manufacturers, 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 year ended July 28, 2002, approximately 17% of our net sales
were attributable to contracts with offices and agencies of the U.S. government.
No other customers accounted for shipments in excess of 10% of net sales.
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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:
Boeing
BAE Systems
Harris
Lockheed Martin
Northrop Grumman
Raytheon
During fiscal 2002, sales to foreign customers accounted for approximately 32%
of our net sales. The governments of Egypt, Japan, South Korea, Taiwan and the
United Kingdom are all significant customers of ours. All of our contracts with
foreign customers are payable in U.S. dollars. International sales are subject
to numerous risks, including political and economic instability in foreign
markets, including currency and economic difficulties in the Pacific Rim,
restrictive trade policies of foreign governments, inconsistent product
regulation by foreign agencies or governments, imposition of product tariffs and
burdens and costs of complying with a wide variety of international and U.S.
export laws and regulatory requirements. Our international sales also are
subject to us obtaining export licenses for certain products and systems.
SALES AND MARKETING
We market our products worldwide to the United States government, prime
contractors and various countries in defense markets, and to OEMs, 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 almost 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.
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We maintain minimal levels of finished products inventory to meet the needs of
our medical products customers. We generally purchase raw materials for specific
contracts, and we purchase common components for stock based on our firm fixed
backlog.
There are no significant environmental control procedures required concerning
the discharge of materials into the environment that require us to invest in any
significant capital equipment or that would have a material effect on our
earnings or our competitive position.
Quality assurance checks are performed on manufacturing processes, purchased
items, work-in-process and finished products. Due to the complexity of our
products, final tests are performed on some products by highly skilled engineers
and technicians.
Our primary manufacturing facilities have earned the ISO 9001 Registration. The
ISO 9000 series standards are internationally recognized quality management
system requirements. ISO 9001, the most comprehensive Standard in the ISO 9000
Series, covers design, manufacturing, installation, and servicing systems.
Assembly, test, package and shipment of products are done at our manufacturing
facilities located in the following cities:
Lancaster, Pennsylvania
Farmingdale, New York
Woburn, Massachusetts
Jerusalem, Israel
BACKLOG
Our total backlog of orders was approximately $82.7 million on July 28, 2002 as
compared to $79.4 million on July 29, 2001. Of our total backlog of $82.7
million at July 28, 2002, $54.3 million is attributable to domestic orders and
$28.4 million is attributable to foreign orders. Management anticipates that
approximately $70.7 million of its backlog will be shipped during the fiscal
year ending August 3, 2003.
All of the orders included in backlog are covered by signed contracts or
purchase orders. Backlog is not directly indicative of future sales.
Accordingly, we do not believe that our backlog as of any particular date is
representative of actual sales for any succeeding period.
Substantially all of our contracts are 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 except for costs
incurred because of change orders issued by the customer.
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. Our primary efforts are focused 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 $5.6 million in fiscal 2002, $4.6 million in fiscal 2001 and $3.5
million in fiscal 2000, of
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which we paid approximately $2.3 million in fiscal 2002, $2.6 million in fiscal
2001 and $2.3 million in 2000. The remainder of these costs were paid by some of
our customers.
COMPETITION
The microwave component and subsystems industry is highly competitive and we
compete against many companies, both foreign and domestic. Many of these
companies are larger, have greater financial resources and are better known. As
a supplier, we also experience significant competition from the in-house
capabilities of our customers.
Competition is generally based upon technology, design, past performance and
price. Our ability to compete depends, in part, on our ability to offer better
design and performance than our competitors and our readiness in facilities,
equipment and personnel to complete the programs. Many of the programs in which
we participate are long standing programs in which we are the sole provider of
our product.
GOVERNMENT REGULATION
Because of our participation in the defense industry, we are subject to audits
by various government agencies for our compliance with government regulations.
We are also subject to a variety of local, state and federal government
regulations relating to, among other things, the storage, discharge, handling,
omission, generation, manufacture and disposal of toxic or other hazardous
substances used to manufacture our products. We believe that we operate our
business in material compliance with applicable laws and regulations. However,
any failure to comply with existing or future laws or regulations could have a
material adverse impact on our business, financial condition and results of
operations.
INTELLECTUAL PROPERTY
We rely primarily on a combination of trade secrets and employee and third-party
nondisclosure agreements to protect our intellectual property, as well as
limiting access to the distribution of proprietary information. We cannot assure
you 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 assure you that, in the future, third parties will not assert
infringement claims against us or with respect to our products for which we have
indemnified certain of our customers. 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 September 29, 2002, we employed 618 persons full time. Of these employees,
105 comprise the engineering staff, 445 constitute manufacturing personnel, 24
occupy sales and marketing positions, and 44 are in executive, management, and
support functions. None of our employees are covered by collective bargaining
agreements and we consider our employee relations to be satisfactory. 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 and stock option plans.
SUBSEQUENT EVENT
The Company entered into an agreement as of September 1, 2002, to acquire all of
the issued and outstanding common stock of EW Simulation Technology, Limited
("EWST"), a British company of Aldershot, UK, which is expected to be operated
9
as a wholly-owned subsidiary. EWST designs, develops and produces electronic
warfare simulator systems for prime defense contractors and countries worldwide.
The transaction, which closed on September 20, 2002, provides for payment of
$3,000,000 in cash and a note for $1,500,000, including interest at 1.8%,
payable in annual installments of $500,000.
OFFICERS OF THE REGISTRANT
Served as
Name Age Officer Since Position(s) and Offices
- ---- --- ------------- -----------------------
Lee N. Blatt 74 1965 Chairman of the Board
Myron Levy 61 1988 Chief Executive Officer
and Director
John M. Kelley 49 1998 Executive Vice President
Howard M. Eckstein 51 1998 Senior Vice President
Mitchell Tuckman 52 1999 Senior Vice President
William Wilson 53 2002 Senior Vice President
Rozalie Schachter 55 2000 Senior Vice President
Anello C. Garefino 55 1993 Vice President-Finance,
Treasurer and Chief
Financial Officer
David H. Lieberman 57 1985 Secretary and Director
Item 2. Properties
Our facilities are as follows:
Owned
or
Location Purpose of Property Area Leased
- -------- ------------------- ---- ------
Lancaster, PA (1) Production, engineering, administrative 86,200 sq. ft. Owned
and executive offices
Woburn, MA Production, engineering and administration 60,000 sq. ft. Owned
Farmingdale, NY (2) Production, engineering and administration 46,000 sq. ft. Leased
14,000 sq. ft. Leased
Jerusalem, Israel Production, engineering and administration 12,000 sq. ft. Owned
Aldershot, England (3) Production, engineering and administration 6,300 sq. ft. Leased
Chicago, IL Engineering and administration 3,000 sq. ft. Leased
Lancaster, PA Land held for expansion 20.4 Acres Owned
- --------------
(1) The Company's executive offices occupy approximately 4,000 sq. ft. of
space at this facility with engineering and administrative offices occupying
10,000 sq. ft. each.
(2) On September 23, 1999 the Company closed on the sale of its prior owned
facility in Amityville, NY and relocated the plant to this leased facility in
Farmingdale, NY. The Company entered into two 10 year lease agreements with a
partnership owned by the children of Messrs Blatt and Levy. The leases provide
for initial minimum annual rent of approximately $312,000 and $92,000,
respectively, in each case subject to escalation of approximately 4% annually
throughout the 10 year term.
(3) As of September 1, 2002, the Company entered into an agreement to
acquire all of the issued and outstanding common stock of EW Simulation
Technology, Limited as discussed in Note R of the financial statements.
In addition to the above operating facilities, the Company has an idle facility
in Billerica, MA which is under lease. The Company is looking to sublease this
facility.
We believe that its facilities are adequate for its current and presently
anticipated future needs.
10
Item 3. Legal Proceedings
On August 14, 2001, Robinson Laboratories, Inc. ("RLI") and Ben Robinson
("Robinson") filed an Amended Complaint against Herley Industries, Inc.
("Herley"). Although the Amended Complaint sets forth fifteen counts, the core
allegations are (i) that Herley failed to issue 97,841 shares of common stock in
connection with certain earn out requirements contained in an Asset Purchase
Agreement dated February 1, 2000; (ii) that Herley breached an Employment
Agreement with Robinson by terminating his employment on August 5, 2001; and
(iii) that Herley breached a Stock Option Agreement dated January 31, 2000, with
Robinson. RLI and Robinson asserted (i) violations of state and federal
securities laws; (ii) fraud claims; (iii) breach of contract claims; and (iv)
other equitable claims arising from the above core factual allegations.
On September 17, 2001, Herley filed an Answer, Affirmative Defenses and
Counterclaims in this matter. In the Answer and Affirmative Defenses, Herley
denied the material allegations of the Amended Complaint. Herley also filed
Counterclaims against both RLI and Robinson. In these counterclaims, Herley's
core allegations concern Robinson's misconduct (i) in connection with the manner
he attempted to satisfy RLI's earn out requirements; (ii) misrepresentations
made in connection with the Asset Purchase Agreement; (iii) wrongdoing as a
Herley employee leading to his termination and (iv) post-Herley employment
wrongdoing in connection with a new company known as RH Laboratories. In
addition to seeking a Declaratory Judgment pursuant to 28 U.S.C. ss. 2201 et.
seq., Herley also asserted claims for, among other things, fraud, breach of
contract, breach of fiduciary duty, unfair competition and tortious interference
with actual and prospective contractual relationships.
On August 5, 2002, a jury trial commenced. A jury verdict was rendered on August
21, 2002 in which the jury determined, among other things, that (i) Herley was
not required to pay any additional stock; (ii) Herley breached the Employment
Agreement with Robinson and awarded Robinson $1.5 million in damages; (iii)
Herley breached the Lease Agreement with Robinson and awarded Robinson
approximately $552,000 in compensatory damages; (iv) Robinson breached fiduciary
duties to Herley and awarded Herley $400,000 in compensatory damages; (v)
Robinson and RLI breached indemnity obligations and awarded Herley $100,000 in
damages; (vi) RLI breached representations and warranties given to Herley and
awarded Herley $320,000 in damages. The court has still not entered final
judgment following the jury verdict, and both parties are expected to appeal.
Additionally, as the prevailing party in connection with the claims asserted by
RLI relating to the earn-out stock, as well as claims advanced relating to the
various breaches of the Asset Purchase Agreement, Herley intends to file a
petition for attorney's fees and costs against both RLI and Robinson for
approximately $2,000,000.
The Company is involved in various other legal proceedings and claims which
arise in the ordinary course of its business. While any litigation contains an
element of uncertainty, management believes that the outcome of such litigation
will not have a material adverse effect on the Company's financial position or
results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholders
Matters
(a) The Company's Common Stock is traded in the NASDAQ National Market
under the symbol HRLY. The following table sets forth the high and
low closing sales price as reported by the NASDAQ National Market for
the Company's Common Stock for the periods indicated and gives effect
retroactively to the three-for-two stock split of the Common Stock on
September 10, 2001.
11
Common Stock
-----------------
High Low
---- ---
Fiscal Year 2001
First Quarter...............................$ 15.17 $ 11.63
Second Quarter.............................. 15.46 8.79
Third Quarter............................... 10.89 8.38
Fourth Quarter.............................. 13.15 9.97
Fiscal Year 2002
First Quarter............................... 18.50 11.17
Second Quarter.............................. 17.13 13.10
Third Quarter............................... 24.49 14.96
Fourth Quarter.............................. 22.33 17.55
Fiscal Year 2003
First Quarter (through October 21, 2002).... 21.30 14.73
The closing price on October 21, 2002 was $16.47.
(b) As of October 21, 2002, there were approximately 234 holders of
record of the Company's Common Stock.
(c) There have been no cash dividends declared or paid by the Company on
its Common Stock during the past two fiscal years.
Item 6. Selected Financial Data (in thousands except per share data)
52 Weeks ended
-------------------------------------------------------------
July 28, July 29, July 30, August 1, August 2,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Net sales (4) $ 92,881 76,494 70,537 61,036 40,798
Income from continuing operations before
extraordinary item $ 10,730 7,573 7,639 7,862 5,497
Loss from discontinued operations $ (921) (168) - - -
Cumulative effect of adopting SFAS 142 $ (4,637) - - - -
Net income $ 5,172 7,405 7,639 7,735 5,497
Per share data from continuing operations (1),
(2), (3)
Basic $ .89 .75 1.05 1 00 .74
Assuming Dilution $ .83 .69 .96 .92 .68
Total Assets $ 190,202 114,597 86,656 74,056 57,553
Total Current Liabilities $ 15,263 18,732 12,783 10,513 9,843
Long-Term Debt net of current portion $ 5,684 2,740 2,931 15,437 4,111
(1) As adjusted to give effect to a 3-for-2 stock split effective September
10, 2001.
(2) Earnings per share from continuing operations are presented
and calculated before extraordinary item in fiscal 1999, before
discontinued operations in 2002 and 2001, and before cumulative effect of
accounting change in 2002.
(3) No cash dividends have been distributed in any of the years presented.
(4) See "Acquisitions" under Item 1. "Business".
12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations
The following table sets forth for the periods indicated certain financial
information derived from the Company's consolidated statements of income
expressed as a percentage of net sales. There can be no assurance that trends in
sales growth or operating results will continue in the future.
52 weeks ended
------------------------------
July 28, July 29, July 30,
2002 2001 2000
---- ---- ----
Net sales 100.0 % 100.0 % 100.0 %
Cost of products sold 66.7 % 66.3 % 62.9 %
----- ----- -----
Gross profit 33.3 % 33.7 % 37.1 %
Selling and administrative expenses 14.3 % 19.0 % 19.2 %
Litigation costs 2.2 % 0.3 % -
Plant closing costs 0.4 % - -
----- ----- -----
Income from operations 16.4 % 14.4 % 17.9 %
----- ----- -----
Other income (expense), net:
Investment income 0.8 % 0.9 % 0.3 %
Interest expense (0.4)% (0.3)% (1.6)%
----- ----- -----
0.4 % 0.6 % (1.3)%
----- ----- -----
Income from continuing operations before
income taxes 16.8 % 15.0 % 16.6 %
Provision for income taxes 5.2 % 5.1 % 5.8 %
----- ----- -----
Income from continuing operations 11.6 % 9.9 % 10.8 %
Loss from discontinued operations 1.0 % 0.2 % -
----- ----- -----
Income before cumulative effect of change
In accounting principle 10.6 % 9.7 % 10.8 %
Cumulative effect of adopting SFAS 142 (5.0)% - -
----- ----- -----
Net income 5.6 % 9.7 % 10.8 %
===== ===== =====
13
Fiscal 2002 Compared to Fiscal 2001
Net sales from continuing operations for the 52 weeks ended July 28, 2002 were
approximately $92,881,000 compared to $76,494,000 for fiscal 2001. The net sales
increase of $16,387,000 (21.4%) is attributable to increased revenue in defense
electronics of $18,638,000; offset by a decrease of $2,251,000 in commercial
technologies.
Gross profit of 33.3% for the 52 weeks ended July 28, 2002 is less than the
prior year of 33.7%. The decline in margin is due primarily to lower margins on
certain Robinson Labs contracts that were transferred to other facilities, and
the investment in new product development related to commercial applications.
The significant increase in net sales in defense electronics cushioned the
decline in gross profit.
Selling and administrative expenses for the 52 weeks ended July 28, 2002 were
$13,229,000 compared to $14,545,000 for fiscal 2001, a net decrease of
$1,316,000. In connection with the adoption of SFAS 142 as of July 30, 2001, the
Company ceased amortization of goodwill (See Note A.8.). Selling and
administrative expenses in fiscal 2001 included goodwill amortization of
$916,000. Cost savings associated with the relocation of the AMT facility
amounted to approximately $605,000. Other significant changes include an
increase in incentive compensation of $363,000 and a reduction in payroll and
related costs of $198,000.
Legal costs in fiscal 2002 increased $1,814,000 over fiscal 2001, directly
related to the Robinson Labs litigation. (See Item 3. "Legal Proceedings").
Plant closing costs in connection with the facilities in Nashua, NH and Anaheim,
CA were accrued in October 2001 in the amount of $406,000 of which $348,000 was
paid as of July 28, 2002.
Other income increased approximately $39,000 from the prior year primarily from
the investment of proceeds of approximately $64,812,000 from the sale of common
stock to the public on April 30, 2002, partially offset by lower interest rates.
Interest expense increased $100,000 as compared to fiscal 2001 due to the
$3,000,000 financing of the expansion of the Lancaster facility through
industrial revenue bonds and interest on temporary borrowings of $4,300,000
under the bank line of credit.
The effective income tax rate decreased to 31.2% in fiscal 2002 from 33.8% in
2001 due to various favorable tax benefits including a lower effective tax rate
on foreign-source income and recognition in the fourth quarter of the tax
benefit attributable to extra territorial income.
Fiscal 2001 Compared to Fiscal 2000
Net sales from continuing operations for the 52 weeks ended July 29, 2001 were
approximately $76,494,000 compared to $70,537,000 for fiscal 2000. The net sales
increase of $5,957,000 (8.4%) is attributable to the acquisition of American
Microwave in the first quarter of fiscal 2001 which contributed $6,812,000 in
net sales, as well as an increase in net sales of approximately $4,573,000 in
commercial products. Defense electronics experienced a drop in revenue of
approximately $5,428,000 due to delayed orders from various customers.
Gross profit of 33.7% for the 52 weeks ended July 29, 2001 is less than the
prior year of 37.1%. The decline in margin of 3.4% is due primarily to lower
margins on commercial products and certain defense electronics products. Margins
also have been impacted by certain inefficiencies at the Nashua facility. This
operation is now being consolidated into the New England and Farmingdale
facilities.
Selling and administrative expenses for the 52 weeks ended July 29, 2001 were
$14,545,000 compared to $13,497,000 for fiscal 2000, an increase of $1,048,000.
The primary increase is due to businesses acquired which added $1,563,000 in
fiscal 2001 and $486,000 in additional personnel expenses associated with power
amplifier marketing costs. Incentive compensation decreased $707,000.
14
Other income increased approximately $447,000 from the prior year primarily from
the investment of proceeds from the exercise of warrants in May and November
2000. Interest expense decreased $906,000 as compared to fiscal 2000 due to the
repayment of bank borrowings out of the proceeds of the exercise of the
warrants.
The effective income tax rate decreased to 33.8% in fiscal 2001 from 35.0% in
2000 due to various favorable tax benefits including a lower effective tax rate
on foreign-source income.
Discontinued operations
The Company entered into an agreement effective as of the close of business
September 30, 2000, to acquire all of the issued and outstanding common stock of
Terrasat, Inc. ("Terrasat"), a California corporation for cash in the amount of
$6,000,000, $3,000,000 of which was paid in December 2000 and $3,000,000 of
which was paid in December 2001. In addition, the agreement provided for
additional cash payments in the future up to $2,000,000, based on gross revenues
through December 31, 2001. The targeted gross revenues under the agreement were
not achieved, therefore no additional cash payments were required.
In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets" which addresses financial accounting and
reporting for the impairment of long-lived assets and for long- lived assets to
be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
retains the fundamental provisions of Statement 121 for (a) recognition and
measurement of the impairment of long-lived assets to be held and used and (b)
measurement of long-lived assets to be disposed of by sale. SFAS 144 also
supersedes the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for segments of a business to be disposed of, but
retains the requirement of Opinion 30 to report discontinued operations
separately from continuing operations and extends that reporting to a component
of an entity that either has been disposed of (by sale, by abandonment, or in a
distribution to owners) or is classified as held for sale. The provisions of
this statement were adopted by the Company effective on July 30, 2001.
In January 2002 the Board of Directors of the Company decided to discontinue the
operations of Terrasat and to seek a buyer for the business. The Company
believed that Terrasat would not be able to generate sufficient returns to
justify continued investment due to the overcapacity in the telecom industry and
deteriorating economic conditions in Terrasat's primary markets. Consequently,
the accompanying consolidated financial statements reflect Terrasat as
discontinued operations in accordance with SFAS No. 144. The assets and
liabilities of Terrasat at July 29, 2001 have been classified in the
accompanying balance sheet as "Assets held for sale", and "Liabilities held for
sale." Results of operations and cash flows of Terrasat have been classified as
"Loss from discontinued operations", and "Net cash provided by (used in)
discontinued operations", respectively.
The sale of certain assets and liabilities, and the business of Terrasat was
consummated on March 1, 2002, effective the close of business January 27, 2002,
to certain current employees of Terrasat for cash and a note which approximates
the value of the net assets held for sale as of January 27, 2002 of $878,000.
Change in accounting principle
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
142 "Goodwill and Other Intangible Assets" which requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangibles. Under a non-amortization approach, goodwill will not be amortized
into results of operations, but instead will be reviewed for impairments which
will be charged to results of operations in the periods in which the recorded
value of goodwill is more than its fair value. The provisions of this statement
were adopted by the Company on July 30, 2001. The adoption of SFAS No.142
resulted in the Company's discontinuation of amortization of its goodwill as of
July 30, 2001.
15
In connection with the adoption of SFAS 142, the Company was required to assess
goodwill for impairment within six months of adoption, and completed its
assessment in the second quarter of fiscal 2002.
The Company operates as a single integrated business and as such has one
operating segment which is also the reportable segment as defined in SFAS 131.
Within the operating segment, the Company has identified two components as
reporting units as defined under SFAS 142, defense electronics and commercial
technologies. The Company has determined the carrying value of each reporting
unit by assigning assets and liabilities, including the existing goodwill and
intangible assets, to those reporting units as of July 30, 2001. The Company has
determined that an impairment of goodwill in the commercial technologies unit
has occurred. Accordingly, a transition adjustment in the amount of $4,637,000
has been recorded as of July 30, 2001 as a cumulative effect of a change in
accounting principle. There is no tax benefit associated with the adjustment
since the impaired goodwill is not deductible for income tax purposes.
There was no impairment in the remaining goodwill at July 28, 2002 of
approximately $21,665,000 related to the defense electronics reporting unit
based on current market capitalization of the Company. An annual impairment test
will be performed in the fourth quarter of each fiscal year and any future
impairment of goodwill will be charged to operations.
Amortization of goodwill charged to continuing operations for the fiscal years
ended July 29, 2001 and July 30, 2000 was approximately $1,296,000 and $958,000,
respectively. Amortization of goodwill charged to discontinued operations for
the fiscal year ended July 29, 2001 was approximately $208,000.
16
Quarterly Results
The following is a summary of the unaudited quarterly operations for the 52
weeks ended July 28, 2002 and July 29, 2001 (in thousands, except for per share
data).
October 28, January 27, April 28, July 28,
2001 2002 2002 2002
-------- -------- -------- ---------
Net sales $ 22,213 21,840 23,499 25,329
Gross profit 7,639 7,036 8,323 7,936
Income from continuing operations 2,439 2,393 2,692 3,206
Loss from discontinued operations (144) (777) - -
Cumulative effect of adopting SFAS 142 (4,637) - - -
Net income (loss) $ (2,342) 1,616 2,692 3,206
====== ====== ====== ======
Earnings (loss) per common share - Basic
Income from continuing operations $ .23 .21 .23 .22
Loss from discontinued operations $ (.01) (.07) - -
Cumulative effect of adopting SFAS 142 $ (.43) - - -
------ ------ ------ ------
Net income (loss) $ (.22) .14 .23 .22
====== ====== ====== ======
Basic weighted average shares 10,695 11,238 11,559 14,671
====== ====== ====== ======
Earnings (loss) per common share - Diluted
Income from continuing operations $ .21 .20 .22 .21
Loss from discontinued operations $ (.01) (.06) - -
Cumulative effect of adopting SFAS 142 $ (.40) - - -
------ ------ ------ ------
Net income (loss) $ (.20) .13 .22 .21
====== ====== ====== ======
Diluted weighted average shares 11,695 11,986 12,495 15,580
====== ====== ====== ======
October 29, January 28, April 29, July 29,
2000 2001 2001 2001
-------- -------- -------- ---------
Net sales $ 17,758 17,065 18,987 22,684
Gross profit 6,777 5,718 6,578 6,730
Income from continuing operations 2,042 1,627 1,721 2,183
Loss from discontinued operations (12) (23) (47) (86)
Net income $ 2,030 1,604 1,674 2,097
====== ====== ====== ======
Earnings (loss) per common share - Basic
Income from continuing operations $ .23 .16 .16 .21
Loss from discontinued operations $ - - - (.01)
------ ------ ------ ------
Net income $ .23 .16 .16 .20
====== ====== ====== ======
Basic weighted average shares 8,985 10,263 10,530 10,535
====== ====== ====== ======
Earnings (loss) per common share - Diluted
Income from continuing operations $ .20 .15 .16 .19
Loss from discontinued operations $ - - - (.01)
------ ------ ------ ------
Net income $ .20 .14 .15 .19
====== ====== ====== ======
Diluted weighted average shares 10,134 11,100 11,045 11,280
====== ====== ====== ======
17
The gross profit margin from quarter to quarter is affected by the change in
product mix. Income from continuing operations in the fourth quarter of fiscal
2002 was favorably affected by the lower effective income tax rate due to the
recognition of the tax benefit attributable to extra territorial income, which
was offset by litigation costs (See Item. 3 "Legal Proceedings").
Liquidity and Capital Resources
As of July 28, 2002 and July 29, 2001, working capital was $129,012,000 and
$46,804,000, respectively, and the ratio of current assets to current
liabilities was 9.45 to 1 and 3.50 to 1, respectively.
As is customary in the defense industry, inventory is partially financed by
progress payments. In addition, it is customary for the Company to receive
advanced payments from customers on major contracts at the time a contract is
entered into. The unliquidated balance of these advanced payments was
approximately $1,371,000 at July 28, 2002, and $261,000 at July 29, 2001.
Net cash provided by continuing operations was approximately $13,139,000 in
fiscal 2002 as compared to $3,858,000 in 2001. Significant items contributing to
the sources of funds include income from operations of $14,647,000 (adjusted for
depreciation and amortization), a decrease in accounts receivable of $1,583,000,
increases in accounts payable and accrued expenses of $429,000, income taxes of
$5,351,000, and advanced payments on contracts of $1,110,000. Offsetting these
sources of funds are an increase in costs incurred and income recognized in
excess of billings on uncompleted contracts of $6,341,000, an increase in
inventory of $1,974,000, and a net change in deferred taxes of $1,183,000.
Net cash used in investing activities consists of $5,488,000 for capital
expenditures, $500,000 for a license of certain technology, and the $3,000,000
deferred payment of the Terrasat purchase price; offset by a partial
distribution from the limited partnership of $626,000.
In June 2002, the Company entered into a new $50,000,000 Revolving Credit Loan
Syndication agreement with two banks on an unsecured basis which may be used for
general corporate purposes, including business acquisitions. The revolving
credit facility requires the payment of interest only on a monthly basis and
payment of the outstanding principal balance on January 31, 2004. The Company
may elect to borrow up to a maximum of $5,000,000 with interest based on the
FOMC Federal Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a
maximum of $45,000,000 with interest based on LIBOR plus a margin of 1.35% to
1.65%. The applicable incremental margin is based on the ratio of total
liabilities to tangible net worth, as those terms are defined in the agreement,
ranging from less than .40 to 1.0, to greater than 1.0 to 1.0. The FOMC Federal
Funds Target Rate and the LIBOR rate was 1.75% and 1.81%, respectively, at July
28, 2002. There is a fee of 15 basis points per annum on the unused portion of
the $45,000,000 LIBOR based portion of the credit facility payable quarterly.
There were no borrowings outstanding as of July 28, 2002 and July 29, 2001.
During the fiscal year ended July 28, 2002, the Company borrowed and repaid
$4,300,000 under the credit facility for working capital needs. Stand-by letters
of credit were outstanding in the amount of $5,062,000 under the credit facility
at July 28, 2002.
During the fiscal year ended July 28, 2002, the Company received proceeds of
$3,000,000 from the issuance of industrial revenue bonds in connection with the
financing of the plant expansion in Lancaster PA, and received approximately
$3,984,000 from the exercise of common stock options by employees.
On April 30, 2002, the Company completed the sale of 3,000,000 shares of common
stock to the public at $23.00 per share. The Company received net proceeds of
approximately $64,812,000 after underwriting discounts and commissions and other
expenses of the offering.
The Company received 206,756 shares of common stock during the fiscal year
valued at $3,847,000 in exchange for payroll taxes due from employees upon the
exercise of stock options.
18
The Company believes that presently anticipated future cash requirements will be
provided by internally generated funds, its existing unsecured credit facility,
and the approximately $64,812,000 net proceeds from the sale of 3,000,000 shares
of common stock to the public on April 30, 2002 (See Note M of the financial
statements). A significant portion of the Company's revenue for fiscal 2003 will
be generated from its existing backlog of sales orders. The backlog of orders at
July 28, 2002 was approximately $82,678,000. All orders included in backlog are
covered by signed contracts or purchase orders. Nevertheless, contracts
involving government programs may be terminated at the discretion of the
government. In the event of the cancellation of a significant amount of
government contracts included in the Company's backlog, the Company will be
required to rely more heavily on cash reserves and its existing credit facility
to fund its operations. The Company is not aware of any events which are
reasonably likely to result in any cancellation of its government contracts. The
Company has $44,938,000 available under its bank credit facility, net of
outstanding stand-by letters of credit of $5,062,000, and cash reserves at July
28, 2002 of approximately $86,210,000.
Future payments required on long-term debt are as follows (in thousands):
During Industrial
fiscal Mortgage revenue
year Total note bonds Other
---- ----- ---- ----- -----
2003 $ 215 $ 81 $ 95 39
2004 208 86 100 22
2005 198 93 105 -
2006 211 101 110 -
2007 223 108 115 -
Future 4,844 2,222 2,475 147
----- ----- ----- ---
$ 5,899 $ 2,691 $ 3,000 208
===== ===== ===== ===
Stand-by letters of credit expire as follows:
During
fiscal
year Amount
---- ------
2003 $ 1,607
2004 3,065
2005 115
2006 275
Minimum annual rentals under noncancellable operating leases are as follows (in
thousands):
During
fiscal
year Amount
---- ------
2003 $ 1,129
2004 966
2005 860
2006 875
2007 901
Future 2,049
19
Critical Accounting Policies
The Company's 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 its
oversight responsibilities, management continually evaluates the propriety of
its accounting methods as new events occur. Management believes that its
policies are applied in a manner which is intended to provide the user of the
Company's financial statements a current, accurate and complete presentation of
information in accordance with Generally Accepted Accounting Principles.
Important accounting practices that require the use of assumptions and judgments
are outlined below.
Revenue under certain long-term, fixed price contracts is recognized using the
percentage of completion method of accounting. Revenue recognized on these
contracts is based on estimated completion to date (the total contract amount
multiplied by percent of performance, based on total costs incurred in relation
to total estimated cost at completion). Prospective losses on long-term
contracts are based upon the anticipated excess of inventoriable manufacturing
costs over the selling price of the remaining units to be delivered and are
recorded when first reasonably determinable. Contract costs include all direct
material and labor costs and those indirect costs related to contract
performance. Actual losses could differ from those estimated due to changes in
the ultimate manufacturing costs. 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.
Subsequent Event
The Company entered into an agreement as of September 1, 2002, to acquire all of
the issued and outstanding common stock of EW Simulation Technology, Limited
("EWST"), a British company of Aldershot, UK, which is expected to be operated
as a wholly-owned subsidiary. EWST designs, develops and produces electronic
warfare simulator systems for prime defense contractors and countries worldwide.
The transaction, which closed on September 20, 2002, provides for payment of
$3,000,000 in cash and a note for $1,500,000, including interest at 1.8%,
payable in annual installments of $500,000. The transaction will be accounted
for in accordance with the provisions of SFAS No. 141, "Business Combinations",
which requires that all business combinations be accounted for using the
purchase method. The allocation of the aggregate estimated purchase price will
be determined based on detailed reviews of the fair value of assets acquired,
including identified intangible assets, and liabilities assumed. Any remaining
excess cost over the fair value of net assets acquired will be recognized as
goodwill.
New Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 is effective for fiscal years
beginning after June 15, 2002. Management does not believe the adoption of this
standard will have a material impact on the Company's financial position or
results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This statement is effective for fiscal years beginning after May 15, 2002. SFAS
145 requires, among other things, eliminating reporting debt extinguishments as
an extraordinary item in the income statement. Management does not believe the
adoption of this standard will have a material impact on the Company's financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The statement is effective for fiscal years
beginning after December 31, 2002. SFAS No. 146
20
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Management does not believe the adoption of this standard
will have a material impact on the Company's financial position or results of
operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is subject to market risk associated with changes in interest rates,
and foreign currency exchange. The Company has not entered into any market risk
sensitive instruments for trading purposes.
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 of the financial statements on a notional amount of
$3,000,000 for a fixed rate of 4.07% for a 10 year period ending October 1,
2011. The notional amount reduces each year in tandem with the annual
installments due on the Bonds. The fixing of the interest rate for this period
offsets the Company's exposure to the uncertainty of floating interest rates on
the Bonds, and as such has been designated as a cash flow hedge. The hedge is
deemed to be highly effective and any ineffectiveness will be recognized in
interest expense in the reporting period. The fair value of the interest rate
swap was a liability of $147,000 as of July 28, 2002. There was no material
hedge ineffectiveness related to cash flow hedges during the period to be
recognized in earnings. There was no gain or loss reclassified from accumulated
other comprehensive income into earnings during the fiscal year ended July 28,
2002 as a result of the discontinuance of a cash flow hedge due to the
probability of the original forecasted transaction not occurring.
Other debt of the Company consists of a mortgage on its facility in Lancaster,
PA at a fixed rate of 7.43%, and a $50,000,000 Revolving Credit Loan Syndication
agreement with two banks on an unsecured basis which may be used for general
corporate purposes, including business acquisitions. The revolving credit
facility requires the payment of interest only on a monthly basis and payment of
the outstanding principal balance on January 31, 2004. The Company may elect to
borrow up to a maximum of $5,000,000 with interest based on the FOMC Federal
Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum of
$45,000,000 with interest based on LIBOR plus a margin of 1.35% to 1.65%. The
applicable incremental margin is based on the ratio of total liabilities to
tangible net worth, as those terms are defined in the agreement, ranging from
less than .40 to 1.0, to greater than 1.0 to 1.0. The FOMC Federal Funds Target
Rate and the LIBOR rate was 1.75% and 1.81%, respectively, at July 28, 2002. The
credit line is reviewed on an annual basis.
Since the acquisition of GMC, the Company is subject to movements in foreign
currency rate changes related to GMC's Israel operations.
The Company does not anticipate any other material changes in its primary market
risk exposures in fiscal 2003.
The table below provides information about the Company's debt that is sensitive
to changes in interest rates. Future principal payment cash flows by maturity
date as required under the mortgage and the industrial revenue bonds, and
corresponding fair values are as follows:
Fiscal year ending: Mortgage Bonds
------------------ -------- -----
2003 $ 81 $ 95
2004 86 100
2005 93 105
2006 101 110
2007 108 115
2008 and later 2,222 2,475
----- -----
$ 2,691 $ 3,000
===== =====
Fair value $ 3,557 $ 3,000
===== =====
21
The Company does not consider the market risk exposure relating to foreign
currency exchange or interest rates to be material.
There were no borrowings outstanding under the revolving credit facility as of
July 28, 2002.
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
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 2003, to be filed with the
Securities and Exchange Commission within 120 days following the end of the
Company's fiscal year ended July 28, 2002.
22
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(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 Employment Agreement between Herley Industries, Inc. and Lee N.
Blatt dated as of July 29, 2002.
10.6 Employment Agreement between Herley Industries, Inc. and Myron Levy
dated as of July 29, 2002.
10.7 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).
10.8 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).
10.9 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).
10.10 Loan Agreement dated June 19, 2002 among the Registrant and Allfirst
Bank and Fulton Bank.
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 Amendment to Loan Agreement dated January 11, 2000 between
Registrant and Allfirst Bank, successor to The First National Bank
of Maryland (Exhibit 10.1 of Form 10-Q dated March 13, 2000).
10.13 Amendment to Loan Agreement dated February 15, 2001 between
Registrant and Allfirst Bank, successor to The First National Bank
of Maryland (Exhibit 10.1 of Form 10-Q dated March 13, 2001).
10.14 Asset Purchase Agreement dated as of October 12, 2000 between
Registrant and American Microwave Technology Inc. (Exhibit 10.1 of
Form 10-Q dated December 12, 2000).
10.15 Common Stock Purchase Agreement dated as of December 4, 2000 between
Registrant and Terrasat, Inc. (Exhibit 10.2 of Form 10-Q dated
December 12, 2000).
10.16 Lease Agreement dated March 1, 2000 between Registrant and RSK
Realty LTD (Exhibit 10.13 of Annual Report on Form 10-K for the
fiscal year ended July 30, 2000).
10.17 Common Stock Purchase Agreement dated as of September 20, 2002
between Registrant and EW Simulation Technology, Limited.
10.18 Trust Indenture dated as of October 19, 2001 between Registrant, and
East Hempfield Township Industrial Development Authority and
Allfirst Bank, as Trustee.
23.1 Consent of Deloitte & Touche LLP.
99.1 Certification required by 18 U.S.C. ss. 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 27.
23
(c) Reports on Form 8-K
During the fourth quarter of fiscal 2002, the Registrant filed the
following reports under Form 8-K:
The Company filed a report on May 24, 2002 for the appointment of Ernst
& Young LLP as its independent auditors for the fiscal year ending July
28, 2002 to replace Arthur Andersen.
The Company filed a report on July 17, 2002 for the appointment of
Deloitte & Touche LLP as its independent auditors for the fiscal year
ending July 28, 2002 to replace Arthur Andersen.
24
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, 2002.
HERLEY INDUSTRIES, INC.
By: /S/ Lee N. Blatt
----------------------------------
Lee N. Blatt, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on October 21, 2002 by the following persons in the
capacities indicated:
By: /S/ Lee N. Blatt Chairman of the Board
------------------------------------------------
Lee N. Blatt
By: /S/ Myron Levy Chief Executive Officer and
------------------------------------------------Director
Myron Levy (Principal Executive Officer)
By: /S/ Anello C. Garefino Vice President Finance, CFO,
------------------------------------------------Treasurer
Anello C. Garefino (Principal Financial Officer)
By: /S/ David H. Lieberman Secretary and Director
---------------------------------------------
David H. Lieberman
By: /S/ Thomas J. Allshouse Director
---------------------------------------------
Thomas J. Allshouse
By: /S/ John A. Thonet Director
------------------------------------------------
John A. Thonet
By: /S/ Alvin M. Silver Director
------------------------------------------------
Alvin M. Silver
By: /S/ Edward K. Walker, Jr. Director
---------------------------------------------
Edward K. Walker, Jr.
25
Certification of Chief Executive Officer
pursuant to Section 302(a) of the SARBANES-OXLEY ACT OF 2002
I, Myron Levy, Chief Executive Officer of Herley Industries, Inc. (the
"Registrant"), certify that:
(a) I have reviewed this annual report on Form 10-K of Herley
Industries, Inc. for the fiscal year ended July 28, 2002;
(b) Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report; and
(c) Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Registrant as of,
and for, the periods presented in this annual report.
Dated: October 21, 2002 By: /s/ Myron Levy
------------------------
Myron Levy
Chief Executive Officer
Certification of Chief Financial Officer
pursuant to Section 302(a) of the SARBANES-OXLEY ACT OF 2002
I, Anello C. Garefino, Chief Financial Officer of Herley Industries, Inc.
(the "Registrant"), certify that:
(a) I have reviewed this annual report on Form 10-K of Herley
Industries, Inc. for the fiscal year ended July 28, 2002;
(b) Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report; and
(c) Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Registrant as of,
and for, the periods presented in this annual report.
Dated: October 21, 2002 By: /s/ Anello C. Garefino
-------------------------
Anello C. Garefino
Chief Financial Officer
26
Schedule II - Valuation and Qualifying Accounts
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions Amount
-------------------------------------
Charged to written
Balance at Charged to other off Balance at
beginning costs and accounts - against end of
Description of period expenses describe reserve period
----------- --------- -------- -------- ------- ------
Valuation accounts deducted from assets to which they apply:
July 28, 2002:
Inventory $ 2,204,993 $ 202,035$ - $ - $ 2,407,028
July 29, 2001:
Inventory 1,891,443 514,663 152,505 (1) 353,618 2,204,993
July 30, 2000:
Inventory 1,935,832 83,317 - 127,706 1,891,443
(1) Reserve established for the acquisition of AMT.
27
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
July 28, July 29,
2002 2001
---------- ----------
ASSETS
Current Assets:
Cash and cash equivalents $ 86,210 $ 13,041
Accounts receivable 14,486 16,069
Costs incurred and income recognized in excess
of billings on uncompleted contracts 6,882 541
Other receivables 274 160
Inventories, net of allowance of $2,407 in 2002
and $1,774 in 2001 33,371 31,397
Prepaid income taxes 382 -
Assets held for sale - 2,370
Deferred taxes and other 2,670 1,958
---------- ----------
Total Current Assets 144,275 65,536
Property, Plant and Equipment, net 22,231 21,312
Goodwill 21,665 26,302
Intangibles, net of accumulated amortization of $145 in 2002
and $104 in 2001 423 464
Available-For-Sale Securities 46 146
Other Investments 195 773
Other Assets 1,367 64
---------- ----------
$ 190,202 $ 114,597
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 215 $ 213
Accounts payable and accrued expenses 12,857 15,304
Billings in excess of costs incurred and
income recognized on uncompleted contracts - 531
Income taxes payable - 1,061
Reserve for contract losses 820 472
Advance payments on contracts 1,371 261
Liabilities held for sale - 890
---------- ----------
Total Current Liabilities 15,263 18,732
Long-term Debt 5,684 2,740
Deferred Income Taxes 3,897 4,452
---------- ----------
24,844 25,924
---------- ----------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized
20,000,000 shares; issued and outstanding
14,680,960 in 2002 and 10,537,289 in 2001 1,468 1,054
Additional paid-in capital 116,579 45,250
Retained earnings 47,541 42,369
Accumulated other comprehensive loss (230) -
---------- ----------
Total Shareholders' Equity 165,358 88,673
---------- ----------
$ 190,202 $ 114,597
========== ==========
The accompanying notes are an integral part of these financial statements.
F-4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data)
52 weeks ended
--------------------------------------------------
July 28, July 29, July 30,
2002 2001 2000
------------- ------------- --------------
Net sales $ 92,881 $ 76,494 $ 70,537
------------- ------------- --------------
Cost and expenses:
Cost of products sold 61,947 50,691 44,382
Selling and administrative expenses 13,229 14,545 13,497
Litigation costs 2,079 265 -
Plant closing costs 406 - -
------------- ------------- --------------
77,661 65,501 57,879
------------- ------------- --------------
Income from operations 15,220 10,993 12,658
Other income (expense), net 386 447 (906)
------------- ------------- --------------
Income from continuing operations
before income taxes 15,606 11,440 11,752
Provision for income taxes 4,876 3,867 4,113
------------- ------------- --------------
Income from continuing operations 10,730 7,573 7,639
Loss from discontinued operations
(including net loss on sale of $1,166)
net of income tax benefit (921) (168) -
------------- ------------- --------------
Income before cumulative effect of change
in accounting principle 9,809 7,405 7,639
Cumulative effect of adopting SFAS 142 (4,637) - -
------------- ------------- --------------
Net income $ 5,172 $ 7,405 $ 7,639
============= ============= ==============
Earnings (loss) per common share - Basic
Income from continuing operations .89 .75 1.05
Loss from discontinued operations (.08) (.02) -
Cumulative effect of adopting SFAS 142 (.39) - -
------------- ------------- --------------
Net earnings $ .43 $ .73 $ 1.05
============= ============= ==============
Basic weighted average shares 12,041 10,082 7,308
============= ============= ==============
Earnings (loss) per common share - Diluted
Income from continuing operations .83 .69 .96
Loss from discontinued operations (.07) (.02) -
Cumulative effect of adopting SFAS 142 (.36) - -
------------- ------------- --------------
Net earnings $ .40 $ .68 $ .96
============= ============= ==============
Diluted weighted average shares 12,978 10,956 7,928
============= ============= ==============
The accompanying notes are an integral part of these financial statements.
F-5
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
52 weeks ended July 28, 2002, July 29, 2001 and July 30, 2000
(In thousands except share data)
Accumulated
Additional Other
Common Stock Paid-in Retained Treasury Comprehensive
Shares Amount Capital Earnings Stock Loss Total
------ ------ ------- -------- ----- ---- -----
Balance at August 1, 1999 5,030,283 $ 503 15,072 27,325 - - $ 42,900
Net income 7,639 7,639
Issuance of common stock in connection
with business acquired 33,841 3 511 514
Exercise of warrants issued in
connection with public offering
in 1998 1,313,613 131 20,361 20,492
Exercise of stock options
and warrants 137,115 14 1,213 (140) 1,087
Tax benefit upon exercise of stock
options 304 304
Purchase of 512,000 shares
of treasury stock (7,565) (7,565)
Retirement of treasury shares (520,982) (52) (7,653) 7,705 0
----------- ------ -------- -------- -------- ------------- --------
Balance at July 30, 2000 5,993,870 $ 599 29,808 34,964 - - $ 65,371
Net income 7,405 7,405
Exercise of warrants issued in
connection with business acquired
in 1999 946,349 95 14,664 14,759
Exercise of stock options
and warrants 94,134 10 1,239 1,249
Tax benefit upon exercise of stock
options 83 83
Purchase of 10,800 shares
of treasury stock (194) (194)
Retirement of treasury shares (10,800) (1) (193) 194 0
Three-for-two stock split 3,513,736 351 (351) 0
----------- ------ -------- -------- -------- ------------- --------
Balance at July 29, 2001 10,537,289 $ 1,054 45,250 42,369 - - $ 88,673
Net income 5,172 5,172
Net proceeds of public offering
of 3,000,000 shares of common stock 3,000,000 300 64,512 64,812
Exercise of stock options
and warrants 1,143,671 178 11,832 (11,873) 137
Tax benefit upon exercise of stock
options 6,794 6,794
Retirement of treasury shares (64) (11,809) 11,873 0
Other comprehensive loss:
Unrealized loss from
available-for-sale securities (66) (66)
Unrealized loss on interest rate swap (97) (97)
Foreign currency translation loss (67) (67)
----------- ------ -------- -------- -------- ------------- --------
Balance at July 28, 2002 14,680,960 $ 1,468 116,579 47,541 - (230) $ 165,358
=========== ====== ======== ======== ======== ============= ========
The accompanying notes are an integral part of these financial statements.
F-6
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
52 weeks ended
-------------------------------------------
July 28, July 29, July 30,
2002 2001 2000
---------- ---------- ----------
Cash flows from operating activities:
Income from continuing operations $ 10,730 $ 7,573 $ 7,639
---------- ---------- ----------
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization 3,917 4,772 3,998
Loss (gain) on sale of fixed assets 45 4 (21)
Equity in income of limited partnership (48) (49) (71)
(Increase) decrease in deferred tax assets (712) 962 (148)
(Decrease) increase in deferred tax liabilities (471) (1,119) 342
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 1,583 (547) (1,568)
(Increase) in costs incurred and income
recognized in excess of billings on
uncompleted contracts (6,341) (395) (146)
(Increase) decrease in other receivables (2) 133 (20)
(Increase) in inventories (1,974) (6,880) (1,625)
Decrease in prepaid expenses and other - 25 4
Increase in accounts payable
and accrued expenses 429 1,088 685
(Decrease) increase in billings in excess of
costs incurred and income recognized
on uncompleted contracts (531) 531 -
Increase (decrease) in income taxes payable 5,351 (281) 1,458
Increase (decrease) in reserve for contract losses 348 (1,201) (1,038)
Increase (decrease) in advance payments on contracts 1,110 (745) 195
Other, net (295) (13) 170
---------- ---------- ----------
Total adjustments 2,409 (3,715) 2,215
---------- ---------- ----------
Net cash provided by continuing operations 13,139 3,858 9,854
---------- ---------- ----------
Cash flows from investing activities:
Acquisition of businesses, net of cash acquired - (8,373) (6,095)
Payment of deferred purchase price of acquired business (3,000) - -
Investment in technology license (500) - -
Proceeds from sale of fixed assets 85 16 4,142
Partial distribution from limited partnership 626 296 -
Capital expenditures (5,488) (3,679) (2,618)
---------- ---------- ----------
Net cash used in investing activities (8,277) (11,740) (4,571)
---------- ---------- ----------
Cash flows from financing activities:
Borrowings under bank line of credit 4,300 7,100 13,900
Proceeds from industrial revenue bond financing 3,000 - -
Net proceeds from public offering of common stock 64,812 - -
Proceeds from exercise of stock options and warrants, net 3,984 16,008 21,574
Payments under lines of credit (4,300) (7,100) (26,400)
Payments of long-term debt (201) (908) (1,868)
Purchase of treasury stock (3,847) (194) (7,565)
---------- ---------- ----------
Net cash provided by (used in) financing activities 67,748 14,906 (359)
---------- ---------- ----------
Net cash provided by (used in) discontinued operations 559 (1,648) -
---------- ---------- ----------
Net increase in cash and cash equivalents 73,169 5,376 4,924
Cash and cash equivalents at beginning of period 13,041 7,665 2,741
---------- ---------- ----------
Cash and cash equivalents at end of period $ 86,210 $ 13,041 $ 7,665
========== ========== ==========
Supplemental cash flow information:
Cashless exercise of stock options $ 8,026 $ - $ 80
========== ========== ==========
Stock issued for business acquired $ - $ - $ 514
========== ========== ==========
Tax benefit related to stock options $ 6,794 $ 83 $ 304
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
F-7
Item 8. Financial Statements and Supplementary Data
HERLEY INDUSTRIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
INDEPENDENT AUDITORS' REPORT F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-3
FINANCIAL STATEMENTS:
Consolidated Balance Sheets, July 28, 2002 and July 29, 2001 F-4
Consolidated Statements of Income for the 52 weeks ended
July 28, 2002, July 29, 2001 and July 30, 2000 F-5
Consolidated Statements of Shareholders' Equity for the 52 weeks
ended July 28, 2002, July 29, 2001 and July 30, 2000 F-6
Consolidated Statements of Cash Flows for the 52 Weeks Ended
July 28, 2002, July 29, 2001 and July 30, 2000 F-7
Notes to Consolidated Financial Statements F-8
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Herley Industries, Inc.
We have audited the accompanying consolidated balance sheet of Herley
Industries, Inc. and Subsidiaries ("the Company") as of July 28, 2002, and the
related consolidated statement of income, shareholders' equity, and cash flows
for the year then ended. Our audit also included the financial statement
schedule listed in the Index at Item 14 as it relates to the year ended July 28,
2002. 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 financial statements and financial statement
schedule based on our audit. The financial statements of the Company for the
years ended July 29, 2001 and July 30, 2000 were audited by other auditors who
have ceased operations. Those auditors expressed an unqualified opinion on those
financial statements in their report dated October 3, 2001, updated as of March
1, 2002.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of July 28, 2002,
and the results of their operations and their cash flows for the year then ended
in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, such financial statement schedule as it
relates to the year ended July 28, 2002, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As discussed in Note A to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill by adopting Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
/s/ DELOITTE & TOUCHE LLP
October 15, 2002
Baltimore, Maryland
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley
Industries, Inc and Subsidiaries as of July 30, 2000 and July 29, 2001, and the
related consolidated statements of income, shareholders' equity and cash flows
for the 52 weeks ended August 1, 1999, July 30, 2000 and July 29, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the 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 includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Herley
Industries, Inc. and Subsidiaries as of July 30, 2000 and July 29, 2001, and the
consolidated results of their operations and their cash flows for the 52 weeks
ended August 1, 1999, July 30, 2000 and July 29, 2001 in conformity with
accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Lancaster, PA
October 3, 2001 (except with respect to the matters discussed in Note P, as to
which the date is March 1, 2002.)
NOTE - This report represents a copy of the predecessor auditor's report
included in the Company's Form S-3 dated April 4, 2002 and does not represent a
reissuance of the report. Note P, as identified in the auditor's report,
represents the Company's previous disclosure regarding discontinued operations
which is included in Note Q of the current notes to the consolidated financial
statements.
F-3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Nature of Operations
The Company, a Delaware corporation, is engaged in research, engineering,
product development, and manufacturing of complex microwave radio frequency
(RF) and millimeter wave components and subsystems for defense and
commercial customers worldwide.
2. Fiscal Year
The Company's fiscal year ends on the Sunday closest to July 31. Normally
each fiscal year consists of 52 weeks, but every five or six years the
fiscal year will consist of 53 weeks. All fiscal years presented consisted
of 52 weeks.
3. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Herley
Industries, Inc. and its subsidiaries, all of which are wholly-owned. All
significant 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 requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements as well as revenues
and expenses during the period. Actual results could differ from those
estimates.
4. Cash and Cash Equivalents
The Company considers all liquid investments with an original maturity of
three months or less at the date of acquisition to be cash equivalents.
Short-term investments are recorded at the amortized cost plus accrued
interest which approximates market value. The Company limits its credit
risk to an acceptable level by evaluating the financial strength of
institutions at which significant investments are made and based upon
credit ratings.
5. Concentration of Credit Risk
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.
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.
F-8
7. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and
amortization are provided principally by the straight-line method over the
estimated useful lives of the related assets. Gains and losses arising from
the sale or disposition of property, plant and equipment are recorded in
other income (expense).
8. Goodwill and Other Intangible Assets
The Company adopted the provisions of SFAS No. 142 "Goodwill and Other
Intangible Assets" on July 30, 2001. SFAS No. 142 requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangibles. Under a non-amortization approach, goodwill and certain
intangibles are not amortized into results of operations, but instead are
reviewed for impairment and written down and charged to results of
operations in the periods in which the recorded value of goodwill and
certain intangibles is more than its fair value. The adoption of SFAS
No.142 resulted in the Company's discontinuation of amortization of its
goodwill and certain intangible assets. The Company was required to assess
its goodwill for impairment under the new standard within six months of
adoption and completed its assessment in the second quarter of fiscal 2002.
The Company operates as a single integrated business and as such has one
operating segment which is also the reportable segment as defined in SFAS
131. Within the operating segment, the Company has identified two
components as reporting units as defined under SFAS 142, defense
electronics and commercial technologies. The Company determined the
carrying value of each reporting unit by assigning assets and liabilities,
including the existing goodwill and intangible assets, to those reporting
units as of July 30, 2001. The Company determined that an impairment of
goodwill in the commercial technologies unit had occurred due to the
overcapacity in the telecom industry and deteriorating economic conditions.
Accordingly, a transition adjustment in the amount of $4,637,000 was
recorded as of July 30, 2001 as a cumulative effect of a change in
accounting principle. There is no tax benefit associated with the
adjustment since the impaired goodwill is not deductible for income tax
purposes.
Amortization of goodwill charged to continuing operations for the fifty-two
weeks ended July 29, 2001 and July 30, 2000 was approximately $1,296,000
and $958,000 respectively. Amortization of goodwill charged to discontinued
operations for the fifty-two weeks ended July 29, 2001 was approximately
$208,000. Pro- forma income from continuing operations and net income and
earnings per share in connection with the adoption of SFAS 142 is as
follows (in thousands except per share data):
F-9
Income from continuing operations:
Fifty-two weeks ended
---------------------
July 28, July 29, July 30,
2002 2001 2000
---- ---- ----
Income from continuing operations
as reported $ 10,730 $ 7,573 $ 7,639
Add goodwill amortization, net of
income tax benefit - 850 623
------ ------ ------
Adjusted income from continuing
operations $ 10,730 $ 8,423 $ 8,262
====== ===== =====
Earnings per common share-basic:
From continuing operations as reported $ .89 $ .75 $ 1.05
Goodwill amortization - .08 .08
--- --- ----
Adjusted $ .89 $ .83 $ 1.13
=== === ====
Earnings per common share-diluted:
From continuing operations as reported $ .83 $ .69 $ .96
Goodwill amortization - .08 .08
--- --- ----
Adjusted $ .83 $ .77 $ 1.04
=== === ====
Net income :
Fifty-two weeks ended
---------------------
July 28, July 29, July 30,
2002 2001 2000
---- ---- ----
Net income as reported $ 5,172 $ 7,405 $ 7,639
Add goodwill amortization, net of
income tax benefit - 987 623
----- ----- -----
Adjusted net income $ 5,172 $ 8,392 $ 8,262
===== ===== =====
Earnings per common share-basic:
As reported $ .43 $ .73 $ 1.05
Goodwill amortization - .10 .08
--- --- ----
Adjusted $ .43 $ .83 $ 1.13
=== === ====
Earnings per common share-diluted:
As reported $ .40 $ .68 $ .96
Goodwill amortization - .09 .08
--- --- ----
Adjusted $ .40 $ .77 $ 1.04
=== === ====
Intangibles, consisting of patents having an estimated useful life of
fourteen years, are carried at an aggregate gross amount of $568,000 with
accumulated amortization at July 29, 2002 of $145,000. Amortization expense
for the fifty-two weeks ended July 29, 2002 and July 30, 2001 was
approximately $41,000.
The carrying amount of intangibles is evaluated on a recurring basis. There
was no impairment in the remaining goodwill at July 28, 2002 of
approximately $21,665,000 related to the defense electronics reporting unit
based on current market capitalization of the Company. An annual impairment
test is performed in the fourth quarter of each fiscal year and any future
impairment of goodwill will be charged to operations.
F-10
9. Marketable Securities
The Company accounts for its investments in marketable securities in
accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of debt securities at
the time of purchase and reevaluates such designation as of each balance
sheet date. Debt securities are classified as held-to- maturity when the
Company has the positive intent and ability to hold the securities to
maturity. Marketable equity securities and debt securities not classified
as held-to-maturity are classified as available-for-sale.
Available-for-sale securities are carried at fair market value with net
unrealized holding gains or losses, net of income taxes, reported as a
separate component of other comprehensive loss. Realized gains and losses
and declines in value judged to be other-than-temporary are included in
other income, net. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities are included in
other income, net.
10. Other Investments
The Company is a limited partner in a nonmarketable limited partnership in
which it owns approximately a 10% interest.
11. Revenue and Cost Recognition
Substantially all of our customer contracts are firm, fixed price
contracts, providing for a predetermined fixed price for the products that
we sell, regardless of the costs we incur. Under fixed-price contracts,
revenue and related costs are recorded primarily as deliveries are made.
Certain costs under long-term, fixed-price contracts (principally either
directly or indirectly with the U.S. Government), which include non-
recurring billable engineering, are deferred until these costs are
contractually billable. Revenue under certain long-term, fixed price
contracts is recognized using the percentage of completion method of
accounting. Revenue recognized on these contracts is based on estimated
completion to date (the total contract amount multiplied by percent of
performance, based on total costs incurred in relation to total estimated
cost at completion). Prospective losses on long-term contracts are based
upon the anticipated excess of inventoriable manufacturing costs over the
selling price of the remaining units to be delivered and are recorded in
the period when first determinable. Actual losses could differ from those
estimated due to changes in the ultimate manufacturing costs and contract
terms.
Contract costs include all direct material and labor costs and those
indirect costs related to contract performance. Selling, general and
administrative costs are charged to expense as incurred.
12. Product Development
The Company's primary efforts are focused on engineering design and product
development activities rather than pure research. The cost of these
development activities, including employees' time and prototype
development, net of amounts paid by customers, was approximately
$2,269,000, $2,588,000, and $2,264,000 in fiscal 2002, 2001, and 2000,
respectively, and are included in cost of products sold.
13. Income Taxes
Income taxes are accounted for by the asset/liability approach in
accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." Deferred taxes represent the expected future
tax consequences when the reported amounts of assets and liabilities are
recovered or paid. They arise from temporary differences between the
financial reporting and tax bases of assets and liabilities and are
adjusted for changes in tax laws and tax rates when those changes are
enacted. The provision for income taxes represents the total of income
taxes paid or payable for the current year, plus the change in deferred
taxes during the year.
F-11
14. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," encourages, but does not require companies to
record compensation cost for stock-based employee compensation plans at
fair value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price
of the Company's stock at the date of the grant over the amount an employee
must pay to acquire the stock. Because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on
the date of grant, no compensation expense is recognized.
15. Foreign Currency Translation
Financial statements of foreign subsidiaries are prepared in their
respective functional currencies and translated into United States dollars
at the current exchange rates for assets and liabilities and an average
rate for 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 loss' in the accompanying consolidated
statements of shareholders' equity.
16. Derivatives
The Company recognizes all derivatives on the balance sheet at fair value.
On the date the derivative instrument is entered into, the Company
generally designates the derivative as either (1) a hedge of the fair value
of a recognized asset or liability or of an unrecognized firm commitment
("fair value hedge") or (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized
asset or liability ("cash flow hedge"). Changes in the fair value of a
derivative that is designated as, and meets all the required criteria for,
a fair value hedge, along with the gain or loss on the hedged asset or
liability that is attributable to the hedged risk, are recorded in current
period earnings. 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.
The portion of the change in fair value of a derivative associated with
hedge ineffectiveness or the component of a derivative instrument excluded
from the assessment of hedge effectiveness is recorded currently in
earnings. Also, changes in the entire fair value of a derivative that is
not designated as a hedge are recorded immediately in earnings. The Company
formally documents all relationships between hedging instruments and hedged
items, as well as its risk-management objective and strategy for
undertaking various hedge transactions. This process includes relating all
derivatives that are designated as fair value or cash flow hedges to
specific assets and liabilities on the balance sheet or to specific firm
commitments or forecasted transactions.
The Company also formally assesses, both at the inception of the hedge and
on an ongoing basis, whether each derivative is highly effective in
offsetting changes in fair values or cash flows of the hedged item. If it
is determined that a derivative is not highly effective as a hedge or if a
derivative ceases to be a highly effective hedge, the Company will
discontinue hedge accounting prospectively.
17. New Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. SFAS No. 143
is effective for fiscal years beginning after June 15, 2002. Management
does not believe the adoption of this standard will have a material impact
on the Company's financial position or results of operations.
F-12
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement is effective for fiscal years beginning after
May 15, 2002. SFAS 145 requires, among other things, eliminating reporting
debt extinguishments as an extraordinary item in the income statement.
Management does not believe the adoption of this standard will have a
material impact on the Company's financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The statement is effective
for fiscal years beginning after December 31, 2002. SFAS No. 146 requires
companies to recognize costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment to an exit
or disposal plan. Management does not believe the adoption of this standard
will have a material impact on the Company's financial position or results
of operations.
NOTE B - ACQUISITIONS
The Company entered into an agreement as of September 1, 2000 to acquire
certain assets and the business, subject to the assumption of certain
liabilities, of American Microwave Technology, Inc., ("AMT"), a California
corporation, which operates as a division of Herley Industries, Inc. The
transaction provided for the payment of $5,400,000 in cash, and the
assumption of approximately $1,153,000 in liabilities. In addition, the
Company entered into an exclusive license agreement for certain products
providing for a royalty of 10% on the net shipments of such products
through October 2004. The transaction has been accounted for under the
purchase method. Accordingly, the consolidated statements of income include
the results of AMT's operations from September 1, 2000.
The Company entered into an agreement, as of January 3, 2000, to acquire
substantially all of the assets of Robinson Laboratories, Inc. ("Robinson"
or "Robinson Labs"), a New Hampshire corporation, which operates as a
division of Herley Industries, Inc. The transaction provided for the
payment of $6,000,000 in cash, the issuance of 50,762 (as adjusted) shares
of Common Stock of the Company valued at $10.125 per share, and the
assumption of approximately $3,140,000 in liabilities. In addition, the
agreement provided for the issuance of additional shares of Common Stock up
to a maximum of 146,761 shares (as adjusted) based on new orders booked
through January 2001. The Company determined that new orders booked through
January 2001 did not meet the earn out provisions of the Asset Purchase
Agreement (See Note F "Litigation"). The transaction has been accounted for
under the purchase method. The consolidated statements of income include
the results of Robinson's operations from January 3, 2000.
Unaudited pro forma consolidated results of operations as if the
acquisitions discussed above had taken place at the beginning of fiscal
2000 would not have been materially different from the amounts reported.
As of September 1, 2002, the Company entered into an agreement to acquire
all of the issued and outstanding common stock of EW Simulation Technology,
Limited, as discussed in Note R.
F-13
NOTE C - INVENTORIES
The major components of inventories are as follows (in thousands):
July 28, July 29,
2002 2001
---- ----
Purchased parts and raw materials $18,680 $ 18,322
Work in process 15,707 12,854
Finished products 1,391 1,995
------- -------
35,778 33,171
Less reserve 2,407 1,774
----- -----
$ 33,371 $ 31,397
====== ======
NOTE D - OTHER INVESTMENTS
In July 1994, the Company invested $1,000,000 for a limited partnership
interest in M.D. Sass Municipal Finance Partners-I, a Delaware limited
partnership. The objectives of the partnership are the preservation and
protection of its capital and the earning of income through the purchase of
certificates or other documentation that evidence liens for unpaid local
taxes on parcels of real property. At July 28, 2002 and July 29, 2001 the
percentage of ownership was approximately 10%. The Company's interest in
the partnership may be transferred to a substitute limited partner, upon
written notice to the managing general partners, only with the unanimous
consent of both general partners at their sole discretion. The Company
received partial distributions of approximately $626,000 and $296,000 from
the Partnership in fiscal 2002 and 2001, respectively. As of July 28, 2002
the Company's limited partnership interest had a carrying value of
$195,000.
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following (in
thousands):
July 28, July 29, Estimated
2002 2001 Useful Life
---- ---- -----------
Land $ 2,908 $ 2,908
Building and building
improvements 9,857 8,643 10-40 years
Machinery and equipment 33,698 30,403 5- 8 years
Furniture and fixtures 1,058 1,049 5-10 years
Automobiles 91 91 3 years
Tools 25 34 5 years
Leasehold improvements 1,589 1,586 5-10 years
------- ------
49,226 44,714
Less accumulated depreciation 26,995 23,402
------ ------
$ 22,231 $ 21,312
====== ======
Depreciation charges totaled $3,776,000, $3,127,000, and $2,889,000 in
fiscal 2002, 2001, and 2000, respectively.
NOTE F - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office, production and warehouse space as well as
computer equipment and automobiles under noncancellable operating leases.
Rent expense for the 52 weeks ended July 28, 2002, July 29, 2001, and July
30, 2000, was approximately $1,244,000, $1,506,000, and $1,053,000,
respectively.
F-14
Minimum annual rentals under noncancellable operating leases are as follows
(in thousands):
Amount
Year ending fiscal 2003 $ 1,129
2004 966
2005 860
2006 875
2007 901
Future 2,049
Employment Agreements
The Company has employment agreements with certain executives of the
Company which expire December 31, 2007, subject to extension for additional
one-year periods annually each January 1 with a final expiration date of
December 31, 2010. The agreements provide for aggregate annual salaries as
of July 29, 2002 of $1,327,000 and provide for a semi-annual cost of living
adjustment based on the consumer price index. The agreements also provide
for incentive compensation at 7% in the aggregate of pretax income of the
Company. Incentive compensation in the amount of $956,000 and $971,000 was
expensed in fiscal years 2002 and 2000, respectively. The executives waived
their incentive for fiscal 2001.
The agreements also provide that, in the event there is a change in control
of the Company, as defined, the executives have the option to terminate the
agreements and receive a lump-sum payment equal to the sum of the salary
payable for the remainder of the employment term, plus the annual bonuses
(based on the average of the three highest annual bonuses awarded during
the ten preceding years) for the remainder of the employment term. As of
July 29, 2002, the amount payable in the event of such termination would be
approximately $12,416,000.
The agreements also provide for consulting periods, one for five and one
for ten years, at the end of the employment period at an annual
compensation equivalent to one-half of the executive's annual salary at the
end of the employment period, subject to annual cost of living adjustments.
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.
Six officers of the Company have severance agreements providing for an
aggregate lump-sum payment of $1,820,000 through September 30, 2004 in the
event of a change of control of the Company as defined in the agreements.
Litigation
On August 14, 2001, Robinson Laboratories, Inc. ("RLI") and Ben Robinson
("Robinson") filed an Amended Complaint against Herley Industries, Inc.
("Herley"). Although the Amended Complaint sets forth fifteen counts, the
core allegations are (i) that Herley failed to issue 97,841 shares of
common stock in connection with certain earn out requirements contained in
an Asset Purchase Agreement dated February 1, 2000; (ii) that Herley
breached an Employment Agreement with Robinson by terminating his
employment on August 5, 2001; and (iii) that Herley breached a Stock Option
Agreement dated January 31, 2000, with Robinson. RLI and Robinson asserted
(i) violations of state and federal securities laws; (ii) fraud claims;
(iii) breach of contract claims; and (iv) other equitable claims arising
from the above core factual allegations.
On September 17, 2001, Herley filed an Answer, Affirmative Defenses and
Counterclaims in this matter. In the Answer and Affirmative Defenses,
Herley denied the material allegations of the Amended Complaint. Herley
also filed Counterclaims against both RLI and Robinson. In these
counterclaims, Herley's core allegations concern Robinson's misconduct (i)
in connection with the manner he attempted to satisfy RLI's
F-15
earn out requirements; (ii) misrepresentations made in connection with the
Asset Purchase Agreement; (iii) wrongdoing as a Herley employee leading to
his termination and (iv) post-Herley employment wrongdoing in connection
with a new company known as RH Laboratories. In addition to seeking a
Declaratory Judgment pursuant to 28 U.S.C. ss. 2201 et. seq., Herley also
asserted claims for, among other things, fraud, breach of contract, breach
of fiduciary duty, unfair competition and tortious interference with actual
and prospective contractual relationships.
On August 5, 2002, a jury trial commenced. A jury verdict was rendered on
August 21, 2002 in which the jury determined, among other things, that (i)
Herley was not required to pay any additional stock; (ii) Herley breached
the Employment Agreement with Robinson and awarded Robinson $1.5 million in
damages; (iii) Herley breached the Lease Agreement with Robinson and
awarded Robinson approximately $552,000 in compensatory damages; (iv)
Robinson breached fiduciary duties to Herley and awarded Herley $400,000 in
compensatory damages; (v) Robinson and RLI breached indemnity obligations
and awarded Herley $100,000 in damages; (vi) RLI breached representations
and warranties given to Herley and awarded Herley $320,000 in damages. The
court has still not entered final judgment following the jury verdict, and
both parties are expected to appeal. Additionally, as the prevailing party
in connection with the claims asserted by RLI relating to the earn-out
stock, as well as claims advanced relating to the various breaches of the
Asset Purchase Agreement, Herley intends to file a petition for attorney's
fees and costs against both RLI and Robinson for approximately $2,000,000.
The Company is involved in various other legal proceedings and claims which
arise in the ordinary course of its business. While any litigation contains
an element of uncertainty, management believes that the outcome of such
litigation will not have a material adverse effect on the Company's
financial position or results of operations.
Stand-by Letters of Credit
The Company maintains a letter of credit facility with a bank 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 January 31, 2004. At July 28, 2002 stand-by letters of
credit aggregating approximately $5,062,000 were outstanding under this
facility.
NOTE G - INCOME TAXES
Income tax expense consisted of the following (in thousands):
52 Weeks ended
--------------------------------------
July 28, July 29, July 30,
2002 2001 2000
---- ---- ----
Current
Federal $ 5,333 $ 3,050 $ 3,573
State 520 275 192
Foreign 204 202 154
----- ----- -----
6,057 3,527 3,919
----- ----- -----
Deferred
Federal (1,090) 248 215
State (106) 92 (21)
Foreign 15 - -
----- ----- -----
(1,181) 340 194
----- ----- -----
$ 4,876 $ 3,867 $ 4,113
===== ===== =====
The Company paid income taxes of approximately $680,000, $4,427,000, and
$2,241000 in fiscal 2002, 2001, and 2000, respectively. The following is a
reconciliation of the U. S. statutory income tax rate and
F-16
the effective tax rate on pretax income:
52 Weeks ended
------------------------------
July 28, July 29, July 30,
2002 2001 2000
---- ---- ----
Statutory income tax rate 34.0 % 34.0 % 34.0 %
State income taxes, net of
federal income tax benefit 0.9 2.4 0.9
Benefit of foreign sales corporation - (2.6) (2.1)
Benefit of extra territorial income (2.4) - -
Non-deductible expenses 0.2 2.5 1.8
Benefit of foreign and
foreign-source income (1.4) (2.3) (1.8)
Other, net (0.1) 0.4 2.2
---- ---- ----
Effective tax rate 31.2 % 34.4 % 35.0 %
==== ==== ====
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):
July 28, 2002 July 29, 2001
--------------------- ---------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
Intangibles $ - $ 1,738 $ - $ 1,943
Accrued vacation pay 386 - 446 -
Accrued bonus 53 - 39 -
Warranty costs 136 - 100 -
Inventory 1,101 - 838 -
Depreciation - 2,159 - 2,873
Contract losses 362 - 146 -
Net operating loss
carry-forwards 230 - 230 -
Other 120 - 342 99
----- ----- ----- -----
$ 2,388 $ 3,897 $ 2,141 $ 4,915
===== ===== ===== =====
As of July 28, 2002 the Company has available net operating loss
carry-forwards for federal and state income tax purposes of approximately
$489,000 and $956,000, respectively which expire through 2020. The Federal
net operating loss arose through the acquisition of Terrasat and its
utilization is subject to certain limitations.
F-17
NOTE H- LONG-TERM DEBT
Long-term debt is summarized as follows (in thousands):
July 28, July 29,
Rate 2002 2001
--------------- ---- ----
Revolving loan facility (a) 3.25% and 3.16% $ - $ -
Mortgage note (b) 7.43% 2,691 2,765
Industrial Revenue Bonds (c) 4.07% 3,000 -
Other - 208 188
----- -----
5,899 2,953
Less current portion 215 213
----- -----
$ 5,684 $ 2,740
===== =====
(a) In June 2002, the Company entered into a new $50,000,000 Revolving
Credit Loan Syndication agreement with two banks on an unsecured basis
which may be used for general corporate purposes, including business
acquisitions. The revolving credit facility requires the payment of
interest only on a monthly basis and payment of the outstanding
principal balance on January 31, 2004. The Company may elect to borrow
up to a maximum of $5,000,000 with interest based on the FOMC Federal
Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum
of $45,000,000 with interest based on LIBOR plus a margin of 1.35% to
1.65%. The applicable incremental margin is based on the ratio of
total liabilities to tangible net worth, as those terms are defined in
the agreement, ranging from less than .40 to 1.0, to greater than 1.0
to 1.0. The FOMC Federal Funds Target Rate and the LIBOR rate was
1.75% and 1.81%, respectively, at July 28, 2002. There is a fee of 15
basis points per annum on the unused portion of the $45,000,000 LIBOR
based portion of the credit facility payable quarterly. There are no
borrowings under the line at July 28, 2002 and July 29, 2001.
The agreement contains various financial covenants, including, among
other matters, minimum tangible net worth, total liabilities to
tangible net worth, debt service coverage, and restrictions on other
borrowings. The Company is in compliance with all covenants at July
28, 2002.
(b) The mortgage loan is for a term of ten years commencing February 16,
1999 with fixed monthly principal and interest installments of
$23,359, including interest at a fixed rate of 7.43%, and is based
upon a twenty year amortization. The loan is secured by a mortgage on
the Company's land and building in Lancaster, Pennsylvania having a
net book value of approximately $1,845,000. The proceeds of the
mortgage loan were used to prepay the existing mortgage note having an
outstanding balance of $2,890,000 plus a prepayment premium of
$115,600.
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 covenants at July 28, 2002. In connection with this loan, the
Company paid approximately $45,000 in financing costs. Such costs are
included in Other Assets in the accompanying consolidated balance
sheets at July 28, 2002 and July 29, 2001, 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 is due October 1, 2002 and
increases each year until the final payment of $225,000 in 2021. The
interest rate on the Bonds is reset weekly at the prevailing market
rate of the BMA Municipal index. The initial rate of interest was
2.1%, which, after giving effect to a ten year interest rate swap
agreement (See Note O) becomes a fixed rate of 4.07%. The interest
rate at July 28, 2002 was 1.59%. 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
F-18
construction of a 15,000 square foot expansion of the Company's
facilities in Lancaster PA, and for manufacturing equipment.
The Bonds are secured by a letter of credit expiring October 18, 2006
and a mortgage on the related properties pledged as collateral. The
net book value of the land and building covered by the mortgage is
approximately $1,802,000 at July 28, 2002.
The Company paid interest of approximately $316,000 in 2002, $289,000 in
2001, and $1,200,000 in 2000.
Future payments required on long-term debt are as follows (in thousands):
Fiscal year
ending during: Amount
------------- ------
2003 $ 215
2004 208
2005 198
2006 211
2007 223
Future 4,844
-----
$ 5,899
NOTE I - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following (in thousands):
July 28, July 29,
2002 2001
---- ----
Accounts payable $ 5,832 $ 6,760
Accrued payroll and bonuses 3,724 3,002
Due for business acquired - 3,000
Accrued commissions 822 591
Accrued interest 11 -
Accrued legal expenses 1,018 174
Accrued warranty costs 235 255
Accrued severance 706 780
Accrued rent expense 163 132
Lease termination cost 58 54
Unearned income 108 -
Other accrued expenses 180 556
------ ------
$ 12,857 $ 15,304
====== ======
NOTE J - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan
("Plan") which qualified as a thrift plan under Section 401(k) of the
Internal Revenue Code. This Plan, as amended and restated, allows employees
to contribute between 2% and 15% of their salaries to the Plan. The
Company, at its discretion can contribute 100% of the first 2% of the
employees' contribution and 25% of the next 4%. Additional Company
contributions can be made depending on profits. The aggregate benefit
payable to an employee is dependent upon his rate of contribution, the
earnings of the fund, and the length of time such employee continues as a
participant. The Company has recognized expenses of approximately $533,000,
$164,000, and $415,000 under the Plan for the 52 weeks ended July 28, 2002,
July 29, 2001, and July 30, 2000, respectively.
F-19
Employees of General Microwave Corporation (" GMC") became eligible to
participate in the Plan as of May 1, 1999. The existing savings and
investing plan of GMC did not provide for company matching contributions
and has been frozen.
At the time of the acquisition, GMC also had a noncontributory defined
benefit pension plan covering all eligible employees of the company. As
part of the acquisition plan, the Company froze all benefits under the plan
effective April 30, 1999 and elected to terminate the plan as of November
1, 1999. All plan assets were liquidated and distributed to plan
participants or used to purchase annuities on their behalf. Excess plan
assets in the amount of approximately $470,000 were transferred in January
2001 directly into the Plan discussed above and inured to the benefit of
Plan employees.
Net pension income recorded by the Company in fiscal 2000 includes the
following components (in thousands):
July 30,
2000
--------
Service cost - benefits earned during the period $ -
Interest cost 237
Return on assets (736)
----
Net pension income $ (499)
====
The following table sets forth the plan's funded status and amounts
recognized in the consolidated balance sheet at July 30, 2000 (in
thousands):
July 30,
2000
--------
Projected benefit obligation at beginning of period $ 4,841
Service costs -
Interest cost 237
Actuarial gain (348)
Benefit payments (214)
-------
Projected benefit obligation, end of year $ 4,516
-------
Change in fair value of plan assets:
Fair value at beginning of period $ 4,342
Return on assets 823
Benefit payments (214)
------
Fair value at end of year 4,951
------
Funded status (435)
Unrecognized net gain 435
------
Accrued pension costs $ -
=======
Assumptions used were:
Discount rate 5.00%
Expected return on plan assets 10.00%
NOTE K - RELATED PARTY TRANSACTIONS
On January 16, 2001, the Board of directors approved the purchase of an
industrial parcel of land adjacent to the existing facility in Lancaster,
PA for $747,000 from a partnership of which the Chairman is general
partner. Settlement on the property was on July 27, 2001. The Company used
this land for a 15,000 square foot addition.
In connection with the move of the Amityville facilities of GMC in fiscal
1999, the Company entered into
F-20
a 10 year lease agreement with a partnership owned by the children of
certain officers of the Company. The lease provides for initial minimum
annual rent of $312,000 subject to escalation of approximately 4% annually
throughout the 10 year term. Additionally, in March 2000, The Company
entered into another 10 year lease with the same partnership for additional
space. The initial minimum annual rent of $92,000 is subject to escalation
of approximately 4% annually.
NOTE L - COMPUTATION OF PER SHARE EARNINGS
The following table shows the calculation of basic earnings per share and
earnings per share assuming dilution (in thousands except per share data):
52 Weeks ended
-------------------------------------------
July 28, 2002 July 29, 2001 July 30, 2000
------------- ------------- -------------
Numerator:
Income from continuing operations $ 10,730 $ 7,573 $ 7,639
Loss from discontinued operations (921) (168) -
Cumulative effect of adopting SFAS 142 (4,637) - -
------ ----- -----
Net Income $ 5,172 $ 7,405 $ 7,639
====== ===== =====
Denominator:
Basic weighted-average shares 12,041 10,082 7,308
Effect of dilutive securities:
Employee stock options and warrants 937 874 620
------ ------ -----
Diluted weighted-average shares 12,978 10,956 7,928
====== ====== =====
Stock options and warrants not included in computation 126 544 2,472
=== === =====
The number of stock options and warrants not included in the computation of
diluted EPS relates to stock options and warrants having exercise prices
that are greater than the average market price of the common shares during
the period, and therefore, are antidilutive. The options and warrants with
exercise prices ranging from $17.42 to $19.52, which expire at various
dates through May 21, 2007 were outstanding as of July 28, 2002.
NOTE M - SHAREHOLDERS' EQUITY
The authorized shares of Common Stock of the Company is 20,000,000 shares.
On April 30, 2002, the Company completed the sale of 3,000,000 shares of
common stock to the public at $23.00. The Company received net proceeds of
approximately $64,812,000 after underwriting discounts and commissions and
other expenses of the offering.
On August 7, 2001 the Board of Directors declared a 3-for-2 stock split
effected as a stock dividend payable September 10, 2001 to holders of
record on August 28, 2001. The distribution increased the number of shares
outstanding from 7,027,553 to 10,541,329. The amount of $351,373 was
transferred from the additional paid-in capital to the common stock account
to record this distribution. All share and per share data (other than
common stock issued and outstanding on the 2000 Consolidated Balance Sheet
and 1999 and 2000 Consolidated Statements of Shareholders' Equity),
including stock options and warrants, included in this annual report have
been restated to reflect the stock split on a retroactive basis.
The Company has various fixed option plans which reserve shares of common
stock for issuance to executives, key employees and directors. The Company
applies APB Opinion No. 25 and related Interpretations in accounting for
these plans. Statement of Financial Accounting Standards No.123,
"Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the
FASB in 1995 and , if fully
F-21
adopted, changes the methods for recognition of cost on plans similar to
those of the Company. The Company has adopted the disclosure-only
provisions of SFAS 123. Accordingly, no compensation cost has been
recognized for the stock option plans. Pro forma information regarding net
income and earnings per share is required by Statement 123, and has been
determined as if the Company had accounted for its employee stock options
under the fair value method of that Statement.
The fair value for options granted is estimated at the date of grant using
a Black-Scholes option pricing model. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options
which have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including the expected stock price volatility.
For purposes of computing pro-forma (unaudited) consolidated net earnings,
the following assumptions were used to calculate the fair value of each
option granted:
52 Weeks ended
---------------------------------------------
July 28, 2002 July 29, 2001 July 30, 2000
------------- ------------- -------------
Expected life of options 1.51 years .73 years .71 years
Volatility .68 .70 .72
Risk-free interest rate 2.8% 3.4% 6.1%
Dividend yield zero zero zero
Had compensation cost for stock options granted in fiscal years 2002, 2001,
and 2000 been determined based on the fair value at the grant date
consistent with the provisions of SFAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts
indicated below using the statutory income tax rate of 34% (in thousands
except per share data):
2002 2001 2000
---- ---- ----
Net income - as reported $ 5,172 $ 7,405 $ 7,639
Net income - pro forma 747 5,795 5,952
Earnings per share - as reported
Basic $.43 $.73 $1.05
Diluted .40 .68 .96
Earnings per share - pro forma
Basic $.06 $.57 $.81
Diluted .06 .53 .75
The effects of applying the pro forma disclosures of SFAS 123 are not
likely to be representative of the effects on reported net income for
future years due to the various vesting schedules.
In September 2000, the Board of Directors approved the 2000 Stock Option
Plan which covers 1,500,000 shares of the Company's common stock. Options
granted under the plan are non-qualified stock options. Under the terms of
the plan, the exercise price for options granted under the plan will be the
fair market value at the date of grant. The nature and terms of the options
to be granted are determined at the time of grant by the compensation
committee or the board of directors. The options expire no later than ten
years from the date of grant, subject to certain restrictions. Options for
1,010,250 and 375,000 shares were granted during the fiscal years ended
July 28, 2002 and July 29, 2001, respectively.
In April 1998, the Board of Directors approved the 1998 Stock Option Plan
which covers 2,250,000 shares of the Company's common stock. Options
granted under the plan may be incentive stock options qualified under
Section 422 of the Internal Revenue Code of 1986 or non-qualified stock
options. Under the terms of the plan, the exercise price for options
granted under the plan will be the fair market value at the date of grant.
Prices for incentive stock options granted to employees who own 10% or more
of the Company's stock are at least 110% of market value at date of grant.
The nature and terms of the options to be granted are determined at the
time of grant by the compensation committee or the board of directors. The
options
F-22
expire no later than ten years from the date of grant, subject to certain
restrictions. Options for 368,342, 440,250 and 969,750 shares were granted
during the fiscal years ended July 28, 2002, July 29, 2001 and July 30,
2000, respectively.
In May 1997, the Board of Directors approved the 1997 Stock Option Plan
which covers 2,500,000 shares of the Company's common stock. Options
granted under the plan may be incentive stock options qualified under
Section 422 of the Internal Revenue Code of 1986 or non-qualified stock
options. Under the terms of the plan, the exercise price for options
granted under the plan will be the fair market value at the date of grant.
Prices for incentive stock options granted to employees who own 10% or more
of the Company's stock are at least 110% of market value at date of grant.
The nature and terms of the options to be granted are determined at the
time of grant by the compensation committee or the board of directors. The
options expire no later than ten years from the date of grant, subject to
certain restrictions. Options for 21,151, 14,250, and 129,000 shares were
granted during the fiscal years ended July 28, 2002, July 29, 2001 and July
30, 2000, respectively.
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. Options
granted under the plan may be incentive stock options qualified under
Section 422 of the Internal Revenue Code of 1986 or non-qualified stock
options. Under the terms of the Plan, the exercise price for options
granted under the plan will be the fair market value at the date of grant.
Prices for incentive stock options granted to employees who own 10% or more
of the Company's stock are at least 110% of market value at date of grant.
The nature and terms of the options to be granted are determined at the
time of grant by the compensation committee or the board of directors. If
not specified, 100% of the shares can be exercised one year after the date
of grant. The options expire ten years from the date of grant. Options for
7,007 shares were granted during the fiscal year ended July 28, 2002.
A summary of stock option activity under all plans for the 52 weeks ended
July 28, 2002, July 29, 2001 and July 30, 2000 is as follows:
Non-Qualified Stock Options
--------------------------------------------------------------------------
Weighted Warrant Agreements
Average -----------------------
Number Price Range Exercise Number Price per
of shares per share Price of shares share
--------- ------------- ----- ---------- -----
Outstanding August 1, 1999 2,091,925 $ 1.69 - 10.97 $ 7.15 320,000 $ 3.09
Granted 1,098,750 9.25 - 11.91 10.33
Exercised (155,985) 1.69 - 9.83 4.68
Canceled (20,550) 7.41 - 10.46 8.47
--------- ------------ -------- ------- ------
Outstanding July 30, 2000 3,014,140 $ 4.06 - 11.91 $ 8.43 320,000 $ 3.09
Granted 829,500 8.38 - 14.25 8.99
Exercised (37,254) 4.06 - 10.46 6.72
Canceled (48,600) 4.31 - 14.25 10.76
--------- ------------- ------- ------- ------
Outstanding July 29, 2001 3,757,786 $ 4.06 - 13.67 $ 8.55 320,000 $ 3.09
Granted 1,406,750 11.90 - 19.52 16.05
Exercised (1,454,660) 4.06 - 13.67 7.50 (320,000) 3.09
Cancelled (282,700) 7.63 - 13.15 10.31
--------- ------------- ------ ------- ------
Outstanding July 28, 2002 3,427,176 $ 4.06 - 19.52 $ 11.92 -
========= =======
F-23
Options Outstanding and Exercisable by Price Range as of July 28, 2002,
with expiration dates ranging from May 12, 2005 to May 21, 2012 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
---------------------------- ----------- ---------------- -------------- ----------- --------------
$ 4.06 - $ 8.08 274,726 5.7 $ 6.21 234,751 $ 5.97
8.38 - 8.67 638,350 6.5 8.38 392,500 8.38
8.77 - 10.46 1,044,900 6.4 10.08 838,125 10.04
10.50 - 13.10 818,200 7.9 12.95 23,800 11.26
15.90 - 19.52 651,000 9.1 19.47 547,500 19.52
---------- --- ----- --------- -----
$ 4.06 - $ 19.52 3,427,176 7.2 $ 8.55 2,714,738 $ 8.21
========= =========
In December 1995, common stock warrants were issued to certain officers for
the right to acquire 440,000 shares of common stock of the Company at the
fair market value of $3.09 per share at date of issue. The warrants vest
immediately and expire December 13, 2005. The remaining warrants for
320,000 shares outstanding at July 29, 2001 were exercised during the
fiscal year ended July 28, 2002.
NOTE N - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, AND EXPORT SALES
The Company's chief operating decision makers are considered to be the
Chairman and the Chief Executive Officer (CEO). The Company's Chairman and
CEO evaluate both consolidated and disaggregated financial information
consisting of revenue information in deciding how to allocate resources and
assess performance. The Chairman and CEO also use certain disaggregated
financial information for the Company's product groups. The Company does
not determine a measure of operating income or loss by product group. The
Company's product groups have similar long-term economic characteristics,
such as application, and are similar in regards to (a) nature of products
and production processes, (b) type of customers, and (c) method used to
distribute products. Accordingly, the Company operates as a single
integrated business and as such has one operating segment as a provider of
complex microwave radio frequency (RF) and millimeter wave components and
subsystems for defense and commercial customers worldwide. All of the
Company's revenues result from sales of its products.
Revenues for fiscal years 2002, 2001 and 2000 were as follows: defense
electronics, $80,615,000, $61,977,000 and $67,405,000, respectively; and
commercial technologies, $12,266,000, $14,517,000, and $3,132,000,
respectively.
Net sales to the U.S. Government in 2002, 2001 and 2000 accounted for
approximately 17%, 19% and 26% of net sales, respectively. No other
customer accounted for shipments in excess of 10% of consolidated net sales
in fiscal 2002, 2001 or 2000. Foreign sales amounted to approximately
$30,070,000, $20,683,000 and $16,506,000 in fiscal 2002, 2001 and 2000,
respectively.
NOTE O - DERIVATIVE FINANCIAL INSTRUMENTS
In October 2001, the Company entered into an interest rate swap with a bank
pursuant to which it exchanged floating rate interest in connection with
the Bonds discussed in Note H on a notional amount of $3,000,000 for a
fixed rate of 4.07% for a 10 year period ending October 1, 2011. The
notional amount reduces each year in tandem with the annual installments
due on the Bonds. The fixing of the interest rate for this period offsets
the Company's exposure to the uncertainty of floating interest rates on the
Bonds, and as such has been designated as a cash flow hedge. The hedge is
deemed to be highly effective and any ineffectiveness will be recognized in
interest expense in the reporting period. The fair value of the interest
rate swap was a liability of $147,000 as of July 28, 2002. There was no
material hedge ineffectiveness related to cash flow
F-24
hedges during the period to be recognized in earnings. There was no gain or
loss reclassified from accumulated other comprehensive income into earnings
during the fiscal year ended July 28, 2002 as a result of the
discontinuance of a cash flow hedge due to the probability of the original
forecasted transaction not occurring.
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance
sheet for cash and cash equivalents approximated its fair value.
Available-for-sale securities: The fair value of available-for-sale
securities was based on quoted market prices.
Long-term debt: The fair value of the mortgage note and industrial
revenue bonds (including the related interest rate swap) were estimated
using discounted cash flow analyses, based on the Company's current
incremental borrowing rate for similar types of borrowing arrangements.
The carrying amounts and fair values of the Company's financial instruments
are presented below (in thousands):
July 28, 2002
---------------------------
Carrying Amount Fair Value
--------------- ----------
Cash and cash equivalents $ 86,210 $ 86,210
Available-for-sale securities 46 46
Long-term debt 5,684 6,550
NOTE Q - DISCONTINUED OPERATIONS
The Company entered into an agreement effective as of the close of business
September 30, 2000, to acquire all of the issued and outstanding common
stock of Terrasat, Inc. ("Terrasat"), a California corporation for cash in
the amount of $6,000,000, $3,000,000 of which was paid in December 2000 and
$3,000,000 of which was paid in December 2001. In addition, the agreement
provided for additional cash payments in the future up to $2,000,000, based
on gross revenues through December 31, 2001. The targeted gross revenues
under the agreement were not achieved, therefore no addition cash payments
were required.
In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets" which addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets
to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," retains the fundamental provisions of Statement 121 for (a)
recognition and measurement of the impairment of long-lived assets to be
held and used and (b) measurement of long-lived assets to be disposed of by
sale. SFAS 144 also supersedes the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," for segments of a
business to be disposed of, but retains the requirement of Opinion 30 to
report discontinued operations separately from continuing operations and
extends that reporting to a component of an entity that either has been
disposed of (by sale, by abandonment, or in a distribution to owners) or is
classified as held for sale. The provisions of this statement were adopted
by the Company effective on July 30, 2001.
In January 2002 the Board of Directors of the Company decided to
discontinue the operations of Terrasat and to seek a buyer for the
business. The Company believed that Terrasat would not be able to generate
F-25
sufficient returns to justify continued investment due to the overcapacity
in the telecom industry and deteriorating economic conditions in Terrasat's
primary markets. Consequently, the accompanying consolidated financial
statements reflect Terrasat as discontinued operations in accordance with
SFAS No. 144. The assets and liabilities of Terrasat at July 29, 2001 have
been classified in the accompanying balance sheet as "Assets held for
sale", and "Liabilities held for sale." Results of operations and cash
flows of Terrasat have been classified as "Loss from discontinued
operations", and "Net cash provided by (used in) discontinued operations",
respectively.
The sale of certain assets and liabilities, and the business of Terrasat
was consummated on March 1, 2002, effective the close of business January
27, 2002, to certain current employees of Terrasat for cash and a note
which approximates the value of the net assets held for sale as of January
27, 2002 of $878,000.
The following table shows the components of assets and liabilities of
Terrasat held for sale as of July 29, 2001:
Assets held for sale:
Accounts receivable $ 978
Prepaid expenses 21
Inventory 1,371
-----
$ 2,370
=====
Liabilities held for sale:
Accounts payable $ 626
Accrued expenses 264
---
$ 890
===
Summarized below are the results of discontinued operations:
52 weeks ended
-------------------
July 28, July 29,
2002 2001
---- ----
Net sales $ 2,147 $ 4,103
----- -----
Loss from discontinued operations (1,395) (147)
Income tax (benefit) provision (474) 21
------ -----
Net loss from discontinued operations $ (921) $ (168)
=== ===
NOTE R - SUBSEQUENT EVENT
The Company entered into an agreement as of September 1, 2002, to acquire
all of the issued and outstanding common stock of EW Simulation Technology,
Limited ("EWST"), a British company of Aldershot, UK, which is expected to
be operated as a wholly-owned subsidiary. EWST designs, develops and
produces electronic warfare simulator systems for prime defense contractors
and countries worldwide. The transaction, which closed on September 20,
2002, provides for payment of $3,000,000 in cash and a note for $1,500,000,
including interest at 1.8%, payable in annual installments of $500,000. The
transaction will be accounted for in accordance with the provisions of SFAS
No. 141, "Business Combinations", which requires that all business
combinations be accounted for using the purchase method. The allocation of
the aggregate estimated purchase price will be determined based on detailed
reviews of the fair value of assets acquired, including identified
intangible assets, and liabilities assumed. Any remaining excess cost over
the fair value of net assets acquired will be recognized as goodwill.
************
F-26