UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the period ended: November 2, 2003
----------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to ___________
Commission File Number 0-5411
HERLEY INDUSTRIES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE #23-2413500
- ------------------------------- ---------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
101 North Pointe Boulevard, Lancaster, Pennsylvania 17601
- --------------------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (717) 735-8117
--------------
------------------------------------------------------
(Former name, former address and former fiscal year, if
changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ]No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING
THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
[ ] Yes [ ]No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of December 8, 2003 - 14,057,301 shares of Common Stock.
HERLEY INDUSTRIES, INC
AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements:
Condensed Consolidated Balance Sheets -
November 2, 2003 and August 3, 2003 2
Condensed Consolidated Statements of Income -
For the Thirteen weeks ended November 2, 2003
and Fourteen weeks ended November 3, 2002 3
Condensed Consolidated Statement of Shareholders' Equity-
For the Thirteen weeks ended November 2, 2003 4
Condensed Consolidated Statements of Cash Flows -
For the Thirteen weeks ended November 2, 2003
and Fourteen weeks ended November 3, 2002 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 16
Item 4 - Controls and Procedures 16
PART II -OTHER INFORMATION
Item 1 - Legal Proceedings 17
Item 6 - Exhibits and Reports on Form 8K 18
Signatures 19
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
November 2, August 3,
2003 2003
----------- ---------
(Unaudited) (Audited)
ASSETS
Current Assets:
Cash and cash equivalents $ 82,538 $ 81,523
Accounts receivable 14,251 16,525
Costs incurred and income recognized in excess
of billings on uncompleted contracts 12,389 6,960
Other receivables 735 827
Inventories, net of allowance of $2,815
at November 2003 and $2,739 at August 2003 39,280 37,545
Deferred taxes and other 3,450 3,207
--------- ---------
Total Current Assets 152,643 146,587
Property, Plant and Equipment, net 22,720 22,406
Goodwill 25,729 25,729
Intangibles, net of accumulated amortization of $472
at November 2003 and $403 at August 2003 1,473 1,542
Available-For-Sale Securities 75 75
Other Investments 142 162
Other Assets 1,009 1,063
--------- ---------
$ 203,791 $ 197,564
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 758 $ 686
Accounts payable and accrued expenses 13,699 14,026
Billings in excess of costs incurred and
income recognized on uncompleted contracts 1,294 --
Income taxes payable 3,322 2,670
Reserve for contract losses 977 736
Advance payments on contracts 585 856
--------- ---------
Total Current Liabilities 20,635 18,974
Long-term Debt 5,892 6,403
Deferred Income Taxes 4,928 4,945
--------- ---------
31,455 30,322
--------- ---------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized
20,000,000 shares; issued and outstanding
14,052,801 at November 2003 and 13,969,151 at August 2003 1,405 1,397
Additional paid-in capital 105,486 104,551
Retained earnings 65,419 61,478
Accumulated other comprehensive income (loss) 26 (184)
--------- ---------
Total Shareholders' Equity 172,336 167,242
--------- ---------
$ 203,791 $ 197,564
========= =========
The accompanying notes are an integral part of these financial statements.
2
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands except per share data)
13 weeks ended 14 weeks ended
November 2, November 3,
2003 2002
-------------- --------------
Net sales $ 28,267 $ 27,290
-------- --------
Cost and expenses:
Cost of products sold 17,625 18,099
Selling and administrative expenses 4,743 3,735
Litigation costs 37 650
-------- --------
22,405 22,484
-------- --------
Operating Income 5,862 4,806
-------- --------
Other (expense) income, net:
Investment income 176 368
Interest expense (87) (95)
Foreign exchange (loss) (173) --
-------- --------
(84) 273
-------- --------
Income before income taxes 5,778 5,079
Provision for income taxes 1,837 1,727
-------- --------
Net income $ 3,941 $ 3,352
======== ========
Earnings per common share - Basic $ .28 $ .23
======== ========
Basic weighted average shares 14,013 14,668
======== ========
Earnings per common share - Diluted $ .27 $ .22
======== ========
Diluted weighted average shares 14,782 15,506
======== ========
The accompanying notes are an integral part of these financial statements.
3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
13 weeks ended November 2, 2003
(In thousands except share data)
Accumulated
Additional Other
Common Stock Paid-in Retained Comprehensive
------------ Capital Earnings Income (Loss) Total
------- -------- ------------- -----
Shares Amount
------ ------
Balance at August 03, 2003 13,969,151 $ 1,397 104,551 61,478 (184) $ 167,242
Net income 3,941 3,941
Exercise of stock options 83,650 8 710 718
Tax benefit upon exercise of stock
options 225 225
Other comprehensive income (loss):
Unrealized (loss) on interest rate swap (35) (35)
Foreign currency translation gain 245 245
----------- ----------- ----------- ----------- ----------- -----------
Balance at November 2, 2003 14,052,801 $ 1,405 105,486 65,419 26 $ 172,336
=========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
13 weeks ended 14 weeks ended
November 2, November 3,
2003 2002
----------- -----------
Cash flows from operating activities:
Net income $ 3,941 $ 3,352
-------- --------
Adjustments to reconcile net income to
net cash provided by operations:
Depreciation and amortization 966 968
Foreign exchange loss 130 --
Equity in income of limited partnership -- (2)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 2,274 (4,374)
(Increase) decrease in costs incurred and income
recognized in excess of billings on
uncompleted contracts (5,429) 832
Decrease (increase) in other receivables 92 (106)
(Increase) in inventories (1,735) (2,035)
Decrease in prepaid income taxes -- 382
(Increase) in prepaid expenses and other (243) (31)
(Decrease) increase in accounts payable
and accrued expenses (327) 1,812
Increase in billings in excess of
costs incurred and income recognized
on uncompleted contracts 1,294 --
Increase in income taxes payable 877 1,261
Increase in reserve for contract losses 241 9
(Decrease) increase in advance payments on contracts (271) 354
Other, net 275 77
-------- --------
Total adjustments (1,856) (853)
-------- --------
Net cash provided by operations 2,085 2,499
-------- --------
Cash flows from investing activities:
Acquisition of businesses, net of cash acquired -- (2,384)
Partial distribution from limited partnership 20 --
Capital expenditures (1,187) (1,106)
-------- --------
Net cash used in investing activities (1,167) (3,490)
-------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options 718 335
Payments of long-term debt (621) (124)
Purchase of treasury stock -- (3,156)
-------- --------
Net cash provided by (used in) financing activities 97 (2,945)
-------- --------
Net (decrease) increase in cash and cash equivalents 1,015 (3,936)
Cash and cash equivalents at beginning of period 81,523 86,210
-------- --------
Cash and cash equivalents at end of period $ 82,538 $ 82,274
======== ========
The accompanying notes are an integral part of these financial statements.
5
Herley Industries, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements - (Unaudited)
1. The condensed 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.
In the opinion of the Company's management, the accompanying condensed
consolidated financial statements reflect all adjustments (which include
only normal recurring adjustments) necessary to present fairly the
consolidated financial position and results of operations and cash flows
for the periods presented. These financial statements (except for the
balance sheet presented at August 3, 2003) are unaudited and have not been
reported on by independent public accountants.
Results of operations for interim periods are not necessarily indicative of
the results of operations for a full year due to external factors which are
beyond the control of the Company.
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. Adoption of this Standard did not have a material impact
on the Company's financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires the
recognition of liabilities for guarantees that are issued or modified
subsequent to December 31, 2002. The liabilities should reflect the fair
value, at inception, of the guarantors' obligations to stand ready to
perform, in the event that the specified triggering events or conditions
occur. Adoption of this Interpretation did not have a material effect on
the Company's results of operations or financial condition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No.
123." The new statement is effective, with respect to the transition
provisions, for fiscal years ending after December 15, 2002; and with
respect to the disclosure provisions, for financial reports containing
condensed financial statements for interim periods beginning after December
15, 2002. SFAS No. 148 provides transition alternatives for companies
adopting the fair value recognition provisions of FASB Statement No. 123
for stock-based employee compensation; and requires the pro forma
disclosures of SFAS No. 123 in interim condensed financial statements for
companies continuing to rely on APB Opinion No. 25 as if the provisions of
SFAS No. 123 had been adopted. The statement also requires that the
pro-forma disclosures of the impact on earnings and earnings-per-share be
provided in a tabular format and included in the Summary of Significant
Accounting Policies or equivalent.
The effect of the adoption of SFAS No. 148 was the inclusion of the
required disclosures in the Company's condensed consolidated interim
financial statements in its quarterly reports, and the addition of a
significant accounting policies note included in the Company's Annual
Report on Form 10K.
The Company has various fixed option plans which reserve shares of common
stock for issuance to executives, key employees and directors. The Company
continues to use the intrinsic value method in accordance with the
recognition and measurement principles of APB Opinion No. 25 and related
Interpretations in accounting for these plans. Statement of Financial
Accounting Standards No.123, "Accounting for Stock-Based Compensation"
6
("SFAS 123") was issued by the FASB in 1995 and , if fully 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
and SFAS 148. Accordingly, no stock-based employee compensation cost has
been recognized for options granted under the stock option plans. Pro forma
information regarding net income and earnings per share as required by
Statements 123 and 148 has been determined as if the Company had accounted
for its employee stock options under the fair value method of Statement
123.
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 for all periods presented:
Expected life of options 1.51 years
Volatility .68
Risk-free interest rate 2.8%
Dividend yield zero
Had compensation cost for stock options granted in the first quarter of
fiscal years 2004 and 2003 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):
Thirteen weeks ended Fourteen weeks ended
November 2, 2003 November 3, 2002
---------------- ----------------
Net income - as reported $ 3,941 $ 3,352
Deduct: total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (206) (898)
------- --------
Net income - pro forma $ 3,735 $ 2,454
======= ========
Earnings per share - as reported
Basic $ .28 $ .23
Diluted .27 .22
Earnings per share - pro forma
Basic $ .27 $ .17
Diluted .25 .16
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 January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities."
The Interpretation clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to certain entities
in which the equity investors do not
7
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The
Interpretation applies immediately to variable interest entities created
after January 31, 2003, or in which the Company obtains an interest after
that date. The Interpretation is effective July 1, 2003 to variable
interest entities in which the Company holds a variable interest acquired
before February 1, 2003. Management has determined that the adoption of
this Interpretation will not have a significant impact on its financial
position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
Derivative Instruments and Hedging Activities." The Statement amends and
clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities under Statement 133. The Statement is effective for contracts
entered into or modified after June 30, 2003, except as stated below and
for hedging relationships designated after June 30, 2003.
The provisions of Statement 149 that relate to Statement 133 implementation
issues that have been effective for fiscal quarters that began prior to
June 15, 2003, will continue to be applied in accordance with their
respective effective dates. In addition, certain provisions relating to
forward purchases or sales of when-issued securities or other securities
that do not yet exist, will apply to existing contracts, as well as new
contracts entered into after June 30, 2003. Management has determined that
the adoption of this Statement will not have a significant impact on the
financial position, results of operations or cash flows of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
The Statement establishes standards for how an issuer classifies and
measures in its statement of financial position certain financial
instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. Many of such
instruments were previously classified as equity. The statement is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities. The Statement is to be
implemented by reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance of the date
of the Statement and still existing at the beginning of the interim period
of adoption. Restatement is not permitted. Management believes that the
adoption of this Statement will not have a significant impact on the
financial position, results of operations or cash flows of the Company.
2. Inventories at November 2, 2003 and August 3, 2003 are summarized as
follows (in thousands):
November 2, 2003 August 3, 2003
---------------- --------------
Purchased parts and raw materials $ 19,801 $ 19,690
Work in process 19,692 18,646
Finished products 2,602 1,948
-------- --------
42,095 40,284
Less reserve for excess and obsolete materials 2,815 2,739
-------- --------
$ 39,280 $ 37,545
======== ========
3. 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
8
liability ("cash flow hedge"). Changes in the fair value of a derivative
that is designated as, and meets all the required criteria for, a cash flow
hedge are recorded in accumulated other comprehensive income (loss) and
reclassified into earnings as the underlying hedged item affects earnings.
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 East Hempfield Township Industrial Development Authority Variable Rate
Demand/Fixed Rate Revenue Bonds Series 2001 (the "Bonds") 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 approximately $125,000,
net of income taxes, as of November 2, 2003. 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 quarter
ended November 2, 2003 as a result of the discontinuance of a cash flow
hedge due to the probability of the original forecasted transaction not
occurring.
4. 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. 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.
There was no change in the carrying amount of goodwill of $25,729,000 for
the quarter ended November 2, 2003.
Intangibles, consisting of patents and intangibles related to the
acquisition of EWST (See Note 9), are carried at an aggregate gross amount
of $1,945,000 with accumulated amortization at November 2, 2003 of
$472,000. Amortization expense for the thirteen weeks ended November 2,
2003 and for the fourteen weeks ended November 3, 2002 was approximately
$69,000 and $11,000, respectively.
Estimated aggregate amortization expense for each of the next five fiscal
years is as follows (in thousands):
2004 $ 277
2005 129
2006 116
2007 115
2008 109
The carrying amount of intangibles is evaluated on a recurring basis.
5. The Company is involved in various 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. In connection with the
Robinson Laboratories, Inc. litigation, as discussed in Part II, Item 1.
"Legal
9
Proceedings", at a proceeding on April 28, 2003, the Court decided to delay
ruling on all of the petitions for fees and costs until after appeals are
exhausted. Accordingly, by Order dated May 6, 2003, the Court denied
without prejudice all of the parties' petitions. On May 12, 2003, Herley
filed its appeal to the United States Court of Appeals for the Second
Circuit. On May 28, 2003, RLI filed a notice of cross-appeal. Robinson has
not appealed. Herley filed its brief in support of its appeal before the
Second Circuit on August 22, 2003. RLI timely filed its brief in response
to Herley's appeal and in support of RLI's cross-appeal. Herley timely
filed a response to RLI's brief and thereafter RLI timely filed a response
to Herley's brief. The briefing schedule is now completed and oral argument
is scheduled for December 18, 2003.
6. The following tables show the components used in the calculation of basic
and diluted weighted-average shares outstanding (in thousands):
Thirteen weeks ended Fourteen weeks ended
November 2, 2003 November 3, 2002
---------------- ----------------
Basic weighted-average shares 14,013 14,668
Effect of dilutive securities:
Employee stock options and warrants 769 838
------ ------
Diluted weighted-average shares 14,782 15,506
====== ======
Options to purchase 697,302 weighted shares of common stock, with exercise
prices ranging from $18.85 to $19.52, were outstanding during the first
quarter of fiscal 2004, but were not included in the computation of diluted
EPS because the exercise price is greater than the average market price of
the common stock. The options, which expire through November 15, 2008, were
still outstanding as of November 2, 2003. Options to purchase 675,541
weighted shares of common stock, with exercise prices ranging from $19.03
to $19.52, were outstanding during the first quarter of fiscal 2003, but
were not included in the computation of diluted EPS because the exercise
price is greater than the average market price of the common stock. The
options, which expire through May 21, 2012, were still outstanding as of
November 3, 2002.
7. The components of comprehensive income are as follows (in thousands):
Thirteen weeks ended Fourteen weeks ended
November 2, 2003 November 3, 2002
---------------- ----------------
Net income $ 3,941 $ 3,352
Unrealized loss on interest rate swap (35) (12)
Foreign currency translation gain 244 1
-------- --------
Comprehensive income $ 4,150 $ 3,341
======== ========
The components of accumulated other comprehensive income (loss) is as
follows (in thousands):
November 2, 2003
----------------
Unrealized loss on available-for-sale
securities $ (48)
Unrealized loss on interest rate swap (85)
Foreign currency translation gain 159
--------
Accumulated other comprehensive income (loss) $ 26
========
8. Revenues for the first quarter of fiscal years 2004, and 2003 were as
follows: defense electronics, $27,299,000,
10
and $24,547,000, respectively; and commercial technologies, $968,000, and
$2,743,000, respectively. Defense electronics includes revenue of
$3,140,000 and $1,322,000 in fiscal 2004 and 2003, respectively,
attributable to the EWST acquisition.
Geographic net sales, based on place of contract performance, were as
follows (in thousands):
Thirteen weeks ended Fourteen weeks ended
November 2, 2003 November 3, 2002
---------------- ----------------
United States $ 22,071 $ 23,157
Israel 3,056 2,811
England 3,140 1,322
-------- ---------
$ 28,267 $ 27,290
======== =========
Net property, plant and equipment by geographic area was as follows (in
thousands):
November 2, 2003 August 3, 2003
---------------- --------------
United States $ 19,217 $ 18,945
Israel 3,100 3,071
England 403 390
--------- ---------
$ 22,720 $ 22,406
========= =========
9. 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 operates as a
wholly-owned subsidiary of the Company. EWST designs, develops and produces
electronic warfare simulator systems for prime defense contractors and
countries worldwide. The acquisition of EW Simulation Technology was driven
by a two part strategic initiative: a) to leverage the Company's microwave
expertise vertically into the international threat and jamming simulator
markets, and b) to increase the amount of microwave content supplied by the
Company on each simulator platform. 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% based on LIBOR at the date of
acquisition. The note has a balance of $1,130,000 at November 2, 2003
(adjusted for foreign exchange rate fluctuations) payable in two remaining
installments annually on October 1, of $565,000. The transaction has been
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.
10. Supplemental cash flow information is as follows (in thousands):
Thirteen weeks ended Fourteen weeks ended
November 2, 200 November 3, 2002
--------------- ----------------
Cash paid during the period for:
Interest $ 80 $ 99
Income taxes 987 65
Tax benefit related to stock options 225 464
Deferred purchase price of business acquired - 1,500
11
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Certain statements contained in this report are "forward-looking statements"
that involve various important assumptions, risks, uncertainties and other
factors which could cause the Company's actual results to differ materially from
those expressed in such forward-looking statements. Forward-looking statements
can be identified by terminology such as "may",
"will","should","expects","intends","anticipates","believes","estimates",
"predicts","continue", or the negative of these terms or other comparable
terminology. These important factors include, without limitation, a large
percentage of sales are under government contracts, cost overruns under fixed
price contracts, doing business in foreign markets, customer concentration,
competitive factors and pricing pressures, effective integration of acquired
businesses, management of future growth, recruiting and retaining qualified
technical personnel, general economic conditions, as well as other risks
previously disclosed in the Company's securities filings and press releases.
Although the Company believes that the expectations reflected in the
forward-looking statements are reasonable, it cannot guarantee future results,
performance or achievements. Further, the Company is under no duty to update any
of the forward-looking statements after the date of this quarterly report to
conform such statements to actual results.
Results of Operations
- ---------------------
Thirteen weeks ended November 2, 2003 and Fourteen weeks ended November 3, 2003
- -------------------------------------------------------------------------------
Net sales for the thirteen weeks ended November 2, 2003 were approximately
$28,267,000 compared to $27,290,000 in the fourteen weeks ended November 3,
2002, an increase of $977,000 (3.5%). Net sales attributable to the acquisition
of EWST accounted for $1,818,000 of the increase, and defense electronics
microwave systems and components was $934,000 of the increase. This was offset
by a decrease of $1,775,000 in commercial technologies. Inter-company sales,
which were eliminated in consolidation, were approximately $2,000,000 in the
quarter ended November 2, 2003 as compared to approximately $350,000 in the
prior year quarter.
The gross profit margin in the thirteen weeks ended November 2, 2003 was 37.6%
compared to 33.7% in the first quarter of fiscal 2003. The increase in gross
margin is attributable to the increased revenue at EWST, higher margins in the
foreign market, as well as improvement in margins through a combination of
production efficiencies related to product mix and more profitable microwave
components shipped in the quarter.
Selling and administrative expenses for the thirteen weeks ended November 2,
2003 were 16.8% of net sales as compared to 13.7% in the first quarter of fiscal
2003. Major components of the net increase in expenses of $1,008,000 includes
increased expenses attributable to the acquisition of EWST of $201,000
(including amortization of acquired intangibles and additional personnel); an
increase in incentive compensation under employment contracts and discretionary
bonuses of $398,000; and additional personnel and related costs, primarily in
domestic and international marketing, of $314,000.
Litigation costs related to the Robinson Labs litigation were $37,000 in the
first quarter of fiscal 2004, as compared to $650,000 in the first quarter of
fiscal 2003. (See Part II, Item 1. "Legal Proceedings").
Investment income decreased by $192,000 in fiscal 2004 as a result of a 50%
decline in the rate of interest earned on the investment of excess cash reserves
and a decrease on average of $5,000,000 in funds invested.
The foreign exchange loss in the first quarter of fiscal 2004 of $173,000 is
attributable to the weaker U. S. dollar during the current quarter causing the
Company's foreign denominated liabilities to increase in value resulting in
12
a net foreign exchange loss realized of $43,000, and an unrealized foreign
exchange loss of $130,000.
Liquidity and Capital Resources
- -------------------------------
As of November 2, 2003 and August 3, 2003, working capital was $132,008,000 and
$127,613,000, respectively, and the ratio of current assets to current
liabilities was 7.4 to 1 and 7.7 to 1, respectively.
As is customary in the defense industry, inventory is partially financed by
customer deposits and progress payments. The unliquidated balance of these
deposits and payments was approximately $585,000 at November 2, 2003, and
$856,000 at August 3, 2003.
Net cash provided by operations during the thirteen weeks ended November 2, 2003
was approximately $2,085,000 as compared to $2,499,000 during the comparable
period in the prior year. Significant items contributing to the sources of funds
include income from operations of $5,037,000 (adjusted for depreciation,
amortization, and foreign exchange losses), and an increase in income taxes
payable of $877,000. Offsetting these sources of funds are a net increase in
costs incurred and income recognized on uncompleted contracts of $4,135,000, and
an increase in inventory of $1,735,000.
Net cash used in investing activities consists of $1,187,000 for capital
expenditures.
Net cash generated from financing activities of $97,000 consists primarily of
the exercise of stock options for $718,000 and the payment of the deferred
purchase price of EWST. The Company has a future commitment for $1,130,000
(adjusted for foreign exchange rate fluctuations), including interest at 1.8%,
in connection with the acquisition of EWST payable in annual installments of
$565,000.
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, 2005. The Company
may elect to borrow up to a maximum of $5,000,000 with interest based on the
Federal Funds Target Rate, as established by the Federal Open Market Committee
("FMOC") of the Federal Reserve Board, 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 1.00% and 1.12%, respectively, at
November 2, 2003. 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 November 2, 2003 and
August 3, 2003. Stand-by letters of credit were outstanding in the amount of
approximately $12,464,000 under the credit facility at November 2, 2003.
The Company believes that presently anticipated future cash requirements will be
provided by internally generated funds, its existing unsecured credit facility,
and cash balances of approximately $83,000,000. A significant portion of the
Company's revenue for fiscal 2004 will be generated from its existing backlog of
sales orders. The backlog of orders at November 2, 2003 was approximately
$92,000,000. 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 $37,536,000 available under its bank
credit facility, net of outstanding stand-by letters of credit of approximately
$12,464,000.
13
Future payments required on long-term debt are as follows (in thousands):
Twelve months Industrial
ended Mortgage revenue Other
October Total note bonds obligations
------- ----- ---- ----- -----------
2004 $ 758 $ 88 $ 105 $ 565
2005 770 95 110 565
2006 217 102 115 -
2007 231 111 120 -
2008 244 119 125 -
Thereafter 4,430 2,075 2,230 125
------- ------- ------- -------
$ 6,650 $ 2,590 $ 2,805 $ 1,255
======= ======= ======= =======
Stand-by letters of credit expire as follows (in thousands):
During
fiscal
year Amount
---- ------
2004 $ 7,181
2005 514
2006 1,922
2007 2,847
--------
$ 12,464
========
Minimum annual rentals under noncancellable operating leases are as follows (in
thousands):
During
fiscal
year Amount
---- ------
2004 $ 1,275
2005 1,056
2006 978
2007 983
2008 958
Thereafter 1,171
-------
$ 6,421
=======
Critical Accounting Policies
- ----------------------------
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
14
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.
New Accounting Pronouncements
- -----------------------------
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. Adoption of this
Standard did not have a material impact on the Company's financial position or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires the recognition of
liabilities for guarantees that are issued or modified subsequent to December
31, 2002. The liabilities should reflect the fair value, at inception, of the
guarantors' obligations to stand ready to perform, in the event that the
specified triggering events or conditions occur. Adoption of this Interpretation
did not have a material effect on the Company's results of operations or
financial condition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123."
The new statement is effective, with respect to the transition provisions, for
fiscal years ending after December 15, 2002; and with respect to the disclosure
provisions, for financial reports containing condensed financial statements for
interim periods beginning after December 15, 2002. SFAS No. 148 provides
transition alternatives for companies adopting the fair value recognition
provisions of FASB Statement No. 123 for stock-based employee compensation; and
requires the pro forma disclosures of SFAS No. 123 in interim condensed
financial statements for companies continuing to rely on APB Opinion No. 25 as
if the provisions of SFAS No. 123 had been adopted. The statement also requires
that the pro-forma disclosures of the impact on earnings and earnings-per-share
be provided in a tabular format and included in the Summary of Significant
Accounting Policies or equivalent.
The effect of the adoption of SFAS No. 148 was the inclusion of the required
disclosures in the Company's condensed consolidated interim financial statements
in its quarterly reports, and the addition of a significant accounting policies
note included in the Company's Annual Report on Form 10K.
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities." The
Interpretation clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to certain entities in which the equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
Interpretation applies immediately to variable interest entities created after
January 31, 2003, or in which the Company obtains an interest after that date.
The Interpretation is effective July 1, 2003 to variable interest entities in
which the Company holds a variable interest acquired before February 1, 2003.
Management has determined that the adoption of this Interpretation will not have
a significant impact on its financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
Derivative Instruments and Hedging Activities." The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
Statement 133. The Statement is effective for contracts entered into or modified
after June 30, 2003, except as stated below and for hedging relationships
15
designated after June 30, 2003.
The provisions of Statement 149 that relate to Statement 133 implementation
issues that have been effective for fiscal quarters that began prior to June 15,
2003, will continue to be applied in accordance with their respective effective
dates. In addition, certain provisions relating to forward purchases or sales of
when-issued securities or other securities that do not yet exist, will apply to
existing contracts, as well as new contracts entered into after June 30, 2003.
Management has determined that the adoption of this Statement will not have a
significant impact on the financial position, results of operations or cash
flows of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." The Statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) because that financial instrument embodies an obligation of the
issuer. Many of such instruments were previously classified as equity. The
statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities. The Statement is to be implemented
by reporting the cumulative effect of a change in accounting principle for
financial instruments created before the issuance of the date of the Statement
and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. Management believes that the adoption of this
Statement will not have a significant impact on the financial position, results
of operations or cash flows of the Company.
Item 3: 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 3 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 approximately $125,000, net of income taxes, as of
November 2, 2003. 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 quarter ended November 2, 2003, as a result of the discontinuance of
a cash flow hedge due to the probability of the original forecasted transaction
not occurring.
Item 4: Controls and Procedures
Within the 90 days prior to the date of this Report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's chief executive officer and chief financial
officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Rule 13a-14 adopted under the
Securities Exchange Act of 1934. Based upon that evaluation, the chief executive
officer and chief financial officer concluded that the Company's disclosure
controls and procedures are effective. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation.
16
PART II - OTHER INFORMATION
Item 1 - 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.
On October 18, 2002, the Court entered a final judgment consistent with the
above, and both parties filed post-trial motions. 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 filed a petition for fees and costs against
both RLI and Robinson on November 27, 2002 for approximately $2,000,000. RLI and
Robinson also filed petitions to recover attorneys fees of approximately
$240,000 for certain claims in which they contend that they were the prevailing
party. On February 5, 2003, the Court denied the post-trial motions filed by the
parties, thus leaving the jury verdict undisturbed.
At a proceeding on April 28, 2003, the Court decided to delay ruling on all of
the petitions for fees and costs until after appeals are exhausted. Accordingly,
by Order dated May 6, 2003, the Court denied without prejudice all of the
parties' petitions. On May 12, 2003, Herley filed its appeal to the United
States Court of Appeals for the Second Circuit. On May 28, 2003, RLI filed a
notice of cross-appeal. Robinson has not appealed. Herley filed its brief in
support of its appeal before the Second Circuit on August 22, 2003. RLI timely
filed its brief in response to Herley's appeal and in support of RLI's
cross-appeal. Herley timely filed a response to RLI's brief and thereafter RLI
timely filed a response to Herley's brief. The briefing schedule is now
completed and oral argument is scheduled for December 18, 2003.
17
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 2 - Changes In Securities:
None
Item 3 - Defaults Upon Senior Securities:
None
Item 4 - Submission Of Matters To A Vote Of Security Holders:
None
Item 5 - Other Information:
None
Item 6 - Exhibits And Reports On Form 8-K:
(a) Exhibits
31.1 Certification of Myron Levy pursuant to Rule 13a-14(a).
31.2 Certification of Anello C. Garefino pursuant to Rule 13a-14(a).
32.1 Certification of Myron Levy pursuant to 18 U.S.C. Section 1350.
32.2 Certification of Anello C. Garefino pursuant to 18 U.S.C. Section
1350.
(b) Reports on Form 8-K
During the first quarter of fiscal 2004, the Registrant filed the
following report on Form 8-K:
The Company filed a report on October 10, 2003 in connection with the
release of its financial results for the fourth quarter and fiscal
year ended August 3, 2003.
18
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HERLEY INDUSTRIES, INC.
-----------------------
Registrant
BY: /S/ Myron Levy
------------------------------------
Myron Levy, Chief Executive Officer
BY: /S/ Anello C. Garefino
------------------------------------------------
Anello C. Garefino, Principal Financial Officer
DATE: December 17, 2003
19