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 quarterly period ended: October 31, 2004
----------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-5411
HERLEY INDUSTRIES, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE #23-2413500
- ------------------------------- -----------------------
(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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
[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 6, 2004 -14,314,657 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 -
October 31, 2004 and August 1, 2004 2
Condensed Consolidated Statements of Income -
For the Thirteen weeks ended October 31, 2004
and November 2, 2003 3
Condensed Consolidated Statement of Shareholders' Equity-
For the Thirteen weeks ended October 31, 2004 4
Condensed Consolidated Statements of Cash Flows -
For the Thirteen weeks ended October 31, 2004
and November 2, 2003 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 17
Item 4 - Controls and Procedures 17
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 17
Item 6 - Exhibits 19
Signatures 20
Item 1 - Financial Statements
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
October 31, August 1,
2004 2004
----------- ---------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 67,884 $ 66,181
Trade accounts receivable 20,809 24,664
Costs incurred and income recognized in excess
of billings on uncompleted contracts 14,035 14,210
Other receivables 840 576
Inventories, net of allowance of $4,081
in fiscal 2005 and $3,937 in 2004 45,885 44,909
Deferred taxes and other 4,054 3,579
------- -------
Total Current Assets 153,507 154,119
Property, Plant and Equipment, net 27,055 25,968
Goodwill 38,859 35,165
Intangibles, net of accumulated amortization of $847
in fiscal 2005 and $752 in 2004 4,463 4,555
Available-For-Sale Securities 147 147
Other Investments 113 117
Other Assets 846 900
------- -------
$ 224,990 $ 220,971
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 812 $ 804
Accounts payable and accrued expenses 16,999 16,934
Billings in excess of costs incurred and
income recognized on uncompleted contracts 679 1,303
Income taxes payable 3,132 2,091
Reserve for contract losses 960 954
Reserve for warranty costs 581 580
Advance payments on contracts 949 1,180
------- -------
Total Current Liabilities 24,112 23,846
Long-term Debt 5,159 5,845
Other Long-term Liabilities 993 932
Deferred Income Taxes 4,833 4,848
------- -------
35,097 35,471
------- -------
Commitments and Contingencies (Note 6)
Shareholders' Equity:
Common stock, $.10 par value; authorized
20,000,000 shares; issued and outstanding
14,285,107 in fiscal 2005 and 14,220,508 in 2004 1,429 1,422
Additional paid-in capital 108,423 107,671
Retained earnings 78,704 75,151
Accumulated other comprehensive income 1,337 1,256
------- -------
Total Shareholders' Equity 189,893 185,500
------- -------
$ 224,990 $ 220,971
======= =======
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)
Thirteen weeks ended
--------------------
October 31, November 2,
2004 2003
----------- -----------
Net sales $ 33,590 $ 28,267
------- -------
Cost and expenses:
Cost of products sold 22,731 17,625
Selling and administrative expenses 5,855 4,780
------- -------
28,586 22,405
------- -------
Operating Income 5,004 5,862
------- -------
Other income (expense), net
Investment income 224 176
Interest expense (79) (87)
Foreign exchange (loss) -- (173)
------- -------
145 (84)
------- -------
Income before income taxes 5,149 5,778
Provision for income taxes 1,596 1,837
------- -------
Net income $ 3,553 $ 3,941
======= =======
Earnings per common share - Basic $ .25 $ .28
=== ===
Basic weighted average shares 14,252 14,013
====== ======
Earnings per common share - Diluted $ .24 $ .27
=== ===
Diluted weighted average shares 14,936 14,782
====== ======
The accompanying notes are an integral part of these financial statements.
3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
Thirteen weeks ended October 31, 2004
(In thousands except share data)
Accumulated
Additional Other
Common Stock Paid-in Retained Comprehensive
------------ Capital Earnings Income (Loss) Total
Shares Amount ------- -------- ------------- -----
------ ------
Balance at August 01, 2004 14,220,508 $ 1,422 107,671 75,151 1,256 $ 185,500
Exercise of stock options 64,599 7 552 559
Tax benefit upon exercise of stock
options 200 200
---------- ----- ------- ------ ----- -------
Subtotal 14,285,107 1,429 108,423 75,151 1,256 186,259
---------- ----- ------- ------ ----- -------
Net income 3,553 3,553
Other comprehensive income (loss):
Unrealized (loss) on interest rate swap (34) (34)
Foreign currency translation gain 115 115
-------
Comprehensive income 3,634
---------- ----- ------- ------ ----- -------
Balance at October 31, 2004 14,285,107 $ 1,429 108,423 78,704 1,337 $ 189,893
========== ===== ======= ====== ===== =======
The accompanying notes are an integral part of these financial statements.
4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Thirteen weeks ended
--------------------
October 31, November 2,
2004 2003
---------- -----------
Cash flows from operating activities:
Net income $ 3,553 $ 3,941
------ ------
Adjustments to reconcile net income to
net cash provided by operations:
Depreciation and amortization 1,149 966
Foreign exchange loss -- 173
Equity in income of limited partnership (6) --
Changes in operating assets and liabilities:
Decrease in accounts receivable 4,126 2,274
Decrease (increase) in costs incurred and income
recognized in excess of billings on
uncompleted contracts 175 (5,429)
(Increase) decrease in other receivables (265) 92
(Increase) in inventories (766) (1,735)
(Increase) in prepaid expenses and other (473) (243)
(Decrease) in accounts payable
and accrued expenses (60) (327)
(Decrease) increase in billings in excess of
costs incurred and income recognized
on uncompleted contracts (624) 1,294
Increase in income taxes payable 1,241 877
(Decrease) increase in reserve for contract losses (327) 241
(Decrease) in advance payments on contracts (231) (271)
Other, net 166 232
------ ------
Total adjustments 4,105 (1,856)
------ ------
Net cash provided by operating activities 7,658 2,085
------ ------
Cash flows from investing activities:
Acquisition of businesses, net of cash acquired (3,753) --
Partial distribution from limited partnership 10 20
Capital expenditures (2,044) (1,187)
------ ------
Net cash used in investing activities (5,787) (1,167)
------ ------
Cash flows from financing activities:
Proceeds from exercise of stock options 559 718
Payments of long-term debt (727) (621)
------ ------
Net cash (used in) provided by financing activities (168) 97
------ ------
Net increase in cash and cash equivalents 1,703 1,015
Cash and cash equivalents at beginning of period 66,181 81,523
------ ------
Cash and cash equivalents at end of period $ 67,884 $ 82,538
====== ======
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. Interim Reporting
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with instructions to Form 10-Q and do not
include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for interim periods are
not necessarily indicative of the results of operations that may be
expected for a full year. These statements should be read in conjunction
with the consolidated financial statements and notes thereto, and the
Company's description of critical accounting policies, included in the
Company's 2004 Annual Report on Form 10-K for the fiscal year ended August
1, 2004, as filed with the Securities and Exchange Commission.
The unaudited condensed consolidated financial statements include the
accounts of Herley Industries, Inc. and its wholly-owned subsidiaries,
collectively referred to as the "Company." All significant intercompany
accounts and transactions have been eliminated.
Certain prior period balances have been reclassified to conform to the
current period's presentation.
2. Acquisitions
The Company entered into an agreement as of March 29, 2004 to acquire
certain assets and the business, subject to the assumption of certain
liabilities, of Communication Techniques, Inc., a Delaware corporation
doing business in Whippany, New Jersey. The facility operates as a
wholly-owned subsidiary of the Company as Herley-CTI, Inc. ("CTI"). CTI
designs, develops and produces state-of-the-art signal generation
components and integrated assemblies for digital radio, SONET, SatCom, test
and instrumentation, datacom, and wired and wireless applications to 45 Ghz
and 45 Gb/s. CTI also recently developed a fast frequency changing direct
synthesizer which, when combined with the capabilities of Herley-Israel,
puts the Company at the forefront of producing broadband microwave sources
for radar, communication, electronic warfare, and microwave test systems.
The transaction provided for a net payment of $14,914,000 in cash and the
assumption of certain liabilities. 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.
The allocation of the aggregate purchase price, based on a detailed review
of the fair value of the assets acquired and liabilities assumed, including
the fair value of identified intangible assets, is as follows (in
thousands):
Current assets $ 2,861
Property, plant and equipment 1,492
Intangible assets 3,200
Goodwill 8,725
Current liabilities (1,364)
------
Aggregate purchase price $ 14,914
======
6
The Company entered into an agreement as of September 1, 2004 to purchase
the majority of the assets and assume the majority of the liabilities of
Reliable System Services Corporation ("RSS"), of Melbourne, Florida for
$3,725,000 in cash. The Company operates the RSS business as a wholly-owned
subsidiary under the name Herley-RSS, Inc. Herley-RSS designs, develops and
produces satellite-based command and control systems for prime defense
contractors and entities worldwide.
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. The condensed
consolidated financial statements reflect preliminary estimates of the fair
value of the assets acquired and liabilities assumed and the related
allocations of the purchase price, and preliminary estimates of adjustments
necessary to conform RSS data to the Company's accounting policies. The
final determination of the fair value of assets acquired and liabilities
assumed and final allocation of the purchase price is expected to be
completed no later than the third quarter of fiscal 2005, and may differ
from the amounts included in the accompanying condensed consolidated
financial statements. The excess cost over the preliminary estimated fair
value of net assets acquired of approximately $3,651,000 has been recorded
as goodwill.
The allocation of the aggregate purchase price, including expenses of
acquisition of $28,000, based on a preliminary review of the fair value of
the assets acquired and liabilities assumed is as follows (in thousands):
Current assets $ 483
Property, plant and equipment 72
Goodwill 3,651
Current liabilities (453)
-----
Aggregate purchase price $ 3,753
=====
3. Inventories
Inventories at October 31, 2004 and August 1, 2004 are summarized as
follows (in thousands):
October 31, 2004 August 1, 2004
---------------- --------------
Purchased parts and raw materials $ 23,085 $ 23,556
Work in process 24,328 22,878
Finished products 2,553 2,412
------ ------
49,966 48,846
Less reserve for excess and obsolete materials 4,081 3,937
------ ------
$ 45,885 $ 44,909
====== ======
4. 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. 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.
7
The change in the carrying amount of goodwill for the three months ended
October 31, 2004 is as follows (in thousands):
Balance at August 1, 2004 $ 35,165
Goodwill acquired during the period 3,651
Foreign currency translation adjustment 43
------
Balance at October 31, 2004 $ 38,859
======
The increase in goodwill was attributable to the acquisition of RSS (See
Note 2).
Intangibles consist of the following (in thousands):
October 31, August 1, Estimated
2004 2004 useful life
---- ---- -----------
Technology $ 3,421 $ 3,421 15 years
Drawings 800 800 15 years
Backlog 325 325 2 years
Non-compete 31 31 5 years
Foreign currency translation
adjustment 165 162
Patents 568 568 14 years
----- -----
5,310 5,307
Accumulated amortization 847 752
----- -----
$ 4,463 $ 4,555
===== =====
Amortization expense for the thirteen weeks ended October 31, 2004 and
November 2, 2003 was approximately $95,000 and $69,000, respectively.
Estimated aggregate amortization expense for each of the next five fiscal
years is as follows (in thousands):
2005 $ 342
2006 329
2007 328
2008 322
2009 322
The carrying amount of intangibles is reviewed for recoverability when
events or changes in circumstances occur that indicate that the carrying
value of the assets may not be recovered.
8
5. Product Warranties
The Company warrants its products generally for a period of one year. The
reserve for warranty is as follows (in thousands):
Thirteen weeks ended
--------------------
October 31, 2004 November 2, 2003
---------------- ----------------
Balance at beginning of period $ 580 $ 359
Provision for warranty obligations 156 120
Warranty costs charged to the reserve (155) (113)
---- ----
Balance at end of period $ 581 $ 366
=== ===
The Company records a provision for estimated warranty costs based on
historical experience.
6. Litigation
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. See the discussion in Part II,
Item 1 - "Legal Proceedings".
7. Comprehensive Income
The components of comprehensive income are as follows (in thousands):
Thirteen weeks ended
--------------------
October 31, 2004 November 2, 2003
---------------- ----------------
Net income $ 3,553 $ 3,941
Unrealized loss on interest rate swap (34) (35)
Foreign currency translation gain 115 244
--- ---
Comprehensive income $ 3,634 $ 4,150
===== =====
The components of accumulated other comprehensive income (loss) is as
follows (in thousands):
October 31, 2004 August 1, 2004
---------------- --------------
Unrealized (loss) from available-for-sale securities $ 1 $ 1
Unrealized (loss) on interest rate swap (107) (73)
Foreign currency translation gain (loss) 1,443 1,328
----- -----
Accumulated other comprehensive income (loss) $ 1,337 $ 1,256
===== =====
8. Stock-Based Compensation
The Company has various fixed stock option plans which reserve shares of
common stock for issuance to executives, key employees and directors.
9
Statement of Financial Accounting Standards ("SFAS") 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 ("APB") 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.
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. 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 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 Company has adopted the disclosure-only provisions of SFAS 123 and SFAS
148. 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
the Black-Scholes option pricing model which requires 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 determine the fair value of each option
granted:
October 31, 2004 November 2, 2003
---------------- ----------------
Expected life (years) .72 1.51
Volatility .91 .68
Risk-free interest rate 2.28% 2.80%
Dividend yield zero zero
If the Company had elected to recognize compensation expense based upon the
fair value at the date of grant for stock options issued under the plans,
the Company's net income and earnings per share would have been reduced to
the pro forma amounts indicated below (in thousands except per share data):
10
Thirteen weeks ended
--------------------
October 31, 2004 November 2, 2003
---------------- ----------------
Net income - as reported $ 3,553 $ 3,941
Deduct: total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (180) (206)
---- ----
Net income - pro forma $ 3,373 $ 3,735
===== =====
Earnings per share - as reported
Basic $ .25 $ .28
Diluted .24 .27
Earnings per share - pro forma
Basic $ .24 $ .27
Diluted .23 .25
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.
9. Earnings Per Share
The following tables show the calculation of basic and diluted
weighted-average shares outstanding (in thousands):
Thirteen weeks ended
--------------------
October 31, 2004 November 2, 2003
---------------- ----------------
Basic weighted-average shares 14,252 14,013
Effect of dilutive securities:
Employee stock options and warrants 684 769
------ ------
Diluted weighted-average shares 14,936 14,782
====== ======
Options to purchase 736,560 weighted shares of common stock, with exercise
prices ranging from $18.65 to $20.45, were outstanding during the first
quarter of fiscal 2005, 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 January 13, 2010, were
still outstanding as of October 31, 2004. 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.
11
10. Geographic Information
The Company operates as a single integrated business and as such has one
operating segment. Geographic net sales for the first quarter, based on
place of contract performance, were as follows (in thousands):
Thirteen weeks ended
--------------------
October 31, 2004 November 2, 2003
---------------- ----------------
United States $ 28,696 $ 22,071
Israel 3,034 3,056
England 1,860 3,140
------ ------
$ 33,590 $ 28,267
====== ======
Net property, plant and equipment by geographic area was as follows (in
thousands):
October 31, 2004 August 1, 2004
---------------- --------------
United States $ 21,833 $ 21,544
Israel 4,170 3,499
England 1,052 925
------ ------
$ 27,055 $ 25,968
====== ======
11. Supplemental cash flow information is as follows (in thousands):
Thirteen weeks ended
--------------------
October 31, 2004 November 2, 2003
---------------- ----------------
Net cash paid during the period for:
Interest $ 79 $ 80
Income taxes 98 987
Tax benefit related to stock options 200 225
12
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.
Business Overview
We are a leading supplier of microwave products and systems to defense and
aerospace entities worldwide. Our primary customers include large defense prime
contractors (including 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, the AMRAAM air to air missile, 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.
Results of Operations
Thirteen weeks ended October 31, 2004 and Thirteen weeks ended November 2, 2003
Net sales for the thirteen weeks ended October 31, 2004 were approximately
$33,590,000, as compared to $28,267,000 in the thirteen weeks ended November 2,
2003, an increase of $5.3 million (18.8%). Net sales at two recent acquisitions,
CTI and RSS, accounted for an increase of approximately $3.5 million, or 66% of
the increase for the quarter. We also experienced an approximate $3.1 million
increase in sales at our US operations due to:
o The start up of shipments of certain RF power amplifier products that
had been in development last year, and
o Shipments of certain microwave frequency modulation components
principally used in electronic warfare simulation systems.
We expect that this increase in sales from the RF power amplifier product line
will continue to impact favorably on quarterly comparisons in fiscal 2005,
somewhat offset by the completion of the shipments under a major order for
13
the microwave frequency modulation components referred to above.
These increases in sales in the first quarter of fiscal 2005 were offset by an
approximate $1.3 million decrease in revenues recognized by EWST, our UK
subsidiary. In the first quarter of fiscal 2004 at EWST, there were a number of
high value contracts that were at a stage where significant direct costs were
incurred. As EWST uses the percentage of completion method for revenue
recognition, these high value/ high direct cost contracts last year, as well as
reduced direct costs in the first quarter of fiscal 2005, accounted for the
reduction in revenue recognized in the first quarter of fiscal 2005. This
revenue reduction at EWST was offset by an approximate $200,000 increase
attributable to the more favorable conversion of Pound Sterling revenue into US
Dollars as compared to last year's first quarter.
The gross profit margin in the thirteen weeks ended October 31, 2004 was 32.3%
compared to 37.7% in the first quarter of fiscal 2004, a decline of 5.4%.
Excluding the impact of two recent acquisitions, the decline in gross profit
margins would have been larger, or a decline of approximately 5.9%. The decrease
in gross profit of approximately $1.9 million (or $2.0 million excluding the
impact of the two recent acquisitions) is primarily attributable to:
o Decreases of gross margins at EWST, principally due to changes in
contract estimates at that operation versus contract estimates in the
first quarter of fiscal 2004. (This item accounted for approximately
half of the decline of consolidated gross margins in the first quarter
of fiscal 2005. The changes in contact estimates, and increases in
estimated costs, were principally due to unanticipated delays in
meeting technical requirements and delivery dates on certain EWST
contracts.);
o A decline of gross margins at one of our US operations due to lower
shipments and higher labor costs attributable to the start up of a
major electronic warfare upgrade program for the US Navy; offset by
o An improvement of gross margins at another US operation due to the
increase in volume attributable to start up of shipments of certain RF
power amplifier products, and shipments of certain microwave frequency
modulation components referred to above.
We expect that gross margins at EWST over the balance of fiscal 2005 will
recover to a level at least equal to the gross margin EWST recognized in fiscal
2004, which was in excess of 24%.
Selling and administrative expenses for the thirteen weeks ended October 31,
2004 were 17.4% of net sales as compared to 16.9% in the first quarter of fiscal
2004. Almost all of the net increase in expenses of $1,075,000 was attributable
to the addition of selling and administrative expenses in connection with the
acquisitions of CTI and RSS. The Company incurred approximately $47,000 in
consulting fees in connection with the Sarbanes-Oxley internal controls
evaluation project in the first quarter of fiscal 2005, and had no such expenses
in the prior year's first quarter. We expect these Sarbanes Oxley costs to
increase during the course of fiscal 2005.
Operating income for the quarter was $5,004,000 or 14.9% of net sales, as
compared to $5,862,000 or 20.7% of net sales in 2004. The decrease in operating
income is primarily attributable to the decline in gross margin percentage (for
the reasons outlined above) and the 0.6% increase in selling and administrative
costs as a percentage of sales, offset by the beneficial impact of the $5.3
million increase in revenue for the quarter. Our foreign operations contributed
$562,000 in operating income for the quarter as compared to $1,546,000 in fiscal
2004. The decline in operating income occurred at the Company's U.K. subsidiary
as discussed above.
Investment income increased by $48,000 in the first quarter of fiscal 2005
because of a 40% increase in the rate of interest earned on the investment of
excess cash reserves during the quarter as compared to interest rates in the
prior year, offset by a decline on average of approximately $15 million in funds
invested. The reduction in the average
14
balance of funds invested in the first quarter of fiscal 2005 versus the prior
year was caused by the investments and capital expenditures financed out of our
investment funds, including the acquisitions of CTI and RSS.
The Company recognized no net foreign exchange gain or loss in the first quarter
of fiscal 2005, versus a $173,000 loss in last year's first quarter. In fiscal
2005, foreign exchange losses in the US that are attributable principally to
Pound Sterling denominated liabilities were substantially offset by foreign
exchange gains recognized in our UK and Israeli subsidiaries. The foreign
exchange gains at our UK subsidiary were recognized in connection with temporary
advances we have made to our UK subsidiary. In last year's first quarter, we
deferred any recognition of these foreign exchange gains, due to uncertainty
regarding when EWST would be able to repay these temporary advances. As a
result, in fiscal 2004's first quarter, the foreign exchange losses recognized
in the income statement for our US operations were not offset by gains
recognized in the income statement of our UK operations.
Liquidity and Capital Resources
As of October 31, 2004 and August 1, 2004, working capital was $129,395,000 and
$130,273,000, respectively, and the ratio of current assets to current
liabilities was 6.4 to 1 and 6.5 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 $949,000 at October 31, 2004, and
$1,180,000 at August 1, 2004.
Net cash provided by operations during the thirteen weeks ended October 31, 2004
was approximately $7,658,000 as compared to $2,085,000 during the comparable
period in the prior year. Significant items contributing to the increase in cash
provided by operations include the following:
1. reduction of approximately $5.6 million in the amount of cash invested
in "Costs incurred and income recognized in excess of billings on
uncompleted contracts",
2. an increase of approximately $1.8 million in cash generated from
collection of accounts receivable during the quarter,
3. a reduction of approximately $1.0 million in the amount of cash
invested in inventories during the course of the quarter, offset by
4. a decrease of approximately $1.9 million in cash generated from
"Billings in excess of costs incurred and income recognized on
uncompleted contracts" during the course of the quarter,
5. a reduction in income from operations of $260,000 from $5,037,000 in
the prior year first quarter to $4,777,000 (adjusted for depreciation,
amortization, and foreign exchange losses), and
6. other net uses of cash.
Of the changes noted in (1) and (2) above, the largest impact was from a major
contract at our Lancaster facility in connection with an upgrade for US Navy
aircraft. This program was accounted for on a percentage of completion basis,
and in last year's first quarter, we were accumulating significant costs into
this contract. The job was largely shipped during fiscal 2004, which also
contributed to the increase in accounts receivable collections in the first
quarter of fiscal 2005.
Net cash used in investing activities includes a net payment of $3,753,000 in
connection with the acquisition of RSS (See Note 2), and capital expenditures of
$2,044,000, including approximately $928,000 related to the relocation of our
Israel and UK operations into expanded facilities. The UK move is now
substantially completed, and approximately $1 million will be incurred
principally during the second quarter for improvements to the new Israel
facility.
15
Net cash used in financing activities of $168,000 consists primarily of the
exercise of stock options for $559,000 and the payment of the deferred purchase
price of EWST.
In June 2002, the Company entered into a new $50,000,000 Revolving Credit Loan
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, 2006 (as amended). The Company
may elect to borrow up to a maximum of $5,000,000 with interest based on the
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. The Federal
Funds Target Rate and the LIBOR rate was 1.75% and 2.00%, respectively, at
October 31, 2004. 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 October 31, 2004 and August
1, 2004. Stand-by letters of credit were outstanding in the amount of
approximately $10,724,000 under the credit facility at October 31, 2004, and
$11,389,000 at August 1, 2004.
The Company believes that presently anticipated future cash requirements will be
provided by internally generated funds, its existing unsecured credit facility,
and existing cash reserves. A significant portion of our revenue for fiscal 2005
will be generated from our existing backlog of sales orders. The backlog of
orders at October 31, 2004 was approximately $99 million. 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. As
of October 31, 2004, the Company has approximately $39,276,000 available under
its bank credit facility, net of outstanding stand-by letters of credit of
approximately $10,724,000, and cash reserves of approximately $67,884,000.
Disclosure About Contractual Obligations and Commitments
Accounting standards require disclosure concerning the Company's obligations and
commitments to make future payments under contracts, including interest, such as
debt and lease agreements, and other contingent commitments, such as standby
letters of credit. The following table summarizes the Company's contractual
obligations and other contingent commitments at August 1, 2004 (in thousands):
Within 2-3 4-5 After 5
Obligations Total 1 Year Years Years Years
----------- ----- ------ ----- ----- -----
Mortgage Note $ 2,662 $ 116 $ 255 $ 235 $ 2,056
Industrial Revenue Bonds 4,023 219 440 442 2,922
EWST Note 1,212 606 606 - -
Operating Lease Obligations 7,752 1,649 2,785 2,462 856
Purchase Obligations 16,448 16,448 - - -
------ ------ ------ ----- -----
32,097 19,038 4,086 3,139 5,834
Standby Letters of Credit 11,389 4,881 6,310 198 -
------ ------ ------ ----- -----
Total Contractual Obligations $ 43,486 $ 23,919 $ 10,396 $ 3,337 $ 5,834
====== ====== ====== ===== =====
Other than the ordinary course fulfillment of open purchase orders and placement
of new purchase orders, there have been no other significant changes to the
Company's contractual obligations table since August 1, 2004.
16
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
The Company's exposures to market risk have not changed significantly since
August 1, 2004.
Item 4 - Controls and Procedures
(a) Evaluation of disclosure controls and procedures. The term "disclosure
controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934 as amended (the "Exchange Act"). These rules
refer to the controls and other procedures of a company that are designed to
ensure that information required to be disclosed by the company in the reports
that it files under the Exchange Act is recorded, processed, summarized and
reported within the required time periods. The Company's management, with
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the design, operation and effectiveness of the Company's
disclosure controls and procedures and have concluded, based on such evaluation,
that such controls and procedures were effective at providing reasonable
assurance that required information will be disclosed in the Company's reports
filed under the Exchange Act as of October 31, 2004.
(b) Changes in internal controls. There were no changes in the Company's
internal controls over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended
October 31, 2004 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings:
On 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
17
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 did not appeal. 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. Oral argument was held on December
18, 2003.
By Summary Order on January 26, 2004, the Second Circuit affirmed the trial
court judgment in its entirety. On February 4, 2004, RLI submitted a letter
request to the trial court for relief from the judgment on RLI's claim for the
earn-out stock under Federal Rule of Civil Procedure 60. RLI contended that it
had "newly discovered evidence," first learned in August 2003, to justify its
requested relief. Herley submitted its response in opposition by letter dated
February 10, 2004. On February 26, 2004, the parties appeared before the Court
concerning the various applications and were directed to submit legal briefs on
various legal issues. By Order dated May 28, 2004 the trial court denied RLI's
Motion for a New Trial. The Court also denied Herley's request that it exercise
its general equitable power to hold Ben Robinson personally liable for any fees
Herley might recover against RLI.
On June 28, 2004, Herley filed suit against Ben Robinson and Frank Holt in the
Superior Court of Hillsborough County, New Hampshire, asserting claims for
fraudulent conveyance and piercing the corporate veil to hold Robinson
personally liable for the fees incurred by Herley in defending RLI's claims
discussed above. In response, Robinson took steps to collect damages awarded to
him under the jury verdict. On July 21, 2004, Herley brought an Emergency Motion
for Injunctive Relief and moved for an immediate order from the New Hampshire
court allowing Herley to escrow the judgment owed to Robinson to be offset
against any award of fees to Herley. The court entered an order denying the
requested relief. On July 27, 2004, Herley paid $1,594,621 (including interest)
to Ben Robinson, an amount calculated by deducting Herley's award against
Robinson from the amounts awarded to Robinson on his claims under the Employment
Agreement and the Lease Agreement. On July 28, 2004, the parties filed a Notice
of Partial Satisfaction of Judgment. Herley's judgment against RLI remains
unsatisfied. Cross petitions for attorney's fees are still pending in the New
York Action.
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.
18
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
31.1 Certification of Myron Levy pursuant to Rule 13a-14(a).
31.2 Certification of Thomas V. Gilboy pursuant to Rule 13a-14(a).
32.1 Certification of Myron Levy pursuant to 18 U.S.C. Section 1350.
32.2 Certification of Thomas V. Gilboy pursuant to 18 U.S.C. Section 1350.
19
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HERLEY INDUSTRIES, INC.
----------------------
Registrant
BY: /S/ Myron Levy
--------------------------------------
Myron Levy, Chief Executive Officer
BY: /S/ Thomas V. Gilboy
---------------------------------------------
Thomas V. Gilboy, Principal Financial Officer
DATE: December 9, 2004
20