Item 1. Business
BACKGROUND
Herley is a leading supplier of microwave products and systems to defense and aerospace entities worldwide. Our primary customers include large defense prime contractors (including Raytheon, Northrop Grumman, Lockheed Martin and Boeing), the U.S. government (including the Department of Defense, NASA and other U.S. government agencies) and international customers (including the Egyptian, German, Japanese and South Korean militaries and suppliers to international militaries). We are a leading provider of microwave technologies for use in command and control systems, flight instrumentation, weapons sensors and electronic warfare systems. We have served the defense industry since 1965 by designing and manufacturing microwave devices for use in high technology defense electronics applications. Our products and systems are currently deployed on a wide range of high profile military platforms, including the 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.
ACQUISITIONS
We have grown internally and through strategic acquisitions over the past ten years and have evolved from a component manufacturer to a systems and service provider. We have successfully integrated these acquisitions by targeting microwave technology companies and focusing their strengths into our existing operations.
- - In September 1992, we acquired Micro-Dynamics, Inc. of Woburn, Massachusetts, a microwave subsystem designer and manufacturer.
- - In June 1993, we acquired Vega Precision Laboratories, Inc. of Vienna, Virginia, a manufacturer of flight instrumentation products.
- - In July 1995, we acquired Stewart Warner Electronics Corp. of Chicago, Illinois, a manufacturer of high frequency radio and IFF interrogator systems.
- - In August 1997, we acquired Metraplex Corporation of Frederick, Maryland, a manufacturer of airborne PCM and FM telemetry and data acquisition systems.
- - In January 1999, we acquired General Microwave Corporation of Farmingdale, New York, a manufacturer of microwave components and electronic systems.
- - In January 2000, we acquired Robinson Laboratories, Inc. of Nashua, New Hampshire, a designer, developer and manufacturer of microwave components and assemblies primarily for defense applications.
- - In September 2000, we acquired American Microwave Technology, Inc. of Anaheim, California, a manufacturer of high power, solid state amplifiers for the scientific and medical markets, which enabled us to enter these markets.
- - In September 2002, we acquired EW Simulation Technology, Limited ("EWST"), a British company of Aldershot, UK. EWST designs, develops and produces electronic warfare simulator systems for prime defense contractors and countries worldwide.
BUSINESS STRATEGY
Our goal is to continue to leverage our proprietary technology, microwave expertise and manufacturing capabilities to further expand our penetration in our market. Our strategies to achieve our objectives include:
- - INCREASE LEVELS OF COMPONENT INTEGRATION AND VALUE ADDED CONTENT. Due to growth of engineering expertise, new product development, and acquisitions, we have increased our capability to provide more component integration. Management believes component integration adds value and will enable us to increase content in defense platforms and systems, thereby increasing our revenue and profitability.
- - MAINTAIN LEADERSHIP IN MICROWAVE TECHNOLOGY. We intend to pursue further technological advances through continued investment in internally-funded and customer-funded research and product development.
- - STRENGTHEN AND EXPAND CUSTOMER RELATIONSHIPS. We have developed mutually beneficial relationships with various agencies of the U.S. government and defense and commercial companies. We expect to continue to build and strengthen these relationships with industry leaders by anticipating and recognizing their needs and providing them with on-time and cost-effective solutions.
- - CAPITALIZE ON OUTSOURCING DYNAMICS IN THE AEROSPACE AND DEFENSE INDUSTRY. Microwave technology has traditionally been an in-house resource of the prime contractors. However, the prime contractors are beginning to outsource the design and manufacture of this specialized engineering work to system sub-contractors. We are well positioned to generate more business as prime contractors continue to focus primarily on integration of defense electronics.
- - PURSUE STRATEGIC ACQUISITIONS. We intend to continue to augment our existing technological base by acquiring specialized companies that complement or expand our product offerings and market strategies. We believe that expansion of our core competencies through the acquisition of such specialized technology companies, when combined with our current technological and manufacturing skills, will provide us with improved levels of horizontal and vertical integration, leading to the creation of subsystems and complete system products.
- - ENHANCE MANUFACTURING CAPABILITIES. We intend to continue to implement process manufacturing automation and believe that our ability to develop a high level of automated production and test capability will help to further improve our cost effectiveness and time to market.
- - PURSUE SELECTIVE COMMERCIAL OPPORTUNITIES. We seek to identify and pursue selected commercial applications for our products and technologies where we can add value based on our microwave expertise.
COMPETITIVE STRENGTHS
Our competitive strengths include:
- - TECHNICAL EXPERTISE. We have developed a leading position in the field of microwave technology through our 38 year focus on research and development and our state-of-the-art design and production capabilities. We have recently completed construction of state-of-the-art manufacturing facilities in Lancaster, Pennsylvania, where we have a full range of capabilities including long and short run production, hardware assembly and full-service engineering. In addition, we have highly capable manufacturing facilities located in Woburn, Massachusetts; Farmingdale, New York; Aldershot, England; and Jerusalem, Israel. We continue to develop and reward our engineers in order to maintain our expertise in-house.
- - HIGH PROPORTION OF LONG-TERM SOLE-PROVIDER PRODUCTION PROGRAMS. We generate a significant proportion of our revenue from continuing, long-term programs, both in the production and upgrade phases, and continue to target high growth, high priority defense programs. Typically, on such long-term defense programs we are the sole provider of microwave equipment.
- - DIVERSE PRODUCT AND CUSTOMER BASE. We have a diverse product and customer base, with only the U.S. government, at approximately 25%, representing more than 10% of our fiscal 2003 revenues. We are a first-tier supplier to all of the prime defense contractors, as well as a direct supplier to all of the service branches of the U.S. military, including products found on over 120 individual platforms. Foreign customers accounted for approximately 36% of our revenues in fiscal 2003.
- - LONG-STANDING INDUSTRY RELATIONSHIPS. We have established long-standing relationships with the U.S. government and other key organizations in the aerospace and defense industry after 38 years in the defense electronic industry. Over this period, we have become recognized for our ability to develop new technologies and meet stringent program requirements.
- - SUCCESSFUL ACQUISITION TRACK RECORD. We have demonstrated that we can successfully integrate acquired companies. We are experienced at evaluating prospective operations in order to increase efficiencies and capitalize on market and technological synergies.
- - EMPHASIS ON RESEARCH AND DEVELOPMENT. In fiscal year 2003, we spent over $6.3 million on new product development, of which our customers funded approximately $3.2 million. Our emphasis on new product development enables us to maintain our technological leadership in current products and to develop new capabilities. This spending helps solidify and strengthen our position on different programs and may serve as a barrier to entry for competitors.
- - EXPERIENCED MANAGEMENT TEAM. Our senior management team averages over 23 years of experience in the defense electronics industry.
PRODUCTS AND SERVICES
We operate in two markets: defense electronics and commercial technologies.
DEFENSE ELECTRONICS
We are a leading supplier of microwave products and systems to defense and aerospace entities worldwide. We design and manufacture microwave components and subassemblies which are embedded in a variety of radars, flight instrumentation, weapons sensors, electronic warfare systems and guidance systems. Our microwave devices are used on our subassemblies and integrated systems (e.g. command and control systems, telemetry systems, transponders, flight termination receivers and identification friend or foe, or IFF, interrogators), in addition to being sold on a component basis.
The following are descriptions of our major systems and products:
Telemetry Systems. Telemetry systems provide wireless data transmission between two or more sites for recording and analysis. Missile, UAV, or target testing on domestic and international test ranges requires flight safety and performance data transmission to maximize flight safety during the test operation. Surveillance and intelligence gathering UAVs also require a data transmission downlink and a command and control systems uplink to accomplish their mission. We have developed a telemetry system capability that can be configured to meet individual customers' needs. Various components of the system include data encoders, transmitters and flight termination receivers. Each has a distinctive role and each is key to the success of the mission.
We are a leading manufacturer of Pulse Code Modulation, or PCM, and Frequency Modulation, or FM, telemetry and data acquisition systems for severe environment applications, and our products are used worldwide for testing space launch vehicle instrumentation, aircraft flight testing, and amphibian, industrial and automotive vehicle testing. The product portfolio ranges in size and complexity from miniature encoders to completely programmable data acquisition systems.
We offer a complete airborne data link system. With our digital capability in data encoding and acquisition elements combined with our radio frequency capability in providing telemetry transmitters and flight termination receivers, we offer a full line of narrow and wide-band airborne telemetry systems to meet a wide variety of industrial needs, both domestically and internationally.
Command and Control Systems. Our command and control systems have been used to fly remotely a large variety of unmanned aerial vehicles, or UAVs, typically aircraft used as target drones or Remotely Piloted Vehicles, or RPVs. Our command and control systems also control surface targets. Operations have been conducted by users on the open ocean, remote land masses, and instrumented test and training ranges. Our command and control systems are currently in service throughout the world. Command and control systems permit a ground operator to fly a target or a UAV through a pre-planned mission. The mission may be for reconnaissance, where the vehicle is equipped with high definition TV sensors and the necessary data links to send information back to its command and control systems ground station. The UAV may also be used as a decoy, since the operator can direct the flight operations that will make the small drone appear to be a larger combat aircraft.
Our MAGIC2 system affords over-the-horizon command and control using GPS guidance and control of multiple targets from a single ground station. The ability to control multiple targets at increased distances represents a significant product improvement. The MAGIC2 is a highly flexible, multiple processor design with high resolution graphics, which can be field-configured within minutes to fly or control any selected vehicle for which it is equipped. The MAGIC2 is used in support of missile, aircraft and other weapons systems development and testing. The system meets a growing requirement to test against multiple threats with the automated defense capabilities of ships like the AEGIS cruiser and the E-2C aircraft.
Transponders. We manufacture a variety of expendable transponders, including range safety, IFF, command and control, and range scoring systems. Transponders are small, expendable, electronic systems consisting of a transmitter, sensitive receiver and internal signal processing equipment comprised of active and passive components, including microwave subassemblies such as amplifiers, oscillators and circulators. The transponder receives signals from radars, changes and amplifies the frequency of the signals, and transmits back a reply on a different frequency and signal level. This reply is a strong, noise-free signal upon which the tracking radar can "lock," and one which is far superior to skin reflection tracking, particularly under adverse weather conditions after the launch.
In range safety applications, transponders enable accurate tracking of space launch and unmanned aerial vehicles, missiles, and target drones so that position and direction are known throughout its flight. In the case of several defense and commercial space launch vehicles (i.e., Delta, Atlas, Titan and Pegasus), our transponder is tracked by the ground launch team all the way to space orbit, and in certain instances through several orbits, as a reference location point in space to assure that the launch payload has been properly placed in orbit.
IFF transponders, which are used in conjunction with the Federal Aviation Authority Air Traffic Control System, enable ground controllers to identify the unmanned targets, drones and cruise missiles on which these units fly and to vector other manned aircraft safely away from the flight path of the unmanned aerial vehicle.
Command and control transponders provide the link through the telemetry system for relaying ground signals to direct the vehicle's flight. The uplink from the ground control station, a series of coded pulse groups, carries the signals that command the flight control guidance system of the vehicle. The downlink to the ground provides both tracking signals for range safety, as well as acknowledgment and status of the uplink commands and their implementation in the vehicle. The transponder is therefore the means to fly the vehicle. Scoring systems are mounted on both airborne and sea targets. Scoring systems enable test and evaluation engineers to determine the "miss-distance" between a projectile and the target at which it has been launched.
Flight Termination Receiver. A flight termination receiver, or FTR, is installed in a test missile, UAV, target or space launch vehicle as a safety device. The FTR has a built-in decoder that enables it to receive a complex series of audio tones which, when appropriate, will set off an explosive charge that will destroy the vehicle. A Range Safety Officer, or RSO, using the range safety transponder will track the vehicle in flight to determine if it is performing as required. If the RSO detects a malfunction in the test or launch vehicle that causes it to veer from a planned trajectory in a manner that may endanger personnel or facilities, the RSO will transmit a coded signal to the onboard FTR to explode the vehicle.
HF Communications and IFF Interrogators. We design and manufacture high frequency radio and IFF interrogators. This high frequency communications equipment is used by the U.S. Navy and foreign navies that conduct joint military exercises with the U.S. Navy. The IFF interrogators are used as part of shipboard equipment and are also placed on coastlines, where they are employed as silent sentries. We have been a significant supplier to the Republic of Korea for over twenty years and have a large, established installed base of equipment. We have been, and continue to be, a supplier to the Republic of Korea KDX destroyer program.
High Power Amplifier. We design and manufacture high power amplifier systems with frequencies ranging from 1.5 MHz to 12GHz with power levels from multi-kilowatts up to 15W, depending on the frequency. Our high power amplifier applications include but are not limited to defense communication, electronic warfare, radar and avionics. We have an exclusive sales and marketing agreement with EADS ewation, Grintek ewation, Sysdel Close Corporation and Indra regarding high power amplifiers for monitoring, reconnaissance and countermeasures.
Microwave Integrated Circuits. We design and manufacture complex microwave integrated circuits, or MICs, which consist of sophisticated assemblies that perform many functions, primarily involving switching of microwave signals. Our MICs are employed in many defense electronics systems and missile programs. We also manufacture magnetrons, which are the power source utilized in the production of our transponders.
High/Low Power Integrated Assembly. Our high power microwave devices are used in radar system transmitters and in long-range missiles. High power devices frequently use small amounts of nuclear material to enhance breakdown of high energy pulses, and we are one of very few companies with an active nuclear license that permits the handling of these trace amounts of nuclear materials. There are relatively few companies with the expertise or facilities to design, manufacture and test high power devices. We also produce lower power, broad band microwave integrated assemblies for the defense electronics industry. These complex assemblies combine microwave functions such as amplification, attenuation, switching of multiple signals, and phase and amplitude control. Their applications include Rear Warning Receivers, or RWRs, Electronics Countermeasure, or ECM, systems and highly sensitive receiver systems.
Solid State Receiver Protector. We have become a preeminent supplier of solid-state receiver protector devices that are able to withstand high energy pulses without the use of nuclear materials. These high power devices protect a radar receiver from transient bursts of microwave energy and are employed in almost every military and commercial radar system. For our engineering efforts in designing solid-state receiver protectors for the F- 16, we received cash awards from the United States Air Force as part of the government's value engineering program.
Digitally Tuned Oscillators (DTO's). We produce microwave sources, which generate signals that are used in microwave oscillators. Our microwave sources are sold to the U.S. defense industry and to various foreign governments. We specialize in digitally tuned oscillators, or DTOs, a critical component in many ECM systems.
Simulation Equipment. EW Simulation Technology Limited ("EWST"), a U.K. company and wholly owned subsidiary, designs and manufactures radar threat and electronic countermeasures simulation equipment for electronic warfare training and test and evaluation applications. Radar threat and countermeasures simulator products include but are not limited to the following:
CHAMELEON is a real time electronic countermeasures ("ECM") jamming simulator. It uses a variety of ECM techniques and radar target modeling for training and testing of both radar and EW operators and systems. CHAMELEON offers a fully programmable ECM capability using Digital RF Memories ("DRFM") technology. The system offers fully coherent jamming in both range and velocity through the use of 8-bit DRFM technology together with GUI software. Target modeling includes Swerling fluctuations, cross-section synthesis and clutter generation. The CHAMELEON is suited for ground-based and airborne ECM test and training systems.
The RSS8000 Series Radar Threat Simulator generates real-time user programmable radar threats and provides output configurations in digital (On-board trainer-OBT) and RF (RSS series) formats. The system can be used for EW system test and evaluation as well as for EW operator training in laboratory and more rugged environments. The RSS8000 equipment covers the 100MHz to 40 GHz range and can be configured to suit any application from a portable single RF source unit to a multiple RF source and multiple port DF system. The DF systems are available in amplitude, DTOA and/or phase formats with the ports being capable of angular rotation.
Mobile EW and Radar Test Systems ("MERTS") is a mobile EW and radar test system providing complete jamming and radar threat test facility for field use. It provides a turnkey test and evaluation equipment for field applications and includes both the CHAMELEON and RSS8000 systems integrated into one operational unit. The MERTS equipment is housed within an air-conditioned ISO container mounted on a four-wheel drive truck that allows on-site test and evaluation of radar and EW systems as well as operator training.
COMMERCIAL TECHNOLOGIES
Our commercial technologies are comprised of scientific products and medical products.
Scientific Products. Our scientific products are used extensively in Nuclear Magnetic Resonance (NMR) systems. These amplifiers, which have dual mode capability and can be operated in either a pulsed or continuous wave, cover the frequency ranges of 6 MHz to 950 MHz, with power levels as high as 2.0KW peak power at 10% duty cycle. Scientific customers include OEM, system manufacturers and research centers.
Medical Products. Our medical products vary in complexity from single modules, to rack mounted amplifiers, to complete systems. The rack-mounted amplifiers and complete systems typically include detection/protection circuitry, built-in power supplies, front panel metering and digital and/or analog interface controls. Both forced air and/or water cooling are used, depending on the customer's requirements. Our medical products are used in Magnetic Resonance Imaging, or MRI, systems. All amplifiers have dual mode capability and can be operated in either a pulsed or continuous wave mode, and cover the frequency ranges of 10 MHz to 200 MHz with power levels as high as 12.0KW peak power at 10% duty cycle. Medical customers include both original equipment and systems manufacturers, as well as universities and research centers.
All products feature highly reliable technical solutions designed for improved production and reliability. Producibility is enhanced through the use of surface mount components and circuit designs which eliminate the need for excessive alignment during the production cycle. High reliability is achieved through the implementation of conservative thermal and RF circuit design and sophisticated self-protection schemes. Reliability is further enhanced during the design phase by employing detailed environmental testing.
CUSTOMERS
During the fiscal year ended August 3, 2003, approximately 25% of our net sales were attributable to contracts with offices and agencies of the U.S. government. No other customers accounted for shipments in excess of 10% of net sales.
We provide defense electronics equipment to major defense prime contractors for integration into larger platforms and systems. Some of our customers for defense electronics equipment include:
Boeing BAE Systems Harris Lockheed Martin Northrop Grumman Raytheon
During fiscal 2003, sales to foreign customers accounted for approximately 36% of our net sales. Domestic sales to foreign customers accounted for 16% of net sales. Sales from England and Israel each accounted for 10% of net sales to foreign customers. The governments of Egypt, Japan, South Korea, Taiwan and the United Kingdom are all significant customers of ours. All of our domestic contracts with foreign customers are payable in U.S. dollars. Contracts with customers originating in Israel and England are either in U.S. dollars or the local functional currency. International sales are subject to numerous risks, including political and economic instability in foreign markets, currency and economic difficulties in the Pacific Rim, restrictive trade policies of foreign governments, inconsistent product regulation by foreign agencies or governments, imposition of product tariffs and burdens and costs of complying with a wide variety of international and U.S. export laws and regulatory requirements. Our international sales also are subject to us obtaining export licenses for certain products and systems.
SALES AND MARKETING
We market our products worldwide to the United States government, prime contractors and various countries in defense markets, and to OEMs, research institutions and universities in commercial markets. Sales are primarily through a sales force generally organized by geographic territory and markets. In addition, we have contracts with manufacturers' representatives in the United States and international representatives who are located in Western Europe, the Middle East and Asia. As part of our marketing efforts, we advertise in major trade publications and attend major industrial shows in the commercial, medical, satellite communications and defense markets.
After we have identified key potential customers, we make sales calls with our own sales, management and engineering personnel. In order to promote widespread acceptance of our products and provide customers with support, our sales and engineering teams work closely with our customers to develop tailored solutions to their requirements. We believe that our customer engineering support provides us with a key competitive advantage.
We also produce microwave components that are sold through our catalog, which for almost forty years has been an industry leader, and sell attenuating devices and IQ modulation and phase shifters through the microwave engineer's handbook.
MANUFACTURING
We manufacture our products from standard components, as well as from items that are manufactured by vendors to our specifications. A majority of our defense electronics and commercial assemblies and subsystems contain proprietary technology which is designed and tested by our engineers and technicians and is manufactured at our own facilities.
We continue to invest in improving our proprietary manufacturing processes and the automation of the manufacturing processes. Automation is critical in meeting our customers' demands for price competitiveness, world class quality and on-time delivery. We are also investing to enhance our responsiveness to the production demands of our customers.
We purchase electronic components and other raw materials used in our products from a large number of suppliers and all such materials are readily available from alternate sources.
We maintain minimal levels of finished products inventory to meet the needs of our medical products customers. We generally purchase raw materials for specific contracts, and we purchase common components for stock based on our firm fixed backlog.
There are no significant environmental control procedures required concerning the discharge of materials into the environment that require us to invest in any significant capital equipment or that would have a material effect on our earnings or our competitive position.
Quality assurance checks are performed on manufacturing processes, purchased items, work-in-process and finished products. Due to the complexity of our products, final tests are performed on some products by highly skilled engineers and technicians.
Our primary manufacturing facilities have earned the ISO 9001 Registration. The ISO 9000 series standards are internationally recognized quality management system requirements. ISO 9001, the most comprehensive Standard in the ISO 9000 Series, covers design, manufacturing, installation, and servicing systems.
Assembly, test, package and shipment of products are done at our manufacturing facilities located in the following cities:
Lancaster, Pennsylvania Farmingdale, New York Woburn, Massachusetts Jerusalem, Israel Aldershot, England
BACKLOG
Our total backlog of orders was approximately $89.9 million on August 3, 2003 as compared to $82.7 million on July 28, 2002. Of our total backlog at August 3, 2003, $51.3 million (57%) is attributable to domestic orders and $38.6 million (43%) is attributable to foreign orders. Management anticipates that approximately $76.9 million of its backlog will be shipped during the fiscal year ending August 1, 2004.
All of the orders included in backlog are covered by signed contracts or purchase orders. Backlog is not directly indicative of future sales. Accordingly, we do not believe that our backlog as of any particular date is representative of actual sales for any succeeding period.
Substantially all of our contracts are fixed price contracts, some of which require delivery over time periods in excess of one year. With this type of contract, we agree to deliver products at a fixed price except for costs incurred because of change orders issued by the customer.
In accordance with Department of Defense procedures, all contracts involving government programs may be terminated by the government, in whole or in part, at the government's discretion for cause or convenience. In the event of a termination for convenience, prime contractors on such contracts are required to terminate their subcontracts on the program, and the government or the prime contractor is obligated to pay the costs incurred by us under the contract to the date of termination plus a fee based on the work completed.
PRODUCT DEVELOPMENT
We believe that our growth depends, in part, on our ability to renew and expand our technology, products, and design and manufacturing processes with an emphasis on cost effectiveness. Our primary efforts are focused on engineering design and product development activities rather than pure research. Our policy is to assign the required engineering and support people, on an ad hoc basis, to new product development as needs require and budgets permit. The cost of these development activities, including employees' time and prototype development, was approximately $6.3 million in fiscal 2003, $5.6 million in fiscal 2002 and $4.6 million in fiscal 2001, of which we paid approximately $3.1 million in fiscal 2003, $2.3 million in fiscal 2002 and $2.6 million in 2001. The remainder of these costs were paid by some of our customers.
COMPETITION
The microwave component and subsystems industry is highly competitive and we compete against many companies, both foreign and domestic. Many of these companies are larger, have greater financial resources and are better known. As a supplier, we also experience significant competition from the in-house capabilities of our customers.
Competition is generally based upon technology, design, past performance and price. Our ability to compete depends, in part, on our ability to offer better design and performance than our competitors and our readiness in facilities, equipment and personnel to complete the programs. Many of the programs in which we participate are long standing programs in which we are the sole provider of our product.
GOVERNMENT REGULATION
Because of our participation in the defense industry, we are subject to audits by various government agencies for our compliance with government regulations. We are also subject to a variety of local, state and federal government regulations relating to, among other things, the storage, discharge, handling, omission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our products. We believe that we operate our business in material compliance with applicable laws and regulations. However, any failure to comply with existing or future laws or regulations could have a material adverse impact on our business, financial condition and results of operations.
INTELLECTUAL PROPERTY
We rely primarily on a combination of trade secrets and employee and third-party non-disclosure agreements to protect our intellectual property, as well as limiting access to the distribution of proprietary information. We cannot assure you that the steps taken to protect our intellectual property rights will be adequate to prevent misappropriation of our technology or to preclude competitors from independently developing such technology. Furthermore, we cannot assure you that, in the future, third parties will not assert infringement claims against us with respect to our products. Asserting our rights or defending against third party claims could involve substantial costs and diversion of resources, thus materially and adversely affecting our business, financial condition and results of operations. In the event a third party were successful in a claim that one of our products infringed its proprietary rights, we may have to pay substantial royalties or damages, remove that product from the marketplace or expend substantial amounts in order to modify the product so that it no longer infringes on such proprietary rights, any of which could have a material adverse effect on our business, financial condition and results of operations.
EMPLOYEES
As of October 5, 2003, we employed 707 persons full time. Of these employees, 115 comprise the engineering staff, 504 constitute manufacturing personnel, 29 occupy sales and marketing positions, and 59 are in executive, management, and support functions. None of our employees are covered by collective bargaining agreements and we consider our employee relations to be satisfactory. We believe that our future success will depend, in part, on our continued ability to recruit and retain highly skilled technical, managerial and marketing personnel, including microwave engineers. To assist in recruiting and retaining such personnel, we have established competitive benefits programs, including a 401(k) employee savings plan and stock option plans.
OFFICERS OF THE REGISTRANT Served as Name Age Officer Since Position(s) and Offices - ---- --- ------------- -----------------------
Lee N. Blatt 75 1965 Chairman of the Board Myron Levy 62 1988 Vice Chairman Chief Executive Officer and Director John M. Kelley 50 1998 President William Wilson 54 2002 Vice President Chief Operating Officer Rozalie Schachter 56 2000 Vice President Business Development Anello C. Garefino 56 1993 Vice President-Finance, Treasurer and Chief Financial Officer John A. Carroll 52 2003 Vice President Human Resources Howard M. Eckstein 52 1998 Vice President Mitchell Tuckman 53 1999 Vice President Richard Poirier 38 2003 Vice President David H. Lieberman 58 1985 Secretary and Director
Item 2.
Item 2. Properties
Our facilities are as follows:
In addition to the above operating facilities, the Company has an idle facility in Billerica, MA which is under sublease.
We believe that its facilities are adequate for its current and presently anticipated future needs.
Item 3.
Item 3. Legal Proceedings
On August 14, 2001, Robinson Laboratories, Inc. ("RLI") and Ben Robinson ("Robinson") filed an Amended Complaint against Herley Industries, Inc. ("Herley"). Although the Amended Complaint sets forth fifteen counts, the core allegations are (i) that Herley failed to issue 97,841 shares of common stock in connection with certain earn out requirements contained in an Asset Purchase Agreement dated February 1, 2000; (ii) that Herley breached an Employment Agreement with Robinson by terminating his employment on August 5, 2001; and (iii) that Herley breached a Stock Option Agreement dated January 31, 2000, with Robinson. RLI and Robinson asserted (i) violations of state and federal securities laws; (ii) fraud claims; (iii) breach of contract claims; and (iv) other equitable claims arising from the above core factual allegations.
On September 17, 2001, Herley filed an Answer, Affirmative Defenses and Counterclaims in this matter. In the Answer and Affirmative Defenses, Herley denied the material allegations of the Amended Complaint. Herley also filed Counterclaims against both RLI and Robinson. In these counterclaims, Herley's core allegations concern Robinson's misconduct (i) in connection with the manner he attempted to satisfy RLI's earn out requirements; (ii) misrepresentations made in connection with the Asset Purchase Agreement; (iii) wrongdoing as a Herley employee leading to his termination and (iv) post-Herley employment wrongdoing in connection with a new company known as RH Laboratories. In addition to seeking a Declaratory Judgment pursuant to 28 U.S.C. ss. 2201 et. seq., Herley also asserted claims for, among other things, fraud, breach of contract, breach of fiduciary duty, unfair competition and tortious interference with actual and prospective contractual relationships.
On August 5, 2002, a jury trial commenced. A jury verdict was rendered on August 21, 2002 in which the jury determined, among other things, that (i) Herley was not required to pay any additional stock; (ii) Herley breached
the Employment Agreement with Robinson and awarded Robinson $1.5 million in damages; (iii) Herley breached the Lease Agreement with Robinson and awarded Robinson approximately $552,000 in compensatory damages; (iv) Robinson breached fiduciary duties to Herley and awarded Herley $400,000 in compensatory damages; (v) Robinson and RLI breached indemnity obligations and awarded Herley $100,000 in damages; (vi) RLI breached representations and warranties given to Herley and awarded Herley $320,000 in damages.
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 is now required to file a response to RLI's brief and thereafter RLI will file a response to Herley's brief. Oral argument has not yet been scheduled.
The Company is involved in various other legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholders Matters
(a) The Company's Common Stock is traded in the NASDAQ National Market under the symbol HRLY. The following table sets forth the high and low closing sales price as reported by the NASDAQ National Market for the Company's Common Stock for the periods indicated and gives retroactive effect to the three-for-two stock split of the Common Stock on September 10, 2001.
Common Stock ------------ High Low ---- --- Fiscal Year 2002 First Quarter................................. $ 18.50 $ 11.17 Second Quarter................................ 17.13 13.10 Third Quarter................................. 24.49 14.96 Fourth Quarter................................ 22.33 17.55
Fiscal Year 2003 First Quarter................................. 21.30 14.50 Second Quarter................................ 18.54 14.00 Third Quarter................................. 17.43 13.06 Fourth Quarter................................ 18.56 14.50 Fiscal Year 2004 First Quarter (through October 17, 2003)...... 20.55 17.50
The closing price on October 17, 2003 was $18.29.
(b) As of October 17, 2003, there were approximately 222 holders of record of the Company's Common Stock. (c) There have been no cash dividends declared or paid by the Company on its Common Stock during the past two fiscal years.
Item 6.
Item 6. Selected Financial Data (in thousands except per share data):
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
The following table sets forth for the periods indicated certain financial information derived from the Company's consolidated statements of income expressed as a percentage of net sales. There can be no assurance that trends in sales growth or operating results will continue in the future.
Fiscal 2003 Compared to Fiscal 2002 -----------------------------------
Net sales from continuing operations for the 53 weeks ended August 3, 2003 were approximately $110,223,000 compared to $92,881,000 for fiscal 2002. The net sales increase of $17,342,000 (18.7%) is attributable to increased revenue in defense electronics of $23,131,000 (including $11,212,000 through the acquisition of EWST); offset by a decrease of $5,789,000 in commercial technologies.
Gross profit of 33.6% for the 53 weeks ended August 3, 2003 is slightly better than the prior year of 33.3%. The Company benefitted from increased absorption of fixed overhead costs and production efficiencies, including automation of certain processes. Offsetting these benefits was the increased investment in product development up from approximately $2.3 million in fiscal 2002 to $3.1 million in fiscal 2003. In addition, the margins on the EWST sales were lower than the Company's historical margins.
Selling and administrative expenses for the 53 weeks ended August 3, 2003 were 14.7% of net sales as compared to 14.3% in fiscal 2002. There was a net increase in expenses of $2,958,000 which includes expenses of EWST of $1,096,000, an increase in incentive compensation under employment contracts of $1,072,000, amortization of acquired intangibles of $217,000 related to EWST, increased audit and tax fees of $134,000, payroll costs of $322,000, and travel expenses of $121,000; offset by a decrease in commissions and fees of $174,000. Various other line item expenses increased during the 53 weeks ended August 3, 2003 by $170,000 on a net basis.
Litigation costs in fiscal 2003 decreased $932,000 from the level of fees incurred in fiscal 2002. The litigation costs are directly related to the Robinson Labs litigation which is currently in the appeals process. (See Item 3. "Legal Proceedings").
Plant closing costs in connection with the facilities in Nashua, NH and Anaheim, CA were accrued in October 2001 in the amount of $406,000 of which $389,000 was paid as of August 3, 2003.
Other income increased on a net basis approximately $383,000 from the prior year primarily due to interest earned on the investment of cash reserves including the proceeds of approximately $64,812,000 received from the sale of common stock to the public at the end of April 2002.
The effective income tax rate for fiscal 2003 was 31.8% as compared to 31.2% in fiscal 2002. The overall effective tax rate is lower than the statutory income tax rate of 34% due to various favorable tax benefits including a lower effective tax rate on foreign-source income and the tax benefit attributable to extra territorial income.
Fiscal 2002 Compared to Fiscal 2001 -----------------------------------
Net sales from continuing operations for the 52 weeks ended July 28, 2002 were approximately $92,881,000 compared to $76,494,000 for fiscal 2001. The net sales increase of $16,387,000 (21.4%) is attributable to increased revenue in defense electronics of $18,638,000; offset by a decrease of $2,251,000 in commercial technologies.
Gross profit of 33.3% for the 52 weeks ended July 28, 2002 is less than the prior year of 33.7%. The decline in margin is due primarily to lower margins on certain Robinson Labs contracts that were transferred to other facilities, and the investment in new product development related to commercial applications. The significant increase in net sales in defense electronics cushioned the decline in gross profit.
Selling and administrative expenses for the 52 weeks ended July 28, 2002 were $13,229,000 compared to $14,545,000 for fiscal 2001, a net decrease of $1,316,000. In connection with the adoption of SFAS 142 as of July 30, 2001, the Company ceased amortization of goodwill (See Note A.8.). Selling and administrative expenses in fiscal 2001 included goodwill amortization of $916,000. Cost savings associated with the relocation of the AMT facility amounted to approximately $605,000. Other significant changes include an
increase in incentive compensation of $363,000 and a reduction in payroll and related costs of $198,000.
Legal costs in fiscal 2002 increased $1,814,000 over fiscal 2001, directly related to the Robinson Labs litigation. (See Item 3. "Legal Proceedings").
Plant closing costs in connection with the facilities in Nashua, NH and Anaheim, CA were accrued in October 2001 in the amount of $406,000 of which $348,000 was paid as of July 28, 2002.
Other income increased approximately $39,000 from the prior year primarily from the investment of proceeds of approximately $64,812,000 from the sale of common stock to the public on April 30, 2002, partially offset by lower interest rates. Interest expense increased $100,000 as compared to fiscal 2001 due to the $3,000,000 financing of the expansion of the Lancaster facility through industrial revenue bonds and interest on temporary borrowings of $4,300,000 under the bank line of credit.
The effective income tax rate decreased to 31.2% in fiscal 2002 from 33.8% in 2001 due to various favorable tax benefits including a lower effective tax rate on foreign-source income and recognition in the fourth quarter of the tax benefit attributable to extra territorial income.
Discontinued operations
The Company entered into an agreement effective as of the close of business September 30, 2000, to acquire all of the issued and outstanding common stock of Terrasat, Inc. ("Terrasat"), a California corporation for cash in the amount of $6,000,000, $3,000,000 of which was paid in December 2000 and $3,000,000 of which was paid in December 2001. In addition, the agreement provided for additional cash payments in the future up to $2,000,000, based on gross revenues through December 31, 2001. The targeted gross revenues under the agreement were not achieved, therefore no additional cash payments were required.
In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment of long-lived assets and for long- lived assets to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of, but retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The provisions of this statement were adopted by the Company effective on July 30, 2001.
In January 2002 the Board of Directors of the Company decided to discontinue the operations of Terrasat and to seek a buyer for the business. The Company believed that Terrasat would not be able to generate sufficient returns to justify continued investment due to the overcapacity in the telecom industry and deteriorating economic conditions in Terrasat's primary markets. Consequently, the accompanying consolidated financial statements reflect Terrasat as discontinued operations in accordance with SFAS No. 144. The assets and liabilities of Terrasat at July 29, 2001 have been classified in the accompanying balance sheet as "Assets held for sale," and "Liabilities held for sale." Results of operations and cash flows of Terrasat have been classified as "Loss from discontinued operations," and "Net cash provided by (used in) discontinued operations," respectively.
The sale of certain assets and liabilities, and the business of Terrasat was consummated on March 1, 2002, effective the close of business January 27, 2002, to certain current employees of Terrasat for cash and a note which approximates the carrying value of the net assets held for sale as of January 27, 2002 of $878,000.
Change in accounting principle
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 142 "Goodwill and Other Intangible Assets" which requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill will not be amortized into results of operations, but instead will be reviewed for impairments which will be charged to results of operations in the periods in which the recorded value of goodwill is more than its fair value. The provisions of this statement were adopted by the Company on July 30, 2001. The adoption of SFAS No.142 resulted in the Company's discontinuation of amortization of its goodwill as of July 30, 2001.
In connection with the adoption of SFAS 142, the Company was required to assess goodwill for impairment within six months of adoption, and completed its assessment in the second quarter of fiscal 2002.
The Company operates as a single integrated business and as such has one operating segment which is also the reportable segment as defined in SFAS 131. Within the operating segment, the Company has identified two components as reporting units as defined under SFAS 142, defense electronics and commercial technologies. The Company has determined the carrying value of each reporting unit by assigning assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of July 30, 2001. The Company has determined that an impairment of goodwill in the commercial technologies unit has occurred. Accordingly, a transition adjustment in the amount of $4,637,000 has been recorded as of July 30, 2001 as a cumulative effect of a change in accounting principle. There is no tax benefit associated with the adjustment since the impaired goodwill is not deductible for income tax purposes.
An impairment test was performed in the fourth quarter of fiscal 2003 based on the current market capitalization of the Company. There was no impairment of goodwill at August 3, 2003. An annual impairment test will be performed in the fourth quarter of each fiscal year and any future impairment of goodwill will be charged to operations.
Amortization of goodwill charged to continuing operations for the fiscal year ended July 29, 2001 was approximately $1,296,000. Amortization of goodwill charged to discontinued operations for the fiscal year ended July 29, 2001 was approximately $208,000.
Quarterly Results
The following is a summary of the unaudited quarterly operations for the 53 weeks ended August 3, 2003 and for the 52 weeks ended July 28, 2002 (in thousands, except for per share data).
The gross profit margin from quarter to quarter is affected by the change in product mix. Income from continuing operations in the fourth quarter of fiscal 2002 was favorably affected by the lower effective income tax rate due to the recognition of the tax benefit attributable to extra territorial income, which was offset by litigation costs (See Item. 3 "Legal Proceedings").
Liquidity and Capital Resources
As of August 3, 2003 and July 28, 2002, working capital was $128,323,000 and $129,012,000, respectively, and the ratio of current assets to current liabilities was 7.8 to 1 and 9.5 to 1, respectively.
As is customary in the defense industry, inventory is partially financed by progress payments. In addition, it is customary for the Company to receive advanced payments from customers on major contracts at the time a contract is entered into. The unliquidated balance of these advanced payments was approximately $856,000 at August 3, 2003, and $1,371,000 at July 28, 2002.
Net cash provided by continuing operations was approximately $14,567,000 in fiscal 2003 as compared to $13,139,000 in 2002. Significant items contributing to the sources of funds include income from operations of $18,239,000 (adjusted for depreciation and amortization), a net increase in deferred taxes of $816,000, and an increase in income taxes of $3,627,000. Offsetting these sources of funds are increases in accounts receivable of $2,039,000, costs incurred and income recognized in excess of billings on uncompleted contracts of $1,258,000, and an increase in inventory of $3,846,000.
Net cash used in investing activities consists of $3,876,000 for capital expenditures, and $2,542,000 for the acquisition of EWST. The Company has a note payable of $1,500,000, including interest at 1.8%, in connection with the acquisition of EWST payable in annual installments of $500,000 beginning October 1, 2003.
During the fiscal year ended August 3, 2003, the Company received approximately $1,994,000 from the exercise of common stock options by employees.
On May 30, 2003 the Company announced an expansion of the stock repurchase program initially announced in October 2002 from 1,000,000 to an aggregate of 2,000,000 shares. As of August 3, 2003, the Company acquired approximately 940,000 shares of common stock under this program at an aggregate cost of approximately $14,668,000.
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 FOMC Federal Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum of $45,000,000 with interest based on LIBOR plus a margin of 1.35% to 1.65%. The applicable incremental margin is based on the ratio of total liabilities to tangible net worth, as those terms are defined in the agreement, ranging from less than .40 to 1.0, to greater than 1.0 to 1.0. The FOMC Federal Funds Target Rate and the LIBOR rate was 1.00% and 1.10%, respectively, at August 3, 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 August 3, 2003 and July 28, 2002. During the fiscal year ended July 28, 2002, the Company borrowed and repaid $4,300,000 under the credit facility for working capital needs. There were no borrowings during fiscal year 2003. Stand-by letters of credit were outstanding in the amount of $12,454,000 under the credit facility at August 3, 2003.
The Company believes that presently anticipated future cash requirements will be provided by internally generated funds, its existing unsecured credit facility, and the approximately $64,812,000 net proceeds from the sale of 3,000,000 shares of common stock to the public on April 30, 2002 (See Note M of the financial statements). A significant portion of the Company's revenue for fiscal 2004 will be generated from its existing backlog of sales orders. The backlog of orders at August 3, 2003 was approximately $89,949,000. 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 $37,546,000 available under its bank credit facility, net of outstanding stand-by letters of credit of $12,454,000, and cash reserves at August 3, 2003 of approximately $81,811,000.
Future payments required on long-term debt are as follows (in thousands):
During Industrial fiscal Mortgage revenue EWST year Total note bonds note Other ---- ----- ---- ----- ---- ----- 2004 $ 686 $ 86 $ 100 $ 500 $ - 2005 698 93 105 500 - 2006 711 101 110 500 - 2007 223 108 115 - - 2008 236 116 120 - - Future 4,535 2,106 2,355 - 74 ----- ----- ----- ----- -- $ 7,089 $ 2,610 $ 2,905 $ 1,500 $ 74 ===== ===== ===== ===== ==
Stand-by letters of credit expire as follows:
During fiscal year Amount ---- ------ 2004 $ 7,365 2005 211 2006 1,930 2007 2,948 ------ $ 12,454 ======
Minimum annual rentals under noncancellable operating leases are as follows (in thousands):
During fiscal year Amount ---- ------ 2004 $ 1,121 2005 1,033 2006 978 2007 957 2008 932 Future 1,143
Critical Accounting Policies and Estimates
The Company's established policies are outlined in the footnotes to the Consolidated Financial Statements entitled "Summary of Significant Accounting Policies" (contained in Part II, Item 8 of this Form 10-K). As part of its oversight responsibilities, management continually evaluates the propriety of its accounting methods as new events occur. Management believes that its policies are applied in a manner which is intended to provide the user of the Company's financial statements a current, accurate and complete presentation of information in accordance with Generally Accepted Accounting Principles in the United States of America. Important accounting practices that require the use of assumptions and judgments are outlined below.
Revenue under certain long-term, fixed price contracts is recognized using the percentage of completion method of accounting. Revenue recognized on these contracts is based on estimated completion to date (the total contract amount multiplied by percent of performance, based on total costs incurred in relation to total estimated cost at completion). Contract costs include all direct material and labor costs and those indirect costs related
to contract performance. Risks and uncertainties inherent in the estimation process could affect the amounts reported in our financial statements. The key assumptions used in the estimate of costs to complete relate to labor costs and indirect costs required to complete the contract. The estimate of rates and hours as well as the application of overhead costs is reviewed on a regular basis. If our business conditions were different, or if we used different assumptions in the application of this and other accounting policies, it is likely that materially different amounts would be reported on our financial statements.
Prospective losses on contracts are based upon the anticipated excess of manufacturing costs over the selling price of the units to be delivered under the contract and are recorded when first reasonably determinable. Actual losses could differ from those estimated due to changes in the ultimate manufacturing costs.
Inventories are stated at lower of cost (principally first-in, first-out) or market. A valuation allowance for obsolete and slow-moving inventory is established based upon an aging of raw material components. Current requirements for raw materials are evaluated based on current backlog of orders for products in which the components are used and anticipated future orders.
Under the non-amortization approach in accounting for goodwill under SFAS No. 142, goodwill is not amortized into results of operations but instead is reviewed for impairment and written down and charged to results of operations in the period in which the recorded value of goodwill is more than its fair value. An annual impairment test is performed in the fourth quarter of each fiscal year and any impairment of goodwill is charged to operations.
Provisions for federal, foreign, state and local income taxes are calculated on reported financial statement pretax income based on current tax law and also include the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows of the Company.
In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment of long-lived assets and for long- lived assets to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of, but retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The provisions of this statement were adopted by the Company effective on July 30, 2001.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement is effective for fiscal years beginning after May 15, 2002. SFAS 145 requires, among other things, eliminating reporting debt extinguishments as an extraordinary item in the income statement. Management adopted this standard on July 29, 2002 and has
determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows 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. Management does not believe the adoption of this standard will have a material impact on the Company's financial position or results of operations.
In 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. The Company is currently evaluating the provisions of this interpretation; however, it does not believe they will have a material effect on the Company's future 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, and the addition of a significant accounting policies note included in this Annual Report Form 10K for the year ended August 3, 2003 (See Note A.14).
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. The Company is in the process of assessing the impact of adopting this Interpretation; however, it does not believe it will have a material effect on its financial position or future 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.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is subject to market risk associated with changes in interest rates, and foreign currency exchange. The Company has not entered into any market risk sensitive instruments for trading purposes.
In October 2001, the Company entered into an interest rate swap with a bank pursuant to which it exchanged floating rate interest in connection with the Bonds discussed in Note H of the financial statements on a notional amount of $3,000,000 for a fixed rate of 4.07% for a 10 year period ending October 1, 2011. The notional amount reduces each year in tandem with the annual installments due on the Bonds. The fixing of the interest rate for this period offsets the Company's exposure to the uncertainty of floating interest rates on the Bonds, and as such has been designated as a cash flow hedge. The hedge is deemed to be highly effective and any ineffectiveness will be recognized in interest expense in the reporting period. The fair value of the interest rate swap was a liability of approximately $74,000 as of August 3, 2003. There was no material hedge ineffectiveness related to cash flow hedges during the fiscal years presented to be recognized in earnings. There was no gain or loss reclassified from accumulated other comprehensive income into earnings during the fiscal year ended August 3, 2003 as a result of the discontinuance of a cash flow hedge due to the probability of the original forecasted transaction not occurring.
The Company also has a $50,000,000 Revolving Credit Loan Syndication agreement with two banks on an unsecured basis which may be used for general corporate purposes, including business acquisitions. The revolving credit facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on January 31, 2005. The Company may elect to borrow up to a maximum of $5,000,000 with interest based on the FOMC Federal Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum of $45,000,000 with interest based on LIBOR plus a margin of 1.35% to 1.65%. The applicable incremental margin is based on the ratio of total liabilities to tangible net worth, as those terms are defined in the agreement, ranging from less than .40 to 1.0, to greater than 1.0 to 1.0. The FOMC Federal Funds Target Rate and the LIBOR rate was 1.00% and 1.10%, respectively, at August 3, 2003. The credit line is reviewed on an annual basis.
Since the acquisitions of GMC and EWST, the Company is subject to movements in foreign currency rate changes related to the Company's operations in Israel and in England.
The Company does not anticipate any other material changes in its primary market risk exposures in fiscal 2004.
The table below provides information about the Company's debt that is sensitive to changes in interest rates. Future principal payment cash flows by maturity date as required under the mortgage and the industrial revenue bonds, and corresponding fair values are as follows:
Fiscal year ending: Bonds ------------------ ----- 2004 $ 100 2005 105 2006 110 2007 115 2008 120 2009 and later 2,355 ----- $2,905 ===== Fair value $2,905 =====
The Company does not consider the market risk exposure relating to foreign currency exchange or interest rates to be material.
There were no borrowings outstanding under the revolving credit facility as of August 3, 2003.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data listed in the Index on Page are filed as a part of this report.
Item 9.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
Not applicable
Item 9A.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits 3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1 Registration Statement No. 2- 87160). 3.2 By-Laws, as amended August 7, 2001 (Exhibit 3.2 of Annual Report on Form 10-K for the fiscal year ended July 29, 2001). 10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the fiscal year ended July 28, 1996). 10.2 1997 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 10, 1997). 10.3 1998 Stock Option Plan (Exhibit 10.3 of Annual Report on Form 10-K for the fiscal year ended August 1, 1999). 10.4 2000 Stock Option Plan (Exhibit 4.1 of Report on Form S-8 dated October 12, 2001). 10.5 2003 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 11, 2003). 10.6 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated as of July 29, 2002. (Exhibit 10.5 of Annual Report on Form 10-K for the fiscal year ended July 28, 2002). 10.7 Employment Agreement between Herley Industries, Inc. and Myron Levy dated as of July 29, 2002. (Exhibit 10.6 of Annual Report on Form 10-K for the fiscal year ended July 28, 2002). 10.8 Agreement and Plan of Reorganization dated as of July 8, 1997 among the Company, Metraplex Acquisition Corporation and Metraplex Corporation (Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997). 10.9 Agreement and Plan of Merger dated as of August 21, 1998 among General Microwave Corp., Eleven General Microwave Corp., Shareholders, GMC Acquisition Corporation and Registrant (Exhibit 1 of Schedule 13D dated August 28, 1998). 10.10 Lease Agreement dated September 1, 1999 between Registrant and RSK Realty LTD. (Exhibit 10.8 of Annual Report on Form 10-K for the fiscal year ended August 1, 1999). 10.11 Loan Agreement dated June 19, 2002 among the Registrant, Allfirst Bank and Fulton Bank. (Exhibit 10.10 of Annual Report on Form 10-K for the fiscal year ended July 28, 2002). 10.12 Amendment (dated May 2, 2003) to Loan Agreement dated June 19, 2002 among the Registrant, Manufacturers and Traders Trust Company, successor in interest to Allfirst Bank, and Fulton Bank. 10.13 Asset Purchase Agreement dated as of February 1, 2000 between Registrant and Robinson Laboratories, Inc. (Exhibit 10.2 of Form 10-Q dated March 13, 2000). 10.14 Asset Purchase Agreement dated as of October 12, 2000 between Registrant and American Microwave Technology Inc. (Exhibit 10.1 of Form 10-Q dated December 12, 2000). 10.15 Common Stock Purchase Agreement dated as of December 4, 2000 between Registrant and Terrasat, Inc. (Exhibit 10.2 of Form 10-Q dated December 12, 2000). 10.16 Lease Agreement dated March 1, 2000 between Registrant and RSK Realty LTD (Exhibit 10.13 of Annual Report on Form 10-K for the fiscal year ended July 30, 2000). 10.17 Common Stock Purchase Agreement dated as of September 20, 2002 between Registrant and EW Simulation Technology, Limited. (Exhibit 10.17 of Annual Report on Form 10-K for the fiscal year ended July 28, 2002). 10.18 Trust Indenture dated as of October 19, 2001 between Registrant, and East Hempfield Township Industrial Development Authority and Allfirst Bank, as Trustee. (Exhibit 10.18 of Annual Report on Form 10-K for the fiscal year ended July 28, 2002). 23.1 Consent of Deloitte & Touche LLP. 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) Financial Statements
(1) See Index to Consolidated Financial Statements at Page.
(2) Schedule II - Valuation and Qualifying Accounts filed as part of this Form 10-K at page 29.
(c) Reports on Form 8-K
During the fourth quarter of fiscal 2003, the Registrant filed the following report under Form 8-K:
The Company filed a report on June 9, 2003 in connection with the release of its financial results for the third quarter and nine months ended May 4, 2003.
SIGNATURES:
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on October 31, 2003.
HERLEY INDUSTRIES, INC.
By: /S/ Lee N. Blatt ----------------------------------- Lee N. Blatt, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on October 31, 2003 by the following persons in the capacities indicated:
By: /S/ Lee N. Blatt Chairman of the Board ----------------------------------------- Lee N. Blatt
By: /S/ Myron Levy Vice Chairman of the Board ----------------------------------------- Chief Executive Officer and Myron Levy Director (Principal Executive Officer)
By: /S/ Anello C. Garefino Vice President Finance, ----------------------------------------- CFO, Treasurer Anello C. Garefino (Principal Financial Officer)
By: /S/ David H. Lieberman Secretary and Director ----------------------------------------- David H. Lieberman
By: /S/ Edward K. Walker, Jr. Director ----------------------------------------- Edward K. Walker, Jr.
By: /S/ John A. Thonet Director ----------------------------------------- John A. Thonet
By: /S/ Robert M. Moore Director ----------------------------------------- Robert M. Moore
By: /S/ Edward A. Bogucz Director ----------------------------------------- Edward A. Bogucz
All other Schedules have been omitted since they are either not required, not applicable, or the information is otherwise included in this Annual Report on Form 10-K.
Item 8. Financial Statements and Supplementary Data
HERLEY INDUSTRIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ----
INDEPENDENT AUDITORS' REPORT
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
FINANCIAL STATEMENTS:
Consolidated Balance Sheets, August 3, 2003 and July 28, 2002
Consolidated Statements of Income for the 53 weeks ended August 3, 2003, and the 52 weeks ended July 28, 2002 and July 29, 2001
Consolidated Statements of Shareholders' Equity for the 53 weeks ended August 3, 2003, and the 52 weeks ended July 28, 2002 and July 29, 2001
Consolidated Statements of Cash Flows for the 53 weeks ended August 3, 2003, and the 52 weeks ended July 28, 2002 and July 29, 2001
Notes to Consolidated Financial Statements
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley Industries, Inc. and Subsidiaries ("the Company") as of August 3, 2003 and July 28, 2002, and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. Our audit also included the financial statement schedule listed in the Index at Item 15 as it relates to the years ended August 3, 2003 and July 28, 2002. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. The financial statements of the Company for the year ended July 29, 2001 were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated October 3, 2001, except with respect to disclosures regarding discontinued operations, now included in Note Q to the financial statements, as to which their report was dated March 1, 2002.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 3, 2003 and July 28, 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule as it relates to the years ended August 3, 2003 and July 28, 2002, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note A to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill by adopting Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
/s/ DELOITTE & TOUCHE LLP
October 24, 2003 Baltimore, Maryland
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley Industries, Inc and Subsidiaries as of July 30, 2000 and July 29, 2001, and the related consolidated statements of income, shareholders' equity and cash flows for the 52 weeks ended August 1, 1999, July 30, 2000 and July 29, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Herley Industries, Inc. and Subsidiaries as of July 30, 2000 and July 29, 2001, and the consolidated results of their operations and their cash flows for the 52 weeks ended August 1, 1999, July 30, 2000 and July 29, 2001 in conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Lancaster, PA
October 3, 2001 (except with respect to the matters discussed in Note P, as to which the date is March 1, 2002.)
NOTE - This report represents a copy of the predecessor auditor's report included in the Company's Form S-3 dated April 4, 2002 and does not represent a reissuance of the report. Note P, as identified in the auditor's report, represents the Company's previous disclosure regarding discontinued operations which is included in Note Q of the current notes to the consolidated financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Nature of Operations
The Company, a Delaware corporation, is engaged in research, engineering, product development, and manufacturing of complex microwave radio frequency (RF) and millimeter wave components and subsystems for defense and commercial customers worldwide.
2. Fiscal Year
The Company's fiscal year ends on the Sunday closest to July 31. Normally each fiscal year consists of 52 weeks, but every five or six years the fiscal year will consist of 53 weeks. Fiscal year 2003 consisted of 53 weeks and all other fiscal years presented consisted of 52 weeks.
3. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant inter-company accounts and transactions have been eliminated in consolidation. The presentation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates.
4. Cash and Cash Equivalents
The Company considers all liquid investments with an original maturity of three months or less at the date of acquisition to be cash equivalents. Short-term investments are recorded at the amortized cost plus accrued interest which approximates market value. The Company limits its credit risk to an acceptable level by evaluating the financial strength of institutions at which significant investments are made and based upon credit ratings.
5. Concentration of Credit Risk
Financial instruments which potentially subject the Company to credit risk consist primarily of trade accounts receivable. Accounts receivable are principally from the U.S. Government, major U.S. Government contractors, several foreign governments, and domestic customers in the defense, aerospace, and medical industries. Credit is extended based on an evaluation of the customer's financial condition and generally collateral is not required. In many cases irrevocable letters of credit accompanied by advanced payments are received from foreign customers, and progress payments are received from domestic customers. The Company performs periodic credit evaluations of its customers and maintains reserves for potential credit losses.
6. Inventories
Inventories, other than inventory costs relating to long-term contracts and programs, are stated at lower of cost (principally first-in, first-out) or market. Inventory costs relating to long-term contracts and programs are stated at the actual production costs, including factory overhead, reduced by amounts identified with revenue recognized on units delivered or progress completed.
Inventory costs relating to long-term contracts and programs are reduced by any amounts in excess of estimated realizable value.
7. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets. Gains and losses arising from the sale or disposition of property, plant and equipment are included in income from operations.
8. Goodwill and Other Intangible Assets
The Company adopted the provisions of SFAS No. 142 "Goodwill and Other Intangible Assets" on July 30, 2001. SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed for impairment and written down and charged to results of operations in the periods in which the recorded value of goodwill and certain intangibles is more than its fair value. The adoption of SFAS No.142 resulted in the Company's discontinuation of amortization of its goodwill and certain intangible assets. The Company was required to assess its goodwill for impairment under the new standard within six months of adoption and completed its assessment in the second quarter of fiscal 2002. The Company operates as a single integrated business and as such has one operating segment which is also the reportable segment as defined in SFAS 131. Within the operating segment, the Company has identified two components as reporting units as defined under SFAS 142, defense electronics and commercial technologies. The Company determined the carrying value of each reporting unit by assigning assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of July 30, 2001. The Company determined that an impairment of goodwill in the commercial technologies unit had occurred due to the overcapacity in the telecom industry and deteriorating economic conditions. Accordingly, a transition adjustment in the amount of $4,637,000 was recorded as of July 30, 2001 as a cumulative effect of a change in accounting principle. There is no tax benefit associated with the adjustment since the impaired goodwill is not deductible for income tax purposes.
The change in the carrying amount of goodwill, based upon the fair value of assets acquired and liabilities assumed related to the acquisition of EWST (See Note B), for the year ended August 3, 2003 is as follows (in thousands):
Balance at July 28, 2002 $ 21,665 Goodwill acquired during period 4,064 ------ Balance at August 3, 2003 $ 25,729 ======
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 impairment in goodwill at August 3, 2003 based on current market capitalization of the Company.
Amortization of goodwill charged to continuing operations for the fifty-two weeks ended July 29, 2001 was approximately $1,296,000. Amortization of goodwill charged to discontinued operations for the fifty-two weeks ended July 29, 2001 was approximately $208,000. Pro forma income from continuing operations and net income and earnings per share in connection with the adoption of SFAS 142 is as follows (in thousands except per share data):
Intangibles consist of the following (in thousands):
August 3, July 28, Estimated 2003 2002 useful life ---- ---- -----------
Technology (1) $ 1,021 $ - 15 years Backlog (1) 325 - 2 years Non-compete (1) 31 - 5 years Patents 568 568 14 years ----- --- 1,945 568 Accumulated amortization 403 145 ----- --- $ 1,542 $ 423 ===== === - --------- (1) Related to the acquisition of EWST (See Note B.)
Amortization expense for the fifty-three and fifty-two weeks ended August 3, 2003 and July 28, 2002, was approximately $258,000 and $41,000, 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.
9. Marketable Securities
The Company accounts for its investments in marketable securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to- maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair market value with net unrealized holding gains or losses, net of income taxes, reported as a separate component of other comprehensive loss. Realized gains and losses and declines in value judged to be other-than-temporary are included in other income, net. The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in other income, net.
10. Other Investments
The Company is a limited partner in a nonmarketable limited partnership in which it owns approximately a 10% interest. The investment is accounted for under the equity method (See Note D.)
11. Revenue and Cost Recognition
Substantially all of our customer contracts are firm, fixed price contracts, providing for a predetermined fixed price for the products that we sell, regardless of the costs we incur. Under fixed-price contracts, revenue and related costs are recorded primarily as deliveries are made. Certain costs under long-term, fixed-price contracts (principally either directly or indirectly with the U.S. Government), which include non- recurring billable engineering, are deferred until these costs are contractually billable. Revenue under
certain long-term, fixed price contracts is recognized using the percentage of completion method of accounting. Revenue recognized on these contracts is based on estimated completion to date (the total contract amount multiplied by percent of performance, based on total costs incurred in relation to total estimated cost at completion). Prospective losses on long-term contracts are based upon the anticipated excess of inventoriable manufacturing costs over the selling price of the remaining units to be delivered and are recorded in the period when first determinable. Actual losses could differ from those estimated due to changes in the ultimate manufacturing costs and contract terms.
Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Selling, general and administrative costs are charged to expense as incurred.
12. Product Development
The Company's primary efforts are focused on engineering design and product development activities rather than pure research. The cost of these development activities, including employees' time and prototype development, net of amounts paid by customers, was approximately $3,083,000, $2,269,000, and $2,588,000 in fiscal 2003, 2002, and 2001, respectively, and are included in cost of products sold.
13. Income Taxes
Income taxes are accounted for by the asset/liability approach in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from temporary differences between the financial reporting and tax bases of assets and liabilities and are adjusted for changes in tax laws and tax rates when those changes are enacted. The provision for income taxes represents the total of income taxes paid or payable for the current year, plus the change in deferred taxes during the year.
14. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
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 that the pro-forma disclosures of the impact on earnings and earnings- per-share for companies continuing to rely on APB No. 25 be provided in a tabular format and included in the Summary of Significant Accounting Policies or equivalent as if the provisions of SFAS No. 123 had been adopted.
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, and the addition of the following information in the significant accounting policies note for the year ended August 3, 2003.
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" ("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:
53 weeks Fifty-two weeks ended ended --------------------- August 3, July 28, July 29, 2003 2002 2001 ---- ---- ---- Expected life of options 1.51 years 1.51 years .73 years Volatility .68 .68 .70 Risk-free interest rate 2.8% 2.8% 3.4% Dividend yield zero zero zero
Had compensation cost for stock options granted in fiscal years 2003, 2002, and 2001 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):
2003 2002 2001 ---- ---- ---- Net income - as reported $13,937 $5,172 $7,405 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (1,926) (4,425) (1,610) ------ ----- ----- Net income - pro forma $12,011 $ 747 $5,795 ====== ===== =====
Earnings per share - as reported Basic $.97 $.43 $.73 Diluted .93 .40 .68 Earnings per share - pro forma Basic $.84 $.06 $.57 Diluted .80 .06 .53
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.
15. Foreign Currency Translation
Financial statements of foreign subsidiaries are prepared in their respective functional currencies and translated into United States dollars at the current exchange rates for assets and liabilities and a monthly average rate during the year for revenues, costs and expenses. Net gains or losses resulting from the translation of foreign financial statements are charged or credited directly to the 'Foreign currency translation' component of 'Accumulated other comprehensive loss' in the accompanying consolidated statements of shareholders' equity.
16. Derivatives
The Company recognizes all derivatives on the balance sheet at fair value. On the date the derivative instrument is entered into, the Company generally designates the derivative as either (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment ("fair value hedge") or (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow hedge"). The Company entered into an interest rate swap in October 2001 with a bank, which it recognized as a cash flow hedge. Changes in the fair value of a derivative that is designated as, and meets all the required criteria for, a cash flow hedge are recorded in accumulated other comprehensive income (loss) and reclassified into earnings as the underlying hedged item affects earnings.
17. New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long- lived assets and the associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows of the Company.
In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long- lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of, but retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The provisions of this statement were adopted by the Company effective on July 30, 2001.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement is effective for fiscal years beginning after May 15, 2002. SFAS 145 requires, among other things, eliminating reporting debt extinguishments as an extraordinary item in the income statement. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows 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. Management does not believe the adoption of this standard will have a material impact on the Company's financial position or results of operations.
In 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. The Company is currently evaluating the provisions of this interpretation; however, it does not believe they will have a material effect on the Company's future 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 and the addition of the following information in the significant accounting policies note for the year ended August 3, 2003.
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. The Company is in the process of assessing the impact of adopting this Interpretation; however, it does not believe it will have a material effect on its financial position or future 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.
NOTE B - ACQUISITIONS
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. This strategy is expected to expand international revenues from new sources and increase content to existing customers. 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, payable in annual installments of $500,000. 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. The Company engaged an independent third party to complete a valuation of the intangible assets of EWST as of the acquisition date.
The allocation of the aggregate purchase price, based on a detailed review of the fair value of assets acquired and liabilities assumed, including the fair value appraisal of identified intangible assets is as follows:
Aggregate purchase price $4,658 =====
Current assets $1,407 Furniture and equipment 251 Technology 1,021 Backlog 325 Non-compete 31 Goodwill 4,064 Current liabilities (2,441)
The Company entered into an agreement as of September 1, 2000 to acquire certain assets and the business, subject to the assumption of certain liabilities, of American Microwave Technology, Inc., ("AMT"), a California corporation, which operates as a division of Herley Industries, Inc. The transaction provided for the payment of $5,400,000 in cash, and the assumption of approximately $1,153,000 in liabilities. In addition, the Company entered into an exclusive license agreement for certain products providing for a royalty of 10% on the net shipments of such products through October 2004. The transaction has been accounted for under the purchase method.
The Company entered into an agreement, as of January 3, 2000, to acquire substantially all of the assets of Robinson Laboratories, Inc. ("Robinson" or "Robinson Labs"), a New Hampshire corporation, which
operates as a division of Herley Industries, Inc. The transaction provided for the payment of $6,000,000 in cash, the issuance of 50,762 (as adjusted) shares of Common Stock of the Company valued at $10.125 per share, and the assumption of approximately $3,140,000 in liabilities. In addition, the agreement provided for the issuance of additional shares of Common Stock up to a maximum of 146,761 shares (as adjusted) based on new orders booked through January 2001. The Company determined that new orders booked through January 2001 did not meet the earn out provisions of the Asset Purchase Agreement (See Note F "Litigation"). The transaction has been accounted for under the purchase method.
NOTE C - INVENTORIES
The major components of inventories are as follows (in thousands):
August 3, July 28, 2003 2002 ---- ---- Purchased parts and raw materials $19,690 $ 18,680 Work in process 18,646 15,707 Finished products 1,948 1,391 ------- ------- 40,284 35,778 Less reserve 2,739 2,407 ------- ------- $ 37,545 $ 33,371 ====== ======
NOTE D - OTHER INVESTMENTS
In July 1994, the Company invested $1,000,000 for a limited partnership interest in M.D. Sass Municipal Finance Partners-I, a Delaware limited partnership. The objectives of the partnership are the preservation and protection of its capital and the earning of income through the purchase of certificates or other documentation that evidence liens for unpaid local taxes on parcels of real property. At August 3, 2003 and July 28, 2002 the percentage of ownership was approximately 10%. The Company's interest in the partnership may be transferred to a substitute limited partner, upon written notice to the managing general partners, only with the unanimous consent of both general partners at their sole discretion. The Company received partial distributions of approximately $49,000 and $626,000 from the Partnership in fiscal 2003 and 2002, respectively. As of August 3, 2003 the Company's limited partnership interest had a carrying value of $162,000, based on the equity method of accounting.
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following (in thousands):
August 3, July 28, Estimated 2003 2002 Useful Life ---- ---- ----------- Land $ 2,908 $ 2,908 Building and building improvements 9,291 9,857 10-40 years Machinery and equipment 37,802 33,698 5- 8 years Furniture and fixtures 1,186 1,058 5-10 years Automobiles - 91 3 years Tools - 25 5 years Leasehold improvements 1,385 1,589 5-10 years ------- ------ 52,572 49,226 Less accumulated depreciation 30,166 26,995 ------ ------ $ 22,406 $ 22,231 ====== ======
Depreciation charges totaled $3,944,000, $3,776,000, and $3,127,000 in fiscal 2003, 2002, and 2001, respectively.
NOTE F - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office, production and warehouse space as well as computer equipment and automobiles under noncancellable operating leases. Rent expense for the 53 weeks ended August 3, 2003, and the 52 weeks ended July 28, 2002 and July 29, 2001, was approximately $1,393,000, $1,244,000, and $1,506,000, respectively. Minimum annual rentals under noncancellable operating leases are as follows (in thousands):
Amount ------ Year ending fiscal 2004 $ 1,121 2005 1,033 2006 978 2007 957 2008 932 Future 1,143
Employment Agreements
The Company has employment agreements with certain executives of the Company which expire December 31, 2008, subject to extension for additional one-year periods annually each January 1 with a final expiration date of December 31, 2010. The agreements provide for aggregate annual salaries as of August 3, 2003 of $1,364,000 and provide for a semi-annual cost of living adjustment based on the consumer price index. The agreements also provide for incentive compensation at 7% in the aggregate of pretax income of the Company. Incentive compensation in the amount of $1,571,000 and $956,000 was charged to expense in fiscal years 2003 and 2002, respectively. The executives waived their incentive compensation for fiscal 2001.
The agreements also provide that, in the event there is a change in control of the Company, as defined, the executives have the option to terminate the agreements and receive a lump-sum payment equal to the sum of the salary payable for the remainder of the employment term, plus the annual bonuses (based on the average of the three highest annual bonuses awarded during the ten preceding years) for the remainder of the employment term. As of August 3, 2003, the amount payable in the event of such termination would be approximately $13,729,000.
The agreements also provide for consulting periods, one for five and one for ten years, at the end of the employment period at an annual compensation equivalent to one-half of the executive's annual salary at the end of the employment period, subject to annual cost of living adjustments.
An employment contract of a retired executive provides for a consulting period which became effective October 1, 1998, and terminates December 31, 2010 at the annual rate of compensation of $100,000.
Six officers of the Company have severance agreements providing for an aggregate lump-sum payment of $2,070,000 through September 30, 2004 in the event of a change of control of the Company as defined in the agreements.
Litigation
On August 14, 2001, Robinson Laboratories, Inc. ("RLI") and Ben Robinson ("Robinson") filed an Amended Complaint against Herley Industries, Inc. ("Herley"). Although the Amended Complaint sets forth fifteen counts, the core allegations are (i) that Herley failed to issue 97,841 shares of common stock in connection with certain earn out requirements contained in an Asset Purchase Agreement dated February 1, 2000; (ii) that Herley breached an Employment Agreement with Robinson by terminating his employment
on August 5, 2001; and (iii) that Herley breached a Stock Option Agreement dated January 31, 2000, with Robinson. RLI and Robinson asserted (i) violations of state and federal securities laws; (ii) fraud claims; (iii) breach of contract claims; and (iv) other equitable claims arising from the above core factual allegations.
On September 17, 2001, Herley filed an Answer, Affirmative Defenses and Counterclaims in this matter. In the Answer and Affirmative Defenses, Herley denied the material allegations of the Amended Complaint. Herley also filed Counterclaims against both RLI and Robinson. In these counterclaims, Herley's core allegations concern Robinson's misconduct (i) in connection with the manner he attempted to satisfy RLI's 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 is now required to file a response to RLI's brief and thereafter RLI will file a response to Herley's brief. Oral argument has not yet been scheduled.
The Company is involved in various other legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations.
Stand-by Letters of Credit
The Company maintains a letter of credit facility with a bank that provides for the issuance of stand-by letters of credit and requires the payment of a fee of 1.0% per annum of the amounts outstanding under the facility. The facility expires January 31, 2005. At August 3, 2003 stand-by letters of credit aggregating approximately $12,454,000 were outstanding under this facility.
NOTE G - INCOME TAXES
Income tax expense consisted of the following (in thousands):
53 weeks Fifty-two weeks ended ended --------------------- August 3, July 28, July 29, 2003 2002 2001 ---- ---- ---- Current Federal $ 5,465 $ 5,333 $ 3,050 State 533 520 275 Foreign 379 204 202 ----- ----- ----- 6,377 6,057 3,527 ----- ----- ----- Deferred Federal (233) (1,090) 248 State (23) (106) 92 Foreign 378 15 - ----- ----- ----- 122 (1,181) 340 ----- ----- -----
$ 6,499 $ 4,876 $ 3,867 ===== ===== =====
The Company paid income taxes of approximately $4,164,000, $680,000, and $4,427,000 in fiscal 2003, 2002, and 2001, respectively. The following is a reconciliation of the U. S. statutory income tax rate and the effective tax rate on pretax income:
53 weeks Fifty-two weeks ended ended --------------------- August 3, July 28, July 29, 2003 2002 2001 ---- ---- ---- Statutory income tax rate 34.0 % 34.0 % 34.0 % State income taxes, net of federal income tax benefit 1.7 0.9 2.4 Benefit of foreign sales corporation - - (2.6) Benefit of extra territorial income (1.0) (2.4) - Non-deductible expenses 0.6 0.2 2.5 Benefit of foreign and foreign-source income (3.4) (1.4) (2.3) Other, net (0.1) (0.1) 0.4 ---- ---- ---- Effective tax rate 31.8 % 31.2 % 34.4 % ==== ==== ====
Income taxes have not been provided on undistributed earnings of foreign subsidiaries. If remitted as dividends, these earnings could become subject to additional tax. The Company's intention is to reinvest non-remitted earnings of subsidiaries outside the United States permanently.
The tax effects of significant items comprising deferred income taxes are as follows (in thousands):
August 3, 2003 July 28, 2002 ------------------- ------------------- Deferred Deferred Deferred Deferred Tax Tax Tax Tax Assets Liabilities Assets Liabilities
Intangibles $ - $ 2,298 $ - $ 1,738 Accrued vacation pay 260 - 386 - Accrued bonus 516 - 53 - Warranty costs 88 - 136 - Inventory 1,125 - 1,101 - Depreciation - 2,647 - 2,159 Contract losses 302 - 362 - Net operating loss carry-forwards 230 - 230 - Other 352 - 120 - ----- ----- ----- ----- $ 2,873 $ 4,945 $ 2,388 $ 3,897 ===== ===== ===== =====
As of August 3, 2003 the Company has available net operating loss carry-forwards for federal and state income tax purposes of approximately $489,000 and $2,800,000, respectively which expire through 2020. The Federal net operating loss arose through the acquisition of Terrasat and its utilization is subject to certain limitations.
NOTE H- LONG-TERM DEBT
Long-term debt is summarized as follows (in thousands):
August 3, July 28, Rate 2003 2002 --------------- ---- ---- Revolving loan facility (a) 2.50% and 2.90% $ - $ - Mortgage note (b) 7.43% 2,610 2,691 Industrial Revenue Bonds (c) 4.07% 2,905 3,000 Note for acquired business (d) 1.8% 1,500 - Other - 74 208 ----- ----- 7,089 5,899 Less current portion 686 215 ----- ----- $ 6,403 $ 5,684 ===== =====
(a) In June 2002, the Company entered into a new $50,000,000 Revolving Credit Loan Syndication agreement with two banks on an unsecured basis which may be used for general corporate purposes, including business acquisitions. The revolving credit facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on January 31, 2005 (as amended). The Company may elect to borrow up to a maximum of $5,000,000 with interest based on the FOMC Federal Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum of $45,000,000 with interest based on LIBOR plus a margin of 1.35% to 1.65%. The applicable incremental margin is based on the ratio of total liabilities to tangible net worth, as those terms are defined in the agreement, ranging from less than .40 to 1.0, to greater than 1.0 to 1.0. The FOMC Federal Funds Target Rate and the LIBOR rate was 1.00% and 1.10%, respectively, at August 3, 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 are no borrowings under the line at August 3, 2003 and July 28, 2002.
The agreement contains various financial covenants, including, among other matters, minimum tangible net worth, total liabilities to tangible net worth, debt service coverage, and restrictions on
other borrowings. The Company is in compliance with all covenants at August 3, 2003.
(b) The mortgage loan is for a term of ten years commencing February 16, 1999 with fixed monthly principal and interest installments of $23,359, including interest at a fixed rate of 7.43%, and is based upon a twenty year amortization. The loan is secured by a mortgage on the Company's land and building in Lancaster, Pennsylvania having a net book value of approximately $1,770,000.
The mortgage note agreement contains various financial covenants, including, among other matters, the maintenance of specific amounts of tangible net worth, debt to tangible net worth, debt service coverage, and restrictions on other borrowings. The Company is in compliance with all covenants at August 3, 2003. In connection with this loan, the Company paid approximately $45,000 in financing costs. Such costs are included in Other Assets in the accompanying consolidated balance sheets at August 3, 2003 and July 28, 2002, and are being amortized over the term of the loan (10 years).
(c) On October 19, 2001, the Company received $3,000,000 in proceeds from the East Hempfield Township Industrial Development Authority Variable Rate Demand/Fixed Rate Revenue Bonds Series of 2001 (the "Bonds"). The Bonds are due in varying annual installments through October 1, 2021. The initial installment of $95,000 was paid October 1, 2002 and increases each year until the final payment of $225,000 in 2021. The interest rate on the Bonds is reset weekly at the prevailing market rate of the BMA Municipal index. The initial rate of interest was 2.1%, which, after giving effect to a ten year interest rate swap agreement (See Note O) becomes a fixed rate of 4.07%. The interest rate at August 3, 2003 was 1.00%. The bond agreement requires a sinking fund payment on a monthly basis to fund the annual Bonds redemption installment. Proceeds from the Bonds were used for the construction of a 15,000 square foot expansion of the Company's facilities in Lancaster PA, and for manufacturing equipment.
The Bonds are secured by a letter of credit expiring October 18, 2006 and a mortgage on the related properties pledged as collateral. The net book value of the land and building covered by the mortgage is approximately $1,776,000 at August 3, 2003.
(d) In connection with the acquisition of EWST as of September 1, 2002, the Company issued a note for $1,500,000, including interest at 1.8%, payable in annual installments of $500,000 beginning October 1, 2003.
The Company paid interest in 2003, 2002 and 2001of approximately $355,000, $316,000 and $289,000, respectively.
Future payments required on long-term debt are as follows (in thousands):
Fiscal year ending during: Amount ------------------------- ------ 2004 $ 686 2005 698 2006 711 2007 223 2008 236 Future 4,535 ----- $ 7,089 =====
NOTE I - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following (in thousands):
August 3, July 28, 2003 2002 ---- ---- Accounts payable $ 7,152 $ 5,832 Accrued payroll costs and bonuses 4,257 3,906 Accrued commissions 508 666 Accrued royalties 284 43 Accrued interest - 11 Accrued legal expenses 20 1,018 Accrued warranty costs 359 235 Accrued severance 849 706 Accrued rent expense 189 163 Lease termination cost 17 58 Unearned income 86 108 Other accrued expenses 305 111 ------ ------ $ 14,026 $ 12,857 ====== ======
NOTE J - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan ("Plan") which qualified as a thrift plan under Section 401(k) of the Internal Revenue Code. This Plan, as amended and restated, allows employees to contribute between 2% and 15% of their salaries to the Plan. The Company, at its discretion can contribute 100% of the first 2% of the employees' contribution and 25% of the next 4%. Additional Company contributions can be made depending on profits. The aggregate benefit payable to an employee is dependent upon his rate of contribution, the earnings of the fund, and the length of time such employee continues as a participant. The Company has recognized expenses of approximately $513,000, $533,000 and $164,000 under the Plan for the 53 weeks ended August 3, 2003, and the 52 weeks ended July 28, 2002 and July 29, 2001, respectively.
Employees of General Microwave Corporation (" GMC") became eligible to participate in the Plan as of May 1, 1999. The existing savings and investing plan of GMC did not provide for company matching contributions and has been frozen.
At the time of the acquisition, GMC also had a noncontributory defined benefit pension plan covering all eligible employees of the company. As part of the acquisition plan, the Company froze all benefits under the plan effective April 30, 1999 and elected to terminate the plan as of November 1, 1999. All plan assets were liquidated and distributed to plan participants or used to purchase annuities on their behalf. Excess plan assets in the amount of approximately $470,000 were transferred in January 2001 directly into the Plan discussed above and inured to the benefit of Plan employees.
NOTE K - RELATED PARTY TRANSACTIONS
On January 16, 2001, the Board of directors approved the purchase of an industrial parcel of land adjacent to the existing facility in Lancaster, PA for $747,000 from a partnership of which the Chairman is general partner. Settlement on the property was on July 27, 2001. The Company used this land for a 15,000 square foot addition.
In connection with the move of the Amityville facilities of GMC in fiscal 1999, the Company entered into a 10 year lease agreement with a partnership owned by the children of certain officers of the Company. The lease provides for initial minimum annual rent of $312,000 subject to escalation of approximately 4% annually throughout the 10 year term. Additionally, in March 2000, The Company entered into another 10
year lease with the same partnership for additional space. The initial minimum annual rent of $92,000 is subject to escalation of approximately 4% annually.
NOTE L - COMPUTATION OF PER SHARE EARNINGS
The following table shows the components used in the calculation of basic earnings per share and earnings per share assuming dilution (in thousands except per share data):
The number of stock options and warrants not included in the computation of diluted EPS relates to stock options and warrants having exercise prices ranging from $17.12 to $19.52 which are greater than the average market price of the common shares during the period, and therefore, are antidilutive. The options and warrants, which were outstanding as of August 3, 2003, expire at various dates through October 3, 2008.
NOTE M - SHAREHOLDERS' EQUITY
The authorized shares of Common Stock of the Company is 20,000,000 shares.
On April 30, 2002, the Company completed the sale of 3,000,000 shares of common stock to the public at $23.00. The Company received net proceeds of approximately $64,812,000 after underwriting discounts and commissions and other expenses of the offering.
On August 7, 2001 the Board of Directors declared a 3-for-2 stock split effected as a stock dividend payable September 10, 2001 to holders of record on August 28, 2001. The distribution increased the number of shares outstanding from 7,027,553 to 10,541,329. The amount of $351,373 was transferred from the additional paid-in capital to the common stock account to record this distribution. All share and per share data (other than common stock issued and outstanding on the 2000 Consolidated Balance Sheet and 1999 and 2000 Consolidated Statements of Shareholders' Equity), including stock options and warrants, included in this annual report have been restated to reflect the stock split on a retroactive basis.
The Company has various fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company continues to use the intrinsic value method in accordance with the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for these plans. 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.
Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("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. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123." 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 pro forma disclosures of the impact on earnings and earnings-per-share for companies continuing to rely on APB No. 25. 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:
53 weeks Fifty-two weeks ended ended ----------------------- August 3, July 28, July 29, 2003 2002 2001 ---- ---- ---- Expected life of options 1.51 years 1.51 years .73 years Volatility .68 .68 .70 Risk-free interest rate 2.8% 2.8% 3.4% Dividend yield zero zero zero
Had compensation cost for stock options granted in fiscal years 2003, 2002, and 2001 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):
2003 2002 2001 ---- ---- ---- Net income - as reported $13,937 $5,172 $7,405 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (1,926) (4,425) (1,610) ------ ----- ----- Net income - pro forma $12,011 $ 747 $5,795 ====== ===== =====
Earnings per share - as reported Basic $.97 $.43 $.73 Diluted .93 .40 .68 Earnings per share - pro forma Basic $.84 $.06 $.57 Diluted .80 .06 .53
The effects of applying the pro forma disclosures of SFAS 123 and 148 are not likely to be representative of the effects on reported net income for future years due to the various vesting schedules.
In March 2003, the Board of Directors approved the 2003 Stock Option Plan which covers 1,000,000 shares of the Company's common stock. Options granted under the plan are non-qualified stock options. Under the terms of the plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. The nature and terms of the options to be granted are determined at the time of grant by the compensation committee or the board of directors. The options expire no later than ten years from the date of grant, subject to certain restrictions. No options have been granted under the plan.
In September 2000, the Board of Directors approved the 2000 Stock Option Plan which covers 1,500,000 shares of the Company's common stock. Options granted under the plan are non-qualified stock options. Under the terms of the plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. The nature and terms of the options to be granted are determined at the time of grant by the compensation committee or the board of directors. The options expire no later than ten years from the date of grant, subject to certain restrictions. Options for 108,500 and 1,010,250 shares were granted during the fiscal years ended August 3, 2003 and July 28, 2002, respectively.
In April 1998, the Board of Directors approved the 1998 Stock Option Plan which covers 2,250,000 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted are determined at the time of grant by the compensation committee or the board of directors. The options expire no later than ten years from the date of grant, subject to certain restrictions. Options for 368,342 and 440,250 shares were granted during the fiscal years ended July 28, 2002 and July 29, 2001, respectively. No options were granted under this plan during the fiscal year ended August 3, 2003.
In May 1997, the Board of Directors approved the 1997 Stock Option Plan which covers 2,500,000 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted are determined at the time of grant by the compensation committee or the board of directors. The options expire no later than ten years from the date of grant, subject to certain restrictions. Options for 21,151 and 14,250, shares were granted during the fiscal years ended July 28, 2002 and July 29, 2001, respectively. No options were granted under this plan during the fiscal year ended August 3, 2003.
In October 1995, the Board of Directors approved the 1996 Stock Option Plan which covers 1,000,000 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted are determined at the time of grant by the compensation committee or the board of directors. If not specified, 100% of the shares can be exercised one year after the date of grant. The options expire ten years from the date of grant. Options for 7,007 shares were granted during the fiscal year ended July 28, 2002. No options were granted under this plan during the fiscal year ended August 3, 2003.
A summary of stock option activity under all plans for the 53 weeks ended August 3, 2003 and the 52 weeks ended July 28, 2002 and July 29, 2001 is as follows:
Options Outstanding and Exercisable by Price Range as of August 3,2003, with expiration dates ranging from May 12, 2005 to June 6, 2013 are as follows:
In December 1995, common stock warrants were issued to certain officers for the right to acquire 440,000 shares of common stock of the Company at the fair market value of $3.09 per share at date of issue. The warrants vest immediately and expire December 13, 2005. The remaining warrants for 320,000 shares outstanding at July 29, 2001 were exercised during the fiscal year ended July 28, 2002.
NOTE N - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, EXPORT SALES, AND GEOGRAPHIC INFORMATION
The Company's chief operating decision makers are considered to be the Chairman and the Chief Executive Officer (CEO). The Company's Chairman and CEO evaluate both consolidated and disaggregated financial information, primarily gross revenues, in deciding how to allocate resources and assess performance. The Chairman and CEO also use certain disaggregated financial information for the Company's product groups. The Company does not determine a measure of operating income or loss by product group. The Company's product groups have similar long-term economic characteristics, such as application, and are similar in regards to (a) nature of products and production processes, (b) type of customers, and (c) method used to distribute products. Accordingly, the Company operates as a single integrated business and as such has one operating segment as a provider of complex microwave radio frequency (RF) and millimeter wave components and subsystems for defense and commercial customers worldwide. All of the Company's revenues result from sales of its products.
Revenues for fiscal years 2003, 2002 and 2001 were as follows: defense electronics, $103,746,000, $80,615,000 and $61,977,000, respectively; and commercial technologies, $6,477,000, $12,266,000, and $14,517,000, respectively. Defense electronics includes revenue of $11,212,000 attributable to the EWST acquisition.
Net sales to the U.S. Government in fiscal 2003, 2002 and 2001 accounted for approximately 25%, 17% and 19% of net sales, respectively. No other customer accounted for shipments in excess of 10% of consolidated net sales during the period. Foreign sales amounted to approximately $39,646,000 (including $11,212,000 in sales for EWST), $30,070,000 and $20,683,000 in fiscal 2003, 2002 and 2001, respectively.
Geographic net sales based on place of contract performance were as follows (in thousands):
2003 2002 2001 ---- ---- ---- United States $ 88,294 $ 82,432 $67,597 Israel 10,717 10,449 8,897 England 11,212 - - ------- ------ ------ $ 110,223 $ 92,881 $ 76,494 ======= ====== ======
Net property, plant and equipment by geographic area was as follows (in thousands):
2003 2002 ---- ---- United States $ 18,945 $ 19,351 Israel 3,071 2,880 England 390 - ------ ------ $ 22,406 $ 22,231 ====== ======
NOTE O - DERIVATIVE FINANCIAL INSTRUMENTS
In October 2001, the Company entered into an interest rate swap with a bank pursuant to which it exchanged floating rate interest in connection with the Bonds discussed in Note H on a notional amount of $3,000,000 for a fixed rate of 4.07% for a 10 year period ending October 1, 2011. The notional amount reduces each year in tandem with the annual installments due on the Bonds. The fixing of the interest rate for this period offsets the Company's exposure to the uncertainty of floating interest rates on the Bonds, and as such has been designated as a cash flow hedge. The hedge is deemed to be highly effective and any ineffectiveness will be recognized in interest expense in the reporting period. The fair value of the interest rate swap was a liability of $74,000 as of August 3, 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 fiscal year ended August 3, 2003 as a result of the discontinuance of a cash flow hedge due to the probability of the original forecasted transaction not occurring.
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximated its fair value.
Available-for-sale securities: The fair value of available-for-sale securities was based on quoted market prices.
Long-term debt: The fair value of the mortgage note and industrial revenue bonds (including the related interest rate swap) were estimated using discounted cash flow analyses, based on the
Company's current incremental borrowing rate for similar types of borrowing arrangements.
The carrying amounts and fair values of the Company's financial instruments are presented below (in thousands): August 3, 2003 --------------------------- Carrying Amount Fair Value --------------- ---------- Cash and cash equivalents $ 81,523 $ 81,523 Available-for-sale securities 75 75 Long-term debt 6,403 7,333
NOTE Q - DISCONTINUED OPERATIONS
The Company entered into an agreement effective as of the close of business September 30, 2000, to acquire all of the issued and outstanding common stock of Terrasat, Inc. ("Terrasat"), a California corporation for cash in the amount of $6,000,000, $3,000,000 of which was paid in December 2000 and $3,000,000 of which was paid in December 2001. In addition, the agreement provided for additional cash payments in the future up to $2,000,000, based on gross revenues through December 31, 2001. The targeted gross revenues under the agreement were not achieved, therefore no addition cash payments were required.
In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of, but retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The provisions of this statement were adopted by the Company effective on July 30, 2001.
In January 2002 the Board of Directors of the Company decided to discontinue the operations of Terrasat and to seek a buyer for the business. The Company believed that Terrasat would not be able to generate sufficient returns to justify continued investment due to the overcapacity in the telecom industry and deteriorating economic conditions in Terrasat's primary markets. Consequently, the accompanying consolidated financial statements reflect Terrasat as discontinued operations in accordance with SFAS No. 144. Results of operations and cash flows of Terrasat have been classified as "Loss from discontinued operations", and "Net cash provided by (used in) discontinued operations", respectively.
The sale of certain assets and liabilities, and the business of Terrasat was consummated on March 1, 2002, effective the close of business January 27, 2002, to certain current employees of Terrasat for cash and a note which approximates the carrying value of the net assets held for sale as of January 27, 2002 of $878,000.
Summarized below are the results of discontinued operations:
52 weeks ended ----------------------- July 28, July 29, 2002 2001 ---- ----
Net sales $ 2,147 $ 4,103 ----- -----
Loss from discontinued operations (1,395) (147) Income tax (benefit) provision (474) 21 ----- ---
Net loss from discontinued operations $ (921) $ (168) === ===
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