10-K405 1 0001.txt ANNUAL REPORT FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended July 30, 2000 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ...............to ............... Commission File No. 0-5411 Herley Industries, Inc. ----------------------- (Exact name of registrant as specified in its charter) Delaware 23-2413500 -------- ------------------- State or other jurisdiction (I.R.S. Employer of incorporation or organization Identification No.) 10 Industry Drive, Lancaster, Pennsylvania 17603 ------------------------------------------ -------- (Address of Principal Executive Offices ) (Zip Code) Registrant's telephone number, including area code: (717) 397-2777 -------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of Exchange on which registered ------------------- ------------------------------------ None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $ .10 par value ----------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[X] Based on the closing sale price of $20.50 as of October 11, 2000 the aggregate market value of the voting stock held by non-affiliates of the registrant was $106,351,335. The number of shares outstanding of registrant's common stock, $ .10 par value as of October 11, 2000 was 5,994,338. Documents incorporated by reference: ----------------------------------- Registrant's definitive proxy statement to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934. HERLEY INDUSTRIES, INC. TABLE OF CONTENTS Page ---- PART I Item 1 Business 1 Item 2 Properties 10 Item 3 Legal Proceedings 10 Item 4 Submission of Matters to a Vote of Security Holders 10 PART II Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 11 Item 6 Selected Financial Data 11 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 7A Quantitative and Qualitative Disclosures About Market Risk 15 Item 8 Financial Statements and Supplementary Data 16 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 16 PART III Item 10 Directors and Executive Officers of the Registrant 16 Item 11 Executive Compensation 16 Item 12 Security Ownership of Certain Beneficial Owners and Management 16 Item 13 Certain Relationships and Related Transactions 16 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8K 17 SIGNATURES 18 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES F-1 PART I Forward-Looking Statements All statements other than statements of historical fact included in this Annual Report, including without limitation statements under, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business," regarding the Company's financial position, business strategy and plans and objectives of management of the Company for future operations, are forward-looking statements. When used in this Annual Report, words such as "anticipate," "believe," "estimate," "expect," "intend" and similar expressions, as they relate to the Company or its management, identify forward-looking statements. Such forward-looking statements are based on the beliefs of the Company's management, as well as assumptions made by and information currently available to the Company's management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors including but not limited to, competitive factors and pricing pressures, changes in legal and regulatory requirements, technological change or difficulties, product development risks, commercialization and trade difficulties and general economic conditions. Such statements reflect the current views of the Company with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to the operations, results of operations, growth strategy and liquidity of the Company. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by this paragraph. Item 1. Business Herley Industries, Inc. ("Herley" or "Company") a Delaware corporation was incorporated in 1965. The Company's executive offices are located at 10 Industry Drive, Lancaster, PA 17603. The Company's common stock is listed on The Nasdaq National Market under the symbol "HRLY". Herley is a microwave technology company with five manufacturing facilities, over sixty microwave engineers and approximately 600 employees. The Company operates in a single business segment consisting of research, engineering, product development, and manufacturing of complex microwave radio frequency (RF) and millimeter wave components and subsystems for commercial wireless, defense and space customers worldwide. Herley has over 35 years of experience in the design and manufacture of sophisticated RF, microwave and millimeter wave electronic components for the defense industry. These products receive, transmit and process wireless data signals. During 1998 the Company began to explore the commercial wireless industry to determine the level of market potential for its technology. Herley believes a significant portion of its microwave technology is transferable to commercial wireless applications. As an example, the Interference Cancellation System ("ICS") was derived from technology developed during the creation of military systems that deliberately jam microwave signals. ICS generates an equal amplitude and opposite phase signal that effectively cancels the interfering signal. The Company's defense business is expected to continue its current rate of growth, generating consistent earnings that would be available, if needed, to invest in the commercial wireless opportunities to achieve top line growth. Herley's acquisition of General Microwave in January 1999 was the first step in this process. The acquisition added depth and breadth to the defense product line, strengthened an already strong team of engineers, and gave the Company an immediate entry into commercial wireless markets with General Microwave's commercial products catalog. Subsequent to the General Microwave acquisition, Herley began to coordinate the direction of its facilities, determine the viability of the existing line of commercial wireless products, and ascertain how best to apply existing microwave technology in the development of new products. Herley Wireless Technologies, Inc. was 1 formed in February 2000 to pursue commercial wireless opportunities through product development, teaming agreements, investments and acquisitions. Herley's technology range covers the entire wireless spectrum, from RF (at 900 MHz to 1800 MHz), microwave frequencies (2.4 GHz through 18.0 GHz), to millimeter wave frequencies (20 GHz through 40 GHz). This capability gives the Company the ability to select opportunities in both fixed wireless broadband and mobile wireless applications. Strategy The Company's strategy is to attempt to continue to leverage its proprietary technology, microwave development and manufacturing capabilities to further expand its penetration in the wireless communications and defense markets. Key components of the Company's strategy include the following: Increase Levels of Component Integration and Value Added Content Due to acquisitions, product development and growth of engineering expertise, the Company has increased its capability to provide more component integration. Component integration adds value and will enable Herley to increase content and revenue levels on wireless and defense systems. Further Expansion into Commercial Markets The Company has over 35 years experience in microwave technology used in designing and manufacturing complex microwave products for the defense industry. The Company recently successfully leveraged this experience into the wireless communications markets and will continue to expand its presence in select markets. Maintain Leadership in Microwave Technology The Company intends to pursue further technological advances through continued investment in research and development. The Company will seek to advance its leadership in microwave technology by continuing its participation in selected defense programs that involve highly sophisticated state-of-the-art microwave technology. Strengthen and Expand Customer Relationships The Company has developed mutually beneficial relationships with defense and commercial companies. The Company expects to continue to build and strengthen relationships with industry leaders by recognizing their needs and providing them with timely and cost effective solutions. Enhance High Volume Manufacturing Capability The Company intends to continue to implement process manufacturing automation and believes that its ability to develop a high level of automated production and test capability will help to further improve its cost effectiveness and time to market. Pursue Strategic Acquisitions The Company intends to continue to augment its existing technology base by acquiring specialized technology companies that complement its product offerings and market strategies. The Company believes that expansion of its core competencies through the acquisition of such specialized technology companies, when combined with its technological and manufacturing skills, will provide improved levels of integration, leading to subsystems and complete systems products. 2 Company Products Commercial Wireless Herley has selected the following applications to focus upon within the commercial wireless market: point-to- point access and point-to-multipoint access; handset, radio and infrastructure test equipment; power amplifiers, repeaters, and interference cancellation systems, and fiber optic communication. Test Equipment Test equipment is used in the manufacturing of cell phones, base stations and radio requiring components and assemblies with very high performance and quality. These systems operate over bandwidths much greater than the transmission bandwidth in order to check parameters outside of the operating band. Herley has pushed the state of the art in wideband components, such as attenuators, IQ modulators and up/down converters. The Company initially focused on this segment of the wireless market because of the wide range of catalog products it can offer and because the price pressures are significantly less than in the higher volume infrastructure equipment. The wireless equipment (handsets and infrastructure) market is likely to increase by approximately 30% in 2000, to $119 billion. Wireless telecom equipment should remain one of the fastest-growing segments of the $340 billion telecom equipment market. It is expected that the market will post a compound annual growth rate of 18% - 20% over the next five years, driven by new applications such as data as well as higher penetration rates. The key driver for wireless equipment spending is the conveniences of "anytime, anywhere" voice communications. Herley expects voice (both minutes of use and new subscribers) to remain a critical catalyst of telecom equipment spending over the next 12-18 months. However, in 2001, as the penetration rate begins to exceed 50% in the developed countries and 10%-15% in many developing countries, the growth rate for wireless voice products is likely to begin to level off. The overall worldwide penetration rate was estimated at 8% at the end of 1999 and should reach over 12% by the end of 2000. Point-to-Point and Point-to-Multipoint Radio Point-to-point radios have been used for some time in line of sight communications where land-based telecommunication was absent. The rapid growth of this market has resulted from the use of radios to connect base stations in the cellular infrastructure. Point-to-point fixed wireless connects a central building to the fiber backbone. It has multiple antennas; each targeted at a single antenna on a customer building, giving each customer the full bandwidth of the antenna, i.e. higher speeds. Maximum speed is 155 million bits per second as compared to a "high speed" line that provides 1.54 million bits per second. Point-to-multipoint fixed wireless connects multiple buildings to the fiber backbone through a central building. For example, the central building has four antennas. Each antenna covers 90 degrees so the central building can communicate with all surrounding buildings. In most cases, all customers share the four antennas. Costs of Point-to-multipoint are less, but this application offers lower speed services. Herley supplies subsystems (receiver/transmitter modules) to digital microwave radio original equipment manufacturers ("OEMs"). Power Amplifiers, Repeaters, and Interference Cancellation System Herley has recently broadened its technical and marketing capability in the area of power amplifiers, which opens opportunities in various power-based products. The cellular infrastructure uses power amplifiers in the base stations and in tower top amplifiers and repeaters to extend the range and capacity of the base stations. The Company's initial focus will be on supplying power amplifiers to service providers. 3 Herley has an additional advantage and opportunity in this market segment. The Company has signed a teaming agreement with Cyber Dynamics to introduce interference cancellation systems into repeaters, which would significantly enhance their performance. This product is unique in the market and is based on patented and proprietary technology from Cyber Dynamics and Herley. It is particularly useful in wideband multicarrier systems expected to dominate the next generation (3G) systems. The interference cancellation system is presently in production for a military communication system and field trials are planned with domestic and international cellular service providers. Fiberoptic Communications The fixed and mobile Internet infrastructure has boosted again the use of high-speed fiberoptics. The speed in fiberoptic communication has been increasing steadily and has now reached into the 10 to 40 Gbit range. This necessitates the use of microwave circuits to drive the optical components. Herley engineers have long predicted the merger of fiberoptics and microwave technologies. In 1993, one of the Company's leading engineers designed an optical device based on Lithium Niobate that can transmit signals at 40 Gbit for which the Company has received a patent. In simple terms, fiber optic technology uses a strand of glass as thin as hair that transmits both voice and data signals in the form of light pulses. Information is encoded in digital signals (binary code) and transmitted through a fiber by modulating a light source similar to a laser effect. At the signal's destination, the signal is decoded and reconstructed as the original information. The fiber optic cable has a core through which the signal travels and a cladding that surrounds and protects the core confining the light signal. These lightwave signals are guided through the core of the optical fiber similar to the way that radio frequency (RF) signals are guided through coaxial cable. Fiber optics are produced in single or multimode. Single mode has smaller cores resulting in higher transmission rates and lower signal losses. Single mode fiber optics have higher transmission and receiving costs but carry 50 to 100 times more capacity. On the other hand, multimode fiber optics are used for short distances or for slower transmission requirements. Fiber is designed to last approximately 20 years or more. Fiber optic cable offers much greater bandwidth than the older copper technologies, is more secure and robust, and has been developed to coexist with next generation networking technologies. The major trunk lines, those between one telephone company switch to another, are now primarily fiber optic cables. However, the cabling from the Telephone Company to residential and some business areas still consists primarily of older coaxial cable and copper pairs. The Company supplies microwave products to fiber optic manufacturers, including voltage controlled oscillators. Defense and Space Products The Company has focused its efforts on providing microwave products to defense programs, which have extended production cycles. Herley's subsystems and integrated components use specialized combinations of components that perform various microwave functions including filters, switches, oscillators, and amplifiers, among others. The Company is involved in the following applications: Carrier Landing Systems Electronic Countermeasure Systems Rear Warning Receivers Space Launch Fire Control Radar 4 Microwave Components Herley manufactures microwave devices at its facilities in Woburn, Massachusetts; in Nashua New Hampshire, in Farmingdale, New York; and in Jerusalem, Israel for existing long-term military programs, for new production units, as well as for spare parts and repair services. These microwave devices are used in a variety of radar, communications and missile applications, including airborne and shipboard navigation and missile guidance systems. The Company designs and manufactures complex microwave integrated circuits ("MICs"), which consist of sophisticated assemblies that perform many functions, primarily involving switching of microwave signals. MICs manufactured by the Company are employed in many defense electronics military systems as well as missile programs. The Company also manufactures magnetrons, which are the power source utilized in the production of the Company's transponders. Command and Control Systems (C2) The Company's command and control systems have been used to fly remotely a large variety of unmanned aerial vehicles ("UAVs"), typically aircraft used as target drones or Remotely Piloted Vehicles ("RPVs") and some surface targets. Operations have been conducted by users on the open ocean, remote landmasses, and instrumented test and training ranges. Telemetry Systems 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. The Company has 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. Transponders The Company manufactures a variety of expendable transponders, including range safety, identification friend or foe ("IFF"), command and control, and 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 sends back a reply on a different frequency and signal level. This reply will be a strong, noise free signal upon which the tracking radar can "lock", and one that is far superior to skin reflection tracking, particularly under adverse weather conditions after the launch. Flight Termination Receiver A flight termination receiver ("FTR") is installed in a test missile, a UAV, a target or a 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 ("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 harmlessly. HF Communications and IFF Interrogators The Company also designs and manufactures 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 5 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. The Company has been a significant supplier to the Republic of Korea ("ROK") for over twenty years and has a large, established installed base of equipment. The Company has been, and continues to be, a supplier to the ROK KDX destroyer program. Customers During the fiscal year ended July 30, 2000, approximately 26% of the Company's 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 consolidated net sales. During fiscal year 2000, sales to foreign customers accounted for approximately 23% of the Company's consolidated net sales and included shipments to 31 countries. All of the Company's contracts with foreign customers are payable in U. S. dollars. Sales to foreign customers for each of the last three fiscal years were $16,506,000, $17,680,000 and $11,943,000 in fiscal 2000, 1999, and 1998, respectively. Herley sells commercial wireless communications products primarily to OEMs, which in turn integrate its products into wireless infrastructure equipment solutions sold to network service providers. In addition, Herley sells certain niche products directly to network service providers. Some of Herley's customers for commercial wireless subsystems include: Alcatel Digital Microwave Teradyne P-Com Tadiran Matra BAe The Company also offers defense electronics equipment to major defense prime contractors for integration into larger systems. Some of its customers for defense electronics equipment include: Boeing British Aerospace Harris Lockheed Martin Litton Northrop Grumman Raytheon Business Acquisition 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 is being operated as a division of Herley Industries, Inc. Robinson designs, develops and manufactures microwave components and subassemblies for the defense, space and telecommunications markets. The transaction, which closed on February 1, 2000, provided for the payment of $6,000,000 in cash, the issuance of 33,841 shares of Common Stock of the Company valued at $15.188 per share, and the assumption of approximately $3,140,000 in liabilities. In addition, the agreement provides for the issuance of additional shares of Common Stock at a future date, aggregating 97,841 shares, based on new orders booked through January 2001. The cash portion of the purchase price was financed by borrowing under the Company's existing line of credit with its bank. The transaction has been accounted for under the purchase method. Accordingly the consolidated statement of income includes the results of Robinson's operations from January 3, 2000. Excess cost over the fair value of net assets acquired of approximately $5,467,000 is being amortized over 20 years. 6 Sales and Marketing The Company markets its products worldwide to OEMs and service providers in commercial markets and prime contractors in defense markets primarily through a sales force generally organized by geographic territory and markets. In addition, the Company has 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 its marketing efforts, the Company advertises in major trade publications and attends major industrial shows in the commercial wireless communications and defense markets. After the Company has identified key potential customers, the Company makes sales calls with its own sales, management and engineering personnel and its manufacturers' representative. In order to promote widespread acceptance of its products and provide customers with support for their wireless communications needs, the Company's sales and engineering teams work closely with its customers to develop tailored solutions to their requirements. The Company believes that its customer engineering support provides it with a key competitive advantage. Manufacturing The Company manufactures its products from standard components, as well as from items that are manufactured by vendors to the company's specifications. A majority of the Company's commercial and defense electronics assemblies and subsystems products contain proprietary technology which is designed and tested by the Company's engineers and technicians and is manufactured at the Company's own facilities. The Company continues to invest in the advancement of its proprietary manufacturing processes and in automation of the manufacturing processes. Automation is critical in meeting its customers' demands for price competitiveness, world class quality and on-time delivery. The Company is also investing to enhance its responsiveness to production demands from its customers. Electronic components and other raw materials used in the Company's products are purchased by the Company from a large number of suppliers and all of such materials are readily available from alternate sources. The Company does not maintain any significant level of finished products inventory. Raw materials are generally purchased for specific contracts and common components are purchased for stock based on the Company's firm fixed backlog. There are no significant environmental control procedures required concerning the discharge of materials into the environment that would require the Company to invest in any significant capital equipment or that would have a material effect on the earnings of the Company or its competitive position. Quality assurance checks are performed on manufacturing processes, purchased items, work-in-process and finished products. Due to the complexity of the Company's products, final tests are performed on some products by highly skilled engineers and technicians. Herley's 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 the Company's manufacturing facilities located in the following cities: Lancaster, Pennsylvania Farmingdale, New York Woburn, Massachusetts 7 Nashua, New Hampshire Jerusalem, Israel Backlog The Company's total backlog of orders was approximately $53,127,000 on July 31, 2000 as compared to $49,230,000 on August 1, 1999. Of the Company's total backlog of $53,127,000 at July 30, 2000, $31,178,000 is attributable to domestic orders and $21,949,000 is attributable to foreign orders. Management anticipates that approximately $41,835,000 of its backlog will be shipped during the fiscal year ending July 29, 2001. All of the orders included in backlog are covered by signed contracts or purchase orders. Backlog is not directly indicative of future sales. Accordingly, the Company does not believe that its backlog as of any particular date is representative of actual sales for any succeeding period. Substantially all of the Company's contracts are fixed price contracts, some of which require delivery over time periods in excess of one year. With this type of contract, the Company agrees 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. In the event of such a termination, 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 the Company under the contract to the date of termination plus a fee based on the work completed. Research and Development The Company believes that its growth depends, in part, on its ability to renew and expand its technology, products, and design and manufacturing processes with an emphasis on cost effectiveness. The Company's primary efforts are focused on engineering design and product development activities rather than pure research. A substantial portion of the Company's development activities has been funded by the Company's customers. Certain of the Company's officers and engineers are involved at various times and in varying degrees in these activities. The Company's 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, net of amounts paid by customers, were approximately $1,727,000, $1,685,000, and $1,562,000 in fiscal 2000, 1999, and 1998, respectively. Competition The microwave component and subsystems industry is highly competitive and the Company competes against many companies, both foreign and domestic, many of these are larger, have greater financial resources and are better known. As a supplier, the Company also experiences significant competition from the in-house capabilities of its actual prospective customers. Competition is generally based upon technology, design, price and past performance. The Company's ability to compete depends, in part, on its ability to offer better design and performance than its competitors and its readiness in facilities, equipment and personnel to undertake to complete the programs. Government Regulation The Company's wireless communications products are incorporated into wireless telecommunications systems that are subject to regulation domestically by the FCC and internationally by other government agencies. In addition, because of its participation in the defense industry, the Company is subject to audit from time to time for its compliance with government regulations by various government agencies. The Company is 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 8 used to manufacture the Company's products. The Company believes that it operates its 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 the Company's business, financial condition and result of operations. Intellectual Property While the Company holds several patents, the Company relies primarily on a combination of trade secret, employee and third-party nondisclosure agreements to protect its intellectual property, as well as limiting access to the distribution of proprietary information. There can be no assurance that the steps taken by the Company to protect its intellectual property rights will be adequate to prevent misappropriation of the Company's technology or to preclude competitors from independently developing such technology. Furthermore, there can be no assurance that, in the future, third parties will assert infringement claims against the Company or with respect to its products for which the Company has indemnified certain of its customers. Asserting the Company's rights or defending against third party claims could involve substantial costs and diversion of resources, thus materially and adversely affecting the Company's business, financial condition and results of operations. In the event a third party were successful in a claim that one of the Company's products infringed its proprietary rights, the Company may have to pay substantial royalties or damages, remove that product from the marketplace or expand substantial amounts in order to modify the product so that it no longer infringes such proprietary rights, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Employees As of October 1, 2000, the Company employed 583 persons full time. Of these employees, 61 comprise the engineering staff, 438 constitute manufacturing personnel, 30 occupy sales and marketing positions, and 35 are in management and support functions. None of the Company's employees are covered by collective bargaining agreements and the Company considers its employee relations to be satisfactory. The Company believes that its future success will depend, in part, on its continued ability to recruit and retain highly skilled technical, managerial and marketing personnel. To assist in recruiting and retaining such personnel, the Company has established competitive benefits programs, including a 401k employee savings plan and stock option plans. 9 Item 2. Properties The Company's properties are as follows:
Owned or Location Purpose of Property Area Leased ------------------- ------------------------------------------ -------------- ------ Lancaster, PA (1) Production, engineering, administrative 71,200 sq. ft. Owned and executive offices Woburn, MA Production, engineering and administration 60,000 sq. ft. Owned Farmingdale, NY (2) Production, engineering and administration 46,000 sq. ft. Leased Jerusalem, Israel Production, engineering and administration 12,000 sq. ft.. Owned Nashua, NH (3) Production, and engineering 20,000 sq. ft. Leased Chicago, IL Engineering and administration 3,000 sq. ft. Leased Lancaster, PA Land held for expansion 20.4 Acres Owned --------------
[FN] (1) The Company's executive offices occupy approximately 4,000 sq. ft. of space at this facility with engineering and administrative offices occupying 10,000 sq. ft. each. (2) On September 23, 1999 the Company closed on the sale of its prior owned facility in Amityville, NY and relocated the plant to this leased facility in Farmingdale, NY. The Company entered into 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 $312,390, subject to escalation of approximately 4% annually throughout the 10 year term. (3) As of January 3, 2000 the Company acquired substantially all of the assets of Robinson Laboratories, Inc. which operates as a division at this location. In addition to the above operating facilities, the Company has an idle facility in Billerica, MA which is under lease. The Company is looking to sublease this facility. The Company believes that its facilities are adequate for its current and presently anticipated future needs. Item 3. Legal Proceedings The Company is not involved in any material legal proceedings. Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. 10 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholders Matters (a) The Company's Common Stock is traded in the NASDAQ National Market under the symbol HRLY. The following table sets forth the high and low sales price as reported by the NASDAQ National Market for the Company's Common Stock for the periods indicated. Common Stock -------------- High Low ----- ----- Fiscal Year 1999 First Quarter................................ 10.50 7.63 Second Quarter............................... 15.31 9.56 Third Quarter................................ 15.13 11.13 Fourth Quarter............................... 16.19 11.50 Fiscal Year 2000 First Quarter................................ 15.00 12.19 Second Quarter............................... 15.50 11.13 Third Quarter................................ 19.38 13.88 Fourth Quarter............................... 19.06 15.69 Fiscal Year 2001 First Quarter (through October 11, 2000)..... 22.75 17.44 The closing price on October 11, 2000 was $20.50. (b) As of October 11, 2000, there were approximately 1,000 record holders of the Company's Common Stock. (c) There have been no cash dividends declared or paid by the Company on its Common Stock during the past two fiscal years. Item 6. Selected Financial Data (in thousands except per share data)
52 Weeks ended ------------------------------------------------------------ July 30, August 1, August 2, August 3, July 28, 2000 (2) 1999 (3) 1998 (4) 1997 1996 -------- -------- -------- ---- ---- Net sales $ 70,537 61,036 40,798 32,195 29,001 ====== ====== ====== ====== ====== Net income $ 7,639 7,735 5,497 4,804 3,669 ====== ====== ======= ======= ======= Earnings per common share (1) Basic $ 1.57 1.48 1.11 1.18 .97 ==== ==== ==== ==== === Assuming Dilution $ 1.45 1.37 1.02 1.01 .86 ==== ==== ==== ==== === Total Assets $ 86,656 74,056 57,553 39,257 42,509 Total Current Liabilities $ 12,783 10,513 9,843 9,813 7,559 Long-Term Debt net of current portion $ 2,931 15,437 4,111 2,890 11,021
[FN] (1) As adjusted to give effect to a 4-for-3 stock split effective September 30, 1997. (2) On January 3, 2000, the Company acquired Robinson Laboratories, Inc. See Note B of the financial statements. (3) On January 4, 1999, the Company acquired General Microwave Corporation. See Note B of the financial statements. (4) On August 4, 1997, the Company acquired Metraplex Corporation. See Note B of the financial statements. 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table sets forth for the periods indicated certain financial information derived from the Company's consolidated statements of income expressed as a percentage of net sales. There can be no assurance that trends in sales growth or operating results will continue in the future.
52 weeks ended ---------------------------------- July 30, August 1, August 2, 2000 1999 1998 ---- ---- ---- Net sales 100.0 % 100.0 % 100.0 % Cost of products sold 62.9 % 60.2 % 59.2 % ---- ---- ---- Gross profit 37.1 % 39.8 % 40.8 % Selling and administrative expenses 19.2 % 19.5 % 20.4 % ---- ---- ---- Operating income 17.9 % 20.3 % 20.4 % ---- ---- ---- Other income (expense), net: Investment income 0.3 % 0.5 % 1.4 % Interest expense (1.6)% (1.2)% (1.1)% ---- ---- ---- (1.3)% (0.7)% 0.3 % ---- ---- ---- Income before income taxes and extraordinary item 16.6 % 19.6 % 20.7 % Provision for income taxes 5.8 % 6.7 % 7.2 % ---- ---- ---- Income before extraordinary item 10.8 % 12.9 % 13.5 % Extraordinary item - (0.2)% - ---- ---- ---- Net income 10.8 % 12.7 % 13.5 % ---- ---- ----
12 Fiscal 2000 Compared to Fiscal 1999 Net sales for the 52 weeks ended July 30, 2000 were approximately $70,537,000 compared to $61,036,000 for fiscal 1999. The sales increase of $9,501,000 (15.6%) is partially attributable to the acquisition of Robinson Labs as of January 3, 2000 which contributed $4,690,000 in revenues, and the acquisition of GMC as of January 4, 1999 which contributed $5,101,000 additional revenue over the volume generated in fiscal 1999, as well as an increase in net sales of approximately $2,478,000 in microwave component. Space and communications products experienced a drop in revenue of approximately $2,768,000. Gross profit of 37.1% for the 52 weeks ended July 30, 2000 is less than the prior year of 39.8%. The decline in margin of 2.7% is due primarily to lower margins on microwave components, which includes the revenues from Robinson Labs and GMC. Selling and administrative expenses for the 52 weeks ended July 30, 2000 were $13,497,000 compared to $11,877,000 for fiscal 1999, an increase of $1,620,000. The primary increase is due to the acquisition of Robinson Labs which added $1,069,000 in selling and administrative expenses in fiscal 2000. As a percentage of revenues, expenses declined from 19.5% in 1999 to 19.2% in 2000. Interest expense increased approximately $390,000 due to additional bank borrowings to fund the acquisitions of GMC and Robinson. The effective income tax rate increased to 35.0% in fiscal 2000 from 34.3% in 1999 due primarily to a decreased benefit received from the Company's foreign sales corporation in fiscal 2000. Fiscal 1999 Compared to Fiscal 1998 Net sales for the 52 weeks ended August 1, 1999 were approximately $61,036,000 compared to $40,798,000 for fiscal 1998. The sales increase of $20,238,000 (49.6%) is primarily attributable to the acquisition of GMC as of January 4, 1999 which contributed $14,374,000 in revenues in fiscal 1999,as well as an increase in net sales of approximately $3,508,000 in space and communications products, and approximately $2,356,000 in microwave components. Gross profit of 39.8% for the 52 weeks ended August 1, 1999 is less than the prior year of 40.8%. The decline in margin of 1% is due primarily to lower margins on microwave components, as well as the lower margins generated from the added GMC revenues. Selling and administrative expenses for the 52 weeks ended August 1, 1999 were $11,877,000 compared to $8,339,000 for fiscal 1998, an increase of $3,538,000. The acquisition of GMC added $3,222,000 in selling and administrative expenses in fiscal 1999. As a percentage of revenues, expenses declined from 20.4% in 1998 to 19.5% in 1999. Investment income declined $288,000 from the prior year due to a decrease in investments, the proceeds of which were used to partially fund the acquisition of GMC. In addition, bank borrowings of approximately $11,400,000 used to fund the balance of the acquisition price resulted in additional interest expense of approximately $302,000. The effective income tax rate decreased from 34.8% in fiscal 1998 to 34.3% in fiscal 1999. In February 1999, the Company refinanced the existing mortgage on its property located in Lancaster, Pa. The proceeds of the new mortgage loan were used to prepay the existing mortgage note having an outstanding principal balance of $2,890,000 plus a prepayment premium of $115,600. Unamortized debt expenses of $79,226 and the $115,600 prepayment premium related to the early extinguishment of the existing mortgage debt were charged to expense as an extraordinary loss, net of an income tax benefit of $68,000. 13 Liquidity and Capital Resources As of July 30, 2000 and August 1, 1999, working capital was approximately $35,476,000 and $25,703,000, respectively, and the ratio of current assets to current liabilities was 3.78 to 1 and 3.44 to 1, respectively. At July 30, 2000, the Company had cash and cash equivalents of approximately $7,665,000. As of January 3, 2000, the Company acquired substantially all of the assets of Robinson Laboratories, Inc. ("Robinson" or "Robinson Labs"), a New Hampshire corporation, which is being operated as a division of Herley Industries, Inc. The transaction provided for the payment of $6,000,000 in cash, the issuance of 33,841 shares of Common Stock of the Company valued at $15.188 per share, and the assumption of approximately $3,140,000 in liabilities. In addition, the agreement provides for the issuance of additional shares of Common Stock at a future date, aggregating 97,841shares, based on new orders booked through January 2001. As of January 4, 1999, the Company completed the acquisition of all of the issued and outstanding common stock of GMC, a New York corporation, including outstanding stock options, for $18.00 per share and 966,675 three-year warrants to purchase one share of the Company's common stock, at an aggregate purchase price of approximately $24,556,000. The purchase price includes shares of common stock of General Microwave purchased in the open market, acquisition of the remaining shares of common stock outstanding, an estimate of the fair market value of the warrants based on the trading price of similar warrants currently on the market, and transaction expenses. The warrants are exercisable at $15.60 per share of common stock of the Company and expire in January 2002. On August 4, 1997, the Company completed the acquisition of Metraplex Corporation, a Maryland corporation for 313,139 (as adjusted) shares of common stock of the Company, with a fair market value of $3,170,471, in exchange for all of the issued and outstanding common stock of Metraplex. As is customary in the defense industry, inventory is partially financed by advance payments. The unliquidated balance of these advance payments was approximately $1,006,000 in 2000, and $439,000 in 1999. Net cash provided by operations was approximately $9,854,000, and $12,723,000, in 2000 and 1999 respectively. Net cash used in investing activities in 2000 of approximately $4,571,000 relates to the acquisition of Robinson Labs, in part for cash of approximately $6,000,000 which was funded by borrowings under the bank line of credit, and capital expenditures of $2,618,000, including building and leasehold improvements of $1,676,000 to accommodate the move of GMC from Amityville, NY to a leased facility in Farmingdale, NY, and consolidation of the GMC leased facilities in Billerica, MA with the Company's Woburn, MA facility. Offsetting the cash outflows were the net proceeds from the sale of the facility in Amityville of $4,125,000. Net cash used in investing activities in 1999 of approximately $21,757,000 relates primarily to the acquisition of GMC, net of cash acquired, which was funded by available cash balances and borrowings under the bank line of credit. Net cash flows from financing activities in fiscal 2000 included: (1) net payments under the bank line of credit of $12,500,000; (2) proceeds from the exercise of stock options and warrants of $21,574,000, including the exercise of approximately 1,314,000 of the warrants issued in connection with the sale of common stock to the public in 1997 resulting in proceeds of approximately $20,492,000; and (3) the acquisition of treasury stock in the aggregate amount of $7,565,000. Net cash flows from financing activities in fiscal 1999 included: (1) net borrowings under the bank line of credit of $11,000,000 the proceeds of which were used to partially fund the acquisition of GMC; (2) refinancing of the existing mortgage on the property in Lancaster, Pa., which reduced the interest rate from 10.4% to 7.43% and extended the repayment schedule to 10 years; and (3) the acquisition of treasury stock in the aggregate amount of $7,688,000. 14 Net cash provided by financing activities in fiscal 1998 consists of net proceeds of $7,452,000 from the sale of 700,000 shares of common stock, and 1,265,000 Common Stock Purchase Warrants to the public. Net borrowings under a bank line of credit provided $1,500,000 in financing. Cash was used in financing activities for payments of long-term debt of $2,257,000 and the purchase of treasury stock of $1,084,000. The Company maintains a revolving credit facility with a bank for an aggregate of $30,000,000, as amended in January 2000, which expires January 31, 2002. As of August 1, 1999 the Company had borrowings outstanding under this facility of $12,500,000. No borrowings were outstanding as of July 30, 2000. During the fiscal years ended July 30, 2000 and August 1, 1999 the Company acquired 512,000 and 561,050 shares of its outstanding common stock for approximately $7,565,000 and $7,688,000, respectively through open market purchases, pursuant to a stock repurchase plan to acquire up to 1,250,000 shares of Common Stock. In January 1998, the Company purchased 89,888 shares of its outstanding common stock for $1,084,326 from certain officers of the Company based on the fair market value of the stock on the date acquired. The Company also acquired 8,982, 410,593 and 42,016 shares of common stock in fiscal 2000, 1999 and 1998, respectively, valued at $80,000, $5,989,000 and $538,000, respectively, in connection with certain "stock-for- stock" exercises of stock options by which certain employees elected to surrender "mature" shares owned in settlement of the option price. Such exercises are treated as an exercise of a stock option and the acquisition of treasury shares by the Company. See "Management - Stock Plans." The Company believes that presently anticipated future cash requirements will be provided by internally generated funds and existing credit facilities. Subsequent Events The Company entered into an agreement, as of August 28, 2000, to acquire substantially all of the assets of American Microwave Technology, Inc. ("AMT"), a California corporation. AMT designs, develops and manufactures radio frequency and microwave power amplifiers for the medical and scientific markets. The transaction, which closed on October 12, 2000, provided for the payment of $5,400,000 in cash, and the assumption of approximately $1,153,000 in liabilities. The transaction will be accounted for under the purchase method of accounting. The allocation of the aggregate estimated purchase price will be determined based on detailed reviews of the fair value of assets acquired and liabilities assumed. Any excess cost over the fair value of net assets acquired will be amortized over 20 years. The Company also entered into an exclusive license agreement with AMT related to certain application specific and wireless products under which the Company will pay a royalty of 10% of net sales of these products for a period of four years, after which no additional royalty will be due. On October 13, 2000 the Company notified the holders of the warrants issued in connection with the acquisition of GMC (see Note Q) of its intent to call the warrants at a price of $1.00 per warrant effective 30 days after notice. The holders of the warrants may elect to exercise the warrant for one share of common stock of the Company at $15.60 per share. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company is subject to market risk associated with changes in interest rates and stock prices. The Company has not entered into any derivative financial instruments to manage the above risks and the Company has not entered into any market risk sensitive instruments for trading purposes. The Company's debt consists of a working capital credit facility with a bank having an interest rate that is set at 1.65% over the FOMC Federal Funds Target Rate based on tangible net worth in excess of $25,000,000, or at an increment of 1.80% if tangible net worth is less than $25,000,001, and a mortgage on its facility in Lancaster, Pa. at a fixed rate of 7.43%. The FOMC Federal Funds Target Rate at July 30, 2000 was 6.50%. The credit line is reviewed on an annual basis. Since the acquisition of GMC, the Company is subject to movements in foreign currency rate changes related to GMC's Israel operations. The Company does not anticipate any other material changes in its primary market risk exposures in fiscal 2000. 15 As of July 30, 2000, the Company holds an investment in the common stock of a public company that is exposed to price risk with a cost basis and a fair market value basis of $143,330. The table below provides information about the Company's debt that is sensitive to changes in interest rates. The table presents principal cash flows by maturity date. Future principal payment cash flows by maturity date required under the mortgage and line of credit, and corresponding fair values are as follows: Fiscal year ending during: Mortgage ------------------------- -------- 2001 $ 69 2002 74 2003 80 2004 85 2005 93 2006 and later 2,439 ----- $2,840 Fair value $2,840 ===== Item 8. Financial Statements and Supplementary Data The financial statements and supplementary data listed in the Index on Page F-1 are filed as a part of this report. Item 9. Changes in and Disagreements on Accounting and Financial Disclosure Not applicable PART III The information required by Part III is incorporated by reference to the Company's definitive proxy statement in connection with its Annual Meeting of Stockholders scheduled to be held in January 2001, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year ended July 30, 2000. 16 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Exhibits 3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1 Registration Statement No. 2- 87160). 3.2 By-Laws, as amended (Exhibit 3(b) of Form S-1 Registration Statement No. 2-87160). 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 Amendments dated January 26, 1999 and July 30, 1999 to Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated as of October 1, 1998 (Exhibit 10.4 of Annual Report on Form 10-K for the fiscal year ended August 1, 1999). 10.5 Amendments dated January 26, 1999 and July 30, 1999 to Employment Agreement between Herley Industries, Inc. and Myron Levy dated as of October 1, 1998 (Exhibit 10.5 of Annual Report on Form 10-K for the fiscal year ended August 1, 1999). 10.6 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). 10.7 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). 10.8 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). 10.9 Loan Agreement dated February 16, 1999 between Registrant and The First National Bank of Maryland, a division of FMB Bank. (Exhibit 10.9 of Annual Report on Form 10-K for the fiscal year ended August 1, 1999). 10.10 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). 10.11 Amendment to Loan Agreement dated January 11, 2000 between Registrant and Allfirst Bank, successor to The First National Bank of Maryland (Exhibit 10.1 of Form 10-Q dated March 13, 2000). 10.12 Asset Purchase Agreement dated as of October 12, 2000 between Registrant and American Microwave Technology Inc. 10.13 Lease Agreement dated March 1, 2000 between Registrant and RSK Realty LTD. 23.1 Consent of Arthur Andersen LLP. 27. Financial Data Schedule (for electronic submission only). (b) Financial Statements See Index to Consolidated Financial Statements at Page F-1. (c) Reports on Form 8-K None 17 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 the 23th day of October, 2000. 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 23, 2000 by the following persons in the capacities indicated: By: /S/ Lee N. Blatt Chairman of the Board ------------------------ (Principal Executive Officer) Lee N. Blatt By: /S/ Myron Levy President and Director ------------------------ Myron Levy By: /S/ Anello C. Garefino Vice President Finance, CFO, Treasurer --------------------------- (Principal Financial Officer) Anello C. Garefino By: /S/ David H. Lieberman Secretary and Director --------------------------- David H. Lieberman By: /S/ Thomas J. Allshouse Director ---------------------------- Thomas J. Allshouse By: /S/ John A. Thonet Director ----------------------- John A. Thonet By: /S/ Alvin M. Silver Director ----------------------- Alvin M. Silver By: /S/ Edward K. Walker, Jr. Director ----------------------------- Edward K. Walker, Jr. 18 Item 8. Financial Statements and Supplementary Data HERLEY INDUSTRIES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page ---- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................ F-2 FINANCIAL STATEMENTS: Consolidated Balance Sheets, July 30, 2000 and August 1, 1999...... F-3 Consolidated Statements of Income for the 52 weeks ended July 30, 2000, August 1, 1999, and August 2, 1998................ F-4 Consolidated Statements of Shareholders' Equity for the 52 weeks ended July 30, 2000, August 1, 1999, and August 2, 1998.......... F-5 Consolidated Statements of Cash Flows for the 52 weeks ended July 30, 2000, August 1, 1999, and August 2, 1998................ F-6 Notes to Consolidated Financial Statements.......................... F-7 Schedules have been omitted as not applicable. F-1 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 August 1, 1999, and the related consolidated statements of income, shareholders' equity and cash flows for the 52 weeks ended July 30, 2000, August 1, 1999 and August 2, 1998. 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 consolidted financial position of Herley Industries, Inc. and Subsidiaries as of July 30, 2000, August 1, 1999, and August 2, 1998, and the consolidated results of their operations and their cash flows for the 52 weeks ended July 30, 2000, August 1, 1999 and August 2, 1998 in conformity with accounting principles generally accepted in the United States. /S/ ARTHUR ANDERSEN LLP Lancaster, PA September 20, 2000 (except with respect to the matters discussed in Note Q, as to which the date is October 13, 2000) F-2 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except share data) July 30, August 1, 2000 1999 ---- ---- ASSETS Current Assets: Cash and cash equivalents $ 7,665 $ 2,741 Accounts receivable 14,315 10,679 Costs incurred and income recognized in excess of billings on uncompleted contracts 146 -- Other receivables 293 273 Inventories 23,045 19,880 Deferred taxes and other 2,795 2,643 ------ ------ Total Current Assets 48,259 36,216 Property, Plant and Equipment, net 18,004 21,888 Intangibles, net of amortization of $3,095 in 2000 and $2,137 in 1999 18,096 13,574 Available-For-Sale Securities 146 148 Other Investments 1,020 948 Other Assets 1,131 1,282 ------ ------ $86,656 $74,056 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt $ 282 $ 258 Accounts payable and accrued expenses 9,602 8,035 Income taxes payable 1,426 276 Reserve for contract losses 467 1,505 Advance payments on contracts 1,006 439 ------ ------ Total Current Liabilities 12,783 10,513 Long-term Debt 2,931 15,437 Deferred Income Taxes 5,571 5,144 Minority Interest -- 62 ------ ------ 21,285 31,156 ------ ------ Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 20,000,000 shares; issued and outstanding 5,993,870 in 2000 and 5,030,283 in 1999 599 503 Additional paid-in capital 29,808 15,072 Retained earnings 34,964 27,325 ------ ------ Total Shareholders' Equity 65,371 42,900 ------ ------ $86,656 $74,056 ====== ====== The accompanying notes are an integral part of these financial statements. F-3 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands except per share data) 52 weeks ended July 30, August 1, August 2, 2000 1999 1998 ------- ------- ------- Net sales $ 70,537 $ 61,036 $ 40,798 ------- ------- ------- Cost and expenses: Cost of products sold 44,382 36,749 24,169 Selling and administrative expenses 13,497 11,877 8,339 ------- ------- ------- 57,879 48,626 32,508 ------- ------- ------- Operating income 12,658 12,410 8,290 ------- ------- ------- Other income (expense), net: Investment income 232 298 587 Interest expense (1,138) (748) (446) ------- ------- ------- (906) (450) 141 ------- ------- ------- Income before income taxes and extraordinary item 11,752 11,960 8,431 Provision for income taxes 4,113 4,098 2,934 ------- ------- ------- Income before extraordinary item 7,639 7,862 5,497 Extraordinary item - loss on extinguishment of debt (net of income tax benefit of $ 68) -- 127 -- ------- ------- ------- Net income $ 7,639 $ 7,735 $ 5,497 ======= ======= ======= Earnings per common share - Basic Earnings before extraordinary item 1.57 1.50 1.11 Extraordinary loss on extinguishment of debt - .02 - ---- ---- ---- Net earnings per common share - Basic $ 1.57 $ 1.48 $ 1.11 ==== ==== ==== Basic weighted average shares 4,872 5,233 4,969 ===== ===== ===== Earnings per common share - Diluted Earnings before extraordinary item 1.45 1.39 1.02 Extraordinary loss on extinguishment of debt - .02 - ---- ---- ---- Net earnings per common share - Diluted $ 1.45 $ 1.37 $ 1.02 ==== ==== ==== Diluted weighted average shares 5,285 5,660 5,407 ===== ===== ===== The accompanying notes are an integral part of these financial statements. F-4 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY 52 weeks ended July 30, 2000, August 1, 1999 and August 2, 1998 (In thousands except share data)
Common Stock Additional -------------- Paid-in Retained Treasury Shares Amount Capital Earnings Stock Total --------- -------- ---------- -------- ------- ------- Balance at August 3, 1997 4,209,365 $ 421 8,857 14,093 - $ 23,370 Net income 5,497 5,497 Net proceeds from public offering of 700,000 shares of common stock and 1,265,000 warrants 700,000 70 7,381 7,451 Issuance of common stock in connection with business acquired 313,139 31 3,139 3,170 Exercise of stock options and warrants 175,559 18 885 (538) 365 Tax benefit upon exercise of stock options 1,671 1,671 Purchase of 89,888 shares of treasury stock (1,084) (1,084) Retirement of treasury shares (131,904) (13) (1,609) 1,622 - --------- -------- ---------- -------- -------- -------- Balance at August 2, 1998 5,266,159 $ 527 20,324 19,590 - $ 40,440 Net income 7,735 7,735 Issuance of warrants in connection with business acquired 1,450 1,450 Exercise of stock options and warrants 735,767 73 4,752 (5,989) (1,164) Tax benefit upon exercise of stock options 2,127 2,127 Purchase of 561,050 shares of treasury stock (7,688) (7,688) Retirement of treasury shares (971,643) (97) (13,581) 13,678 - --------- -------- ---------- -------- -------- -------- Balance at August 1, 1999 5,030,283 $ 503 15,072 27,325 - $ 42,900 Net income 7,639 7,639 Issuance of common stock in connection with business acquired 33,841 3 511 514 Exercise of warrants issued in connection with public offering in 1998 1,313,613 131 20,361 20,492 Exercise of stock options and warrants 137,115 14 1,213 (140) 1,087 Tax benefit upon exercise of stock options 304 304 Purchase of 512,000 shares of treasury stock (7,565) (7,565) Retirement of treasury shares (520,982) (52) (7,653) 7,705 - --------- -------- ---------- -------- -------- -------- Balance at July 30, 2000 5,993,870 $ 599 29,808 34,964 - $ 65,371 ========= ======== ========== ======== ======== ========
The accompanying notes are an integral part of these financial statements. F-5 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
52 weeks ended July 30, August 1, August 2, 2000 1999 1998 -------- -------- -------- Cash flows from operating activities: Net Income $ 7,639 $ 7,735 $ 5,497 ------ ------ ------ Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 3,998 3,289 1,869 Gain on sale of fixed assets (21) -- -- Extraordinary loss on extinguishment of debt, net of income taxes -- 127 -- Equity in income of limited partnership (71) (99) (129) (Increase) decrease in deferred tax assets (148) 483 1,207 Increase (decrease) in deferred tax liabilities 342 (141) 173 Changes in operating assets and liabilities: (Increase) in accounts receivable (1,568) (361) (768) Decrease in notes receivable-officers -- -- 2,101 (Increase) decrease in costs incurred and income recognized in excess of billings on uncompleted contracts (146) 1,665 (1,665) (Increase) decrease in other receivables (20) 36 (23) Decrease (increase) in prepaid income taxes -- 377 (377) (Increase) decrease in inventories (1,625) 729 (3,758) Decrease (increase) in prepaid expenses and other 4 199 (55) Increase (decrease) in accounts payable and accrued expenses 685 (2,119) 773 Increase in income taxes payable 1,458 2,019 469 (Decrease) increase in reserve for contract losses (1,038) 360 667 Increase (decrease) in advance payments on contracts 195 (1,620) (1,364) Other, net 170 44 (46) ------ ------ ------ Total adjustments 2,215 4,988 (926) ------ ------ ------ Net cash provided by operations 9,854 12,723 4,571 ------ ------ ------ Cash flows from investing activities: Acquisition of business, net of cash acquired (6,095) (20,101) -- Proceeds from sale of fixed assets 4,142 6 1 Partial distribution from limited partnership -- -- 593 Capital expenditures (2,618) (1,662) (1,645) ------ ------ ------ Net cash used in investing activities (4,571) (21,757) (1,051) ------ ------ ------ Cash flows from financing activities: Net proceeds from public offering of common stock -- -- 7,452 Borrowings under bank line of credit 13,900 29,500 4,050 Proceeds from refinance of mortgage note -- 2,915 -- Proceeds from exercise of stock options and warrants, net 21,574 (1,164) 364 Payments under bank line of credit (26,400) (18,500) (2,550) Payments of long-term debt (1,868) (971) (2,257) Extinguishment of debt -- (3,006) -- Purchase of treasury stock (7,565) (7,688) (1,084) ------ ------ ------ Net cash (used in) provided by financing activities (359) 1,086 5,975 ------ ------ ------ Net increase (decrease) in cash and cash equivalents 4,924 (7,948) 9,495 Cash and cash equivalents at beginning of period 2,741 10,689 1,194 ------ ------ ------ Cash and cash equivalents at end of period $ 7,665 $ 2,741 $ 10,689 ====== ====== ====== Supplemental cash flow information: Cashless exercise of stock options $ 80 $ 5,989 $ 538 ====== ====== ====== Stock issued for business acquired $ 514 -- 3,170 ====== ====== ====== Warrants issued for business acquired $ -- 1,450 -- ====== ====== ====== Tax benefit related to stock options $ 304 2,127 1,671 ====== ====== ======
The accompanying notes are an integral part of these financial statements. F-6 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 commercial wireless, defense and space customers worldwide. 2. Fiscal Year The Company's fiscal year ends on the Sunday closest to July 31. Normally each fiscal year consists of 52 weeks, but every five or six years the fiscal year will consist of 53 weeks. All fiscal years presented consisted of 52 weeks. 3. Basis of Financial Statement Presentation The consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant inter-company accounts and transactions have been eliminated in consolidation. The presentation of financial statements in conformity with generally accepted accounting principles 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 aerospace, communications, and defense 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. The costs attributed to units delivered under long-term contracts and programs are based on the average costs of all units produced. F-7 7. Property, Plant and Equipment Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets. Gains and losses arising from the sale or disposition of property, plant and equipment are recorded in income. 8. Intangibles Intangibles are comprised of customer lists, installed products base, drawings, patents, licenses, certain government qualifications and technology and goodwill in connection with the acquisitions of Robinson Laboratories, Inc. in 2000, General Microwave Corporation in 1999, Metraplex Corporation in 1997, and Vega Precision Laboratories, Inc. in 1993. Intangibles are being amortized over twenty years. Amortization charges totaled $1,109,000, $754,000, and ($71,000) in fiscal 2000, 1999, and 1998, respectively. The negative amortization in 1998 is attributable to the negative goodwill in connection with the acquisition of Stewart Warner Electronics in 1995. The carrying amount of intangibles is evaluated on a recurring basis. Current and future profitability as well as current and future undiscounted cash flows of the acquired businesses are primary indicators of recoverability. For the three fiscal years ended July 30, 2000, there were no adjustments to the carrying amount of the cost in excess of net assets acquired resulting from these evaluations. 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 value. 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. This investment is accounted for under the equity method. 11. Revenue and Cost Recognition 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 when first reasonably determinable. Actual losses could differ from those estimated due to changes in the ultimate manufacturing costs and contract terms. F-8 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. 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. 13. 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. 14. 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 $1,727,000, $1,685,000, and $1,562,000 in fiscal 2000, 1999, and 1998, respectively. NOTE B - ACQUISITIONS 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 is being operated as a division of Herley Industries, Inc. The transaction provided for the payment of $6,000,000 in cash, the issuance of 33,841 shares of Common Stock of the Company valued at $15.188 per share, and the assumption of approximately $3,140,000 in liabilities. In addition, the agreement provides for the issuance of additional shares of Common Stock at a future date, aggregating 97,841shares, based on new orders booked through January 2001. The transaction has been accounted for under the purchase method. Accordingly, the consolidated balance sheet includes the assets and liabilities of Robinson at July 30, 2000, and the consolidated statement of income includes the results of Robinson's operations from January 3, 2000. Excess cost over the fair value of net assets acquired of approximately $5,467,000 is being amortized over 20 years. Pre-acquisition debt in the amount of $1,479,000 was paid during the quarter ended April 30, 2000. On the basis of a pro forma consolidation of the results of operations as if the acquisition had taken place at the beginning of fiscal 1999, unaudited consolidated net sales, net income, basic earnings per share, and diluted earnings per share for the fifty-two weeks ended August 1, 1999 would have been approximately $69,283,000, $7,272,000, $1.39, and $1.28, and approximately $73,246,000, $7,275,000, $1.49, and $1.38, respectively, for the fifty-two weeks ended July 30, 2000. The pro forma information includes adjustments for additional depreciation based on the estimated fair value of the property, plant, and equipment acquired, the amortization of intangibles, and additional interest on bank borrowings arising from the transaction. The pro forma financial information is not necessarily F-9 indicative of the results of operations as they would have been had the transaction been affected at the beginning of fiscal 1999. As of January 4, 1999, the Company completed the acquisition of all of the issued and outstanding common stock of General Microwave Corporation ("GMC"), a New York corporation, including outstanding stock options, for $18.00 per share and 966,675 three-year warrants to purchase one share of the Company's common stock, at an aggregate purchase price of approximately $24,556,000. This transaction was accounted for under the purchase method. The purchase price includes shares of common stock of GMC purchased in the open market, acquisition of the remaining shares of common stock outstanding, an estimate of the fair market value of the warrants based on the trading price of similar warrants currently on the market, and transaction expenses. The warrants are exercisable at $15.60 per share of common stock of the Company, subject to a call provision after October 11, 2000 at $1.00 per warrant if the average last reported sales price of the common stock of the Company has been not less than $17.60 per share for fifteen consecutive trading days immediately preceding the call date. The warrants expire in January 2002. The aggregate purchase price is calculated as follows (in thousands, except share and per share data): 365,600 shares previously acquired in the open market $ 6,273 848,675 shares at $18.00 per share 15,276 118,000 stock options at $18.00 per share, net of exercise price 1,279 966,675 warrants at $1.50 1,450 Transaction expenses 278 Purchase price $ 24,556 The cash portions of the acquisition were financed through available cash equivalents and borrowings under the Company's line of credit. GMC designs, manufactures and markets microwave components and subsystems, and related electronic test and measurement equipment. The company is headquartered in Farmingdale, New York, and operates another facility in Israel. The transaction has been accounted for under the purchase method. Accordingly, the consolidated statements of income include the results of GMC operations from January 4, 1999. The acquisition resulted in excess cost over fair value of net assets acquired of $7,538,501 which is being amortized over 20 years. As part of the Company's GMC acquisition plans, the Company closed GMC's Billerica, MA operations and moved it into the Company's existing Woburn, MA location. In connection with the closure of the Billerica facility, $180,000 of lease termination costs and $250,000 of severance was accrued as part of purchase accounting. Through July 30, 2000, $46,000 of lease termination costs were paid and $200,000 of severance was paid. On the basis of a pro forma consolidation of the results of operations as if the acquisition had taken place at the beginning of fiscal 1998, unaudited consolidated net sales, net income, basic earnings per share, and diluted earnings per share for the fifty-two weeks ended August 2, 1998 would have been approximately $63,477,000, $6,606,000, $1.33, and $1.22, and for the fifty-two weeks ended August 1, 1999 would have been approximately $70,349,000, $7,481,000, $1.43, and $1.32, respectively. The pro forma information includes adjustments for additional depreciation based on the estimated fair market value of the property, plant, and equipment acquired, and the amortization of intangibles arising from the transaction. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been effected at the beginning of fiscal 1998. On August 4, 1997, the Company completed the acquisition of Metraplex Corporation, a Delaware corporation, for 313,139 (as adjusted) shares of common stock of the Company, with a fair market value of $3,170,471, in exchange for all of the issued and outstanding common stock of Metraplex. Metraplex F-10 is a leading manufacturer of pulse code modulation and frequency modulation, telemetry and data acquisition systems for severe environment applications. The transaction has been accounted for by the purchase method. Accordingly, the consolidated statements of income include the results of Metraplex operations from August 4, 1997. The acquisition resulted in excess of cost over fair value of net assets acquired of $2,162,725 which is being amortized over twenty years. NOTE C - NOTES RECEIVABLE-OFFICERS In fiscal 1996 the Company loaned an aggregate of $2,000,000 to certain officers, as authorized by the Board of Directors, pursuant to the terms of nonnegotiable promissory notes. The loans were paid in full with accrued interest as of December 19, 1997. NOTE D - INVENTORIES The major components of inventories are as follows (in thousands): July 30, August 1, 2000 1999 ---- ---- Purchased parts and raw materials $ 12,804 $ 9,862 Work in process 9,358 8,781 Finished products 883 1,237 ------ ------ $ 23,045 $ 19,880 ====== ====== NOTE E - OTHER INVESTMENTS In July 1994, the Company invested $1,000,000 for a limited partnership interest in M.D. Sass Municipal Finance Partners-I, a Delaware limited partnership. The objectives of the partnership are the preservation and protection of its capital and the earning of income through the purchase of certificates or other documentation that evidence liens for unpaid local taxes on parcels of real property. At July 30, 2000 and August 1, 1999 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. In July 1998, the Company received a partial distribution of $593,000 from the Partnership. As of July 30, 2000 the Company's limited partnership interest had an estimated fair value of $1,020,000. NOTE F - PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are comprised of the following (in thousands): July 30, August 1, Estimated 2000 1999 Useful Life -------- --------- ----------- Land $ 1,161 $ 1,161 Building and building improvements 8,418 11,731 10-40 years Machinery and equipment 26,293 24,995 5- 8 years Furniture and fixtures 915 789 5-10 years Automobiles 108 131 3 years Tools 34 34 5 years Leasehold improvements 1,351 455 5-10 years ------ ------ 38,280 39,296 Less accumulated depreciation 20,276 17,408 ------ ------ $ 18,004 $ 21,888 ====== ====== Depreciation charges totaled $2,889,000, $2,535,000, and $1,940,000 in fiscal 2000, 1999, and 1998, respectively. F-11 NOTE G - COMMITMENTS AND CONTINGENCIES Leases The Company leases office, production and warehouse space as well as computer equipment and automobiles under noncancellable operating leases. Rent expense for the 52 weeks ended July 30, 2000, August 1, 1999, and August 2, 1998, was approximately $1,053,000, $519,000, and $546,000, respectively. Minimum annual rentals under noncancellable operating leases are as follows (in thousands): Amount ------ Year ending fiscal 2001 $ 848 2002 727 2003 701 2004 691 2005 624 Future 2,407 Employment Agreements The Company has employment agreements with various executives and employees of the Company, which, as amended, expire at various dates through December 31, 2002, subject to extension each January 1 for three years, commencing January 1, 2000. These agreements provide for aggregate annual salaries for fiscal 2000 of $1,022,000. Certain agreements provide for an annual cost of living adjustment based on the consumer price index, and also provide for incentive compensation based on pretax income of the Company in excess of $2,000,000. Incentive compensation in the amount of $971,000, $969,000, and $728,000 was expensed in fiscal years 2000, 1999, and 1998, respectively. Certain 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 of approximately three times their annual salary. As of July 30, 2000, the amount payable in the event of such termination would be approximately $3,154,000. One of the employment contracts provides for a consulting agreement commencing at the end of the employment period which became effective October 1, 1998, and terminating December 31, 2010 at the annual rate of $100,000. Another one of the employment contracts, as amended October 1, 1998, provides for a consulting period commencing at the end of the period of active employment and continuing for a period of five years at the annual rate of $100,000. Seven officers of the Company have severance agreements providing for a lump-sum payment of $2,020,000 through fiscal 2002 in the event of a change of control of the Company as defined in the agreements. Litigation The Company is involved in various legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations. 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, 2002. At July 30, 2000 stand-by letters of credit aggregating approximately $1,809,000 were F-12 outstanding under this facility. NOTE H - INCOME TAXES Income tax provision consisted of the following (in thousands): 52 Weeks ended --------------------------------------- July 30, August 1, August 2, 2000 1999 1998 ---- ---- ---- Current Federal $ 3,573 $ 3,328 (1) $ 1,469 State 192 399 85 Foreign 154 29 - 3,919 3,756 1,554 Deferred Federal 215 540 1,308 State (21) (198) 72 194 342 1,380 $ 4,113 $ 4,098 $ 2,934 (1) Excludes benefit of $68 from extraordinary loss incurred as a result of early extinguishment of long term debt (See Note I). The Company paid income taxes of approximately $2,241,000, $1,324,000, and $1,486,000 in fiscal 2000, 1999, and 1998, respectively. The following is a reconciliation of the U. S. statutory income tax rate and the effective tax rate on pretax income: 52 Weeks ended ---------------------------------- July 30, August 1, August 2, 2000 1999 1998 ---- ---- ---- U.S. Federal statutory rate 34.0 % 34.0 % 34.0 % State taxes, net of federal tax benefit 0.9 1.4 1.5 Benefit of foreign sales corporation (2.1) (3.2) (1.8) Non-deductible expenses 1.8 1.4 .8 Benefit of foreign and foreign-source income (1.8) (1.2) - Other, net 2.2 1.9 .3 Effective tax rate 35.0 % 34.3 % 34.8 % 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 unremitted earnings of subsidiaries outside the United States permanently. Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. F-13 Components of deferred tax assets and liabilities are as follows (in thousands):
July 30, 2000 August 1, 1999 ---------------------- ----------------------- Deferred Deferred Deferred Deferred Tax Tax Tax Tax Assets Liabilities Assets Liabilities -------- ----------- -------- ----------- Intangibles $ - $ 1,766$ $ - $ 1,790 Alternative minimum tax - - 643 - Accrued vacation pay 323 - 242 - Accrued bonus 578 - 415 - Accrued pension - - 199 - Warranty costs 95 - 123 - Inventory 1,011 - 1,176 - Depreciation - 3,770 - 4,415 Contract losses 345 - 390 - Net operating loss carryforwards 96 - 219 - Other 201 195 266 210 ----- ----- ----- ----- $ 2,649 $ 5,731 $ 3,673 $ 6,415 ===== ===== ===== =====
As of July 30, 2000 the Company has available net operating loss carryforwards for state income tax purposes of approximately $96,000 which expire from fiscal 2001 through 2009. NOTE I- LONG-TERM DEBT Long-term debt is summarized as follows (in thousands): July 30, August 1, Rate 2000 1999 --------------- ---- ---- Revolving loan facility (a) 8.15% and 6.65% $ - $ 12,500 Mortgage note (b) 7.43% 2,840 2,902 Other - 373 293 ----- ------ 3,213 15,695 Less current portion 282 258 ----- ------ $ 2,931 $ 15,437 ===== ====== (a) In January 2000, the Company entered into an amendment to its revolving loan agreement with a bank that provides for a revolving unsecured loan in the aggregate principal amount of $30,000,000 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, 2002. Interest is set at 1.65% over the FOMC Federal Funds Target Rate based on tangible net worth in excess of $25,000,000, or at an increment of 1.80% if tangible net worth is less than $25,000,001. The FOMC Federal Funds Target Rate was 6.50% at July 30, 2000. There is a fee of 15 basis points per annum on the unused portion of the credit line in excess of $20,000,000 payable quarterly. There are no borrowings under the line at July 30, 2000. The agreement contains various financial covenants, including, among other matters, minimum tangible net worth, debt to tangible net worth, debt service coverage, and restrictions on other borrowings. (b) The mortgage loan is for a term of ten years 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 $1,946,000. The proceeds of the mortgage loan were used F-14 to prepay the existing mortgage note having an outstanding balance of $2,890,000 plus a prepayment premium of $115,600. The mortgage note agreement contains various financial covenants, including, among other matters, the maintenance of specific amounts of tangible net worth, debt to tangible net worth, debt service coverage, and restrictions on other borrowings. 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 sheet at July 30, 2000 and are being amortized over the term of the loan (10 years). Unamortized debt expenses of $79,226 related to the prior mortgage and the $115,600 prepayment premium were charged to expense in 1999 as an extraordinary loss in connection with the prepayment of this mortgage note. The Company paid interest of approximately $1,200,000 in 2000, $730,000 in 1999, and $441,000 in 1998. Future payments required on long-term debt are as follows (in thousands): Fiscal year ending during: Amount ------------------------- ------ 2001 $ 282 2002 186 2003 108 2004 106 2005 92 Future 2,439 ----- $ 3,213 ===== NOTE J - ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses include the following (in thousands): July 30, August 1, 2000 1999 ---- ---- Accounts payable $ 3,812 $ 2,668 Accrued payroll and bonuses 3,430 2,636 Accrued commissions 710 488 Accrued interest 19 84 Accrued legal expenses 129 123 Accrued warranty costs 220 284 Accrued pension cost - 499 Accrued severance 594 538 Lease termination cost 134 180 Accrued expenses 554 535 ----- ----- $ 9,602 $ 8,035 ===== ===== NOTE K - EMPLOYEE BENEFIT PLANS In August 1985, the Board of Directors approved an Employee Savings 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. Employees of 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 F-15 company matching contributions and has been frozen. The Company has recognized expenses of approximately $415,000, $266,000 and $197,000 for the 52 weeks ended July 30, 2000, August 1, 1999 and August 2, 1998, respectively. 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 part of the allocation of the purchase price, the Company recorded a liability at the date of acquisition of $464,000. Net pension (income) expense recorded by the Company in fiscal 2000 and 1999 includes the following components (in thousands): July 30, August 1, 2000 1999 ---- ---- Service cost - benefits earned during the period $ - $ 21 Interest cost 237 137 Return on assets (736) (123) --- --- Net pension (income) expense $ (499) $ 35 === === The following table sets forth the plan's funded status and amounts recognized in the consolidated balance sheets at July 30, 2000 and August 1, 1999 (in thousands): July 30, August 1, 2000 1999 ---- ---- Projected benefit obligation, beginning of period $ 4,841 $ 4,793 Service costs - 21 Interest cost 237 137 Actuarial gain (348) - Benefit payments (214) (110) Projected benefit obligation, end of year $ 4,516 $ 4,841 Change in fair value of plan assets: Fair value at beginning of period $ 4,342 $ 4,329 Return on assets 823 123 Benefit payments (214) (110) Fair value at end of year 4,951 4,342 Funded status (435) 499 Unrecognized net gain 435 - Accrued pension costs $ - $ 499 Assumptions used were: Discount rate 5.00% 5.00% Expected return on plan assets 10.00% 5.00% Assets held by the trust are comprised primarily of U.S. Treasury securities. NOTE L - RELATED PARTY TRANSACTIONS 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 F-16 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 M - COMPUTATION OF PER SHARE EARNINGS The following table shows the calculation of basic earnings per share and earnings per share assuming dilution (in thousands except per share data):
52 Weeks ended --------------------------------- July 30, August 1, August 2, 2000 1999 1998 ---- ---- ---- Numerator: Income before extraordinary item $ 7,639 $ 7,862 $ 5,497 Extraordinary loss - 127 - ----- ----- ----- Net Income $ 7,639 $ 7,735 $ 5,497 ===== ===== ===== Denominator: Basic weighted-average shares 4,872 5,233 4,969 Effect of dilutive securities: Employee stock options and warrants 413 427 438 ----- ----- ----- Diluted weighted-average shares 5,285 5,660 5,407 ===== ===== ===== Stock options and warrants not included in computation 1,648 3,047 1,424 ===== ===== =====
The number of stock options and warrants not included in the computation of diluted EPS relates to stock options and warrants having exercise prices that are greater than the average market price of the common shares during the period, and therefore, are antidilutive. The options and warrants with exercise prices ranging from $15.60 to $17.88, which expire at various dates through May 26, 2010 were outstanding as of July 30, 2000. NOTE N - SHAREHOLDERS' EQUITY At the annual meeting of stockholders held on February 18, 1998, the stockholders of the Company approved a proposal to amend the Certificate of Incorporation to increase the authorized shares of Common Stock from 10,000,000 to 20,000,000 shares. In December 1997, the Company completed the sale of 1,100,000 shares of common stock to the public, of which 700,000 shares were sold by the Company and 400,000 shares were sold by certain selling stockholders. In addition, the Company also sold 1,265,000 Common Stock Purchase Warrants ("Warrant(s)"). The Company received net proceeds of $7,451,579 after underwriting discounts and commissions and other expenses of the offering. Each Warrant entitles the holder to purchase one share of common stock at $15.60 per share (subject to adjustment under certain conditions) through May 2000, as extended. The Company also issued to the underwriters, for their own accounts, Managing Underwriters' Warrants which entitle the holder to purchase 110,000 shares of common stock of the Company (subject to adjustment under certain circumstances), at a price of $14.40 per share through December 2002, and the right to purchase 110,000 Warrants (as described above) at a price of $.12 per Warrant through May 2000, as extended. Approximately 1,314,000 of the warrants which were due to expire May 18, 2000 were exercised at $15.60 per share of common stock resulting in proceeds of approximately $20,492,000. The proceeds were used to pay off the bank debt under the revolving credit facility. On September 4, 1997 the Board of Directors declared a 4-for-3 stock split effected as a stock dividend payable September 30, 1997 to holders of record on September 15, 1997. The amount of $105,234 was transferred from additional paid-in capital to the common stock account to record this distribution. All share and per share data, including stock options and warrants, included in the financial statements have been restated to reflect the stock split. F-17 The Company has various fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company applies APB Opinion No. 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock option plans. Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for options granted is estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management' s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of computing pro-forma (unaudited) consolidated net earnings, the following assumptions were used to calculate the fair value of each option granted: 52 Weeks ended ---------------------------- July 30, 2000 August 1, 1999 August 2, 1998 ------------- -------------- -------------- Expected life of options .71 years .65 years .40 years Volatility .72 .58 .59 Risk-free interest rate 6.1% 5.1% 4.9% Dividend yield zero zero zero Had compensation cost for stock options granted in fiscal years 2000, 1999, and 1998 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): 2000 1999 1998 ---- ---- ---- Net income - as reported $7,639 $7,735 $5,497 Net income - pro forma 5,952 5,940 4,925 Earnings per share - as reported Basic $1.57 $1.48 $1.11 Diluted 1.45 1.37 1.02 Earnings per share - pro forma Basic $1.22 $1.14 $.99 Diluted 1.13 1.05 .91 The effects of applying the pro forma disclosures of SFAS 123 are not likely to be representative of the effects on reported net income for future years due to the various vesting schedules. In April 1998, the Board of Directors approved the 1998 Stock Option Plan which covers 1,500,000 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 is determined at the time of grant by the Board of Directors. The options expire ten years from the date of grant, subject to certain restrictions. Options for 646,500 and 375,000 shares F-18 were granted during the fiscal years ended July 30, 2000 and August 1, 1999, respectively. In May 1997, the Board of Directors approved the 1997 Stock Option Plan which covers 1,666,666 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 is determined at the time of grant by the Board of Directors. The options expire ten years from the date of grant, subject to certain restrictions. Options for 86,000, 875,500 and 88,333 shares were granted during the fiscal years ended July 30, 2000, August 1, 1999 and August 2, 1998, respectively. In October 1995, the Board of Directors approved the 1996 Stock Option Plan which covers 666,666 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 is determined at the time of grant by 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 663,989 shares were granted during the fiscal year ended August 3, 1997. A summary of stock option activity under all plans for the 52 weeks ended July 30, 2000, August 1, 1999 and August 2, 1998 follows:
Non-Qualified Stock Options ----------------------------------------- Weighted Warrant Agreements Average ------------------------ Number Price Range Exercise Number Price Range of shares per share Price of shares per share --------- -------------- -------- --------- ------------- Outstanding August 3, 1997........... 916,327 $ 2.54 -10.41 $ 5.87 320,000 $ 4.64 - 5.35 Granted .......................... 88,333 10.31 -13.88 12.04 Exercised......................... (135,594) 2.54 - 6.94 5.08 (40,000) 5.35 Canceled.......................... (8,222) 2.54 - 6.47 5.31 --------- ------------- ----- ------- ----------- Outstanding August 2, 1998........... 860,844 $ 2.54 -13.88 $ 6.65 280,000 $ 4.64 Granted .......................... 1,250,500 9.25 -16.46 11.44 Exercised......................... (669,100) 2.54 - 9.94 6.56 (66,667) 4.64 Canceled.......................... (47,631) 6.47 -16.46 11.16 --------- ------------- ----- ------- ----------- Outstanding August 1, 1999........... 1,394,613 $ 2.54 -16.46 $10.74 213,333 $ 4.64 Granted .......................... 732,500 13.88 -17.88 15.51 Exercised......................... (103,990) 2.54 -14.75 7.03 4.64 Canceled.......................... (13,700) 11.13 -15.69 12.72 --------- ------------- ----- ------- ----------- Outstanding July 30, 2000............ 2,009,423 $ 6.09 -17.88 $12.65 213,333 $ 4.64 ========= =======
F-19 Options Outstanding and Exercisable by Price Range as of July 30, 2000:
Options Outstanding Options Exercisable ---------------------------------------------- -------------------------- Weighted Average Weighted Weighted Range of Exercise Number Remaining Average Number Average Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price ----------------- ----------- ---------------- -------------- ----------- -------------- $ 6.09 - $ 9.25 517,323 7.5 $ 8.27 312,133 $ 7.96 10.41 - 13.88 577,100 8.7 12.46 331,300 12.16 13.94 - 15.00 280,500 8.9 14.01 257,600 13.96 15.69 - 17.88 634,500 8.0 15.80 372,000 15.70 $6.09 - $17.88 2,009,423 8.2 $12.65 1,273,033 $12.53
In April 1993, common stock warrants were issued to certain officers and directors for the right to acquire 573,333 shares of common stock of the Company at the fair market value of $5.35 per share at date of issue. In December 1995 warrants for 533,333 shares were canceled, and the remaining 40,000 warrants were exercised in fiscal 1998. In December 1995, common stock warrants were issued to certain officers for the right to acquire 293,333 shares of common stock of the Company at the fair market value of $4.64 per share at date of issue. The warrants vest immediately and expire December 13, 2005. NOTE O - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, AND EXPORT SALES The Company's chief operating decision maker is considered to be the Chairman and Chief Executive Officer (CEO). The Company's CEO evaluates both consolidated and disaggregated financial information consisting of revenue information in deciding how to allocate resources and assess performance. The CEO uses certain disaggregated financial information for the Company's two product groups: Space and Communications and Microwave Components. The Company does not determine a measure of operating income or loss by product group. The Company's two 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 is in a single reportable segment as a provider of complex microwave radio frequency (RF) and millimeter wave components and subsystems for commercial wireless, defense and space customers worldwide. All of the Company's revenues result from sales of its products. Revenues by product group (as defined by the Company) for fiscal years 2000, 1999 and 1998 were as follows: Space and Communications, $27,590,000, $33,846,000 and $30,338,000, respectively; Microwave Components, $42,947,000, $27,190,000, and $10,460,000, respectively. Net sales to the U.S. Government in 2000, 1999, and 1998 accounted for approximately 26%, 17%, and 26% of net sales, respectively. No other customer accounted for shipments in excess of 10% of consolidated net sales in fiscal 2000. One customer accounted for 12% of net sales in 1999. Foreign sales amounted to approximately $16,506,000, $17,680,000, and $11,943,000 in fiscal 2000, 1999 and 1998, respectively. Included in accounts receivable as of July 30, 2000 and August 1, 1999 are amounts due from the U.S. Government of approximately $2,269,000 and $2,470,000 respectively. 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. F-20 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 was estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rate for similar types of borrowing arrangements. The carrying amounts and fair values of the Company's financial instruments are presented below (in thousands): July 30, 2000 ---------------- Carrying Fair Amount Value -------- ----- Cash and cash equivalents $7,665 $7,665 Long-term debt 2,931 2,931 NOTE Q - SUBSEQUENT EVENTS The Company entered into an agreement, as of August 28, 2000, to acquire substantially all of the assets of American Microwave Technology, Inc. ("AMT"), a California corporation, which is being operated as Herley- AMT, a division of Herley Industries, Inc. The transaction, which closed on October 12, 2000, provided for the payment of $5,400,000 in cash, and the assumption of approximately $1,153,000 in liabilities. The transaction will be accounted for under the purchase method of accounting. The allocation of the aggregate estimated purchase price will be determined based on detailed reviews of the fair value of assets acquired and liabilities assumed. Any excess cost over the fair value of net assets acquired will be amortized over 20 years. The Company also entered into an exclusive license agreement with AMT related to certain application specific and wireless products under which the Company will pay a royalty of 10% of net sales of these products for a period of four years, after which no additional royalty will be due. On October 13, 2000 the Company notified the holders of the warrants issued in connection with the acquisition of GMC (see Note B) of its intent to call the warrants at a price of $1.00 per warrant effective 30 days after notice. The holders of the warrants may elect to exercise the warrant for one share of common stock of the Company at $15.60 per share. F-21