10-Q 1 filing10q050403.txt FORM 10Q QUARTER ENDED MAY 4, 2003 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended: May 4, 2003 ----------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 0-5411 HERLEY INDUSTRIES, INC. ---------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE #23-2413500 ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 101 North Pointe Boulevard, Lancaster, Pennsylvania 17601 --------------------------------------------------- ------------ (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, including Area Code: (717) 735-8117 -------------- 3061 Industry Drive, Lancaster, Pennsylvania 17603 -------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. [ ] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of June 10, 2003 - 13,860,901 shares of Common Stock. HERLEY INDUSTRIES, INC AND SUBSIDIARIES INDEX TO FORM 10-Q PAGE PART I - FINANCIAL INFORMATION Item 1 - Financial Statements: Condensed Consolidated Balance Sheets - May 4, 2003 and July 28, 2002 2 Condensed Consolidated Statements of Income - For the Thirteen and Forty weeks ended May 4, 2003 and Thirteen and Thirty-nine weeks ended April 28, 2002 3 Condensed Consolidated Statement of Shareholders' Equity- For the Forty weeks ended May 4, 2003 4 Condensed Consolidated Statements of Cash Flows - For the Forty weeks ended May 4, 2003 and Thirty-nine weeks ended April 28, 2002 5 Notes to Condensed Consolidated Financial Statements 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 21 Item 4 - Controls and Procedures 22 PART II -OTHER INFORMATION Item 1 - Legal Proceedings 22 Item 6 - Exhibits and Reports on Form 8K 23 Signatures 24 Certifications pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002 25
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands except share data) May 4, July 28, 2003 2002 --------- -------- (Unaudited) ASSETS Current Assets: Cash and cash equivalents $ 79,098 $ 86,210 Accounts receivable 14,624 14,486 Costs incurred and income recognized in excess of billings on uncompleted contracts 3,263 6,882 Other receivables 558 274 Inventories, net of reserve of $2,522 in fiscal 2003 and $2,407 in fiscal 2002 39,430 33,371 Prepaid income taxes - 382 Deferred taxes and other 2,588 2,670 ------- ------- Total Current Assets 139,561 144,275 Property, Plant and Equipment, net 22,572 22,231 Goodwill 27,106 21,665 Intangibles, net of accumulated amortization of $176 in fiscal 2003 and $145 in fiscal 2002 392 423 Available-For-Sale Securities 46 46 Other Investments 160 195 Other Assets 1,062 1,367 ------- ------- $ 190,899 $ 190,202 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt $ 713 $ 215 Accounts payable and accrued expenses 11,144 12,857 Income taxes payable 1,327 - Reserve for contract losses 975 820 Advance payments on contracts 1,636 1,371 ------- ------- Total Current Liabilities 15,795 15,263 Long-term Debt 6,519 5,684 Deferred Income Taxes 3,897 3,897 ------- ------- 26,211 24,844 ------- ------- Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 20,000,000 shares; issued and outstanding 13,993,201 at May 4, 2003 and 14,680,960 at July 28, 2002 1,399 1,468 Additional paid-in capital 105,995 116,579 Retained earnings 57,539 47,541 Accumulated other comprehensive loss (245) (230) ------- ------- Total Shareholders' Equity 164,688 165,358 ------- ------- $ 190,899 $ 190,202 ======= =======
The accompanying notes are an integral part of these financial statements. 2
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In thousands except per share data) Thirteen weeks ended Forty Thirty-nine ----------------------- weeks ended weeks ended May 4, April 28, May 4, April 28, 2003 2002 2003 2002 ------ ------ ------ ------ Net sales $ 26,897 $ 23,499 $ 79,202 $ 67,552 ------ ------ ------ ------ Cost and expenses: Cost of products sold 18,046 15,176 52,487 44,554 Selling and administrative expenses 3,839 3,629 11,628 10,291 Litigation costs 241 585 1,069 956 Plant closing costs - - - 406 ------ ------ ------ ------ 22,126 19,390 65,184 56,207 ------ ------ ------ ------ Income from operations 4,771 4,109 14,018 11,345 Other income (expense), net 155 (31) 642 55 ------ ------ ------ ------ Income from continuing operations before income taxes 4,926 4,078 14,660 11,400 Provision for income taxes 1,567 1,386 4,662 3,876 ------ ------ ------ ------ Income from continuing operations 3,359 2,692 9,998 7,524 Loss from discontinued operations (including loss on net assets held for sale of $1,166 in 2002) net of income taxes - - - (921) ------ ------ ------ ------ Income before cumulative effect of change in accounting principle 3,359 2,692 9,998 6,603 Cumulative effect of adopting SFAS 142 - - - (4,637) ------ ------ ------ ------ Net income $ 3,359 $ 2,692 $ 9,998 $ 1,966 ====== ====== ====== ====== Earnings (loss) per common share - Basic Income from continuing operations $ .24 $ .23 $ .69 $ .67 Loss from discontinued operations - - - (.08) Cumulative effect of adopting SFAS 142 - - - (.42) --- --- --- --- Net earnings $ .24 $ .23 $ .69 $ .18 === === === === Basic weighted average shares 14,218 11,559 14,449 11,164 ====== ====== ====== ====== Earnings (loss) per common share - Diluted Income from continuing operations $ .23 $ .22 $ .66 .62 Loss from discontinued operations - - - (.08) Cumulative effect of adopting SFAS 142 - - - (.38) --- --- --- --- Net earnings $ .23 $ .22 $ .66 $ .16 === === === === Diluted weighted average shares 14,848 12,495 15,175 12,099 ====== ====== ====== ======
The accompanying notes are an integral part of these financial statements. 3
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED) Forty weeks ended May 4, 2003 (In thousands except share data) Accumulated Common Stock Additional Other ------------ Paid-in Retained Treasury Comprehensive Shares Amount Capital Earnings Stock Loss Total ------ ------ ------- -------- ----- ---- ----- Balance at July 28, 2002 14,680,960 $ 1,468 116,579 47,541 - (230) $ 165,358 Net income 9,998 9,998 Exercise of stock options 88,649 9 695 704 Tax benefit upon exercise of stock options 830 830 Purchase of 776,408 shares of treasury stock (12,187) (12,187) Retirement of treasury shares (776,408) (78) (12,109) 12,187 - Other comprehensive loss: Unrealized loss on interest rate swap (21) (21) Foreign currency translation gain 6 6 ---------- ----- ------- ------- ------ --- ------- Balance at May 4, 2003 13,993,201 $ 1,399 105,995 57,539 - (245) $ 164,688 ========== ===== ======= ======= ====== === =======
The accompanying notes are an integral part of these financial statements. 4
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands) Forty Thirty-nine weeks ended weeks ended May 4, April 28, 2003 2002 ---- ---- Cash flows from operating activities: Income from continuing operations $ 9,998 $ 7,524 ------ ------ Adjustments to reconcile income from continuing operations to net cash provided by operations: Depreciation and amortization 3,005 2,885 Loss on sale of fixed assets - 68 Equity in income of limited partnership (14) (52) (Increase) in deferred tax assets - (743) Changes in operating assets and liabilities: (Increase) decrease in accounts receivable (138) 273 Decrease (increase) in costs incurred and income recognized in excess of billings on uncompleted contracts 2,439 (6,129) (Increase) in other receivables (111) (444) (Increase) in inventories (5,731) (3,217) Decrease in prepaid expenses and other 755 - (Decrease) increase in accounts payable and accrued expenses (2,266) 1,029 (Decrease) in billings in excess of costs incurred and income recognized on uncompleted contracts - (531) Increase in income taxes payable 2,157 3,405 (Decrease) increase in reserve for contract losses (554) 9 Increase in advance payments on contracts 265 1,225 Other, net 241 (108) ------ ------ Total adjustments 48 (2,330) ------ ------ Net cash provided by operating activities 10,046 5,194 ------ ------ Cash flows from investing activities: Investment of unexpended industrial revenue bond proceeds - (353) Investment in technology license - (500) Acquisition of business, net of cash acquired (2,542) - Payment of deferred purchase price of acquired business - (3,000) Partial distribution from limited partnership 49 573 Capital expenditures (2,994) (4,819) ------ ------ Net cash used in investing activities (5,487) (8,099) ------ ------ Cash flows from financing activities: Borrowings under bank line of credit - 4,300 Proceeds from industrial revenue bond financing - 3,000 Proceeds from exercise of stock options and warrants 704 3,654 Payments under lines of credit - (4,300) Payments of long-term debt (188) (172) Purchase of treasury stock (12,187) (3,848) ------ ------ Net cash (used in) provided by financing activities (11,671) 2,634 ------ ------ Net cash provided by discontinued operations - 559 ------ ------ Net (decrease) increase in cash and cash equivalents (7,112) 288 Cash and cash equivalents at beginning of period 86,210 13,041 ------ ------ Cash and cash equivalents at end of period $ 79,098 $ 13,329 ====== ======
The accompanying notes are an integral part of these financial statements. 5 Herley Industries, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements - (Unaudited) 1. The condensed consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant inter-company accounts and transactions have been eliminated in consolidation. In the opinion of the Company's management, the accompanying condensed consolidated financial statements reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position and results of operations and cash flows for the periods presented. These financial statements (except for the balance sheet presented at July 28, 2002) are unaudited and have not been reported on by independent public accountants. Results of operations for interim periods are not necessarily indicative of the results of operations for a full year due to external factors which are beyond the control of the Company. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows of the Company. In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment of long-lived assets and for long- lived assets to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for segments of a business to be disposed of, but retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The provisions of this statement were adopted by the Company effective on July 30, 2001. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement is effective for fiscal years beginning after May 15, 2002. SFAS 145 requires, among other things, eliminating reporting debt extinguishments as an extraordinary item in the income statement. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows of the Company. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The statement is effective for fiscal years beginning after December 31, 2002. SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Management does not believe the adoption of this standard will have a material impact on the Company's financial position or results of operations. 6 In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123." The new statement is effective, with respect to the transition provisions, for fiscal years ending after December 15, 2002; and with respect to the disclosure provisions, for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. SFAS No. 148 provides transition alternatives for companies adopting the fair value recognition provisions of FASB Statement No. 123 for stock-based employee compensation; and requires the pro forma disclosures of SFAS No. 123 in interim condensed financial statements for companies continuing to rely on APB Opinion No. 25 as if the provisions of SFAS No. 123 had been adopted. The statement also requires that the pro-forma disclosures of the impact on earnings and earnings-per-share be provided in a tabular format and included in the Summary of Significant Accounting Policies or equivalent. The effect of the adoption of SFAS No. 148 was the inclusion of the required disclosures in Note 1 of the Company's condensed consolidated interim financial statements in quarterly reports beginning with this initial Form 10-Q for the 13 weeks ended May 4, 2003, and the addition of a significant accounting policies Note 1 to be included in the Company's Annual Report on Form 10K for the year ending August 3, 2003. The Company has various fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company continues to use the intrinsic value method in accordance with the recognition and measurement principles of APB Opinion No. 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123 and SFAS 148. Accordingly, no stock-based employee compensation cost has been recognized for options granted under the stock option plans. Pro forma information regarding net income and earnings per share as required by Statements 123 and 148 has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value for options granted is estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. For purposes of computing pro-forma (unaudited) consolidated net earnings, the following assumptions were used to calculate the fair value of each option granted for all periods presented: Expected life of options 1.51 years Volatility .68 Risk-free interest rate 2.8% Dividend yield zero Had compensation cost for stock options granted in the first nine months of fiscal years 2003 and 2002 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): 7
Thirteen weeks ended Forty Thirty-nine -------------------- weeks ended weeks ended May 4, April 28, May 4, April 28, 2003 2002 2003 2002 ---- ---- ---- ---- Net income - as reported $ 3,359 $ 2,692 $ 9,998 $ 1,966 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (283) (688) (1,655) (1,293) -------- ------ ------- ------- Net income - pro forma $ 3,076 $ 2,004 $ 8,343 $ 673 ===== ===== ===== ====== Earnings per share - as reported Basic $ .24 $ .23 $ .69 $ .18 Diluted .23 .22 .66 .16 Earnings per share - pro forma Basic $ .22 $ .17 $ .58 $ .06 Diluted .21 .16 .55 .06
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 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 Derivative Instruments and Hedging Activities." The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. The Statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The provisions of Statement 149 that relate to Statement 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, will continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, will apply to existing contracts, as well as new contracts entered into after June 30, 2003. Management has determined that the adoption of this Statement will not have a significant impact on the financial position, results of operations or cash flows of the Company. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. Many of such instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. The Statement is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of the date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. Management believes that the adoption of this Statement will not have a significant impact on the financial position, results of operations or cash flows of the Company. 8 2. The Company entered into an agreement as of September 1, 2002, to acquire all of the issued and outstanding common stock of EW Simulation Technology, Limited ("EWST"), a British company of Aldershot, UK, which operates as a wholly-owned subsidiary. EWST designs, develops and produces electronic warfare simulator systems for prime defense contractors and countries worldwide. The acquisition of EW Simulation Technology was driven by a two part strategic initiative: a) to leverage the Company's microwave expertise vertically into the international threat and jamming simulator markets, and b) to increase the amount of microwave content supplied by the Company on each simulator platform. This strategy will expand international revenues from new sources and increase content to existing customers. The transaction, which closed on September 20, 2002, provides for payment of $3,000,000 in cash and a note for $1,500,000, including interest at 1.8% based on LIBOR at the date of acquisition, payable in annual installments of $500,000. The transaction has been accounted for in accordance with the provisions of SFAS No. 141, "Business Combinations", which requires that all business combinations be accounted for using the purchase method. The condensed consolidated financial statements reflect preliminary estimates of the fair value of the assets acquired and liabilities assumed and the related allocations of the purchase price, and preliminary estimates of adjustments necessary to conform EWST data to the Company's accounting policies. The Company has engaged an independent third party to complete a valuation of the intangible assets of EWST as of the acquisition date. The final valuation of intangible assets is expected to be completed in the fourth quarter of fiscal 2003. The final determination of the fair value of assets acquired and liabilities assumed and final allocation of the purchase price may differ from the amounts included in the accompanying condensed consolidated financial statements. The excess cost over the preliminary estimated fair value of net assets acquired of approximately $5,423,000 has been recorded as goodwill. 3. In September 2000, the Company acquired all of the issued and outstanding common stock of Terrasat, Inc. ("Terrasat"), a California corporation, for cash of $6,000,000, $3,000,000 of which was paid in December 2000 and $3,000,000 of which was paid in December 2001. In addition, the agreement provided for additional cash payments in the future up to $2,000,000, based on gross revenues through December 31, 2001. The targeted gross revenues under the agreement were not achieved, therefore no addition cash payments were made. In January 2002 the Board of Directors of the Company determined that Terrasat would no longer be able to generate sufficient returns to justify continued investment due to the overcapacity in the telecom industry and deteriorating economic conditions in Terrasat's primary markets. Therefore, the Company decided to discontinue the operations of Terrasat and to seek a purchaser for the business. Consequently, the accompanying condensed consolidated financial statements reflect Terrasat as discontinued operations in accordance with SFAS No. 144. Results of operations and cash flows of Terrasat have been classified in the January 2002 financial statements as "Loss from discontinued operations", and "Net cash used in discontinued operations", respectively. The sale of certain assets and liabilities, and the business of Terrasat was consummated on March 1, 2002, effective the close of business January 27, 2002, to certain current employees of Terrasat for cash and a note which approximates the value of the net assets held for sale as of January 27, 2002 of $878,000. 9 Summarized below are the results of discontinued operations (in thousands): Thirty-nine weeks ended April 28, 2002 Net sales $ 2,147 ----- Loss from discontinued operations (229) Loss on net assets held for sale (1,166) Income tax benefit (474) ----- Net loss from discontinued operations $ (921) ===== 4. Inventories at May 4, 2003 and July 28, 2002 are summarized as follows (in thousands):
May 4, 2003 July 28, 2002 ----------- ------------- Purchased parts and raw materials $ 18,833 $ 18,680 Work in process 21,283 15,707 Finished products 1,836 1,391 ------ ------ 41,952 35,778 Less reserve for excess and obsolete materials 2,522 2,407 ------ ------ $ 39,430 $ 33,371 ====== ======
5. The Company recognizes all derivatives on the balance sheet at fair value. On the date the derivative instrument is entered into, the Company generally designates the derivative as either (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment ("fair value hedge") or (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow hedge"). Changes in the fair value of a derivative that is designated as, and meets all the required criteria for, a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is designated as, and meets all the required criteria for, a cash flow hedge are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. The portion of the change in fair value of a derivative associated with hedge ineffectiveness or the component of a derivative instrument excluded from the assessment of hedge effectiveness is recorded currently in earnings. Also, changes in the entire fair value of a derivative that is not designated as a hedge are recorded immediately in earnings. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes relating all derivatives that are designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the inception of the hedge and on an ongoing basis, whether each derivative is highly effective in offsetting changes in fair values or cash flows of the hedged item. If it is determined that a derivative is not highly effective as a hedge or if a derivative ceases to be a highly effective hedge, the Company will discontinue hedge accounting prospectively. In October 2001, the Company entered into an interest rate swap with a bank pursuant to which it exchanged floating rate interest in connection with the East Hempfield Township Industrial Development Authority Variable Rate Demand/Fixed Rate Revenue Bonds Series 2001(the "Bonds") on a notional amount of $3,000,000 for a fixed rate of 4.07% for a 10 year period ending October 1, 2011. The notional amount reduces each year in tandem with the annual installments due on the Bonds. The fixing of the interest rate for this period 10 offsets the Company's exposure to the uncertainty of floating interest rates on the Bonds, and as such has been designated as a cash flow hedge. The hedge is deemed to be highly effective and any ineffectiveness will be recognized in interest expense in the reporting period. The fair value of the interest rate swap was a liability of approximately $118,000, net of income taxes, as of May 4, 2003. There was no material hedge ineffectiveness related to cash flow hedges during the period to be recognized in earnings. There was no gain or loss reclassified from accumulated other comprehensive income into earnings during the quarter ended May 4, 2003 as a result of the discontinuance of a cash flow hedge due to the probability of the original forecasted transaction not occurring. 6. In July 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible Assets," which requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non- amortization approach, goodwill will not be amortized into results of operations, but instead will be reviewed for impairments, which will be charged to results of operations in the periods in which the recorded value of goodwill is more than its fair value. The provisions of this statement were adopted by the Company on July 30, 2001. The adoption of SFAS No.142 resulted in the Company's discontinuation of amortization of its goodwill as of July 30, 2001. In connection with the adoption of SFAS 142, the Company was required to assess goodwill for impairment within six months of adoption, and completed its assessment in the second quarter of fiscal 2002. The Company operates as a single integrated business and as such has one operating segment which is also the reportable segment as defined in SFAS 131. Within the operating segment, the Company has identified two components as reporting units as defined under SFAS 142, defense electronics and commercial technologies. The Company has determined the carrying value of each reporting unit by assigning assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of July 30, 2001. The Company determined that an impairment of goodwill in the commercial technologies unit had occurred, and accordingly, a transition adjustment in the amount of $4,637,000 was recorded as of July 30, 2001 as a cumulative effect of a change in accounting principle. There is no tax benefit associated with the adjustment since the impaired goodwill is not deductible for income tax purposes. The change in the carrying amount of goodwill, based upon the preliminary estimates of the fair value of assets acquired and liabilities assumed related to the acquisition of EWST (See Note 2), for the nine months ended May 4, 2003 is as follows (in thousands): Balance at July 28, 2002 $ 21,665 Goodwill acquired during period 5,441 ------ Balance at May 4, 2003 $ 27,106 ====== An annual impairment test is performed in the fourth quarter of each fiscal year and any future impairment of goodwill will be charged to operations. Intangibles, consisting of patents having an estimated useful life of fourteen years, are carried at an aggregate gross amount of $568,000 with accumulated amortization at May 4, 2003 of $176,000. Amortization expense for the thirteen weeks ended May 4, 2003 and April 28, 2002 was approximately $10,000, and for the Forty and Thirty-nine weeks ended May 4, 2003 and April 28, 2002 was approximately $31,000. Estimated annual amortization expense for each of the next five fiscal years is approximately $41,000. 7. 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 11 such litigation will not have a material adverse effect on the Company's financial position or results of operations. In connection with the Robinson Laboratories, Inc. litigation, as discussed in Part II, Item 1. "Legal Proceedings", at a proceeding on April 28, 2003, the Court decided to delay ruling on all of the petitions for fees and costs until after appeals are exhausted. Accordingly, by Order dated May 6, 2003, the Court denied without prejudice all of the parties' petitions. On May 12, 2003, Herley filed its appeal to the United States Court of Appeals for the Second Circuit. No appeals have been filed by Robinson or RLI at this time, although Herley anticipates that appeals will be filed. 8. The following tables show the calculation of basic and diluted weighted-average shares outstanding (in thousands):
Thirteen weeks ended ----------------------------- May 4, 2003 April 28, 2002 Basic weighted-average shares 14,218 11,559 Effect of dilutive securities: Employee stock options and warrants 630 936 ------ ------ Diluted weighted-average shares 14,848 12,495 ====== ======
Options to purchase 707,000 weighted shares of common stock, with exercise prices ranging from $15.90 to $19.52, were outstanding during the second quarter of fiscal 2003, but were not included in the computation of diluted EPS because the exercise price is greater than the average market price of the common stock. The options, which expire through May 21, 2012, were still outstanding as of May 4, 2003. There were no anti- dilutive options outstanding during the third quarter of fiscal 2002.
Forty Thirty-nine weeks ended weeks ended May 4, 2003 April 28, 2002 ----------- -------------- Basic weighted-average shares 14,449 11,164 Effect of dilutive securities: Employee stock options and warrants 726 935 ------ ------ Diluted weighted-average shares 15,175 12,099 ====== ======
Options to purchase 697,911 weighted shares of common stock, with exercise prices ranging from $16.80 to $19.52, were outstanding during the first nine months of fiscal 2003, but were not included in the computation of diluted EPS because the exercise price is greater than the average market price of the common stock. The options, which expire through May 21, 2012, were still outstanding as of May 4, 2003. Options to purchase 3,077 weighted shares of common stock, with an exercise prices of $17.42, were outstanding during the first nine months of fiscal 2002, but were not included in the computation of diluted EPS because the exercise price is greater than the average market price of the common stock. 9. In March 2003, the Board of Directors approved the 2003 Stock Option Plan which covers 1,000,000 shares of the Company's common stock. Options granted under the plan are non-qualified stock options. Under the terms of the plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. The nature and terms of the options to be granted are determined at the time of grant by the compensation committee or the board of directors. The options expire no later than ten years from the date of grant, subject to certain restrictions. No options have been granted under the plan. 12 10. The components of comprehensive income are as follows (in thousands):
Thirteen weeks ended Forty Thirty-nine -------------------- weeks ended weeks ended May 4, April 28, May 4, April 28, 2003 2002 2003 2002 ---- ---- ---- ---- Net income $ 3,359 $ 2,692 $ 9,998 $ 1,966 Unrealized loss on interest rate swap (9) - (21) - Foreign currency translation gain 47 - 6 - ----- ----- ----- ----- Comprehensive income $ 3,397 $ 2,692 $ 9,983 $ 1,966 ===== ===== ===== =====
The components of accumulated other comprehensive loss is as follows (in thousands): May 4, 2003 ----------- Unrealized loss from available-for-sale securities $ 66 Unrealized loss on interest rate swap 118 Foreign currency translation loss 61 ---- Accumulated other comprehensive loss $ 245 === 11. Supplemental cash flow information is as follows (in thousands):
Forty Thirty-nine weeks ended weeks ended May 4, 2003 April 28, 2002 ----------- -------------- Cash paid during the period for: Interest $ 260 $ 232 Income taxes 4,296 475 Cashless exercise of stock options - 8,026 Tax benefit related to stock options 830 6,710 Note issued for business acquired 1,500 -
13 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Certain statements contained in this report are "forward-looking statements" that involve various important assumptions, risks, uncertainties and other factors which could cause the Company's actual results to differ materially from those expressed in such forward-looking statements. Forward-looking statements can be identified by terminology such as "may", "will", "should", "expects", "intends", "anticipates", "believes", "estimates", "predicts", "continue", or the negative of these terms or other comparable terminology. These important factors include, without limitation, a large percentage of sales are under government contracts, cost overruns under fixed price contracts, doing business in foreign markets, customer concentration, competitive factors and pricing pressures, effective integration of acquired businesses, management of future growth, recruiting and retaining qualified technical personnel, general economic conditions, as well as other risks previously disclosed in the Company's securities filings and press releases. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, performance or achievements. Further, the Company is under no duty to update any of the forward-looking statements after the date of this quarterly report to conform such statements to actual results. Results of Operations Thirteen weeks ended May 4, 2003 and April 28, 2002 Net sales from continuing operations for the thirteen weeks ended May 4, 2003 were approximately $26,897,000 compared to $23,499,000 in the thirteen weeks ended April 28, 2002, an increase of $3,398,000 (14.5%). Excluding the sales of $4,265,000 attributable to the acquisition of EWST, revenue in defense electronics microwave systems and components increased by $210,000. This was offset by a decrease of $1,077,000 in commercial technologies. The gross profit margin of 32.9% in the thirteen weeks ended May 4, 2003 is lower than the margin of 35.4% in the third quarter of the prior year. The net decrease in gross margin is attributable to a combination of greater production efficiencies, including automation, and a change in product mix; offset by the investment in product design and development related to certain new programs, as well as lower margins than the Company's historical margins from the EWST revenues. Selling and administrative expenses for the thirteen weeks ended May 4, 2003 were 14.3% of net sales as compared to 15.4% in the third quarter of fiscal 2002. The net increase in expenses of $210,000 includes expenses of EWST of $278,000, an increase in incentive compensation under employment contracts of $192,000, and a decrease in commissions of $210,000. Various other line item expenses decreased $50,000 in the quarter on a net basis. Litigation costs related to the Robinson Labs litigation were $241,000 in the third quarter of fiscal 2003, as compared to $585,000 in the third quarter of fiscal 2002. (See Part II, Item 1. "Legal Proceedings"). Other income increased on a net basis approximately $186,000 from the prior year third quarter primarily due to interest earned during the quarter ended May 4, 2003 on the investment of cash reserves including the proceeds of approximately $64,812,000 received from the sale of common stock to the public at the end of April 2002. 14 Forty weeks ended May 4, 2003 and Thirty-nine weeks ended April 28, 2002 Net sales from continuing operations for the forty weeks ended May 4, 2003 were approximately $79,202,000 compared to $67,552,000 in the first nine months of fiscal 2002. The sales increase of $11,650,000 (17.2%) is attributable to increased revenue in defense electronics of $16,365,000 (including $6,930,000 attributable to the acquisition of EWST); offset by a decrease in revenue of $4,715,000 in commercial technologies. The gross profit margin of 33.7% in the forty weeks ended May 4, 2003 is lower than the margin of 34.0% in fiscal 2002 primarily due to the combination of greater production efficiencies, including automation, and a change in product mix; offset by the investment in product design and development related to certain new programs, as well as lower margins then the Company's historical margins from the EWST revenues. Selling and administrative expenses for the forty weeks ended May 4, 2003 were 14.7% of net sales as compared to 15.2% in the thirty-nine weeks of fiscal 2002. There was a net increase in expenses of $1,337,000 which includes expenses of EWST of $699,000, an increase in incentive compensation under employment contracts of $749,000, and a decrease in commissions of $135,000. Various other line item expenses increased during the forty weeks ended May 4, 2003 by $24,000 on a net basis. Litigation costs related to the Robinson Labs litigation were $1,069,000 in the nine months ended May 4, 2003, as compared to $956,000 in fiscal 2002. (See Part II, Item 1. "Legal Proceedings"). Plant closing costs in connection with the facilities in Nashua, NH and Anaheim, CA were accrued in October 2001 in the amount of $406,000 of which $379,000 was paid as of May 4, 2003. Other income increased on a net basis approximately $697,000 from the prior year primarily due to interest earned on the investment of cash reserves including the proceeds of approximately $64,812,000 received from the sale of common stock to the public at the end of April 2002. Discontinued operations In January 2002 the Board of Directors of the Company decided to discontinue the operations of the Company's telecommunications subsidiary, Terrasat, Inc. and to seek a buyer for the business. The Company believed that Terrasat would not be able to generate sufficient returns to justify continued investment due to the overcapacity in the telecom industry and deteriorating economic conditions in Terrasat's primary markets. The sale of the assets and liabilities, and the business of Terrasat was consummated on March 1, 2002 to certain employees of Terrasat for cash and a note which approximates the value of the net assets held for sale as of January 27, 2002. Net sales of Terrasat were approximately $2,147,000 for the thirty-nine weeks ended April 28, 2002. The net loss from discontinued operations was $921,000 in 2002. The results for 2002 includes an impairment of assets adjustment of $1,166,000 and a tax benefit of $474,000. Change in accounting principle The Company adopted the provisions of SFAS No. 142 "Goodwill and Other Intangible Assets" on July 30, 2001. SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed for impairment and written down and charged to results of operations in the periods in which the recorded value of goodwill and certain intangibles is more than its fair value. The adoption of SFAS No.142 resulted in the Company's discontinuation of amortization of its goodwill and certain intangibles as 15 of July 30, 2001. In connection with the adoption of SFAS 142, the Company was required to assess goodwill for impairment within six months of adoption and completed its assessment in the second quarter of fiscal 2002. The Company operates as a single integrated business and as such has one operating segment which is also the reportable segment as defined in SFAS 131. Within the operating segment, the Company has identified two components as reporting units as defined under SFAS 142, defense electronics and commercial technologies. The Company determined the carrying value of each reporting unit by assigning assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of July 30, 2001. The Company determined that an impairment of goodwill in the commercial technologies unit had occurred due to the overcapacity in the telecom industry and deterioration economic conditions. Accordingly, a transition adjustment in the amount of $4,637,000 was recorded as of July 30, 2001 as a cumulative effect of a change in accounting principle. There is no tax benefit associated with the adjustment since the impaired goodwill is not deductible for income tax purposes. An annual impairment test is performed in the fourth quarter of each fiscal year and any future impairment of goodwill will be charged to operations. Liquidity and Capital Resources As of May 4, 2003 and July 28, 2002, working capital was $123,766,000 and $129,012,000, respectively, and the ratio of current assets to current liabilities was 8.8 to 1 and 9.5 to 1, respectively. As is customary in the defense industry, inventory is partially financed by customer deposits and progress payments. The unliquidated balance of these deposits and payments was approximately $1,636,000 at May 4, 2003, and $1,371,000 at July 28, 2002. The increase is primarily attributable to contract awards at EWST. Net cash provided by continuing operations during the forty weeks ended May 4, 2003 was approximately $10,046,000 as compared to $5,194,000 during the comparable period in the prior year. Significant items contributing to the sources of funds include income from continuing operations of $13,003,000 (adjusted for depreciation and amortization), and a decrease in costs incurred and income recognized on uncompleted contracts of $2,439,000 primarily as a result of the application of advance payments, and an increase in income taxes payable of $2,157,000. Offsetting these sources of funds are a decrease in accounts payable and accrued expenses of $2,266,000, and an increase in inventory of $5,731,000. Net cash used in investing activities consists of net cash paid for the acquisition of EWST of $2,542,000, and $2,994,000 for capital expenditures. The Company has a future commitment for $1,500,000, including interest at 1.8%, in connection with the acquisition of EWST payable in annual installments of $500,000. Net cash used in financing activities of $11,671,000 consists primarily of the acquisition of approximately 776,000 shares of treasury stock, which has been retired, for $12,187,000 under a stock buyback program approved by the Board of Directors in October 2002 for the purchase of up to 1,000,000 shares of common stock. In May 2003 the Board expanded the program by an additional 1,000,000 shares. In June 2002, the Company entered into a new $50,000,000 Revolving Credit Loan Syndication agreement with two banks on an unsecured basis which may be used for general corporate purposes, including business acquisitions. The revolving credit facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on January 31, 2005. The Company may elect to borrow up to a maximum of $5,000,000 with interest based on the FOMC Federal Funds Target Rate plus a margin of 1.50% to 1.80%, or up to a maximum of 16 $45,000,000 with interest based on LIBOR plus a margin of 1.35% to 1.65%. The applicable incremental margin is based on the ratio of total liabilities to tangible net worth, as those terms are defined in the agreement, ranging from less than .40 to 1.0, to greater than 1.0 to 1.0. The FOMC Federal Funds Target Rate and the LIBOR rate was 1.25% and 1.31%, respectively, at May 4, 2003. There is a fee of 15 basis points per annum on the unused portion of the $45,000,000 LIBOR based portion of the credit facility payable quarterly. There were no borrowings outstanding as of May 4, 2003 and July 28, 2002. Stand-by letters of credit were outstanding in the amount of approximately $12,321,000 under the credit facility at May 4, 2003. The Company believes that presently anticipated future cash requirements will be provided by internally generated funds, its existing unsecured credit facility, and cash balances of approximately $79,000,000. A significant portion of the Company's revenue for fiscal 2003 will be generated from its existing backlog of sales orders. The backlog of orders at May 4, 2003 was approximately $96,000,000. All orders included in backlog are covered by signed contracts or purchase orders. Nevertheless, contracts involving government programs may be terminated at the discretion of the government. In the event of the cancellation of a significant amount of government contracts included in the Company's backlog, the Company will be required to rely more heavily on cash reserves and its existing credit facility to fund its operations. The Company is not aware of any events which are reasonably likely to result in any cancellation of its government contracts. The Company has $37,679,000 available under its bank credit facility, net of outstanding stand-by letters of credit of approximately $12,321,000. Future payments required on long-term debt are as follows (in thousands):
Twelve months Industrial ended Mortgage revenue Other April Total note bonds obligations ----- ----- ---- ----- ----------- 2004 $ 713 $ 84 $ 100 $ 529 2005 697 92 105 500 2006 709 99 110 500 2007 221 106 115 - 2008 234 114 120 - Thereafter 4,658 2,135 2,355 168 ----- ----- ----- ----- $ 7,232 $ 2,630 $ 2,905 $ 1,697 ===== ===== ===== =====
Stand-by letters of credit expire as follows (in thousands): During fiscal year Amount 2004 $ 7,419 2005 115 2006 1,839 2007 2,948 ------ $ 12,321 ====== 17 Minimum annual rentals under noncancellable operating leases are as follows (in thousands): During fiscal year Amount ---- ------ 2003 $ 299 2004 1,106 2005 954 2006 969 2007 948 Thereafter 2,049 ----- $ 6,325 ===== Critical Accounting Policies Revenue under certain long-term, fixed price contracts is recognized using the percentage of completion method of accounting. Revenue recognized on these contracts is based on estimated completion to date (the total contract amount multiplied by percent of performance, based on total costs incurred in relation to total estimated cost at completion). Prospective losses on long-term contracts are based upon the anticipated excess of inventoriable manufacturing costs over the selling price of the remaining units to be delivered and are recorded when first reasonably determinable. Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Actual losses could differ from those estimated due to changes in the ultimate manufacturing costs. Risks and uncertainties inherent in the estimation process could affect the amounts reported in our financial statements. The key assumptions used in the estimate of costs to complete relate to labor costs and indirect costs required to complete the contract. The estimate of rates and hours as well as the application of overhead costs is reviewed on a regular basis. If our business conditions were different, or if we used different assumptions in the application of this and other accounting policies, it is likely that materially different amounts would be reported on our financial statements. New Accounting Pronouncements In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows of the Company. In August 2001, the FASB issued SFAS No 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. SFAS No 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of, but retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The provisions of this statement were adopted by the Company effective on July 30, 2001. 18 In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement is effective for fiscal years beginning after May 15, 2002. SFAS 145 requires, among other things, eliminating reporting debt extinguishments as an extraordinary item in the income statement. Management adopted this standard on July 29, 2002 and has determined that the adoption did not have a significant impact on the financial position, results of operations or cash flows of the Company. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The statement is effective for fiscal years beginning after December 31, 2002. SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Management does not believe the adoption of this standard will have a material impact on the Company's financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123." The new statement is effective, with respect to the transition provisions, for fiscal years ending after December 15, 2002; and with respect to the disclosure provisions, for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. SFAS No. 148 provides transition alternatives for companies adopting the fair value recognition provisions of FASB Statement No. 123 for stock-based employee compensation; and requires the pro forma disclosures of SFAS No. 123 in interim condensed financial statements for companies continuing to rely on APB Opinion No. 25 as if the provisions of SFAS No. 123 had been adopted. The statement also requires that the pro-forma disclosures of the impact on earnings and earnings-per-share be provided in a tabular format and included in the Summary of Significant Accounting Policies or equivalent. The effect of the adoption of SFAS No. 148 was the inclusion of the required disclosures in Note 1 of the Company's condensed consolidated interim financial statements in quarterly reports beginning with this initial Form 10-Q for the 13 weeks ended May 4, 2003, and the addition of a significant accounting policies Note 1 to be included in the Company's Annual Report on Form 10K for the year ending August 3, 2003. The Company has various fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company continues to use the intrinsic value method in APB Opinion No. 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123 and SFAS 148. Accordingly, no stock-based employee compensation cost has been recognized for options granted under the stock option plans. Pro forma information regarding net income and earnings per share as required by Statements 123 and 148 has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value for options granted is estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. 19 For purposes of computing pro-forma (unaudited) consolidated net earnings, the following assumptions were used to calculate the fair value of each option granted for all periods presented: Expected life of options 1.51 years Volatility .68 Risk-free interest rate 2.8% Dividend yield zero Had compensation cost for stock options granted in the first nine months of fiscal years 2003 and 2002 been determined based on the fair value at the grant date consistent with the provisions of SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below using the statutory income tax rate of 34% (in thousands except per share data):
Thirteen weeks ended Forty Thirty-nine -------------------- weeks ended weeks ended May 4, April 28, May 4, April 28, 2003 2002 2003 2002 ---- ---- ---- ---- Net income - as reported $ 3,359 $ 2,692 $ 9,998 $ 1,966 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (283) (688) (1,655) (1,293) ----- ------ ----- ----- Net income - pro forma $ 3,076 $ 2,004 $ 8,343 $ 673 ===== ===== ===== ===== Earnings per share - as reported Basic $ .24 $ .23 $ .69 $ .18 Diluted .23 .22 .66 .16 Earnings per share - pro forma Basic $ .22 $ .17 $ .58 $ .06 Diluted .21 .16 .55 .06
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 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 Derivative Instruments and Hedging Activities." The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. The Statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The provisions of Statement 149 that relate to Statement 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, will continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, will apply to existing contracts, as well as new contracts entered into after June 30, 2003. Management has determined that the adoption of this Statement will not have a significant impact on the financial position, results of operations or cash flows of the Company. 20 In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. Many of such instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. The Statement is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of the date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. Management believes that the adoption of this Statement will not have a significant impact on the financial position, results of operations or cash flows of the Company. Item 3: Quantitative and Qualitative Disclosures About Market Risk The Company is subject to market risk associated with changes in interest rates, and foreign currency exchange. The Company has not entered into any market risk sensitive instruments for trading purposes. In October 2001, the Company entered into an interest rate swap with a bank pursuant to which it exchanged floating rate interest in connection with the Bonds discussed in Note 4 on a notional amount of $3,000,000 for a fixed rate of 4.07% for a 10 year period ending October 1, 2011. The notional amount reduces each year in tandem with the annual installments due on the Bonds. The fixing of the interest rate for this period offsets the Company's exposure to the uncertainty of floating interest rates on the Bonds, and as such has been designated as a cash flow hedge. The hedge is deemed to be highly effective and any ineffectiveness will be recognized in interest expense in the reporting period. The fair value of the interest rate swap was a liability of approximately $118,000, net of income taxes, as of May 4, 2003. There was no material hedge ineffectiveness related to cash flow hedges during the period to be recognized in earnings. There was no gain or loss reclassified from accumulated other comprehensive income into earnings during the quarter ended May 4, 2003, as a result of the discontinuance of a cash flow hedge due to the probability of the original forecasted transaction not occurring. 21 Item 4: Controls and Procedures Within the 90 days prior to the date of this Report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-14 adopted under the Securities Exchange Act of 1934. Based upon that evaluation, the chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures are effective. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. PART II - OTHER INFORMATION Item 1 - Legal Proceedings: On August 14, 2001, Robinson Laboratories, Inc. ("RLI") and Ben Robinson ("Robinson") filed an Amended Complaint against Herley Industries, Inc. ("Herley"). Although the Amended Complaint sets forth fifteen counts, the core allegations are (i) that Herley failed to issue 97,841 shares of common stock in connection with certain earn out requirements contained in an Asset Purchase Agreement dated February 1, 2000; (ii) that Herley breached an Employment Agreement with Robinson by terminating his employment on August 5, 2001; and (iii) that Herley breached a Stock Option Agreement dated January 31, 2000, with Robinson. RLI and Robinson asserted (i) violations of state and federal securities laws; (ii) fraud claims; (iii) breach of contract claims; and (iv) other equitable claims arising from the above core factual allegations. On September 17, 2001, Herley filed an Answer, Affirmative Defenses and Counterclaims in this matter. In the Answer and Affirmative Defenses, Herley denied the material allegations of the Amended Complaint. Herley also filed Counterclaims against both RLI and Robinson. In these counterclaims, Herley's core allegations concern Robinson's misconduct (i) in connection with the manner he attempted to satisfy RLI's earn out requirements; (ii) misrepresentations made in connection with the Asset Purchase Agreement; (iii) wrongdoing as a Herley employee leading to his termination and (iv) post-Herley employment wrongdoing in connection with a new company known as RH Laboratories. In addition to seeking a Declaratory Judgment pursuant to 28 U.S.C. ss. 2201 et. seq., Herley also asserted claims for, among other things, fraud, breach of contract, breach of fiduciary duty, unfair competition and tortious interference with actual and prospective contractual relationships. On August 5, 2002, a jury trial commenced. A jury verdict was rendered on August 21, 2002 in which the jury determined, among other things, that (i) Herley was not required to pay any additional stock; (ii) Herley breached the Employment Agreement with Robinson and awarded Robinson $1.5 million in damages; (iii) Herley breached the Lease Agreement with Robinson and awarded Robinson approximately $552,000 in compensatory damages; (iv) Robinson breached fiduciary duties to Herley and awarded Herley $400,000 in compensatory damages; (v) Robinson and RLI breached indemnity obligations and awarded Herley $100,000 in damages; (vi) RLI breached representations and warranties given to Herley and awarded Herley $320,000 in damages. On October 18, 2002, the Court entered a final judgment consistent with the above, and both parties filed post-trial motions. Additionally, as the prevailing party in connection with the claims asserted by RLI relating to the earn-out stock, as well as claims advanced relating to the various breaches of the Asset Purchase Agreement, Herley filed a petition for fees and costs against both RLI and Robinson on November 27, 2002 for approximately $2,000,000. RLI and Robinson also filed petitions to recover attorneys fees of approximately $240,000 for certain claims in which they contend that they were the prevailing party. On February 5, 2003, the Court denied the post-trial motions filed by the parties, thus leaving the jury verdict undisturbed. At a proceeding on April 28, 2003, the Court decided to delay ruling on all of the petitions for fees and costs until after appeals are exhausted. Accordingly, by Order dated 22 May 6, 2003, the Court denied without prejudice all of the parties' petitions. On May 12, 2003, Herley filed its appeal to the United States Court of Appeals for the Second Circuit. No appeals have been filed by Robinson or RLI at this time, although Herley anticipates that appeals will be filed. The Company is involved in various other legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations. Item 2 - Changes In Securities: None Item 3 - Defaults Upon Senior Securities: None Item 4 - Submission Of Matters To A Vote Of Security Holders: None Item 5 - Other Information: None Item 6 - Exhibits And Reports On Form 8-K: (a) Exhibits 10.1 2003 Stock Option Plan 99.1 Certification of Chief Executive Officer 99.2 Certification of Chief Financial Officer (b) Reports on Form 8-K No reports on Form 8-K were filed during the third quarter of fiscal 2003. 23 FORM 10-Q SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HERLEY INDUSTRIES, INC. ----------------------- Registrant BY: /S/ Myron Levy ------------------------------------- Myron Levy, Chief Executive Officer BY: /S/ Anello C. Garefino ------------------------------------- Anello C. Garefino Principal Financial Officer DATE: June 11, 2003 24 CERTIFICATIONS PURSUANT TO RULE 13-A-14 OF THE SECURITIES ACT OF 1934 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION I, Myron Levy, Chief Executive Officer of Herley Industries, Inc., hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of Herley Industries, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: June 11, 2003 By: /S/ Myron Levy ----------------------- Myron Levy Chief Executive Officer 25 CERTIFICATION I, Anello C. Garefino, Vice President Finance and Chief Financial Officer of Herley Industries, Inc., do hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of Herley Industries, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: June 11, 2003 By: /S/ Anello C. Garefino --------------------------- Anello C. Garefino Vice President Finance and Chief Financial Officer 26 EXHIBIT 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. In connection with the Quarterly Report on Form 10-Q of Herley Industries, Inc. and subsidiaries (the "Company") for the quarterly period ended May 4, 2003as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I Myron Levy, Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /S/ Myron Levy ----------------------- Myron Levy Chief Executive Officer Dated: June 11, 2003 This certification accompanies the Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss. 18 of the Securities Exchange Act of 1934, as amended. 27 EXHIBIT 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. In connection with the Quarterly Report on Form 10-Q of Herley Industries, Inc. and subsidiaries (the "Company") for the quarterly period ended May 4, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I Anello C. Garefino, Vice President Finance, and Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /S/ Anello C. Garefino --------------------------- Anello C. Garefino Vice President Finance and Chief Financial Officer Dated: June 11, 2003 This certification accompanies the Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss. 18 of the Securities Exchange Act of 1934, as amended. 28