-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IAkeo1TwbDgEFQVDzDDqPIkapMLIBl69PJskhPrJeWClVrqXN7O/Zy+z1Ipy4TS0 OxEuAWo8MxpCIrjDaiSyHQ== 0001201800-08-000069.txt : 20080612 0001201800-08-000069.hdr.sgml : 20080612 20080612163643 ACCESSION NUMBER: 0001201800-08-000069 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20080504 FILED AS OF DATE: 20080612 DATE AS OF CHANGE: 20080612 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HERLEY INDUSTRIES INC /NEW CENTRAL INDEX KEY: 0000047035 STANDARD INDUSTRIAL CLASSIFICATION: SEARCH, DETECTION, NAVIGATION, GUIDANCE, AERONAUTICAL SYS [3812] IRS NUMBER: 232413500 STATE OF INCORPORATION: DE FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-05411 FILM NUMBER: 08896107 BUSINESS ADDRESS: STREET 1: 101 NORTH POINTE BOULEVARD CITY: LANCASTER STATE: PA ZIP: 17601-4133 BUSINESS PHONE: 7177358117 MAIL ADDRESS: STREET 1: 101 NORTH POINTE BOULEVARD CITY: LANCASTER STATE: PA ZIP: 17601-4133 FORMER COMPANY: FORMER CONFORMED NAME: HERLEY MICROWAVE SYSTEMS INC DATE OF NAME CHANGE: 19900510 FORMER COMPANY: FORMER CONFORMED NAME: HERLEY INDUSTRIES INC DATE OF NAME CHANGE: 19831103 10-Q 1 hrly10q-may2008.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: May 4, 2008 ----------- 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 -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No --- --- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): [ ] Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes X No --- --- As of June 6, 2008 - 13,510,177 shares of Common Stock are outstanding. 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, 2008 (Unaudited) and July 29, 2007 2 Condensed Consolidated Statements of Operations (Unaudited) - For the thirteen and forty weeks ended May 4, 2008 and for the thirteen and thirty-nine weeks ended April 29, 2007 3 Condensed Consolidated Statement of Shareholders' Equity (Unaudited) - For the forty weeks ended May 4, 2008 4 Condensed Consolidated Statements of Cash Flows (Unaudited) - For the forty weeks ended May 4, 2008 and for the thirty-nine weeks ended April 29, 2007 5 Notes to Condensed Consolidated Financial Statements (Unaudited) 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 22 Item 4 - Controls and Procedures 22 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 22 Item 1A- Risk Factors 24 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 24 Item 3 - Defaults Upon Senior Securities 24 Item 4 - Submission of Matters to a Vote of Security Holders 24 Item 5 - Other Information 24 Item 6 - Exhibits 25 Signatures 26
Part I - Financial Information Item 1 - Financial Statements HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
May 4, 2008 July 29, (Unaudited) 2007 ------------ ------------ ASSETS Current Assets: Cash and cash equivalents $ 20,583 $ 35,181 Trade accounts receivable, net 23,548 28,058 Income Taxes Receivable 2,056 819 Costs incurred and income recognized in excess of billings on uncompleted contracts and claims 19,833 14,448 Other receivables 3,837 2,816 Inventories, net 60,321 51,815 Deferred income taxes 11,340 4,254 Other current assets 1,546 1,069 ------------ ------------ Total Current Assets 143,064 138,460 Property, Plant and Equipment, net 30,957 29,996 Goodwill 73,903 74,044 Intangibles, net of accumulated amortization of $6,943 at May 4, 2008 and $5,256 at July 29, 2007 16,624 18,431 Other Assets 551 1,662 ------------ ------------ Total Assets $ 265,099 $ 262,593 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt $ 1,387 $ 1,346 Current portion of employment settlement agreement - (net of imputed interest of $124 at May 4, 2008 and $245 at July 29, 2007) 1,234 1,113 Current portion of litigation settlements (net of imputed interest of $62) 10,438 - Accounts payable, accrued expenses and other 30,903 21,719 Billings in excess of costs incurred and income recognized on uncompleted contracts 527 99 Income taxes payable 411 3,518 Advance payments on contracts 7,111 7,163 ------------ ------------ Total Current Liabilities 52,011 34,958 Long-term Debt 4,927 5,951 Long-term Portion of Employment Settlement Agreement - (net of imputed interest of $471 at May 4, 2008 and $580 at July 29, 2007) 3,192 4,117 Long-term portion of litigation settlement (net of imputed interest of $122) 878 - Other Long-term Liabilities 1,598 1,311 Deferred Income Taxes 8,675 6,615 Accrued Income Taxes Payable 507 - ------------ ------------ Total Liabilities 71,788 52,952 ------------ ------------ Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 20,000,000 shares; issued and outstanding 13,510,177 at May 4, 2008, and 13,977,115 at July 29, 2007 1,351 1,398 Additional paid-in capital 101,085 107,094 Retained earnings 89,381 99,404 Accumulated other comprehensive income 1,494 1,745 ------------ ------------ Total Shareholders' Equity 193,311 209,641 ------------ ------------ Total Liabilities and Shareholders' Equity $ 265,099 $ 262,593 ============ ============
See notes to condensed consolidated financial statements. 2 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except per share data) (Unaudited)
Forty Thirty-Nine Weeks Weeks Thirteen weeks ended Ended Ended May 4, April 29, May 4, April 29, 2008 2007 2008 2007 ----------- ---------- ---------- ----------- Net sales $ 38,549 $ 44,401 $ 108,343 $ 122,514 ----------- ---------- ---------- ----------- Cost and expenses: Cost of products sold 29,982 31,687 84,790 89,528 Selling and administrative expenses 9,951 8,895 27,869 25,315 Litigation settlements (Notes 2 and 6) 9,500 - 15,542 - Employment contract settlement costs (Note 2) - - - 8,914 ----------- ---------- ---------- ----------- 49,433 40,582 128,201 123,757 ----------- ---------- ---------- ----------- (Loss) income from operations (10,884) 3,819 (19,858) (1,243) ----------- ---------- ---------- ----------- Other income (expense): Investment income 147 375 955 854 Interest expense (164) (213) (427) (578) Foreign exchange transactions gain (loss) 42 195 (6) 478 ----------- ---------- ---------- ----------- 25 357 522 754 ----------- ---------- ---------- ----------- (Loss) income before income taxes (10,859) 4,176 (19,336) (489) (Benefit) provision for income taxes (7,267) 298 (9,313) (29) ----------- ---------- ---------- ----------- Net (loss) income $ (3,592) $ 3,878 $ (10,023) $ (460) =========== ========== ========== =========== (Loss) earnings per common share - Basic $ (.27) $ .28 $ (.73) $ (.03) =========== ========== ========== =========== Basic weighted average shares 13,507 13,969 13,696 13,911 =========== ========== ========== =========== (Loss) earnings per common share - Diluted $ (.27) $ .27 $ (.73) $ (.03) =========== ========== ========== =========== Diluted weighted average shares 13,507 14,449 13,696 13,911 =========== ========== ========== ===========
See notes to condensed consolidated financial statements. 3 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) Forty weeks ended May 4, 2008 (In thousands, except share data)
Accumulated Additional Other Common Stock Paid-in Retained Treasury Comprehensive Shares Amount Capital Earnings Stock Income (Loss) Total ------------- -------- ----------- --------- --------- --------------- --------- Balance at July 29, 2007 13,977,115 $ 1,398 $ 107,094 $ 99,404 $ - $ 1,745 $ 209,641 Exercise of stock options 27,000 1 224 225 Purchases of 493,938 shares of treasury stock (7,138) (7,138) Tax benefit upon exercise of stock options 57 57 Stock-based compensation costs 800 800 Retirement of treasury stock (493,938) (48) (7,090) 7,138 - ------------- -------- ----------- --------- --------- --------------- --------- Subtotal 13,510,177 1,351 101,085 99,404 - 1,745 203,585 --------- Net loss (10,023) (10,023) Other comprehensive loss: Unrealized loss on interest rate swap (34) (34) Foreign currency translation loss (217) (217) --------- Comprehensive loss (10,274) ------------- -------- ----------- --------- --------- --------------- --------- Balance at May 4, 2008 13,510,177 $ 1,351 $ 101,085 $ 89,381 $ - $ 1,494 $ 193,311 ============= ======== =========== ========= ========= =============== =========
See notes to condensed consolidated financial statements. 4 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands)
Forty Thirty-nine weeks weeks ended ended May 4, April 29, 2008 2007 --------- ---------- Cash flows from operating activities: Net Loss $ (10,023) $ (460) --------- ---------- Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and amortization 5,573 5,271 Stock-based compensation costs 800 326 Excess tax benefit from exercises of stock options (57) (235) Employment contract settlement costs (includes $196 of stock option modification costs) - 5,914 Litigation settlement costs 15,442 - Imputed interest 347 199 Deferred tax benefit (4,999) (2,314) Loss (gain) on sale of fixed assets 8 (107) Foreign exchange transaction losses (gains) 48 (96) Inventory valuation reserve charges 1,287 1,102 Reduction in accrual for contract losses (826) (699) Warranty reserve charges 848 976 Changes in operating assets and liabilities: Trade accounts receivable 4,416 (243) Income taxes receivable (1,237) - Costs incurred and income recognized in excess of billings on uncompleted contracts and claims (5,385) 334 Other receivables (1,021) (1,310) Inventories (9,876) (389) Other current assets (477) (438) Accounts payable, accrued expenses and other 10,079 (3,597) Billings in excess of costs incurred and income recognized on uncompleted contracts 428 51 Income taxes payable (2,543) 1,796 Employment settlement payments (1,034) (443) Litigation settlement payments (4,000) - Advance payments on contracts (52) 4,202 Other, net (531) 449 --------- ---------- Total adjustments 7,238 10,749 --------- ---------- Net cash (used in) provided by operating activities (2,785) 10,289 --------- ---------- Cash flows from investing activities: Acquisition of technology license - (179) Proceeds from sale of fixed assets - 202 Capital expenditures (3,912) (3,516) --------- ---------- Net cash used in investing activities (3,912) (3,493) --------- ---------- Cash flows from financing activities: Borrowings under bank line of credit 13,900 13,000 Borrowings - other 1,746 Proceeds from exercise of stock options 225 1,164 Excess tax benefit from exercises of stock options 57 235 Payments of long-term debt (1,044) (690) Payments under bank line of credit (13,900) (13,000) Purchase of treasury stock (7,138) - --------- ---------- Net cash (used in) provided by financing activities (7,900) 2,455 --------- ---------- Effect of exchange rate changes on cash (1) 8 --------- ---------- Net (decrease) increase in cash and cash equivalent (14,598) 9,259 Cash and cash equivalents at beginning of period 35,181 22,303 --------- ---------- Cash and cash equivalents at end of period $ 20,583 $ 31,562 ========= ==========
See notes to condensed consolidated financial statements. 5 HERLEY INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (UNAUDITED) 1. Principles of Consolidation and Basis of Presentation The unaudited condensed consolidated financial statements include the accounts of Herley Industries, Inc. and its wholly-owned subsidiaries, collectively referred to as the "Company." All significant intercompany accounts and transactions have been eliminated. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information and note disclosures normally included in annual financial statements as required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items, as well as the recording of the litigation settlement costs and employment contract settlement costs discussed in Note 2 and Note 6) considered necessary for a fair presentation have been included in the accompanying condensed consolidated financial statements. Operating results for this quarter are not necessarily indicative of the results of operations that may be expected for any other interim period or for the full year. These statements should be read in conjunction with the consolidated financial statements and notes thereto, and the Company's description of critical accounting policies, included in the Company's 2007 Annual Report on Form 10-K/A Amendment No. 1 for the fiscal year ended July 29, 2007, as filed with the Securities and Exchange Commission ("SEC"). The accounting policies used in preparing these unaudited condensed interim financial statements are consistent with those described in the July 29, 2007 audited financial statements except for the adoption of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"), which is discussed in Note 4. The consolidated balance sheet at July 29, 2007 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires that management of the Company make certain estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting periods. These judgments can be subjective and complex, and consequently actual results could differ from those estimates and assumptions. The most significant estimates include: valuation and recoverability of long-lived assets; income taxes; recognition of revenue and costs on production contracts; estimated claims and unpriced change orders under contracts; the valuation of inventory; and stock-based compensation costs valued in accordance with FAS 123(R). Each of these areas requires the Company to make use of reasoned estimates including estimating the cost to complete a contract, the recoverability of contractual claims, the net realizable value of its inventory and the market value of its products. Changes in estimates can have a material impact on the Company's financial position and results of operations. The remaining accrual for contract losses associated with the ICI acquisition (more fully described in Note A-3 and Note B of Form 10-K/A Amendment No. 1 for the fiscal year ended July 29, 2007), in the amount of $826,000 was eliminated in the forty weeks ended May 4, 2008 (which is included as a reduction of costs of products sold) as a result of the customer not exercising the remaining two contract options under the contract. Shipments under the contract were completed during the first quarter of fiscal 2008 and the remaining options under the contract expired. In the forty weeks ended May 4, 2008, the Company recognized a loss of approximately $1,200,000 on a development contract due to cost overruns and a change in management's estimate of the recoverability of the costs on future contracts; and a loss of approximately $1,000,000 due to cost overruns on two other development contract. Certain prior period balances have been reclassified to conform to the current period's financial statement presentation. 2. Significant Events In connection with the legal matters discussed in Note 6 "Litigation," to avoid the delay, expense, inconvenience and uncertainty of protracted litigation, the Company entered into an agreement with the Office of the United States Attorney for the Eastern District of Pennsylvania to settle all existing criminal claims. Under the terms of the agreement dated May 5, 2008 the Company agreed to pay a fine of $3,500,000. In addition, the Company entered into an agreement to settle all existing civil claims with the Civil Division of the Office of the United States Attorney for the Eastern District of Pennsylvania which requires the payment of $6,000,000. These payments were made on May 5, 2008 and are included in "Current portion of litigation settlements" in the accompanying Condensed Consolidated Balance Sheet at May 4, 2008. The Company anticipated that the trial of the criminal matter would have been between two to three months and the trial of the Justice Department's civil action would have been a similar time period. The legal fees for both trials have been estimated to be in excess of the settlement amounts. The Company has advised the Department of the Navy, Acquisition Integrity 6 Office about the terms and conditions of the criminal and civil settlement agreements and the Company has been advised that no action will be taken to suspend or debar the Company based on these settlements. Various actions leading up to these settlements are discussed below. On June 27, 2007, the Company was notified by the Office of the General Counsel, Acquisition Integrity Office, Department of Navy (the "Navy"), that certain of its operations had been suspended from receiving new contract awards from the U.S. Government as discussed in Note A-1 in the Company's 2007 Annual Report on Form 10-K/A Amendment No. 1 for the fiscal year ended July 29, 2007. The affected operations included facilities in Lancaster, Pennsylvania; Woburn, Massachusetts and Chicago, Illinois. The Chicago, Illinois location is a two-person marketing office. On August 15, 2007 the suspension was lifted following an amendment to the Administrative Agreement (originally signed on October 12, 2006) with the Navy as discussed below. While the suspension was in place, these facilities could not be solicited for or awarded new contracts or contract extensions without special exceptions. The suspended facilities were permitted to receive contract awards or subcontracts from the Federal Government if the head of the agency stated in writing the compelling reason to do so. A significant portion of our business is received under contracts where we are the only qualified supplier on critical defense programs. On June 13, 2006, in connection with the legal matter discussed in Note 6 "Litigation," the Company was notified that certain of its operations had been suspended from receiving new contract awards from the U. S. Government. The affected operations included facilities in Lancaster, Pennsylvania; Woburn, Massachusetts; Chicago, Illinois and the Company's subsidiary in Farmingdale, New York. The result of this suspension was that these facilities were not solicited for or awarded new contracts or contract extensions without special exceptions, pending the outcome of the legal proceedings. The suspended facilities were permitted to receive contract awards or subcontracts from the Federal Government if the contracting agency stated in writing the compelling reason to do so. A significant portion of the Company's business is received under contracts where the Company is the only qualified supplier on critical defense programs. The Company's facilities which were not included in the action and who were free at all times to contract with the U.S. Government are the facilities in Whippany, New Jersey (Herley-CTI); Jerusalem (Herley-Israel); McLean, Virginia (Innovative Concepts, Inc.); Fort Walton Beach, Florida (Micro Systems, Inc. and Herley-RSS) and Farnborough, U.K. (EW Simulation Technology, Limited). Effective October 12, 2006, the Company entered into an Administrative Agreement with the Department of the Navy, on behalf of the Department of Defense that requires the Company, among other things, to implement a comprehensive program of compliance reviews, audits and reports for a period of four years (as amended August 15, 2007) or until settlement or adjudication of the legal matter referenced above, whichever is later, unless shortened or extended by written agreement of the parties. In addition, the Company was required to sever its relationship with its former Chairman of the Board of Directors, as an employee or consultant to the Company. In return, the Navy, on behalf of the Department of Defense terminated the suspension of the Company from receiving new contract awards from the U.S. Government. Effective October 12, 2006 and as a condition to entering into the Administrative Agreement with the Department of the Navy noted above, the Company entered into an agreement (the "Agreement") with its former Chairman to terminate the Employment Agreement between him and the Company dated as of July 29, 2002 and modified on December 9, 2003. Aggregate costs of approximately $8,914,000 under the Agreement, including a cash payment of $3,000,000, payments due under a Promissory Note of approximately $5,354,000, medical and life insurance benefits of approximately $364,000 (both discounted at an imputed interest rate of 6.75%) and the fair value of the modification of stock options of approximately $196,000 (using the Black-Scholes option valuation model), have been recorded in the Company's condensed consolidated financial statements in the thirty-nine weeks ended April 29, 2007. In connection with a lawsuit filed on April 10, 2007, by EADS Deutschland GmbH ("EADS"), a German corporation, against the Company (see Note 6), the parties have entered into an agreement effective December 5, 2007 providing for a mutual release and dismissal, with prejudice and without costs or attorney's fees to either party, of all claims and counterclaims filed. To avoid further dilution of management's time and energies, as well as legal costs on a long and protracted legal dispute, the Company agreed to pay to EADS the sum of $6,000,000. A payment of $2,500,000 was made on December 5, 2007; a payment of $1,500,000 was made on March 31, 2008; and payments of $1,000,000 are due on March 31, 2009 and March 31, 2010, respectively. The agreement further provides for the transfer to EADS of all drawings in the Company's possession, custody or control for the equipment supplied in conjunction with a contract between the parties; providing EADS with the use of such drawings for the exclusive purpose of fulfilling its obligations towards its own customers under the contract. As security for the payments due in March of 2008, 2009 and 2010, the Company issued an irrevocable stand-by letter of credit in the amount of $3,500,000 under its existing credit facility. The letter of credit was reduced to $2,000,000 in connection with the payment made in March 2008. The Company recorded a charge to operations in the forty weeks ended May 4, 2008 of approximately $6,042,000 consisting of payments due under the agreement of approximately $5,699,000, net of imputed interest of approximately $301,000 discounted at an imputed interest rate of 7.25%, plus costs and other direct settlement expenses of approximately $343,000. 7 3. Inventories The major components of inventories are as follows (in thousands):
May 4, July 29, 2008 2007 ---- ---- Purchased parts and raw materials $ 31,092 $ 28,526 Work in process 34,358 27,797 Finished products 2,236 2,576 ------ ------ $ 67,686 $ 58,899 Less: Allowance for obsolete and slow moving inventory 6,093 5,163 Unliquidated progress payments 1,272 1,921 ------ ------ $ 60,321 $ 51,815 ====== ======
4. Income Taxes On July 30, 2007, the Company adopted Interpretation No. 48, "Accounting for Uncertainty in Income Taxes (as amended) - an interpretation of FASB Statement No. 109" ("FIN 48"). The cumulative effect of applying the provisions of FIN 48 resulted in a reclassification of $3,139,000 of tax liabilities (including interest and penalties of $ 734,000) from current to non-current and did not require an adjustment to retained earnings. The total amount of unrecognized tax benefits could increase or decrease within the next twelve months for a number of reasons including audit settlements, tax examination activities and the recognition and measurement considerations under FIN 48. As of May 4, 2008, the Company's unrecognized tax benefits, that if recognized would affect the Company's effective tax rate were $507,000. During the quarter ended May 4, 2008 the Company recognized a tax benefit of $2,737,000, including interest and penalties of $806,000, due to the expiration of the statute of limitations in April 2008, for a deduction taken for an impaired investment on a prior year's income tax return. The ultimate timing of the tax consequences of the other tax benefits is uncertain. The Company has elected to retain its existing accounting policy with respect to the treatment of interest and penalties attributable to income taxes in accordance with FIN 48, and continues to reflect interest and penalties attributable to income taxes, to the extent they arise, as a component of its income tax provision or benefit as well as its outstanding income tax assets and liabilities. At May 4, 2008, the Company had $33,000 of accrued interest and penalties which is included as "Accrued Income Taxes Payable" under long-term liabilities in the accompanying Condensed Consolidated Balance Sheet. The Company has identified its federal tax return and its state tax return in Pennsylvania as major tax jurisdictions. The Company is also subject to multiple other state and foreign jurisdictions. The Company's evaluation of FIN 48 tax matters was performed for tax years ended 2002 through 2007, the only periods subject to examination. The Company believes that its income tax positions and deductions would be sustained on audit and does not anticipate any adjustments, other than those identified above that would result in a material change to its financial position. The income tax benefit recognized in the first nine months of fiscal 2008 was $9,313,000 (an effective income tax benefit rate of 48.2%) compared to a benefit of $29,000 (an effective rate of 6.0%) in the first nine months of the prior fiscal year. The estimated effective tax benefit rate for fiscal year 2008 is 48.8%, which is greater than the statutory rate of 35% primarily due to the reversal of a FIN 48 liability offset by the non-deductible penalty paid as part of the litigation settlement. Other non-recurring items contributing to the tax benefit in the first nine months of fiscal 2008 include a research and development credit carryover and a lower than expected tax rate in Israel for fiscal 2007 which increased the income tax benefit for the first nine months of fiscal 2008 by approximately 3.6% resulting in an overall effective rate for the first nine months of 48.2%. The Company incurred an estimated net operating loss in the forty weeks ended May 4, 2008 of approximately $16,800,000 for Federal and state income tax purposes of which approximately $7,930,000 would be available to carry back two years for Federal income taxes; and approximately $8,870,000 would be available to carry forward for Federal and state income taxes which will expire in 2028. 5. Product Warranties The Company warrants its products generally for a period of one year. Product warranty costs are accrued based on historical claims expense. Accrued warranty costs are reduced as warranty repair costs are incurred. The following table presents the change in the accrual for product warranty costs for the thirteen and forty weeks ended May 4, 2008 and the thirteen and thirty-nine weeks ended April 29, 2007 (in thousands): 8
Thirty- Forty nine Thirteen weeks ended weeks weeks -------------------- ended ended May 4, April 29, May 4, April 29, 2008 2007 2008 2007 ---- ---- ---- ---- Balance at beginning of period $ 1,017 $ 1,150 $ 1,106 $ 986 Provision for warranty obligations 282 342 848 976 Warranty costs charged to the reserve (262) (363) (917) (833) ----- ----- ----- ----- Balance at end of period $ 1,037 $ 1,129 $ 1,037 $ 1,129 ===== ===== ===== =====
6. Litigation On June 6, 2006, in connection with a continuing investigation by the U.S. Attorneys' Office in Pennsylvania which, inter alia, involves pricing under contracts with the U.S. Department of Defense relating to voltage control oscillators and powerheads, an indictment was returned against the Company and Lee Blatt, its former Chairman. No other officer or director of the Company was named in the indictment. The contracts aggregate approximately $3.9 million in total revenue. The indictment as superseded on January 30, 2007 alleges 27 counts of violations of the wire fraud statute (18 U.S.C. Section 1343); 2 counts of violations of the obstruction of a federal audit statute (18 U.S.C. Section 1516); 1 count of violating the major fraud against the United States statute (18 U.S.C. Section 1031); 3 counts of violating the false statements to the government statute (18 U.S.C. Section 1001); aiding and abetting (18 U.S.C. Section 2); and a notice of forfeiture. The Company moved to dismiss the indictment and that motion was denied on November 5, 2007. A trial was scheduled for May 5, 2008. On May 5, 2008, the Company entered into an agreement with the United States Attorney's Office for the Eastern District of Pennsylvania in which (a) the Company agreed to plead guilty to two counts of obstructing an audit relating solely to the powerheads; (b) the Company agreed to pay a fine of $3.5 million; and (c) the Government agreed to dismiss all other counts of the Superseding Indictment. The agreement was presented to the Court on May 5, 2008, and the Court accepted the agreement and sentenced the Company to the agreed-upon fine. With respect to Mr. Blatt, the Court, at the Government's request, dismissed all of the charges against him in the indictment and the Government filed a Superseding Information charging Mr. Blatt with a misdemeanor violation of the tax code in a single count, and Mr. Blatt has entered a guilty plea for failing to keep Company records of the allocation of an $18,000 corporate research expense. Mr. Blatt has been fined $25,000, has received a term of probation of one year and is required to perform some community service. Under the terms of an indemnification agreement with Mr. Blatt, the Company has agreed to provide indemnification with regard to certain legal proceedings so long as he has acted in good faith and in a manner believed to be in, or not opposed to, the Company's best interest with respect to any criminal proceeding and had no reasonable cause to believe his conduct was unlawful. Shortly before the indictment mentioned above, Company counsel were notified by representatives of the United States Attorney's Office for the Eastern District of Pennsylvania, Civil Division, that they intended to file a civil lawsuit against the Company pursuant to inter alia, the False Claims Act, 31 U.S.C. Section 3729 et. seq. The Company entered into a Tolling Agreement on June 21, 2006, deferring any further activity related to this potential claim until after the trial of the criminal matter mentioned above. By agreement dated May 5, 2008, the United States Attorney's Office for the Eastern District of Pennsylvania and the Company entered into an agreement to resolve the potential issues arising from the lawsuit threatened against the Company pursuant to, among other things, the False Claims Act, 31 U.S.C. Section 3729 et. seq. for the matters alleged in the Superseding Indictment. The Company agreed to pay $6 million in exchange for, among other things, a release. In June and July 2006, the Company was served with several class-action complaints against the Company and certain of its officers in the United States District Court for the Eastern District of Pennsylvania. The claims are made under Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. All defendants in the class-action complaints filed motions to dismiss on April 6, 2007. On July 17, 2007, the Court issued an order denying the Company's and Mr. Blatt's motion to dismiss and granted, in part, the other defendants' motion to dismiss. Specifically, the Court dismissed the Section 10(b) claim against the other defendants and denied the motion to dismiss the Section 20(a) claim against them. On July 18, 2007, the Court granted defendant's motion to stay these actions until after the trial of the criminal matter referenced above. On February 8, 2008, the Court issued an Order allowing for certain document discovery to commence. On May 9, 2008, the Court lifted the stay. A Scheduling Order has now been entered requiring the parties to complete discovery by January 2009. At this stage of the proceedings, it is not possible to predict what, if any, liability the Company may have from the Securities Class Actions. In July and August 2006, the Company and certain of its current and former 9 officers and directors were also served with two separate derivative complaints for breach of fiduciary duty brought pursuant to Rule 23.1 of the Federal Rules of Civil Procedure. The complaints relate to the Company's indictment in the matter discussed above and were consolidated into one action on March 9, 2006. All defendants in the derivative complaints filed motions to dismiss on February 26, 2007. On July 20, 2007, the Court issued an order denying defendants' motions in part and granting them in part. Specifically, the Court dismissed the claim that the named officers and directors failed to oversee Mr. Blatt and denied the motions with respect to the other alleged claims. The Court also granted defendants' motion to stay the action until after the trial of the criminal matter. On February 8, 2008, the Court issued an Order allowing for certain document discovery to commence. On May 9, 2008, the Court lifted the stay. A Scheduling Order has now been entered requiring the parties to complete discovery by January 2009. At this stage of the proceedings, it is not possible to predict what, if any, liability the Company may have from the Derivative Actions. The Company believes it is entitled to recovery of certain legal fees associated with the above matters under its D&O insurance policy. Accordingly, as of May 4, 2008, the Company recorded claims of approximately $4,802,000 (net of a deductible of $500,000) in anticipation of recoveries. As of May 4, 2008, partial payments of approximately $1,997,000 have been received leaving a receivable balance of $2,805,000. The amount is included in other receivables in the accompanying condensed consolidated balance sheet at May 4, 2008. Subsequent to May 4, 2008, the Company received an additional payment of approximately $238,000. The insurance carrier may contest the claim in whole or in part. In addition, the Company has entered into an agreement dated January 11, 2007 with the insurance carrier whereby if it is determined by final decision of an arbitration panel, or by final judgment of a court, or other final decision of a tribunal having jurisdiction thereof, that any amount paid by the insurance carrier was not a loss, as that term is defined in the policy, the Company shall repay to the insurance carrier any such uncovered sums previously advanced to the Company. The term "Loss" is defined in the policy as follows: "Loss means the amount that any Insured becomes legally obligated to pay on account of any covered Claim, including but not limited to damages (including punitive or exemplary damages, or the multiple portion of any multiplied damage award, if and to the extent such damages are insurable under the law of the jurisdiction most favorable to the insurability of such damages provided such jurisdiction has a substantial relationship to the relevant Insureds, to the Company, or to the Claim giving rise to the damages), judgments, settlements, pre-judgment and post-judgment interest, Defense Costs and, solely with respect to Insuring Clause 2, Settlement fees." Further, the policy defines "Defense Costs" as follows: "Defense Costs means that part of Loss consisting of reasonable costs, charges, fees (including but not limited to attorneys' fees and experts' fees) and expenses (other than regular or overtime wages, salaries, fees or benefits of the directors, officers or employees of the Organization) incurred in defending any Claim and the premium for appeal, attachment or similar bonds." In establishing the receivable for legal recoveries, the Company identified and segregated defense costs related to the defense of the class action lawsuits and the defense of the former Chairman and officer of the Company in the criminal case. The Company believes such costs represent a "loss" under its D&O policy and are recoverable. The Company excluded all defense costs related to the defense of the Company pertaining to the criminal case as such costs may not be recoverable under the D&O policy. On June 27, 2007, the Company was notified by the Office of the General Counsel, Acquisition Integrity Office, Department of Navy (the "Navy"), that certain of its operations had been suspended from receiving new contract awards from the U.S. Government. The affected operations included facilities in Lancaster, Pennsylvania; Woburn, Massachusetts and Chicago, Illinois. The Chicago, Illinois location is a two-person marketing office. On August 15, 2007 the suspension was lifted following an amendment to the Administrative Agreement with the Navy (originally signed on October 12, 2006) extending the term of the agreement for one additional year. While the suspension was in place, these facilities could not be solicited for or awarded new contracts or contract extensions without special exceptions. The suspended facilities were permitted to receive contract awards or subcontracts from the Federal Government if the head of the agency stated in writing the compelling reason to do so. A significant portion of our business is received under contracts where we are the only qualified supplier on critical defense programs. Prior to May 5, 2008, counsel for the Company met with representatives of the Department of Navy, Suspension and Debarment Office, Acquisition Integrity Office to discuss (a) the possible agreement between the United States Attorney's Office for the Eastern District of Pennsylvania and the Company, as such is set forth above, and (b) the possible agreement with the Civil Division of the U.S. Attorney's Office and the Company, as is mentioned above. Representatives from the Navy advised that no action would be taken to suspend or debar the Company based upon these agreements, and no action was in fact taken or is expected to be taken. On April 10, 2007, EADS Deutschland GmbH ("EADS"), a German corporation, filed a lawsuit against Herley Industries, Inc., General Microwave 10 Corporation and General Microwave Export Corporation d/b/a Herley Power Amplifier Systems (collectively the "Company") in the United States District Court for the Eastern District of New York. EADS claims that the Company breached a Transfer of Technology Agreement entered into on May 30, 2001 under which the Company was granted the right to use certain technology owned by EADS in performing under an exclusive sales and marketing agreement entered into on May 30, 2001. EADS asserted claims for breach of contract and conversion, claiming that the Company was wrongfully in possession of the intellectual property that was transferred to the Company. EADS also sought a preliminary injunction. The Company denied any wrongdoing and filed counterclaims against EADS. On August 2, 2007, the Company and EADS entered into a settlement of this motion, which was reduced to a written consent decree entered by the Court on August 29, 2007. EADS's claims for breach of contract and for conversion remained pending, as did the Company's counterclaims. Pursuant to the consent decree, the parties agreed to a mediation/settlement conference of all their respective claims with the Court, and further agreed to stay all proceedings pending the outcome of that mediation/settlement conference on October 17, 2007. In November 2007, the Company reached a comprehensive settlement agreement with EADS effective December 5, 2007, as discussed in Note 2. 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 other litigation will not have a material adverse effect on the Company's financial position or results of operations. 7. Comprehensive (Loss) Income Comprehensive (loss) income for the periods presented is as follows (in thousands):
Thirty- Forty nine weeks weeks Thirteen weeks ended ended ended May 4, April 29, May 4, April 29, 2008 2007 2008 2007 ---- ---- ---- ---- Net (loss) income $ (3,592) $ 3,878 $ (10,023) $ (460) Unrealized (loss) income on interest rate swap 18 (10) (34) (20) Foreign currency translation (loss) gain (71) 118 (217) 534 ------------ ------------ ------------ ------------ Comprehensive (loss) income $ (3,645) $ 3,986 $ (10,274) $ 54 ============ ============ ============ ============
The foreign currency translation (loss) gain relates to the Company's investment in its U.K. subsidiary and fluctuations in exchange rates between its local currency and the U.S. dollar. The components of accumulated other comprehensive income is as follows (in thousands):
May 4, July 29, 2008 2007 ---- ---- Unrealized loss on interest rate swap $ (63) $ (29) Foreign currency translation gain 1,557 1,774 ----- ----- Accumulated other comprehensive income $ 1,494 $ 1,745 ===== =====
8. Share-Based Compensation The Company has various fixed stock option plans which are described in Note N of the Company's July 29, 2007 Annual Report on Form 10-K/A Amendment No. 1 that provide for the grant of stock options to eligible employees and directors. The Company recorded total share-based costs related to stock options, included as compensation costs in operating expenses, of approximately $287,000 and $800,000 for the thirteen and forty weeks ended May 4, 2008 and approximately $101,000 and $326,000 for the thirteen and thirty-nine weeks ended April 29, 2007, respectively. As of May 4, 2008, there were 3,528,950 stock options outstanding. Options for 4,000 shares of common stock were issued at an average price of $13.87 during the forty weeks ended May 4, 2008. The aggregate fair value of the options issued, as determined using a Black-Scholes option valuation model, is approximately $23,000. No stock options were granted during the thirty-nine weeks ended April 29, 2007. The aggregate value of unvested options as of May 4, 2008, as determined using a Black-Scholes option valuation model, was approximately $1,076,000 (net of estimated forfeitures) which is expected to be recognized over a weighted-average period of 1.7 years. Options for 27,000 shares of common stock were exercised during the forty weeks ended May 4, 2008 at an average exercise price of $8.35 per share for 11 total proceeds of $225,000 and options for 88,500 shares of common stock expired or were forfeited during the period. The total intrinsic value of options exercised during the forty weeks ended May 4, 2008, based on the difference between the Company's stock price at the time of exercise and the related exercise price, was approximately $150,000. A summary of stock option activity under all plans for the forty weeks ended May 4, 2008 is as follows: Non-Qualified Stock Options ---------------------------
Weighted Aggregate Average Intrinsic Number Price Range Exercise Value of shares per share Price (in thousands) --------- --------- ----- -------------- Outstanding July 29, 2007 3,640,450 $ 7.25 - 21.18 $ 14.84 Granted 4,000 $ 12.58 - 15.16 $ 13.87 Exercised (27,000) $ 7.25 - 9.13 $ 8.35 Cancelled (88,500) $ 17.98 - 20.09 $ 19.21 --------- ------------- ----- Outstanding May 4, 2008 3,528,950 $ 7.62 - 21.18 $ 14.78 $ 2,730 ========= ----- ----- Exercisable May 4, 2008 (1) 3,149,750 $ 14.53 $ 2,730 --------- ----- ----- Vested and expected to vest May 4, 2008 3,491,422 $ 14.75 $ 2,730 --------- ----- ----- (1) There are 2,052,800 vested options with exercise prices greater than the closing stock price of $12.00 as of May 4, 2008.
9. (Loss) earnings per Common Share ("EPS") The following table shows the components used in the calculation of basic loss per common share and loss per common share assuming dilution (in thousands):
Thirty- Forty nine weeks weeks Thirteen weeks ended ended ended May 4, April 29, May 4, April 29, 2008 2007 2008 2007 ---- ---- ---- ---- Numerator: Net (loss) income $ (3,592) $ 3,878 $ (10,023) $ (460) ===== ===== ====== === Denominator: Basic weighted-average shares 13,507 13,969 13,696 13,911 Effect of dilutive securities: Employee stock options - 480 - - ------ ------ ------ ------ Diluted weighted-average shares 13,507 14,449 13,696 13,911 ====== ====== ====== ====== Stock options not included in computation 3,529 1,673 3,529 3,241 ====== ====== ====== ====== Exercise price range per share $7.62 - $21.18 $15.78 - $21.18 $7.62 - $21.18 $4.31 - $21.18 ============= ============== ============= =============
No employee stock options were considered in the computation of diluted net loss per share for the thirteen and forty weeks ended May 4, 2008 and for the thirty-nine weeks ended April 29, 2007 as their effect is anti-dilutive. The options which were outstanding as of May 4, 2008 and excluded from the computation in the table above expire at various dates through June 8, 2017. 10. Stock Buyback Program On October 12, 2007, the Company announced that its Board of Directors had approved an expansion of its existing stock buyback program to make additional purchases of up to 1,000,000 shares of its common stock in the open market or private transactions, in accordance with applicable SEC rules. During the forty weeks ended May 4, 2008 the Company repurchased and retired 493,938 shares of its common stock, pursuant to this program at an aggregate cost of approximately $7,138,000 including transaction costs. 12 Funds to acquire the shares came from excess cash reserves. Common stock at par value and additional paid-in capital were reduced by approximately $48,000 and $7,090,000, respectively. The timing, actual number and value of any additional shares that may be repurchased under this program will depend on a number of factors, including the Company's future financial performance, the Company's available cash resources and competing uses for the cash, prevailing market prices of the Company's common stock and the number of shares that become available for sale at prices that the Company believes are attractive. As of May 4, 2008, approximately 614,000 shares are eligible for future purchase under the Company's buyback program. 11. Geographic Information and Major Customers The Company's chief operating decision makers are considered to be the Chairman/Chief Executive Officer and the Chief Operating Officer. These individuals evaluate both consolidated and disaggregated financial information, primarily gross revenues, in deciding how to allocate resources and assess performance. They also use certain disaggregated financial information for the Company's product groups. The Company does not determine a measure of operating income or loss by product group. The Company's product groups have similar long-term economic characteristics, such as application, and are similar in regards to (a) nature of products and production processes, (b) type of customers and (c) method used to distribute products. Accordingly, the Company operates as a single integrated business and as such has one operating segment as a provider of complex microwave technology solutions for the defense, aerospace and medical industries worldwide. All of the Company's revenues result from sales of its products. Net sales for defense electronics and commercial technologies were as follows:
Thirty- Forty nine weeks weeks Thirteen weeks ended ended ended May 4, April 29, May 4, April 29, 2008 2007 2008 2007 ---- ---- ---- ---- Defense electronics $ 35,866 $ 41,199 $ 100,461 $ 110,442 Commercial technologies 2,683 3,202 7,882 12,072 ---------- --------- ---------- -------- Net sales $ 38,549 $ 44,401 $ 108,343 $ 122,514 ========== ========= ========== ========
Net sales directly to the U.S. Government in the forty and thirty-nine weeks ended May 4, 2008 and April 29, 2007 accounted for approximately 16% and 22% of net sales, respectively, and in the thirteen and thirteen weeks ended May 4, 2008 and April 29, 2007 net sales directly to the U.S. Government accounted for approximately 21% and 24% of net sales. Lockheed Martin and Northrop Grumman each accounted for approximately 12% and 11% of net sales, respectively in the forty weeks ended May 4, 2008. No other customer accounted for 10% or more of consolidated net sales in the periods presented. Foreign sales amounted to approximately $34,434,000 (32%) and $33,803,000 (28%) in the forty and thirty-nine weeks ended May 4, 2008 and April 29, 2007, respectively; and in the thirteen and thirteen weeks ended May 4, 2008 and April 29, 2007 foreign sales amounted to approximately $11,448,000 (30%) and $10,157,000 (23%), respectively. Geographic net sales based on place of contract performance, were as follows (in thousands):
Thirty- Forty nine weeks weeks Thirteen weeks ended ended ended May 4, April 29, May 4, April 29, 2008 2007 2008 2007 ---- ---- ---- ---- United States $ 33,715 $ 38,214 $ 91,745 $ 103,476 Israel 4,380 5,170 14,388 15,054 England 454 1,017 2,210 3,984 ----------- ----------- ------------ ----------- Net sales $ 38,549 $ 44,401 $ 108,343 $ 122,514 =========== =========== ============ ===========
Net property, plant and equipment by geographic area were as follows (in thousands):
May 4, July 29, 2008 2007 ---- ---- United States $ 26,291 $ 24,904 Israel 4,458 4,844 England 208 248 ------- ------- $ 30,957 $ 29,996 ======= =======
13 12. Supplemental Cash Flow information is as follows (in thousands):
Forty Thirty-nine weeks ended weeks ended May 4, 2008 April 29, 2007 ----------- -------------- Net cash paid during the period for: Interest $ 323 $ 357 Income taxes $ 324 $ - Non-cash financing transactions: Retirement of 493,938 shares of treasury stock $ 7,138 $ -
13. New Accounting Pronouncements In March 2008, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 161 ("SFAS 161"), Disclosures about Derivative Instruments and Hedging Activities--an amendment of FASB Statement No.133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 161 requires companies to provide enhanced disclosures regarding derivative instruments and hedging activities in order to better convey the purpose of derivative use in terms of risk management. Disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect a company's financial position, financial performance, and cash flows, are required. This Statement retains the same scope as SFAS No. 133 and is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact, if any, that the adoption of SFAS No. 161 will have on its consolidated financial position, cash flows and results of operations. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS No. 157 (i) establishes a single definition of fair value and a framework for measuring fair value, (ii) sets out a fair value hierarchy to be used to classify the source of information used in fair value measurements, and (iii) requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. This statement applies under other accounting pronouncements that require or permit fair value measurements. In February 2008, the FASB issued Staff Positions (FSPs) No. 157-1 and No. 157-2, which, respectively, remove leasing transactions from the scope of SFAS No. 157 and defer its effective date for one year relative to certain nonfinancial assets and liabilities. As a result, the application of the definition of fair value and related disclosures of SFAS No. 157 (as impacted by these two FSPs) will be effective for the Company's fiscal year beginning August, 2008 on a prospective basis with respect to fair value measurements of (a) nonfinancial assets and liabilities that are recognized or disclosed at fair value in the Company's financial statements on a recurring basis (at least annually) and (b) all financial assets and liabilities. The remaining aspects of SFAS No. 157 for which the effective date was deferred under FSP No. 157-2 are currently being evaluated by the Company and will be effective for the Company's fiscal year beginning August, 2009. Areas impacted by the deferral relate to nonfinancial assets and liabilities that are measured at fair value, but are recognized or disclosed at fair value on a nonrecurring basis. This deferral applies to such items as nonfinancial assets and liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods) or nonfinancial long-lived asset groups measured at fair value for an impairment assessment. The effects of SFAS No. 157 and FSPs No. 157-1 and No. 157-2 are currently being evaluated by the Company but are not expected to have a material impact on its consolidated results of operations, cash flows or financial condition. In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" (SFAS 141(R)). The objective of this Statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination. Specifically, it establishes principles and requirements over how the acquirer (1) recognizes and measures the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (2) recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase, and; (3) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) also requires acquisition-related transaction expenses and restructuring costs be expensed as incurred rather than capitalized as a component of the business combination. This Statement is effective for fiscal years beginning after December 15, 2008 (the Company's 2010 fiscal year). The Company does not believe this Statement will have a material impact on the financial statements. SFAS 141(R) would have an impact on accounting for any businesses acquired after the effective date of this pronouncement. In December 2007, the FASB issued Statement of Financial Accounting Standard No. 160, "Noncontrolling Interests in Consolidated Financial Statements an amendment of ARB No. 51" (SFAS 160). The objective of this Statement is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards for the noncontrolling interest in a subsidiary (minority interests) and for the deconsolidation of a subsidiary. SFAS 160 also requires that a retained noncontrolling interest upon the deconsolidation 14 of a subsidiary be initially measured at its fair value. Upon adoption of SFAS 160, the Company would be required to report any noncontrolling interests as a separate component of stockholders' equity. The Company would also be required to present any net income allocable to noncontrolling interests and net income attributable to the stockholders of the Company separately in its consolidated statements of income. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008 (the Company's 2010 fiscal year). SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests, and would have an impact on the presentation and disclosure of the noncontrolling interest of any non wholly-owned businesses acquired in the future. 14. Related Party Transactions The Company leases one of its buildings in Fort Walton Beach, Florida from MSI Investments, a Florida General Partnership which is owned by four individuals, two of whom are currently employees of MSI and one who serves as a consultant. Rent expense in the thirteen and forty weeks ended May 4, 2008 was approximately $71,000 and $213,000, respectively, and for the thirteen and thirty-nine weeks ended April 29, 2007 was approximately $69,000 and $204,000, respectively. The Company leases its facilities in Farmingdale, New York from a partnership partially owned by the children of an officer of the Company. Rent expense in the thirteen and forty weeks ended May 4, 2008 was approximately $208,000 and $506,000, respectively, and for the thirteen and thirty-nine weeks ended April 29, 2007 was approximately $173,000 and $515,000, respectively. 15. Line of Credit and Stand-by Letters of Credit On April 30, 2007, The Company replaced its existing credit facility with a new $40 million Revolving Credit Loan Agreement with two banks on an unsecured basis which may be used for general corporate purposes, including business acquisitions and stand-by letters of credit. The revolving credit facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on March 31, 2010 (as amended May 2, 2008.) The Company may elect to borrow with interest based on the bank's prime rate of interest minus 0.50% or based on LIBOR plus a margin of 1.65% (as amended May 2, 2008.) There is a fee of 20 basis points per annum on the unused portion of the credit facility payable quarterly. If at any time our backlog of orders falls below $50 million, the bank may obtain a security interest in eligible accounts receivable, as defined, and if the outstanding advances are greater than 100% of eligible receivables, a lien on all inventory. Our backlog as of May 4, 2008 was approximately $158 million. During the forty weeks ended May 4, 2008, the Company utilized the credit facility for short-term working capital needs to the extent of $13.9 million. There are no borrowings under the credit line at May 4, 2008 and July 29, 2007. The Company borrowed $1.5 million under the credit line on May 5, 2008. The Company maintains a letter of credit facility in connection with its revolving credit agreement with two banks that provides for the issuance of stand-by letters of credit, subject to a maximum of loans and letters of credit outstanding of $40,000,000, and requires the payment of a fee of 1.0% per annum of the amounts outstanding under the facility. The facility expires March 31, 2010 as amended. At May 4, 2008 and July 29, 2007, stand-by letters of credit aggregating approximately $17,420,000 and $11,535,000, respectively were outstanding under this facility. The agreement contains various financial covenants, including, among other matters, minimum tangible net worth, total liabilities to tangible net worth, debt services coverage, and restrictions on other borrowings. The Company was in compliance with all covenants (as amended May 2, 2008) at May 4, 2008. 16. Subsequent Event On May 6, 2008 the Company announced a plan to significantly downsize its manufacturing facility in Farmingdale, New York and transfer the bulk of its workload to its other facilities in Whippany, New Jersey; Woburn, Massachusetts; Lancaster, Pennsylvania; and Jerusalem, Israel. 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 15 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. Explanatory Note We begin Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") of Herley Industries, Inc. with a business overview. This is followed by a discussion of the critical accounting estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results, which we discuss under "Results of Operations." We then provide an analysis of cash flows under "Liquidity and Capital Resources." This MD&A should be read in conjunction with our unaudited condensed consolidated financial statements, the notes thereto, the other unaudited financial data included elsewhere in this 10-Q and our 2007 Form 10-K/A Amendment No. 1. Business Overview We are a leading supplier of microwave products and systems to defense and aerospace entities worldwide. Our primary customers include large defense prime contractors (including Northrop Grumman Corporation, Lockheed Martin Corporation, Raytheon Company, The Boeing Company, BAE Systems and Harris Corporation), the U.S. Government (including the Department of Defense, NASA and other U.S. Government agencies) and international customers (including the Egyptian, German, Japanese and South Korean militaries and suppliers to international militaries). We are a leading provider of microwave technologies for use in command and control systems, flight instrumentation, weapons sensors and electronic warfare systems. We have served the defense industry since 1965 by designing and manufacturing microwave devices for use in high technology defense electronics applications. Our products and systems are currently deployed on a wide range of high profile military platforms, including the F-16 Falcon, the F/A-18E/F Super Hornet, the E-2C/D Hawkeye, EA-18G Growler, the AEGIS class surface combatants, the EA-6B Prowler, the AMRAAM air to air missile, CALCM (Conventional Air Launch Cruise Missile), Multi-mission Maritime Aircraft and unmanned aerial vehicles, or UAVs, as well as high priority national security programs such as National Missile Defense and the Trident II D-5. Critical Accounting Policies and Estimates Our significant accounting policies are described in Note A of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K/A Amendment No. 1 for the fiscal year ended July 29, 2007. A discussion of our critical accounting policies and estimates are included in Management's Discussion and Analysis of Results of Operations and Financial Condition in our Annual Report on Form 10-K/A Amendment No. 1 for the fiscal year ended July 29, 2007. Management has discussed the development and selection of these policies with the Audit Committee of the Company's Board of Directors, and the Audit Committee of the Board of Directors has reviewed the Company's disclosures of these policies. We adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48) effective July 30, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes," and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We had no cumulative effect adjustment related to the adoption. However, certain amounts have been reclassified in the consolidated balance sheet in order to comply with the requirements of the statement. Other than the adoption of FIN 48, there have been no material changes to the critical accounting policies or estimates reported in Management's Discussion and Analysis section of the audited financial statements for the fiscal year ended July 29, 2007 as filed with the Securities and Exchange Commission. Results of Operations Our Company's senior management regularly reviews the performance of our operations including reviews of key performance metrics as well as the status of operating initiatives. We review information on the financial performance of the operations, new business opportunities, customer relationships and initiatives, IR&D activities, human resources, manufacturing effectiveness, cost reduction activities, as well as other subjects. We compare performance against budget, against prior comparable periods, and against our most recent internal forecasts. The following table presents a financial summary comparison (in thousands) of the key performance metrics. 16
Third Quarter Nine Months Year to Date ------------------------------------ ------------------------------------ 2008 2007 % Change 2008 2007 % Change ------------------------------------ ------------------------------------ Key performance metrics: Net sales $38,549 $44,401 (13)% $108,343 $122,514 (12)% Gross profit $8,567 $12,714 (33)% $23,553 $32,986 (29)% Gross profit percentage 22.2% 28.6% 21.7% 26.9% Operating (loss) income ($10,884) $3,819 (385)% ($19,858) ($1,243) (1,498)% Bookings $49,159 $58,731 (16)% $131,132 $146,927 (11)% Backlog $158,089 $150,496 5 % $158,089 $150,496 5 %
The results of operations for the Company in our third quarter included a $9.5 million charge for the settlement of the Department of Justice litigation matters. Our gross profit in the quarter improved versus the second quarter of fiscal 2008 and we believe this improvement will continue. In our discussion below, we will explain the key performance metrics and provide an analysis of the performance of the Company in the third quarter. While the results of the third quarter did not meet expectations, we believe the underlying strength of the business is continuing to show operational improvement and we believe we will return to profitability in the fourth quarter. However, there can be no assurance that we will achieve our expectations. We believe the overall prospects for our financial performance continues to be promising. Our backlog remains at high levels while our proposal activity continues to be very active. The poor financial performance year to date, and particularly in the second quarter, is driven largely by engineering and manufacturing difficulties on a number of significant and important contracts, including development contracts. We understand the various technical problems we are facing and are progressing with action plans to resolve them. In addition, the operational issues are being carefully, but aggressively addressed, as evidenced in part by the recently announced restructuring of our Farmingdale facility. Although there can be no assurance that we will succeed, we are confident that we will successfully work through these challenges. During recent months, a number of operational improvement initiatives have been undertaken at our operating facilities. We expect many of these initiatives to provide operational performance improvement in the near term and, in fact, we are already seeing some of their impact on the businesses. We have established four improvement objectives across all locations. They are: improve cycle time, reduce defects, improve customer satisfaction, and increase Herley pride. We motivated our employees to actively engage in this program. Across our eight locations we have more than 100 active teams addressing company specific improvement objectives aligned with these four corporate objectives. Each of these teams has a quantifiable improvement objective targeted for completion on or before the end of our fiscal year. We are also emphasizing a culture of honoring our commitments in everything we do. We are seeing this process improvement culture beginning to take root in our operations. Although we believe that our expectations for the success of these initiatives are reasonable, there are no guarantees that future results, performance or achievements may be realized. Similarly, we formed five Councils which are: Technology, Operations, Business Development, Finance, and Contracts. Each Council has a representative from each of our locations and is chartered with the objective of implementing process improvements in their respective discipline that crosses all locations as well as sharing of best practices across Herley. Each Council has identified specific, measurable objectives which are expected to be achieved on or before the end of this fiscal year. Approximately thirty different issues are being addressed by the Councils, each of which we believe will improve the performance of the Company. In addition, we are identifying and implementing specific and substantive actions immediately to control costs and focus the resources of the Company directly on the operational performance issues which are designed to bring about measurable improvement in a short period of time. Accordingly, we believe we are taking appropriate and aggressive actions to meet the challenges facing our Company and we remain optimistic that the Company's performance issues will be short-lived. Thirteen weeks ended May 4, 2008 and April 29, 2007 - --------------------------------------------------- Net sales for the thirteen weeks ended May 4, 2008 were approximately $38.5 million, as compared to $44.4 million in the thirteen weeks ended April 29, 2007, a decrease of $5.9 million (13%). This decrease is primarily attributable to: o A decrease of $1.9 million due to the completion of a contract for radio communications equipment in a prior period at ICI; o A decrease of more than $1.6 million at Herley Farmingdale as the result of delays in certain microwave development programs; o A decrease of $0.8 million at Herley Israel due to the timing of shipments on a particular contract; o A decrease of approximately $0.5 million at EWST due to cost overruns on a percentage completion contract for a simulation system for an international customer; o A decrease of $0.5 million in activity on various cost plus fixed fee contracts at ICI due to contract mix and timing; o A decrease at Herley Medical Products of approximately $0.5 million in medical equipment sales due to timing of key customer capital purchasing requirements; 17 o A decrease of $0.4 million at Herley New England due to a temporary decline in production output resulting from turnover of certain key technicians; and o A decrease of $0.2 million versus the prior year quarter as certain commercial programs ended and the transition towards military business progressed at Herley CTI. Offsetting these decreases was: o An increase of $0.6 million at Micro Systems, Inc. across several contracts. Domestic and foreign sales from all locations were 70% and 30% respectively of total net sales in the quarter, versus 77% and 23% respectively in the prior year quarter. Bookings in the third quarter were approximately $49.2 million, and were 85% domestic and 15% foreign. This compares to bookings of approximately $58.7 million in the prior year third quarter which were 69% domestic and 31% foreign, and included a large $8.3 million order at Herley Israel for an Airborne Electronic Warfare program. Gross profit in the thirteen weeks ended May 4, 2008 was $8.6 million (22.2% of net sales) compared to $12.7 million (28.6% of net sales) in the third quarter of fiscal 2007, a decrease of approximately $4.1 million. Contributing to the decrease in gross profit for the quarter are the following items: o Reduced volume of revenues across several Herley operations affected gross margin by approximately $1.7 million; o Loss provisions of approximately $0.8 million were established for two development contracts at Herley Farmingdale due to changes in management's estimate of the costs required to complete the contract requirements; o Gross profit at our EWST operation decreased by $0.5 million due to changes in management's estimate of the costs required to complete the contract requirements of a development contract for an international customer; o We incurred higher independent research and development costs of approximately $0.6 million on investments in certain strategic opportunities at multiple Herley operations; o Higher costs at our Israeli subsidiary of approximately $0.4 million due to the unfavorable exchange rate of the U.S. Dollar versus the Israeli Shekel; and o Products mix both domestically and internationally. Offset by o Gross profit improvement within certain operations due to reduced overhead spending, product mix, or performance improvement. Selling and administrative expenses for the thirteen weeks ended May 4, 2008 increased approximately $1.1 million over the third quarter of fiscal 2007 and was 26% of net sales as compared to 20% in fiscal 2007. Significant expenses during the period included: o An increase in legal fees, net of accrued insurance recoveries, over the prior year third quarter of approximately $1.0 million. During the thirteen weeks ended May 4, 2008, gross legal costs were approximately $2.4 million, while legal costs net of accrued insurance recoveries were approximately $1.2 million as compared to $0.2 million in thirteen weeks ended April 29, 2007. Legal costs in both periods are primarily attributable to the indictment by the Department of Justice and the subsequent class action lawsuits; o An increase in sales commissions of approximately $0.4 million over the prior year third quarter; o An increase in stock compensation costs recorded per SFAS 123(R) of approximately $0.2 million; and o An increase in amortization of intangibles of approximately $0.1 million. Offset by o A net decrease in general expenses at various locations of approximately $0.6 million. We believe we are entitled to recovery of certain legal fees associated with the recent indictment and class-action complaints under our D&O insurance policy. Accordingly, as of May 4, 2008, we have recorded a claim of approximately $4.8 million (net of a deductible of $0.5 million) and have received partial payments of approximately $2.0 million leaving a receivable balance of $2.8 million. The amount is included in other receivables in the accompanying condensed consolidated balance sheet at May 4, 2008. The insurance carrier may contest the claim in whole or in part. In addition, we have entered into an agreement dated January 11, 2007 with the insurance carrier whereby if it is determined by final decision of an arbitration panel, or by final judgment of a court, or other final decision of a tribunal having jurisdiction thereof, that any amount paid by the insurance carrier was not a loss, as that term is defined in the policy, we shall repay to the insurance carrier any such uncovered sums previously advanced to us. 18 The term "Loss" is defined in the policy as follows: "Loss means the amount that any Insured becomes legally obligated to pay on account of any covered Claim, including but not limited to damages (including punitive or exemplary damages, or the multiple portion of any multiplied damage award, if and to the extent such damages are insurable under the law of the jurisdiction most favorable to the insurability of such damages provided such jurisdiction has a substantial relationship to the relevant Insureds, to the Company, or to the Claim giving rise to the damages), judgments, settlements, pre-judgment and post-judgment interest, Defense Costs and, solely with respect to Insuring Clause 2, Settlement fees." Further, the policy defines "Defense Costs" as follows: "Defense Costs means that part of Loss consisting of reasonable costs, charges, fees (including but not limited to attorneys' fees and experts' fees) and expenses (other than regular or overtime wages, salaries, fees or benefits of the directors, officers or employees of the Organization) incurred in defending any Claim and the premium for appeal, attachment or similar bonds." In establishing the receivable for legal recoveries, the Company identified and segregated defense costs related to the defense of the class action lawsuits and the defense of the former Chairman and officer of the Company in the criminal case. The Company believes such costs represent a "loss" under its D&O policy and are recoverable. The Company excluded all defense costs related to the defense of the Company pertaining to the criminal case as such costs may not be recoverable under the D&O policy. Loss from operations for the third quarter of fiscal 2008 was $10.9 million or 28.2% of net sales, as compared to income from operations of $3.8 million or 8.6% of net sales in the prior year. The loss from operations for the third quarter of fiscal 2008 included the $9.5 million litigation settlement costs and was also impacted by the shortfall in gross margin as well as the increased general and administrative costs as described above. Other income (expense) decreased in the third quarter of fiscal 2008 over the prior year by approximately $0.3 million primarily due to reduced investment income on lower cash balances and foreign currency exchange fluctuations. The foreign exchange gains and losses are attributable to fluctuations in exchange rates between the U.S. dollar and the local currency of our U.K. subsidiary primarily in connection with temporary advances we have made to them in U.S. dollars. The income tax benefit recognized in the third quarter of fiscal 2008 was $7.3 million as compared to a provision of $0.3 million in the prior year's third quarter. The benefit in fiscal 2008 consists primarily of the tax benefit of $4.7 million attributable to the loss in the quarter (adjusted for the non-deductible fine of $3.5 million paid as part of the litigation settlement); plus the recognition of a tax benefit of $2.7 million due to the expiration of the statute of limitations in April 2008. This benefit primarily relates to a deduction taken for an impaired investment on the Company's fiscal year 2004 income tax return. Forty weeks ended May 4, 2008 and thirty-nine weeks ended April 29, 2007 - ------------------------------------------------------------------------ Net sales for the forty weeks ended May 4, 2008 were approximately $108.3 million compared to $122.5 million in the first nine months of fiscal 2007, a decrease of $14.2 million (12%). The decrease in net sales is primarily related to: o a decrease of approximately $5.5 million due to delays in booking and reduction in scope for certain cost plus fixed fee contracts for software development at ICI; o a decrease of approximately $3.0 million in deliveries due to the completion of a contract for radio communications equipment at ICI; o delays in key microwave development and production programs at Herley Farmingdale of approximately $3.9 million; o a decrease at Herley Medical Products of approximately $1.9 million in equipment sales to two key commercial customers due to timing of their capital purchasing requirements; o a decrease of approximately $1.8 million at EWST due to cost overruns on a percentage completion contract for a simulation system for an international customer and timing of other contract activity; o disruptions across several production programs due to supplier quality issues, primarily affecting the second quarter; and o a decrease in revenues of approximately $2.2 million versus the first nine months of the prior year as certain commercial programs ended and the transition towards military business progressed at Herley CTI. Offsetting these decreases was: o an increase of $4.1 million of simulation systems and other product sales through Micro Systems, Inc.; and o an increase of approximately $0.4 million at Herley New England due to volume of certain key second generation production programs. Domestic and foreign sales were 68% and 32% respectively of net sales in the forty weeks ended May 4, 2008, versus 72% and 28% respectively in the prior year comparable period. Bookings were approximately $131.1 million, and were 79% domestic and 21% foreign. This compares to bookings of approximately $146.9 million in the prior year period which were 66% domestic and 34% foreign. 19 Gross profit in the forty weeks ended May 4, 2008 was $23.6 million (21.7% of net sales) compared to $33.0 million (26.9% of net sales) in the first nine months of fiscal 2007, a decrease of $9.4 million. The decrease was approximately $0.3 million during the first quarter, $5.0 million during the second quarter, and $4.1 million during the third quarter. Contributing to the reduction in gross profit during the first nine months of fiscal 2008 are the following items: o Reduced volume of revenues across several Herley operations affected gross margin by approximately $3.7 million; o Higher independent research and development costs of approximately $2.7 million on investments in certain strategic opportunities at several Herley operations. o Approximately $1.0 million at Herley Farmingdale due to cost overruns and a change in management's estimate of the recoverability of the costs on future contracts. o Higher costs at our Israeli subsidiary due to the unfavorable exchange rate of the U.S. Dollar versus the Israeli Shekel reduced gross margins by approximately $0.9 million; and o Product mix of contracts both domestically and internationally. Selling and administrative expenses for the forty weeks ended May 4, 2008 were 26% of net sales as compared to 21% in the first nine months of fiscal 2007. The $2.6 million increase in selling and administrative expenses is attributable to an increase in legal costs; an increase in commissions related primarily to our international business, an increase in stock compensation costs recorded per SFAS 123(R); and an increase in amortization expense. We had an operating loss for the first nine months of fiscal 2008 of $19.9 million compared to an operating loss of $1.2 million in the comparable period of fiscal 2007 which includes the $9.5 million settlement of the Department of Justice litigation and the $6.0 million settlement of the EADS litigation as discussed in Note 2 to the condensed consolidated financial statements. Excluding both the litigation settlement costs in the first and third quarters of fiscal 2008 and the employment contract settlement costs recorded in the first quarter of fiscal 2007, operating loss for the first nine months of fiscal 2008 was $4.4 million or 4.1% of net sales, as compared to operating income of $7.7 million or 6.3% of net sales in the first nine months of fiscal 2007. The decrease in operating income is primarily attributable to the 12% reduction in sales volume, the 5.2% decrease in gross margin percentage as discussed above, and the increase in selling and administrative expenses. Investment income was $1.0 million, an increase of $0.1 million in the first nine months of fiscal 2008 because of higher interest rates earned on higher average cash balances through a portion of the year. Interest expense was $0.4 million, a decrease of $0.2 million versus the prior year comparable period. We recognized a net foreign exchange loss of $0.5 million through the third quarter of fiscal 2007. The foreign exchange losses and gains are attributable to fluctuations in exchange rates between the U.S. dollar and the local currency of our U.K. subsidiary primarily in connection with temporary advances we have made to them in U.S. Dollars. The income tax benefit recognized in the first nine months of fiscal 2008 was $9.3 million (an effective income tax benefit rate of 48.2%.) The estimated effective tax benefit rate for fiscal year 2008 is 48.8%, which is greater than the statutory rate of 35% primarily due to the recognition of the FIN 48 liability that could now be recognized offset by the non-deductible penalty paid as part of the litigation settlement. Other non-recurring items contributing to the tax benefit in the first nine months of fiscal 2008 include a research and development credit carryover and a lower than expected tax rate in Israel for fiscal 2007 which increased the income tax benefit for the first nine months of fiscal 2008 by approximately 3.6% resulting in an overall effective rate for the first nine months of 48.2%. Liquidity and Capital Resources - ------------------------------- As of May 4, 2008 and July 29, 2007, working capital was $91.1 million and $103.5 million, respectively, and the ratio of current assets to current liabilities was 2.8 to 1 and 4.0 to 1, respectively. As is customary in the defense industry, inventory is partially financed by progress payments. In addition, it is customary for us to receive advanced payments from customers on major contracts at the time a contract is entered into. The un-liquidated balance of progress payments was approximately $1.3 million at May 4, 2008 and $1.9 million at July 29, 2007. The balance of advanced payments was approximately $7.1 million at May 4, 2008 and $7.2 million at July 29, 2007. Net cash used in operations during the forty weeks ended May 4, 2008 was approximately $2.8 million as compared to net cash provided by operations of $1.4 million during the first three quarters of the prior year, a net decrease of approximately $4.2 million. We had a net loss in the first three quarters of the current fiscal year of $10.0 million versus a loss of $4.3 million in the prior year first three quarters, an increase in the loss of approximately $5.7 million. The first three quarters of fiscal 2008 was impacted by the settlement costs of various litigation and related expenses of approximately $15.5 million and the first three quarters of fiscal 2007 included employment settlement costs of approximately $8.9 million, including a cash payment of $3.0 million (as discussed in Note 2 to the condensed consolidated financial statements). 20 Significant increases in cash provided by operating activities during the forty weeks ended May 4, 2008 include the following: 1. A decrease in trade accounts receivable of $4.4 million, and 2. an increase of approximately $9.3 million generated through amounts due to vendors and accrued expenses. Offset primarily by the following decreases in cash provided by operating activities: 1. An increase of approximately $5.4 million in the amount of cash invested in costs incurred and income recognized in excess of billings on uncompleted contracts and claims, 2. an increase in inventory of approximately $9.9 million partially due to delays in shipping certain contracts due to technical issues, 3. payments of $4.0 million in connection with the EADS litigation settlement, 4. payments of $1.0 million in connection with the employment settlement agreement in 2007, and 5. an increase in refundable income taxes of $1.2 million. On May 5, 2008, the Company paid $9.5 million in fines and settlement costs in connection with the settlement of litigation (see Note 6 to the condensed consolidated financial statements). Net cash used in investing activities relates to capital expenditures of approximately $3.9 million. Net cash used in financing activities includes: 1. The purchase and retirement of 493,938 shares of our common stock at an aggregate cost of approximately $7.1 million, including transaction costs, pursuant to an expansion of a stock buyback program to make additional purchases of up to 1,000,000 shares of our common stock in the open market or private transactions. As of May 4, 2008, approximately 614,000 shares are available for purchase under the buyback program, and 2. payments of $1.0 million related to our long-term debt. During the forty weeks ended May 4, 2008 we borrowed and repaid $13.9 million under our revolving credit facility for short-term working capital needs. On May 5, 2008 we borrowed $1.5 million under our credit facility in connection with the litigation settlement payment. On April 30, 2007, we replaced our existing credit facility with a new $40 million Revolving Credit Loan Agreement with two banks on an unsecured basis which may be used for general corporate purposes, including business acquisitions and stand-by letters of credit. The revolving credit facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on March 31, 2010 (as amended May 2, 2008). We may elect to borrow with interest based on the bank's prime rate of interest minus 0.50% or based on LIBOR plus a margin of 1.65% (as amended May 2, 2008). There is a fee of 20 basis points per annum on the unused portion of the credit facility payable quarterly. If at any time our backlog of orders falls below $50 million, the bank may obtain a security interest in eligible accounts receivable, as defined, and if the outstanding advances are greater than 100% of eligible receivables, a lien on all inventory. Our backlog as of May 4, 2008 was approximately $158 million. During the forty weeks ended May 4, 2008, we utilized the credit facility for short-term working capital needs to the extent of $13.9 million. There are no borrowings under the credit line at May 4, 2008 and July 29, 2007. Stand-by letters of credit were outstanding in the amount of approximately $17.4 million under the credit facility at May 4, 2008, and $11.5 million at July 29, 2007. As indicated above, we borrowed $1.5 million under the credit line on May 5, 2008. The agreement contains various financial covenants, including, among other matters, minimum tangible net worth, total liabilities to tangible net worth, debt services coverage, and restrictions on other borrowings. We are in compliance with all covenants (as amended May 2, 2008) at May 4, 2008. We believe that presently anticipated future cash requirements will be provided by internally generated funds, our existing unsecured credit facility, and existing cash reserves. A significant portion of our revenue for fiscal 2008 will be generated from our existing backlog of sales orders. Our backlog at May 4, 2008 was approximately $158 million. In the event of the cancellation of a significant amount of government contracts included in our backlog, we will be required to rely more heavily on cash reserves and our existing credit facility to fund operations. We are not aware of any events which are reasonably likely to result in any cancellation of our government contracts. As of May 4, 2008, we have approximately $22.6 million available under our bank credit facility, net of outstanding stand-by letters of credit of approximately $17.4 million and operating cash of approximately $20.6 million. 21 Contractual Financial Obligations, Commitments and Off-Balance Sheet Arrangements Our financial obligations and commitments to make future payments under contracts include purchase orders, debt and lease agreements, and contingent commitments such as stand-by letters of credit. These financial obligations are recorded in accordance with accounting rules applicable to the underlying transaction, with the result that some are recorded as liabilities on the Condensed Consolidated Balance Sheet, while others are required to be disclosed in the Notes to Consolidated Financial Statements and Management's Discussion and Analysis. The Company's contractual financial obligations and other contingent commitments are disclosed in our Annual Report on Form 10-K/A Amendment No. 1 for the fiscal year ended July 29, 2007 under Management's Discussion and Analysis. In addition to the financial obligations contained therein, the following payments (including imputed interest), and a stand-by letter of credit, are required under the terms of the litigation settlement discussed in Note 2 to the condensed consolidated financial statements (in thousands):
Stand-by Letters of Credit -------------------------- Payments Litigation Other -------- ---------- ----- Within one year $1,000 $1,000 $3,960 2 years 1,000 1,000 - ------- ------- ------ Total $2,000 $2,000 $3,960 ======= ======= =======
Upon the adoption of FIN 48, the Company reclassified to long term its liabilities for unrecognized tax benefits in the amount of approximately $3.1 million, as discussed in Note 4 to the Condensed Consolidated Financial Statements. Approximately $2.7 million of the unrecognized tax benefit was realized in the quarter ended May 4, 2008 due to the expiration of the statute of limitations in April 2008. The Company is unable to make reasonable estimates as to the period(s) in which cash will be paid for the remaining liabilities. New Accounting Pronouncements - ----------------------------- For a discussion of new accounting standards, see Note 13 to our Condensed Consolidated Financial Statements - (Unaudited) in Item 1. Item 3: Quantitative and Qualitative Disclosures About Market Risk The Company's exposures to market risk have not changed significantly since July 29, 2007. Item 4: Controls and Procedures (a) Evaluation of disclosure controls and procedures. The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 as amended (the "Exchange Act"). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within the required time periods. The Company's management, with participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the design, operation and effectiveness of the Company's disclosure controls and procedures and have concluded, based on such evaluation, that such controls and procedures were effective at providing reasonable assurance that required information will be disclosed in the Company's reports filed under the Exchange Act as of May 4, 2008. (b) Changes in internal controls. There were no changes in the Company's internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended May 4, 2008 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II - OTHER INFORMATION Item 1 - Legal Proceedings: On June 6, 2006, in connection with a continuing investigation by the U.S. Attorneys' Office in Pennsylvania which, inter alia, involves pricing under contracts with the U.S. Department of Defense relating to voltage control oscillators and powerheads, an indictment was returned against the Company and Lee Blatt, its former Chairman. No other officer or director of the Company was named in the indictment. The contracts aggregate approximately $3.9 million in total revenue. The indictment as superseded on January 30, 2007 alleges 27 counts of violations of the wire fraud statute (18 U.S.C. Section 1343); 2 counts of violations of the obstruction of a federal audit statute (18 U.S.C. Section 1516); 1 count of violating the major fraud against the United States statute (18 U.S.C. Section 1031); 3 counts of violating the false statements to the government statute (18 U.S.C. Section 1001); aiding and abetting (18 U.S.C. Section 2); and a notice of forfeiture. The Company moved to dismiss the indictment and that motion was denied on November 5, 2007. A trial was scheduled for May 5, 2008. 22 On May 5, 2008, the Company entered into an agreement with the United States Attorney's Office for the Eastern District of Pennsylvania in which (a) the Company agreed to plead guilty to two counts of obstructing an audit relating solely to the powerheads; (b) the Company agreed to pay a fine of $3.5 million; and (c) the Government agreed to dismiss all other counts of the Superseding Indictment. The agreement was presented to the Court on May 5, 2008, and the Court accepted the agreement and sentenced the Company to the agreed-upon fine. With respect to Mr. Blatt, the Court, at the Government's request, dismissed all of the charges against him in the indictment and the Government filed a Superseding Information charging Mr. Blatt with a misdemeanor violation of the tax code in a single count, and Mr. Blatt has entered a guilty plea for failing to keep Company records of the allocation of an $18,000 corporate research expense. Mr. Blatt has been fined $25,000, has received a term of probation of one year and is required to perform some community service. Under the terms of an indemnification agreement with Mr. Blatt, the Company has agreed to provide indemnification with regard to certain legal proceedings so long as he has acted in good faith and in a manner believed to be in, or not opposed to, the Company's best interest with respect to any criminal proceeding and had no reasonable cause to believe his conduct was unlawful. Shortly before the indictment mentioned above, Company counsel were notified by representatives of the United States Attorney's Office for the Eastern District of Pennsylvania, Civil Division, that they intended to file a civil lawsuit against the Company pursuant to inter alia, the False Claims Act, 31 U.S.C. Section 3729 et. seq. The Company entered into a Tolling Agreement on June 21, 2006, deferring any further activity related to this potential claim until after the trial of the criminal matter mentioned above. By agreement dated May 5, 2008, the United States Attorney's Office for the Eastern District of Pennsylvania and the Company entered into an agreement to resolve the potential issues arising from the lawsuit threatened against the Company pursuant to, among other things, the False Claims Act, 31 U.S.C. Section 3729 et. seq. for the matters alleged in the Superseding Indictment. The Company agreed to pay $6 million in exchange for, among other things, a release. In June and July 2006, the Company was served with several class-action complaints against the Company and certain of its officers in the United States District Court for the Eastern District of Pennsylvania. The claims are made under Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. All defendants in the class-action complaints filed motions to dismiss on April 6, 2007. On July 17, 2007, the Court issued an order denying the Company's and Mr. Blatt's motion to dismiss and granted, in part, the other defendants' motion to dismiss. Specifically, the Court dismissed the Section 10(b) claim against the other defendants and denied the motion to dismiss the Section 20(a) claim against them. On July 18, 2007, the Court granted defendant's motion to stay these actions until after the trial of the criminal matter referenced above. On February 8, 2008, the Court issued an Order allowing for certain document discovery to commence. On May 9, 2008, the Court lifted the stay. A Scheduling Order has now been entered requiring the parties to complete discovery by January 2009. At this stage of the proceedings, it is not possible to predict what, if any, liability the Company may have from the Securities Class Actions. In July and August 2006, the Company and certain of its current and former officers and directors were also served with two separate derivative complaints for breach of fiduciary duty brought pursuant to Rule 23.1 of the Federal Rules of Civil Procedure. The complaints relate to the Company's indictment in the matter discussed above and were consolidated into one action on March 9, 2006. All defendants in the derivative complaints filed motions to dismiss on February 26, 2007. On July 20, 2007, the Court issued an order denying defendants' motions in part and granting them in part. Specifically, the Court dismissed the claim that the named officers and directors failed to oversee Mr. Blatt and denied the motions with respect to the other alleged claims. The Court also granted defendants' motion to stay the action until after the trial of the criminal matter. On February 8, 2008, the Court issued an Order allowing for certain document discovery to commence. On May 9, 2008, the Court lifted the stay. A Scheduling Order has now been entered requiring the parties to complete discovery by January 2009. At this stage of the proceedings, it is not possible to predict what, if any, liability the Company may have from the Derivative Actions. The Company believes it is entitled to recovery of certain legal fees associated with the above matters under its D&O insurance policy. Accordingly, as of May 4, 2008, the Company recorded claims of approximately $4,802,000 (net of a deductible of $500,000) in anticipation of recoveries. As of May 4, 2008, partial payments of approximately $1,997,251 have been received leaving a receivable balance of $2,805,000. The amount is included in other receivables in the accompanying condensed consolidated balance sheet at May 4, 2008. Subsequent to May 4, 2008, the Company received an additional payment of approximately $238,000. The insurance carrier may contest the claim in whole or in part. In addition, the Company has entered into an agreement dated January 11, 2007 with the insurance carrier whereby if it is determined by final decision of an arbitration panel, or by final judgment of a court, or other final decision of a tribunal having jurisdiction thereof, that any amount paid by the insurance carrier was not a loss, as that term is defined in the policy, the Company shall repay to the insurance carrier any such uncovered sums previously advanced to the Company. The term "Loss" is defined in the policy as follows: "Loss means the amount that any Insured becomes legally obligated to pay on account of any covered Claim, including but not limited to damages 23 (including punitive or exemplary damages, or the multiple portion of any multiplied damage award, if and to the extent such damages are insurable under the law of the jurisdiction most favorable to the insurability of such damages provided such jurisdiction has a substantial relationship to the relevant Insureds, to the Company, or to the Claim giving rise to the damages), judgments, settlements, pre-judgment and post-judgment interest, Defense Costs and, solely with respect to Insuring Clause 2, Settlement fees." Further, the policy defines "Defense Costs" as follows: "Defense Costs means that part of Loss consisting of reasonable costs, charges, fees (including but not limited to attorneys' fees and experts' fees) and expenses (other than regular or overtime wages, salaries, fees or benefits of the directors, officers or employees of the Organization) incurred in defending any Claim and the premium for appeal, attachment or similar bonds." In establishing the receivable for legal recoveries, the Company identified and segregated defense costs related to the defense of the class action lawsuits and the defense of the former Chairman and officer of the Company in the criminal case. The Company believes such costs represent a "loss" under its D&O policy and are recoverable. The Company excluded all defense costs related to the defense of the Company pertaining to the criminal case as such costs may not be recoverable under the D&O policy. On June 27, 2007, the Company was notified by the Office of the General Counsel, Acquisition Integrity Office, Department of Navy (the "Navy"), that certain of its operations had been suspended from receiving new contract awards from the U.S. Government. The affected operations included facilities in Lancaster, Pennsylvania; Woburn, Massachusetts and Chicago, Illinois. The Chicago, Illinois location is a two-person marketing office. On August 15, 2007 the suspension was lifted following an amendment to the Administrative Agreement with the Navy (originally signed on October 12, 2006) extending the term of the agreement for one additional year. While the suspension was in place, these facilities could not be solicited for or awarded new contracts or contract extensions without special exceptions. The suspended facilities were permitted to receive contract awards or subcontracts from the Federal Government if the head of the agency stated in writing the compelling reason to do so. A significant portion of our business is received under contracts where we are the only qualified supplier on critical defense programs. Prior to May 5, 2008, counsel for the Company met with representatives of the Department of Navy, Suspension and Debarment Office, Acquisition Integrity Office to discuss (a) the possible agreement between the United States Attorney's Office for the Eastern District of Pennsylvania and the Company, as such is set forth above, and (b) the possible agreement with the Civil Division of the U.S. Attorney's Office and the Company, as is mentioned above. Representatives from the Navy advised that no action would be taken to suspend or debar the Company based upon these agreements, and no action was in fact taken or is expected to be taken. On April 10, 2007, EADS Deutschland GmbH ("EADS"), a German corporation, filed a lawsuit against Herley Industries, Inc., General Microwave Corporation and General Microwave Export Corporation d/b/a Herley Power Amplifier Systems (collectively the "Company") in the United States District Court for the Eastern District of New York. EADS claims that the Company breached a Transfer of Technology Agreement entered into on May 30, 2001 under which the Company was granted the right to use certain technology owned by EADS in performing under an exclusive sales and marketing agreement entered into on May 30, 2001. EADS asserted claims for breach of contract and conversion, claiming that the Company was wrongfully in possession of the intellectual property that was transferred to the Company. EADS also sought a preliminary injunction. The Company denied any wrongdoing and filed counterclaims against EADS. On August 2, 2007, the Company and EADS entered into a settlement of this motion, which was reduced to a written consent decree entered by the Court on August 29, 2007. EADS's claims for breach of contract and for conversion remained pending, as did the Company's counterclaims. Pursuant to the consent decree, the parties agreed to a mediation/settlement conference of all their respective claims with the Court, and further agreed to stay all proceedings pending the outcome of that mediation/settlement conference on October 17, 2007. In November 2007, the Company reached a comprehensive settlement agreement with EADS effective December 5, 2007, as discussed in Note 2 to the condensed consolidated financial statements. 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 other litigation will not have a material adverse effect on the Company's financial position or results of operations. Item 1A - Risk Factors In addition to the other information set forth in this report, you should carefully consider the risk factors disclosed under Part 1 -"Item 1A. Risk Factors" in our Annual Report on Form 10-K/A Amendment No. 1 for the year ended July 29, 2007, which could materially adversely affect our business, financial condition, operating results and cash flows. The risks and uncertainties described in our Form 10-K/A Amendment No. 1 for the year ended July 29, 2007 are not the only ones we face. Risks and uncertainties not currently known to us or that we currently deem immaterial also may materially adversely affect our business, financial condition, operating results or cash flows. 24 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds: None Item 3 - Defaults Upon Senior Securities: None Item 4 - Submission of Matters to a Vote of Security Holders: Information relating to the Annual Meeting of the Company held on February 26, 2008 was included in the Company's Form 10-Q for the quarter ended February 3, 2008 filed on March 12, 2008. Item 5 - Other Information: None 25 Item 6 - Exhibits 31. Certifications pursuant to Rules 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32. Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 26 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/ Kevin J. Purcell ----------------------------------------- Kevin J. Purcell, Chief Financial Officer DATE: June 12, 2008 EX-31 2 hrly10qmay2008-ex31.txt CERTIFICATIONS EXHIBIT 31 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO RULE 13a-14(a) I, Myron Levy, Chairman of the Board and Chief Executive Officer, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Herley Industries, Inc. ("the registrant"); 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining "disclosure controls and procedures" (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fiscal quarter ended May 4, 2008 that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 12, 2008 By: /S/ Myron Levy -------------------------- Name: Myron Levy Title: Chairman of the Board and Chief Executive Officer CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO RULE 13a-14(a) I, Kevin J. Purcell, Chief Financial Officer, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Herley Industries, Inc. ("the registrant"); 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining "disclosure controls and procedures" (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fiscal quarter ended May 4, 2008 that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 12, 2008 By: /S/ Kevin J. Purcell ------------------------ Name: Kevin J. Purcell Title: Chief Financial Officer EX-32 3 hrly10qmay2008-ex32.txt CERTIFICATIONS EXHIBIT 32 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER 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 of Herley Industries, Inc. (the "Company") on Form 10-Q for the quarter ended May 4, 2008, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Myron Levy, Chairman of the Board and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) Such Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: June 12, 2008 By: /S/ Myron Levy ---------------------------------- Name: Myron Levy Title: Chairman of the Board and Chief Executive Officer CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER 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 of Herley Industries, Inc. (the "Company") on Form 10-Q for the quarter ended May 4, 2008, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Kevin J. Purcell, Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) Such Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: June 12, 2008 By: /S/ Kevin J. Purcell ------------------------------- Name: Kevin J. Purcell Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----