Item 1. Business
Herley Industries, Inc. ("Herley" or the "Company") principally designs, manufactures and sells flight instrumentation components and systems, primarily to the U.S. government, foreign governments, and aerospace companies. Flight instrumentation products include command and control systems, transponders, flight termination receivers, telemetry transmitters and receivers, pulse code modulator ("PCM") encoders and decoders, and scoring systems. Flight instrumentation products are used to: (i) accurately track the flight of space launch vehicles, targets, and unmanned airborne vehicles (UAV's), (ii) communicate between ground systems and the airborne vehicle, (iii) if necessary, destroy the vehicle if it is veering from its planned trajectory, and (iv) train troops and test weapons.
The Company's command and control systems are used on training and testing ranges in the U. S. and foreign countries. The Company has an established base of approximately 100 command and control systems installed around the world, which are either shelter mounted or portable radar units. Herley also manufactures microwave devices used in its flight instrumentation products and in connection with the radar and defense electronic systems on tactical fighter aircraft.
The Company has grown internally and through selected acquisitions. As a result of acquisitions made by the Company in the past five years, the Company has evolved from a components to a systems manufacturer and has broadened its interests to the commercial and international markets. Since its inception in 1965, the Company has designed and manufactured microwave devices for use on various tactical military programs. In June 1986, the Company acquired a small engineering company, Mission Design, Inc., engaged in the design and development of transponders. This acquisition enabled the Company to enter the flight instrumentation business beginning with the design and manufacture of range safety transponders. In September 1992, the Company acquired substantially all of the assets of Micro-Dynamics, Inc. ("MDI") of Woburn, Massachusetts, a microwave subsystem designer and manufacturer. In June 1993, the Company acquired Vega Precision Laboratories, Inc. ("Vega") of Vienna, Virginia, and moved the operations to Lancaster, Pennsylvania in October 1993. In March 1994, the Company entered into an exclusive license agreement for the manufacture, marketing and sale of the Multiple Aircraft GPS Integrated Command & Control (MAGIC2) systems. In July 1995, the Company acquired certain assets and the business of Stewart Warner Electronics Corp. of Chicago, Illinois, a manufacturer of high frequency radio and IFF interrogator systems. In August 1997,
the Company acquired Metraplex Corporation ("Metraplex") of Frederick, Maryland, which has enabled the Company to enter the airborne PCM and FM telemetry and data acquisition systems market.
With these recent acquisitions, the Company has four operating facilities; HERLEY-VEGA SYSTEMS ("HVS"), operating in Lancaster, Pennsylvania; HERLEY-MDI ("MDI") operating in Woburn, Massachusetts, Stewart Warner Electronics Co. ("SWE") operating in Chicago, Illinois; and Metraplex Corporation operating in Frederick, Maryland. In January 1996 the Company created its Global Security Systems ("GSS") division, a marketing group, to serve the international marketplace.
Products
Command and Control Systems (C 2S)
For over thirty years, Vega has been manufacturing products in the radar enhancement field. The Company's command and control systems have been used to fly remotely a large variety of unmanned aerial vehicles, typically aircraft used as target drones or Remotely Piloted Vehicles ("RPVs") and some surface targets. Operations have been conducted by many users on the open ocean, remote land masses, and instrumented test and training ranges.
The Company believes that its command and control systems are currently in service throughout the world. The Company's pulse-positioned-coded ("PPC") concept enables the use of standard radar technology to track and control unmanned vehicles. Using the radar beacon mode, PPC pulse groups are transmitted and received for transfer of command and telemetry data while employing the location precision and advantages of radar techniques.
Command and control systems permit a ground operator to fly a target or a UAV through a pre-planned mission. That mission may be for reconnaissance, where the vehicle is equipped with high definition TV sensors and the necessary data links to send information back to its C2S ground station. The UAV may also be used as a decoy, since the operator can direct the flight operations that will make the small drone appear to be a larger combat aircraft.
With the 1994 licensing of the MAGIC2 systems, the Company has increased the selection of command and control systems that it offers. The 6104 TTCS (Target Tracking and Control System) unit is a reliable line-of-sight C2S with an installed base of equipment worldwide. The Company's engineers and marketers are now able to offer the MAGIC2 system as a supplement to, or replacement for, this installed base of equipment. The MAGIC2 affords over-the-horizon C2 S using GPS guidance and control of multiple targets from a single ground station. Thus, control of multiple targets at increased distances represents a significant product improvement. The increasing demand for enhanced performance by the U.S. Navy as well as foreign navies in littoral warfare scenarios can be ideally met by the use of the MAGIC2 system.
The new Model 6104 TTCS is a highly flexible, multiple processor design with high resolution graphics, which can be field configured within minutes to fly or control any selected vehicle for which it is equipped. The system is delivered with the necessary command panels and graphics display software to operate with a large variety of vehicles. A basic TTCS configuration is normally supplied with a standard command panel and the software peculiar to one vehicle. Telemetry display software is embedded for the specified vehicle, and a magnetic hard drive is supplied with a mission map prepared in accordance with a customer supplied detailed map of the area.
Military surveillance operations typically use UAVs, RPVs, or drones to avoid the cost and risk of manned surveillance vehicles in the event of an accident or if the vehicle is shot down. These inexpensive drones are controlled in flight by a Company C2 S, which may be mounted in a trailer that may be moved from place to place by helicopter or truck. The Company also supplies portable command and control systems that are mounted on tripods that can be easily transported by an operational team. The portable units permit ready deployment in rugged terrain and may also be used on ships during open ocean exercises.
In recent years, teaming arrangements between prime military contractors and the Company have increased. Large companies bidding on major programs seek to align themselves with parts and systems manufacturers such as the Company for economic reasons as well as for the technical expertise afforded by such alliance. Teaming arrangements with Tracor Corporation and Northrop Grumman Corporation have resulted in recent awards to the Company for C2 S in Australia and Singapore and the Company is presently negotiating additional teaming arrangements.
Telemetry Systems
Missile, UAV, or target testing on domestic and international test ranges require flight safety and performance data transmission to maximize flight safety during the test operation. Surveillance and intelligence gathering UAVs also require a data transmission downlink and a C2 S uplink to accomplish their mission. The Company has developed a telemetry system capability that can be configured to meet individual customers' needs. Various components of the system include data encoders, transmitters and flight termination receivers. Each has a distinctive role and each is key to the success of the mission.
In 1972 Metraplex began developing data encoding and acquisition, and signal conditioning equipment. The Company believes that Metraplex is now a leading manufacturer of PCM and FM telemetry and data acquisition systems for severe environment applications. Metraplex products are used worldwide for testing space launch vehicle instrumentation, aircraft flight testing, and amphibian, industrial and automotive vehicle testing. A product portfolio ranges in size and complexity from miniature encoders to completely programmable data acquisition systems.
The Company's recent acquisition of Metraplex will allow the Company to offer a complete airborne telemetry system package. With the digital experience of Metraplex in data encoding and acquisition elements combined with the radio frequency capability of the Company in providing its telemetry transmitters and flight termination receivers, the Company can offer a full line of narrow or wide band airborne telemetry systems to meet a wide variety of industry needs, both domestically and internationally.
Transponders
The Company manufactures a variety of expendable transponders, including range safety, identification friend or foe ("IFF"), command and control, and scoring systems.
Transponders are small, expendable, electronic systems consisting of a transmitter, sensitive receiver and internal signal processing equipment comprised of active and passive components, including microwave subassemblies such as amplifiers, oscillators and circulators. The transponder receives signals from radars, changes and amplifies the frequency of the signals, and sends back a reply on a different frequency and signal level. This reply will be a strong, noise free signal upon which the tracking radar can "lock", and one which is far superior to skin reflection tracking.
In range safety applications, transponders enable accurate tracking of space launch and unmanned aerial vehicles, missiles, and target drones so that position and direction are known throughout its flight. In the case of several defense and commercial space launch vehicles (i.e., Delta, Atlas, Titan and Pegasus), the Herley transponder is tracked by the ground launch team all the way to space orbit, and in certain instances through several orbits, as a reference location point in space to assure that the launch payload has been properly placed in orbit. The use of the transponder is far more effective than simple skin reflection tracking, particularly under adverse weather conditions after the launch.
IFF transponders, which are used in conjunction with the FAA Air Traffic Control System, enable ground controllers to identify the unmanned targets, drones and cruise missiles on which these units fly and to vector other manned aircraft safely away from the flight path of the unmanned aerial vehicle.
Command and control transponders provide the link through the telemetry system for relaying ground signals to direct the vehicle's flight. The uplink from the ground control station, a series of coded pulse
groups, carries the signals that command the flight control guidance system of the vehicle. The downlink to the ground provides both tracking signals for range safety, as well as acknowledgment and status of the uplink commands and their implementation in the vehicle. The transponder is therefore the means to fly the vehicle.
Scoring systems are mounted on both airborne and sea targets. Scoring systems enable test and evaluation engineers to determine the "miss-distance" between a projectile and the target at which it has been launched.
Flight Termination Receiver
A flight termination receiver ("FTR") is installed in a test missile, UAV, target or a space launch vehicle as a safety device. The FTR has a built-in decoder that enables it to receive a complex series of audio tones which, when appropriate, will set off an explosive charge that will destroy the vehicle. A Range Safety Officer ("RSO") using the range safety transponder will track the vehicle in flight to determine if it is performing as required. If the RSO detects a malfunction in the test or launch vehicle that causes it to veer from a planned trajectory in a manner that may endanger personnel or facilities, the RSO will transmit a coded signal to the onboard FTR to explode the vehicle harmlessly. The FTR can be programmed for complex combinations of audio tone frequencies so that it will not accidentally explode the vehicle, but will not fail to explode the vehicle when so commanded.
Microwave Devices
Herley manufactures solid state microwave devices in both Lancaster, Pennsylvania and at its MDI facility in Woburn, Massachusetts for use in its transponders and in existing long-term military programs, both as part of new production and for spare parts and repair services. These microwave devices are used in a variety of radar, communications and missile applications, including airborne and shipboard navigation and missile guidance systems.
At MDI, the Company designs and manufactures complex microwave integrated circuits ("MICs"), which consist of sophisticated assemblies that perform many functions, primarily involving switching of microwave signals. MICs manufactured by the Company are employed in many defense electronics military systems as well as missile programs.
The Company also produces receiver protector devices at MDI. These high power devices protect a radar receiver from transient bursts of microwave energy and are employed in almost every military and commercial radar system. With the contraction of the defense business, the Company believes that it has only a single competitor in this market.
In its Chicago facility, the Company designs and manufactures high frequency radio and IFF interrogators. This high frequency communications equipment is used by the U.S. Navy and foreign navies that conduct joint military exercises with the U. S. Navy. The IFF interrogators are used as part of shipboard equipment and are also placed on coastlines, where they are employed as silent sentries.
New Product Development and Applications
The Company believes that its growth depends on its ability to renew and expand its technology, products, and design and manufacturing processes with an emphasis on cost effectiveness. The Company's primary efforts are focused on engineering design and product development activities rather than pure research. A substantial portion of the Company's development activities have been funded by the Company's customers. Certain of the Company's officers and engineers are involved at various times and in varying degrees in these activities. The Company's policy is to assign the required engineering and support people, on an ad hoc basis, to new product development as needs and budgets require. The cost of these development activities, including employees' time and prototype development, net of amounts paid by
customers, were approximately $1,828,000, $1,453,000, and $970,000 in fiscal 1997, 1996, and 1995, respectively.
Over the past two years, the Company has been seeking commercial applications for its magnetron tube capability. In 1995, the Company signed agreements to develop miniature cost-effective magnetron tubes, using electrode-less high density ("EHD") techniques, for medical and industrial lighting applications. The Company believes that its partner in this joint engineering program is one of the largest lighting companies in the world. Based on initial engineering results, prototype tubes were designed, manufactured and tested satisfactorily to the specifications required. The Company and its partner are currently planning limited production of magnetron tubes to be used in an EHD industrial lighting application.
The new products and systems that the Company plans to design, manufacture and sell are data link systems, which encompass telemetry systems and telemetry data encoders. These products are currently being sold by others to the Company's existing customers. Together with transponders, they comprise the principal airborne flight instrumentation package for space launches. The Company believes that transponders represent approximately 5% to 10% of the total cost for the flight instrumentation package on a space launch vehicle. The Company anticipates sales of these new products to commence April 1998.
Telemetry Systems
Telemetry systems contain transmitters, amplifiers and receivers and provide the means of communication between the control tower, the ground station and the test or launch vehicle. Telemetry systems are the equivalent of telephone links between the air and ground portions of launch vehicles or test and training ranges. The uplink communication to the airborne vehicle is transmitted via a telemetry signal from the ground to the vehicle. The telemetry signals are used to command the airborne vehicle through its command control transponder. The transponder will then change the flight control guidance system as directed. The downlink signals from the airborne telemetry transmitter to the ground telemetry receiver provide tracking signals for range safety, confirmation of the uplink command and their implementation by the vehicle and compilation of the data from on-board sensors gathered by the data encoder.
Telemetry Data Encoders
Airborne targets and flight test missiles must have many critical parameters simultaneously monitored from the ground to gain the data required for verification of satisfactory performance or for identification of details of hardware requiring design improvements. On-board sensors may measure temperature, strain levels, vibration level and frequency, acoustic noise levels, air pressure, air velocity, humidity and other parameters of interest. The function of the encoder system is to convert the output of each of these sensors to a signal form that may be sequentially sampled by an electronic switch (multiplexer) in a known sequence and rate so as to create a data stream that may be transmitted to the ground by the telemetry system.
Government Contracts
A substantial part of the Company's sales are made to U.S. government agencies or prime contractors or subcontractors on military or aerospace programs. Government contracts are awarded either on a competitive bid basis or on a negotiated sole source procurement basis. Contracts awarded on a bid basis involve several competitors bidding on the same program with the contract being awarded based upon price and ability to perform. Negotiated sole source procurement is utilized if the Company is deemed by the customer to have developed proprietary equipment not available from other parties or where there is a very stringent delivery schedule.
All of the Company's government contracts are fixed price contracts, some of which require delivery over time periods in excess of one year. With this type of contract, the Company agrees to deliver products at a fixed price except for costs incurred because of change orders issued by the customer.
In accordance with Department of Defense procedures, all contracts involving government programs may be terminated by the government, in whole or in part, at the government's discretion. In the event of such a termination, prime contractors on such contracts are required to terminate their subcontracts on the program and the government or the prime contractor is obligated to pay the costs incurred by the Company under the contract to the date of termination plus a fee based upon the work completed.
Marketing and Distribution
The Company's marketing approach is to determine customer requirements in the early stages of a program. Marketing and engineering personnel work directly with the customer's engineering group to develop product specifications. The Company receives its awards based upon an evaluation of a number of factors including technical ranking, price, overall capability and past performance. Follow-up contracts on the same program are normally negotiated with customers rather than being subject to a competitive bidding process.
Backlog
The Company's backlog of firm orders was approximately $36,911,000 on August 3, 1997 ($26,135,000 in domestic orders and $10,776,000 in foreign orders) as compared to approximately $23,770,000 on July 28, 1996 ($13,632,000 in domestic orders and $10,138,000 in foreign orders). Management anticipates that approximately $30,330,000 of the backlog will be shipped during the fiscal year ending August 2, 1998. There can be no assurance that the Company's backlog will result in sales in any particular period or at all, or that the contracts included in the backlog that result in sales will be profitable.
Manufacturing, Assembly and Testing
Flight instrumentation devices manufactured by the Company for military and space launch applications are subject to stringent testing procedures based upon customer requests. All of such testing is performed by the Company at its Lancaster facility.
All electronic parts are procured in controlled lots that are subjected to extensive physical inspection and screening at Herley before use in products. Physical inspection requires the use of high power microscopes and laser scanned optical comparators, which match the characteristics of the part under inspection to previously stored images.
The testing of high reliability space equipment is performed by complex computer controlled consoles that take measurements that continuously monitor and analyze operating parameters. Flight instrumentation products are tested over their full operating temperature range, after which the equipment is evaluated under combined vibration and temperature cycling. For initial design qualification, this testing may extend for several months and include evaluation of electromagnetic interference behavior (EMI), ability to survive pyrotechnic shock (simulating explosive charge detonation for space vehicle stage separation) and the combined effects of external vacuum with heating and cooling.
Electronic components and other raw materials used in the Company's products are purchased by the Company from a large number of suppliers and all of such materials are readily available from alternate sources.
The Company does not maintain any significant level of finished products inventory. Raw materials are generally purchased for specific contracts and common components are purchased for stock based on the Company's firm fixed backlog.
There are no significant environmental control procedures required concerning the discharge of materials into the environment that would require the Company to invest in any significant capital equipment or that would have a material effect on the earnings of the Company or its competitive position.
Competition
The flight instrumentation products which the Company manufactures are subject to varied competition depending on the product and market served. Competition is generally based upon technology, design, price and past performance. The Company's ability to compete for defense contracts depends, in part, on its ability to offer better design and performance than its competitors and its readiness in facilities, equipment and personnel to undertake to complete the programs. In certain products on programs, the Company believes that it is sole source, which means that all work is directed to a single manufacturer. In other cases, there may be other suppliers who have the capability to compete for the programs involved, but they can only enter or reenter the market if the government should choose to reopen the particular program to competition. Competition in follow-on procurements is generally limited after an initial award unless the original supplier has had performance problems. Many of Herley's competitors are larger and may have greater financial resources than the Company. Competitors include Aydin Corporation, L3 Communications, Microsystems, Inc., AMP, Inc., and REMEC, Inc.
Employees
As of October 12, 1997, the Company employed 286 full-time persons. A total of 203 employees were engaged in manufacturing, 38 in engineering, 20 in marketing, contract administration and field services and the balance in general and administrative functions. None of the Company's employees are covered by collective bargaining agreements and the Company considers its employee relations to be satisfactory.
The Company believes that its future success will depend, in part, on its continued ability to recruit and retain highly skilled technical, managerial and marketing personnel. To assist in recruiting and retaining such personnel, the Company has established competitive benefits programs, including a 401k employee savings plan, and stock option plans.
Intellectual Property
The Company does not presently hold any significant patents applicable to its products. In order to protect its intellectual property rights, the Company relies on a combination of trade secret, copyright and trademark laws and certain employee and third-party non-disclosure agreements, as well as limiting access to and distribution of proprietary information. There can be no assurance that the steps taken by the Company to protect its intellectual property rights will be adequate to prevent misappropriation of the Company's technology or to preclude competitors from independently developing such technology. Trade secret and copyright laws afford the Company limited protection. Furthermore, there can be no assurance that, in the future, third parties will not assert infringement claims against the Company or with respect to its products for which the Company has indemnified certain of its customers. Asserting the Company's rights or defending against third party claims could involve substantial costs and diversion of resources, thus materially and adversely affecting the Company's business, results of operations and financial condition. In the event a third party were successful in a claim that one of the Company's products infringed its proprietary rights, the Company would have to pay substantial royalties or damages, remove that product from the marketplace or expend substantial amounts to modify the product so that it no longer infringe such proprietary rights, any of which could have a material adverse effect on the Company's business, results of operations and financial condition.
Item 2.
Item 2. Properties
The Company's properties are as follows:
Area Owned Occupied or Location Purpose of Property (Sq. Ft.) Leased - ----------------- ------------------------------------------ --------- ------ Lancaster, PA (1) Production, engineering, administrative 71,200 Owned and executive offices Woburn, MA Production, engineering and administration 60,000 Owned
Chicago, IL Production, engineering and administration 9,700 Leased
Frederick, MD Production, engineering and administration 14,700 Leased
Lancaster, PA Land held for expansion 26 Acres Owned - -------------- (1) The Company's executive offices occupy approximately 4,000 sq. ft. of space at this facility with engineering and administrative offices occupying 10,000 sq. ft. each. The Company believes that its facilities are adequate for its current and presently anticipated future needs.
Item 3.
Item 3. Legal Proceedings
The Company is not involved in any material legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholders Matters
(a) The Company's Common Stock is traded in the over-the-counter National Market System under the symbol HRLY. The following table sets forth the high and low closing sales price as reported by NASDAQ - National Market System for the Company's Common Stock for the periods indicated.
Common Stock High Low Fiscal Year 1996 First Quarter.................................. 4.59 3.66 Second Quarter................................. 6.19 3.84 Third Quarter.................................. 7.97 5.25 Fourth Quarter................................. 9.19 6.00 Fiscal Year 1997 First Quarter.................................. 7.97 6.19 Second Quarter................................. 10.69 7.31 Third Quarter.................................. 8.91 6.09 Fourth Quarter................................. 10.69 6.19
The closing price on October 1, 1997 was $13.875.
(b) As of October 1, 1997, there were approximately 1,000 record holders of the Company's Common Stock. (c) There have been no cash dividends declared or paid by the Company on its Common Stock during the past two years. The above prices have been adjusted to give effect to a 4-for-3 stock split on September 30, 1997.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company principally designs, manufactures and sells flight instrumentation components and systems, primarily to the U.S. government, foreign governments, and aerospace companies. Flight instrumentation products include command and control systems, transponders, flight termination receivers, telemetry transmitters and receivers, PCM encoders and decoders, and scoring systems. Flight instrumentation products are used to: (i) accurately track the flight of space launch vehicles, targets, and UAVs, (ii) communicate between ground systems and the airborne vehicle, (iii) if necessary, destroy the vehicle if it is veering from its planned trajectory, and (iv) train troops and test weapons.
Of the Company's total backlog of $36,911,000 at August 3, 1997, $26,135,000 is attributable to domestic orders and $10,776,000 is attributable to foreign orders. Management anticipates that approximately $30,330,000 of its backlog will be shipped during the fiscal year ending August 2, 1998. The Company includes in its backlog only firm orders for which it has accepted a written purchase order. In accordance with Department of Defense procedures, all contracts involving government programs may be terminated by the government, in whole or in part, at the government's discretion. In the event of such a termination, prime contractors on such contracts are required to terminate their subcontracts on the program and the government or the prime contractor is obligated to pay the costs incurred by the Company under the contract to the date of termination plus a fee based upon work completed.
Substantially all of the Company's contracts are fixed price contracts, wherein sales and related costs are generally recorded as deliveries are made. Many o f these contracts include options exercisable by the customer for additional products or systems at a fixed price. Certain costs under long-term fixed price contracts, principally directly or indirectly with the U.S. Government, which include non-recurring engineering, are deferred until these costs are contractually billable. The failure to anticipate technical problems, estimate costs accurately or control costs during a fixed price contract, including with respect to any option for additional products or systems, may reduce the Company's profitability or cause a loss under the contract. Revenue under certain long-term, fixed price contracts, principally command and control shelters, is recognized using the percentage of completion method of accounting. Revenues recognized on these contracts are based on estimated completion to date, which is the total contract amount multiplied by percent of performance, based on direct labor costs. There were no long-term contracts of this nature as of August 3, 1997 or July 28, 1996. Losses, if any, on contracts are recorded when first reasonably determined.
The Company believes that its growth depends on its ability to renew and expand its technology, products, and design and manufacturing processes with an emphasis on cost effectiveness. The Company's primary efforts are focused on engineering design and product development activities, rather than pure research. The cost of these development activities, including employees' time and prototype development, net of amounts paid by customers, was approximately $1,828,000, $1,453,000 and $970,000 in fiscal years 1997, 1996 and 1995, respectively. Costs of the Company's internally funded product development efforts are included in the Company's operating expenses as cost of products sold. Revenue from customer funded product development is included in net sales and the related product development costs also are included in cost of products sold.
The Company's effective tax rate for fiscal 1996 and 1997 was 2.7% and 9.1%, respectively, reflecting the utilization of prior year net operating loss carryforwards and the reversal of a valuation allowance established in 1995. The valuation allowance was established based on management's uncertainty that past performance would be indicative of future earnings. In August 1997, the Company established a foreign sales corporation as part of an overall domestic tax strategy to reduce its effective income tax rate. The Company anticipates that its effective income tax rate for fiscal 1998 will be approximately 34%.
Results of Operations
The following table sets forth for the periods indicated certain financial information derived from the Company's consolidated statements of operations expressed as a percentage of net sales. There can be no assurance that trends in sales growth or operating results will continue in the future.
52 Weeks ended 53 Weeks ---------------- ended July 30, July 28, August 3, 1995 1996 1997 ---- ---- ----
Net sales 100.0 % 100.0 % 100.0 %
Cost of products sold 74.1 % 68.3 % 64.5 % ----- ---- ---- Gross profit 25.9 % 31.7 % 35.5 % Selling and administrative expenses 20.7 % 20.1 % 19.5 % ----- ---- ---- Income before unusual item 5.2 % 11.6 % 16.0 % Unusual item 22.3 % - - ----- ---- ----
Operating income (loss) (17.1)% 11.6 % 16.0 % ----- ---- ----
Other income (expense): Net gain (loss) on available-for-sale securities and other investments (1.5)% 3.1 % 1.3 % Dividend and interest income 2.5 % 1.3 % 0.8 % Interest expense (3.9)% (3.0)% (1.7)% ----- ---- ----- (2.9)% 1.4 % 0.4 % ----- ---- -----
Income (loss) before income taxes (20.0)% 13.0 % 16.4 % Provision for income taxes 0.0 % 0.4 % 1.5 % ----- ---- ----
Net income (loss) (20.0)% 12.7 % 14.9 % ----- ---- ----
Fiscal 1997 Compared to Fiscal 1996
Net sales for the 53 weeks ended August 3, 1997 were approximately $32,195,000 compared to $29,001,000 for fiscal 1996. The sales increase of $3,194,000 (11%) is primarily attributable to an increase in the sales of flight instrumentation products, including a Target Tracking Control System for the Republic of Korea.
Gross profit of 35.5% for the 53 weeks ended August 3, 1997 exceeded the prior year of 31.7% due to an increase of $2,842,000 in higher margin foreign sales from $6,556,000 in 1996 to $9,398,000 in 1997, as well as an increase in absorption of fixed costs due to the higher sales volume.
Selling and administrative expenses for the 53 weeks ended August 3, 1997 were $6,293,000 compared to $5,832,000 for fiscal 1996, an increase of $461,000 of which $360,000 was attributable to settlement and litigation costs involving two class action law suits, $325,000 to performance incentives, and $52,000 to additional travel costs. These increases were offset by a reduction in representative fees on foreign sales
of $205,000 (partially due to a negotiated decrease in the rate paid), and a reduction of $75,000 in personnel and related expenses. As a percentage of net sales, selling and administrative expenses decreased from 20.1% in 1996 to 19.5% in 1997.
Other income (expense) for the 53 weeks ended August 3, 1997 decreased $265,000 from the prior year due to decreases in gains on the sale of investments and dividend and interest income of $488,000 and $118,000, respectively, offset by a decrease in interest expense of $341,000.
The effective tax rate in 1997 was 9.1%. The 1997 and 1996 tax provisions reflect the utilization of prior year net operating loss carryforwards. In 1995 a valuation allowance had been provided to reduce deferred tax assets to their net realizable value primarily based on management's uncertainty that past performance would be indicative of future earnings. In 1997 the valuation allowance was reversed through the deferred tax provision. A determining factor in assessing the change was the cumulative income in recent years. See Note I entitled "Income Taxes" to the Consolidated Financial Statements.
Fiscal 1996 Compared to Fiscal 1995
Net sales for the 52 weeks ended July 28, 1996 were approximately $29,001,000 compared to $24,450,000 for fiscal 1995. The sales increase of $4,551,000 (18.6%) is attributable to an increase of approximately $5,845,000 in flight instrumentation products, of which Stewart Warner Electronics Co., acquired in July 1995, contributed $4,321,000, offset by a decrease of $1,294,000 in microwave components.
Gross profit of 31.7% for the 52 weeks ended July 28, 1996 exceeded the prior year of 25.9% due to an increase of $2,648,000 in higher margin foreign sales from $3,908,000 in 1995 to $6,556,000 in 1996, as well as an increase in absorption of fixed costs due to the higher sales volume.
Selling and administrative expenses for the 52 weeks ended July 28, 1996 were $5,832,000 compared to $5,072,000 for fiscal 1995, an increase of $760,000 of which $388,000 is attributable to increased representative fees on foreign sales, an increase of $233,000 in personnel and related expenses and other expenses of $46,000, offset by a reduction of $150,000 in the provision for customer disputed charges, and decreases in group insurance of $90,000, depreciation of $69,000 and outside services of $48,000. The addition of Stewart Warner Electronics Co. added $450,000 in selling and administrative expenses in fiscal 1996, the specific expenses of which are included in the above numbers. As a percentage of net sales, selling and administrative expenses decreased from 20.7% in 1995 to 20.1% in 1996.
Income before unusual items in 1996 was $3,370,882 as compared to $1,260,553 in 1995. Included in unusual items in 1995 are settlement costs in connection with certain legal actions of $4,310,000, legal fees of $829,000, and related expenses of $308,000.
Other income (expense) for the 52 weeks ended July 28, 1996 increased $1,100,000 from the prior year due to net gains on available-for-sale securities and other long-term investments of $898,000 as compared to losses of $356,000 in 1995, and a decrease in interest expense of $88,000; offset by decreased dividend and interest income of $242,000.
The effective tax rate in 1996 was 2.7%. The 1996 tax provision reflects the utilization of prior year net operating loss carryforwards. No income tax benefit was recorded in 1995 due to an increase in the valuation allowance. The valuation allowance was provided relating to that portion of net operating loss carryforwards that management believed might expire unutilized.
Liquidity and Capital Resources
As of August 3, 1997 and July 28, 1996, working capital was approximately $10,662,000 and $8,704,000, respectively, and the ratio of current assets to current liabilities was 2.09 to 1 and 2.15 to 1, respectively. At August 3, 1997, the Company had cash and cash equivalents of approximately $1,195,000.
As is customary in the defense industry, inventory is partially financed by advance payments. The unliquidated balance of these advance payments was approximately $3,091,000 in 1997, and $1,480,000 in 1996.
Net cash provided from operations and investing activities in 1997 and 1996 was approximately $3,647,000, and $6,159,000, respectively. Cash provided by investing activities resulted primarily from the liquidation of all the available-for-sale securities, and the sale of the Company's interest in the M. D. Sass Re/Enterprise-II, L.P., limited partnership. The Company used approximately $9,715,000 of these funds in financing activities primarily for the net payment of outstanding bank debt of $7,250,000, and the purchase of treasury stock for $2,783,000.
The Company maintains a revolving credit facility with a bank for an aggregate of $11,000,000, which expires January 31, 1999. No borrowings were outstanding on this line at August 3, 1997. As of July 28, 1996, the Company had borrowings outstanding of $6,950,000.
During the fiscal year ended August 3, 1997 the Company acquired 244,519 shares of its outstanding common stock for $2,782,686 through open market purchases, pursuant to a stock purchase plan to acquire up to 300,000 pre-split shares of Common Stock, which was terminated in June 1997. The Company also acquired 463,639 shares, valued at $6,429,124 in connection with certain "stock-for-stock" exercises of stock options by which certain employees elected to surrender "mature" shares owned in settlement of the option price. Such exercises are treated as an exercise of a stock option and the acquisition of treasury shares by the Company. See "Management Stock Plans."
The Company believes that presently anticipated future cash requirements will be provided by internally generated funds and existing credit facilities.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data listed in the Index on Page are filed as a part of this report.
Item 9.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
Not applicable
PART III
The information required by Part III is incorporated by reference to the Company's definitive proxy statement in connection with its Annual Meeting of Stockholders scheduled to be held in December 1997, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year ended August 3, 1997.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1 Registration Statement No. 2-87160). 3.2 By-Laws, as amended (Exhibit 3(b) of Form S-1 Registration Statement No. 2-87160). 10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the fiscal year ended July 28, 1996). 10.2 1997 Stock Option Plan (Eshibit 10.1 of Report on Form 10-Q dated June 10, 1997). 10.3 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated as of January 1, 1997 (Exhibit 10.2 of Report on Form 10-Q dated June 10, 1997). 10.4 Employment Agreement between Herley Industries, Inc. and Myron Levy dated as of January 1, 1997 (Exhibit 10.3 of Report on Form 10-Q dated June 10, 1997). 10.5 (a) Employment Agreement with Gerald I. Klein dated April 1, 1990, (Exhibit 10.5 of Annual Report on Form 10-K for the fiscal year ended July 31, 1990). (b) Employment Agreement with Gerald I. Klein dated January 1, 1992, (Exhibit 10.7 of Form S-2 Registration Statement No. 33-44959). (c) Modification Agreement to Employment Agreement with Gerald I. Klein dated November 30, 1992, (Exhibit 10(b) of Report on Form 8-K dated November 30, 1992). 10.6 (a) Revised Non-Negotiable Promissory Note of Lee N. Blatt dated June 2, 1997 (Exhibit 10.4 of Report on Form 10-Q dated June 10, 1997). (b) Revised Non-Negotiable Promissory Note of Gerald I Klein dated June 2, 1997 (Exhibit 10.5 of Report on Form 10-Q dated June 10, 1997). (c) Revised Non-Negotiable Promissory Note of Myron Levy dated June 2, 1997 (Exhibit 10.6 of Report on Form 10-Q dated June 10, 1997). 10.7 Loan Agreement between Registrant and Allstate Municipal Income Opportunities Trust (Exhibit 10.6 of Annual Report on Form 10-K for the fiscal year ended July 31, 1989). 10.8 Asset Purchase Agreement dated as of September 1, 1992 between Micro-Dynamics, Inc. and Herley Industries, Inc. (Exhibit 7(c) of Report on Form 8-K dated October 22, 1992). 10.9 Stock Purchase Agreement dated as of June 1, 1993 between Herley Industries, Inc., Herley Interim Corp., Milton C. Barnard, Edward M. Webber, Marvin Adler and Carlton Industries, Inc. (Exhibit 7(c) of Report on Form 8-K dated June 18, 1993). 10.10 Agreement and Plan of Reorganization dated as of July 8, 1997 among the Company, Metraplex Acquisition Corporation and Metraplex Corporation (Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997). 11. Computation of per share earnings. 23. Consent of Independent Public Accountants. 27. Financial Data Schedule (for electronic submission only).
(b) Financial Statements
See Index to Consolidated Financial Statements at Page.
(c) Reports on Form 8-K
None
SIGNATURES:
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 30th day of October, 1997.
HERLEY INDUSTRIES, INC.
By: /S/ Lee N. Blatt ----------------------------------- Lee N. Blatt, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on October 30, 1997 by the following persons in the capacities indicated:
By: /S/ Lee N. Blatt ------------------ Chairman of the Board Lee N. Blatt (Principal Executive Officer)
By: /S/ Myron Levy President and Director ---------------- Myron Levy
By: /S/ Anello C. Garefino Vice President Finance, CFO, Treasurer ------------------------ (Principal Financial Officer) Anello C. Garefino
By: /S/ David H. Lieberman Director ------------------------ David H. Lieberman
By: /S/ Thomas J. Allshouse Director ------------------------- Thomas J. Allshouse
By: /S/ John A. Thonet Director -------------------- John A. Thonet
Item 8. Financial Statements and Supplementary Data
HERLEY INDUSTRIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................
FINANCIAL STATEMENTS:
Consolidated Balance Sheets, August 3, 1997 and July 28, 1996......
Consolidated Statements of Operations for the 53 Weeks Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996 and July 30, 1995.................................................
Consolidated Statements of Shareholders' Equity for the 53 Weeks Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996 and July 30, 1995................................................
Consolidated Statements of Cash Flows for the 53 Weeks Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996 and July 30, 1995....................................................
Notes to Consolidated Financial Statements..........................
Schedules have been omitted as not applicable.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley Industries, Inc. and Subsidiaries as of August 3, 1997 and July 28, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for the 53 weeks ended August 3, 1997 , and the 52 weeks ended July 28, 1996 and July 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Herley Industries, Inc. and Subsidiaries as of August 3, 1997 and July 28, 1996, and the consolidated results of their operations and their cash flows for the 53 weeks ended August 3, 1997, and the 52 weeks ended July 28, 1996, and July 30, 1995 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Lancaster, PA September 19, 1997
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
August 3, July 28, 1997 1996 ---------- ---------- ASSETS
Current Assets: Cash and cash equivalents $ 1,194,650 $ 1,104,445 Accounts receivable 5,176,523 3,249,225 Notes receivable-officers 2,100,913 2,083,543 Other receivables 152,148 124,992 Inventories 9,790,382 8,010,687 Deferred taxes and other 2,061,066 1,689,988 ---------- ---------- Total Current Assets 20,475,682 16,262,880 Property, Plant and Equipment, net 11,704,755 12,579,044 Intangibles, net of amortization of $1,133,750 in 1997 and $861,650 in 1996 4,308,136 4,580,236 Available-for-sale Securities - 4,912,387 Other Investments 1,313,502 3,000,000 Other Assets 1,455,111 1,174,395 ========== ========== $39,257,186 $42,508,942 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities: Current portion of long-term debt $ 335,000 $ 300,000 Note payable to related party 846,000 - Accounts payable and accrued expenses 4,986,740 5,123,868 Income taxes payable 76,635 166,295 Reserve for contract losses 478,000 489,110 Advance payments on contracts 3,091,001 1,480,033 ---------- ---------- Total Current Liabilities 9,813,376 7,559,306 Long-term Debt 2,890,000 11,021,000 Deferred Income Taxes 2,696,394 1,923,058 Excess of fair value of net assets of business acquired over cost, net of amortization of $973,666 in 1997 and $486,833 in 1996 486,833 973,667 ---------- ---------- 15,886,603 21,477,031 ---------- ---------- Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 10,000,000 shares; issued and outstanding 4,209,365 in 1997 and 2,936,122 in 1996 420,936 293,612 Additional paid-in capital 8,856,516 11,448,827 Retained earnings 14,093,131 9,289,472 ---------- ---------- Total Shareholders' Equity 23,370,583 21,031,911
========== ========== $39,257,186 $42,508,942 ========== ==========
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Nature of Operations
The Company principally designs, manufactures and sells flight instrumentation and microwave products, primarily to aerospace companies, the U.S. government, and several foreign governments. The Company's main products include a variety of transponders which are used to enhance radar signals to accurately track the flight of space launch vehicles and aircraft, as well as microwave devices and command and control systems.
2. Fiscal Year
The Company's fiscal year ends on the Sunday closest to July 31. Normally each fiscal year consists of 52 weeks, but every five or six years the fiscal year will consist of 53 weeks. Fiscal year 1997 consisted of 53 weeks, and fiscal years 1996 and 1995 consisted of 52 weeks.
3. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates.
4. Revenue and Cost Recognition
Under fixed-price contracts, sales and related costs are recorded primarily as deliveries are made. Certain costs under long-term, fixed-price contracts (principally either directly or indirectly with the U.S. Government), which include non-recurring billable engineering, are deferred until these costs are contractually billable. Revenue under certain long-term, fixed price contracts, principally shelters, is recognized using the percentage of completion method of accounting. Revenue recognized on these contracts is based on estimated completion to date (the total contract amount multiplied by percent of performance, based on direct labor dollars). Losses on contracts are recorded when first reasonably determined.
Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Selling, general and administrative costs are charged to expense as incurred.
5. Inventories
Inventories, other than inventory costs relating to long-term contracts and programs, are stated at lower of cost (principally first-in, first-out) or market. Inventory costs relating to long-term contracts and programs are stated at the actual production costs, including factory overhead, reduced by amounts identified with revenue recognized on units delivered or progress completed.
Inventory costs relating to long-term contracts and programs are reduced by any amounts in excess of estimated realizable value. The costs attributed to units delivered under long-term contracts and programs are based on the average costs of all units produced.
6. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets. Gains and losses arising from the sale or disposition of property, plant and equipment are recorded in income.
7. Intangibles
Intangibles are comprised of customer lists, installed products base, drawings, patents, licenses, certain government qualifications and technology and goodwill in connection with the acquisition of Vega Precision Laboratories, Inc. in 1993. Intangibles are being amortized over twenty years.
The carrying amount of intangibles is evaluated on a recurring basis. Current and future profitability as well as current and future undiscounted cash flows of the acquired businesses are primary indicators of recoverability. For the three fiscal years ended August 3, 1997, there were no adjustments to the carrying amount of the cost in excess of net assets acquired resulting from these evaluations.
8. Marketable Securities
The Company accounts for its investments in marketable securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Realized gains and losses and declines in value judged to be other-than-temporary are included in other income (expense). The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in other income (expense).
9. Other Investments
The Company is a limited partner in certain nonmarketable limited partnerships in which it owns approximately a 10% interest. Beginning in 1997 other investments are accounted for under the equity method. Previously, the cost method was utilized as the amount was not significantly different from the equity method.
10. Income Taxes
Income taxes are accounted for by the asset/liability approach in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from temporary differences between the financial reporting and tax bases of assets and liabilities and are adjusted for changes in tax laws and tax rates when those changes are enacted. The provision for income taxes represents the total of income taxes paid or payable for the current year, plus the change in deferred taxes during the year.
11. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
12. Earnings Per Common Share
Earnings per common share and common equivalent share is based on the weighted average number of outstanding shares of common stock (reflective of a 4-for-3 stock split on September 15, 1997), including common stock equivalents (options and warrants) as determined under the treasury stock method as follows: 4,733,682 shares in 1997; 4,253,785 shares in 1996; and 4,978,868 shares in 1995.
13. Cash and Cash Equivalents
For purposes of the statement of cash flows, short-term investments which have a maturity of ninety days or less at the date of acquisition are considered cash equivalents.
14. Product Development
The Company's primary efforts are focused on engineering design and product development activities rather than pure research. The cost of these development activities, including employees' time and prototype development, net of amounts paid by customers, was approximately $1,828,000, $1,453,000, and $970,000 in fiscal 1997, 1996, and 1995, respectively.
15. New Accounting Standards
In March 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"), which is effective for both interim and annual periods ending after December 15, 1997. SFAS 128 supersedes APB No. 15 to conform earnings per share with international standards as well as to simplify the complexity of the computation under APB No. 15. The previous primary earnings per share ("EPS") calculation is replaced with a basic EPS calculation. The basic EPS differs from the primary EPS calculation in that the basic EPS does not include any potentially dilutive securities. Fully dilutive EPS is replaced with diluted EPS and should be disclosed regardless of dilutive impact to basic EPS. Earlier application of this Statement is not permitted. Therefore, the EPS in the Consolidated Statements of Operations are presented under APB No. 15.
NOTE B - ACQUISITIONS AND DISPOSALS
In July 1995, the Company entered into an agreement effective as of the close of business June 30, 1995, to acquire certain assets and the business (consisting principally of inventories and trade receivables) of Stewart Warner Electronics Corporation, a Delaware corporation. The transaction, which closed on July 28, 1995, provided for the payment of $250,000 in cash and the assumption of approximately $915,000 in liabilities and has been accounted for by the purchase method. The acquisition resulted in excess of fair value over cost of net assets acquired of $1,460,500 which is being amortized over a three-year period.
NOTE C - NOTES RECEIVABLE-OFFICERS
In fiscal 1996 the Company loaned $1,400,000, $300,000, and $300,000 to certain officers, as authorized by the Board of Directors, pursuant to the terms of nonnegotiable promissory notes. The notes were initially due November 1996, November 1996 and March 1997, respectively. The notes may be renewed by the Company from year to year. The notes were extended by the Company in fiscal 1997
and are now due April 30, 1998, January 31, 1998, and January 31, 1998, respectively. The loans are secured by 594,365 shares of common stock of the Company. Interest is payable at maturity at the average rate of interest paid by the Company on borrowed funds during the fiscal year. The pledge agreement also provides for the Company to have the right of first refusal to purchase the pledged securities, based on a formula as defined, in the event of the death or disability of the officer.
NOTE D - INVENTORIES
The major components of inventories are as follows:
August 3, July 28, 1997 1996 Purchased parts and raw materials $ 4,780,336 $ 3,358,256 Work in process 4,899,551 4,580,538 Finished products 110,495 71,893 ------------ ----------- $ 9,790,382 $ 8,010,687 ========== =========
NOTE E - AVAILABLE-FOR-SALE SECURITIES
In September 1996, the Company liquidated all of its available-for-sale securities for approximately $4,912,000 and used the proceeds to reduce its long-term bank debt. A provision for unrealized losses of $121,550 is included in the statement of operations for fiscal year 1996. The fair value of available-for-sale securities at July 28, 1996 was $4,912,387.
NOTE F - OTHER INVESTMENTS
In April 1996, the Company acquired a limited partnership interest in M.D. Sass Re/Enterprise-II, L.P., a Delaware limited partnership for $2,000,000. The objective of the partnership is to achieve superior long-term capital appreciation through investments consisting primarily of securities of companies that are experiencing significant financial or business difficulties. In April 1997, the Company sold its investment and terminated its limited partnership interest for $2,080,630 realizing a gain of $80,630.
In December 1995, the Company sold its investment and terminated its limited partnership interest in M.D. Sass Re/Enterprise Partners, L.P., a Delaware limited partnership for $3,823,233 realizing a gain of $1,095,727.
In July 1994, the Company invested $1,000,000 for a limited partnership interest in M.D. Sass Municipal Finance Partners-I, a Delaware limited partnership. The objectives of the partnership are the preservation and protection of its capital and the earning of income through the purchase of certificates or other documentation that evidence liens for unpaid local taxes on parcels of real property. At August 3, 1997 and July 28, 1996 the percentage of ownership was approximately 10%. The Company's interest in the partnership may be transferred to a substitute limited partner, upon written notice to the managing general partners, only with the unanimous consent of both general partners at their sole discretion.
NOTE G - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following:
August 3, July 28, Estimated 1997 1996 Useful Life ---- ---- -----------
Land $ 880,270 $ 880,270 Building and building improvements 5,438,663 5,362,409 10-40 years Machinery and equipment 17,515,954 16,788,901 5- 8 years Furniture and fixtures 494,056 494,056 5-10 years Tools 24,869 24,869 5 years Leasehold improvements 288,757 288,757 5-10 years ---------- ---------- 24,642,569 23,839,262 Less accumulated depreciation 12,937,814 11,260,218 ---------- ---------- $11,704,755 $12,579,044 ========== ==========
NOTE H - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office, production and warehouse space as well as computer equipment and automobiles under noncancellable operating leases.
Rent expense for the 53 weeks ended August 3, 1997, and the 52 weeks ended July 28, 1996 and July 30, 1995 was approximately $229,900, $284,600, and $158,000, respectively.
Minimum annual rentals under noncancellable leases are as follows:
Amount ------- Year ending fiscal 1998 $204,800 1999 153,900 2000 97,400
Employment Agreements
The Company has employment agreements with various executives and employees of the Company, which, as amended, expire at various dates through December 31, 2002, subject to extension each January 1 for six years from that date not to extend, in any event, beyond December 31, 2006. These agreements provide for aggregate annual salaries of $1,185,000. Certain agreements provide for an annual increment equal to the greater of a cost of living adjustment based on the consumer price index or 10%, and also provide for incentive compensation related to pretax income. Incentive compensation in the amount of $665,352 was expensed in fiscal year ended August 3, 1997. Incentive compensation of $446,750 was expensed in fiscal 1996. No incentive compensation was due for the fiscal year ended July 30, 1995.
Certain agreements also provide that, in the event there is a change in control of the Company, as defined, the executives have the option to terminate the agreements and receive a lump-sum payment. As of August 3, 1997, the amount payable in the event of such termination would be approximately $2,050,000.
One of the employment contracts provides for a consulting agreement commencing January 1, 2002 and terminating December 31, 2010 at the annual rate of $100,000. Another one of the employment contracts, as amended January 1, 1997, provides for a consulting period commencing at the end of the
period of active employment and continuing for a period of five years at the annual rate of $60,000. One officer of the Company has a severance agreement providing for a lump-sum payment of $220,000 through June 1999, adjusted to $110,000 through June 2002.
Litigation
In November 1996, the Company settled all claims in connection with two class action complaints, related to the Company's acquisition of Carlton Industries, Inc. and its subsidiary, Vega Precision Laboratories, Inc. for $450,000.
In August 1997, the Company settled all claims in connection with a class action complaint filed in 1995 for $170,000. The claim related to the Company's settlement of the Litton Action in the Essex Superior Court of Massachusetts which alleged, inter alia, that there was insufficient disclosure by the Company of its true potential exposure in that claim.
In July 1996, the Company was notified by the American Arbitration Association of the decision of the arbitrators in an action commenced in March 1994 by the principal selling shareholders of Carlton Industries, Inc. and its subsidiary, Vega Precision Laboratories, Inc. According to the award, the Company was to pay to the claimants the sum of $1,052,900, inclusive of interest. Correspondingly, the claimants were to pay the Company the sum of $277,719, inclusive of interest. The Company paid $775,181 to claimants, representing the difference between the award to the claimants and the award to the Company, in August, 1996. The award to the claimants was offset by $593,162 otherwise payable to one of the selling shareholders.
The Company is also involved in other legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations.
Stand-by Letters of Credit
The Company maintains a letter of credit facility with a bank that provides for the issuance of stand-by letters of credit and requires the payment of a fee of 1.0% per annum of the amounts outstanding under the facility. The facility expires January 31, 1999. At August 3, 1997 stand-by letters of credit aggregating $3,241,392 were outstanding under this facility.
NOTE I - INCOME TAXES
Income tax provision consisted of the following:
52 Weeks ended 53 Weeks ended -------------------- August 3, July 28, July 30, 1997 1996 1995 ---- ---- ---- Current Federal $ (52,000) $ 90,000 $ - State 89,000 12,400 - --------- -------- ----- 37,000 102,400 - --------- ------- ----- Deferred Federal (142,000) - 4,000 State 585,000 - - -------- ------- ----- 443,000 - 4,000 -------- ------- -----
$ 480,000 $ 102,400 $ 4,000 ======= ======= =====
The Company paid income taxes of approximately $178,000 in 1997, $19,000 in 1996, and $122,000 in 1995. The following is a reconciliation of the U. S. statutory income tax rate and the effective tax rate on pretax income: 53 Weeks ended 52 Weeks ended
August 3, July 28, July 30, 1997 1996 1995 ---- ---- ---- U.S. Federal statutory rate 34.0 % 34.0 % (34.0) % State taxes, net of federal tax benefit 12.2 0.2 - Alternative minimum tax - 2.4 - Benefit of net operating loss carryforward (30.8) (35.2) - Non-deductible expenses .3 1.3 - Increase (decrease)in valuation allowance (9.4) - 34.0 Other, net 2.8 - - ----- ----- ----- Effective tax rate 9.1 % 2.7 % - % ===== ===== =====
The 1997 and 1996 tax provisions reflect the utilization of prior year net operating loss carryforwards. In 1995 a valuation allowance had been provided to reduce deferred tax assets to their net realizable value primarily based on management's uncertainty that past performance would be indicative of future earnings. In 1997 the valuation allowance was reversed through the deferred tax provision. A determining factor in assessing the change was the cumulative income in recent years.
Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes.
As of August 3, 1997, the Company has net operating loss carryforwards for Federal income tax purposes of approximately $2,000,000 which expire in 2010.
Components of deferred tax assets and liabilities are as follows:
NOTE J- LONG-TERM DEBT
Long-term debt is summarized as follows: August 3, July 28, Rate 1997 1996 ------------- ---- ---- Note payable bank (a) 6.22% -8.50% $ - $ 6,950,000 Mortgage note (b) 10.4% 3,225,000 3,525,000 Long term liability (c) - - 846,000 --------- ---------- 3,225,000 11,321,000 Less current portion 335,000 300,000 --------- ---------- $2,890,000 $ 11,021,000 ========= ==========
(a) In January 1997, the Company renewed the revolving credit agreement with its bank that provides for the extension of credit in the aggregate principal amount of $11,000,000 and may be used for general corporate purposes, including business acquisitions. The facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on January 31, 1999. Interest is set biweekly at 1% over the FOMC Target Rate applied to outstanding balances up to 80% of the net equity value of available-for-sale securities, and at the bank's Base Rate for outstanding balances in excess of this limit. There were no borrowings outstanding at August 3, 1997. The premium rate portion of the facility would be secured by any available-for-sale securities.
The agreement contains various financial covenants, including, among other matters, the maintenance of working capital, tangible net worth, and restrictions on cash dividends and other borrowings.
(b) The mortgage note provides for annual principal payments at varying amounts through 2004 plus semiannual interest payments. Land and buildings in Lancaster, Pa. are pledged as collateral.
The mortgage note agreement contains various financial covenants, including, among other matters, the maintenance of specific amounts of working capital and tangible net worth. In connection with this loan, the Company paid approximately $220,000 in financing costs. Such costs are included in Other Assets in the accompanying consolidated balance sheets at August 3, 1997 and July 28,1996 and are being amortized over the term of the loan (15 years).
(c) Under a contract for the purchase of an industrial parcel of land from its Chairman, the Company is obligated to pay $846,000 at settlement on or before April 30, 1998.
The Company paid interest of approximately $567,000 in 1997, $854,000 in 1996, and $1,010,000 in 1995.
Future payments required on long-term debt are as follows:
Fiscal year ending during: Amount ------ 1998 $335,000 1999 370,000 2000 410,000 2001 450,000 2002 500,000 Thereafter 1,160,000 --------- $3,225,000
NOTE K - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following:
August 3, July 28, 1997 1996 --------- --------- Accounts payable $ 1,841,468 $ 1,579,230 Accrued payroll and bonuses 1,483,915 1,160,345 Accrued commissions 205,692 247,687 Accrued interest 55,900 95,925 Accrued litigation expenses 297,538 1,206,914 Accrued expenses 1,102,227 833,794 ---------- ----------- $ 4,986,740 $ 5,123,868 ========== ==========
NOTE L - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan which qualified as a thrift plan under Section 401(k) of the Internal Revenue Code. This Plan, as amended and restated, allows employees to contribute between 2% and 15% of their salaries to the Plan. The Company, at its discretion can contribute 100% of the first 2% of the employees' contribution and 25% of the next 4%. Additional Company contributions can be made depending on profits. The aggregate benefit payable to an employee is dependent upon his rate of contribution, the earnings of the fund, and the length of time such employee continues as a participant.
The Company has accrued approximately $178,000 for the 53 weeks ended August 3, 1997, and contributed approximately $159,000, and $151,000 to this plan for the 52 weeks ended July 28, 1996, and July 30, 1995, respectively.
NOTE M - SHAREHOLDERS' EQUITY
The Company has two fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company applies APB Opinion No, 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock option plans. Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 6.1%; volatility factor of the expected market price of the Company's common stock of .63; and a weighted-average expected life of the option of .4 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management' s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Had compensation cost for stock options granted in fiscal 1997 been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
--------- Net earnings - as reported $4,803,659 Net earnings - pro forma $3,451,882 Earnings per share - as reported $1.01 Earnings per share - pro forma $.73
No options were granted in fiscal 1996.
The effects of applying the pro forma disclosures of SFAS 123 are not likely to be representative of the effects on reported net earnings for future years due to the various vesting schedules.
In May 1997, the Board of Directors approved the 1997 Stock Option Plan which covers 1,666,666 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. The options expire ten years from the date of grant, subject to certain restrictions. Options for 801,660 shares were granted during the fiscal year ended August 3, 1997.
In October 1995, the Board of Directors approved the 1996 Stock Option Plan which covers 666,666 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. If not specified, 100% of the shares can be exercised one year after the date of grant. The options expire ten years from the date of grant. Options for 663,989 shares were granted during the fiscal year ended August 3, 1997.
In December 1992, the Board of Directors approved the 1992 Non-Qualified Stock Option Plan which covers 1,333,333 shares, as amended, of the Company's common stock. Under the terms of the Plan, the purchase price of the shares, subject to each option granted, is 100% of the fair market value at the date of grant. The date of exercise is determined at the time of grant by the Board of Directors; however, if not specified, 50% of the shares can be exercised each year beginning one year after the date of grant. The options expire ten years from the date of grant. Options for 339,986 shares were granted during the fiscal year ended July 30, 1995. These options may be exercised cumulatively at the rate of 25% per year beginning one year after the date of grant. This plan was terminated in December 1995, except for outstanding options thereunder.
In October 1987, the Board of Directors approved the 1988 Non-Qualified Stock Option Plan which covers 666,666 shares of the Company's common stock. Under the terms of the Plan, the purchase price of the shares, subject to each option granted, will not be less than 85% of the fair market value at the date of grant. The date of exercise may be determined at the time of grant by the Board of Directors; however, if not specified, 20% of the shares can be exercised each year beginning one year after the date of grant and generally expire five years from the date of grant. This plan was terminated in December 1995, except for outstanding options thereunder.
A summary of stock option activity under all plans for the 53 weeks ended August 3, 1997, and the 52 weeks ended July 28, 1996, and July 30, 1995 follows:
Options to purchase 130,218 shares of common stock were exercisable under all plans at August 3, 1997 at a weighted average exercise price of $5.59 with a weighted average remaining contractual life of 6.8 years as follows:
Options Outstanding and Exercisable by Price Range as of August 3, 1997
In April 1993, common stock warrants were issued to certain officers and directors for the right to acquire 573,333 shares of common stock of the Company at the fair market value of $5.35 per share at date of issue. In December 1995 warrants for 533,333 shares were canceled. The warrants vest immediately and expire April 30, 1998. In December 1995, common stock warrants were issued to certain officers for the right to acquire 293,333 shares of common stock of the Company at the fair market value of $4.64 per share at date of issue. The warrants vest immediately and expire December 13, 2005. Warrants for 13,333 shares were exercised in fiscal 1997.
In connection with the sale of common stock to the public in 1992, the Company issued to the underwriter, for its own account, warrants to purchase 170,529 shares of common stock of the Company (as adjusted under the agreement), exercisable for a period of four years at a price of $9.06 per share (as adjusted under the agreement), subject to further adjustment in certain events. The warrants expired in February 1997.
On July 31, 1993, the Company issued 46,666 shares of common stock valued at $5.91 per share in connection with the acquisition of substantially all of the assets of Micro-Dynamics, Inc. These shares were subsequently canceled and reissued in January 1995.
NOTE N - RELATED PARTY TRANSACTIONS
On March 6, 1996, the Board of directors approved the purchase of an industrial parcel of land from the Chairman of the Company for $940,000. A deposit of $94,000 was paid on execution of the contract, and the balance of $846,000 will be paid at settlement on or before April 30, 1998. The Company intends to use this land for possible future expansion.
NOTE O - MAJOR CUSTOMERS
Net sales to the U.S. Government in 1997, 1996, and 1995 accounted for approximately 34%, 33%, and 30% of net sales, respectively. Net sales to the Republic of Korea and Lockheed Martin accounted for approximately 22% of net sales in 1997. Foreign sales amounted to approximately $9,320,000, $6,556,000, and $3,908,000 in fiscal 1997, 1996, and 1995, respectively.
Included in accounts receivable as of August 3, 1997 and July 28, 1996 are amounts due from the U.S. Government of approximately $1,454,000 and $933,000, respectively.
NOTE P - UNUSUAL ITEM
The Consolidated Statements of Operations for the fifty-two weeks ended July 30, 1995 includes an unusual charge of $5,447,005 for settlement costs, legal fees, and related expenses in connection with the settlement of certain legal claims against the Company. Payments of $2,000,000 each, without interest, were made in July 1995 and July 1996 in connection with the settlement of one of the claims.
NOTE Q - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximated its fair value.
Notes receivable-officers: The carrying amount reported in the balance sheet for notes receivable from officers approximated its fair value.
Available-for-sale securities: The fair value of available-for-sale securities was based on quoted market prices.
Long-term debt: The fair value of the mortgage note was estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rate for similar types of borrowing arrangements.
Off balance sheet financial instruments:
Stand-by letters of credit: These letters of credit primarily collateralize the Company's obligations to customers for advanced payments received under contracts. The contract amounts of the letters of credit approximate their fair value.
The carrying amounts and fair values of the Company's financial instruments are presented below:
August 3, 1997 -------------------------- Carrying Amount Fair Value --------------- ---------- Cash and cash equivalents $ 1,194,650 $ 1,194,650 Notes receivable-officers 2,100,913 2,100,913 Long-term debt 2,890,000 3,408,000 Stand-by letters of credit - 3,241,392
NOTE R - CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to credit risk consist primarily of trade accounts receivable. Credit risk with respect to trade receivables is minimized since most of the Company's business is direct to the U. S. Government or as a subcontractor to companies with significant financial resources acting as prime contractors to the U. S. Government, as well as to foreign governments. Additionally, shipments to foreign governments are generally under irrevocable letters of credit.
NOTE S - SUBSEQUENT EVENTS
On August 4, 1997, the Company completed the acquisition of Metraplex Corporation , a Maryland corporation for 234,895 shares of common stock of the Company in exchange for all of the issued and outstanding common stock of Metraplex. Metraplex is a leading manufacturer of pulse code modulation and frequency modulation, telemetry and data acquisition systems for severe environment applications. Metraplex products are used worldwide for testing space launch vehicle instrumentation, aircraft flight testing, and amphibian, industrial and automotive vehicle testing. The transaction will be accounted for under the purchase method.
On September 4, 1997 the Board of Directors declared a 4-for-3 stock split effected as a stock dividend payable September 29, 1997 to holders of record on September 15, 1997. The effect of the split is presented within shareholders' equity at August 3, 1997. The distribution increased the number of shares outstanding from 3,157,024 to 4,209,365. The amount of $105,234 was transferred from the additional paid-in capital to the common stock account to record this distribution. All share and per share data, including stock options and warrants, included in this annual report have been restated to reflect the stock split.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1 Registration Statement No. 2-87160). 3.2 By-Laws, as amended (Exhibit 3(b) of Form S-1 Registration Statement No. 2-87160). 10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the fiscal year ended July 28, 1996). 10.2 1997 Stock Option Plan (Eshibit 10.1 of Report on Form 10-Q dated June 10, 1997). 10.3 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated as of January 1, 1997 (Exhibit 10.2 of Report on Form 10-Q dated June 10, 1997). 10.4 Employment Agreement between Herley Industries, Inc. and Myron Levy dated as of January 1, 1997 (Exhibit 10.3 of Report on Form 10-Q dated June 10, 1997). 10.5 (a) Employment Agreement with Gerald I. Klein dated April 1, 1990, (Exhibit 10.5 of Annual Report on Form 10-K for the fiscal year ended July 31, 1990). (b) Employment Agreement with Gerald I. Klein dated January 1, 1992, (Exhibit 10.7 of Form S-2 Registration Statement No. 33-44959). (c) Modification Agreement to Employment Agreement with Gerald I. Klein dated November 30, 1992, (Exhibit 10(b) of Report on Form 8-K dated November 30, 1992). 10.6 (a) Revised Non-Negotiable Promissory Note of Lee N. Blatt dated June 2, 1997 (Exhibit 10.4 of Report on Form 10-Q dated June 10, 1997). (b) Revised Non-Negotiable Promissory Note of Gerald I Klein dated June 2, 1997 (Exhibit 10.5 of Report on Form 10-Q dated June 10, 1997). (c) Revised Non-Negotiable Promissory Note of Myron Levy dated June 2, 1997 (Exhibit 10.6 of Report on Form 10-Q dated June 10, 1997). 10.7 Loan Agreement between Registrant and Allstate Municipal Income Opportunities Trust (Exhibit 10.6 of Annual Report on Form 10-K for the fiscal year ended July 31, 1989). 10.8 Asset Purchase Agreement dated as of September 1, 1992 between Micro-Dynamics, Inc. and Herley Industries, Inc. (Exhibit 7(c) of Report on Form 8-K dated October 22, 1992). 10.9 Stock Purchase Agreement dated as of June 1, 1993 between Herley Industries, Inc., Herley Interim Corp., Milton C. Barnard, Edward M. Webber, Marvin Adler and Carlton Industries, Inc. (Exhibit 7(c) of Report on Form 8-K dated June 18, 1993). 10.10 Agreement and Plan of Reorganization dated as of July 8, 1997 among the Company, Metraplex Acquisition Corporation and Metraplex Corporation (Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997). 11. Computation of per share earnings. 23. Consent of Independent Public Accountants. 27. Financial Data Schedule (for electronic submission only).
(b) Financial Statements
See Index to Consolidated Financial Statements at Page.
(c) Reports on Form 8-K
None
SIGNATURES:
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 30th day of October, 1997.
HERLEY INDUSTRIES, INC.
By: /S/ Lee N. Blatt ----------------------------------- Lee N. Blatt, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on October 30, 1997 by the following persons in the capacities indicated:
By: /S/ Lee N. Blatt ------------------ Chairman of the Board Lee N. Blatt (Principal Executive Officer)
By: /S/ Myron Levy President and Director ---------------- Myron Levy
By: /S/ Anello C. Garefino Vice President Finance, CFO, Treasurer ------------------------ (Principal Financial Officer) Anello C. Garefino
By: /S/ David H. Lieberman Director ------------------------ David H. Lieberman
By: /S/ Thomas J. Allshouse Director ------------------------- Thomas J. Allshouse
By: /S/ John A. Thonet Director -------------------- John A. Thonet
Item 8. Financial Statements and Supplementary Data
HERLEY INDUSTRIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................
FINANCIAL STATEMENTS:
Consolidated Balance Sheets, August 3, 1997 and July 28, 1996......
Consolidated Statements of Operations for the 53 Weeks Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996 and July 30, 1995.................................................
Consolidated Statements of Shareholders' Equity for the 53 Weeks Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996 and July 30, 1995................................................
Consolidated Statements of Cash Flows for the 53 Weeks Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996 and July 30, 1995....................................................
Notes to Consolidated Financial Statements..........................
Schedules have been omitted as not applicable.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Herley Industries, Inc.
We have audited the accompanying consolidated balance sheets of Herley Industries, Inc. and Subsidiaries as of August 3, 1997 and July 28, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for the 53 weeks ended August 3, 1997 , and the 52 weeks ended July 28, 1996 and July 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Herley Industries, Inc. and Subsidiaries as of August 3, 1997 and July 28, 1996, and the consolidated results of their operations and their cash flows for the 53 weeks ended August 3, 1997, and the 52 weeks ended July 28, 1996, and July 30, 1995 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Lancaster, PA September 19, 1997
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
August 3, July 28, 1997 1996 ---------- ---------- ASSETS
Current Assets: Cash and cash equivalents $ 1,194,650 $ 1,104,445 Accounts receivable 5,176,523 3,249,225 Notes receivable-officers 2,100,913 2,083,543 Other receivables 152,148 124,992 Inventories 9,790,382 8,010,687 Deferred taxes and other 2,061,066 1,689,988 ---------- ---------- Total Current Assets 20,475,682 16,262,880 Property, Plant and Equipment, net 11,704,755 12,579,044 Intangibles, net of amortization of $1,133,750 in 1997 and $861,650 in 1996 4,308,136 4,580,236 Available-for-sale Securities - 4,912,387 Other Investments 1,313,502 3,000,000 Other Assets 1,455,111 1,174,395 ========== ========== $39,257,186 $42,508,942 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities: Current portion of long-term debt $ 335,000 $ 300,000 Note payable to related party 846,000 - Accounts payable and accrued expenses 4,986,740 5,123,868 Income taxes payable 76,635 166,295 Reserve for contract losses 478,000 489,110 Advance payments on contracts 3,091,001 1,480,033 ---------- ---------- Total Current Liabilities 9,813,376 7,559,306 Long-term Debt 2,890,000 11,021,000 Deferred Income Taxes 2,696,394 1,923,058 Excess of fair value of net assets of business acquired over cost, net of amortization of $973,666 in 1997 and $486,833 in 1996 486,833 973,667 ---------- ---------- 15,886,603 21,477,031 ---------- ---------- Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 10,000,000 shares; issued and outstanding 4,209,365 in 1997 and 2,936,122 in 1996 420,936 293,612 Additional paid-in capital 8,856,516 11,448,827 Retained earnings 14,093,131 9,289,472 ---------- ---------- Total Shareholders' Equity 23,370,583 21,031,911
========== ========== $39,257,186 $42,508,942 ========== ==========
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Nature of Operations
The Company principally designs, manufactures and sells flight instrumentation and microwave products, primarily to aerospace companies, the U.S. government, and several foreign governments. The Company's main products include a variety of transponders which are used to enhance radar signals to accurately track the flight of space launch vehicles and aircraft, as well as microwave devices and command and control systems.
2. Fiscal Year
The Company's fiscal year ends on the Sunday closest to July 31. Normally each fiscal year consists of 52 weeks, but every five or six years the fiscal year will consist of 53 weeks. Fiscal year 1997 consisted of 53 weeks, and fiscal years 1996 and 1995 consisted of 52 weeks.
3. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates.
4. Revenue and Cost Recognition
Under fixed-price contracts, sales and related costs are recorded primarily as deliveries are made. Certain costs under long-term, fixed-price contracts (principally either directly or indirectly with the U.S. Government), which include non-recurring billable engineering, are deferred until these costs are contractually billable. Revenue under certain long-term, fixed price contracts, principally shelters, is recognized using the percentage of completion method of accounting. Revenue recognized on these contracts is based on estimated completion to date (the total contract amount multiplied by percent of performance, based on direct labor dollars). Losses on contracts are recorded when first reasonably determined.
Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Selling, general and administrative costs are charged to expense as incurred.
5. Inventories
Inventories, other than inventory costs relating to long-term contracts and programs, are stated at lower of cost (principally first-in, first-out) or market. Inventory costs relating to long-term contracts and programs are stated at the actual production costs, including factory overhead, reduced by amounts identified with revenue recognized on units delivered or progress completed.
Inventory costs relating to long-term contracts and programs are reduced by any amounts in excess of estimated realizable value. The costs attributed to units delivered under long-term contracts and programs are based on the average costs of all units produced.
6. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets. Gains and losses arising from the sale or disposition of property, plant and equipment are recorded in income.
7. Intangibles
Intangibles are comprised of customer lists, installed products base, drawings, patents, licenses, certain government qualifications and technology and goodwill in connection with the acquisition of Vega Precision Laboratories, Inc. in 1993. Intangibles are being amortized over twenty years.
The carrying amount of intangibles is evaluated on a recurring basis. Current and future profitability as well as current and future undiscounted cash flows of the acquired businesses are primary indicators of recoverability. For the three fiscal years ended August 3, 1997, there were no adjustments to the carrying amount of the cost in excess of net assets acquired resulting from these evaluations.
8. Marketable Securities
The Company accounts for its investments in marketable securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Realized gains and losses and declines in value judged to be other-than-temporary are included in other income (expense). The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in other income (expense).
9. Other Investments
The Company is a limited partner in certain nonmarketable limited partnerships in which it owns approximately a 10% interest. Beginning in 1997 other investments are accounted for under the equity method. Previously, the cost method was utilized as the amount was not significantly different from the equity method.
10. Income Taxes
Income taxes are accounted for by the asset/liability approach in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from temporary differences between the financial reporting and tax bases of assets and liabilities and are adjusted for changes in tax laws and tax rates when those changes are enacted. The provision for income taxes represents the total of income taxes paid or payable for the current year, plus the change in deferred taxes during the year.
11. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
12. Earnings Per Common Share
Earnings per common share and common equivalent share is based on the weighted average number of outstanding shares of common stock (reflective of a 4-for-3 stock split on September 15, 1997), including common stock equivalents (options and warrants) as determined under the treasury stock method as follows: 4,733,682 shares in 1997; 4,253,785 shares in 1996; and 4,978,868 shares in 1995.
13. Cash and Cash Equivalents
For purposes of the statement of cash flows, short-term investments which have a maturity of ninety days or less at the date of acquisition are considered cash equivalents.
14. Product Development
The Company's primary efforts are focused on engineering design and product development activities rather than pure research. The cost of these development activities, including employees' time and prototype development, net of amounts paid by customers, was approximately $1,828,000, $1,453,000, and $970,000 in fiscal 1997, 1996, and 1995, respectively.
15. New Accounting Standards
In March 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"), which is effective for both interim and annual periods ending after December 15, 1997. SFAS 128 supersedes APB No. 15 to conform earnings per share with international standards as well as to simplify the complexity of the computation under APB No. 15. The previous primary earnings per share ("EPS") calculation is replaced with a basic EPS calculation. The basic EPS differs from the primary EPS calculation in that the basic EPS does not include any potentially dilutive securities. Fully dilutive EPS is replaced with diluted EPS and should be disclosed regardless of dilutive impact to basic EPS. Earlier application of this Statement is not permitted. Therefore, the EPS in the Consolidated Statements of Operations are presented under APB No. 15.
NOTE B - ACQUISITIONS AND DISPOSALS
In July 1995, the Company entered into an agreement effective as of the close of business June 30, 1995, to acquire certain assets and the business (consisting principally of inventories and trade receivables) of Stewart Warner Electronics Corporation, a Delaware corporation. The transaction, which closed on July 28, 1995, provided for the payment of $250,000 in cash and the assumption of approximately $915,000 in liabilities and has been accounted for by the purchase method. The acquisition resulted in excess of fair value over cost of net assets acquired of $1,460,500 which is being amortized over a three-year period.
NOTE C - NOTES RECEIVABLE-OFFICERS
In fiscal 1996 the Company loaned $1,400,000, $300,000, and $300,000 to certain officers, as authorized by the Board of Directors, pursuant to the terms of nonnegotiable promissory notes. The notes were initially due November 1996, November 1996 and March 1997, respectively. The notes may be renewed by the Company from year to year. The notes were extended by the Company in fiscal 1997
and are now due April 30, 1998, January 31, 1998, and January 31, 1998, respectively. The loans are secured by 594,365 shares of common stock of the Company. Interest is payable at maturity at the average rate of interest paid by the Company on borrowed funds during the fiscal year. The pledge agreement also provides for the Company to have the right of first refusal to purchase the pledged securities, based on a formula as defined, in the event of the death or disability of the officer.
NOTE D - INVENTORIES
The major components of inventories are as follows:
August 3, July 28, 1997 1996 Purchased parts and raw materials $ 4,780,336 $ 3,358,256 Work in process 4,899,551 4,580,538 Finished products 110,495 71,893 ------------ ----------- $ 9,790,382 $ 8,010,687 ========== =========
NOTE E - AVAILABLE-FOR-SALE SECURITIES
In September 1996, the Company liquidated all of its available-for-sale securities for approximately $4,912,000 and used the proceeds to reduce its long-term bank debt. A provision for unrealized losses of $121,550 is included in the statement of operations for fiscal year 1996. The fair value of available-for-sale securities at July 28, 1996 was $4,912,387.
NOTE F - OTHER INVESTMENTS
In April 1996, the Company acquired a limited partnership interest in M.D. Sass Re/Enterprise-II, L.P., a Delaware limited partnership for $2,000,000. The objective of the partnership is to achieve superior long-term capital appreciation through investments consisting primarily of securities of companies that are experiencing significant financial or business difficulties. In April 1997, the Company sold its investment and terminated its limited partnership interest for $2,080,630 realizing a gain of $80,630.
In December 1995, the Company sold its investment and terminated its limited partnership interest in M.D. Sass Re/Enterprise Partners, L.P., a Delaware limited partnership for $3,823,233 realizing a gain of $1,095,727.
In July 1994, the Company invested $1,000,000 for a limited partnership interest in M.D. Sass Municipal Finance Partners-I, a Delaware limited partnership. The objectives of the partnership are the preservation and protection of its capital and the earning of income through the purchase of certificates or other documentation that evidence liens for unpaid local taxes on parcels of real property. At August 3, 1997 and July 28, 1996 the percentage of ownership was approximately 10%. The Company's interest in the partnership may be transferred to a substitute limited partner, upon written notice to the managing general partners, only with the unanimous consent of both general partners at their sole discretion.
NOTE G - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following:
August 3, July 28, Estimated 1997 1996 Useful Life ---- ---- -----------
Land $ 880,270 $ 880,270 Building and building improvements 5,438,663 5,362,409 10-40 years Machinery and equipment 17,515,954 16,788,901 5- 8 years Furniture and fixtures 494,056 494,056 5-10 years Tools 24,869 24,869 5 years Leasehold improvements 288,757 288,757 5-10 years ---------- ---------- 24,642,569 23,839,262 Less accumulated depreciation 12,937,814 11,260,218 ---------- ---------- $11,704,755 $12,579,044 ========== ==========
NOTE H - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office, production and warehouse space as well as computer equipment and automobiles under noncancellable operating leases.
Rent expense for the 53 weeks ended August 3, 1997, and the 52 weeks ended July 28, 1996 and July 30, 1995 was approximately $229,900, $284,600, and $158,000, respectively.
Minimum annual rentals under noncancellable leases are as follows:
Amount ------- Year ending fiscal 1998 $204,800 1999 153,900 2000 97,400
Employment Agreements
The Company has employment agreements with various executives and employees of the Company, which, as amended, expire at various dates through December 31, 2002, subject to extension each January 1 for six years from that date not to extend, in any event, beyond December 31, 2006. These agreements provide for aggregate annual salaries of $1,185,000. Certain agreements provide for an annual increment equal to the greater of a cost of living adjustment based on the consumer price index or 10%, and also provide for incentive compensation related to pretax income. Incentive compensation in the amount of $665,352 was expensed in fiscal year ended August 3, 1997. Incentive compensation of $446,750 was expensed in fiscal 1996. No incentive compensation was due for the fiscal year ended July 30, 1995.
Certain agreements also provide that, in the event there is a change in control of the Company, as defined, the executives have the option to terminate the agreements and receive a lump-sum payment. As of August 3, 1997, the amount payable in the event of such termination would be approximately $2,050,000.
One of the employment contracts provides for a consulting agreement commencing January 1, 2002 and terminating December 31, 2010 at the annual rate of $100,000. Another one of the employment contracts, as amended January 1, 1997, provides for a consulting period commencing at the end of the
period of active employment and continuing for a period of five years at the annual rate of $60,000. One officer of the Company has a severance agreement providing for a lump-sum payment of $220,000 through June 1999, adjusted to $110,000 through June 2002.
Litigation
In November 1996, the Company settled all claims in connection with two class action complaints, related to the Company's acquisition of Carlton Industries, Inc. and its subsidiary, Vega Precision Laboratories, Inc. for $450,000.
In August 1997, the Company settled all claims in connection with a class action complaint filed in 1995 for $170,000. The claim related to the Company's settlement of the Litton Action in the Essex Superior Court of Massachusetts which alleged, inter alia, that there was insufficient disclosure by the Company of its true potential exposure in that claim.
In July 1996, the Company was notified by the American Arbitration Association of the decision of the arbitrators in an action commenced in March 1994 by the principal selling shareholders of Carlton Industries, Inc. and its subsidiary, Vega Precision Laboratories, Inc. According to the award, the Company was to pay to the claimants the sum of $1,052,900, inclusive of interest. Correspondingly, the claimants were to pay the Company the sum of $277,719, inclusive of interest. The Company paid $775,181 to claimants, representing the difference between the award to the claimants and the award to the Company, in August, 1996. The award to the claimants was offset by $593,162 otherwise payable to one of the selling shareholders.
The Company is also involved in other legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations.
Stand-by Letters of Credit
The Company maintains a letter of credit facility with a bank that provides for the issuance of stand-by letters of credit and requires the payment of a fee of 1.0% per annum of the amounts outstanding under the facility. The facility expires January 31, 1999. At August 3, 1997 stand-by letters of credit aggregating $3,241,392 were outstanding under this facility.
NOTE I - INCOME TAXES
Income tax provision consisted of the following:
52 Weeks ended 53 Weeks ended -------------------- August 3, July 28, July 30, 1997 1996 1995 ---- ---- ---- Current Federal $ (52,000) $ 90,000 $ - State 89,000 12,400 - --------- -------- ----- 37,000 102,400 - --------- ------- ----- Deferred Federal (142,000) - 4,000 State 585,000 - - -------- ------- ----- 443,000 - 4,000 -------- ------- -----
$ 480,000 $ 102,400 $ 4,000 ======= ======= =====
The Company paid income taxes of approximately $178,000 in 1997, $19,000 in 1996, and $122,000 in 1995. The following is a reconciliation of the U. S. statutory income tax rate and the effective tax rate on pretax income: 53 Weeks ended 52 Weeks ended
August 3, July 28, July 30, 1997 1996 1995 ---- ---- ---- U.S. Federal statutory rate 34.0 % 34.0 % (34.0) % State taxes, net of federal tax benefit 12.2 0.2 - Alternative minimum tax - 2.4 - Benefit of net operating loss carryforward (30.8) (35.2) - Non-deductible expenses .3 1.3 - Increase (decrease)in valuation allowance (9.4) - 34.0 Other, net 2.8 - - ----- ----- ----- Effective tax rate 9.1 % 2.7 % - % ===== ===== =====
The 1997 and 1996 tax provisions reflect the utilization of prior year net operating loss carryforwards. In 1995 a valuation allowance had been provided to reduce deferred tax assets to their net realizable value primarily based on management's uncertainty that past performance would be indicative of future earnings. In 1997 the valuation allowance was reversed through the deferred tax provision. A determining factor in assessing the change was the cumulative income in recent years.
Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes.
As of August 3, 1997, the Company has net operating loss carryforwards for Federal income tax purposes of approximately $2,000,000 which expire in 2010.
Components of deferred tax assets and liabilities are as follows:
NOTE J- LONG-TERM DEBT
Long-term debt is summarized as follows: August 3, July 28, Rate 1997 1996 ------------- ---- ---- Note payable bank (a) 6.22% -8.50% $ - $ 6,950,000 Mortgage note (b) 10.4% 3,225,000 3,525,000 Long term liability (c) - - 846,000 --------- ---------- 3,225,000 11,321,000 Less current portion 335,000 300,000 --------- ---------- $2,890,000 $ 11,021,000 ========= ==========
(a) In January 1997, the Company renewed the revolving credit agreement with its bank that provides for the extension of credit in the aggregate principal amount of $11,000,000 and may be used for general corporate purposes, including business acquisitions. The facility requires the payment of interest only on a monthly basis and payment of the outstanding principal balance on January 31, 1999. Interest is set biweekly at 1% over the FOMC Target Rate applied to outstanding balances up to 80% of the net equity value of available-for-sale securities, and at the bank's Base Rate for outstanding balances in excess of this limit. There were no borrowings outstanding at August 3, 1997. The premium rate portion of the facility would be secured by any available-for-sale securities.
The agreement contains various financial covenants, including, among other matters, the maintenance of working capital, tangible net worth, and restrictions on cash dividends and other borrowings.
(b) The mortgage note provides for annual principal payments at varying amounts through 2004 plus semiannual interest payments. Land and buildings in Lancaster, Pa. are pledged as collateral.
The mortgage note agreement contains various financial covenants, including, among other matters, the maintenance of specific amounts of working capital and tangible net worth. In connection with this loan, the Company paid approximately $220,000 in financing costs. Such costs are included in Other Assets in the accompanying consolidated balance sheets at August 3, 1997 and July 28,1996 and are being amortized over the term of the loan (15 years).
(c) Under a contract for the purchase of an industrial parcel of land from its Chairman, the Company is obligated to pay $846,000 at settlement on or before April 30, 1998.
The Company paid interest of approximately $567,000 in 1997, $854,000 in 1996, and $1,010,000 in 1995.
Future payments required on long-term debt are as follows:
Fiscal year ending during: Amount ------ 1998 $335,000 1999 370,000 2000 410,000 2001 450,000 2002 500,000 Thereafter 1,160,000 --------- $3,225,000
NOTE K - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following:
August 3, July 28, 1997 1996 --------- --------- Accounts payable $ 1,841,468 $ 1,579,230 Accrued payroll and bonuses 1,483,915 1,160,345 Accrued commissions 205,692 247,687 Accrued interest 55,900 95,925 Accrued litigation expenses 297,538 1,206,914 Accrued expenses 1,102,227 833,794 ---------- ----------- $ 4,986,740 $ 5,123,868 ========== ==========
NOTE L - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan which qualified as a thrift plan under Section 401(k) of the Internal Revenue Code. This Plan, as amended and restated, allows employees to contribute between 2% and 15% of their salaries to the Plan. The Company, at its discretion can contribute 100% of the first 2% of the employees' contribution and 25% of the next 4%. Additional Company contributions can be made depending on profits. The aggregate benefit payable to an employee is dependent upon his rate of contribution, the earnings of the fund, and the length of time such employee continues as a participant.
The Company has accrued approximately $178,000 for the 53 weeks ended August 3, 1997, and contributed approximately $159,000, and $151,000 to this plan for the 52 weeks ended July 28, 1996, and July 30, 1995, respectively.
NOTE M - SHAREHOLDERS' EQUITY
The Company has two fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company applies APB Opinion No, 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock option plans. Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 6.1%; volatility factor of the expected market price of the Company's common stock of .63; and a weighted-average expected life of the option of .4 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management' s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Had compensation cost for stock options granted in fiscal 1997 been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
--------- Net earnings - as reported $4,803,659 Net earnings - pro forma $3,451,882 Earnings per share - as reported $1.01 Earnings per share - pro forma $.73
No options were granted in fiscal 1996.
The effects of applying the pro forma disclosures of SFAS 123 are not likely to be representative of the effects on reported net earnings for future years due to the various vesting schedules.
In May 1997, the Board of Directors approved the 1997 Stock Option Plan which covers 1,666,666 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. The options expire ten years from the date of grant, subject to certain restrictions. Options for 801,660 shares were granted during the fiscal year ended August 3, 1997.
In October 1995, the Board of Directors approved the 1996 Stock Option Plan which covers 666,666 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. If not specified, 100% of the shares can be exercised one year after the date of grant. The options expire ten years from the date of grant. Options for 663,989 shares were granted during the fiscal year ended August 3, 1997.
In December 1992, the Board of Directors approved the 1992 Non-Qualified Stock Option Plan which covers 1,333,333 shares, as amended, of the Company's common stock. Under the terms of the Plan, the purchase price of the shares, subject to each option granted, is 100% of the fair market value at the date of grant. The date of exercise is determined at the time of grant by the Board of Directors; however, if not specified, 50% of the shares can be exercised each year beginning one year after the date of grant. The options expire ten years from the date of grant. Options for 339,986 shares were granted during the fiscal year ended July 30, 1995. These options may be exercised cumulatively at the rate of 25% per year beginning one year after the date of grant. This plan was terminated in December 1995, except for outstanding options thereunder.
In October 1987, the Board of Directors approved the 1988 Non-Qualified Stock Option Plan which covers 666,666 shares of the Company's common stock. Under the terms of the Plan, the purchase price of the shares, subject to each option granted, will not be less than 85% of the fair market value at the date of grant. The date of exercise may be determined at the time of grant by the Board of Directors; however, if not specified, 20% of the shares can be exercised each year beginning one year after the date of grant and generally expire five years from the date of grant. This plan was terminated in December 1995, except for outstanding options thereunder.
A summary of stock option activity under all plans for the 53 weeks ended August 3, 1997, and the 52 weeks ended July 28, 1996, and July 30, 1995 follows:
Options to purchase 130,218 shares of common stock were exercisable under all plans at August 3, 1997 at a weighted average exercise price of $5.59 with a weighted average remaining contractual life of 6.8 years as follows:
Options Outstanding and Exercisable by Price Range as of August 3, 1997
In April 1993, common stock warrants were issued to certain officers and directors for the right to acquire 573,333 shares of common stock of the Company at the fair market value of $5.35 per share at date of issue. In December 1995 warrants for 533,333 shares were canceled. The warrants vest immediately and expire April 30, 1998. In December 1995, common stock warrants were issued to certain officers for the right to acquire 293,333 shares of common stock of the Company at the fair market value of $4.64 per share at date of issue. The warrants vest immediately and expire December 13, 2005. Warrants for 13,333 shares were exercised in fiscal 1997.
In connection with the sale of common stock to the public in 1992, the Company issued to the underwriter, for its own account, warrants to purchase 170,529 shares of common stock of the Company (as adjusted under the agreement), exercisable for a period of four years at a price of $9.06 per share (as adjusted under the agreement), subject to further adjustment in certain events. The warrants expired in February 1997.
On July 31, 1993, the Company issued 46,666 shares of common stock valued at $5.91 per share in connection with the acquisition of substantially all of the assets of Micro-Dynamics, Inc. These shares were subsequently canceled and reissued in January 1995.
NOTE N - RELATED PARTY TRANSACTIONS
On March 6, 1996, the Board of directors approved the purchase of an industrial parcel of land from the Chairman of the Company for $940,000. A deposit of $94,000 was paid on execution of the contract, and the balance of $846,000 will be paid at settlement on or before April 30, 1998. The Company intends to use this land for possible future expansion.
NOTE O - MAJOR CUSTOMERS
Net sales to the U.S. Government in 1997, 1996, and 1995 accounted for approximately 34%, 33%, and 30% of net sales, respectively. Net sales to the Republic of Korea and Lockheed Martin accounted for approximately 22% of net sales in 1997. Foreign sales amounted to approximately $9,320,000, $6,556,000, and $3,908,000 in fiscal 1997, 1996, and 1995, respectively.
Included in accounts receivable as of August 3, 1997 and July 28, 1996 are amounts due from the U.S. Government of approximately $1,454,000 and $933,000, respectively.
NOTE P - UNUSUAL ITEM
The Consolidated Statements of Operations for the fifty-two weeks ended July 30, 1995 includes an unusual charge of $5,447,005 for settlement costs, legal fees, and related expenses in connection with the settlement of certain legal claims against the Company. Payments of $2,000,000 each, without interest, were made in July 1995 and July 1996 in connection with the settlement of one of the claims.
NOTE Q - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximated its fair value.
Notes receivable-officers: The carrying amount reported in the balance sheet for notes receivable from officers approximated its fair value.
Available-for-sale securities: The fair value of available-for-sale securities was based on quoted market prices.
Long-term debt: The fair value of the mortgage note was estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rate for similar types of borrowing arrangements.
Off balance sheet financial instruments:
Stand-by letters of credit: These letters of credit primarily collateralize the Company's obligations to customers for advanced payments received under contracts. The contract amounts of the letters of credit approximate their fair value.
The carrying amounts and fair values of the Company's financial instruments are presented below:
August 3, 1997 -------------------------- Carrying Amount Fair Value --------------- ---------- Cash and cash equivalents $ 1,194,650 $ 1,194,650 Notes receivable-officers 2,100,913 2,100,913 Long-term debt 2,890,000 3,408,000 Stand-by letters of credit - 3,241,392
NOTE R - CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to credit risk consist primarily of trade accounts receivable. Credit risk with respect to trade receivables is minimized since most of the Company's business is direct to the U. S. Government or as a subcontractor to companies with significant financial resources acting as prime contractors to the U. S. Government, as well as to foreign governments. Additionally, shipments to foreign governments are generally under irrevocable letters of credit.
NOTE S - SUBSEQUENT EVENTS
On August 4, 1997, the Company completed the acquisition of Metraplex Corporation , a Maryland corporation for 234,895 shares of common stock of the Company in exchange for all of the issued and outstanding common stock of Metraplex. Metraplex is a leading manufacturer of pulse code modulation and frequency modulation, telemetry and data acquisition systems for severe environment applications. Metraplex products are used worldwide for testing space launch vehicle instrumentation, aircraft flight testing, and amphibian, industrial and automotive vehicle testing. The transaction will be accounted for under the purchase method.
On September 4, 1997 the Board of Directors declared a 4-for-3 stock split effected as a stock dividend payable September 29, 1997 to holders of record on September 15, 1997. The effect of the split is presented within shareholders' equity at August 3, 1997. The distribution increased the number of shares outstanding from 3,157,024 to 4,209,365. The amount of $105,234 was transferred from the additional paid-in capital to the common stock account to record this distribution. All share and per share data, including stock options and warrants, included in this annual report have been restated to reflect the stock split.