Item 1. Business
Herley Industries, Inc., a Delaware corporation, ("Herley" or the "Company") is engaged in the design, development, and manufacture of flight instrumentation components and systems, and microwave products sold 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 scoring systems. Flight instrumentation products are used to: (i) accurately track the flight of space launch vehicles, targets, and unmanned airborne vehicles ("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. The Company's command and control systems are used on training and test ranges domestically and in foreign countries. The Company has an installed base of approximately 100 command and control systems around the world, which are either fixed installations, transportable units or portable units.
Herley is also engaged in the design, development, manufacture and marketing of microwave devices and electronic systems, equipment and components. A substantial portion of the Company's microwave products are sold to manufacturers and users of microwave systems and equipment for applications in the defense electronics industry, including in connection with the radar and defense electronic systems on tactical fighter aircraft; as well as being used in the Company's flight instrumentation systems and products. The Company also sells these components and equipment for use in the industrial sector as well as in commercial telecommunications industries. Typical applications for the Company's microwave products include electronic warfare and countermeasures, airborne and shipboard navigation and communications, radar systems, missile guidance systems, automatic test equipment, and satellite communications.
The Company has grown internally and through six strategic acquisitions. As a result, the Company has evolved from a components manufacturer to a systems and service provider and has leveraged its technical capabilities and expertise into domestic commercial and foreign defense markets.
Since its inception in 1965, the Company has designed and manufactured microwave devices for use in 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. of Vienna, Virginia, a manufacturer of flight instrumentation products. 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. As of January 4, 1999, the Company acquired all of the issued and outstanding common stock of General Microwave Corporation ("GMC") expanding its offering of microwave components and electronic systems, and its customer base in the industrial sector as well as in the commercial telecommunications industries.
Products - Space and Communications
Command and Control Systems (C2)
For over thirty years, the Company 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 users on the open ocean, remote land masses, and instrumented test and training ranges.
The Company's 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 command and control systems ground station. The UAV may also be used as a decoy, since the operator can direct the flight operations that will make the small drone appear to be a larger combat aircraft.
With the 1994 licensing of the MAGIC2 system, the Company increased the selection of command and control systems. The 6104 TTCS (Target Tracking and Control System) unit is a line-of-sight command and control system 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 system affords over-the-horizon command and control using GPS guidance and control of multiple targets from a single ground station. The ability to control multiple targets at increased distances represents a significant product improvement. The increasing demand for enhanced performance by the U.S. Navy as well as foreign navies in littoral warfare scenarios can be satisfied 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 designed to operate with a large variety of vehicles. A basic TTCS configuration is normally supplied with a standard Company 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. The TTCS is used in support of missile, aircraft
and other weapons systems development and testing. Herley continues to provide this system to customers to support their requirement.
The MAGIC2 system provides control of multiple targets from a single ground control system, and utilizes GPS to provide accurate position information. The MAGIC2 system meets a growing requirement to test against multiple threats with the automated defense capabilities of ships like the AEGIS cruiser and the E-2C aircraft.
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 command and control system, which may be mounted in a trailer that may be moved from place to place by helicopter or truck. The Company also manufactures 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 alliances. Teaming arrangements with Tracor Corporation and Northrop Grumman Corporation have resulted in awards to the Company for command and control systems 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 requires flight safety and performance data transmission to maximize flight safety during the test operation. Surveillance and intelligence gathering UAVs also require a data transmission downlink and a command and control systems uplink to accomplish their mission. The Company has developed a telemetry system capability that can be configured to meet individual customers' needs. Various components of the system include data encoders, transmitters and flight termination receivers. Each has a distinctive role and each is key to the success of the mission.
In 1972, Metraplex began developing data encoding and acquisition, and signal conditioning equipment. Metraplex is now a leading manufacturer of PCM and FM telemetry and data acquisition systems for severe environment applications, whose products are used worldwide for testing space launch vehicle instrumentation, aircraft flight testing, and amphibian, industrial and automotive vehicle testing. The product portfolio ranges in size and complexity from miniature encoders to completely programmable data acquisition systems.
The Company's 1997 acquisition of Metraplex allows the Company to offer a complete airborne data link system. With the digital capability 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 offers a full line of narrow or wide band airborne telemetry systems to meet a wide variety of industrial 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, particularly under adverse weather conditions after the launch.
In range safety applications, transponders enable accurate tracking of space launch and unmanned aerial vehicles, missiles, and target drones so that position and direction are known throughout its flight. In the case of several defense and commercial space launch vehicles (i.e., Delta, Atlas, Titan and Pegasus), 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.
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, a UAV, a target or a space launch vehicle as a safety device. The FTR has a built-in decoder that enables it to receive a complex series of audio tones which, when appropriate, will set off an explosive charge that will destroy the vehicle. A Range Safety Officer ("RSO") using the range safety transponder will track the vehicle in flight to determine if it is performing as required. If the RSO detects a malfunction in the test or launch vehicle that causes it to veer from a planned trajectory in a manner that may endanger personnel or facilities, the RSO will transmit a coded signal to the onboard FTR to explode the vehicle harmlessly.
HF Communications and IFF Interrogators
The Company also designs and manufactures high frequency radio and IFF interrogators. This high frequency communications equipment is used by the U.S. Navy and foreign navies that conduct joint military exercises with the U.S. Navy. The IFF interrogators are used as part of shipboard equipment and are also placed on coastlines, where they are employed as silent sentries. The Company has been a significant supplier to the Republic of Korea ("ROK") for over twenty years and has a large, established installed base of equipment. The Company has been, and continues to be, a supplier to the ROK KDX destroyer program.
Products - Microwave Components
Herley manufactures microwave devices at its facilities in Woburn, Massachusetts; in Farmingdale, New York; and in Jerusalem, Israel for existing long-term military programs, for new production units, as well as for spare parts and repair services. These microwave devices are used in a variety of radar, communications and missile applications, including airborne and shipboard navigation and missile guidance systems.
The Company designs and manufactures complex microwave integrated circuits ("MICs"), which consist of sophisticated assemblies that perform many functions, primarily involving switching of microwave signals. MICs manufactured by the Company are employed in many defense electronics military systems as well as
missile programs. The Company also manufactures magnetrons, which are the power source utilized in the production of the Company's transponders.
The Company's three facilities that manufacture microwave devices each have an area of specialization that tends to limit the competitive pricing pressures generally found in the commercial business area. Herley seeks the more limited production, higher unit cost microwave subsystem applications, where the Company's engineering experience is of primary advantage to its customers.
In Woburn, Herley specializes in high power microwave devices, generally narrow band, that are used in radar system transmitters and in long range missiles. While there are many suppliers of low power microwave components, there are relatively few companies with the expertise, or facilities to design and test high power devices. High power devices frequently use small amounts of nuclear material to enhance breakdown of high energy pulses and Herley is one of very few companies with an active nuclear license that permits the handling of these trace amounts of nuclear materials.
The Company has more recently become the preeminent supplier of solid state receiver protector devices, that are able to withstand high energy pulses without the use of nuclear materials. These high power devices protect a radar receiver from transient bursts of microwave energy and are employed in almost every military and commercial radar system. For its engineering efforts in designing solid state receiver protectors for the, the United States Air Force awarded the Company cash awards as part of the government's value engineering program.
In Farmingdale, Herley produces lower power, broad band microwave integrated assemblies for the electronic defense business area. These costly, complex assemblies combine microwave functions such as amplification, attenuation, switching of multiple signals, and phase and amplitude control. Their applications include Rear Warning Receivers (RWR's), Electronics Countermeasure (ECM) systems, and highly sensitive receiver systems.
In Farmingdale, the Company also produces components that are sold through its GMC catalog, which for almost forty years has been the microwave engineer's handbook for attenuating devices and IQ modulation and phase shifters.
The Company sells its catalog products to engineering design facilities on a worldwide basis, and is considered the industry leader in attenuators and phase shifters.
The Company's Israel division supplies microwave sources, which generate signals that are used in microwave oscillators. Herley's Israel operation sells approximately equally to various foreign governments and to the U.S. defense industry. The Company specializes in digitally tuned oscillators (DTO's), a critical component of many ECM systems.
With its three facilities and their diverse specialties, Herley is able to offer its customers a more broadly based solution in the form of complex, integrated microwave assemblies. In the modular approach now common in the design of radar and ECM systems, the entire system may comprise only a handful of SR (Shop Replaceable) or LR (Line Replaceable) units. The Company's goal is to become a supplier of this magnitude to its existing customer base, through the combination of its microwave capabilities.
New Product Development and Applications
The Company believes that its growth depends, in part, on its ability to renew and expand its technology, products, and design and manufacturing processes with an emphasis on cost effectiveness. The Company's primary efforts are focused on engineering design and product development activities rather than pure research. A substantial portion of the Company's development activities 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 require and budgets permit. The cost of these development activities, including employees' time and prototype development, net of amounts paid by customers, were approximately $1,685,000, $1,562,000, and $1,828,000 in fiscal 1999, 1998, and 1997, respectively.
Government Contracts
A substantial part of the Company's sales are made to U.S. government agencies, 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.
Substantially 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 on the work completed.
Business Acquisition
As of January 4, 1999, the Company completed the acquisition of all of the issued and outstanding common stock of GMC, a New York corporation, including outstanding stock options, for $18.00 per share and 966,675 three-year warrants to purchase one share of the Company's common stock, at an aggregate purchase price of approximately $24,556,000. The purchase price includes shares of common stock of GMC purchased in the open market, acquisition of the remaining shares of common stock outstanding, an estimate of the fair market value of the warrants based on the trading price of similar warrants currently on the market, and transaction expenses. The warrants are exercisable at $15.60 per share of common stock of the Company and expire in January 2002.
GMC designs, manufactures and markets microwave components and subsystems, and related electronic test and measurement equipment. The company is headquartered in Farmingdale, New York, and operates two other facilities, one in Billerica, Massachusetts, and one in Israel. The transaction has been accounted for under the purchase method.
Marketing and Distribution The Company's marketing approach is to determine customer requirements in the developmental 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 (including options) 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 $49,230,000 on August 1, 1999 ($30,533,000 in domestic orders and $18,697,000 in foreign orders) as compared to approximately $38,724,000 on August 2, 1998 ($25,727,000 in domestic orders and $12,997,000 in foreign orders). Management anticipates that approximately $42,585,000 of the backlog will be shipped during the fiscal year ending July 30, 2000. 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 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 testing procedures based upon customer requests. All of such testing is performed by the Company at its facilities.
All electronic parts are procured in controlled lots that are subjected to physical inspection and screening at Herley facilities before use in products. Physical inspection may require 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 continuously monitor, analyze and measure 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, with the exception of one component part which, if unavailable, can be manufactured by the Company.
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 and microwave products that 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 or programs, the Company believes it is sole source, which means that all work is directed to a single manufacturer. In other cases, there may be other suppliers that 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 Signal Technology, L-3 Communications Corporation, Microsystems, Inc., AMP, Inc. and Remec, Inc.
Employees
As of October 10, 1999, the Company employed 511 full-time persons. A total of 386 employees were engaged in manufacturing, 63 in engineering, 26 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 a significant number of 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 nondisclosure 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.
Item 2.
Item 2. Properties
The Company's properties are as follows:
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 NASDAQ National Market under the symbol HRLY. The following table sets forth the high and low sales price as reported by the NASDAQ National Market for the Company's Common Stock for the periods indicated and gives effect to the four-for-three stock split of the Common Stock on September 30, 1997. Common Stock -------------- High Low ----- ----- Fiscal Year 1998 First Quarter............................... 15.00 10.13 Second Quarter.............................. 14.75 10.50 Third Quarter............................... 14.69 10.88 Fourth Quarter.............................. 14.25 8.63 Fiscal Year 1999 First Quarter............................... 10.50 7.63 Second Quarter.............................. 15.31 9.56 Third Quarter............................... 15.13 11.13 Fourth Quarter.............................. 16.19 11.50 Fiscal Year 2000 First Quarter (through October 11, 1999).... 15.00 12.94
The closing price on October 11, 1999 was $14.375.
(b) As of October 11, 1999, there were approximately 1,000 record holders of the Company's Common Stock. (c) There have been no cash dividends declared or paid by the Company on its Common Stock during the past two fiscal years.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company is engaged in the design, manufacture and sale of flight instrumentation components and systems, and microwave products, 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 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.
The Company is also engaged in the design, development, manufacture and marketing of microwave devices and electronic systems, equipment and components. A substantial portion of the Company's microwave products are sold to manufacturers and users of microwave systems and equipment for applications in the defense electronics industry, including in connection with the radar and defense electronic systems on tactical fighter aircraft, as well as in the Company's flight instrumentation systems and products. The Company also sells these components and equipment for use in the industrial sector as well as in commercial telecommunications industries. Typical applications for the Company's microwave products include electronic warfare and countermeasures, airborne and shipboard navigation and communications, radar systems, missile guidance systems, automatic test equipment, and satellite communications.
Of the Company's total backlog of $49,230,000 at August 1, 1999, $30,533,000 is attributable to domestic orders and $18,697,000 is attributable to foreign orders. Management anticipates that approximately $42,585,000 of its backlog will be shipped during the fiscal year ending July 30, 2000. 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 of 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. Revenue recognized on these contracts is based on estimated completion to date, which is the total contract amount multiplied by percent of performance, based on total costs incurred in relation to total estimated cost at completion. As of August 2, 1998, costs incurred and income recognized in excess of billings on uncompleted contracts was $1,665,008. There were no long-term contracts of this nature as of August 1, 1999. 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 $1,685,000,$1,562,000, and $1,828,000 in fiscal years 1999, 1998 and 1997, 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 1999 and 1998 was 34.3% and 34.8%, respectively. The lower effective rate of 9.1% in 1997 reflects 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.
Results of Operations
The following table sets forth for the periods indicated certain financial information derived from the Company's consolidated statements of income expressed as a percentage of net sales. There can be no assurance that trends in sales growth or operating results will continue in the future.
Fiscal 1999 Compared to Fiscal 1998
Net sales for the 52 weeks ended August 1, 1999 were approximately $61,036,000 compared to $40,798,000 for fiscal 1998. The sales increase of $20,238,000 (49.6%) is primarily attributable to the acquisition of GMC as of January 4, 1999 which contributed $14,374,000 in revenues in fiscal 1999,as well as an increase in net sales of approximately $3,508,000 in flight instrumentation products, and approximately $2,356,000 in microwave components.
Gross profit of 39.8% for the 52 weeks ended August 1, 1999 is less than the prior year of 40.8%. The decline in margin of 1% is due primarily to lower margins on microwave components, as well as the lower margins generated from the added GMC revenues.
Selling and administrative expenses for the 52 weeks ended August 1, 1999 were $11,877,000 compared to $8,339,000 for fiscal 1998, an increase of $3,538,000. The acquisition of GMC added $3,222,000 in selling and administrative expenses in fiscal 1999. As a percentage of revenues, expenses declined from 20.4% in 1998 to 19.5% in 1999.
Investment income declined $288,000 from the prior year due to a decrease in investments, the proceeds of which were used to partially fund the acquisition of GMC. In addition, bank borrowings of approximately $11,400,000 used to fund the balance of the acquisition price resulted in additional interest expense of approximately $302,000.
In February 1999, the Company refinanced the existing mortgage on its property located in Lancaster, Pa. The proceeds of the new mortgage loan were used to prepay the existing mortgage note having an outstanding principal balance of $2,890,000 plus a prepayment premium of $115,600. Unamortized debt expenses of $79,226 and the $115,600 prepayment premium related to the early extinguishment of the existing mortgage debt were charged to expense as an extraordinary loss, net of an income tax benefit of $68,000.
Fiscal 1998 Compared to Fiscal 1997
Net sales for the 52 weeks ended August 2, 1998 were approximately $40,798,000 compared to $32,195,000 for fiscal 1997. The sales increase of $8,603,000 (26.7%) is primarily attributable to the acquisition of Metraplex Corporation as of August 4, 1997 which contributed $4,015,000 in revenues in fiscal 1998, an increase of approximately $3,542,000 in flight instrumentation products, and an increase of approximately $1,046,000 in microwave components.
Gross profit of 40.8% for the 52 weeks ended August 2, 1998 exceeded the prior year of 35.5% due to an increase of $2,545,000 in higher margin foreign sales from $9,398,000 in 1997 to $11,943,000 in 1998, and improved margins in microwave components, 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 August 2, 1998 were $8,339,000 compared to $6,293,000 for fiscal 1997, an increase of $2,046,000. The addition of Metraplex Corporation added $1,195,000 in selling and administrative expenses in fiscal 1998. In addition, $304,000 of the change is attributable to increased representative fees on foreign sales, $415,000 is due to increased personnel and related expenses, including additional travel expenses, and $350,000 relates to increased consulting fees primarily for software changes addressing the year 2000 computer software issues. Such increases were offset by cost savings of $243,000 related to the transfer of substantially all of the production from the Stewart Warner facilities in Chicago to the Company's facilities in Lancaster, Pennsylvania. As a percentage of net sales, selling and administrative expenses increased from 19.5% in 1997 to 20.4% in 1998.
Other income, net, for the 52 weeks ended August 2, 1998 was consistent with the prior year.
The effective tax rate in 1998 was 34.8% as compared to 9.1% in fiscal 1997. The 1997 tax provision reflects 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.
Liquidity and Capital Resources
As of August 1, 1999 and August 2, 1998, working capital was approximately $25,703,000 and $26,593,000, respectively, and the ratio of current assets to current liabilities was 3.44 to 1 and 3.70 to 1, respectively. At August 1, 1999, the Company had cash and cash equivalents of approximately $2,741,000.
As of January 4, 1999, the Company completed the acquisition of all of the issued and outstanding common stock of GMC, a New York corporation, including outstanding stock options, for $18.00 per share and 966,675 three-year warrants to purchase one share of the Company's common stock, at an aggregate purchase price of approximately $24,556,000. The purchase price includes shares of common stock of General Microwave purchased in the open market, acquisition of the remaining shares of common stock outstanding, an estimate of the fair market value of the warrants based on the trading price of similar warrants currently on the market, and transaction expenses. The warrants are exercisable at $15.60 per share of common stock of the Company and expire in January 2002.
On August 4, 1997, the Company completed the acquisition of Metraplex Corporation, a Maryland corporation for 313,139 (as adjusted) shares of common stock of the Company, with a fair market value of $3,170,471, in exchange for all of the issued and outstanding common stock of Metraplex.
As is customary in the defense industry, inventory is partially financed by advance payments. The unliquidated balance of these advance payments was approximately $439,000 in 1999, and $1,825,000 in 1998. The decrease in the current fiscal year is directly attributable to shipments under the related contracts.
Net cash provided by operations was approximately $12,723,000, and $4,571,000, in 1999, and 1998 respectively.
Net cash used in investing activities in 1999 of approximately $21,757,000 relates primarily to the acquisition of GMC, net of cash acquired, which was funded by available cash balances and borrowings under the bank line of credit.
Net cash flows from financing activities in fiscal 1999 included: (1) net borrowings under the bank line of credit of $11,000,000 the proceeds of which were used to partially fund the acquisition of GMC; (2) refinancing of the existing mortgage on the property in Lancaster, Pa., which reduced the interest rate from 10.4% to 7.43% and extended the repayment schedule to 10 years; and (3) the acquisition of treasury stock in the aggregate amount of $7,688,000 (which was funded through operations).
Net cash provided by financing activities in fiscal 1998 consists of net proceeds of $7,452,000 from the sale of 700,000 shares of common stock, and 1,265,000 Common Stock Purchase Warrants to the public. Net borrowings under a bank line of credit provided $1,500,000 in financing. The Company received a partial distribution of $592,824 from its M.D. Sass Municipal Finance Partners-I limited partnership investment. Cash was used in financing activities for payments of long-term debt of $2,257,000 and the purchase of treasury stock of $1,084,000. Cash provided by investing activities in 1997 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 $20,000,000, which expires January 31, 2001. As of August 1, 1999 and August 2, 1998, the Company had borrowings outstanding under this facility of $12,500,000 and $1,500,000, respectively.
During the fiscal year ended August 1, 1999 the Company acquired 561,050 shares of its outstanding common stock for $7,688,134 through open market purchases, pursuant to a stock repurchase plan to acquire up to 1,250,000 shares of Common Stock. In January 1998, the Company purchased 89,888 shares of its outstanding common stock for $1,084,326 from certain officers of the Company based on the fair market value of the stock on the date acquired. 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 410,593, 42,016 and 463,639 shares of common stock in fiscal 1999, 1998 and 1997, respectively, valued at $5,989,335, $538,376 and $6,429,124, respectively, in connection with certain "stock-for-stock" exercises of stock options by which certain employees elected to surrender "mature" shares owned in settlement of the option price. Such exercises are treated as an exercise of a stock option and the acquisition of treasury shares by the Company. See "Management - Stock Plans."
The Company believes that presently anticipated future cash requirements will be provided by internally generated funds and existing credit facilities.
Subsequent Event
On September 23, 1999 the Company closed on the sale of GMC's property in Amityville, New York and relocated the plant to a leased facility in Farmingdale, New York. The Company used the net proceeds from the sale of approximately $4,159,000, which approximates the net carrying value of the property, to partially fund the buy back of its common stock through open market purchases in September 1999.
Year 2000 Readiness
The "Year 2000" problem relates to computer systems that have time and date-sensitive programs that were designed to read years beginning with "19", but may not properly recognize the year 2000. If a computer system or software application used by the Company or a third party dealing with the Company fails because of the inability of the system or application to properly read the year 2000 the results could have a material adverse effect on the Company.
A substantial part of the Company's revenues are derived from firm fixed price contracts with U.S. government agencies, prime contractors or subcontractors on military or aerospace programs, and many foreign governments. If the Company is unable to perform under these contracts due to a Year 2000 problem, the customer could terminate the contract for default. While lost revenues from such an event are a concern for the Company, the greater risks are the consequential damages for which the Company could be liable for failure to perform under the contracts. Such damages could have a material adverse impact on the Company's results of operations and financial position.
The most likely reason for a customer to terminate a contract for default would be due to the Company's inability to manufacture and deliver product under the contract. Breakdowns in any number of the Company's computer systems and applications could prevent the Company from being able to manufacture and ship its products. Examples are failures in the Company's manufacturing application software, computer chips embedded in engineering test equipment, lack of supply of materials from its suppliers, or lack of power, heat,
or water from utilities servicing its facilities. The Company's products do not contain computer devices that require remediation to meet Year 2000 requirements. A review of the Company's status with respect to remediating its computer systems for Year 2000 compliance is presented below.
For its information technology requirements at its facilities in Lancaster, PA and Woburn, MA, the Company currently utilizes a Hewlett Packard HP3000-based computing environment. The HP3000 hardware is in compliance with Year 2000 requirements. The Company's financial, manufacturing, and other software applications related to the HP3000 were updated to comply with Year 2000 requirements during the fiscal year ended August 2, 1998 at a cost of approximately $350,000. All modules have been fully tested and are compliant. In addition, the Company utilizes a wide area network ("WAN") to connect its operating facilities to the HP3000. The WAN has been updated to comply with Year 2000 requirements. A local area network ("LAN") is used to supplement the HP3000 environment and has also been upgraded and is fully Year 2000 compliant. The financial and operational systems of GMC in Farmingdale, NY have also been reviewed and tested and are in compliance with Year 2000 requirements.
The Company has also reviewed its utility systems (heat, light, phones, liquid nitrogen, etc.) for the impact of Year 2000, as well as determining the state of readiness of its material suppliers and test equipment manufacturers. The Company has received responses to its questionnaire from its major suppliers and test equipment manufacturers regarding their compliance and attempts to identify any problem areas with respect to their systems and equipment. No major problems have been identified. However, the Company cannot control the conduct of its suppliers. Therefore, there can be no guarantee that Year 2000 problems originating with a supplier will not occur. The Company has developed multiple sources for a substantial portion of its raw material requirements and has obtained Year 2000 compliance statements from its critical suppliers, and therefore, does not believe there would be a significant disruption in supply.
The information set forth above identifies the key steps taken by the Company to address the Year 2000 problem. There can be no absolute assurance that third parties will convert their systems in a timely manner. The Company believes that its actions will minimize these risks and that any additional cost of Year 2000 compliance for its information and production systems will not be material to its consolidated results of operations and financial position.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is subject to market risk associated with changes in interest rates and stock prices. The Company has not entered into any derivative financial instruments to manage the above risks and the Company has not entered into any market risk sensitive instruments for trading purposes. The Company's debt consists of a working capital line of credit with a bank having an interest rate that is set biweekly at 1.65% over the FOMC Target Rate (an aggregate of 6.65% as of August 1, 1999), and a mortgage on its facilities in Lancaster, Pa. at a fixed rate of 7.43% The credit line is reviewed on an annual basis. Since the acquisition of GMC, the Company is subject to movements in foreign currency rate changes related to GMC's Israel operations. The Company does not anticipate any other material changes in its primary market risk exposures in fiscal 2000.
As of August 1, 1999, the Company holds an investment in the common stock of a public company that is exposed to price risk with a cost basis and a fair market value basis of $143,330.
The table below provides information about the Company's debt that is sensitive to changes in interest rates. The table presents principal cash flows by maturity date. Future principal payment cash flows by maturity date required under the mortgage and line of credit, and corresponding fair values are as follows:
Fiscal year ending during: Mortgage Line of Credit -------------------------- -------- -------------- 2000 $ 68,000 $ 2001 73,000 12,500,000 2002 78,000 2003 84,000 2004 91,000 2005 and later 2,509,000 --------- ---------- $2,903,000 $12,500,000 ========= ========== Fair value $2,903,000 $12,500,000 ========= ==========
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 January 2000, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year ended August 1, 1999.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1 Registration Statement No. 2- 87160).
3.2 By-Laws, as amended (Exhibit 3(b) of Form S-1 Registration Statement No. 2-87160).
10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the fiscal year ended July 28, 1996).
10.2 1997 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 10, 1997).
10.3 1998 Stock Option Plan.
10.4 Amendments dated January 26, 1999 and July 30, 1999to Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated as of October 1, 1998.
10.5 Amendments dated January 26, 1999 and July 30, 1999 to Employment Agreement between Herley Industries, Inc. and Myron Levy dated as of October 1, 1998.
10.6 Agreement and Plan of Reorganization dated as of July 8, 1997 among the Company, Metraplex Acquisition Corporation and Metraplex Corporation (Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997).
10.7 Agreement and Plan of Merger dated as of August 21, 1998 among General Microwave Corp., Eleven General Microwave Corp., Shareholders, GMC Acquisition Corporation and Registrant (Exhibit 1 of Schedule 13D dated August 28, 1998).
10.8 Lease Agreement dated September 1, 1999 between Registrant and RSK Realty LTD.
10.9 Loan Agreement dated February 16, 1999 between Registrant and The First National Bank of Maryland, a division of FMB Bank.
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Brightman, BarLeva, Friedman & Co.
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 26th day of October, 1999.
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 26, 1999 by the following persons in the capacities indicated:
By: /S/ Lee N. Blatt Chairman of the Board ------------------ (Principal Executive Officer) Lee N. Blatt
By: /S/ Myron Levy President and Director ---------------- Myron Levy
By: /S/ Anello C. Garefino Vice President Finance, CFO, Treasurer ------------------------ (Principal Financial Officer) Anello C. Garefino
By: /S/ David H. Lieberman Secretary and Director ------------------------ David H. Lieberman
By: /S/ Thomas J. Allshouse Director ------------------------- Thomas J. Allshouse
By: /S/ John A. Thonet Director -------------------- John A. Thonet
By: /S/ Alvin M. Silver Director -------------------- Alvin M. Silver
By: /S/ Edward K. Walker, Jr. Director -------------------------- Edward K. Walker, Jr.
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 1, 1999 and August 2, 1998.....
Consolidated Statements of Income for the 52 weeks ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997.............................................
Consolidated Statements of Shareholders' Equity for the 52 weeks ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997.............................................
Consolidated Statements of Cash Flows for the 52 Weeks Ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997.............................................
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 1, 1999 and August 2, 1998, and the related consolidated statements of income, shareholders' equity and cash flows for the 52 weeks ended August 1, 1999 and August 2, 1998, and the 53 weeks ended August 3, 1997. 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 did not audit the financial statements of General Microwave (Israel) Corporation and Subsidiary, which statements represent total assets and total revenues of 7% and 4%, respectively, in 1999 of the related consolidated totals. Those statements were audited by other auditors whose report was furnished to us, and our opinion, insofar as it relates to the amounts included for those entities, is based solely on the report of the other auditors.
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 and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, 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 1, 1999 and August 2, 1998, and the consolidated results of their operations and their cash flows for the 52 weeks ended August 1, 1999 and August 2, 1998, and the 53 weeks ended August 3, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Lancaster, PA September 17, 1999
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
August 1, August 2, 1999 1998 ---------- ---------- ASSETS Current Assets: Cash and cash equivalents $ 2,741,163 $ 10,689,193 Accounts receivable 10,678,638 6,193,947 Costs incurred and income recognized in excess of billings on uncompleted contracts - 1,665,008 Other receivables 212,515 248,298 Prepaid income taxes - 377,448 Inventories 19,880,370 15,068,618 Deferred taxes and other 2,703,179 2,194,004 ---------- ---------- Total Current Assets 36,215,865 36,436,516
Property, Plant and Equipment, net 21,888,553 12,549,343 Intangibles, net of amortization of $2,137,459 in 1999 and $1,524,393 in 1998 13,573,653 6,080,218 Available-for-sale Securities 148,105 143,330 Other Investments 947,983 849,324 Other Assets 1,282,078 1,493,798 ========== ========== $ 74,056,237 $ 57,552,529 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities: Current portion of long-term debt $ 258,383 $ 404,984 Accounts payable and accrued expenses 8,035,211 6,468,183 Income taxes payable 276,160 - Reserve for contract losses 1,505,048 1,145,128 Advance payments on contracts 438,538 1,824,746 ---------- ---------- Total Current Liabilities 10,513,340 9,843,041 Long-term Debt 15,437,390 4,110,885 Deferred Income Taxes 5,143,837 3,158,353 Minority Interest 62,062 - ---------- ---------- 31,156,629 17,112,279 ---------- ---------- Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 20,000,000 shares; issued and outstanding 5,030,283 in 1999 and 5,266,159 in 1998 503,028 526,616 Additional paid-in capital 15,071,964 20,323,895 Retained earnings 27,324,616 19,589,739 ---------- ---------- Total Shareholders' Equity 42,899,608 40,440,250
========== ========== $ 74,056,237 $ 57,552,529 ========== ==========
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
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, a Delaware corporation, is engaged in the design, development, manufacture and sale of flight instrumentation components and systems, 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 years 1999 and 1998 consisted of 52 weeks, and fiscal year 1997 consisted of 53 weeks.
3. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant inter-company accounts and transactions have been eliminated in consolidation. The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates.
4. Cash and Cash Equivalents
The Company considers all liquid investments with an original maturity of three months or less at the date of acquisition to be cash equivalents. Short-term investments are recorded at the amortized cost plus accrued interest which approximates market value. The Company limits its credit risk to an acceptable level by evaluating the financial strength of institutions at which significant investments are made and based upon credit ratings.
5. Concentration of Credit Risk
Financial instruments which potentially subject the Company to credit risk consist primarily of trade accounts receivable. Accounts receivable are principally from the U.S. Government, major U.S. Government contractors, several foreign governments, and domestic customers in the aerospace and defense industries. Credit is extended based on an evaluation of the customer's financial condition and generally collateral is not required. In many cases irrevocable letters of credit accompanied by advanced payments are received from foreign customers, and progress payments are received from domestic customers. The Company performs periodic credit evaluations of its customers and maintains reserves for potential credit losses.
6. Inventories
Inventories, other than inventory costs relating to long-term contracts and programs, are stated at lower of cost (principally first-in, first-out) or market. Inventory costs relating to long-term contracts and programs are stated at the actual production costs, including factory overhead, reduced by amounts identified with revenue recognized on units delivered or progress completed.
Inventory costs relating to long-term contracts and programs are reduced by any amounts in excess of estimated realizable value. The costs attributed to units delivered under long-term contracts and programs are based on the average costs of all units produced.
7. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets. Gains and losses arising from the sale or disposition of property, plant and equipment are recorded in income.
8. Intangibles
Intangibles are comprised of customer lists, installed products base, drawings, patents, licenses, certain government qualifications and technology and goodwill in connection with the acquisitions of General Microwave Corporation in 1999, Metraplex Corporation in 1997, and Vega Precision Laboratories, Inc. in 1993. Intangibles are being amortized over twenty years. Amortization charges totaled $754,358, ($70,795), and ($182,667) in fiscal 1999, 1998, and 1997, respectively. The negative amortization in 1998 and 1997 is attributable to the negative goodwill in connection with the acquisition of Stewart Warner Electronics in 1995.
The carrying amount of intangibles is evaluated on a recurring basis. Current and future profitability as well as current and future undiscounted cash flows of the acquired businesses are primary indicators of recoverability. For the three fiscal years ended August 1, 1999, there were no adjustments to the carrying amount of the cost in excess of net assets acquired resulting from these evaluations.
9. Marketable Securities
The Company accounts for its investments in marketable securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value. Realized gains and losses and declines in value judged to be other-than-temporary are included in other income , net. The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in other income, net.
10. Other Investments
The Company is a limited partner in a nonmarketable limited partnership in which it owns approximately a 10% interest. This investment is accounted for under the equity method.
11. Revenue and Cost Recognition
Under fixed-price contracts, revenue and related costs are recorded primarily as deliveries are made. Certain costs under long-term, fixed-price contracts (principally either directly or indirectly with the U.S. Government), which include non-recurring billable engineering, are deferred until these costs are
contractually billable. Revenue under certain long-term, fixed price contracts, principally command and control 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 total costs incurred in relation to total estimated cost at completion). Prospective losses on long-term contracts are based upon the anticipated excess of inventoriable manufacturing costs over the selling price of the remaining units to be delivered and are recorded when first reasonably determinable. Actual losses could differ from those estimated due to changes in the ultimate manufacturing costs and contract terms.
Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Selling, general and administrative costs are charged to expense as incurred.
12. Income Taxes
Income taxes are accounted for by the asset/liability approach in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from temporary differences between the financial reporting and tax bases of assets and liabilities and are adjusted for changes in tax laws and tax rates when those changes are enacted. The provision for income taxes represents the total of income taxes paid or payable for the current year, plus the change in deferred taxes during the year.
13. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
14. Earnings Per Common Share
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"), which replaced 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. In accordance with SFAS 128, all earnings per share amounts for all periods presented have been restated (reflective of a 4-for-3 stock split on September 30, 1997).
15. 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 $1,685,000, $1,562,000, and $1,828,000 in fiscal 1999, 1998, and 1997, respectively.
16. New Accounting Standards
In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," ("SFAS 132"), which was effective for fiscal years beginning after December 15, 1997. This statement revises financial statement disclosure requirements for pension and other postretirement benefit plans, but does not change the measurement or recognition of those plans. Adoption of SFAS 132 did not impact the financial results of the Company and the required disclosures have been provided in Note K - Employee Benefit Plans.
The Company has adopted SFAS 131, "Disclosure About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for reporting information about operating segments in annual financial statements and requires that segments be determined based on how management measures performance and makes decisions about allocating resources. The required new disclosures have been provided in Note O to the Consolidated Financial Statements.
NOTE B - ACQUISITIONS
As of January 4, 1999, the Company completed the acquisition of all of the issued and outstanding common stock of General Microwave Corporation ("GMC"), a New York corporation, including outstanding stock options, for $18.00 per share and 966,675 three-year warrants to purchase one share of the Company's common stock, at an aggregate purchase price of approximately $24,556,000. This transaction was accounted for under the purchase method. The purchase price includes shares of common stock of GMC purchased in the open market, acquisition of the remaining shares of common stock outstanding, an estimate of the fair market value of the warrants based on the trading price of similar warrants currently on the market, and transaction expenses. The warrants are exercisable at $15.60 per share of common stock of the Company and expire in January 2002.
The aggregate purchase price is calculated as follows (in thousands, except share and per share data):
365,600 shares previously acquired in the open market $ 6,273 848,675 shares at $18.00 per share 15,276 118,000 stock options at $18.00 per share, net of exercise price 1,279 966,675 warrants at $1.50 1,450 Transaction expenses 278 ------ Purchase price $ 24,556 ======
The cash portions of the acquisition were financed through available cash equivalents and borrowings under the Company's line of credit.
GMC designs, manufactures and markets microwave components and subsystems, and related electronic test and measurement equipment. The company is headquartered in Amityville, New York, and operates two other facilities, one in Billerica, Massachusetts, and one in Israel. The transaction has been accounted for under the purchase method. Accordingly, the consolidated balance sheet includes the assets and liabilities of GMC at August 1, 1999, and the consolidated statements of income include the results of General Microwave operations from January 4, 1999. The acquisition resulted in excess cost over fair value of net assets acquired of $7,538,501 which is being amortized over 20 years.
As part of the Company's GMC acquisition plans, the Company is moving GMC's Billerica, MA operations into the Company's existing Woburn, MA location. The Company had also decided to terminate GMC's defined benefit pension plan. Both of these actions are to be completed in fiscal 2000. In connection with these actions, the Company accrued, as part of purchase accounting, $180,000 of
lease termination costs related to the Billerica facility, $250,000 of severance costs, and $463, 834 related to the termination of the GMC pension plan. Through August 1, 1999, no amounts were paid under the lease termination or pension termination and approximately $150,000 of severance was paid.
On the basis of a pro forma consolidation of the results of operations as if the acquisition had taken place at the beginning of fiscal 1998, unaudited consolidated net sales, net income, basic earnings per share, and diluted earnings per share for the fifty-two weeks ended August 2, 1998 would have been approximately $63,477,000, $6,606,000, $1.33, and $1.22, and for the fifty-two weeks ended August 1, 1999 would have been approximately $70,349,000, $7,481,000, $1.43, and $1.32, respectively. The pro forma information includes adjustments for additional depreciation based on the estimated fair market value of the property, plant, and equipment acquired, and the amortization of intangibles arising from the transaction. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been effected at the beginning of fiscal 1998.
On August 4, 1997, the Company completed the acquisition of Metraplex Corporation, a Delaware corporation, for 313,139 (as adjusted) shares of common stock of the Company, with a fair market value of $3,170,471, in exchange for all of the issued and outstanding common stock of Metraplex. Metraplex is a leading manufacturer of pulse code modulation and frequency modulation, telemetry and data acquisition systems for severe environment applications. The transaction has been accounted for by the purchase method. Accordingly, the consolidated balance sheet includes the assets and liabilities of Metraplex at August 2, 1998, and the consolidated statements of income include the results of Metraplex operations from August 4, 1997. The acquisition resulted in excess of cost over fair value of net assets acquired of $2,162,725 which is being amortized over twenty years.
On the basis of a pro forma consolidation of the results of operations as if the Metraplex acquisition had taken place at the beginning of fiscal 1997, unaudited consolidated net sales, net income, basic earnings per share, and diluted earnings per share for the year ended August 3, 1997 would have been approximately $36,589,333, $4,686,236, $1.07, and $.93, respectively. The pro forma information includes adjustments for additional depreciation based on the fair market value of the property and equipment acquired, and the amortization of intangibles arising from the transaction. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been effected at the beginning of fiscal 1997.
NOTE C - NOTES RECEIVABLE-OFFICERS
In fiscal 1996 the Company loaned an aggregate of $2,000,000 to certain officers, as authorized by the Board of Directors, pursuant to the terms of nonnegotiable promissory notes. The loans were paid in full with accrued interest as of December 19, 1997.
NOTE D - INVENTORIES
The major components of inventories are as follows:
August 1 August 2, 1999 1998 ---- ---- Purchased parts and raw materials $ 9,862,727 $ 7,377,882 Work in process 8,780,767 7,303,533 Finished products 1,236,876 387,203 ---------- ---------- $19,880,370 $15,068,618 ========== ==========
NOTE E - 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 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 1, 1999 and August 2, 1998 the percentage of ownership was approximately 10%. The Company's interest in the partnership may be transferred to a substitute limited partner, upon written notice to the managing general partners, only with the unanimous consent of both general partners at their sole discretion. In July 1998, the Company received a partial distribution of $592,824 from the Partnership. As of August 1, 1999 the Company's limited partnership interest had an estimated fair value of $947,983.
NOTE F - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following:
August 1, August 2, Estimated 1999 1998 Useful Life ---- ---- ----------- Land $ 1,160,895 $ 880,270 Building and building improvements 11,731,575 5,486,900 10-40 years Machinery and equipment 24,994,829 20,104,794 5- 8 years Furniture and fixtures 788,919 624,576 5-10 years Automobiles 131,000 - 3 years Tools 34,495 34,495 5 years Leasehold improvements 454,706 292,894 5-10 years ---------- ---------- 39,296,419 27,423,929 Less accumulated depreciation 17,407,866 14,874,586 ---------- ---------- $ 21,888,553 $ 12,549,343 ========== ==========
Depreciation charges totaled $2,534,945, $1,940,254, and $1,720,950 in fiscal 1999, 1998, and 1997, respectively.
NOTE G - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office, production and warehouse space as well as computer equipment and automobiles under noncancellable operating leases.
Rent expense for the 52 weeks ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997 was approximately $519,000, $546,000, and $230,000, respectively.
Minimum annual rentals under noncancellable operating leases are as follows:
Amount ------ Year ending fiscal 2000 $ 760,000 2001 638,000 2002 612,000 2003 567,000 2004 429,000 Future 2,356,000
Employment Agreements
The Company has employment agreements with various executives and employees of the Company, which, as amended, expire at various dates through December 31, 2002, subject to extension each January 1 for three years, commencing January 1, 2000. These agreements provide for aggregate annual salaries for fiscal 2000 of $1,022,000. Certain agreements provide for an annual cost of living adjustment based on the consumer price index, and also provide for incentive compensation based on pretax income of the Company in excess of $2,000,000. Incentive compensation in the amount of $968,627, $727,659, and $665,352 was expensed in fiscal years 1999, 1998, and 1997, respectively.
Certain agreements also provide that, in the event there is a change in control of the Company, as defined, the executives have the option to terminate the agreements and receive a lump-sum payment of approximately three times their annual salary. As of August 1, 1999, the amount payable in the event of such termination would be approximately $3,066,000.
One of the employment contracts provides for a consulting agreement commencing at the end of the employment period which became effective October 1, 1998, and terminating December 31, 2010 at the annual rate of $100,000. Another one of the employment contracts, as amended October 1, 1998, provides for a consulting period commencing at the end of the period of active employment and continuing for a period of five years at the annual rate of $100,000. Two officers of the Company have severance agreements providing for a lump-sum payment of $345,000 through fiscal 2000, adjusted to $240,000 through fiscal 2002, and $105,000 in fiscal 2003.
Litigation
The Company is involved in various legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations.
Stand-by Letters of Credit
The Company maintains a letter of credit facility with a bank that provides for the issuance of stand-by letters of credit and requires the payment of a fee of 1.0% per annum of the amounts outstanding under the facility. The facility expires January 31, 2001. At August 1, 1999 stand-by letters of credit aggregating $996,965 were outstanding under this facility.
NOTE H - INCOME TAXES
Income tax provision consisted of the following:
52 Weeks ended -------------- 53 Weeks ended August 1, August 2, August 3, 1999 1998 1997 ---- ---- ---- Current Federal $ 3,328,378(1) $ 1,468,665 $ (52,000) State 399,070 85,000 89,000 Foreign 28,517 - - --------- --------- ------- 3,755,965 1,553,665 37,000 --------- --------- ------- Deferred Federal 540,288 1,307,970 (142,000) State (198,253) 72,365 585,000 --------- --------- ------- 342,035 1,380,335 443,000 --------- --------- -------
$ 4,098,000 $ 2,934,000 $ 480,000 ========= ========= =======
(1) Excludes benefit of $68,000 from extraordinary loss incurred as a result of early extinguishment of long term debt (See Note I).
The Company paid income taxes of approximately $1,324,000, $1,486,000, and $178,000 in fiscal 1999, 1998, and 1997, respectively. The following is a reconciliation of the U. S. statutory income tax rate and the effective tax rate on pretax income:
52 Weeks ended -------------- 53 Weeks ended August 1, August 2, August 3, 1999 1998 1997 ---- ---- ---- U.S. Federal statutory rate 34.0 % 34.0 % 34.0 % State taxes, net of federal tax benefit 1.4 1.5 12.2 Benefit of foreign sales corporation (3.2) (1.8) - Benefit of net operating loss carryforward - - (30.8) Non-deductible expenses 1.4 .8 .3 Decrease in valuation allowance - - (9.4) Benefit of foreign and foreign-source income (1.2) - - Other, net 1.9 .3 2.8 ---- ---- ---- Effective tax rate 34.3 % 34.8 % 9.1 % ==== ==== ====
The 1997 tax provision reflects 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.
Income taxes have not been provided on undistributed earnings of foreign subsidiaries. If remitted as dividends, these earnings could become subject to additional tax. The Company's intention is to reinvest unremitted earnings of subsidiaries outside the United States permanently.
Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes.
Components of deferred tax assets and liabilities are as follows:
As of August 1, 1999 the Company has available a $642,485 alternative minimum tax credit to carry forward for an indefinite period of time, and net operating loss carryforwards for state income tax purposes of approximately $219,392 which expire from fiscal 2000 through 2009.
NOTE I- LONG-TERM DEBT
Long-term debt is summarized as follows:
The Company paid interest of approximately $730,000 in 1999, $441,000 in 1998, and $567,000 in 1997.
Future payments required on long-term debt are as follows:
Fiscal year ending during: Amount ------ 2000 $ 258,383 2001 12,650,867 2002 102,523 2003 84,396 2004 90,885 Future 2,508,719 ---------- $ 15,695,773
NOTE J - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following:
August 1, August 2, 1999 1998 ---- ---- Accounts payable $ 2,668,285 $ 3,064,596 Accrued payroll and bonuses 2,635,816 1,865,426 Accrued commissions 488,249 615,022 Accrued interest 83,939 56,491 Accrued legal expenses 122,873 37,487 Accrued warranty costs 284,573 200,000 Accrued pension cost 498,775 - Accrued severance 537,845 - Lease termination cost 180,000 - Accrued expenses 534,856 629,161 --------- --------- $ 8,035,211 $ 6,468,183 ========= =========
NOTE K - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan which qualified as a thrift plan under Section 401(k) of the Internal Revenue Code. This Plan, as amended and restated, allows employees to contribute between 2% and 15% of their salaries to the Plan. The Company, at its discretion can contribute 100% of the first 2% of the employees' contribution and 25% of the next 4%. Additional Company contributions can be made depending on profits. The aggregate benefit payable to an employee is dependent upon his rate of contribution, the earnings of the fund, and the length of time such employee continues as a participant.
Employees of GMC became eligible to participate in the Plan as of May 1, 1999. The existing savings and investing plan of GMC did not provide for company matching contributions and has been frozen.
The Company has recognized expenses of approximately $266,000 for the 52 weeks ended August 1, 1999, and $197,000, and $181,000 for the 52 weeks ended August 2, 1998 and the 53 weeks ended August 3, 1997, respectively.
At the time of the acquisition, GMC also had a noncontributory defined benefit pension plan covering all eligible employees of the company. As part of the acquisition plan, the Company froze all benefits under the plan effective April 30, 1999 and elected to terminate the plan. As part of the allocation of the purchase price, the Company recorded a liability at the date of acquisition of $463,834.
Net pension expense from the date of acquisition to April 30, 1999, the date benefits were frozen, includes the following components:
Service cost - benefits earned during the period $ 21,550 Interest cost 136,651 Actual return on assets (123,260) ------- Net pension expense $ 34,941 =======
The following table sets forth the plan's funded status and amount recognized in the consolidated balance sheet at August 1, 1999:
Projected benefit obligation at date of acquisition $ 4,793,104 Service costs 21,550 Interest cost 136,651 Benefit payments (110,376) --------- Projected benefit obligation, end of year $ 4,840,929 ---------
Change in fair value of plan assets: Fair value at date of acquisition $ 4,329,270 Return on assets 123,260 Benefit payments (110,376) --------- Fair value at end of year 4,342,154 ---------
Funded status and accrued pension cost $ 498,775 =========
Assumptions used were: Discount rate 5.00% Expected return on plan assets 5.00%
Assets held by the trust are comprised primarily of marketable equity securities.
NOTE L - RELATED PARTY TRANSACTIONS
In connection with the move of the Amityville facilities of GMC, (See Note Q - Subsequent Events), the Company entered into a 10 year lease agreement with a partnership owned by the children of certain officers of the Company. The lease provides for initial minimum annual rent of $312,390, subject to escalation of approximately 4% annually throughout the 10 year term.
NOTE M - COMPUTATION OF PER SHARE EARNINGS
The following table shows the calculation of basic earnings per share and earnings per share assuming dilution:
Options and warrants to purchase 3,047,133 shares of common stock, with exercise prices ranging from $12.00 to $16.46 were outstanding during fiscal year 1999 but were not included in the computation of diluted EPS because the exercise prices are greater than the average market price of the common shares during the period. The options and warrants, which expire at various dates through June 17, 2009, were still outstanding as of August 1, 1999. Options and warrants to purchase 1,423,958 shares of common stock, with exercise prices ranging from $13.69 to $14.40 were outstanding during fiscal year 1998 but were not included in the computation of diluted EPS because the exercise prices are greater than the average market price of the common shares during the period.
NOTE N - SHAREHOLDERS' EQUITY
At the annual meeting of stockholders held on February 18, 1998, the stockholders of the Company approved a proposal to amend the Certificate of Incorporation to increase the authorized shares of Common Stock from 10,000,000 to 20,000,000 shares.
In December 1997, the Company completed the sale of 1,100,000 shares of common stock to the public, of which 700,000 shares were sold by the Company and 400,000 shares were sold by certain selling stockholders. In addition , the Company also sold 1,265,000 Common Stock Purchase Warrants ("Warrant(s)"). The Company received net proceeds of $7,451,579 after underwriting discounts and commissions and other expenses of the offering. Each Warrant entitles the holder to purchase one share of common stock at $15.60 per share (subject to adjustment under certain conditions) until they expire in January 2000. The Company has also issued to the underwriters, for their own accounts, Managing Underwriters' Warrants which entitle the holder to purchase 110,000 shares of common stock of the Company (subject to adjustment under certain circumstances), at a price of $14.40 per share through December 2002, and the right to purchase 110,000 Warrants (as described above) at a price of $.12 per Warrant through January 2000.
On September 4, 1997 the Board of Directors declared a 4-for-3 stock split effected as a stock dividend payable September 30, 1997 to holders of record on September 15, 1997. The amount of $105,234 was transferred from additional paid-in capital to the common stock account to record this distribution. All share and per share data, including stock options and warrants, included in the financial statements have been restated to reflect the stock split.
The Company has various fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company applies APB Opinion No. 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock option plans. Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for 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 5.1%; volatility factor of the expected market price of the Company's common stock of .58; and a weighted-average expected life of the option, after the vesting period, of .65 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 years 1999, 1998 and 1997 been determined based on the fair value at the grant date consistent with the provisions of SFAS 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below using the statutory income tax rate of 34%:
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 April 1998, the Board of Directors approved the 1998 Stock Option Plan which covers 1,500,000 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. The options expire ten years from the date of grant, subject to certain restrictions. Options for 375,000 shares were granted during the fiscal year ended August 1, 1999.
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 875,500, 88,333 and 801,660 shares were granted during the fiscal years ended August 1, 1999, August 2, 1998, and August 3, 1997, respectively.
In October 1995, the Board of Directors approved the 1996 Stock Option Plan which covers 666,666 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. If not specified, 100% of the shares can be exercised one year after the date of grant. The options expire ten years from the date of grant. Options for 663,989 shares were granted during the fiscal year ended August 3, 1997.
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 52 weeks ended August 1, 1999 and August 2, 1998, and the 53 weeks ended August 3, 1997 follows:
Options to purchase 783,889 shares of common stock were exercisable under all plans at August 1, 1999 at a weighted average exercise price of $11.15 with a weighted average remaining contractual life of 8.8 years as follows:
Options Outstanding and Exercisable by Price Range as of August 1, 1999
In April 1993, common stock warrants were issued to certain officers and directors for the right to acquire 573,333 shares of common stock of the Company at the fair market value of $5.35 per share at
date of issue. In December 1995 warrants for 533,333 shares were canceled, and the remaining 40,000 warrants were exercised in fiscal 1998. In December 1995, common stock warrants were issued to certain officers for the right to acquire 293,333 shares of common stock of the Company at the fair market value of $4.64 per share at date of issue. The warrants vest immediately and expire December 13, 2005. Warrants for 66,667 and 13,333 shares were exercised in fiscal 1999 and 1997, respectively.
NOTE O - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, AND EXPORT SALES
The Company's chief operating decision maker is considered to be the Chairman and Chief Executive Officer (CEO). The Company's CEO evaluates both consolidated and disaggregated financial information consisting of revenue information in deciding how to allocate resources and assess performance. The CEO uses certain disaggregated financial information for the Company's two product groups: Space and Communications and Microwave Components. The Company does not determine a measure of operating income or loss by product group. The Company's two product groups have similar long-term economic characteristics, such as application, and are similar in regards to (a) nature of products and production processes, (b) type of customers, and (c) method used to distribute products. Accordingly, the Company is in a single reportable segment as a provider of flight instrumentation components and systems and microwave products for the U.S. government, foreign governments, and aerospace companies. All of the Company's revenues result from sales of its products. Revenues by product group (as defined by the Company) for fiscal years 1999, 1998 and 1997 were as follows: Space and Communications, $33,846,000, $30,338,000 and $22,781,000, respectively; Microwave Components, $27,190,000,$10,460,000 and $9,414,000, respectively.
Net sales to the U.S. Government in 1999, 1998, and 1997 accounted for approximately 17%, 26%, and 34% of net sales, respectively. One other customer accounted for 12% of net sales in 1999. Foreign sales amounted to approximately $17,680,000, $11,943,000, and $9,398000 in fiscal 1999, 1998, and 1997, respectively.
Included in accounts receivable as of August 1, 1999 and August 2, 1998 are amounts due from the U.S. Government of approximately $2,470,000 and $933,000, respectively.
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximated its fair value.
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 1, 1999 -------------- Carrying Amount Fair Value --------------- ---------- Cash and cash equivalents $ 2,741,163 $ 2,741,163 Long-term debt 15,437,390 15,437,390 Stand-by letters of credit - 996,965
NOTE Q - SUBSEQUENT EVENTS
On September 23, 1999, the Company closed on the sale of GMC's property in Amityville, New York and relocated the plant to a leased facility in Farmingdale, New York. The Company used the net proceeds from the sale of approximately $4,159,000, which approximates the net carrying value of the property, to partially fund the buy back of its common stock through open market purchases in September 1999.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Certificate of Incorporation, as amended (Exhibit 3(a) of Form S-1 Registration Statement No. 2- 87160).
3.2 By-Laws, as amended (Exhibit 3(b) of Form S-1 Registration Statement No. 2-87160).
10.1 1996 Stock Option Plan (Exhibit 10.1 of Annual Report on Form 10-K for the fiscal year ended July 28, 1996).
10.2 1997 Stock Option Plan (Exhibit 10.1 of Report on Form 10-Q dated June 10, 1997).
10.3 1998 Stock Option Plan.
10.4 Amendments dated January 26, 1999 and July 30, 1999to Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated as of October 1, 1998.
10.5 Amendments dated January 26, 1999 and July 30, 1999 to Employment Agreement between Herley Industries, Inc. and Myron Levy dated as of October 1, 1998.
10.6 Agreement and Plan of Reorganization dated as of July 8, 1997 among the Company, Metraplex Acquisition Corporation and Metraplex Corporation (Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997).
10.7 Agreement and Plan of Merger dated as of August 21, 1998 among General Microwave Corp., Eleven General Microwave Corp., Shareholders, GMC Acquisition Corporation and Registrant (Exhibit 1 of Schedule 13D dated August 28, 1998).
10.8 Lease Agreement dated September 1, 1999 between Registrant and RSK Realty LTD.
10.9 Loan Agreement dated February 16, 1999 between Registrant and The First National Bank of Maryland, a division of FMB Bank.
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Brightman, BarLeva, Friedman & Co.
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 26th day of October, 1999.
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 26, 1999 by the following persons in the capacities indicated:
By: /S/ Lee N. Blatt Chairman of the Board ------------------ (Principal Executive Officer) Lee N. Blatt
By: /S/ Myron Levy President and Director ---------------- Myron Levy
By: /S/ Anello C. Garefino Vice President Finance, CFO, Treasurer ------------------------ (Principal Financial Officer) Anello C. Garefino
By: /S/ David H. Lieberman Secretary and Director ------------------------ David H. Lieberman
By: /S/ Thomas J. Allshouse Director ------------------------- Thomas J. Allshouse
By: /S/ John A. Thonet Director -------------------- John A. Thonet
By: /S/ Alvin M. Silver Director -------------------- Alvin M. Silver
By: /S/ Edward K. Walker, Jr. Director -------------------------- Edward K. Walker, Jr.
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 1, 1999 and August 2, 1998.....
Consolidated Statements of Income for the 52 weeks ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997.............................................
Consolidated Statements of Shareholders' Equity for the 52 weeks ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997.............................................
Consolidated Statements of Cash Flows for the 52 Weeks Ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997.............................................
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 1, 1999 and August 2, 1998, and the related consolidated statements of income, shareholders' equity and cash flows for the 52 weeks ended August 1, 1999 and August 2, 1998, and the 53 weeks ended August 3, 1997. 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 did not audit the financial statements of General Microwave (Israel) Corporation and Subsidiary, which statements represent total assets and total revenues of 7% and 4%, respectively, in 1999 of the related consolidated totals. Those statements were audited by other auditors whose report was furnished to us, and our opinion, insofar as it relates to the amounts included for those entities, is based solely on the report of the other auditors.
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 and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, 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 1, 1999 and August 2, 1998, and the consolidated results of their operations and their cash flows for the 52 weeks ended August 1, 1999 and August 2, 1998, and the 53 weeks ended August 3, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Lancaster, PA September 17, 1999
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
August 1, August 2, 1999 1998 ---------- ---------- ASSETS Current Assets: Cash and cash equivalents $ 2,741,163 $ 10,689,193 Accounts receivable 10,678,638 6,193,947 Costs incurred and income recognized in excess of billings on uncompleted contracts - 1,665,008 Other receivables 212,515 248,298 Prepaid income taxes - 377,448 Inventories 19,880,370 15,068,618 Deferred taxes and other 2,703,179 2,194,004 ---------- ---------- Total Current Assets 36,215,865 36,436,516
Property, Plant and Equipment, net 21,888,553 12,549,343 Intangibles, net of amortization of $2,137,459 in 1999 and $1,524,393 in 1998 13,573,653 6,080,218 Available-for-sale Securities 148,105 143,330 Other Investments 947,983 849,324 Other Assets 1,282,078 1,493,798 ========== ========== $ 74,056,237 $ 57,552,529 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities: Current portion of long-term debt $ 258,383 $ 404,984 Accounts payable and accrued expenses 8,035,211 6,468,183 Income taxes payable 276,160 - Reserve for contract losses 1,505,048 1,145,128 Advance payments on contracts 438,538 1,824,746 ---------- ---------- Total Current Liabilities 10,513,340 9,843,041 Long-term Debt 15,437,390 4,110,885 Deferred Income Taxes 5,143,837 3,158,353 Minority Interest 62,062 - ---------- ---------- 31,156,629 17,112,279 ---------- ---------- Commitments and Contingencies Shareholders' Equity: Common stock, $.10 par value; authorized 20,000,000 shares; issued and outstanding 5,030,283 in 1999 and 5,266,159 in 1998 503,028 526,616 Additional paid-in capital 15,071,964 20,323,895 Retained earnings 27,324,616 19,589,739 ---------- ---------- Total Shareholders' Equity 42,899,608 40,440,250
========== ========== $ 74,056,237 $ 57,552,529 ========== ==========
The accompanying notes are an integral part of these financial statements.
HERLEY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
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, a Delaware corporation, is engaged in the design, development, manufacture and sale of flight instrumentation components and systems, 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 years 1999 and 1998 consisted of 52 weeks, and fiscal year 1997 consisted of 53 weeks.
3. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Herley Industries, Inc. and its subsidiaries, all of which are wholly-owned. All significant inter-company accounts and transactions have been eliminated in consolidation. The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates.
4. Cash and Cash Equivalents
The Company considers all liquid investments with an original maturity of three months or less at the date of acquisition to be cash equivalents. Short-term investments are recorded at the amortized cost plus accrued interest which approximates market value. The Company limits its credit risk to an acceptable level by evaluating the financial strength of institutions at which significant investments are made and based upon credit ratings.
5. Concentration of Credit Risk
Financial instruments which potentially subject the Company to credit risk consist primarily of trade accounts receivable. Accounts receivable are principally from the U.S. Government, major U.S. Government contractors, several foreign governments, and domestic customers in the aerospace and defense industries. Credit is extended based on an evaluation of the customer's financial condition and generally collateral is not required. In many cases irrevocable letters of credit accompanied by advanced payments are received from foreign customers, and progress payments are received from domestic customers. The Company performs periodic credit evaluations of its customers and maintains reserves for potential credit losses.
6. Inventories
Inventories, other than inventory costs relating to long-term contracts and programs, are stated at lower of cost (principally first-in, first-out) or market. Inventory costs relating to long-term contracts and programs are stated at the actual production costs, including factory overhead, reduced by amounts identified with revenue recognized on units delivered or progress completed.
Inventory costs relating to long-term contracts and programs are reduced by any amounts in excess of estimated realizable value. The costs attributed to units delivered under long-term contracts and programs are based on the average costs of all units produced.
7. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets. Gains and losses arising from the sale or disposition of property, plant and equipment are recorded in income.
8. Intangibles
Intangibles are comprised of customer lists, installed products base, drawings, patents, licenses, certain government qualifications and technology and goodwill in connection with the acquisitions of General Microwave Corporation in 1999, Metraplex Corporation in 1997, and Vega Precision Laboratories, Inc. in 1993. Intangibles are being amortized over twenty years. Amortization charges totaled $754,358, ($70,795), and ($182,667) in fiscal 1999, 1998, and 1997, respectively. The negative amortization in 1998 and 1997 is attributable to the negative goodwill in connection with the acquisition of Stewart Warner Electronics in 1995.
The carrying amount of intangibles is evaluated on a recurring basis. Current and future profitability as well as current and future undiscounted cash flows of the acquired businesses are primary indicators of recoverability. For the three fiscal years ended August 1, 1999, there were no adjustments to the carrying amount of the cost in excess of net assets acquired resulting from these evaluations.
9. Marketable Securities
The Company accounts for its investments in marketable securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value. Realized gains and losses and declines in value judged to be other-than-temporary are included in other income , net. The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in other income, net.
10. Other Investments
The Company is a limited partner in a nonmarketable limited partnership in which it owns approximately a 10% interest. This investment is accounted for under the equity method.
11. Revenue and Cost Recognition
Under fixed-price contracts, revenue and related costs are recorded primarily as deliveries are made. Certain costs under long-term, fixed-price contracts (principally either directly or indirectly with the U.S. Government), which include non-recurring billable engineering, are deferred until these costs are
contractually billable. Revenue under certain long-term, fixed price contracts, principally command and control 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 total costs incurred in relation to total estimated cost at completion). Prospective losses on long-term contracts are based upon the anticipated excess of inventoriable manufacturing costs over the selling price of the remaining units to be delivered and are recorded when first reasonably determinable. Actual losses could differ from those estimated due to changes in the ultimate manufacturing costs and contract terms.
Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Selling, general and administrative costs are charged to expense as incurred.
12. Income Taxes
Income taxes are accounted for by the asset/liability approach in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from temporary differences between the financial reporting and tax bases of assets and liabilities and are adjusted for changes in tax laws and tax rates when those changes are enacted. The provision for income taxes represents the total of income taxes paid or payable for the current year, plus the change in deferred taxes during the year.
13. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
14. Earnings Per Common Share
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"), which replaced 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. In accordance with SFAS 128, all earnings per share amounts for all periods presented have been restated (reflective of a 4-for-3 stock split on September 30, 1997).
15. 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 $1,685,000, $1,562,000, and $1,828,000 in fiscal 1999, 1998, and 1997, respectively.
16. New Accounting Standards
In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," ("SFAS 132"), which was effective for fiscal years beginning after December 15, 1997. This statement revises financial statement disclosure requirements for pension and other postretirement benefit plans, but does not change the measurement or recognition of those plans. Adoption of SFAS 132 did not impact the financial results of the Company and the required disclosures have been provided in Note K - Employee Benefit Plans.
The Company has adopted SFAS 131, "Disclosure About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for reporting information about operating segments in annual financial statements and requires that segments be determined based on how management measures performance and makes decisions about allocating resources. The required new disclosures have been provided in Note O to the Consolidated Financial Statements.
NOTE B - ACQUISITIONS
As of January 4, 1999, the Company completed the acquisition of all of the issued and outstanding common stock of General Microwave Corporation ("GMC"), a New York corporation, including outstanding stock options, for $18.00 per share and 966,675 three-year warrants to purchase one share of the Company's common stock, at an aggregate purchase price of approximately $24,556,000. This transaction was accounted for under the purchase method. The purchase price includes shares of common stock of GMC purchased in the open market, acquisition of the remaining shares of common stock outstanding, an estimate of the fair market value of the warrants based on the trading price of similar warrants currently on the market, and transaction expenses. The warrants are exercisable at $15.60 per share of common stock of the Company and expire in January 2002.
The aggregate purchase price is calculated as follows (in thousands, except share and per share data):
365,600 shares previously acquired in the open market $ 6,273 848,675 shares at $18.00 per share 15,276 118,000 stock options at $18.00 per share, net of exercise price 1,279 966,675 warrants at $1.50 1,450 Transaction expenses 278 ------ Purchase price $ 24,556 ======
The cash portions of the acquisition were financed through available cash equivalents and borrowings under the Company's line of credit.
GMC designs, manufactures and markets microwave components and subsystems, and related electronic test and measurement equipment. The company is headquartered in Amityville, New York, and operates two other facilities, one in Billerica, Massachusetts, and one in Israel. The transaction has been accounted for under the purchase method. Accordingly, the consolidated balance sheet includes the assets and liabilities of GMC at August 1, 1999, and the consolidated statements of income include the results of General Microwave operations from January 4, 1999. The acquisition resulted in excess cost over fair value of net assets acquired of $7,538,501 which is being amortized over 20 years.
As part of the Company's GMC acquisition plans, the Company is moving GMC's Billerica, MA operations into the Company's existing Woburn, MA location. The Company had also decided to terminate GMC's defined benefit pension plan. Both of these actions are to be completed in fiscal 2000. In connection with these actions, the Company accrued, as part of purchase accounting, $180,000 of
lease termination costs related to the Billerica facility, $250,000 of severance costs, and $463, 834 related to the termination of the GMC pension plan. Through August 1, 1999, no amounts were paid under the lease termination or pension termination and approximately $150,000 of severance was paid.
On the basis of a pro forma consolidation of the results of operations as if the acquisition had taken place at the beginning of fiscal 1998, unaudited consolidated net sales, net income, basic earnings per share, and diluted earnings per share for the fifty-two weeks ended August 2, 1998 would have been approximately $63,477,000, $6,606,000, $1.33, and $1.22, and for the fifty-two weeks ended August 1, 1999 would have been approximately $70,349,000, $7,481,000, $1.43, and $1.32, respectively. The pro forma information includes adjustments for additional depreciation based on the estimated fair market value of the property, plant, and equipment acquired, and the amortization of intangibles arising from the transaction. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been effected at the beginning of fiscal 1998.
On August 4, 1997, the Company completed the acquisition of Metraplex Corporation, a Delaware corporation, for 313,139 (as adjusted) shares of common stock of the Company, with a fair market value of $3,170,471, in exchange for all of the issued and outstanding common stock of Metraplex. Metraplex is a leading manufacturer of pulse code modulation and frequency modulation, telemetry and data acquisition systems for severe environment applications. The transaction has been accounted for by the purchase method. Accordingly, the consolidated balance sheet includes the assets and liabilities of Metraplex at August 2, 1998, and the consolidated statements of income include the results of Metraplex operations from August 4, 1997. The acquisition resulted in excess of cost over fair value of net assets acquired of $2,162,725 which is being amortized over twenty years.
On the basis of a pro forma consolidation of the results of operations as if the Metraplex acquisition had taken place at the beginning of fiscal 1997, unaudited consolidated net sales, net income, basic earnings per share, and diluted earnings per share for the year ended August 3, 1997 would have been approximately $36,589,333, $4,686,236, $1.07, and $.93, respectively. The pro forma information includes adjustments for additional depreciation based on the fair market value of the property and equipment acquired, and the amortization of intangibles arising from the transaction. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been effected at the beginning of fiscal 1997.
NOTE C - NOTES RECEIVABLE-OFFICERS
In fiscal 1996 the Company loaned an aggregate of $2,000,000 to certain officers, as authorized by the Board of Directors, pursuant to the terms of nonnegotiable promissory notes. The loans were paid in full with accrued interest as of December 19, 1997.
NOTE D - INVENTORIES
The major components of inventories are as follows:
August 1 August 2, 1999 1998 ---- ---- Purchased parts and raw materials $ 9,862,727 $ 7,377,882 Work in process 8,780,767 7,303,533 Finished products 1,236,876 387,203 ---------- ---------- $19,880,370 $15,068,618 ========== ==========
NOTE E - 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 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 1, 1999 and August 2, 1998 the percentage of ownership was approximately 10%. The Company's interest in the partnership may be transferred to a substitute limited partner, upon written notice to the managing general partners, only with the unanimous consent of both general partners at their sole discretion. In July 1998, the Company received a partial distribution of $592,824 from the Partnership. As of August 1, 1999 the Company's limited partnership interest had an estimated fair value of $947,983.
NOTE F - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following:
August 1, August 2, Estimated 1999 1998 Useful Life ---- ---- ----------- Land $ 1,160,895 $ 880,270 Building and building improvements 11,731,575 5,486,900 10-40 years Machinery and equipment 24,994,829 20,104,794 5- 8 years Furniture and fixtures 788,919 624,576 5-10 years Automobiles 131,000 - 3 years Tools 34,495 34,495 5 years Leasehold improvements 454,706 292,894 5-10 years ---------- ---------- 39,296,419 27,423,929 Less accumulated depreciation 17,407,866 14,874,586 ---------- ---------- $ 21,888,553 $ 12,549,343 ========== ==========
Depreciation charges totaled $2,534,945, $1,940,254, and $1,720,950 in fiscal 1999, 1998, and 1997, respectively.
NOTE G - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office, production and warehouse space as well as computer equipment and automobiles under noncancellable operating leases.
Rent expense for the 52 weeks ended August 1, 1999, and August 2, 1998, and the 53 weeks ended August 3, 1997 was approximately $519,000, $546,000, and $230,000, respectively.
Minimum annual rentals under noncancellable operating leases are as follows:
Amount ------ Year ending fiscal 2000 $ 760,000 2001 638,000 2002 612,000 2003 567,000 2004 429,000 Future 2,356,000
Employment Agreements
The Company has employment agreements with various executives and employees of the Company, which, as amended, expire at various dates through December 31, 2002, subject to extension each January 1 for three years, commencing January 1, 2000. These agreements provide for aggregate annual salaries for fiscal 2000 of $1,022,000. Certain agreements provide for an annual cost of living adjustment based on the consumer price index, and also provide for incentive compensation based on pretax income of the Company in excess of $2,000,000. Incentive compensation in the amount of $968,627, $727,659, and $665,352 was expensed in fiscal years 1999, 1998, and 1997, respectively.
Certain agreements also provide that, in the event there is a change in control of the Company, as defined, the executives have the option to terminate the agreements and receive a lump-sum payment of approximately three times their annual salary. As of August 1, 1999, the amount payable in the event of such termination would be approximately $3,066,000.
One of the employment contracts provides for a consulting agreement commencing at the end of the employment period which became effective October 1, 1998, and terminating December 31, 2010 at the annual rate of $100,000. Another one of the employment contracts, as amended October 1, 1998, provides for a consulting period commencing at the end of the period of active employment and continuing for a period of five years at the annual rate of $100,000. Two officers of the Company have severance agreements providing for a lump-sum payment of $345,000 through fiscal 2000, adjusted to $240,000 through fiscal 2002, and $105,000 in fiscal 2003.
Litigation
The Company is involved in various legal proceedings and claims which arise in the ordinary course of its business. While any litigation contains an element of uncertainty, management believes that the outcome of such litigation will not have a material adverse effect on the Company's financial position or results of operations.
Stand-by Letters of Credit
The Company maintains a letter of credit facility with a bank that provides for the issuance of stand-by letters of credit and requires the payment of a fee of 1.0% per annum of the amounts outstanding under the facility. The facility expires January 31, 2001. At August 1, 1999 stand-by letters of credit aggregating $996,965 were outstanding under this facility.
NOTE H - INCOME TAXES
Income tax provision consisted of the following:
52 Weeks ended -------------- 53 Weeks ended August 1, August 2, August 3, 1999 1998 1997 ---- ---- ---- Current Federal $ 3,328,378(1) $ 1,468,665 $ (52,000) State 399,070 85,000 89,000 Foreign 28,517 - - --------- --------- ------- 3,755,965 1,553,665 37,000 --------- --------- ------- Deferred Federal 540,288 1,307,970 (142,000) State (198,253) 72,365 585,000 --------- --------- ------- 342,035 1,380,335 443,000 --------- --------- -------
$ 4,098,000 $ 2,934,000 $ 480,000 ========= ========= =======
(1) Excludes benefit of $68,000 from extraordinary loss incurred as a result of early extinguishment of long term debt (See Note I).
The Company paid income taxes of approximately $1,324,000, $1,486,000, and $178,000 in fiscal 1999, 1998, and 1997, respectively. The following is a reconciliation of the U. S. statutory income tax rate and the effective tax rate on pretax income:
52 Weeks ended -------------- 53 Weeks ended August 1, August 2, August 3, 1999 1998 1997 ---- ---- ---- U.S. Federal statutory rate 34.0 % 34.0 % 34.0 % State taxes, net of federal tax benefit 1.4 1.5 12.2 Benefit of foreign sales corporation (3.2) (1.8) - Benefit of net operating loss carryforward - - (30.8) Non-deductible expenses 1.4 .8 .3 Decrease in valuation allowance - - (9.4) Benefit of foreign and foreign-source income (1.2) - - Other, net 1.9 .3 2.8 ---- ---- ---- Effective tax rate 34.3 % 34.8 % 9.1 % ==== ==== ====
The 1997 tax provision reflects 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.
Income taxes have not been provided on undistributed earnings of foreign subsidiaries. If remitted as dividends, these earnings could become subject to additional tax. The Company's intention is to reinvest unremitted earnings of subsidiaries outside the United States permanently.
Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes.
Components of deferred tax assets and liabilities are as follows:
As of August 1, 1999 the Company has available a $642,485 alternative minimum tax credit to carry forward for an indefinite period of time, and net operating loss carryforwards for state income tax purposes of approximately $219,392 which expire from fiscal 2000 through 2009.
NOTE I- LONG-TERM DEBT
Long-term debt is summarized as follows:
The Company paid interest of approximately $730,000 in 1999, $441,000 in 1998, and $567,000 in 1997.
Future payments required on long-term debt are as follows:
Fiscal year ending during: Amount ------ 2000 $ 258,383 2001 12,650,867 2002 102,523 2003 84,396 2004 90,885 Future 2,508,719 ---------- $ 15,695,773
NOTE J - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following:
August 1, August 2, 1999 1998 ---- ---- Accounts payable $ 2,668,285 $ 3,064,596 Accrued payroll and bonuses 2,635,816 1,865,426 Accrued commissions 488,249 615,022 Accrued interest 83,939 56,491 Accrued legal expenses 122,873 37,487 Accrued warranty costs 284,573 200,000 Accrued pension cost 498,775 - Accrued severance 537,845 - Lease termination cost 180,000 - Accrued expenses 534,856 629,161 --------- --------- $ 8,035,211 $ 6,468,183 ========= =========
NOTE K - EMPLOYEE BENEFIT PLANS
In August 1985, the Board of Directors approved an Employee Savings Plan which qualified as a thrift plan under Section 401(k) of the Internal Revenue Code. This Plan, as amended and restated, allows employees to contribute between 2% and 15% of their salaries to the Plan. The Company, at its discretion can contribute 100% of the first 2% of the employees' contribution and 25% of the next 4%. Additional Company contributions can be made depending on profits. The aggregate benefit payable to an employee is dependent upon his rate of contribution, the earnings of the fund, and the length of time such employee continues as a participant.
Employees of GMC became eligible to participate in the Plan as of May 1, 1999. The existing savings and investing plan of GMC did not provide for company matching contributions and has been frozen.
The Company has recognized expenses of approximately $266,000 for the 52 weeks ended August 1, 1999, and $197,000, and $181,000 for the 52 weeks ended August 2, 1998 and the 53 weeks ended August 3, 1997, respectively.
At the time of the acquisition, GMC also had a noncontributory defined benefit pension plan covering all eligible employees of the company. As part of the acquisition plan, the Company froze all benefits under the plan effective April 30, 1999 and elected to terminate the plan. As part of the allocation of the purchase price, the Company recorded a liability at the date of acquisition of $463,834.
Net pension expense from the date of acquisition to April 30, 1999, the date benefits were frozen, includes the following components:
Service cost - benefits earned during the period $ 21,550 Interest cost 136,651 Actual return on assets (123,260) ------- Net pension expense $ 34,941 =======
The following table sets forth the plan's funded status and amount recognized in the consolidated balance sheet at August 1, 1999:
Projected benefit obligation at date of acquisition $ 4,793,104 Service costs 21,550 Interest cost 136,651 Benefit payments (110,376) --------- Projected benefit obligation, end of year $ 4,840,929 ---------
Change in fair value of plan assets: Fair value at date of acquisition $ 4,329,270 Return on assets 123,260 Benefit payments (110,376) --------- Fair value at end of year 4,342,154 ---------
Funded status and accrued pension cost $ 498,775 =========
Assumptions used were: Discount rate 5.00% Expected return on plan assets 5.00%
Assets held by the trust are comprised primarily of marketable equity securities.
NOTE L - RELATED PARTY TRANSACTIONS
In connection with the move of the Amityville facilities of GMC, (See Note Q - Subsequent Events), the Company entered into a 10 year lease agreement with a partnership owned by the children of certain officers of the Company. The lease provides for initial minimum annual rent of $312,390, subject to escalation of approximately 4% annually throughout the 10 year term.
NOTE M - COMPUTATION OF PER SHARE EARNINGS
The following table shows the calculation of basic earnings per share and earnings per share assuming dilution:
Options and warrants to purchase 3,047,133 shares of common stock, with exercise prices ranging from $12.00 to $16.46 were outstanding during fiscal year 1999 but were not included in the computation of diluted EPS because the exercise prices are greater than the average market price of the common shares during the period. The options and warrants, which expire at various dates through June 17, 2009, were still outstanding as of August 1, 1999. Options and warrants to purchase 1,423,958 shares of common stock, with exercise prices ranging from $13.69 to $14.40 were outstanding during fiscal year 1998 but were not included in the computation of diluted EPS because the exercise prices are greater than the average market price of the common shares during the period.
NOTE N - SHAREHOLDERS' EQUITY
At the annual meeting of stockholders held on February 18, 1998, the stockholders of the Company approved a proposal to amend the Certificate of Incorporation to increase the authorized shares of Common Stock from 10,000,000 to 20,000,000 shares.
In December 1997, the Company completed the sale of 1,100,000 shares of common stock to the public, of which 700,000 shares were sold by the Company and 400,000 shares were sold by certain selling stockholders. In addition , the Company also sold 1,265,000 Common Stock Purchase Warrants ("Warrant(s)"). The Company received net proceeds of $7,451,579 after underwriting discounts and commissions and other expenses of the offering. Each Warrant entitles the holder to purchase one share of common stock at $15.60 per share (subject to adjustment under certain conditions) until they expire in January 2000. The Company has also issued to the underwriters, for their own accounts, Managing Underwriters' Warrants which entitle the holder to purchase 110,000 shares of common stock of the Company (subject to adjustment under certain circumstances), at a price of $14.40 per share through December 2002, and the right to purchase 110,000 Warrants (as described above) at a price of $.12 per Warrant through January 2000.
On September 4, 1997 the Board of Directors declared a 4-for-3 stock split effected as a stock dividend payable September 30, 1997 to holders of record on September 15, 1997. The amount of $105,234 was transferred from additional paid-in capital to the common stock account to record this distribution. All share and per share data, including stock options and warrants, included in the financial statements have been restated to reflect the stock split.
The Company has various fixed option plans which reserve shares of common stock for issuance to executives, key employees and directors. The Company applies APB Opinion No. 25 and related Interpretations in accounting for these plans. Statement of Financial Accounting Standards No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and , if fully adopted, changes the methods for recognition of cost on plans similar to those of the Company. The Company has adopted the disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock option plans. Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for 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 5.1%; volatility factor of the expected market price of the Company's common stock of .58; and a weighted-average expected life of the option, after the vesting period, of .65 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 years 1999, 1998 and 1997 been determined based on the fair value at the grant date consistent with the provisions of SFAS 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below using the statutory income tax rate of 34%:
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 April 1998, the Board of Directors approved the 1998 Stock Option Plan which covers 1,500,000 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. The options expire ten years from the date of grant, subject to certain restrictions. Options for 375,000 shares were granted during the fiscal year ended August 1, 1999.
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 875,500, 88,333 and 801,660 shares were granted during the fiscal years ended August 1, 1999, August 2, 1998, and August 3, 1997, respectively.
In October 1995, the Board of Directors approved the 1996 Stock Option Plan which covers 666,666 shares of the Company's common stock. Options granted under the plan may be incentive stock options qualified under Section 422 of the Internal Revenue Code of 1986 or non-qualified stock options. Under the terms of the Plan, the exercise price for options granted under the plan will be the fair market value at the date of grant. Prices for incentive stock options granted to employees who own 10% or more of the Company's stock are at least 110% of market value at date of grant. The nature and terms of the options to be granted is determined at the time of grant by the Board of Directors. If not specified, 100% of the shares can be exercised one year after the date of grant. The options expire ten years from the date of grant. Options for 663,989 shares were granted during the fiscal year ended August 3, 1997.
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 52 weeks ended August 1, 1999 and August 2, 1998, and the 53 weeks ended August 3, 1997 follows:
Options to purchase 783,889 shares of common stock were exercisable under all plans at August 1, 1999 at a weighted average exercise price of $11.15 with a weighted average remaining contractual life of 8.8 years as follows:
Options Outstanding and Exercisable by Price Range as of August 1, 1999
In April 1993, common stock warrants were issued to certain officers and directors for the right to acquire 573,333 shares of common stock of the Company at the fair market value of $5.35 per share at
date of issue. In December 1995 warrants for 533,333 shares were canceled, and the remaining 40,000 warrants were exercised in fiscal 1998. In December 1995, common stock warrants were issued to certain officers for the right to acquire 293,333 shares of common stock of the Company at the fair market value of $4.64 per share at date of issue. The warrants vest immediately and expire December 13, 2005. Warrants for 66,667 and 13,333 shares were exercised in fiscal 1999 and 1997, respectively.
NOTE O - SIGNIFICANT SEGMENTS, MAJOR CUSTOMERS, AND EXPORT SALES
The Company's chief operating decision maker is considered to be the Chairman and Chief Executive Officer (CEO). The Company's CEO evaluates both consolidated and disaggregated financial information consisting of revenue information in deciding how to allocate resources and assess performance. The CEO uses certain disaggregated financial information for the Company's two product groups: Space and Communications and Microwave Components. The Company does not determine a measure of operating income or loss by product group. The Company's two product groups have similar long-term economic characteristics, such as application, and are similar in regards to (a) nature of products and production processes, (b) type of customers, and (c) method used to distribute products. Accordingly, the Company is in a single reportable segment as a provider of flight instrumentation components and systems and microwave products for the U.S. government, foreign governments, and aerospace companies. All of the Company's revenues result from sales of its products. Revenues by product group (as defined by the Company) for fiscal years 1999, 1998 and 1997 were as follows: Space and Communications, $33,846,000, $30,338,000 and $22,781,000, respectively; Microwave Components, $27,190,000,$10,460,000 and $9,414,000, respectively.
Net sales to the U.S. Government in 1999, 1998, and 1997 accounted for approximately 17%, 26%, and 34% of net sales, respectively. One other customer accounted for 12% of net sales in 1999. Foreign sales amounted to approximately $17,680,000, $11,943,000, and $9,398000 in fiscal 1999, 1998, and 1997, respectively.
Included in accounts receivable as of August 1, 1999 and August 2, 1998 are amounts due from the U.S. Government of approximately $2,470,000 and $933,000, respectively.
NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximated its fair value.
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 1, 1999 -------------- Carrying Amount Fair Value --------------- ---------- Cash and cash equivalents $ 2,741,163 $ 2,741,163 Long-term debt 15,437,390 15,437,390 Stand-by letters of credit - 996,965
NOTE Q - SUBSEQUENT EVENTS
On September 23, 1999, the Company closed on the sale of GMC's property in Amityville, New York and relocated the plant to a leased facility in Farmingdale, New York. The Company used the net proceeds from the sale of approximately $4,159,000, which approximates the net carrying value of the property, to partially fund the buy back of its common stock through open market purchases in September 1999.