| HERLEY INDUSTRIES INC /NEW Item 1A Risk Factors |
| 11 Item 1A Risk Factors You should carefully consider the factors described below and other information contained in this report |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also impair our business operations |
| If any of the following risks actually occurs, our business, financial condition or results of operations could be materially and adversely affected |
| In such case, the trading price of our common stock could decline, and you may lose all or part of your investment |
| This report also contains forward-looking statements that involve risks and uncertainties |
| Please refer to "e Forward-Looking Statements "e included elsewhere in this report |
| Risks Related to Recent Legal Proceedings A finding of criminal liability against us in connection with the recent indictment by the US Attorneyapstas office could have a material adverse effect on our business and operating results |
| On June 6, 2006 an indictment was returned against Herley Industries, Inc |
| and Lee Blatt, our former Chairman by the US Attorneyapstas Office for the Eastern District of Pennsylvania in connection with three government contracts completed in October 2002 aggregating revenue of approximately dlra3dtta9 million |
| No other officer, director or employee of ours was named in the indictment |
| The indictment is on multiple charges in connection with purported activities resulting in alleged excessive profits by us on three contracts with the US Government |
| Blatt could be fined up to approximately dlra13 million each and we could be required to forfeit monies paid under the contracts |
| Under the terms of an indemnification agreement with Mr |
| Blatt, the Company has agreed to provide indemnification with regard to certain legal proceedings so long as he has acted in good faith and in a manner believed to be in, or not opposed to, the Companyapstas best interest with respect to any criminal proceeding and had no reasonable cause to believe his conduct was unlawful |
| We believe we have substantial defenses to the charges alleged in the indictment and intend to vigorously defend against these allegations; however, there can be no assurance that we will be successful |
| A further suspension of certain of our facilities from receiving new contract awards could have a material adverse effect on our business |
| On June 13, 2006, we were notified that as a consequence of the indictment, certain of our operations had been suspended from receiving new contract awards from the U S Government |
| The affected operations include facilities in Lancaster, Pennsylvania, Woburn, Massachusetts, Chicago, Illinois and our subsidiary in Farmingdale, New York |
| The result of this suspension was that these facilities could not be solicited for or awarded new contracts or contract extensions without special exceptions, pending the outcome of the criminal proceeding |
| The suspended facilities could receive contract awards or subcontracts from the Federal Government if the head of the agency states in writing the compelling reason to do so |
| 11 Effective October 12, 2006, we entered into an Administrative Agreement with the Department of the Navy, on behalf of the Department of the Defense that required us, among other things, to implement a comprehensive program of compliance reviews, audits and reports for a period of three years or until settlement or adjudication of the legal matter referenced above, whichever is later, unless shortened or extended by written agreement of the parties |
| In addition, we were required to sever our relationship with Mr |
| Lee N Blatt, former Chairman of the Board of Directors, as our employee or consultant |
| In return, the Navy, on behalf of the Department of Defense has terminated the suspension and debarment of our operations from receiving new contract awards from the US Government |
| Our failure to comply with this Administrative Order or an unfavorable outcome of the recent indictment could lead to a further suspension |
| The recent class-action complaints against us could result in costly litigation and payment of damages |
| Since June 6, 2006, we have been served with several class-action complaints against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania |
| The claims arise out of the criminal indictment and are made under Section 10(b) and 20(a) of the Securities Exchange act of 1934 and Rule 10b-5 thereunder |
| While we intend to vigorously defend against these actions, their ultimate outcome is presently not determinable as they are in the preliminary phase |
| Thus, we cannot at this time determine the likelihood of an adverse judgment or a likely range of damages in the event of an adverse judgment |
| If a class were ultimately certified, any settlement of or judgment arising from such lawsuit could be material, and we cannot give any assurance that we would have resources available to pay such settlement or judgment |
| Additionally, any litigation to which we are subject may be costly and could require significant involvement of our senior management and may divert managementapstas attention from our business and operations |
| Risks Related to Our Business A significant percentage of our sales are under government contracts which are only partially funded initially and may lose funding or be terminated in future years |
| Approximately 67prca of our net sales for fiscal 2006 and 65prca of our net sales for fiscal 2005 were made to United States government agencies and their contractors and subcontractors for defense programs |
| Over its lifetime, a government program may be implemented by the award of many different individual contracts and subcontracts |
| The funding of government programs is subject to congressional appropriations |
| Although multi-year contracts may be authorized in connection with major procurements, Congress generally appropriates funds on a fiscal year basis even though a program may continue for several years |
| Consequently, programs are often only partially funded initially and additional funds are committed only as Congress makes further appropriations |
| The termination of funding for a government program would result in a loss of anticipated future revenues attributable to that program which could have a negative impact on our operations |
| Generally, government contracts contain provisions permitting the government agency to terminate the contract at its convenience, in whole or in part, without prior notice, and to provide for payment of compensation only for work done and commitments made at the time of termination |
| We cannot guarantee that one or more of our government contracts will not be terminated under these circumstances |
| Also, we cannot guarantee that we would be able to procure new government contracts to offset the revenues lost as a result of termination of any contracts |
| Because a substantial part of our revenues are dependent on our procurement, performance and payment under our contracts, our failure to replace sales attributable to a significant defense program or contract at its termination, whether due to cancellation, spending cuts, budgetary constraints or otherwise, could have a material adverse effect upon our business, financial condition and results of operations |
| Fixed-price contracts are common in all of our markets and may increase risks of cost overruns and product non-performance |
| Our customers set demanding specifications for product performance, reliability and cost |
| Most of our customer contracts are firm, fixed price contracts, providing for a predetermined fixed price for the products that we make, regardless of the costs we incur |
| Thus, we must make pricing commitments to our customers based on our expectation that we will achieve more cost effective product designs and automate more of our manufacturing operations |
| The manufacture of our products requires a complex integration of demanding processes involving unique technical skill sets |
| We face risks of cost overruns or order cancellations if we fail to achieve forecasted product design and manufacturing efficiencies or if products cost more to produce than expected |
| The expense of producing products can rise due to increased cost of materials, components, labor, capital equipment or other factors |
| We may have cost overruns or problems with the performance or reliability of our products in the future |
| 12 If we fail to win competitively awarded contracts in the future, we may experience a reduction in our sales, which could negatively affect our profitability |
| We obtain many of our US Government contracts through a competitive bidding process |
| We cannot provide assurance that we will continue to win competitively awarded contracts or that awarded contracts will generate sales sufficient to result in our profitability |
| We are also subject to risks associated with the following: o the frequent need to bid on programs in advance of the completion of their design (which may result in unforeseen technological difficulties and cost overruns); o the substantial time and effort, including the relatively unproductive design and development required to prepare bids and proposals, spent for competitively awarded contracts that may not be awarded to us; o design complexity and rapid technological obsolescence; and o the constant need for design improvement Our government contracts may be subject to protest or challenge by unsuccessful bidders or to termination, reduction or modification in the event of changes in government requirements, reductions in federal spending or other factors |
| In addition, failure to obtain a renewal or follow-on contract with US Government or foreign governments would result in a loss of revenues |
| If revenues from the award of new contracts fail to offset this loss, it could have a material adverse effect on our results of operations and financial position |
| Our international sales are subject to risks related to doing business in foreign countries |
| In fiscal 2006 and 2005, international sales comprised approximately 24prca and 27prca, respectively, of our net sales, and we expect our international business to continue to account for a significant part of our revenues |
| We currently maintain significant manufacturing facilities in the United Kingdom and Israel |
| International sales are subject to numerous risks, including political and economic instability in foreign markets, currency and economic difficulties in the Pacific Rim, restrictive trade policies of foreign governments, inconsistent product regulation by foreign agencies or governments, imposition of product tariffs and burdens and costs of complying with a wide variety of international and US export laws and regulatory requirements |
| The governments of Japan, South Korea, Taiwan and the United Kingdom are all significant customers |
| Our international sales also are subject to us obtaining export licenses for certain products and systems |
| We cannot provide assurance that we will be able to continue to compete successfully in international markets or that our international sales will be profitable |
| Substantially all of our revenues in fiscal 2006 at our domestic locations and our operation in Israel were denominated in US dollars, and we intend to continue to enter only into US dollar-denominated contracts |
| Revenues reported at our EWST (UK) facility are primarily denominated in Pound Sterling and accounts for approximately 4prca to 8prca of our consolidated net sales in US dollars over the last three fiscal years |
| In addition, fluctuations in currency could adversely affect our customers, which may lead to delays in the timing and execution of orders |
| We rely on a small number of significant customers |
| A significant part of our sales have historically come mainly from contracts with agencies of, and prime contractors to, the US government |
| Net sales directly to the US government accounted for 22prca of fiscal year 2006 net sales |
| Additionally, approximately 38prca of our net sales were attributable to our next five largest customers for fiscal year 2006 |
| Variations in the demand for our products by any of these direct and indirect customers could have a serious, adverse impact on our performance |
| If we were to lose any of these or any other major customers, or if orders by any major customer were otherwise to be delayed or reduced, including reductions due to market or competitive conditions in commercial markets or further decreases in government defense spending, then our business, financial condition and results of operations would be harmed |
| We have limited intellectual property rights |
| Our success is dependent upon our proprietary technology |
| We rely principally on trade secret and copyright laws, certain employee and third-party non-disclosure agreements, as well as limited access to and distribution of proprietary information, in order to protect our technology |
| Trade secret laws afford us limited protection because they cannot be used to prevent third parties from reverse engineering and reproducing our products |
| Similarly, copyright laws afford us limited protection because copyright protection extends only to how an idea is expressed and does not protect the idea itself |
| Moreover, third parties could independently develop technologies that compete with our technologies |
| We cannot provide assurance that the obligations on the part of our employees and business partners to maintain the confidentiality of our proprietary technology will prevent 13 disclosure of such information by our employees or third parties |
| Litigation may be necessary for us to defend against claims of infringement or protect our proprietary technology, which could result in substantial cost to us and diversion of our efforts |
| We cannot provide assurance that we would prevail in any such litigation |
| Our inability to protect our proprietary technology could have a material adverse effect on our business, financial condition and results of operations |
| Although we believe that our products and proprietary rights do not infringe on the patents and proprietary rights of third parties, we cannot provide assurance that infringement claims, regardless of merit, will not be asserted against us |
| In addition, effective copyright and trade secret protection of our proprietary technology may be unavailable or limited in certain foreign countries |
| We are subject to environmental laws and regulations and our ongoing operations may expose us to environmental liabilities |
| Our operations are subject to federal, state, foreign and local environmental laws and regulations |
| As a result, we may be involved from time to time in administrative or legal proceedings relating to environmental matters |
| We cannot provide assurance that the aggregate amount of future clean-up costs and other environmental liabilities will not be material |
| We cannot predict what environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist |
| Enactment of more stringent laws or regulations or more strict interpretations of existing laws and regulations may require us to make additional expenditures, some of which could be material |
| A failure to attract and retain technical personnel could reduce our revenues and our operational effectiveness |
| There is a continuing demand for qualified technical personnel |
| We believe that our future growth and success will depend upon our ability to attract, train and retain such personnel |
| Competition for personnel in the defense industry is intense and there are a limited number of persons, especially engineers, with knowledge of and experience in microwave technology |
| Our design and development efforts depend on hiring and retaining qualified technical personnel |
| Although we currently experience relatively low rates of turnover for our technical personnel, the rate of turnover may increase in the future |
| An inability to attract or maintain a sufficient number of technical personnel could have a material adverse effect on our contract performance or on our ability to capitalize on market opportunities |
| The markets in which we operate are competitive |
| Our historical defense markets and our more recent commercial markets are characterized by rapid technological change as new products are generally developed quickly and industry standards are constantly evolving |
| Thus, our products can become obsolete over a short period of time unless we succeed in remaining technologically innovative and in anticipating new market demands |
| The defense industry in particular has experienced substantial consolidation due, among other things, to increasing pressures for cost reductions |
| This has substantially increased competitive pressures and introduced delays in contract funding and awards into our historical markets in the defense industry |
| Many of our competitors are larger than us and have substantially greater financial and other resources than we have |
| As a supplier, we also experience significant competition from the in-house capabilities of our customers |
| Our ability to compete for defense contracts largely depends on the following factors: o our ability to offer better performance than our competitors; o the readiness of our facilities, equipment and personnel to undertake the programs for which we compete; and o the effectiveness and innovations of our research and development programs |
| We may encounter difficulties in effectively integrating acquired businesses |
| As part of our business strategy, we have augmented our technology base by acquiring companies with compatible or related products |
| Historically, we have acquired a number of such companies and products and have integrated those companies into our business |
| These and any future acquisitions we make will be accompanied by the risks commonly encountered in acquisitions of companies, which include, among other things: o potential exposure to unknown liabilities of acquired companies; o higher than anticipated acquisition costs and expenses; o difficulty and expense of assimilating the operations and personnel of the companies, especially if the acquired operations are geographically distant; o potential disruption of our ongoing business and diversion of management time and attention; o failure to maximize our financial and strategic position by the successful incorporation of acquired technology; o difficulties in adopting and maintaining uniform standards, controls, procedures and policies; 14 o loss of key employees and customers as a result of changes in management; and o possible dilution to our shareholders |
| We may not be successful in overcoming these risks or any other problems encountered in connection with any of our acquisitions |
| We may make a strategic acquisition knowing that the transaction may adversely affect our short-term profitability, perhaps because the acquisition candidate may be experiencing operating losses |
| We may believe that acquiring such a company outweighs the operating losses the candidate is experiencing and the losses that we expect to experience before being able to make the acquisition candidate profitable |
| The completion of such an acquisition in the future would negatively affect our profitability and may cause a decline in our stock price |
| Our backlog is subject to reduction and cancellation |
| Backlog represents products or services that our customers have committed by contract to purchase from us |
| Our backlog as of July 30, 2006, was approximately dlra125 million |
| Typically, the majority of our backlog is filled within 12 months |
| Our backlog is subject to fluctuations and is not necessarily indicative of future backlog or sales |
| Moreover, cancellations of purchase orders or reductions of product quantities in existing contracts could substantially and materially reduce our backlog and, consequently, future revenues |
| Our failure to replace canceled or reduced backlog could result in lower revenues |
| Risks Related to Our Securities Our stock price has fluctuated significantly and may continue to do so |
| A number of factors could cause the market price of our common stock to fluctuate significantly, including: o our quarterly operating results or those of other defense companies; o the publicapstas reaction to our press releases, announcements and our filings with the Securities and Exchange Commission, including developments with respect to the recent indictment and suspension; o changes in earnings estimates or recommendations by research analysts; o changes in general conditions in the US economy, financial markets or defense industry; o natural disasters, terrorist attacks or acts of war; and o other developments affecting us or our competitors |
| In recent years, the stock market has experienced extreme price and volume fluctuations |
| This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to the operating performance of these companies |
| Delaware law and our charter documents may impede or discourage a takeover, which could cause the market price of our shares to decline |
| We are a Delaware corporation and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our existing shareholders |
| Our certificate of incorporation and by-laws provide, among other things, for a classified board of directors serving staggered three-year terms |
| Our incorporation under Delaware law, the acceleration of the vesting of outstanding stock options including options that we have granted upon a change in control, and certain provisions of our certificate of incorporation and by-laws could impede a merger, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer for our common stock, which, under certain circumstances, could reduce the market value of our common stock |