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EX-31.1 - AEROFLEX HOLDING CORP.v221489_ex31-1.htm
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EX-31.6 - AEROFLEX HOLDING CORP.v221489_ex31-6.htm
EX-32.4 - AEROFLEX HOLDING CORP.v221489_ex32-4.htm
EX-10.2 - AEROFLEX HOLDING CORP.v221489_ex10-2.htm
EX-31.5 - AEROFLEX HOLDING CORP.v221489_ex31-5.htm
EX-32.2 - AEROFLEX HOLDING CORP.v221489_ex32-2.htm
EX-32.3 - AEROFLEX HOLDING CORP.v221489_ex32-3.htm
EX-31.4 - AEROFLEX HOLDING CORP.v221489_ex31-4.htm
EX-10.1 - AEROFLEX HOLDING CORP.v221489_ex10-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

Commission File
 
Registrant; State of Incorporation;
 
IRS Employer
Number
 
Address and Telephone Number
 
Identification No.
         
001-34974
 
Aeroflex Holding Corp.
 
01-0899019
   
Delaware
   
   
35 South Service Road
   
   
P.O. Box 6022
   
   
Plainview, NY 11803-0622
   
   
(516) 694-6700
   
         
033-88878
 
Aeroflex Incorporated
 
11-1974412
   
Delaware
   
   
35 South Service Road
   
   
P.O. Box 6022
   
   
Plainview, NY 11803-0622
   
   
(516) 694-6700
   
 
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.

Aeroflex Holding Corp.      Yes x                                                                No o
Aeroflex Incorporated         Yes x                                                                No o

Indicate by check mark whether the registrants have submitted electronically and posted on their corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Aeroflex Holding Corp.      Yes o                                                                No o
Aeroflex Incorporated         Yes o                                                                No o

Indicate by check mark whether each registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
   
Large accelerated
   
Accelerated
   
Non-accelerated
   
Smaller reporting
 
   
filer
   
filer
   
filer
   
company
 
Aeroflex Holding Corp.
    o       o       x       o  
Aeroflex Incorporated
    o       o       x       o  

Indicate by check mark whether the registrants are shell companies (as defined in Rule 12b-2 of the Exchange Act).

Aeroflex Holding Corp.    Yes o                                                                No x
Aeroflex Incorporated       Yes o                                                                No x
 
Number of shares of common stock outstanding as of May 10, 2011:

Aeroflex Holding Corp. -    84,789,180 shares
Aeroflex Incorporated  -              1,000 shares

Aeroflex Incorporated meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced disclosure format.
 


 
 

 
 
OVERVIEW

This quarterly report on Form 10-Q for the period ended March 31, 2011 is a combined quarterly report being separately filed by two registrants: Aeroflex Holding Corp. (“Aeroflex Holding”) and Aeroflex Incorporated (“Aeroflex”), a direct wholly-owned subsidiary of Aeroflex Holding.  Unless the context provides otherwise, references to “we,” “our,” “the Company,” or “us” refer collectively to Aeroflex Holding and its subsidiary, Aeroflex, including Aeroflex’s consolidated subsidiaries.

Filing a combined report which contains full financial information of both Aeroflex Holding and its wholly owned subsidiary Aeroflex is both economical and efficient, as Aeroflex Holding is a holding company which does not conduct business operations on its own – i.e., all business operations are conducted by Aeroflex and its consolidated subsidiaries. All assets, liabilities, income, expenses and cash flows presented for all periods represent those of Aeroflex and its subsidiaries, except for activity related to Aeroflex Holding’s equity and earnings per share. Aeroflex Holding’s only asset is its investment in Aeroflex. As such, other than any discussions of liquidity and capital resources (including indebtedness and cash flows), equity and earnings per share, controls and procedures, unregistered sales of equity securities, use of proceeds and any material differences between Aeroflex Holding and Aeroflex which would require separate disclosures, all information presented in this quarterly report will be combined and pertain to both Aeroflex Holding and Aeroflex.

In this Form 10-Q, unless the context requires otherwise, references to (i) the term “Sponsors” refers collectively to affiliates of or funds managed by The Veritas Capital Fund III, L.P., Golden Gate Private Equity, Inc., and GS Direct, LLC, which indirectly control Aeroflex Holding, and (ii) “fiscal year” refers to the twelve months ended June 30 of the applicable year.  For example, “fiscal 2010” refers to the twelve months ended June 30, 2010.

Aeroflex Holding’s board of directors authorized an increase of Aeroflex Holding’s authorized shares of common stock to 300,000,000 and a 65,000,000 for 1 common stock split, both of which became effective on November 18, 2010. Aeroflex Holding’s stockholders’ equity has been retroactively adjusted to give effect to the stock split for all periods presented by reclassifying the par value of the additional shares issued in connection with the split from additional paid-in capital to common stock. In addition, all share numbers and per share amounts in Aeroflex Holding’s consolidated financial statements have been retroactively adjusted to give effect to the stock split.

On November 19, 2010, Aeroflex Holding consummated an initial public offering (“IPO”) of common stock in which it sold 19,789,180 shares of common stock, par value of $.01 per share, at a price of $13.50 per share. Aeroflex Holding received net proceeds of $244.0 million from the IPO, after deducting underwriting discounts and offering expenses, including a $2.5 million transaction fee which was paid to affiliates of the Sponsors under the advisory agreement with them for services directly attributable to the equity offering (“Transaction Fee”).  Aeroflex Holding used the net proceeds of the IPO to make a capital contribution to Aeroflex.  In connection with the IPO, Aeroflex:

·  
Repurchased an aggregate of $186.6 million of its senior unsecured notes and senior subordinated unsecured term loans and paid the tender premiums and expenses related thereto;

·  
Paid a $16.9 million termination fee to affiliates of the Sponsors to terminate the advisory agreement with them, which, including the related write-off of prepaid advisory fees, resulted in an $18.1 million expense (“Termination Fee”); and
 
·  
Amended its senior secured credit facility, for which a $3.3 million fee was paid to the lenders.
 
 
 

 
 
AEROFLEX HOLDING CORP.
AND SUBSIDIARIES

INDEX

     
PAGE
 
PART I: FINANCIAL INFORMATION
   
       
Item 1
FINANCIAL STATEMENTS OF AEROFLEX HOLDING CORP. AND SUBSIDIARIES
   
 
Unaudited Condensed Consolidated Balance Sheets
   
 
March 31, 2011 and June 30, 2010
 
2
       
 
Unaudited Condensed Consolidated Statements Of Operations
   
 
Three Months Ended March 31, 2011 and 2010
 
3
 
Nine Months Ended March 31, 2011 and 2010
 
4
       
 
Unaudited Condensed Consolidated Statement Of Stockholders’ Equity and Comprehensive Income (Loss)
   
 
Nine Months Ended March 31, 2011
 
5
       
 
Unaudited Condensed Consolidated Statements Of Cash Flows
   
 
Nine Months Ended March 31, 2011 and 2010
 
6
       
 
FINANCIAL STATEMENTS OF AEROFLEX INCORPORATED AND SUBSIDIARIES
   
 
Unaudited Condensed Consolidated Balance Sheets
   
 
March 31, 2011 and June 30, 2010
 
7
       
 
Unaudited Condensed Consolidated Statements Of Operations
   
 
Three Months Ended March 31, 2011 and 2010
 
8
 
Nine Months Ended March 31, 2011 and 2010
 
9
       
 
Unaudited Condensed Consolidated Statement Of Stockholder’s Equity and Comprehensive Income (Loss)
   
 
Nine Months Ended March 31, 2011
 
10
       
 
Unaudited Condensed Consolidated Statements Of Cash Flows
   
 
Nine Months Ended March 31, 2011 and 2010
 
11
       
 
COMBINED NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
12 – 36
       
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
   
 
Three and Nine Months Ended March 31, 2011 and 2010
 
36 – 51
       
Item 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
51
       
Item 4
CONTROLS AND PROCEDURES
 
52
       
 
PART II: OTHER INFORMATION
   
       
Item 1
LEGAL PROCEEDINGS
 
52
       
Item 1A
RISK FACTORS
 
53
       
Item 2
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
53
       
Item 3
DEFAULTS UPON SENIOR SECURITIES
 
53
       
Item 4
[REMOVED AND RESERVED]
 
53
       
Item 5
OTHER INFORMATION
 
53
       
Item 6
EXHIBITS
 
53
       
SIGNATURE
 
55
     
EXHIBIT INDEX
 
56
     
CERTIFICATIONS
 
57 - 66

 
1

 

Aeroflex Holding Corp. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share and per share data )
 
   
March 31,
   
June 30,
 
   
2011
   
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
 
$
67,152
   
$
100,663
 
Accounts receivable, less allowance for doubtful accounts of $1,213 and $1,821
   
158,382
     
141,595
 
Inventories
   
171,212
     
126,568
 
Deferred income taxes
   
25,903
     
28,018
 
Prepaid expenses and other current assets
   
13,212
     
10,983
 
Total current assets
   
435,861
     
407,827
 
                 
Property, plant and equipment, net of accumulated depreciation of $71,672 and $60,755
   
101,776
     
101,662
 
Non-current marketable securities, net
   
-
     
9,769
 
Deferred financing costs, net
   
16,298
     
20,983
 
Other assets
   
28,516
     
21,818
 
Intangible assets with definite lives, net
   
199,449
     
238,313
 
Intangible assets with indefinite lives
   
114,689
     
109,894
 
Goodwill
   
460,664
     
445,874
 
                 
Total assets
 
$
1,357,253
   
$
1,356,140
 
                 
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Current portion of long-term debt
 
$
360
   
$
21,817
 
Accounts payable
   
47,240
     
28,803
 
Advance payments by customers and deferred revenue
   
31,519
     
30,741
 
Income taxes payable
   
1,323
     
4,615
 
Accrued payroll expenses
   
22,717
     
23,082
 
Accrued expenses and other current liabilities
   
43,616
     
58,817
 
Total current liabilities
   
146,775
     
167,875
 
                 
Long-term debt
   
695,908
     
880,030
 
Deferred income taxes
   
92,511
     
138,849
 
Defined benefit plan obligations
   
5,526
     
5,763
 
Other long-term liabilities
   
12,830
     
12,639
 
Total liabilities
   
953,550
     
1,205,156
 
                 
Stockholders’ equity:
               
Preferred stock $.01 par value; 50,000,000 shares authorized, no shares issued and outstanding
   
-
     
-
 
Common stock, par value $.01 per share;  300,000,000 shares authorized;  84,789,180 and 65,000,000 shares issued and outstanding
   
848
     
650
 
Additional paid-in capital
   
643,600
     
398,291
 
Accumulated other comprehensive income (loss)
   
(33,270
)
   
(53,575
)
Accumulated deficit
   
(207,475
)
   
(194,382
)
Total stockholders’ equity
   
403,703
     
150,984
 
                 
Total liabilities and stockholders’ equity
 
$
1,357,253
   
$
1,356,140
 
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
2

 
 
Aeroflex Holding Corp. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(In thousands, except per share data)
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
Net sales
  $ 193,219     $ 168,435  
Cost of sales
    86,861       78,135  
Gross profit
    106,358       90,300  
                 
Selling, general and administrative costs
    38,265       31,285  
Research and development costs
    24,663       20,844  
Amortization of acquired intangibles
    15,900       15,408  
Restructuring charges
    2,698       105  
      81,526       67,642  
Operating income
    24,832       22,658  
                 
Other income (expense):
               
Interest expense
    (13,852 )     (20,815 )
Other income (expense), net
    (119 )     222  
Total other income (expense)
    (13,971 )     (20,593 )
                 
Income before income taxes
    10,861       2,065  
Provision (benefit) for income taxes
    6,734       (791 )
                 
Net income
  $ 4,127     $ 2,856  
                 
Net income per common share - Basic
  $ 0.05     $ 0.04  
                 
Weighted average number of common shares outstanding - Basic
    84,789       65,000  
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
3

 
 
Aeroflex Holding Corp. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(In thousands, except per share data)

   
Nine Months Ended March 31,
 
   
2011
   
2010
 
Net sales
  $ 530,729     $ 465,290  
Cost of sales
    249,705       223,259  
Gross profit
    281,024       242,031  
                 
Selling, general and administrative costs
    113,234       92,988  
Research and development costs
    68,477       55,286  
Amortization of acquired intangibles
    47,706       46,527  
Termination of Sponsor Advisory Agreement
    18,133       -  
Restructuring charges
    10,790       356  
Loss on liquidation of foreign subsidiary
    -       7,696  
      258,340       202,853  
Operating income
    22,684       39,178  
                 
Other income (expense):
               
Interest expense
    (55,803 )     (63,272 )
Loss on extinguishment of debt
    (25,178 )     -  
Gain from a bargain purchase of a business
    173       -  
Other income (expense), net
    (526 )     701  
Total other income (expense)
    (81,334 )     (62,571 )
                 
Income (loss) before income taxes
    (58,650 )     (23,393 )
Provision (benefit) for income taxes
    (45,557 )     4,908  
                 
Net income (loss)
  $ (13,093 )   $ (28,301 )
                 
Net income (loss) per common share - Basic
  $ (0.18 )   $ (0.44 )
                 
Weighted average number of common shares outstanding - Basic
    74,608       65,000  
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
4

 
 
Aeroflex Holding Corp. and Subsidiaries
Unaudited Condensed Consolidated Statement of Stockholders' Equity
and Comprehensive Income (Loss)
(In thousands)

                           
Accumulated
             
                     
Additional
   
Other
             
         
Common Stock
   
Paid-in
   
Comprehensive
   
Accumulated
   
Comprehensive
 
   
Total
   
Shares
   
Par Value
   
Capital
   
Income(Loss)
   
Deficit
   
Income (Loss)
 
Balance, June 30, 2010
  $ 150,984       65,000     $ 650     $ 398,291     $ (53,575 )   $ (194,382 )      
Proceeds from issuance of common stock
    244,021       19,789       198       243,823       -       -        
Share-based compensation
    1,655       -       -       1,655       -       -        
Other changes
    (169 )     -       -       (169 )     -       -        
Other comprehensive income (loss)
    20,305       -       -       -       20,305       -     $ 20,305  
Net income (loss)
    (13,093 )     -       -       -       -       (13,093 )     (13,093 )
Balance, March 31, 2011
  $ 403,703       84,789     $ 848     $ 643,600     $ (33,270 )   $ (207,475 )   $ 7,212  

See combined notes to unaudited condensed consolidated financial statements.
 
 
5

 
 
Aeroflex Holding Corp. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)

   
Nine Months Ended March 31,
 
   
2011
   
2010
 
             
Cash flows from operating activities:
           
Net income (loss)
  $ (13,093 )   $ (28,301 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    62,426       62,178  
Gain from a bargain purchase of a business
    (173 )     -  
Acquisition related adjustment to cost of sales
    998       246  
Loss on liquidation of foreign subsidiary
    -       7,696  
Loss on extinguishment of debt
    25,178       -  
Deferred income taxes
    (52,317 )     (1,286 )
Share-based compensation
    1,655       1,563  
Non - cash restructuring charges
    4,860       -  
Amortization of deferred financing costs
    3,976       3,579  
Paid in kind interest
    2,434       13,377  
Other, net
    496       758  
Change in operating assets and liabilities, net of effects from purchases of businesses:
               
Decrease (increase) in accounts receivable
    (10,890 )     10,754  
Decrease (increase) in inventories
    (39,936 )     4,450  
Decrease (increase) in prepaid expenses and other assets
    (8,142 )     (2,711 )
Increase (decrease) in accounts payable, accrued expenses and other liabilities
    4,430       (20,053 )
                 
Net cash provided by (used in) operating activities
    (18,098 )     52,250  
                 
Cash flows from investing activities:
               
Payments for purchase of businesses, net of cash acquired
    (23,593 )     (4,000 )
Capital expenditures
    (17,132 )     (13,176 )
Proceeds from sale of marketable securities
    10,357       8,580  
Proceeds from the sale of property, plant and equipment
    819       1,021  
Other, net
    -       (12 )
                 
Net cash provided by (used in) investing activities
    (29,549 )     (7,587 )
                 
Cash flows from financing activities:
               
Net proceeds from issuance of common stock
    244,021       -  
Repurchase of senior unsecured notes and senior subordinated unsecured term loans, including premiums and fees
    (207,690 )     -  
Debt repayments
    (21,458 )     (4,012 )
Debt financing costs
    (3,332 )     -  
                 
Net cash provided by (used in) financing activities
    11,541       (4,012 )
Effect of exchange rate changes on cash and cash equivalents
    2,595       (2,051 )
                 
Net increase (decrease) in cash and cash equivalents
    (33,511 )     38,600  
Cash and cash equivalents at beginning of period
    100,663       57,748  
Cash and cash equivalents at end of period
  $ 67,152     $ 96,348  
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
6

 

Aeroflex Incorporated and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share and per share data )
 
   
March 31,
   
June 30,
 
   
2011
   
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 67,152     $ 100,663  
Accounts receivable, less allowance for doubtful accounts of $1,213 and $1,821
    158,382       141,595  
Inventories
    171,212       126,568  
Deferred income taxes
    25,903       28,018  
Prepaid expenses and other current assets
    13,212       10,983  
Total current assets
    435,861       407,827  
                 
Property, plant and equipment, net of accumulated depreciation of $71,672 and $60,755
    101,776       101,662  
Non-current marketable securities, net
    -       9,769  
Deferred financing costs, net
    16,298       20,983  
Other assets
    28,516       21,818  
Intangible assets with definite lives, net
    199,449       238,313  
Intangible assets with indefinite lives
    114,689       109,894  
Goodwill
    460,664       445,874  
                 
Total assets
  $ 1,357,253     $ 1,356,140  
                 
Liabilities and Stockholder’s Equity
               
Current liabilities:
               
Current portion of long-term debt
  $ 360     $ 21,817  
Accounts payable
    47,240       28,803  
Advance payments by customers and deferred revenue
    31,519       30,741  
Income taxes payable
    1,323       4,615  
Accrued payroll expenses
    22,717       23,082  
Accrued expenses and other current liabilities
    43,616       58,817  
Total current liabilities
    146,775       167,875  
                 
Long-term debt
    695,908       880,030  
Deferred income taxes
    92,511       138,849  
Defined benefit plan obligations
    5,526       5,763  
Other long-term liabilities
    12,830       12,639  
Total liabilities
    953,550       1,205,156  
                 
Stockholder’s equity:
               
Common stock, par value $.10 per share; 1,000 shares authorized, issued and outstanding
    -       -  
Additional paid-in capital
    644,448       398,941  
Accumulated other comprehensive income (loss)
    (33,270 )     (53,575 )
Accumulated deficit
    (207,475 )     (194,382 )
Total stockholder’s equity
    403,703       150,984  
                 
Total liabilities and stockholder’s equity
  $ 1,357,253     $ 1,356,140  

See combined notes to unaudited condensed consolidated financial statements.
 
 
7

 
 
Aeroflex Incorporated and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(In thousands)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Net sales
  $ 193,219     $ 168,435  
Cost of sales
    86,861       78,135  
Gross profit
    106,358       90,300  
                 
Selling, general and administrative costs
    38,265       31,285  
Research and development costs
    24,663       20,844  
Amortization of acquired intangibles
    15,900       15,408  
Restructuring charges
    2,698       105  
      81,526       67,642  
Operating income
    24,832       22,658  
                 
Other income (expense):
               
Interest expense
    (13,852 )     (20,815 )
Other income (expense), net
    (119 )     222  
Total other income (expense)
    (13,971 )     (20,593 )
                 
Income before income taxes
    10,861       2,065  
Provision (benefit) for income taxes
    6,734       (791 )
                 
Net income
  $ 4,127     $ 2,856  
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
8

 

Aeroflex Incorporated and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(In thousands)

   
Nine Months Ended March 31,
 
   
2011
   
2010
 
Net sales
  $ 530,729     $ 465,290  
Cost of sales
    249,705       223,259  
Gross profit
    281,024       242,031  
                 
Selling, general and administrative costs
    113,234       92,988  
Research and development costs
    68,477       55,286  
Amortization of acquired intangibles
    47,706       46,527  
Termination of Sponsor Advisory Agreement
    18,133       -  
Restructuring charges
    10,790       356  
Loss on liquidation of foreign subsidiary
    -       7,696  
      258,340       202,853  
Operating income
    22,684       39,178  
                 
Other income (expense):
               
Interest expense
    (55,803 )     (63,272 )
Loss on extinguishment of debt
    (25,178 )     -  
Gain from a bargain purchase of a business
    173       -  
Other income (expense), net
    (526 )     701  
Total other income (expense)
    (81,334 )     (62,571 )
                 
Income (loss) before income taxes
    (58,650 )     (23,393 )
Provision (benefit) for income taxes
    (45,557 )     4,908  
                 
Net income (loss)
  $ (13,093 )   $ (28,301 )
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
9

 
 
Aeroflex Incorporated and Subsidiaries
Unaudited Condensed Consolidated Statement of Stockholder's Equity
and Comprehensive Income (Loss)
(In thousands)
 
                           
Accumulated
             
                     
Additional
   
Other
             
         
Common Stock
   
Paid-in
   
Comprehensive
   
Accumulated
   
Comprehensive
 
   
Total
   
Shares
   
Par Value
   
Capital
   
Income(Loss)
   
Deficit
   
Income (Loss)
 
Balance, June 30, 2010
  $ 150,984       1     $ -     $ 398,941     $ (53,575 )   $ (194,382 )      
Proceeds from capital contribution from Aeroflex Holding
    244,021       -       -       244,021       -       -        
Share-based compensation
    1,655       -       -       1,655       -       -        
Other changes
    (169 )     -       -       (169 )     -       -        
Other comprehensive income (loss)
    20,305       -       -       -       20,305       -     $ 20,305  
Net income (loss)
    (13,093 )     -       -       -       -       (13,093 )     (13,093 )
Balance, March 31, 2011
  $ 403,703       1     $ -     $ 644,448     $ (33,270 )   $ (207,475 )   $ 7,212  
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
10

 
 
Aeroflex Incorporated and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)

   
Nine Months Ended March 31,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net income (loss)
  $ (13,093 )   $ (28,301 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    62,426       62,178  
Gain from a bargain purchase of a business
    (173 )     -  
Acquisition related adjustment to cost of sales
    998       246  
Loss on liquidation of foreign subsidiary
    -       7,696  
Loss on extinguishment of debt
    25,178       -  
Deferred income taxes
    (52,317 )     (1,286 )
Share-based compensation
    1,655       1,563  
Non - cash restructuring charges
    4,860       -  
Amortization of deferred financing costs
    3,976       3,579  
Paid in kind interest
    2,434       13,377  
Other, net
    496       758  
Change in operating assets and liabilities, net of effects from purchases of businesses:
               
Decrease (increase) in accounts receivable
    (10,890 )     10,754  
Decrease (increase) in inventories
    (39,936 )     4,450  
Decrease (increase) in prepaid expenses and other assets
    (8,142 )     (2,711 )
Increase (decrease) in accounts payable, accrued expenses and other liabilities
    4,430       (20,053 )
                 
Net cash provided by (used in) operating activities
    (18,098 )     52,250  
                 
Cash flows from investing activities:
               
Payments for purchase of businesses, net of cash acquired
    (23,593 )     (4,000 )
Capital expenditures
    (17,132 )     (13,176 )
Proceeds from sale of marketable securities
    10,357       8,580  
Proceeds from the sale of property, plant and equipment
    819       1,021  
Other, net
    -       (12 )
                 
Net cash provided by (used in) investing activities
    (29,549 )     (7,587 )
                 
Cash flows from financing activities:
               
Capital contribution from Aeroflex Holding
    244,021       -  
Repurchase of senior unsecured notes and senior subordinated unsecured term loans, including premiums and fees
    (207,690 )     -  
Debt repayments
    (21,458 )     (4,012 )
Debt financing costs
    (3,332 )     -  
                 
Net cash provided by (used in) financing activities
    11,541       (4,012 )
Effect of exchange rate changes on cash and cash equivalents
    2,595       (2,051 )
                 
Net increase (decrease) in cash and cash equivalents
    (33,511 )     38,600  
Cash and cash equivalents at beginning of period
    100,663       57,748  
Cash and cash equivalents at end of period
  $ 67,152     $ 96,348  
 
See combined notes to unaudited condensed consolidated financial statements.
 
 
11

 
 
COMBINED NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1.    Basis of Presentation

Stock Split, Initial Public Offering and Use of Proceeds

This quarterly report for the period ended March 31, 2011 is a combined quarterly report being separately filed by two registrants: Aeroflex Holding Corp. (“Aeroflex Holding”) and Aeroflex Incorporated (“Aeroflex”), a direct wholly-owned subsidiary of Aeroflex Holding.  Unless the context provides otherwise, references to “we,” “our,” “the Company,” or “us” refer collectively to Aeroflex Holding and its subsidiary, Aeroflex, including Aeroflex’s consolidated subsidiaries.

Filing a combined report which contains full financial information of both Aeroflex Holding and its wholly owned subsidiary Aeroflex is both economical and efficient, as Aeroflex Holding is a holding company which does not conduct business operations on its own – i.e., all business operations are conducted by Aeroflex and its consolidated subsidiaries. All assets, liabilities, income, expenses and cash flows presented for all periods represent those of Aeroflex and its subsidiaries, except for activity related to Aeroflex Holding’s equity and earnings per share. Aeroflex Holding’s only asset is its investment in Aeroflex.  As such, other than any discussions of liquidity and capital resources (including indebtedness and cash flows), equity and earnings per share, use of proceeds and any material differences between Aeroflex Holding and Aeroflex which would require separate disclosures, all information presented in these notes to the unaudited condensed consolidated financial statements pertains to both Aeroflex Holding and Aeroflex.

Unless the context requires otherwise, references to (i) the term “Sponsors” refers collectively to affiliates of or funds managed by The Veritas Capital Fund III, L.P., Golden Gate Private Equity, Inc., and GS Direct, LLC, which indirectly control Aeroflex Holding, and (ii) “fiscal year” refers to the twelve months ended June 30 of the applicable year.  For example, “fiscal 2010” refers to the twelve months ended June 30, 2010.

Aeroflex Holding’s board of directors authorized an increase of Aeroflex Holding’s authorized shares of common stock to 300,000,000 and a 65,000,000 for 1 common stock split, both of which became effective on November 18, 2010. Aeroflex Holding’s stockholders’ equity has been retroactively adjusted to give effect to the stock split for all periods presented by reclassifying the par value of the additional shares issued in connection with the split from additional paid-in capital to common stock. In addition, all share numbers and per share amounts in Aeroflex Holding’s consolidated financial statements have been retroactively adjusted to give effect to the stock split.

On November 19, 2010, Aeroflex Holding consummated an initial public offering (“IPO”) of common stock in which it sold 19,789,180 shares of common stock, par value of $.01 per share, at a price of $13.50 per share. Aeroflex Holding received net proceeds of $244.0 million from the IPO, after deducting underwriting discounts and offering expenses, including a $2.5 million transaction fee which was paid to affiliates of the Sponsors under the advisory agreement with them for services directly attributable to the equity offering (“Transaction Fee”).  Aeroflex Holding used the net proceeds of the IPO to make a capital contribution to Aeroflex.  In connection with the IPO, Aeroflex:

 
·
Repurchased an aggregate of $186.6 million of its senior unsecured notes and senior subordinated unsecured term loans and paid the tender premiums and expenses related thereto;

 
·
Paid a $16.9 million termination fee to affiliates of the Sponsors to terminate the advisory agreement with them, which, including the related write-off of prepaid advisory fees, resulted in an $18.1 million expense (“Termination Fee”); and
 
 
12

 
 
 
·
Amended its senior secured credit facility, for which a $3.3 million fee was paid to the lenders.

Basis of Accounting

The accompanying unaudited condensed consolidated financial information of Aeroflex Holding and Aeroflex has been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and the rules and regulations of the United States Securities and Exchange Commission (“SEC”), and reflects all adjustments, consisting only of normal recurring adjustments, which in management’s opinion are necessary to state fairly the Company’s financial position as of March 31, 2011, the results of operations for the three and nine month periods ended March 31, 2011 and 2010 and the cash flows for the nine month periods ended March 31, 2011 and 2010. The June 30, 2010 balance sheet information has been derived from audited financial statements, but does not include all information or disclosures required by U.S. GAAP.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of sales and expenses during the reporting period. Actual results may differ from those estimates, and such differences may be material to the financial statements.

These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in Aeroflex Holding’s amended registration statement on Form S-1 filed with the SEC on November 9, 2010 (“Aeroflex Holding’s Registration Statement”) and in Aeroflex’s annual report on Form 10-K for the fiscal year ended June 30, 2010 (“Aeroflex’s Fiscal 2010 Form 10-K”).

The accompanying condensed consolidated financial statements of Aeroflex Holding are essentially identical to the accompanying condensed consolidated financial statements of Aeroflex, with the following significant exceptions:  Aeroflex Holding has 84,789,180 shares of common stock outstanding at a par value of $.01 per share, of which 65,000,000 shares (as a result of the 65,000,000 for 1 stock split on November 18, 2010) are held by one shareholder and 19,789,180 shares are held by public shareholders by virtue of the IPO on November 19, 2010, which resulted in net proceeds of $244.0 million after deducting underwriting discounts and offering expenses, whereas Aeroflex has 1,000 shares of common stock outstanding at a par value of $.10 per share, all of which are held by Aeroflex Holding, and Aeroflex received a capital contribution of $244.0 million from Aeroflex Holding from the net proceeds of the IPO. The combined notes to the condensed consolidated financial statements are essentially identical for Aeroflex Holding and Aeroflex, except as noted. 

Results of operations for interim periods are not necessarily indicative of results to be expected for the full fiscal year or any future periods.

Reclassifications

Certain reclassifications have been made to the fiscal 2010 consolidated financial statements to conform to the fiscal 2011 presentation.

2.    Accounting Pronouncements

Recently Adopted Accounting Pronouncements
 
On July 1, 2010, we adopted the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) on the consolidation of variable interest entities. The new guidance requires revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. The adoption of this new guidance did not have an impact on our consolidated financial statements.
 
 
13

 
 
Recently Issued Accounting Pronouncements Not Yet Adopted

In January 2010, the FASB issued authoritative guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements.  The guidance requires a roll forward of activities on purchases, sales, issuance, and settlements on a gross basis of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). We believe the adoption on July 1, 2011 of the gross presentation of the Level 3 roll forward will not have an impact on our consolidated financial statements.

3.    Acquisitions of Businesses and Intangible Assets

Test Evolution Corporation
 
On October 1, 2007, we purchased 40% of the outstanding stock of Test Evolution Corporation, or TEC, for $4.0 million. TEC, located in Massachusetts, develops and manufactures digital, analog and RF semiconductor automated test equipment. We determined that we have control of this company and have consolidated TEC’s assets and liabilities and results of operations, all of which were insignificant, into our financial statements commencing October 1, 2007. On August 5, 2010, we invested another $2.0 million in TEC and, as a result of this and other capital transactions, our ownership interest is approximately 51%. The amounts attributable to the non-controlling interest in TEC’s equity and results of operations are not material to our consolidated financial statements and have been included in other long-term liabilities and other income (expense), respectively.  TEC is included in our Test Solutions segment.

Radiation Assured Devices
 
On June 30, 2010, we acquired 100% of the stock of Radiation Assured Devices, Inc., or  RAD, for $14.0 million in cash, plus contingent payments equal to 50% of the acquired company’s EBITDA (as defined in the agreement) for the five year period of fiscal 2011 to fiscal 2015, provided certain EBITDA thresholds are met.  The fair value of the contingent consideration as of June 30, 2010 was $7.1 million and was reflected in other long-term liabilities and considered in the allocation of the purchase price.  The fair value of the contingent consideration as of March 31, 2011 was $8.3 million, of which $1.4 million was reflected in accrued expenses and other current liabilities and $6.9 million was reflected in other long-term liabilities. The increase in the fair value of the contingent consideration was $409,000 and $1.2 million for the three and nine months ended March 31, 2011, respectively, and was recorded in selling, general and administrative costs. RAD, located in Colorado Springs, Colorado, uses commercial and specialty technologies to provide state of the art radiation engineering and qualification services, as well as to produce radiation hardened products for commercial and military spaceborne electronics.  RAD is included in our Microelectronic Solutions segment.

Advanced Control Components
 
On August 31, 2010, we acquired 100% of the stock of Advanced Control Components, Inc., or ACC, for $19.2 million in cash, which was net of a preliminary working capital adjustment made at closing.  The purchase price is subject to a further working capital adjustment, based on the amount by which the final adjusted net working capital at the date of closing is lower than the target set forth in the purchase agreement.  We currently estimate an additional $764,000 deficiency in adjusted net working capital, reducing the purchase price to $18.4 million. ACC, located in Eatontown, New Jersey, designs, manufacturers and markets a wide range of radio frequency, or RF, and microwave products for the military, civilian radar, scientific and communications markets. ACC is included in our Microelectronic Solutions segment. 
 
 
14

 

We allocated the purchase price based on the estimated fair value of the assets acquired and liabilities assumed as follows:
 
(In thousands)
     
Current assets (excluding cash of $15)
  $ 4,899  
Property, plant and equipment
    1,156  
Other assets
    60  
Customer related intangibles
    5,680  
Non-compete arrangements
    30  
Tradenames
    3,010  
Goodwill
    10,057  
   Total assets acquired
    24,892  
Current liabilities
    (2,895 )
Deferred taxes
    (3,576 )
   Total liabilities assumed
    (6,471 )
   Net assets acquired
  $ 18,421  
 
The customer related intangibles and non-compete arrangements are being amortized on a straight-line basis over a range of 1 to 9 years.  The tradenames have an indefinite life.  The goodwill is not deductible for tax purposes.
 
On a pro forma basis, had the ACC acquisition taken place as of the beginning of the periods presented, our results of operations for those periods would not have been materially affected.

Cash Paid for the Purchase of Businesses

For the nine months ended March 31, 2011, we had net cash outlays of $23.6 million for the purchase of businesses, net of cash acquired.  This was primarily comprised of $18.4 million for the purchase of ACC and $5.6 million of contingent consideration payments ($4.6 million for Gaisler Research AB, acquired on June 30, 2008 and $1.0 million for Airflyte Electronics Company, acquired on June 26, 2009), partially offset by working capital adjustment refunds for prior year acquisitions.

Intangible Assets with Definite Lives

The components of amortizable intangible assets were as follows:
 
   
March 31, 2011
   
June 30, 2010
 
   
(In thousands)
 
   
Gross
         
Gross
       
   
Carrying
   
Accumulated
   
Carrying
   
Accumulated
 
   
Amount
   
Amortization
   
Amount
   
Amortization
 
                         
Developed technology
  $ 200,791     $ 121,997     $ 197,422     $ 94,672  
Customer related intangibles
    229,297       115,342       222,026       94,656  
Non-compete arrangements
    10,443       5,942       10,087       4,420  
Tradenames
    3,396       1,197       3,184       658  
   Total
  $ 443,927     $ 244,478     $ 432,719     $ 194,406  
 
 
15

 
 
4.    Restructuring Charges

The following table sets forth the charges and payments related to the restructuring liability for the period indicated:
 
   
Balance
June 30,
2010
   
Nine Months Ended March 31, 2011
   
Balance
March 31,
2011
 
   
Restructuring
Liability
   
Net
Additions
   
Cash
Payments
   
Effect of
foreign
currency
   
Restructuring
Liability
 
   
(In thousands)
 
Work force reduction
  $ 172     $ 4,936     $ (3,140 )   $ 64     $ 2,032  
Closure of facilities
    632       994       (1,181 )     50       495  
Total
  $ 804     $ 5,930     $ (4,321 )   $ 114     $ 2,527  
 
Restructuring charges for the nine months ended March 31, 2011 amounted to $10.8 million, consisting of (a) $5.9 million of severance and facility closure costs in connection with continued consolidation activities related to certain manufacturing operations located in Europe and one of our domestic components facilities located in Whippany, New Jersey, and (b) a $4.9 million impairment charge based on the fair value of the Whippany, New Jersey facility we intend to sell.

5.    Net Income (Loss) Per Common Share

The consolidated statements of operations for Aeroflex Holding present only basic net income (loss) per common share, as it does not have any potentially dilutive securities. Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period.

Earnings per share information is not presented for Aeroflex because, as a wholly-owned subsidiary of Aeroflex Holding, such information is not relevant.

6.    Inventories

Inventories consisted of the following:
 
   
March 31,
   
June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Raw materials
  $ 93,272     $ 61,278  
Work in process
    55,858       44,022  
Finished goods
    22,082       21,268  
    $ 171,212     $ 126,568  
 
 
16

 
 
7.    Derivative Financial Instruments

We address certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments. When deemed appropriate to do so, we enter into interest rate swap derivatives to manage the effects of interest rate movements on portions of Aeroflex’s debt. We routinely enter into foreign currency forward contracts, not designated as hedging instruments, to protect us from fluctuations in exchange rates.

The fair values of our derivative financial instruments included in the consolidated balance sheets as of March 31, 2011 and June 30, 2010 are as follows:
 
   
Asset (Liability) Derivatives
   
March 31, 2011
 
June 30, 2010
   
Balance Sheet
  Fair  
Balance Sheet
  Fair
(In thousands)
 
Location
  Value(1)  
Location
  Value(1)
Derivatives designated as hedging
                   
   instruments:
                   
   Interest rate swap contracts
 
Accrued expenses and
       
Accrued expenses and
     
   
   other current liabilities
  $
-
 
   other current liabilities
  $
(6,613)
                     
Derivatives not designated as
                   
   hedging instruments:
                   
   Foreign currency forward contracts
 
Prepaid expenses and
       
Accrued expenses and
     
   
   other current assets
   
3
 
   other current liabilities
   
(293)
                     
          Total derivatives, net
      $
3
      $
(6,906)
 

(1)  See Note 8 for further information about how the fair values of derivative assets and liabilities are determined.
 
The gains and losses related to our derivative financial instruments designated as hedging instruments for the three and nine months ended March 31, 2011 and 2010 were as follows:
 
Derivatives in Cash Flow
Hedging Relationships
 
Amount of Gain or (Loss)
Recognized on Derivatives in
Other Comprehensive Income
(Effective Portion) (1)
 
   
Three Months Ended
March 31,
   
Nine Months Ended
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
Interest rate swap contracts
  $ -     $ (1,279 )   $ (612 )   $ (5,550 )
 
 
17

 
 
Location of Gain or (Loss)
Reclassified from Accumulated
Other Comprehensive Income
into Income (Effective Portion)
 
Amount of Gain or (Loss)
Reclassified from
Accumulated Other Comprehensive Income
into Income (Effective Portion) (1)
 
   
Three Months Ended
March 31,
   
Nine Months Ended
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
Interest expense
  $ (1,033 )   $ (3,666 )   $ (7,225 )   $ (10,848 )
 

(1) See Note 11 for additional information on changes to accumulated other comprehensive income (loss).

The amounts of the gains and losses related to our derivative financial instruments not designated as hedging instruments for the three and nine months ended March 31, 2011 and 2010 were as follows:

Derivatives Not
Designated as
Hedging Instruments
 
Location of Gain or (Loss)
Recognized in Earnings on
Derivative
 
Amount of Gain or (Loss)
Recognized in Earnings on
Derivative
 
       
Three Months Ended
March 31,
   
Nine Months Ended
March 31,
 
       
2011
   
2010
   
2011
   
2010
 
       
(In thousands)
 
Foreign currency forward contracts
 
Other income (expense)
  $ (15 )   $ 410     $ 296     $ 641  
 
Interest Rate Swap Cash-Flow Hedges

We enter into interest rate swap contracts with counterparties that are rated investment grade to manage the effects of interest rate movements on portions of our debt. Such contracts effectively fix the borrowing rates on floating rate debt to limit the exposure against the risk of rising rates.  We do not enter into interest rate swap contracts for speculative purposes. Our interest rate swap contracts that were outstanding as of June 30, 2010, all of which were entered into in fiscal 2008 for an aggregate notional amount of $425.0 million, matured during the nine months ended March 31, 2011.  As of March 31, 2011 we have not entered into new interest rate swap contracts.

       Foreign Currency Contract Derivatives

Foreign currency contracts are used to protect us from fluctuations in exchange rates. We enter into foreign currency contracts, which are not designated as hedges. The change in fair value is included in other income (expense) as it occurs. As of March 31, 2011, we had $50.3 million of notional value foreign currency forward contracts maturing through April 29, 2011. Notional amounts do not quantify risk or represent assets or liabilities of the Company, but are used in the calculation of cash settlements under the contracts.

8.    Fair Value Measurements
 
We account for certain assets and liabilities at fair value.  The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring the fair value are observable in the market.  We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety.  These levels are:
 
 
Level 1:
Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.
 
 
18

 
 
 
Level 2:
Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
 
 
Level 3:
Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.  The inputs are unobservable in the market and significant to the instruments’ valuation.

The following table presents for each hierarchy level, financial assets and liabilities measured at fair value on a recurring basis:
 
As of March 31, 2011
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Significant Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Total
 
   
(In thousands)
 
Assets:
                       
Foreign currency forward contracts
  $ -     $ 3     $ -     $ 3  
 
As of June 30, 2010
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Significant Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Total
 
   
(In thousands)
 
Assets:
                       
Non-current marketable securities
  $ -     $ -     $ 9,769     $ 9,769  
Liabilities:
                               
Foreign currency forward contracts
  $ -     $ 293     $ -     $ 293  
Interest rate swap contracts
    -       6,613       -       6,613  
   Total Liabilities
  $ -     $ 6,906     $ -     $ 6,906  
 
 
19

 
 
The following table presents the changes in the carrying value of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended March 31, 2011:
 
   
Fair Value Measurements
Using Significant
Unobservable Inputs
(Level 3)
 
   
Auction
Rate
Securities
 
   
(In thousands)
 
Balance at June 30, 2010
  $ 9,769  
Sold at par
    (2,000 )
Transfer to Level 2
    (9,045 )
Transfer of unrealized loss from accumulated other comprehensive income (loss) to realized loss recorded in other expense
    688  
Unrealized gain (loss) in accumulated other comprehensive income (loss)
    588  
Balance at March 31, 2011
  $ -  
 
Marketable Securities – In December 2010, $2.0 million of our auction rate securities were sold at par.  In January 2011, the remaining $9.0 million of our auction rate securities were sold at an average of 92.4% of par. The resulting $688,000 realized loss was recorded in the statement of operations for the nine months ended March 31, 2011. 
 
Foreign Currency Forward Contracts – The fair values of our foreign currency forward contracts were determined using a pricing model with all significant inputs based on observable market data such as measurement date spot and forward rates.

Interest Rate Swap Contracts – The fair values of our interest rate swap contracts were based on valuations received from the counterparties and corroborated by measurement date equivalent swap rates.

9.    Long Term Debt and Credit Agreements

All indebtedness has been incurred by Aeroflex; such indebtedness is reflected on the balance sheets of Aeroflex Holding by virtue of the principles of consolidation.

All of the net proceeds of Aeroflex Holding’s IPO were used to make a capital contribution to Aeroflex to enable it to, among other things, tender for a portion of its senior unsecured notes and offer to repurchase a portion of its senior subordinated unsecured term loans.  In December 2010, Aeroflex repurchased approximately $32.2 million of its senior unsecured notes and $154.4 million of its senior subordinated unsecured term loans. This resulted in a $25.2 million loss on extinguishment of debt, which is comprised of the following:

 
·
an 11% premium paid on the debt repurchased, which amounted to $20.5 million;

 
·
the write-off of the related deferred financing costs of $4.0 million; and

 
·
professional fees of $614,000.
 
 
20

 
 
On November 4, 2010, Aeroflex amended its senior secured credit facility, for which it paid a $3.3 million fee to the lenders which was recorded as deferred financing costs and $579,000 of other costs that were expensed as incurred, which allowed Aeroflex to, among other things:

 
·
increase the amount of cash it can spend for acquisitions of businesses from $20 million per year and a $100 million aggregate amount, to $200 million in the aggregate (with no annual limit), from the effective date of the amendment to the credit facility maturity date, August 15, 2014;

 
·
pay certain fees to affiliates of our Sponsors upon the completion of the Aeroflex Holding IPO.  These fees were paid on November 24, 2010, and consisted of the $2.5 million Transaction Fee for services directly attributable to the equity offering, which was recorded as a reduction of additional paid-in capital, and the $16.9 million Termination Fee. The Termination Fee, when combined with the related write-off of prepaid advisory fees, amounted to an $18.1 million expense which is reported in the statement of operations as Termination of Sponsor Advisory Agreement; and

 
·
base its interest rate margin above LIBOR on a grid, with reference to its current credit rating. This increased the interest rate margin by 75 basis points for all tranches of debt within the secured credit facility.

The fair values of Aeroflex’s debt instruments are summarized as follows:
 
   
March 31, 2011
       
   
Carrying
   
Estimated
 
   
Amount
   
Fair Value
 
   
(In thousands)
 
Senior secured credit facility B-1 term loan
  $ 372,651     $ 374,515  
Senior secured B-2 term loan
    116,454       116,454  
Senior unsecured notes
    192,845       209,237  
Senior subordinated unsecured term loan
    13,573       14,913  
Other
    745       745  
     Total debt
  $ 696,268     $ 715,864  
 
As of June 30, 2010, Aeroflex’s total debt had a carrying value of $901.8 million and a fair value of $877.7 million.

The estimated fair values of each of Aeroflex’s debt instruments are based on quoted market prices for the same or similar issues. Fair value estimates related to Aeroflex’s debt instruments are made at a specific point in time based on relevant market information.  These estimates are subjective in nature and involve uncertainties and matters of significant judgments and therefore cannot be determined with precision.  Changes in assumptions could significantly affect these estimates.

As of March 31, 2011, Aeroflex is in compliance with all of the covenants contained in the loan agreements.

Interest paid was $56.7 million and $52.8 million for the nine months ended March 31, 2011 and 2010, respectively. Accrued interest of $5.7 million and $13.9 million was included in accrued expenses and other current liabilities at March 31, 2011 and June 30, 2010, respectively.

On May 9, 2011, Aeroflex entered into a new senior secured credit facility with various lenders, consisting of a senior secured term loan facility of $725.0 million and a senior secured revolving credit facility of $75.0 million, to refinance $695.5 million of its outstanding debt.  See Note 16 for additional information on the debt refinancing.
 
 
21

 

10.  Loss on Liquidation of Foreign Subsidiary
 
In connection with the 2003 acquisition of one of our wireless businesses in the U.K., we set up a foreign partnership to finance the acquisition.  We invested $19.5 million in the partnership and the partnership advanced those funds to our foreign holding company in the form of a loan, the proceeds of which were used for the acquisition.
 
During the nine months ended March 31, 2010, the loan was fully repaid to the partnership, with interest, and we received a return of capital and dividends.  The partnership has been substantially liquidated.
 
As a result of changes in foreign currency rates, there was a cumulative translation adjustment of $7.7 million remaining after substantially all of the assets were returned to us and substantially all of the liabilities were satisfied.  In accordance with U.S. GAAP, this remaining cumulative translation adjustment has been expensed in the period during which the substantial liquidation of the partnership occurred and presented as a non-cash loss on liquidation of foreign subsidiary in our Condensed Consolidated Statement of Operations for the nine months ended March 31, 2010.  This loss was not deductible for income tax purposes.
 
11.  Comprehensive Income

The components of comprehensive income (loss) were as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
March 31,
         
March 31,
       
   
2011
   
2010
   
2011
   
2010
 
(In thousands)
                       
Net income (loss)
  $ 4,127     $ 2,856     $ (13,093 )   $ (28,301 )
Increase (decrease) in fair value of
                               
   interest rate swap contracts, net of tax
                               
   provision (benefit) of $401, $927,
                               
   $2,567 and $2,013
    632       1,460       4,046       3,285  
Valuation allowance against
                               
   non-current marketable securities
    -       780       1,276       1,002  
Foreign currency translation adjustment,
                               
    net of tax provision (benefit) of $0, $(1,033),
                               
    $625 and $(416)
    7,200       (7,890 )     14,983       (1,877 )
Total comprehensive income (loss)
  $ 11,959     $ (2,794 )   $ 7,212     $ (25,891 )
 
 
22

 
 
Accumulated other comprehensive income (loss) was as follows:
 
   
Unrealized
   
Valuation
                   
   
Gain (Loss)
    Allowance    
Minimum
   
Foreign
       
   
on Interest
   
Against
   
Pension
   
Currency
       
   
Rate Swap
   
Non-Current
   
Liability
   
Translation
       
   
Contracts
   
Marketable
   
Adjustment
   
Adjustment
   
Total
 
   
(net of tax)
   
Securities
   
(net of tax)
   
(net of tax)
   
(net of tax)
 
   
(In thousands)
 
                               
Balance, June 30, 2010
  $ (4,046 )   $ (1,276 )   $ (773 )   $ (47,480 )   $ (53,575 )
Nine months' activity
    4,046       1,276       -       14,983       20,305  
Balance, March 31, 2011
  $ -     $ -     $ (773 )   $ (32,497 )   $ (33,270 )

The valuation allowance for non-current marketable securities was not adjusted for income taxes as it would have created a capital loss carryforward upon realization for which we would have recorded a valuation allowance against the related deferred tax asset.

Although, as of March 31, 2011, deferred U.S. income taxes have been provided on certain undistributed foreign earnings of a U.K. limited partnership subsidiary, we have not recorded a deferred U.S. income tax on the foreign currency translation adjustment since only an insignificant amount relates to that subsidiary.

12.  Legal Matters
 
In March 2005, we sold the net assets of our shock and vibration control device manufacturing business, which we refer to as VMC. Under the terms of the sale agreements, we retained certain liabilities relating to adverse environmental conditions that existed at the premises occupied by VMC as of the date of sale. We recorded a liability for the estimated remediation costs related to adverse environmental conditions that existed at the VMC premises when it was sold. The accrued environmental liability at March 31, 2011 was $1.4 million, of which $322,000 was expected to be paid within one year.

We have identified instances of noncompliance with the International Traffic in Arms Regulations (“ITAR”) in certain of our past business activities as well as in the pre-acquisition business activities of certain recently acquired companies. These include the inadvertent misclassification and/or export of products without the required license and the disclosure of controlled technology to certain foreign national employees. These matters were formally disclosed to the U.S. Department of State from time to time during the period from 2007 through 2010.

For example, in fiscal 2007, when we became aware that certain RadHard bidirectional multipurpose transceivers sold by us since 1999 may have been subject to the licensing jurisdiction of the U.S. Department of State in accordance with ITAR, we filed a Voluntary Disclosure with the  Department of State describing the details of the possible inadvertent misclassification and identifying certain unauthorized exports from the United States to end-users in a number of countries, including China and Russia. Once our request for reclassification was denied and a determination was made that the product was subject to the licensing jurisdiction of the Department of State in accordance with ITAR, on September 18, 2008, we filed an addendum to our Voluntary Disclosure identifying other products that may have been subject to the licensing jurisdiction of the U.S. Department of State in accordance with ITAR but were inadvertently misclassified and exported without a license.

At this time it is not possible to determine whether any fines or other penalties will be asserted against us or the materiality of the outcome of any of these ITAR matters.
 
 
23

 
 
We are also involved in various other claims and legal actions that arise in the ordinary course of business. We do not believe that the ultimate resolution of any of these actions will have a material adverse effect on our business, results of operations, financial position, liquidity or capital resources.

13.  Business Segments

We are a global provider of radio frequency, or RF, and microwave integrated circuits, components and systems used in the design, development and maintenance of technically demanding, high-performance wireless communication systems. Our solutions include highly specialized microelectronic components and test and measurement equipment used by companies in the space, avionics, defense, commercial wireless communications, medical and other markets. Approximately 26% and 32% of our sales for the three months ended March 31, 2011 and 2010, respectively, and 29% and 33% for the nine months ended March 31, 2011 and 2010 were to agencies of the United States government or to prime defense contractors or subcontractors of the United States government. No customer constituted more than 10% of sales during any of the periods presented. Inter-segment sales were not material and have been eliminated from the tables below.

The majority of our operations are located in the United States. We also have operations in Europe and Asia, with our most significant foreign operations in the U.K.  Net sales from facilities located in the U.K. were approximately $47.5 million and $48.9 million for the three months ended March 31, 2011 and 2010 and $128.0 million and $120.0 million for the nine months ended March 31, 2011 and 2010, respectively.  Total assets of the U.K. operations were $188.3 million as of March 31, 2011 and $159.9 million as of June 30, 2010.

Net sales, based on the customers’ locations, attributed to the United States and other regions were as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
March 31,
         
March 31,
       
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
United States of America
  $ 101,533     $ 94,700     $ 291,364     $ 267,089  
Europe and Middle East
    40,623       40,975       105,281       103,684  
Asia and Australia
    44,726       29,550       117,841       85,655  
Other regions
    6,337       3,210       16,243       8,862  
    $ 193,219     $ 168,435     $ 530,729     $ 465,290  
 
We organize our operations into two segments: Aeroflex Microelectronics Solutions, or AMS and Aeroflex Test Solutions, ATS. We engineer, manufacture and market a diverse range of products in each of our segments.
 
AMS offers a broad range of microelectronics products and is a leading provider of high-performance, high reliability specialty microelectronics components. Its products include high reliability, or HiRel, microelectronics/semiconductors, RF and microwave components, mixed-signal/digital ASICs and motion control products. ATS is a leading provider of a broad line of specialized test and measurement hardware and software products. Its products include wireless test equipment, military radio and private mobile radio test equipment, avionics test equipment, synthetic test equipment and other general purpose test equipment.
 
 
24

 
Selected financial data by segment is as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
March 31,
   
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
                         
Net sales
                       
   Microelectronic solutions ("AMS")
  $ 97,856     $ 83,418     $ 264,386     $ 229,939  
   Test solutions ("ATS")
    95,363       85,017       266,343       235,351  
   Net sales
  $ 193,219     $ 168,435     $ 530,729     $ 465,290  
                                 
Segment adjusted operating income
                               
    - AMS
  $ 28,796     $ 23,029     $ 70,625     $ 59,940  
    - ATS
    18,996       19,005       43,024       47,156  
    - General corporate expense
    (3,233 )     (2,189 )     (8,496 )     (7,378 )
Adjusted operating income
    44,559       39,845       105,153       99,718  
                                 
Amortization of acquired intangibles
                               
   - AMS
    (9,220 )     (8,733 )     (27,676 )     (26,312 )
   - ATS
    (6,680 )     (6,675 )     (20,030 )     (20,215 )
Share-based compensation
                               
   - Corporate
    (629 )     (518 )     (1,655 )     (1,563 )
Restructuring charges
                               
   - AMS
    (797 )     -       (6,928 )     -  
   - ATS
    (1,901 )     (105 )     (3,862 )     (356 )
Business acquisition costs
                               
   - Corporate
    -       -       (282 )     -  
Merger related expenses - Corporate
    -       (647 )     (1,222 )     (2,111 )
Termination of Sponsor Advisory
                               
   Agreement - Corporate
    -       -       (18,133 )     -  
Loss on liquidation of foreign
                               
   subsidiary - ATS
    -       -       -       (7,696 )
Increase in fair value of acquisition
                               
   contingent consideration liability
                               
   - Corporate
    (409 )     -       (1,193 )     -  
Current period impact of acquisition
                               
   related adjustments:
                               
   Inventory - AMS
    -       -       (551 )     (246 )
   Inventory - ATS
    -       -       (447 )     -  
   Depreciation - AMS
    (38 )     (251 )     (180 )     (791 )
   Depreciation - ATS
    23       (172 )     (76 )     (989 )
   Depreciation - Corporate
    (55 )     (55 )     (165 )     (165 )
   Deferred revenue - ATS
    (21 )     (31 )     (69 )     (96 )
Operating income (GAAP)
    24,832       22,658       22,684       39,178  
                                 
Interest expense
    (13,852 )     (20,815 )     (55,803 )     (63,272 )
Loss on extinguishment of debt
    -       -       (25,178 )     -  
Gain from a bargain purchase of
                               
   a business
    -       -       173       -  
Other income (expense), net
    (119 )     222       (526 )     701  
Income (loss) before income taxes
  $ 10,861     $ 2,065     $ (58,650 )   $ (23,393 )
 
 
25

 
 
Management evaluates the operating results of our two segments based upon adjusted operating income, which is pre-tax operating income before costs related to amortization of acquired intangibles, share-based compensation, restructuring charges, business acquisition and merger related expenses, Termination of Sponsor Advisory Agreement, loss on liquidation of foreign subsidiary and the impact of any acquisition related adjustments. We have set out above our adjusted operating income by segment and in the aggregate, and have provided a reconciliation of adjusted operating income to operating income (loss) on a GAAP basis and income (loss) before income taxes for the periods presented.

14.
Income Taxes

The income tax benefit was $45.6 million for the nine months ended March 31, 2011 on a pre-tax loss of $58.7 million.  We recorded an income tax provision for the nine months ended March 31, 2010 of $4.9 million on a pre-tax loss of $23.4 million. The effective income tax rate for both periods differed from the amount computed by applying the U.S. Federal income tax rate to income before income taxes primarily due to foreign, state and local income taxes, including U.S. income tax on certain foreign net income that we anticipate will be repatriated to the U.S. The provisions are a combination of projected annual U.S. tax benefits on domestic losses and foreign tax expense on foreign earnings. The resulting projected net consolidated income tax benefit was then applied to the projected consolidated pre-tax amount for the year to calculate the annual effective tax rate, which contributed to the high income tax benefit as a percentage of pre-tax loss.

During the three months ended September 30, 2010, we identified an overstatement of deferred income tax liabilities established in the fourth quarter of fiscal 2009 and throughout fiscal 2010 related to U.S. income taxes provided on unremitted foreign earnings. After consideration of both quantitative and qualitative factors, we determined the amounts were not material to any of those prior period financial statements or the fiscal 2011 estimated results and thus corrected the balance in the three months ended September 30, 2010.  The adjustment resulted in a reduction of deferred income tax liabilities of $3.7 million, with a corresponding increase in income tax benefit in the statement of operations for the three months ended September 30, 2010.  The adjustment did not impact the statement of cash flows.

The income tax benefit for the nine months ended March 31, 2011 reflects various discrete items, including a $1.2 million income tax benefit for the retroactive reinstatement of the U.S. R&D credit and a reduction of $5.8 million of deferred tax liabilities related to U.S. income taxes previously provided on unremitted foreign earnings.  As a direct result of Aeroflex Holding’s IPO, and related repurchase of a portion of Aeroflex’s debt in the quarter ended December 31, 2010, interest payments have decreased.  Consequently, in the quarter ended December 31, 2010 we changed our intent as to the amount and method of repatriations of foreign earnings, which resulted in the reduction of deferred tax liabilities.

The tax provision for the nine months ended March 31, 2010 was affected by the unfavorable impact of a $7.7 million nondeductible loss on the liquidation of a foreign subsidiary, and the favorable impact of a $10.3 million loss for tax purposes on the write-off of our investment in a foreign subsidiary in fiscal 2009.  For financial statement purposes, the loss had been recognized in the prior periods, however, for tax purposes the loss was recognized at the time of divestiture, effective September 2009.

 
26

 

15. 
Guarantor/Non-Guarantor Financial Information

The following supplemental condensed consolidating financial information sets forth, on an unconsolidated basis, the balance sheets at March 31, 2011 and June 30, 2010, the statements of operations for the three and nine months ended March 31, 2011 and 2010 and the statements of cash flows for the nine months ended March 31, 2011 and 2010 for Aeroflex (“Parent”), the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries. The supplemental condensed consolidating financial information reflects for all periods presented, the investments of Parent in the Guarantor Subsidiaries as well as investments of Parent and the Guarantor Subsidiaries in the Non-Guarantor Subsidiaries, in all cases using the equity method.  For purposes of this note, Guarantor Subsidiaries refer to the subsidiaries of Parent that have guaranteed principal debt obligations of Parent.  The purchase price allocation adjustments, including applicable intangible assets, arising from business acquisitions have been pushed down to the applicable subsidiary columns (see Note 3).

Each of the Guarantor Subsidiaries is 100% owned directly or indirectly by the Parent and guarantees the debt on an unconditional and joint and several basis.

Aeroflex Incorporated
Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2011
(In thousands)

         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
                               
Net sales
  $ -     $ 137,617     $ 57,673     $ (2,071 )   $ 193,219  
Cost of sales
    -       65,153       23,830       (2,122 )     86,861  
   Gross profit
    -       72,464       33,843       51       106,358  
Selling, general and administrative costs
    4,326       24,397       9,542       -       38,265  
Research and development costs
    -       16,507       8,156       -       24,663  
Amortization of acquired intangibles
    -       13,554       2,346       .       15,900  
Restructuring charges
    -       797       1,901       -       2,698  
Operating income (loss)
    (4,326 )     17,209       11,898       51       24,832  
                                         
Other income (expense):
                                       
   Interest expense
    (13,830 )     (14 )     (8 )     -       (13,852 )
   Other income (expense), net
    12       7       (138 )     -       (119 )
Intercompany charges
    20,149       (19,561 )     (588 )     -       -  
Income (loss) before income taxes
    2,005       (2,359 )     11,164       51       10,861  
Provision (benefit) for income taxes
    416       (489 )     2,565       4,242       6,734  
Equity income (loss) of subsidiaries
    2,538       8,248       -       (10,786 )     -  
Net income (loss)
  $ 4,127     $ 6,378     $ 8,599     $ (14,977 )   $ 4,127  

 
27

 

Aeroflex Incorporated
Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2010
(In thousands)

         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
                               
Net sales
  $ -     $ 115,931     $ 54,171     $ (1,667 )   $ 168,435  
Cost of sales
    -       59,178       20,773       (1,816 )     78,135  
   Gross profit
    -       56,753       33,398       149       90,300  
Selling, general and administrative costs
    3,409       19,247       8,629       -       31,285  
Research and development costs
    -       14,023       6,821       -       20,844  
Amortization of acquired intangibles
    -       13,250       2,158       -       15,408  
Restructuring charges
    -       -       105       -       105  
Operating income (loss)
    (3,409 )     10,233       15,685       149       22,658  
                                         
Other income (expense):
                                       
   Interest expense
    (20,797 )     (17 )     (1 )     -       (20,815 )
   Other income (expense), net
    138       213       (129 )     -       222  
Intercompany charges
    19,808       (19,317 )     (491 )     -       -  
Income (loss) before income taxes
    (4,260 )     (8,888 )     15,064       149       2,065  
Provision (benefit) for income taxes
    (774 )     928       2,697       (3,642 )     (791 )
Equity income (loss) of subsidiaries
    6,342       12,049       -       (18,391 )     -  
Net income (loss)
  $ 2,856     $ 2,233     $ 12,367     $ (14,600 )   $ 2,856  
 
 
28

 

Aeroflex Incorporated
Condensed Consolidating Statement of Operations
For the Nine Months Ended March 31, 2011
(In thousands)

         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
                               
Net sales
  $ -     $ 374,276     $ 162,017     $ (5,564 )   $ 530,729  
Cost of sales
    -       184,512       71,182       (5,989 )     249,705  
   Gross profit
    -       189,764       90,835       425       281,024  
Selling, general and administrative costs
    13,013       68,770       31,451       -       113,234  
Research and development costs
    -       43,954       24,523       -       68,477  
Amortization of acquired intangibles
    -       40,792       6,914       -       47,706  
Termination of Sponsor Advisory Agreement
    18,133       -       -       -       18,133  
Restructuring charges
    -       6,928       3,862       -       10,790  
Operating income (loss)
    (31,146 )     29,320       24,085       425       22,684  
                                         
Other income (expense):
                                       
   Interest expense
    (55,753 )     (42 )     (8 )     -       (55,803 )
   Loss on extinguishment of debt
    (25,178 )     -       -       -       (25,178 )
   Gain from a bargain purchase of a business
    -       -       173       -       173  
   Other income (expense), net
    (273 )     125       (378 )     -       (526 )
Intercompany charges
    60,173       (58,400 )     (1,773 )     -       -  
Income (loss) before income taxes
    (52,177 )     (28,997 )     22,099       425       (58,650 )
Provision (benefit) for income taxes
    (28,658 )     (9,994 )     4,636       (11,541 )     (45,557 )
Equity income (loss) of subsidiaries
    10,426       16,735       -       (27,161 )     -  
Net income (loss)
  $ (13,093 )   $ (2,268 )   $ 17,463     $ (15,195 )   $ (13,093 )
 
 
29

 

Aeroflex Incorporated
Condensed Consolidating Statement of Operations
For the Nine Months Ended March 31, 2010
(In thousands)

         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
                               
Net sales
  $ -     $ 333,946     $ 135,530     $ (4,186 )   $ 465,290  
Cost of sales
    -       170,892       56,597       (4,230 )     223,259  
   Gross profit
    -       163,054       78,933       44       242,031  
Selling, general and administrative costs
    11,217       56,403       25,368       -       92,988  
Research and development costs
    -       36,169       19,117       -       55,286  
Amortization of acquired intangibles
    -       39,909       6,618       -       46,527  
Restructuring charges
    -       -       356       -       356  
Loss on liquidation of foreign subsidiary
    -       7,696       -       -       7,696  
Operating income (loss)
    (11,217 )     22,877       27,474       44       39,178  
                                         
Other income (expense):
                                       
   Interest expense
    (63,218 )     (51 )     (3 )     -       (63,272 )
   Other income (expense), net
    479       587       (365 )     -       701  
Intercompany charges
    59,399       (57,953 )     (1,446 )     -       -  
Income (loss) before income taxes
    (14,557 )     (34,540 )     25,660       44       (23,393 )
Provision (benefit) for income taxes
    (5,573 )     436       4,962       5,083       4,908  
Equity income (loss) of subsidiaries
    (19,317 )     19,683       -       (366 )     -  
Net income (loss)
  $ (28,301 )   $ (15,293 )   $ 20,698     $ (5,405 )   $ (28,301 )
 
 
30

 
 
Aeroflex Incorporated
Condensed Consolidating Balance Sheet
As of March 31, 2011
(In thousands)
 
         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
Assets
                             
Current assets:
                             
Cash and cash equivalents
  $ 30,275     $ 2,117     $ 34,760     $ -     $ 67,152  
Accounts receivable, net
    -       91,575       66,807       -       158,382  
Inventories
    -       119,526       52,570       (884 )     171,212  
Deferred income taxes
    2,372       23,274       257       -       25,903  
Prepaid expenses and other current assets
    1,219       6,005       5,988       -       13,212  
Total current assets
    33,866       242,497       160,382       (884 )     435,861  
                                         
Property, plant and equipment, net
    12,340       67,041       22,395       -       101,776  
Deferred financing costs, net
    16,298       -       -       -       16,298  
Other assets
    14,061       8,195       6,260       -       28,516  
Intangible assets with definite lives, net
    -       172,766       26,683       -       199,449  
Intangible assets with indefinite lives
    -       88,413       26,276       -       114,689  
Goodwill
    (10 )     414,994       45,680       -       460,664  
Total assets
  $ 76,555     $ 993,906     $ 287,676     $ (884 )   $ 1,357,253  
                                         
Liabilities and Stockholder's Equity
                                       
Current liabilities:
                                       
Current portion of long-term debt
  $ -     $ 360     $ -     $ -     $ 360  
Accounts payable
    53       23,930       23,257       -       47,240  
Advance payments by customers and deferred
                                       
revenue
    -       17,991       13,528       -       31,519  
Income taxes payable
    (1,375 )     259       2,439       -       1,323  
Accrued payroll expenses
    2,204       18,084       2,429       -       22,717  
Accrued expenses and other current liabilities
    12,897       14,671       16,048       -       43,616  
Total current liabilities
    13,779       75,295       57,701       -       146,775  
                                         
Long-term debt
    695,523       385       -       -       695,908  
Deferred income taxes
    (12,757 )     103,202       13,606       (11,540 )     92,511  
Defined benefit plan obligations
    5,526       -       -       -       5,526  
Other long-term liabilities
    8,324       1,276       3,230       -       12,830  
Intercompany investment
    (316,126 )     86,765       229,361       -       -  
Intercompany receivable/payable
    (854,579 )     889,490       (34,428 )     (483 )     -  
Total liabilities
    (460,310 )     1,156,413       269,470       (12,023 )     953,550  
                                         
Stockholder's equity
    536,865       (162,507 )     18,206       11,139       403,703  
Total liabilities and stockholder's equity
  $ 76,555     $ 993,906     $ 287,676     $ (884 )   $ 1,357,253  
 
 
31

 
 
Aeroflex Incorporated
Condensed Consolidating Balance Sheet
As of June 30, 2010
(In thousands)
 
         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
Assets
                             
Current assets:
                             
Cash and cash equivalents
  $ 75,187     $ (3,821 )   $ 29,297     $ -     $ 100,663  
Accounts receivable, net
    -       88,051       53,544       -       141,595  
Inventories
    -       94,669       33,209       (1,310 )     126,568  
Deferred income taxes
    4,939       23,224       (145 )     -       28,018  
Prepaid expenses and other current assets
    3,046       2,840       5,097       -       10,983  
Total current assets
    83,172       204,963       121,002       (1,310 )     407,827  
                                         
Property, plant and equipment, net
    12,491       69,150       20,021       -       101,662  
Non-current marketable securities, net
    9,769       -       -       -       9,769  
Deferred financing costs, net
    20,983       -       -       -       20,983  
Other assets
    13,634       6,385       1,799       -       21,818  
Intangible assets with definite lives, net
    -       207,849       30,464       -       238,313  
Intangible assets with indefinite lives
    -       85,404       24,490       -       109,894  
Goodwill
    (10 )     404,632       41,252       -       445,874  
Total assets
  $ 140,039     $ 978,383     $ 239,028     $ (1,310 )   $ 1,356,140  
                                         
Liabilities and Stockholder's Equity
                                       
Current liabilities:
                                       
Current portion of long-term debt
  $ 21,457     $ 360     $ -     $ -     $ 21,817  
Accounts payable
    4       14,376       14,423       -       28,803  
Advanced payments by customers and deferred
                                       
revenue
    -       19,091       11,650       -       30,741  
Income taxes payable
    969       43       3,603       -       4,615  
Accrued payroll expenses
    2,198       18,834       2,050       -       23,082  
Accrued expenses and other current liabilities
    33,904       12,598       12,315       -       58,817  
Total current liabilities
    58,532       65,302       44,041       -       167,875  
                                         
Long-term debt
    879,645       385       -       -       880,030  
Deferred income taxes
    15,835       109,570       13,444       -       138,849  
Defined benefit plan obligations
    5,763       -       -       -       5,763  
Other long-term liabilities
    1,595       8,303       2,741       -       12,639  
Intercompany investment
    (287,515 )     60,154       227,361       -       -  
Intercompany receivable/payable
    (842,950 )     878,174       (34,740 )     (484 )     -  
Total liabilities
    (169,095 )     1,121,888       252,847       (484 )     1,205,156  
                                         
Stockholder's equity:
    309,134       (143,505 )     (13,819 )     (826 )     150,984  
Total liabilities and stockholder's equity
  $ 140,039     $ 978,383     $ 239,028     $ (1,310 )   $ 1,356,140  
 
 
32

 
 
Aeroflex Incorporated
Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended March 31, 2011
(In thousands)
 
         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
                               
Cash flows from operating activities:
                             
Net income (loss)
  $ (13,093 )   $ (2,268 )   $ 17,463     $ (15,195 )   $ (13,093 )
Changes in operating assets and liabilities and non-cash items included in net income (loss)
    (47,693 )     37,493       (10,000 )     15,195       (5,005 )
Net cash provided by (used in) operating activities
    (60,786 )     35,225       7,463       -       (18,098 )
Cash flows from investing activities:
                                       
Payments for purchase of businesses, net of cash acquired
    (5,624 )     (17,969 )     -       -       (23,593 )
Capital expenditures
    (400 )     (11,813 )     (4,919 )     -       (17,132 )
Proceeds from sale of marketable securities
    10,357       -       -       -       10,357  
Proceeds from sale of property, plant and equipment
    -       495       324       -       819  
Net cash provided by (used in) investing activities
    4,333       (29,287 )     (4,595 )     -       (29,549 )
                                         
Cash flows from financing activities:
                                       
Capital contribution from Aeroflex Holding
    244,021       -       -       -       244,021  
                                         
                                         
Repurchase of senior unsecured notes and senior subordinated unsecured term loans, including premiums and fees
    (207,690 )     -       -       -       (207,690 )
Debt repayments
    (21,458 )     -       -       -       (21,458 )
Debt financing costs
    (3,332 )     -       -       -       (3,332 )
Net cash provided by (used in) financing activities
    11,541       -       -       -       11,541  
Effect of exchange rate changes on cash and cash equivalents
    -       -       2,595       -       2,595  
Net increase (decrease) in cash and cash equivalents
    (44,912 )     5,938       5,463       -       (33,511 )
Cash and cash equivalents at beginning of period
    75,187       (3,821 )     29,297       -       100,663  
Cash and cash equivalents at end of period
  $ 30,275     $ 2,117     $ 34,760     $ -     $ 67,152  
 
 
33

 
 
Aeroflex Incorporated
Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended March 31, 2010
(In thousands)
 
         
Guarantor
   
Non-Guarantor
             
   
Parent
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Consolidated
 
                               
Cash flows from operating activities:
                             
Net income (loss)
  $ (28,301 )   $ (15,293 )   $ 20,698     $ (5,405 )   $ (28,301 )
                                         
Changes in operating assets and liabilities and non-cash items included in net income (loss)
    66,418       23,792       (15,064 )     5,405       80,551  
Net cash provided by (used in) operating activities
    38,117       8,499       5,634       -       52,250  
Cash flows from investing activities:
                                       
Payment for purchase of business
    (4,000 )     -       -       -       (4,000 )
Capital expenditures
    (171 )     (9,444 )     (3,561 )     -       (13,176 )
Proceeds from sale of marketable securities
    8,580       -       -       -       8,580  
Proceeds from the sale of property, plant and equipment
    -       770       251       -       1,021  
Other, net
    (12 )     -       -       -       (12 )
Net cash provided by (used in) investing activities
    4,397       (8,674 )     (3,310 )     -       (7,587 )
Cash flows from financing activities:
                                       
Debt repayments
    (4,012 )     -       -       -       (4,012 )
Net cash provided by (used in) financing activities
    (4,012 )     -       -       -       (4,012 )
Effect of exchange rate changes on cash and cash equivalents
    -       -       (2,051 )     -       (2,051 )
Net increase (decrease) in cash and cash equivalents
    38,502       (175 )     273       -       38,600  
Cash and cash equivalents at beginning of period
    31,221       (15 )     26,542       -       57,748  
Cash and cash equivalents at end of period
  $ 69,723     $ (190 )   $ 26,815     $ -     $ 96,348  
 
 
34

 
16. 
Subsequent Event

Debt Refinancing

On May 9, 2011, Aeroflex entered into a new senior secured credit facility with various lenders, consisting of a senior secured term loan facility of $725.0 million and a senior secured revolving credit facility of $75.0 million, to refinance $695.5 million of its outstanding debt. The new term loan facility provides for $1.8 million quarterly principal repayments commencing September 30, 2011, with the remaining balance due at maturity on May 9, 2018. Unless terminated earlier, the new revolving credit facility will expire on May 9, 2016. No amounts have been drawn under the revolving credit agreement. The new senior secured credit facility is subject to mandatory prepayments based on certain events, including a percentage of our excess cash flows, which ranges from 0% to 50%, depending on the level of our senior secured leverage ratio. The outstanding borrowings under the new senior secured credit facility bear interest, payable quarterly, at a rate per annum equal to either: (i) the base rate (as defined in the new senior secured credit facility), plus an applicable margin of 2.0%, or (ii) the adjusted LIBOR rate (as defined in the new senior secured credit facility), plus an applicable margin of 3.0%. The adjusted LIBOR rate has a floor of 1.25% on the term loan. Certain customary fees are payable to the lenders and the agents under the new senior secured credit facility, including, without limitation, commitment fees, letter of credit fees, issuer fronting fees and an annual facility servicing fee. The new senior secured credit facility contains various customary affirmative and negative covenants and customary events of default. Aeroflex’s new senior secured credit facility contains a maximum leverage ratio of total debt (less up to $15.0 million of unrestricted cash) to Adjusted EBITDA financial covenant, as defined in the new senior secured credit facility. The maximum leverage ratio permitted as of June 30, 2011 is 5.20, which periodically decreases to 4.75 on June 30, 2012. Additional covenants include restrictions on indebtedness, liens, investments, dividends, disposition of assets, acquisitions and transactions with shareholders and affiliates.
 
The $725.0 million proceeds were, or will be, used:

 
1)
to refinance $695.5 million of Aeroflex’s outstanding debt, as follows:

 
·
to repay the entire outstanding balance of $489.1 million under Aeroflex’s existing senior secured credit facilities;

 
·
to repurchase, pursuant to a tender offer initiated on April 25, 2011, all of Aeroflex’s senior notes of $192.8 million (Aeroflex expects to call any notes not tendered); and

 
·
to repurchase all of Aeroflex’s senior subordinated unsecured term loans of $13.6 million.

 
2)
to pay fees and expenses totaling $33.8 million in connection with the refinancing, including:

 
·
fees to the lenders of $14.2 million;

 
·
a premium of approximately 9% on the repurchased senior notes and senior subordinated unsecured term loans, which amounted to $18.3 million; and

 
·
professional fees and other expenses of approximately $1.3 million.

The total cash outlay related to the debt refinancing, including premiums, fees and expenses listed above and $10.7 million of interest accrued through May 9, 2011, exceeds the $725.0 million proceeds by $15.0 million, which was paid from our available cash.

 
35

 

We will record approximately $15.5 million of these fees related to the new facility as deferred financing costs and record approximately $34.2 million related to the repayment of the existing debt as a loss on extinguishment of debt, including the write-off of the existing deferred financing costs of $15.9 million.

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q for the period ended March 31, 2011 is a combined quarterly report being separately filed by two registrants: Aeroflex Holding Corp. (“Aeroflex Holding”) and Aeroflex Incorporated (“Aeroflex”), a direct wholly-owned subsidiary of Aeroflex Holding.  Unless the context provides otherwise, references to “we,” “our,” “the Company,” or “us” refer collectively to Aeroflex Holding and its subsidiary, Aeroflex, including Aeroflex’s consolidated subsidiaries.

Forward-Looking Statements

This report contains forward-looking statements. All statements other than statements of historical fact are forward-looking statements for purposes of the U.S. federal and state securities laws. These statements may be identified by the use of forward looking terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will” or the negative thereof or other variations thereon or comparable terminology.
 
We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond our control. These and other important factors may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. A listing of some of the key factors that could cause actual results to differ from our expectations is included under the caption “Risk Factors” disclosed in Aeroflex Holding’s Registration Statement and Aeroflex’s Fiscal 2010 Form 10-K.

Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements.  The forward-looking statements included in this Form 10-Q are made only as of the date hereof.  We undertake no obligation to update or revise any forward-looking statements, either to reflect new developments, or for any other reason, except as required by law.

Overview

Company Background

We are a leading global provider of RF and microwave integrated circuits, components and systems used in the design, development and maintenance of technically demanding, high-performance wireless communication systems.  Our solutions include highly specialized microelectronic components and test and measurement equipment used by companies in the space, avionics, defense, commercial wireless communications, medical and other markets.  We have targeted customers in these end markets because we believe our solutions address their technically demanding requirements.  We were founded in 1937 and have proprietary technology that is based on extensive know-how and a long history of research and development focused on specialized technologies, often in collaboration with our customers.
 
 
36

 

Business Segments

Our business segments and major products included in each segment are as follows:

Microelectronic Solutions (“AMS”)

 
·
HiRel microelectronics/semiconductors
 
 
·
RF and microwave components
 
 
·
Mixed-signal/digital ASICs
 
 
·
Motion control products
 
Test Solutions (“ATS”)

 
·
Wireless test equipment
 
 
·
Military radio and Private Mobile Radio, or PMR, test equipment
 
 
·
Avionics test equipment
 
 
·
Synthetic test equipment
 
 
·
General purpose test equipment and other
 
Stock Split

Aeroflex Holding’s board of directors authorized an increase in Aeroflex Holding’s authorized shares of common stock to 300,000,000 and a 65,000,000 for 1 common stock split, both of which became effective on November 18, 2010. Aeroflex Holding’s stockholders’ equity has been retroactively adjusted to give effect to the stock split for all periods presented by reclassifying the par value of the additional shares issued in connection with the split from additional paid-in capital to common stock. In addition, all share numbers and per share amounts in Aeroflex Holding’s consolidated financial statements have been retroactively adjusted to give effect to the stock split.

Initial Public Offering

On November 19, 2010, Aeroflex Holding consummated an initial public offering (“IPO”) of common stock in which it sold 19,789,180 shares of common stock, par value of $.01 per share, at a price of $13.50 per share. Aeroflex Holding received net proceeds of $244.0 million from the IPO, after deducting underwriting discounts and offering expenses, including a $2.5 million transaction fee which was paid to affiliates of the Sponsors under the advisory agreement with them for services directly attributable to the equity offering (“Transaction Fee”).  Aeroflex Holding used the net proceeds of the IPO to make a capital contribution to Aeroflex.  In connection with the IPO, Aeroflex:

 
·
Repurchased $186.6 million of its senior unsecured notes and senior subordinated unsecured term loans and paid tender premiums and expenses related thereto;

 
·
Paid a $16.9 million termination fee to affiliates of the Sponsors to terminate the advisory agreement with them, which, including the related write-off of prepaid advisory fees, resulted in an $18.1 million expense (“Termination Fee”); and

 
·
Amended its senior secured credit facility, for which a $3.3 million fee was paid to the lenders.
 
 
37

 

Debt Repurchase

In December 2010, Aeroflex repurchased approximately $32.2 million of its senior unsecured notes and $154.4 million of its senior subordinated unsecured term loans. This resulted in a $25.2 million loss on extinguishment of debt, which is comprised of the following:

 
·
an 11% premium paid on the debt repurchased, which amounted to $20.5 million;

 
·
the write-off of the related deferred financing costs of $4.0 million; and

 
·
professional fees of $614,000.

Amendment to Senior Secured Debt Agreement

On November 4, 2010, Aeroflex amended its senior secured credit facility, for which it paid a $3.3 million fee to the lenders which was recorded as deferred financing costs and $579,000 of other costs that were expensed as incurred, which allowed Aeroflex to, among other things:

 
·
increase the amount of cash it can spend for acquisitions of businesses from $20 million per year and a $100 million aggregate amount, to $200 million in the aggregate (with no annual limit), from the effective date of the amendment to the credit facility maturity date, August 15, 2014;

 
·
pay certain fees to affiliates of the Sponsors upon the completion of the Aeroflex Holding IPO.  These fees were paid on November 24, 2010, and consisted of the $2.5 million Transaction Fee for services directly attributable to the equity offering, which was recorded as a reduction of additional paid-in capital, and the $16.9 million Termination Fee. The Termination Fee, when combined with the related write-off of prepaid advisory fees, amounted to an $18.1 million expense which is reported in the statement of operations as Termination of Sponsor Advisory Agreement; and

 
·
base its interest rate margin above LIBOR on a grid, with reference to its current credit rating. This increased the interest rate margin by 75 basis points for all tranches of debt within the secured credit facility.
 
 
38

 

Results of Operations

The following table sets forth our historical results of operations as a percentage of net sales for the periods indicated below:
 
   
Three Months Ended
March 31,
   
Nine Months Ended
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %
Costs of sales
    45.0       46.4       47.0       48.0  
   Gross profit
    55.0       53.6       53.0       52.0  
                                 
Operating expenses:
                               
Selling, general and administrative costs
    19.7       18.5       21.4       19.9  
Research and development costs
    12.8       12.4       12.9       11.9  
Amortization of acquired intangibles
    8.2       9.1       9.0       10.0  
Termination of Sponsor Advisory Agreement
    -       -       3.4       -  
Restructuring charges
    1.4       0.1       2.0       0.1  
Loss on liquidation of foreign subsidiary
    -       -       -       1.7  
Total operating expenses
    42.1       40.1       48.7       43.6  
                                 
Operating income
    12.9       13.5       4.3       8.4  
                                 
Other income (expense):
                               
   Interest expense
    (7.2 )     (12.4 )     (10.5 )     (13.6 )
   Loss on extinguishment of debt
    -       -       (4.7 )     -  
   Gain from a bargain purchase of a
                               
      business
    -       -       -       -  
   Other income (expense), net
    (0.1 )     0.1       (0.1 )     0.2  
                                 
Income (loss) before income taxes
    5.6       1.2       (11.0 )     (5.0 )
Provision (benefit) for income taxes
    3.5       (0.5 )     (8.6 )     1.1  
                                 
Net income (loss)
    2.1 %     1.7 %     (2.4 )%     (6.1 )%
 
 
39

 

Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010

Net Sales.  Net sales increased $24.8 million, or 15%, to $193.2 million for the three months ended March 31, 2011 from $168.4 million for the three months ended March 31, 2010.  Businesses acquired since March 31, 2010 contributed $8.9 million to sales, or 5%, in the current quarter.
 
   
Net Sales
 
Three Months
       
% of
         
% of
       
Ended
       
Consolidated
         
Consolidated
       
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Total
 
   
(In thousands, except percentages)
 
2010
  $ 83,418       49.5 %   $ 85,017       50.5 %   $ 168,435  
2011
  $ 97,856       50.6 %   $ 95,363       49.4 %   $ 193,219  
 
Net sales in the AMS segment increased $14.4 million, or 17%, to $97.9 million for the three months ended March 31, 2011 from $83.4 million for the three months ended March 31, 2010.  Specific variances include a volume driven $7.5 million increase in sales of HiRel RadHard integrated circuits; a volume driven $7.4 million increase in sales of components, including $3.3 million from Advanced Control Components, Inc., or ACC, acquired in August 2010; and additional sales of $1.6 million from Radiation Assured Devices, Inc., or RAD, acquired in June 2010.  The increases in sales were partially offset by volume driven reductions of $1.1 million in sales of motion control products and $1.0 million in sales of microelectronics modules.
 
Net sales in the ATS segment increased $10.3 million, or 12%, to $95.4 million for the three months ended March 31, 2011 from $85.0 million for the three months ended March 31, 2010.  Specific variances include a volume driven $16.6 million increase in sales of radio test products; a volume driven $3.2 million increase in sales of avionic products; and  a volume driven increase in wireless test products sales of $2.2 million, which includes, $3.9 million of sales from Willtek Communications, or Willtek, acquired in May 2010. The increases in net sales were partially offset by a volume driven reduction of $11.6 million in sales of general purpose test products.

Gross Profit.  Gross profit equals net sales less cost of sales. Cost of sales includes materials, direct labor, amortization of capitalized software development costs and overhead expenses such as engineering labor, fringe benefits, depreciation, allocable occupancy costs and manufacturing supplies.

On a consolidated basis, gross profit was $106.4 million, or 55.0% of net sales, for the three months ended March 31, 2011 and $90.3 million, or 53.6% of net sales, for the three months ended March 31, 2010.

   
Gross Profit
 
Three Months
                                   
Ended
       
% of
         
% of
         
% of
 
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Total
   
Net Sales
 
   
(In thousands, except percentages)
 
2010
  $ 42,286       50.7 %   $ 48,014       56.5 %   $ 90,300       53.6 %
2011
  $ 51,971       53.1 %   $ 54,387       57.0 %   $ 106,358       55.0 %
 
Gross margins in the AMS segment were 53.1% for the three months ended March 31, 2011 and 50.7% for the three months ended March 31, 2010.  The increase in gross margins is principally attributable to increased sales of HiRel RadHard integrated circuits, combined with the additional sales of services by RAD, acquired in June 2010, (which has margins higher than the segment average).  Gross profit increased $9.7 million for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010 due to both increased sales and the aforementioned increase in gross margins.
 
 
40

 

Gross margins in the ATS segment were 57.0% for the three months ended March 31, 2011 and 56.5% for the three months ended March 31, 2010. Gross profit increased $6.4 million for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010 due to increased sales.

Selling, General and Administrative Costs.  Selling, general and administrative (“SG&A”) costs include sales, office and management salaries, fringe benefits, commissions, insurance and professional fees.

On a consolidated basis, SG&A costs increased $7.0 million, or 22%, to $38.3 million for the three months ended March 31, 2011.  This increase was primarily attributable to the additional SG&A costs of the acquired businesses, the expansion of our sales and marketing team in the Asia-Pacific region and the increase in the fair value of contingent consideration of an acquired business. SG&A related to the acquired businesses increased SG&A by $1.9 million, or 6% of 2010 total SG&A. As a percentage of sales, SG&A costs increased from 18.5% to 19.7% from the three months ended March 31, 2010 to the three months ended March 31, 2011.

   
Selling, General and Administrative Costs
 
Three Months
                                         
Ended
       
% of
         
% of
               
% of
 
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Corporate
   
Total
   
Net Sales
 
   
(In thousands, except percentages)
 
2010
  $ 10,799       12.9 %   $ 17,077       20.1 %   $ 3,409     $ 31,285       18.5 %
2011
  $ 13,483       13.8 %   $ 20,456       21.5 %   $ 4,326     $ 38,265       19.7 %

In the AMS segment, SG&A costs increased $2.7 million, or 25%, to $13.5 million for the three months ended March 31, 2011. This increase is primarily due to additional SG&A costs of $1.0 million related to RAD, acquired in June 2010, and ACC, acquired in August 2010, and general increases in our existing businesses, primarily due to increased employee related expenses of $1.2 million. SG&A costs in the AMS segment increased from 12.9% to 13.8%, as a percentage of sales, from the three months ended March 31, 2010 to the three months ended March 31, 2011.

In the ATS segment, SG&A costs increased $3.4 million, or 20%, to $20.5 million for the three months ended March 31, 2011, primarily due to increased employee related expenses of $1.8 million, primarily related to the expansion of our sales and marketing team in the Asia-Pacific region, and additional costs of $919,000 related to Willtek, acquired in May 2010.  As a percentage of sales, SG&A costs in the ATS segment increased from 20.1% to 21.5% from the three months ended March 31, 2010 to the three months ended March 31, 2011.

Corporate general and administrative costs increased $917,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 primarily due to increased employee related expenses of $1.1 million and a $409,000 increase in the fair value of contingent consideration of an acquired business, partially offset by a reduction in merger related expenses and sponsor fees of $647,000.

Research and Development Costs. Research and development costs include materials, engineering labor and allocated overhead.

On a consolidated basis, research and development costs increased by $3.8 million, or 18%, to $24.7 million for the three months ended March 31, 2011. This increase was primarily attributable to the additional costs of the acquired businesses and the acceleration of research and development projects in our ATS segment to meet customer requirements for new products. Research and development costs of acquired businesses increased research and development costs by $1.8 million, or 9% of 2010 total research and development costs. As a percentage of sales, research and development costs increased from 12.4% to 12.8% from the three months ended March 31, 2010 to the three months ended March 31, 2011.
 
 
41

 

   
Research and Development Costs
 
Three Months
                                   
Ended
       
% of
         
% of
         
% of
 
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Total
   
Net Sales
 
   
(In thousands, except percentages)
 
2010
  $ 8,709       10.4 %   $ 12,135       14.3 %   $ 20,844       12.4 %
2011
  $ 9,729       9.9 %   $ 14,934       15.7 %   $ 24,663       12.8 %

AMS segment self-funded research and development costs increased $1.0 million, or 12%, to $9.7 million for the three months ended March 31, 2011 primarily due to additional costs of $828,000 related to RAD, acquired in June 2010, and ACC, acquired in August 2010, and additional spending on HiRel RadHard integrated circuits projects.  As a percentage of sales, AMS segment research and development costs decreased from 10.4% for the three months ended March 31, 2010 to 9.9% for the three months ended March 31, 2011.

ATS segment self-funded research and development costs increased $2.8 million, or 23%, to $14.9 million for the three months ended March 31, 2011 primarily due to increases in our radio test and avionics divisions, for the development of a common platform technology, and additional costs of $954,000 related to Willtek, acquired in May 2010. As a percentage of sales, ATS segment research and development costs increased from 14.3% for the three months ended March 31, 2010 to 15.7% for the three months ended March 31, 2011.

Amortization of Acquired Intangibles.  Amortization of acquired intangibles increased $492,000 for the three months ended March 31, 2011 to $15.9 million primarily due to additional amortization related to intangible assets recorded in connection with the acquisitions of Willtek, in May 2010; RAD, in June 2010; and ACC, in August 2010.  The increases in amortization were partially offset by certain intangibles becoming fully amortized during fiscal 2010.  By segment, the amortization increased $487,000 in the AMS segment and increased $5,000 in the ATS segment.

Restructuring Charges.  The AMS segment incurred total restructuring costs of $797,000 for the three months ended March 31, 2011 which primarily relate to consolidation of our components operations by relocating our Whippany, New Jersey facility’s production to our Ann Arbor, Michigan facility and to our Eatontown, New Jersey facility. There were no comparable charges for the three months ended March 31, 2010.

The ATS segment incurred restructuring costs of $1.9 million for the three months ended March 31, 2011, primarily related to the integration of Willtek with our U.K. operations.  In comparison, for the three months ended March 31, 2010, the ATS segment incurred restructuring costs of $105,000 for continued reorganization efforts in our European operations.

Other Income (Expense).  Interest expense was $13.9 million for the three months ended March 31, 2011 and $20.8 million for the three months ended March 31, 2010. The decrease resulted from the repurchase, in December 2010, of $186.6 million of Aeroflex’s senior unsecured notes and senior subordinated unsecured term loans with the proceeds from the IPO.  Other income (expense) of $(119,000) for the three months ended March 31, 2011 consisted primarily of $(406,000) of foreign currency transaction losses, offset by $287,000 of interest and miscellaneous income.  Other income (expense) of $222,000 for the three months ended March 31, 2010 consisted primarily of $329,000 of interest and miscellaneous income, offset by $(107,000) of foreign currency transaction losses.
 
Income Taxes.   The income tax provision was $6.7 million for the three months ended March 31, 2011 on pre-tax income of $10.9 million.  We recorded an income tax benefit for the three months ended March 31, 2010 of $791,000 on pre-tax income of $2.1 million. The effective income tax rate for both periods differed from the amount computed by applying the U.S. Federal income tax rate to income before income taxes primarily due to foreign, state and local income taxes, including U.S. income tax on certain foreign net income that we anticipate will be repatriated to the U.S. The provisions are a combination of projected annual U.S. tax benefits on domestic losses and foreign tax expense on foreign earnings.  The resulting projected net consolidated income tax benefit was then applied to the projected consolidated pre-tax amount for the year to calculate the annual effective tax rate, which contributed to the high income tax provision as a percentage of pre-tax income.
 
 
42

 

In the three months ended March 31, 2011 and 2010, we paid income taxes of $4.1 million and $622,000, respectively.

Net Income.  Net income was $4.1 million for the three months ended March 31, 2011 and $2.9 million for the three months ended March 31, 2010.

Nine Months Ended March 31, 2011 Compared to Nine Months Ended March 31, 2010

Net Sales.  Net sales increased $65.4 million, or 14%, to $530.7 million for the nine months ended March 31, 2011 from $465.3 million for the nine months ended March 31, 2010.   Businesses acquired since March 31, 2010 contributed $27.7 million to sales, or 5%, in the current fiscal year.

   
Net Sales
 
Nine Months
       
% of
         
% of
       
Ended
       
Consolidated
         
Consolidated
       
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Total
 
   
(In thousands, except percentages)
 
2010
  $ 229,939       49.4 %   $ 235,351       50.6 %   $ 465,290  
2011
  $ 264,386       49.8 %   $ 266,343       50.2 %   $ 530,729  
 
Net sales in the AMS segment increased $34.4 million, or 15%, to $264.4 million for the nine months ended March 31, 2011 from $229.9 million for the nine months ended March 31, 2010.  Specific variances include a volume driven $18.8 million increase in sales of components, including $8.9 million from ACC, acquired in August 2010; a volume driven $16.9 million increase in sales of integrated circuits, primarily HiRel RadHard; and additional sales of $4.4 million from RAD, acquired in June 2010.  The increases in sales were partially offset by volume driven reductions of $2.9 million in sales of microelectronics modules and $2.7 million in sales of motion control products.
 
Net sales in the ATS segment increased $31.0 million, or 13%, to $266.3 million for the nine months ended March 31, 2011 from $235.4 million for the nine months ended March 31, 2010.  Specific variances include a volume driven $22.3 million increase in sales of wireless test product sales, which includes, sales of $14.4 million from Willtek, acquired in May 2010; a volume driven $19.0 million increase in sales of radio test products; a volume driven $9.1 million increase in sales of avionic products. The increases in net sales were partially offset by a volume driven reduction of $19.3 million in sales of general purpose test products.

Gross Profit.  On a consolidated basis, gross profit was $281.0 million, or 53.0% of net sales, for the nine months ended March 31, 2011 and $242.0 million, or 52.0% of net sales, for the nine months ended March 31, 2010.
 
   
Gross Profit
 
Nine Months
                                   
Ended
       
% of
         
% of
         
% of
 
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Total
   
Net Sales
 
   
(In thousands, except percentages)
 
2010
  $ 112,487       48.9 %   $ 129,544       55.0 %   $ 242,031       52.0 %
2011
  $ 135,386       51.2 %   $ 145,638       54.7 %   $ 281,024       53.0 %

 
43

 

Gross margins in the AMS segment were 51.2% for the nine months ended March 31, 2011 and 48.9% for the nine months ended March 31, 2010.  The increase in gross margins is principally attributable to a favorable product mix, combined with the additional sales of services by RAD, acquired in June 2010, (which has margins higher than the segment average). Gross profit increased $22.9 million for the nine months ended March 31, 2011 as compared to the nine months ended March 31, 2010 principally due to both increased sales and the aforementioned increase in gross margins.

Gross margins in the ATS segment were 54.7% for the nine months ended March 31, 2011, and 55.0% for the nine months ended March 31, 2010.  Gross profit increased $16.1 million for the nine months ended March 31, 2011 as compared to the nine months ended March 31, 2010 due to increased sales.

Selling, General and Administrative Costs.  On a consolidated basis, SG&A costs increased $20.2 million, or 22%, to $113.2 million for the nine months ended March 31, 2011.  This increase was primarily attributable to the additional SG&A costs of the acquired businesses, the expansion of our sales and marketing team in the Asia-Pacific region and the increase in the fair value of contingent consideration of an acquired business. The SG&A of the acquired businesses increased SG&A by $6.4 million, or 7% of total 2010 SG&A. As a percentage of sales, SG&A costs increased from 19.9% to 21.4% from the nine months ended March 31, 2010 to the nine months ended March 31, 2011.

    Selling, General and Administrative Costs  
Nine Months
                                         
Ended
       
% of
         
% of
               
% of
 
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Corporate
   
Total
   
Net Sales
 
   
(In thousands, except percentages)
 
2010
  $ 31,382       13.6 %   $ 50,389       21.4 %   $ 11,217     $ 92,988       19.9 %
2011
  $ 39,463       14.9 %   $ 60,758       22.8 %   $ 13,013     $ 113,234       21.4 %

In the AMS segment, SG&A costs increased $8.1 million, or 26%, to $39.5 million for the nine months ended March 31, 2011. This increase is primarily due to additional costs of $3.3 million related to RAD, acquired in June 2010, and ACC, acquired in August 2010 and general increases in our existing businesses, primarily due to increased employee related expenses of $2.7 million and external commissions of $531,000.  SG&A costs in the AMS segment increased from 13.6% to 14.9%, as a percentage of sales, from the nine months ended March 31, 2010 to the nine months ended March 31, 2011.

In the ATS segment, SG&A costs increased $10.4 million, or 21%, to $60.8 million for the nine months ended March 31, 2011, primarily due to increased employee related expenses of $4.5 million, primarily related to the expansion of our sales and marketing team in the Asia-Pacific region; increased commissions of $3.8 million, due to the increase in sales volume; and additional costs of $3.1 million related to Willtek, acquired in May 2010.  As a percentage of sales, SG&A costs in the ATS segment increased from 21.4% to 22.8% from the nine months ended March 31, 2010 to the nine months ended March 31, 2011.

Corporate general and administrative costs increased $1.8 million for the nine months ended March 31, 2011 compared to the nine months ended March 31, 2010 primarily related to (i) business acquisition costs of $1.5 million, which includes a $1.2 million increase in the fair value of contingent consideration of an acquired business; and (ii) increased employee related expenses of $1.1 million; partially offset by (iii) a reduction in merger related expenses and sponsor fees of $889,000.
 
 
44

 

Research and Development Costs. On a consolidated basis, research and development costs increased by $13.2 million, or 24%, to $68.5 million for the nine months ended March 31, 2011. This increase was primarily attributable to the additional costs of the acquired businesses and the acceleration of research and development projects in our ATS segment to meet customer requirements for new products. Research and development costs of acquired businesses increased research and development by $4.2 million, or 8% of 2010 total research and development costs. As a percentage of sales, research and development costs increased from 11.9% to 12.9% from the nine months ended March 31, 2010 to the nine months ended March 31, 2011.
 
   
Research and Development Costs
 
Nine Months
                                   
Ended
       
% of
         
% of
         
% of
 
March 31,
 
AMS
   
Net Sales
   
ATS
   
Net Sales
   
Total
   
Net Sales
 
   
(In thousands, except percentages)
 
2010
  $ 22,202       9.7 %   $ 33,084       14.1 %   $ 55,286       11.9 %
2011
  $ 26,028       9.8 %   $ 42,449       15.9 %   $ 68,477       12.9 %

AMS segment self-funded research and development costs increased $3.8 million, or 17%, to $26.0 million for the nine months ended March 31, 2011 primarily due to the increased efforts in the development of next generation component products and additional spending on HiRel RadHard integrated circuits projects.  As a percentage of sales, AMS segment research and development costs increased from 9.7% for the nine months ended March 31, 2010 to 9.8% for the nine months ended March 31, 2011.

ATS segment self-funded research and development costs increased $9.4 million, or 28%, to $42.4 million for the nine months ended March 31, 2011 primarily due to increases in our radio test and avionics divisions, for the development of a common platform technology, and additional costs of $2.9 million related to Willtek, acquired in May 2010.  As a percentage of sales, ATS segment research and development costs increased from 14.1% for the nine months ended March 31, 2010 to 15.9% for the nine months ended March 31, 2011.

Amortization of Acquired Intangibles.  Amortization of acquired intangibles increased $1.2 million for the nine months ended March 31, 2011 to $47.7 million primarily due to additional amortization related to intangible assets recorded in connection with the acquisitions of Willtek, in May 2010; RAD, in June 2010; and ACC, in August 2010.  The increases in amortization were partially offset by certain intangibles becoming fully amortized during fiscal 2010.  By segment, the amortization increased $1.4 million in the AMS segment and decreased $185,000 in the ATS segment.

Termination of Sponsor Advisory Agreement. In connection with the Aeroflex Holding IPO, we paid a $16.9 million Termination Fee to affiliates of the Sponsors on November 24, 2010 to terminate the Sponsor Advisory Agreement with them and eliminate all future payments to the Sponsors under that agreement, which, including the related write-off of prepaid advisory fees, resulted in an $18.1 million expense for the nine months ended March 31, 2011. There was no similar charge recorded for the nine months ended March 31, 2010.

Restructuring Charges.  The AMS segment incurred total restructuring costs of $6.9 million for the nine months ended March 31, 2011 which primarily relate to consolidation of our components operations by relocating our Whippany, New Jersey facility’s production to our Ann Arbor, Michigan facility and to our Eatontown, New Jersey facility. In connection with this consolidation, we recorded a $4.9 million impairment charge based on the fair value of the Whippany, New Jersey facility we intend to sell. There were no comparable charges for the nine months ended March 31, 2010.

The ATS segment incurred restructuring costs of $3.9 million for the nine months ended March 31, 2011, primarily related to the integration of Willtek with our U.K. operations.  In comparison, for the nine months ended March 31, 2010, the ATS segment incurred restructuring costs of $356,000 for continued reorganization efforts in our European operations.

Loss on Liquidation of Foreign Subsidiary. During the nine months ended March 31, 2010, we recognized a $7.7 million non-cash loss on liquidation of a foreign subsidiary.  There was no similar charge recorded for the nine months ended March 31, 2011.

 
45

 

Other Income (Expense).  Interest expense was $55.8 million for the nine months ended March 31, 2011 and $63.3 million for the nine months ended March 31, 2010.  The interest expense decreased as a result of the repurchase, in December 2010, of $186.6 million of Aeroflex’s senior unsecured notes and senior subordinated unsecured term loans with the proceeds from the IPO. During the nine months ended March 31, 2011 we incurred a $25.2 million loss on extinguishment of debt, which was comprised primarily of $20.5 million in premiums paid on the debt repurchased and $4.0 million for the write-off of the related deferred financing costs.  In addition, we recognized a $173,000 gain on a bargain purchase related to the final working capital adjustment to the purchase price of Willtek, acquired in June 2010. There were no comparable charges for the nine months ended March 31, 2010.  Other income (expense) of $(526,000) for the nine months ended March 31, 2011 consisted primarily of a $(688,000) realized loss recorded on the sale of our auction rate securities and $(711,000) of foreign currency transaction losses offset by $873,000 of interest and miscellaneous income. Other income (expense) of $701,000 for the nine months ended March 31, 2010 consisted primarily of $1.4 million of interest and miscellaneous income, offset by $(692,000) of foreign currency transaction losses.

Income Taxes.   The income tax benefit was $45.6 million for the nine months ended March 31, 2011 on a pre-tax loss of $58.7 million.  We recorded an income tax provision for the nine months ended March 31, 2010 of $4.9 million on a pre-tax loss of $23.4 million. The effective income tax rate for both periods differed from the amount computed by applying the U.S. Federal income tax rate to income before income taxes primarily due to foreign, state and local income taxes, including U.S. income tax on certain foreign net income that we anticipate will be repatriated to the U.S. The provisions are a combination of projected annual U.S. tax benefits on domestic losses and foreign tax expense on foreign earnings. The resulting projected net consolidated income tax benefit was then applied to the projected consolidated pre-tax amount for the year to calculate the annual effective tax rate, which contributed to the high income tax benefit as a percentage of pre-tax loss.  During the three months ended September 30, 2010, we identified an overstatement of deferred income tax liabilities established in the fourth quarter of fiscal 2009 and throughout fiscal 2010 related to U.S. income taxes provided on unremitted foreign earnings. After consideration of both quantitative and qualitative factors, we determined the amounts were not material to any of those prior period financial statements or the fiscal 2011 estimated results and thus corrected the balance in the three months ended September 30, 2010.  The adjustment resulted in a reduction of deferred income tax liabilities of $3.7 million, with a corresponding increase in income tax benefit in the statement of operations for the three months ended September 30, 2010.  The adjustment did not impact the statement of cash flows.  The income tax benefit for the nine months ended March 31, 2011 also reflects various discrete items, including a $1.2 million income tax benefit for the retroactive reinstatement of the U.S. R&D credit and a reduction of $5.8 million of deferred tax liabilities related to U.S. income taxes previously provided on unremitted foreign earnings.  As a direct result of Aeroflex Holding’s IPO, and related repurchase of a portion of Aeroflex’s debt in the quarter ended December 31, 2010, interest payments have decreased.  Consequently, in the quarter ended December 31, 2010, we changed our intent as to the amount and method of repatriations of foreign earnings, which resulted in the reduction of deferred tax liabilities. The tax provision for the nine months ended March 31, 2010 was affected by the unfavorable impact of a $7.7 million nondeductible loss on the liquidation of a foreign subsidiary, and the favorable impact of a $10.3 million loss for tax purposes on the write-off of our investment in a foreign subsidiary in fiscal 2009.  For financial statement purposes, the loss had been recognized in the prior periods, however, for tax purposes the loss was recognized at the time of divestiture, effective September 2009.

In the nine months ended March 31, 2011, we paid income taxes of $14.3 million and received tax refunds of $3.1 million related to federal, state and foreign income taxes.  In the nine months ended March 31, 2010, we paid income taxes of $5.2 million and received refunds of $627,000.

Net Income (Loss).  The net loss was $13.1 million for the nine months ended March 31, 2011 and $28.3 million for the nine months ended March 31, 2010.
 
 
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Liquidity and Capital Resources

The liquidity and capital resources of Aeroflex Holding are essentially identical to the liquidity and capital resources of Aeroflex, with the following significant exception:  Aeroflex Holding, in connection with its IPO of common stock on November 19, 2010, received net proceeds of $244.0 million after deducting underwriting discounts and offering expenses, whereas Aeroflex received the net proceeds of the IPO of $244.0 million in the form of a capital contribution from Aeroflex Holding.  All indebtedness has been incurred by Aeroflex; such indebtedness is reflected on the balance sheets of Aeroflex Holding by virtue of the principles of consolidation. Aeroflex Holding’s principal source of liquidity has been the proceeds of the IPO.  Aeroflex’s principal sources of liquidity include cash generated from operations, borrowings and availability under its credit facilities and capital contributions from Aeroflex Holding.

As of March 31, 2011, Aeroflex had $67.2 million of cash and cash equivalents, $289.1 million in working capital and its current ratio was 2.97 to 1.

Aeroflex’s principal liquidity requirements are to service its debt and interest and meet its working capital and capital expenditure needs. As of March 31, 2011, Aeroflex had $696.3 million of debt outstanding (of which $695.9 million was long-term), including approximately $489.1 million under the senior secured credit facility, $192.8 million of senior unsecured notes and $13.6 million under the senior subordinated unsecured credit facility.

On May 9, 2011, Aeroflex entered into a new senior secured credit facility with various lenders, consisting of a senior secured term loan facility of $725.0 million and a senior secured revolving credit facility of $75.0 million. The new term loan facility provides for $1.8 million quarterly principal repayments commencing September 30, 2011, with the remaining balance due at maturity on May 9, 2018. No amounts have been drawn under the revolving credit agreement.

The $725.0 million proceeds were, or will be, used:

    1)    to refinance $695.5 million of Aeroflex’s outstanding debt, as follows:

 
·
to repay the entire outstanding balance of $489.1 million under Aeroflex’s existing senior secured credit facilities;

 
·
to repurchase, pursuant to a tender offer initiated on April 25, 2011, all of Aeroflex’s senior notes of $192.8 million (Aeroflex expects to call any notes not tendered); and

 
·
to repurchase all of Aeroflex’s senior subordinated unsecured term loans of $13.6 million.

           2)     to pay fees and expenses totaling $33.8 million in connection with the refinancing, including:

 
·
fees to the lenders of $14.2 million;

 
·
a premium of approximately 9% on the repurchased senior notes and senior subordinated unsecured term loans, which amounted to $18.3 million; and

 
·
professional fees and other expenses of approximately $1.3 million.

The total cash outlay related to the debt refinancing, including premiums, fees and expenses listed above and $10.7 million of interest accrued through May 9, 2011, exceeds the $725.0 million proceeds by $15.0 million, which was paid from our available cash.
 
 
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We will record approximately $15.5 million of these fees related to the new facility as deferred financing costs and record approximately $34.2 million related to the repayment of the existing debt as a loss on extinguishment of debt, including the write-off of the existing deferred financing costs of $15.9 million.

The following is a summary of required principal repayments of Aeroflex’s new debt for the next five years and thereafter as of March 31, 2011 reflecting the May 9, 2011 refinancing:

Twelve Months Ended March 31,
 
(In thousands)
 
2012
  $ 5,798  
2013
    7,635  
2014
    7,250  
2015
    7,250  
2016
    7,250  
Thereafter
    690,562  
Total
  $ 725,745  
 
As of March 31, 2011, Aeroflex and its subsidiaries were in compliance with all of the covenants contained in the then existing loan agreements. Certain loan covenants are based on Adjusted EBITDA. Adjusted EBITDA is defined as EBITDA (net income (loss), before interest expense, income taxes, depreciation and amortization), adjusted to add back certain non-cash, non-recurring and other items, as required by various covenants in the debt agreements.  Our use of the term Adjusted EBITDA may vary from others in our industry.  EBITDA and Adjusted EBITDA are not measures of operating income (loss), performance or liquidity under U.S. GAAP and are subject to important limitations.  A reconciliation of net income (loss), which is a U.S. GAAP measure of our operating results, to Adjusted EBITDA, as defined in the then existing loan agreements, is as follows:
 
   
Three Months Ended
March 31,
   
Nine Months Ended
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
Net income (loss)
  $ 4,127     $ 2,856     $ (13,093 )   $ (28,301 )
Interest expense
    13,852       20,815       55,803       63,272  
Provision (benefit) for income taxes
    6,734       (791 )     (45,557 )     4,908  
Depreciation and amortization
    20,892       20,404       62,426       62,178  
EBITDA
    45,605       43,284       59,579       102,057  
                                 
Non-cash purchase accounting adjustments
    21       31       1,067       342  
Merger related expenses
    -       647       1,222       2,111  
Restructuring costs and related pro forma savings (a)
    3,747       105       13,821       356  
Non-cash share-based compensation
    629       518       1,655       1,563  
Termination of Sponsor Advisory Agreement
    -       -       18,133       -  
Loss on extinguishment of debt
    -       -       25,178       -  
Non-cash loss on liquidation of foreign subsidiary
    -       -       -       7,696  
Other defined items (b)
    659       (4 )     3,172       (346 )
Adjusted EBITDA
  $ 50,661     $ 44,581     $ 123,827     $ 113,779  
 
 
(a)
Primarily reflects costs associated with the reorganization of our European operations and consolidation of certain of our U.S. components facilities.  Pro forma savings reflect the amount of costs that we estimate would have been eliminated during the fiscal year in which a restructuring occurred had the restructuring occurred as of the first day of that fiscal year.  Pro forma savings were estimated to be $3.0 million for the nine months ended March 31, 2011, $1.0 million of which is applicable to the three months ended March 31, 2011, $1.2 million applicable to the three months ended December 31, 2010 and $800,000 applicable to the three months ended September 30, 2010.
 
 
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(b)
Reflects other adjustments required in calculating Aeroflex’s debt covenant compliance.  These other defined items include pro forma EBITDA for periods prior to the acquisition dates for companies acquired during the periods presented.
 
Financial covenants in Aeroflex’s then existing senior secured credit facility include (i) a maximum leverage ratio of total debt (less up to $15.0 million of unrestricted cash) to Adjusted EBITDA, as defined in the then existing senior secured credit facility, and (ii) maximum consolidated capital expenditures. The maximum leverage ratio permitted for the twelve months ended March 31, 2011 was 5.90, whereas the actual leverage ratio was 3.87.

Aeroflex’s new senior secured credit facility contains a maximum leverage ratio of total debt (less up to $15.0 million of unrestricted cash) to Adjusted EBITDA financial covenant, as defined in the new senior secured credit facility.  The maximum leverage ratio permitted as of June 30, 2011 is 5.20, which periodically decreases to 4.75 on June 30, 2012.

Aeroflex’s new senior secured credit facility contains restrictions on its activities, including but not limited to covenants that restrict Aeroflex and its restricted subsidiaries, as defined in the new senior subordinated unsecured credit facility, from:

 
·
incurring additional indebtedness and issuing disqualified stock or preferred stock;

 
·
making certain investments or other restricted payments;

 
·
paying dividends and making other distributions with respect to capital stock, or repurchasing, redeeming or retiring capital stock or subordinated debt;

 
·
selling or otherwise disposing of assets;

 
·
under certain circumstances, issuing or selling equity interests;

 
·
creating liens on assets;

 
·
consolidating or merging with, or acquiring in excess of specified annual limitations, another business, or selling or disposing of all or substantially all of their assets; and

 
·
entering into certain transactions with affiliates.
 
If for any reason Aeroflex fails to comply with the covenants in the senior secured credit facility, it would be in default under the terms of the agreements governing its outstanding debt. If such a default were to occur, the lenders under the senior secured credit facility could elect to declare all amounts outstanding thereunder   immediately due and payable, and the lenders would not be obligated to continue to advance funds to Aeroflex.  If the amounts outstanding under these debt agreements are accelerated, Aeroflex’s assets may not be sufficient to repay in full the amounts owed.
 
 
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We expect that cash generated from operating activities and availability under the revolving portion of Aeroflex’s new senior secured credit facility will be Aeroflex’s principal sources of liquidity. Aeroflex’s ability to make payments on and to refinance its indebtedness and to fund working capital needs and planned capital expenditures will depend on its ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive and other factors that are beyond our control. In addition, to the extent Aeroflex has consolidated excess cash flows, as defined in the credit agreement governing the new senior secured credit facility, Aeroflex must use specified portions of the excess cash flows to prepay the new senior secured credit facility. Based on its current level of operations, we believe Aeroflex’s cash flow from operations and available borrowings under its new senior secured credit facility will be adequate to meet Aeroflex’s liquidity needs for at least the next twelve months. We cannot assure you, however, that its business will generate sufficient cash flow from operations, or those future borrowings will be available under the new senior secured credit facility in an amount sufficient to enable Aeroflex to repay its indebtedness at maturity or to fund other liquidity needs. Aeroflex may need to refinance all or a portion of its indebtedness on or before the maturity thereof. We cannot assure you that Aeroflex will be able to refinance any of its indebtedness on commercially reasonable terms or at all.

Cash Flows

For the nine months ended March 31, 2011, Aeroflex’s cash flow used by operations was $18.1 million primarily due to increased inventory of $39.9 million in anticipation of higher sales.  Its investing activities used cash of $29.5 million, primarily for payments for the purchase of businesses of $23.6 million and for capital expenditures of $17.1 million partially offset by proceeds from the sale of marketable securities of $10.4 million combined with the sale of property, plant and equipment of $819,000. Aeroflex’s financing activities provided cash of $11.5 million - $244.0 million was received by Aeroflex as a capital contribution from Aeroflex Holding and was partially offset by the repurchase of senior unsecured notes and senior subordinated unsecured term loans, including premiums and fees, of $207.7 million plus debt repayments of $21.5 million.

For the nine months ended March 31, 2010, Aeroflex’s cash flow provided by operations was $52.3 million. Its investing activities used cash of $7.6 million, primarily for capital expenditures of $13.2 million and a $4.0 million contingent consideration payment for the purchase of a business, partially offset by proceeds from the sale of marketable securities of $8.6 million combined with the sale of property, plant and equipment of $1.0 million. Aeroflex’s financing activities used cash of $4.0 million to repay indebtedness.

Aeroflex Holding’s cash flows are identical to those of Aeroflex with the following exception: Aeroflex Holding’s cash flows from financing activities for the nine months ended March 31, 2011 reflect the fact that Aeroflex Holding received the $244.0 million proceeds from its IPO of common stock.

Capital Expenditures

Capital expenditures were $17.1 million and $13.2 million for the nine months ended March 31, 2011 and 2010, respectively.  Our capital expenditures primarily consist of equipment replacements.

Contractual Obligations

 Debt Repurchase

As of June 30, 2010, Aeroflex had $225.0 million due under its senior unsecured notes and $165.5 million due under its senior subordinated unsecured term loans.  In connection with Aeroflex Holding’s IPO, the net proceeds were used to make a capital contribution to Aeroflex to enable it to, among other things, tender for a portion of its senior unsecured notes and offer to repurchase a portion of its senior subordinated unsecured term loans. In December 2010 Aeroflex repurchased approximately $32.2 million of senior unsecured notes and $154.4 million of senior subordinated unsecured term loans.

Termination of Sponsor Advisory Agreement

Also in connection with the Aeroflex Holding IPO, we paid a $16.9 million Termination Fee to affiliates of the Sponsors on November 24, 2010 to terminate the Sponsor Advisory Agreement with them and eliminate all future payments to the Sponsors under that agreement, which including the related write-off of prepaid advisory fees, resulted in an $18.1 million expense.
 
 
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Debt Refinance

On May 9, 2011, Aeroflex entered into a new senior secured credit facility with various lenders, consisting of a senior secured term loan facility of $725.0 million and a senior secured revolving credit facility of $75.0 million, to refinance $695.5 million of its outstanding debt.  The new term loan facility provides for $1.8 million quarterly principal repayments commencing September 30, 2011, with the remaining balance due at maturity on May 9, 2018.
 
Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have material current or future effect upon our results of operations or financial condition.
 
Seasonality
 
Historically our net sales and earnings increase sequentially from quarter to quarter within a fiscal year, but the first quarter is typically less than the previous year’s fourth quarter.
 
Critical Accounting Policies and Estimates

Information regarding the Company’s critical accounting policies and estimates appears within the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Aeroflex Holding’s Registration Statement and in Aeroflex’s Fiscal 2010 Form 10-K.  During the nine month period ended March 31, 2011, there were no significant changes to any critical accounting policies or to the related estimates and judgments involved in applying those policies.

Recently Adopted Accounting Pronouncements

See Note 2 of the combined notes to the unaudited condensed consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

See Note 2 of the combined notes to the unaudited condensed consolidated financial statements.
 
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk.  We are subject to interest rate risk in connection with borrowings under Aeroflex’s new senior secured credit facility.  We currently do not have interest rate swap agreements hedging this debt. As of May 9, 2011, there is $725.0 million outstanding under the term-loan portion of the new senior secured credit facility, all of which is subject to variable interest rates.  The adjusted LIBOR, as defined in the new senior secured credit facility, has a floor of 1.25% on the term loan. An increase of 1% in interest rates would result in a 0.06% increase, due to the 1.25% floor, or a $460,000 increase in our annual interest expense. Any 1% increase in interest rates above the 1.25% floor would result in a $7.4 million increase in our annual interest expense. A 1% change in interest rates would result in a $763,000 change in our annual interest expense on the revolving loan borrowings, assuming the entire $75.0 million was outstanding. Any debt we incur in the future may also bear interest at floating rates.
 
 
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Foreign Currency Risk.   Foreign currency contracts are used to protect us from exchange rate fluctuation from the time customers are invoiced in local currency until such currency is exchanged for U.S. dollars. Aeroflex periodically enters into foreign currency contracts, which are not designated as hedges, and the change in the fair value is included in income currently within other income (expense). As of March 31, 2011, Aeroflex had $50.3 million of notional value foreign currency forward contracts maturing through April 29, 2011. Notional amounts do not quantify risk or represent assets or liabilities of Aeroflex, but are used in the calculation of cash settlements under the contracts. The fair value of these contracts at March 31, 2011 was an asset of $3,000.  If foreign currency exchange rates (primarily the British pound and the Euro) change by 10% from the levels at March 31, 2011, the effect on our comprehensive income would be approximately $24.3 million.

Inflation Risk.  Inflation has not had a material impact on our results of operations or financial condition during the preceding three years.
 
ITEM 4.   CONTROLS AND PROCEDURES – AEROFLEX HOLDING

Aeroflex Holding’s disclosure controls and procedures under the Securities Exchange Act of 1934, as amended, are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. Aeroflex Holding’s disclosure controls and procedures are also designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to its management, including its chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure. The Principal Executive Officer and the Principal Financial Officer, with the assistance from other members of management, have reviewed the effectiveness of its disclosure controls and procedures as of March 31, 2011 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date.

There have been no changes in Aeroflex Holding’s internal controls over financial reporting that occurred during the quarter ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

ITEM 4.   CONTROLS AND PROCEDURES - AEROFLEX

Aeroflex’s disclosure controls and procedures under the Securities Exchange Act of 1934, as amended, are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. Aeroflex’s disclosure controls and procedures are also designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to its management, including its chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure. The Principal Executive Officer and the Principal Financial Officer, with the assistance from other members of management, have reviewed the effectiveness of its disclosure controls and procedures as of March 31, 2011 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date.

There have been no changes in Aeroflex’s internal controls over financial reporting that occurred during the quarter ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.
 
PART II – OTHER INFORMATION

Item 1.    Legal Proceedings
 
 
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There have been no material changes in our legal proceedings disclosed in Aeroflex Holding’s Registration Statement and Aeroflex’s Fiscal 2010 Form 10-K.

Item 1A.  Risk Factors

There have been no material changes in our risk factors disclosed in Aeroflex Holding’s Registration Statement and Aeroflex’s Fiscal 2010 Form 10-K.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

          None

Item 3.  Defaults upon Senior Securities
 
          None

Item 4.  [Removed and Reserved]

Item 5.   Other Information

          None

Item 6.   Exhibits

Exhibit No.
 
Exhibit Description
10.1
  Credit and Guaranty Agreement, dated as of May 9, 2011, amoung Aeroflex Incorporated, Aeroflex Holding Corp., the Guarantor Subsidiaries, the lenders party thereto and JPMorgan Chase Bank, N.A.
     
10.2
  Pledge and Security Agreement, dated as of May 9, 2011, by the Grantors Party thereto in favor of JPMorgan Chase Bank, N.A., as collateral agent.
     
31.1
 
Certification of Aeroflex Holding Corp. pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
31.2
 
Certification of Aeroflex Incorporated pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
31.3
 
Certification of Aeroflex Holding Corp. pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
     
31.4
 
Certification of Aeroflex Incorporated pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
     
31.5
 
Certification of Aeroflex Holding Corp. pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Principal Accounting Officer)
     
31.6
 
Certification of Aeroflex Incorporated pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Principal Accounting Officer)
     
32.1
 
Certification of Aeroflex Holding Corp. pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
 
 
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32.2
 
Certification of Aeroflex Incorporated pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
32.3
 
Certification of Aeroflex Holding Corp. pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
     
32.4
 
Certification of Aeroflex Incorporated pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
 
 
54

 
 
SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, Aeroflex Holding Corp. and Aeroflex Incorporated have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.

     
AEROFLEX HOLDING CORP.
 
         
May 10, 2011
   
/s/ John Adamovich, Jr.
 
 
   
John Adamovich, Jr.
 
 
   
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
 
 
     
AEROFLEX INCORPORATED
 
         
May 10, 2011
   
/s/ John Adamovich, Jr.
 
 
   
John Adamovich, Jr.
 
 
   
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
 
 

 
 
55

 

EXHIBIT INDEX
 
Exhibit No.   Exhibit Description
10.1
 
Credit and Guaranty Agreement, dated as of May 9, 2011, amoung Aeroflex Incorporated, Aeroflex Holding Corp., the Guarantor Subsidiaries, the lenders party thereto and JPMorgan Chase Bank, N.A.
     
10.2
  Pledge and Security Agreement, dated as of May 9, 2011, by the Grantors Party thereto in favor of JPMorgan Chase Bank, N.A., as collateral agent.
     
31.1
 
Certification of Aeroflex Holding Corp. pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
31.2
 
Certification of Aeroflex Incorporated pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
31.3
 
Certification of Aeroflex Holding Corp. pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
     
31.4
 
Certification of Aeroflex Incorporated pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
     
31.5
 
Certification of Aeroflex Holding Corp. pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Principal Accounting Officer)
     
31.6
 
Certification of Aeroflex Incorporated pursuant to Rules 13a-14(a)/15d-14a as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Principal Accounting Officer)
     
32.1
 
Certification of Aeroflex Holding Corp. pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
32.2
 
Certification of Aeroflex Incorporated pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Executive Officer)
     
32.3
 
Certification of Aeroflex Holding Corp. pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
     
32.4
 
Certification of Aeroflex Incorporated pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Chief Financial Officer)
 
 
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