Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - MERCURY SYSTEMS INCmrcy-3312015xexx321.htm
EX-31.1 - EXHIBIT 31.1 - MERCURY SYSTEMS INCmrcy-3312015xexx311.htm
EXCEL - IDEA: XBRL DOCUMENT - MERCURY SYSTEMS INCFinancial_Report.xls
XML - IDEA: XBRL DOCUMENT - MERCURY SYSTEMS INCR9999.htm
EX-31.2 - EXHIBIT 31.2 - MERCURY SYSTEMS INCmrcy-3312015xexx312.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
________________________________________________________________
FORM 10-Q
________________________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                      TO                     
COMMISSION FILE NUMBER: 0-23599
________________________________________________________________
MERCURY SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
________________________________________________________________
 
MASSACHUSETTS
 
04-2741391
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
201 RIVERNECK ROAD
CHELMSFORD, MA
 
01824
(Address of principal executive offices)
 
(Zip Code)
978-256-1300
(Registrant’s telephone number, including area code)
 ________________________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
¨
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Shares of Common Stock outstanding as of April 30, 2015: 34,198,343 shares




MERCURY SYSTEMS, INC.
INDEX
 
 
 
PAGE
NUMBER
PART I. FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II. OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 
 
 


2



PART I. FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
MERCURY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
 
March 31,
2015
 
June 30,
2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
66,520

 
$
47,287

Accounts receivable, net of allowance for doubtful accounts of $57 and $34 at March 31, 2015 and June 30, 2014, respectively
47,552

 
37,625

Unbilled receivables and costs in excess of billings
20,475

 
22,036

Inventory
32,526

 
31,655

Deferred income taxes
13,044

 
15,216

Prepaid income taxes
3,981

 
1,481

Prepaid expenses and other current assets
3,661

 
3,631

Current assets of discontinued operations

 
1,374

Total current assets
187,759

 
160,305

Restricted cash
264

 
265

Property and equipment, net
12,391

 
14,144

Goodwill
168,146

 
168,146

Intangible assets, net
19,739

 
25,006

Other non-current assets
941

 
987

Non-current assets of discontinued operations

 
4,859

Total assets
$
389,240

 
$
373,712

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
14,387

 
$
7,054

Accrued expenses
9,190

 
8,377

Accrued compensation
9,062

 
9,983

Deferred revenues and customer advances
8,094

 
5,898

Current liabilities of discontinued operations

 
1,618

Total current liabilities
40,733

 
32,930

Deferred gain on sale-leaseback
1,218

 
2,086

Deferred income taxes
3,174

 
5,911

Income taxes payable
2,255

 
3,154

Other non-current liabilities
1,195

 
1,666

Non-current liabilities of discontinued operations

 
818

Total liabilities
48,575

 
46,565

Commitments and contingencies (Note I)


 


Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding

 

Common stock, $0.01 par value; 85,000,000 shares authorized; 32,361,497 and 31,284,273 shares issued and outstanding at March 31, 2015 and June 30, 2014, respectively
324

 
312

Additional paid-in capital
251,000

 
241,725

Retained earnings
88,538

 
84,099

Accumulated other comprehensive income
803

 
1,011

Total shareholders’ equity
340,665

 
327,147

Total liabilities and shareholders’ equity
$
389,240

 
$
373,712

The accompanying notes are an integral part of the consolidated financial statements.

3



MERCURY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
(Unaudited)
 
 
 
Three Months Ended 
 March 31,
 
Nine Months Ended 
 March 31,
 
 
2015
 
2014
 
2015
 
2014
Net revenues
 
$
59,578

 
$
53,393

 
$
170,728

 
$
155,051

Cost of revenues
 
31,660

 
29,017

 
91,776

 
84,788

Gross margin
 
27,918

 
24,376

 
78,952

 
70,263

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
11,842

 
12,363

 
36,809

 
40,628

Research and development
 
8,115

 
8,166

 
23,961

 
27,620

Amortization of intangible assets
 
1,744

 
1,777

 
5,268

 
5,565

Restructuring and other charges
 
27

 
3,477

 
2,457

 
3,559

Acquisition costs and other related expenses
 
33

 

 
33

 

Total operating expenses
 
21,761

 
25,783

 
68,528

 
77,372

Income (loss) from operations
 
6,157

 
(1,407
)
 
10,424

 
(7,109
)
Interest income
 
6

 
2

 
13

 
6

Interest expense
 
(7
)
 
(11
)
 
(23
)
 
(37
)
Other income, net
 
7

 
337

 
399

 
1,209

Income (loss) from continuing operations before income taxes
 
6,163

 
(1,079
)
 
10,813

 
(5,931
)
Tax provision (benefit)
 
1,469

 
(809
)
 
2,516

 
(2,570
)
Income (loss) from continuing operations
 
4,694

 
(270
)
 
8,297

 
(3,361
)
Loss from discontinued operations, net of income taxes
 
(1,019
)
 
(308
)
 
(3,858
)
 
(518
)
Net income (loss)
 
$
3,675

 
$
(578
)
 
$
4,439

 
$
(3,879
)
 
 
 
 
 
 
 
 
 
Basic net earnings (loss) per share:
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
0.14

 
$
(0.01
)
 
$
0.26

 
$
(0.11
)
Loss from discontinued operations, net of income taxes
 
(0.03
)
 
(0.01
)
 
(0.12
)
 
(0.02
)
Net income (loss)
 
$
0.11

 
$
(0.02
)
 
$
0.14

 
$
(0.13
)
 
 
 
 
 
 
 
 
 
Diluted net earnings (loss) per share:
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
0.14

 
$
(0.01
)
 
$
0.25

 
$
(0.11
)
Loss from discontinued operations, net of income taxes
 
(0.03
)
 
(0.01
)
 
(0.12
)
 
(0.02
)
Net income (loss)
 
$
0.11

 
$
(0.02
)
 
$
0.13

 
$
(0.13
)
 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
32,298

 
31,156

 
32,001

 
30,932

Diluted
 
33,233

 
31,156

 
32,953

 
30,932

 
 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
$
3,675

 
$
(578
)
 
$
4,439

 
$
(3,879
)
Foreign currency translation adjustments
 

 
23

 
(208
)
 
8

Total comprehensive income (loss)
 
$
3,675

 
$
(555
)
 
$
4,231

 
$
(3,871
)
The accompanying notes are an integral part of the consolidated financial statements.


4



MERCURY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended 
 March 31,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income (loss)
$
4,439

 
$
(3,879
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
10,446

 
11,892

Stock-based compensation expense
6,765

 
7,466

Benefit for deferred income taxes
(817
)
 
(5,177
)
Impairment of goodwill from discontinued operations
2,283

 

Excess tax benefit from stock-based compensation
(834
)
 
(16
)
Loss on sale of discontinued operations
892

 

Other non-cash items
(234
)
 
(740
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, unbilled receivables, and costs in excess of billings
(8,373
)
 
(3,807
)
Inventory
(969
)
 
2,144

Prepaid income taxes
(2,499
)
 
(744
)
Prepaid expenses and other current assets
49

 
2,801

Other non-current assets
428

 
840

Accounts payable and accrued expenses
7,019

 
2,646

Deferred revenues and customer advances
1,853

 
(1,287
)
Income taxes payable
(898
)
 
(109
)
Other non-current liabilities
(30
)
 
(298
)
Net cash provided by operating activities
19,520

 
11,732

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(3,467
)
 
(5,067
)
Proceeds from sale of discontinued operations
885

 

Decrease (increase) in other investing activities
1

 
(300
)
Net cash used in investing activities
(2,581
)
 
(5,367
)
Cash flows from financing activities:
 
 
 
Proceeds from employee stock plans
2,048

 
872

Excess tax benefit from stock-based compensation
834

 
16

Payments of capital lease obligations
(481
)
 
(564
)
Net cash provided by financing activities
2,401

 
324

Effect of exchange rate changes on cash and cash equivalents
(107
)
 
(105
)
Net increase in cash and cash equivalents
19,233

 
6,584

Cash and cash equivalents at beginning of period
47,287

 
39,126

Cash and cash equivalents at end of period
$
66,520

 
$
45,710

Cash paid during the period for:
 
 
 
Interest
$
23

 
$
38

Income taxes
$
5,749

 
$
4,733

Supplemental disclosures—non-cash activities:
 
 
 
Issuance of restricted stock awards to employees
$
9,514

 
$
8,313

Capital lease financings
$

 
$
494

The accompanying notes are an integral part of the consolidated financial statements.

5



MERCURY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share data)
(Unaudited)
A.
Description of Business
Mercury Systems, Inc. is a leading high-tech commercial provider of more affordable secure and sensor processing subsystems designed and made in the U.S.A. for critical defense and intelligence applications. The Company delivers innovative solutions, rapid time-to-value and service and support to its defense prime contractor customers. The Company’s products and solutions have been deployed in more than 300 programs with over 25 different defense prime contractors. Key programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program ("SEWIP"), Gorgon Stare, Predator, F-35 and Reaper. The Company’s organizational structure allows it to deliver capabilities that combine technology building blocks and deep domain expertise in the defense sector.
The Company's goal is to grow and build on its position as a critical component of the defense industrial base and become the leading provider of open and affordable secure and sensor processing subsystems. The Mercury Commercial Electronics (“MCE”) operating segment designs, develops and builds open sensor processing products and subsystems that include embedded processing modules and subsystems, radio frequency (“RF”) and microwave multi-function assemblies as well as subsystems, and RF and microwave components. The Mercury Defense Systems (“MDS”) operating segment provides significant capabilities relating to pre-integrated, open, affordable electronic warfare ("EW"), electronic attack ("EA") and electronic counter measure ("ECM") subsystems and significant capabilities in signals intelligence ("SIGINT"), electro-optical/infrared ("EO/IR") processing technologies and radar environment test and simulation systems.
In June 2014, the Company initiated a plan to divest the Mercury Intelligence Systems (“MIS”) operating segment, based on the Company's strategic direction and investment priorities focusing on its core business. As a result, the Company's MIS operating segment met the “held for sale” criteria in accordance with Financial Accounting Standard Boards (“FASB”) Accounting Standards Codification (“ASC”) 205, Presentation of Financial Statements, (“FASB ASC 205”) as of June 30, 2014 and all reporting periods thereafter (see Note C to the Consolidated Financial Statements). The consolidated financial statements, excluding the statements of cash flows, and the notes to the consolidated financial statements were restated for all periods presented to reflect the discontinuation of the MIS operating segment, in accordance with FASB ASC 205. On January 23, 2015, the Company completed the sale of the MIS operating segment.
B.
Summary of Significant Accounting Policies
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to the Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures, normally included in annual consolidated financial statements have been condensed or omitted pursuant to those rules and regulations; however, in the opinion of management the financial information reflects all adjustments, consisting of adjustments of a normal recurring nature, necessary for fair presentation. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the fiscal year ended June 30, 2014 which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on August 14, 2014. The results for the three and nine months ended March 31, 2015 are not necessarily indicative of the results to be expected for the full fiscal year.
The Company is comprised of the following operating segments: MCE and MDS. See Note L of the Notes to Consolidated Financial Statements for further discussion.
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

6



REVENUE RECOGNITION
The Company relies upon FASB ASC 605, Revenue Recognition to account for its revenue transactions. Revenue is recognized upon shipment provided that title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the related receivable is reasonably assured, and customer acceptance criteria, if any, have been successfully demonstrated. Out-of-pocket expenses that are reimbursable by the customer are included in revenue and cost of revenue.
Certain contracts with customers require the Company to perform tests of its products prior to shipment to ensure their performance complies with the Company’s published product specifications and, on occasion, with additional customer-requested specifications. In these cases, the Company conducts such tests and, if they are completed successfully, includes a written confirmation with each order shipped. As a result, at the time of each product shipment, the Company believes that no further customer testing requirements exist and that there is no uncertainty of acceptance by its customer.
The Company uses FASB Accounting Standards Update (“ASU”) No. 2009-13 (“FASB ASU 2009-13”), Multiple-Deliverable Revenue Arrangements. FASB ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence (“VSOE”) if available; (2) third-party evidence (“TPE”) if VSOE is not available; and (3) best estimated selling price (“BESP”), if neither VSOE nor TPE are available. Additionally, FASB ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. 
The Company enters into multiple-deliverable arrangements that may include a combination of hardware components, related integration or other services. These arrangements generally do not include any performance-, cancellation-, termination- or refund-type provisions. Total revenue recognized under multiple-deliverable revenue arrangements was 26% and 27% of total revenues in the three and nine months ended March 31, 2015, respectively. Total revenue recognized under multiple-deliverable revenue arrangements was 35% and 40% of total revenues in the three and nine months ended March 31, 2014, respectively.
In accordance with the provisions of FASB ASU 2009-13, the Company allocates arrangement consideration to each deliverable in an arrangement based on its relative selling price. The Company generally expects that it will not be able to establish VSOE or TPE due to limited single element transactions and the nature of the markets in which the Company competes, and, as such, the Company typically determines its relative selling price using BESP.
The objective of BESP is to determine the price at which the Company would transact if the product or service were sold by the Company on a standalone basis. Determination of BESP involves the consideration of several factors based on the specific facts and circumstances of each arrangement. Specifically, the Company considers the cost to produce the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts, the Company’s ongoing pricing strategy and policies as evident from the price list established and updated by management on a regular basis, the value of any enhancements that have been built into the deliverable and the characteristics of the varying markets in which the deliverable is sold.
The Company analyzes the selling prices used in its allocation of arrangement consideration at a minimum on an annual basis and on a more frequent basis if a significant change in the Company’s business necessitates a more timely analysis or if the Company experiences significant variances in its selling prices.
Each deliverable within the Company’s multiple-deliverable revenue arrangements is accounted for as a separate unit of accounting under the guidance of FASB ASU 2009-13 if both of the following criteria are met: the delivered item or items have value to the customer on a standalone basis; and for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. The Company's revenue arrangements do not include a general right of return for delivered products. The Company considers a deliverable to have standalone value if the item is sold separately by the Company or another vendor or if the item could be resold by the customer.
Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriate allocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting.
The Company also engages in long-term contracts for development, production and services activities which it accounts for consistent with FASB ASC 605-35, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and other relevant revenue recognition accounting literature. The Company considers the nature of these contracts and the types of products and services provided when determining the proper accounting for a particular contract. Generally for fixed-price contracts, other than service-type contracts, revenue is recognized primarily under the percentage of completion method or, for certain short-term contracts, by the completed contract method. Revenue from service-type fixed-price contracts is recognized ratably over the contract period or by other appropriate input or output methods to measure service provided, and contract costs are expensed as incurred. The Company establishes billing terms at the time project deliverables and milestones are agreed. Revenues recognized in excess of the amounts invoiced to clients are classified as unbilled receivables. For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract

7



billing rate, as well as reimbursement of other billable direct costs. For all types of contracts, the Company recognizes anticipated contract losses as soon as they become known and estimable.
The use of contract accounting requires significant judgment relative to estimating total contract revenues and costs, including assumptions relative to the length of time to complete the contract, the nature and complexity of the work to be performed, anticipated increases in wages and prices for subcontractor services and materials, and the availability of subcontractor services and materials. The Company’s estimates are based upon the professional knowledge and experience of its engineers, program managers and other personnel, who review each long-term contract monthly to assess the contract’s schedule, performance, technical matters and estimated cost at completion. Changes in estimates are applied prospectively and when adjustments in estimated contract costs are identified, such revisions may result in current period adjustments to earnings applicable to performance in prior periods.
The Company defines service revenues as revenue from activities that are not associated with the design, development, production, or delivery of tangible assets, software or specific capabilities sold by us. Examples of the Company's service revenues include: consulting, maintenance and other support, testing and installation. The Company combines its product and service revenues into a single class as service revenues do not exceed 10 percent of total revenues.
The Company does not provide its customers with rights of product return, other than those related to warranty provisions that permit repair or replacement of defective goods. The Company accrues for anticipated warranty costs upon product shipment. Revenues from product royalties are recognized upon invoice by the Company. Additionally, all revenues are reported net of government assessed taxes (e.g. sales taxes or value-added taxes).
WEIGHTED-AVERAGE SHARES
Weighted-average shares were calculated as follows:
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2015
 
2014
 
2015
 
2014
Basic weighted-average shares outstanding
32,298

 
31,156

 
32,001

 
30,932

Effect of dilutive equity instruments
935

 

 
952

 

Diluted weighted-average shares outstanding
33,233

 
31,156

 
32,953

 
30,932

Equity instruments to purchase 147 and 428 shares of common stock were not included in the calculation of diluted net earnings per share for the three and nine months ended March 31, 2015, because the equity instruments were anti-dilutive. Equity instruments to purchase 3,590 shares of common stock were not included in the calculation of diluted net earnings per share for the three and nine months ended March 31, 2014, because the equity instruments were anti-dilutive.
C.Discontinued Operations
During the fourth quarter of fiscal 2014, the Company conducted a strategic review of the Mercury Intelligence Systems (“MIS”) operating segment which encompassed an assessment of MIS' financial performance and contemporaneous future financial projections. The Company, with Board of Director's approval, concluded that a plan to divest the MIS operating segment would be in the best interests of the Company and its shareholders.
As of June 30, 2014, the Company's MIS operating segment met the "held for sale" criteria in accordance with FASB ASC 205. The MIS operating results have been reported as a discontinued operation for all periods presented. On January 23, 2015, the Company completed the sale of MIS for approximately $1,600. The sale resulted in net proceeds of $885 and a loss on disposal of $892, which is reflected within discontinued operations of the Company's accompanying consolidated financial statements. The Company does not have continuing involvement in the operations of MIS after its divestiture.
During the three months ended December 31, 2014, the Company determined that the MIS reporting unit’s carrying value of goodwill exceeded its implied fair value, resulting in a goodwill impairment charge of $2,283. The impairment charge is reflected within discontinued operations of the Company’s accompanying consolidated financial statements.


8



The amounts reported in loss from discontinued operations, net of income taxes were as follows:
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2015
 
2014
 
2015
 
2014
Net revenues of discontinued operations
$
333

 
$
2,107

 
$
3,493

 
$
7,479

Costs of discontinued operations:
 
 
 
 
 
 
 
Cost of revenues
209

 
1,356

 
2,385

 
5,092

Selling, general and administrative
715

 
738

 
1,961

 
2,327

Research and development
29

 
211

 
305

 
332

Amortization of intangible assets
32

 
124

 
279

 
371

Restructuring and other charges

 
25

 

 
25

Acquisition costs and other related expenses
(109
)
 

 

 

Impairment of goodwill

 

 
2,283

 

Loss from discontinued operations before income taxes
(543
)
 
(347
)
 
(3,720
)
 
(668
)
Loss on disposal of discontinued operations before income taxes
(892
)
 

 
(892
)
 

Tax benefit
(416
)
 
(39
)
 
(754
)
 
(150
)
Loss from discontinued operations, net of income taxes
$
(1,019
)
 
$
(308
)
 
$
(3,858
)
 
$
(518
)

The amounts reported as assets and liabilities of the discontinued operations were as follows:
 
June 30,
2014
Accounts receivable, net
$
925

Unbilled receivables and costs in excess of billings
248

Deferred income taxes
77

Prepaid income taxes

Prepaid expenses and other current assets
124

Property and equipment, net
475

Goodwill
2,283

Intangible assets, net
2,062

Other non-current assets
39

Assets of discontinued operations
$
6,233

Accounts payable
$
127

Accrued expenses
802

Accrued compensation
689

Deferred income taxes
818

Liabilities of discontinued operations
$
2,436




9



The depreciation, amortization and significant operating and investing non-cash items of the discontinued operations were as follows:
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2015
 
2014
 
2015
 
2014
Depreciation
$
11

 
$
40

 
$
100

 
$
117

Amortization of intangible assets
$
32

 
$
124

 
$
279

 
$
371

Capital expenditures
$

 
$
44

 
$

 
$
62

Restructuring and other charges
$

 
$
25

 
$

 
$
25

Impairment of goodwill
$

 
$

 
$
2,283

 
$

Stock-based compensation expense
$
(38
)
 
$
48

 
$
89

 
$
196

D.
Fair Value of Financial Instruments
The Company measures at fair value certain financial assets and liabilities, including cash equivalents and restricted cash. FASB ASC 820, Fair Value Measurement and Disclosures, specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs have created the following fair-value hierarchy:
Level 1—Quoted prices for identical instruments in active markets;
Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The following table summarizes the Company’s financial assets measured at fair value on a recurring basis at March 31, 2015: 
 
 
Fair Value Measurements
 
 
March 31, 2015
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
66,520

 
$
66,520

 
$

 
$

Restricted cash
 
264

 
264

 

 

Total
 
$
66,784

 
$
66,784

 
$

 
$

The carrying values of cash and cash equivalents, including all U.S. Treasury Bills and money market funds, accounts receivable and payable, and accrued liabilities approximate fair value due to the short-term maturities of these assets and liabilities.
E.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market value, and consists of materials, labor and overhead. On a quarterly basis, the Company uses consistent methodologies to evaluate inventory for net realizable value. Once an item is written down, the value becomes the new inventory cost basis. The Company reduces the value of inventory for excess and obsolete inventory, consisting of on-hand inventory in excess of estimated usage. The excess and obsolete inventory evaluation is based upon assumptions about future demand, history, product mix and possible alternative uses. Inventory was comprised of the following:
 
 
March 31, 2015
 
June 30, 2014
Raw materials
 
$
15,244

 
$
13,755

Work in process
 
12,994

 
12,677

Finished goods
 
4,288

 
5,223

Total
 
$
32,526

 
$
31,655


10



There are no amounts in inventory relating to contracts having production cycles longer than one year.
F.
Goodwill
The following table sets forth the carrying amount of goodwill by reporting units as of March 31, 2015 and June 30, 2014:
 
 
March 31, 2015
 
June 30, 2014
MCE goodwill
 
$
134,378

 
$
134,378

MDS goodwill
 
33,768

 
33,768

Total goodwill
 
$
168,146

 
$
168,146

In the nine months ended March 31, 2015, there were no triggering events, as defined by FASB ASC 350, which required an interim goodwill impairment test. The Company performs its annual goodwill impairment test in the fourth quarter of each fiscal year.
The Company determines its reporting units in accordance with FASB ASC 350, by assessing whether discrete financial information is available and if management regularly reviews the operating results of that component. Following this assessment, the Company determined that its reporting units are the same as its operating segments, MCE and MDS.
G.
Restructuring
 
During fiscal 2014 the Company announced a restructuring plan that was implemented as part of the final phase of integration activities relating to the Company’s recent acquisitions. This acquisition integration plan included the consolidation of manufacturing facilities, centralization of administrative functions using common information systems and processes, and realignment of research and development resources. The Company had successfully completed the acquisition integration activities during the second fiscal quarter of 2015. In the event that the Company is unable to sublease the unoccupied portion of its headquarters complex in Chelmsford, MA, it will incur nominal, periodic restructuring charges through fiscal 2017 in its MCE reportable segment. During the three months ended March 31, 2015, the Company has incurred restructuring and other charges of $27.
The following table presents the detail of activity for the Company’s restructuring plans:
 
 
Severance &
Related
 
Facilities
& Other
 
Total
Restructuring liability at June 30, 2014
 
$
1,371

 
$
772

 
$
2,143

MCE restructuring and other charges
 
997

 
1,601

 
2,598

MDS restructuring and other charges
 
49

 

 
49

Cash paid
 
(1,785
)
 
(849
)
 
(2,634
)
Reversals(*)
 
(190
)
 

 
(190
)
Restructuring liability at March 31, 2015
 
$
442

 
$
1,524

 
$
1,966

*)    Reversals result from unused outplacement services.
All of the restructuring and other charges are classified as operating expenses in the consolidated statements of operations and comprehensive income (loss) and any remaining obligations are expected to be paid by the end of fiscal 2017. The restructuring liability is classified as accrued expenses in the consolidated balance sheets.
On April 23, 2015, the Company incurred restructuring and other charges related to involuntary separation costs associated with a headcount reduction within its MCE reportable segment. The Company expects to incur approximately $700 by the end of the fourth quarter related to the continued optimization of its advanced microelectronics centers.
H.
Income Taxes
The Company recorded a tax provision of $1,469 and a tax benefit of $809 on income from continuing operations before income taxes of $6,163 and loss from continuing operations before income taxes of $1,079 for the three months ended March 31, 2015 and 2014, respectively. The Company recorded a tax provision of $2,516 and a tax benefit of $2,570 on income from continuing operations before income taxes of $10,813 and a loss from continuing operations before income taxes of $5,931 for the nine months ended March 31, 2015 and 2014, respectively. Income tax provision for the three and nine months ended March 31, 2015 differed from the federal statutory rate primarily due to the impact of federal research and development tax credits, domestic

11



manufacturing deduction, stock compensation, state taxes and the realization of previously unrecognized tax benefits. Income tax benefit for the three and nine months ended March 31, 2014 differed from the federal statutory rate primarily due to the impact of federal research and development tax credits, domestic manufacturing deduction, stock compensation and state taxes.
On December 19, 2014, the Tax Increase Prevention Act of 2014 was enacted, which retroactively reinstated and extended the federal research and development tax credits from January 1, 2014 through December 31, 2014. Based on the extension, the Company estimates that there was an additional $894 credit earned in calendar year 2014, of which $487 relating to fiscal year 2014 was recognized as a discrete benefit in the three months ended December 31, 2014.
The Company’s unrecognized tax positions decreased by $1,022 and $899 during the three and nine months ended March 31, 2015, respectively. The decrease during the three months ended March 31, 2015 relates to the realization of previously unrecognized tax benefits of $1,022. The decrease of $899 during the nine months ended March 31, 2015 was a result of the realization of previously unrecognized tax benefits of $1,022, partially offset by an increase relating to additional research and development tax credits for fiscal year 2014.
The Company is currently under audit by the Internal Revenue Service for fiscal year 2013. There have been no significant changes to the status of this examination during the nine months ended March 31, 2015.
I.
Commitments and Contingencies
LEGAL CLAIMS
The Company is subject to litigation, claims, investigations and audits arising from time to time in the ordinary course of our business. Although legal proceedings are inherently unpredictable, the Company believes that it has valid defenses with respect to any matters currently pending against the Company and intends to defend itself vigorously. The outcome of these matters, individually and in the aggregate, is not expected to have a material impact on the Company’s cash flows, results of operations, or financial position.
INDEMNIFICATION OBLIGATIONS
The Company’s standard product sales and license agreements entered into in the ordinary course of business typically contain an indemnification provision pursuant to which the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. Such provisions generally survive termination or expiration of the agreements. The potential amount of future payments the Company could be required to make under these indemnification provisions is, in some instances, unlimited.
In connection with the sale of the Company’s former MIS business, the Company provided indemnification to the buyer of the business. The Company’s indemnification obligations generally cover the buyer for damages resulting from breaches of representations, warranties and covenants contained in the purchase and sale agreement and generally cover pre-closing tax liabilities of the business. The Company’s indemnification obligations regarding the MIS business are generally subject to caps.
PURCHASE COMMITMENTS
As of March 31, 2015, the Company has entered into non-cancelable purchase commitments for certain inventory components and services used in its normal operations. The purchase commitments covered by these agreements are for less than one year and aggregate to $38,619.
J.
Debt
Senior Unsecured Credit Facility
As of March 31, 2015, there was $126,935 of borrowing capacity available under the Company's credit agreement with a syndicate of commercial banks, with Key Bank National Association acting as the administrative agent. The Company can borrow up to $200,000 based on the Company's consolidated EBITDA for the trailing four quarters and subject to compliance with the financial covenants in the credit agreement. There were no borrowings outstanding on the credit agreement; however, there were outstanding letters of credit of $3,858. The Company was in compliance with all covenants and conditions under the credit agreement.

12



K.
Stock-Based Compensation
STOCK OPTION PLANS
The number of shares authorized for issuance under the Company’s 2005 Stock Incentive Plan, as amended and restated (the “2005 Plan”), is 11,424 shares at March 31, 2015. On October 21, 2014, the Company's number of shares authorized for issuance under the 2005 Plan increased 3,406 shares, including 206 shares as a result of cancellations, forfeitures or terminations under the 1997 Plan. The 2005 Plan provides for the grant of non-qualified and incentive stock options, restricted stock, stock appreciation rights and deferred stock awards to employees and non-employees. All stock options are granted with an exercise price of not less than 100% of the fair value of the Company’s common stock at the date of grant and the options generally have a term of seven years. There were 3,718 shares available for future grant under the 2005 Plan at March 31, 2015.
On August 15, 2014, as part of the Company's ongoing annual equity grant program for employees, the Company granted, for the first time, performance-based restricted stock awards to certain executives pursuant to the 2005 Plan. These performance awards vest annually over a three year requisite service period subject to the achievement of specific financial performance targets related to adjusted EBITDA as a percentage of revenue. Based on the performance targets, these awards require graded vesting that results in more rapid expense recognition compared to traditional time-based vesting over the same vesting period. The Company will monitor the probability of achieving the performance targets on a quarterly basis and may adjust periodic compensation expense accordingly.
EMPLOYEE STOCK PURCHASE PLAN
The number of shares authorized for issuance under the Company’s 1997 Employee Stock Purchase Plan, as amended and restated (“ESPP”), is 1,400 shares. Under the ESPP, rights are granted to purchase shares of common stock at 85% of the lesser of the market value of such shares at either the beginning or the end of each six-month offering period. The ESPP permits employees to purchase common stock through payroll deductions, which may not exceed 10% of an employee’s compensation as defined in the ESPP. There were 41 and 55 shares issued under the ESPP during the nine months ended March 31, 2015 and 2014, respectively. Shares available for future purchase under the ESPP totaled 123 at March 31, 2015.
STOCK OPTION AND AWARD ACTIVITY
The following table summarizes activity of the Company’s stock option plans since June 30, 2014:
 
 
Options Outstanding
 
 
Number of
Shares
 
Weighted Average
Exercise Price
 
Weighted Average
Remaining
Contractual Term
(Years)
Outstanding at June 30, 2014
 
1,435

 
$
11.76

 
2.23
Granted
 

 

 
 
Exercised
 
(339
)
 
7.38

 
 
Cancelled
 
(101
)
 
19.73

 
 
Outstanding at March 31, 2015
 
995

 
$
12.45

 
1.87
The following table summarizes the status of the Company’s non-vested restricted stock awards since June 30, 2014:
 
 
Non-vested Restricted Stock Awards
 
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Outstanding at June 30, 2014
 
2,091

 
$
10.15

Granted
 
802

 
11.86

Vested
 
(759
)
 
10.51

Forfeited
 
(286
)
 
10.73

Outstanding at March 31, 2015
 
1,848

 
$
10.65


13



STOCK-BASED COMPENSATION EXPENSE
The Company recognized the full expense of its share-based payment plans in the consolidated statements of operations for the three and nine months ended March 31, 2015 and 2014 in accordance with FASB ASC 718 and did not capitalize any such costs on the consolidated balance sheets, as such costs that qualified for capitalization were not material. Under the fair value recognition provisions of FASB ASC 718, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the service period, net of estimated forfeitures. The following table presents share-based compensation expenses included in the Company’s consolidated statements of operations:
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2015
 
2014
 
2015
 
2014
Cost of revenues
$
110

 
$
104

 
$
375

 
$
503

Selling, general and administrative
1,446

 
1,383

 
5,190

 
5,701

Research and development
314

 
179

 
1,111

 
1,066

Share-based compensation expense before tax
1,870

 
1,666

 
6,676

 
7,270

Income tax benefit
(682
)
 
(591
)
 
(2,442
)
 
(2,616
)
Net compensation expense
$
1,188

 
$
1,075

 
$
4,234

 
$
4,654

L.
Operating Segment, Geographic Information and Significant Customers
Operating segments are defined as components of an enterprise evaluated regularly by the Company's chief operating decision maker (“CODM”) in deciding how to allocate resources and assess performance. The Company utilizes the management approach for determining reportable segments in accordance with the authoritative guidance. The following operating segments were determined based upon the nature of the products offered to customers, the market characteristics of each operating segment and the Company's management structure:
Mercury Commercial Electronics (“MCE”): this operating segment delivers affordable, innovative, commercially developed, specialized processing subsystems for critical commercial, defense and intelligence applications. MCE delivers secure solutions that are based upon open architectures and widely adopted industry standards. MCE delivers rapid time-to-value and service and support to prime defense contractors and commercial customers. MCE provides solutions to prime contractor customers on a variety of programs. MCE also provides technology building blocks to Mercury Defense Systems on key classified and unclassified programs. MCE has a legacy of embedded multi-computing and embedded sensor processing expertise. More recently, MCE has added substantial capabilities around radio frequency ("RF") and microwave technologies as well as emerging new manufacturing capabilities to bring design, production and test capabilities of its RF and microwave solutions to market on a more scalable basis.
Mercury Defense Systems (“MDS”): this operating segment provides significant capabilities relating to pre-integrated, open, affordable electronic warfare ("EW"), electronic attack ("EA") and electronic counter measure ("ECM") subsystems, and signals intelligence ("SIGINT") and electro-optical/infrared ("EO/IR") processing technologies and radar environment test and simulation systems. MDS deploys these solutions on behalf of defense prime contractors and the Department of Defense ("DoD"), leveraging commercially available technologies and solutions (or “building blocks”) from the MCE business and other commercial suppliers. MDS leverages this technology to develop integrated sensor processing subsystems, often including classified application-specific software and intellectual property ("IP") for the C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance), EW, and ECM markets. MDS brings significant domain expertise to customers, drawing on over 25 years of experience in EW, SIGINT, and radar environment test and simulation.
The Company's operating segments were evaluated in accordance with FASB ASC 280 “Segment Reporting” in order to determine which operating segments qualified as reportable segments. The Company determined that both MCE and MDS met the quantitative thresholds for reporting.
Prior year results have been restated for the reclassification of the MIS operating segment as discontinued operations. MIS was previously aggregated with MDS into one reportable segment based on similar economic and qualitative factors in accordance with FASB ASC 280 (see Note C).
The accounting policies of the reportable segments are the same as those described in “Note B: Summary of Significant Accounting Policies.” The profitability measure employed by the Company and its CODM as the basis for allocating resources to segments and assessing segment performance is adjusted EBITDA. The Company believes the adjusted EBITDA financial

14



measure assists in providing an enhanced understanding of its underlying operational measures to manage its business, to evaluate its performance compared to prior periods and the marketplace, and to establish operational goals.
Adjusted EBITDA is defined as income from continuing operations before interest income and expense, income taxes, depreciation, amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition and financing costs, fair value adjustments from purchase accounting and stock-based compensation costs. Additionally, asset information by reportable segment is not reported because the Company and its CODM utilize consolidated asset information when making business decisions. The following is a summary of the performance of the Company's operations by reportable segment:
 
 
MCE
 
MDS
 
Eliminations
 
Total
THREE MONTHS ENDED
MARCH 31, 2015
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
52,748

 
$
6,714

 
$
116

 
$
59,578

Intersegment revenues
 
2,325

 
32

 
(2,357
)
 

Net revenues
 
$
55,073

 
$
6,746

 
$
(2,241
)
 
$
59,578

Adjusted EBITDA
 
$
12,073

 
$
614

 
$
(1,172
)
 
$
11,515

THREE MONTHS ENDED
MARCH 31, 2014
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
43,041

 
$
8,884

 
$
1,468

 
$
53,393

Intersegment revenues
 
4,568

 

 
(4,568
)
 

Net revenues
 
$
47,609

 
$
8,884

 
$
(3,100
)
 
$
53,393

Adjusted EBITDA
 
$
6,763

 
$
1,242

 
$
(232
)
 
$
7,773

NINE MONTHS ENDED
MARCH 31, 2015
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
153,110

 
$
16,860

 
$
758

 
$
170,728

Intersegment revenues
 
3,750

 
244

 
(3,994
)
 

Net revenues
 
$
156,860

 
$
17,104

 
$
(3,236
)
 
$
170,728

Adjusted EBITDA
 
$
29,872

 
$
1,384

 
$
(1,032
)
 
$
30,224

NINE MONTHS ENDED
MARCH 31, 2014
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
128,835

 
$
25,245

 
$
971

 
$
155,051

Intersegment revenues
 
8,415

 

 
(8,415
)
 

Net revenues
 
$
137,250

 
$
25,245

 
$
(7,444
)
 
$
155,051

Adjusted EBITDA
 
$
13,188

 
$
3,370

 
$
(225
)
 
$
16,333

The following table reconciles the Company’s income (loss) from continuing operations, the most directly comparable GAAP financial measure, to its adjusted EBITDA:
 
 
Three Months Ended March 31,
 
Nine Months Ended March 31,

 
2015
 
2014
 
2015
 
2014
Income (loss) from continuing operations
 
$
4,694

 
$
(270
)
 
$
8,297

 
$
(3,361
)
Interest expense, net
 
1

 
9

 
10

 
31

Tax provision (benefit)
 
1,469

 
(809
)
 
2,516

 
(2,570
)
Depreciation
 
1,510

 
1,923

 
4,800

 
5,839

Amortization of intangible assets
 
1,744

 
1,777

 
5,268

 
5,565

Restructuring and other charges
 
27

 
3,477

 
2,457

 
3,559

Acquisition and financing costs
 
200

 

 
200

 

Stock-based compensation expense
 
1,870

 
1,666

 
6,676

 
7,270

Adjusted EBITDA
 
$
11,515

 
$
7,773

 
$
30,224

 
$
16,333


15



The geographic distribution of the Company’s revenues is summarized as follows:
 
 
 
US
 
Europe
 
Asia Pacific
 
Eliminations
 
Total
THREE MONTHS ENDED
MARCH 31, 2015
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
58,307

 
$
439

 
$
832

 
$

 
$
59,578

Inter-geographic revenues
 
1,200

 
54

 

 
(1,254
)
 

Net revenues
 
$
59,507

 
$
493

 
$
832

 
$
(1,254
)
 
$
59,578

THREE MONTHS ENDED
MARCH 31, 2014
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
50,608

 
$
1,028

 
$
1,757

 
$

 
$
53,393

Inter-geographic revenues
 
1,403

 
1,065

 

 
(2,468
)
 

Net revenues
 
$
52,011

 
$
2,093

 
$
1,757

 
$
(2,468
)
 
$
53,393

NINE MONTHS ENDED
MARCH 31, 2015
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
167,017

 
$
1,140

 
$
2,571

 
$

 
$
170,728

Inter-geographic revenues
 
2,747

 
233

 

 
(2,980
)
 

Net revenues
 
$
169,764

 
$
1,373

 
$
2,571

 
$
(2,980
)
 
$
170,728

NINE MONTHS ENDED
MARCH 31, 2014
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
150,414

 
$
1,987

 
$
2,650

 
$

 
$
155,051

Inter-geographic revenues
 
2,901

 
1,269

 
140

 
(4,310
)
 

Net revenues
 
$
153,315

 
$
3,256

 
$
2,790

 
$
(4,310
)
 
$
155,051

Foreign revenue is based on the country in which the Company’s legal subsidiary is domiciled.
The geographic distribution of the Company’s long-lived assets is summarized as follows:
 
 
U.S.
 
Europe
 
Asia Pacific
 
Eliminations
 
Total
March 31, 2015
 
$
12,335

 
$
29

 
$
27

 
$

 
$
12,391

June 30, 2014
 
$
14,090

 
$
48

 
$
6

 
$

 
$
14,144

Identifiable long-lived assets exclude goodwill and intangible assets.
Customers comprising 10% or more of the Company’s revenues for the periods shown below are as follows:
 
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
 
2015
 
2014
 
2015
 
2014
Raytheon Company
 
37
%
 
*

 
36
%
 
10
%
Lockheed Martin Corporation
 
19
%
 
17
%
 
22
%
 
19
%
Northrop Grumman Corporation
 
*

 
13
%
 
*

 
14
%
 
 
56
%
 
30
%
 
58
%
 
43
%
*
Indicates that the amount is less than 10% of the Company’s revenues for the respective period.

16



While the Company typically has customers from which it derives 10% or more of its revenue, the sales to each of these customers are spread across multiple programs and platforms. Programs comprising 10% or more of the Company’s revenues for the periods shown below are as follows:
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
 
2015
 
2014
 
2015
 
2014
Patriot
 
20
%
 

 
19
%
 

F-35
 
16
%
 
*

 
13
%
 
*

Aegis
 
13
%
 
16
%
 
11
%
 
16
%
 
 
49
%
 
16
%
 
43
%
 
16
%
*
Indicates that the amount is less than 10% of the Company’s revenues for the respective period.
M.
Subsequent Events
The Company has evaluated subsequent events from the date of the consolidated balance sheet through the date the consolidated financial statements were issued.





17



ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
From time to time, information provided, statements made by our employees or information included in our filings with the Securities and Exchange Commission may contain statements that are not historical facts but that are “forward-looking statements,” which involve risks and uncertainties. You can identify these statements by the use of the words “may,” “will,” “could,” “should,” “would,” “plans,” “expects,” “anticipates,” “continue,” “estimate,” “project,” “intend,” “likely,” “forecast,” “probable,” “potential,” and similar expressions. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not limited to, continued funding of defense programs, the timing and amounts of such funding, general economic and business conditions, including unforeseen weakness in the Company's markets, effects of continued geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in, or in the U.S. Government’s interpretation of, federal export control or procurement rules and regulations, market acceptance of the Company's products, shortages in components, production delays due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions, divestitures and restructurings, or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, changes to export regulations, increases in tax rates, changes to generally accepted accounting principles, difficulties in retaining key employees and customers, unanticipated costs under fixed-price service and system integration engagements, and various other factors beyond our control. These risks and uncertainties also include such additional risk factors as set forth under Part I-Item 1A (Risk Factors) in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2014. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.
OVERVIEW
Mercury Systems, Inc. is a leading high-tech commercial provider of more affordable secure and sensor processing subsystems designed and made in the U.S.A. for critical defense and intelligence applications. We deliver innovative solutions, rapid time-to-value and service and support to our defense prime contractor customers. Our products and solutions have been deployed in more than 300 programs with over 25 different defense prime contractors. Key programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program ("SEWIP"), Gorgon Stare, Predator, F-35 and Reaper. Our organizational structure allows us to deliver capabilities that combine technology building blocks and deep domain expertise in the defense sector. Mercury Systems operates across a broad spectrum of defense programs and, effective for fiscal 2015, we deliver our solutions and services via two operating segments: (i) Mercury Commercial Electronics; and (ii) Mercury Defense Systems. In the fourth quarter of fiscal 2014, we initiated a plan to divest our Mercury Intelligence Systems ("MIS") operating segment. Consequently, its operating results are included in discontinued operations for all periods presented. On January 23, 2015, we completed the sale of MIS (see Note C to the consolidated financial statements).
As of March 31, 2015, we had 641 employees. Our revenue, income from continuing operations and adjusted EBITDA for the three month period ended March 31, 2015 were $59.6 million, $4.7 million, and $11.5 million, respectively. Our revenue, income from continuing operations and adjusted EBITDA for the nine month period ended March 31, 2015 were $170.7 million, $8.3 million, and $30.2 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation of our income from continuing operations to adjusted EBITDA.
Our operations are organized in the following two reportable segments: (i) Mercury Commercial Electronics ("MCE") and (ii) Mercury Defense Systems ("MDS").
Mercury Commercial Electronics, or MCE, provides affordable, innovative, commercially designed and developed, specialized processing subsystems for critical defense and intelligence applications. We deliver innovative solutions, rapid time-to-value and service and support to our prime defense contractor customers. Our technologies and capabilities include embedded processing modules and subsystems, RF and microwave multi-function assemblies as well as subsystems, and RF and microwave components.
MCE utilizes leading edge, high performance computing technologies architected by leveraging open standards and open architectures to address highly data-intensive applications that include signal, sensor and image processing; all of this while addressing the packaging challenges, often referred to as “SWaP” (size, weight, and power) that are common in military applications. In addition, MCE designs and builds RF and microwave components and subsystems to meet the needs of the electronic warfare ("EW"), signals intelligence ("SIGINT") and other high bandwidth communications requirements and applications.
For the nine months ended March 31, 2015, MCE accounted for approximately 90% of our total net revenues.

18



Mercury Defense Systems, or MDS, provides significant capabilities relating to pre-integrated, open, affordable EW, electronic attack ("EA") and electronic counter measure ("ECM") subsystems, SIGINT and electro-optical/infrared ("EO/IR") processing technologies, and radar environment test and simulation systems. MDS deploys these solutions on behalf of defense prime contractors and the Department of Defense ("DoD"), leveraging commercially available technologies and solutions (or “building blocks”) from our MCE business and other commercial suppliers. MDS leverages this technology to develop integrated sensor processing subsystems, often including classified application-specific software and intellectual property ("IP") for the C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance), EW, and ECM markets. MDS brings significant domain expertise to customers, drawing on over 25 years of experience in EW, SIGINT, and radar environment test and simulation.
For the nine months ended March 31, 2015, MDS accounted for approximately 10% of our total net revenues.
Since we are an OEM supplier to our commercial markets and conduct much of our business with our defense customers via commercial items, requests by customers are a primary driver of revenue fluctuations from quarter to quarter. Customers specify delivery date requirements that coincide with their need for our products. Because these customers may use our products in connection with a variety of defense programs or other projects of different sizes and durations, a customer’s orders for one quarter generally do not indicate a trend for future orders by that customer. Additionally, order patterns do not necessarily correlate amongst customers and, therefore, we generally cannot identify sequential quarterly trends, even within our operating segements.
RESULTS OF OPERATIONS:
Three months ended March 31, 2015 compared to the three months ended March 31, 2014
The following tables set forth, for the three months periods indicated, financial data from the consolidated statements of operations:
(In thousands)
 
March 31, 2015
 
As a % of
Total Net
Revenue
 
March 31, 2014
 
As a % of
Total Net
Revenue
Net revenues
 
$
59,578

 
100.0
 %
 
$
53,393

 
100.0
 %
Cost of revenues
 
31,660

 
53.1

 
29,017

 
54.3

Gross margin
 
27,918

 
46.9

 
24,376

 
45.7

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
11,842

 
19.9

 
12,363

 
23.2

Research and development
 
8,115

 
13.6

 
8,166

 
15.3

Amortization of intangible assets
 
1,744

 
2.9

 
1,777

 
3.3

Restructuring and other charges
 
27

 

 
3,477

 
6.5

Acquisition costs and other related expenses
 
33

 
0.1

 

 

Total operating expenses
 
21,761

 
36.5

 
25,783

 
48.3

Income (loss) from operations
 
6,157

 
10.4

 
(1,407
)
 
(2.6
)
Other income, net
 
6

 
0.0

 
328

 
0.6

Income (loss) from continuing operations before income taxes
 
6,163

 
10.4

 
(1,079
)
 
(2.0
)
Tax provision (benefit)
 
1,469

 
2.5

 
(809
)
 
(1.5
)
Income (loss) from continuing operations
 
4,694

 
7.9

 
(270
)
 
(0.5
)
Loss from discontinued operations, net of taxes
 
(1,019
)
 
(1.7
)
 
(308
)
 
(0.6
)
Net income (loss)
 
$
3,675

 
6.2
 %
 
$
(578
)
 
(1.1
)%
REVENUES
(In thousands)
 
March 31, 2015
 
March 31, 2014
 
$ Change
 
% Change
MCE
 
$
52,748

 
$
43,041

 
$
9,707

 
23
 %
MDS
 
6,714

 
8,884

 
(2,170
)
 
(24
)%
Eliminations
 
116

 
1,468

 
(1,352
)
 
(92
)%
Total revenues
 
$
59,578

 
$
53,393

 
$
6,185

 
12
 %

19



Total revenues increased $6.2 million, or 12%, to $59.6 million during the three months ended March 31, 2015 as compared to the comparable period in fiscal 2014. This increase was driven by higher defense sales of $5.0 million and higher commercial sales of $1.2 million. The increase in total revenues is primarily attributed to higher revenues from the Patriot, SEWIP, and F-35 programs. International revenues, which consist of foreign military sales through prime defense contractor customers and direct sales to non-U.S. based customers, decreased $1.5 million to $10.0 million during the three months ended March 31, 2015, compared to $11.5 million in the same period in the prior fiscal year. The decrease was primarily driven by lower revenues from the DEWS program and commercial sales. International revenues represented 14% and 18% of total revenues during the three months ended March 31, 2015 and 2014, respectively.
Net MCE revenues increased $9.7 million, or 23%, during the three months ended March 31, 2015 as compared to the same period in the prior fiscal year. This increase was primarily driven by higher defense sales of $8.5 million related to increases from the Patriot, SEWIP, and F-35 programs, and a $1.2 million increase in commercial sales.
Net MDS revenues decreased $2.2 million, or 24%, during the three months ended March 31, 2015 as compared to the same period in the previous fiscal year. This decrease was primarily driven by lower revenues related to the Gorgon Stare program in the most recent quarter.
Eliminations revenue is attributable to development programs where the revenue is recognized in each segment under contract accounting, and reflects the reconciliation to our consolidated results.
GROSS MARGIN
Gross margin was 46.9% for the three months ended March 31, 2015, an increase of 120 basis points from the 45.7% gross margin achieved during the same period in fiscal 2014. The higher gross margin between years was due to changes in product mix, including more revenues from certain higher-margin digital processing products and programs within MCE during the three months ended March 31, 2015 as compared to the same period in the prior fiscal year.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses decreased $0.5 million, or 4%, to $11.8 million during the three months ended March 31, 2015, compared to $12.3 million in the comparable period in fiscal 2014. The decrease was primarily due to lower employee compensation expenses from the completion of our plan to integrate and consolidate facilities, systems, and processes. Selling, general and administrative expenses decreased as a percentage of revenues to 19.9% during the three months ended March 31, 2015 from 23.2% during the same period in fiscal 2014 due to higher revenues in the third quarter of fiscal 2015 coupled with overall expense reductions, as compared to the comparable period in fiscal 2014.
RESEARCH AND DEVELOPMENT
Research and development expenses decreased approximately $0.1 million, or 1%, to $8.1 million during the three months ended March 31, 2015, compared to $8.2 million during the comparable period in fiscal 2014. The decrease was primarily due to higher customer funded development partially offset by an increase in compensation expenses during fiscal 2015.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets was $1.7 million for the three months ended March 31, 2015, slightly decreased from $1.8 million for the three months ended March 31, 2014.
RESTRUCTURING AND OTHER CHARGES
In fiscal 2014, we announced a restructuring plan that was implemented as part of the final phase of integration activities relating to our recent acquisitions. This acquisition integration plan included the consolidation of manufacturing facilities, centralization of administrative functions using common information systems and processes, and realignment of research and development resources. During the second quarter of fiscal 2015, the acquisition integration activities were completed. In the third quarter of fiscal 2015, we incurred restructuring and other charges of less than $0.1 million, primarily associated with such nominal, periodic restructuring charges for the unoccupied portion of our corporate headquarters complex. The $3.5 million restructuring and other charges for the third quarter of fiscal 2014 were primarily related to the reduction in force incurred in the third quarter of fiscal 2014. We anticipate incurring restructuring charges of approximately $0.7 million in the fourth quarter of fiscal 2015. These charges relate to the consolidation of resources and continued optimization of our advanced microelectronics centers within our MCE operating segment.
OTHER INCOME, NET
Other income, net decreased $0.3 million during the three months ended March 31, 2015, as compared to the same period in fiscal 2014. The decrease was primarily driven by the inclusion of $0.2 million in bank fees which were classified as selling, general, and administrative expenses in prior periods and a foreign exchange loss of $0.2 million driven by the weakening Japanese

20



yen in the third quarter of fiscal 2015. Other income, net for the three months ended March 31, 2015 and 2014, include $0.3 million related to the amortization of the gain on the sale leaseback of our corporate headquarters located in Chelmsford, Massachusetts. Interest income and interest expense were de minimis.
INCOME TAXES
We recorded an income tax provision of $1.5 million during the three months ended March 31, 2015 as compared to a $0.8 million income tax benefit for the comparable period in the prior fiscal year. Our income taxes for the three months ended March 31, 2015 differed from the federal statutory tax rate of 35% primarily due to the impact of federal research and development tax credits, domestic manufacturing deduction, stock compensation, state taxes and the realization of previously unrecognized tax benefits. Our income tax benefit during the comparable period in fiscal 2014 differed from the federal statutory rate primarily due to the impact of federal research and development tax credits, domestic manufacturing deduction, stock compensation and state taxes.
DISCONTINUED OPERATIONS
We incurred a loss from discontinued operations of $1.0 million in the three months ended in March 31, 2015 compared to a loss from discontinued operations of $0.3 million for the same period in fiscal 2014. The loss from discontinued operations during the three months ended March 31, 2015 included a $0.9 million loss on disposal of discontinued operations before income taxes from the sale of MIS operating segment, which we completed on January 23, 2015.
SEGMENT OPERATING RESULTS
We use adjusted EBITDA as the profitability measure for our segment reporting. Adjusted EBITDA for MCE increased $5.3 million during the three months ended March 31, 2015 to $12.1 million as compared to $6.8 million for the comparable period in fiscal 2014. The increase in adjusted EBITDA is driven by higher revenues of $9.7 million primarily from defense programs, coupled with lower operating expenses.
Adjusted EBITDA for MDS decreased $0.6 million during the three months ended March 31, 2015 to $0.6 million as compared to $1.2 million for the comparable period in fiscal 2014. The decrease in adjusted EBITDA was primarily due to lower revenues from the Gorgon Stare program.
See Note L to our consolidated financial statements included in this report for more information regarding our operating segments.
Nine months ended March 31, 2015 compared to the nine months ended March 31, 2014
The following tables set forth, for the nine months periods indicated, financial data from the consolidated statements of operations:
(In thousands)
 
March 31, 2015
 
As a % of
Total Net
Revenue
 
March 31, 2014
 
As a % of
Total Net
Revenue
Net revenues
 
$
170,728

 
100.0
 %
 
$
155,051

 
100.0
 %
Cost of revenues
 
91,776

 
53.8

 
84,788

 
54.7

Gross margin
 
78,952

 
46.2

 
70,263

 
45.3

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
36,809

 
21.6

 
40,628

 
26.2

Research and development
 
23,961

 
14.0

 
27,620

 
17.8

Amortization of intangible assets
 
5,268

 
3.1

 
5,565

 
3.6

Restructuring and other charges
 
2,457

 
1.4

 
3,559

 
2.3

Acquisition costs and other related expenses
 
33

 

 

 

Total operating expenses
 
68,528

 
40.1

 
77,372

 
49.9

Income (loss) from operations
 
10,424

 
6.1

 
(7,109
)
 
(4.6
)
Other income, net
 
389

 
0.2

 
1,178

 
0.8

Income (loss) from continuing operations before income taxes
 
10,813

 
6.3

 
(5,931
)
 
(3.8
)
Tax provision (benefit)
 
2,516

 
1.4

 
(2,570
)
 
(1.6
)
Income (loss) from continuing operations
 
$
8,297

 
4.9

 
$
(3,361
)
 
(2.2
)
Loss from discontinued operations, net of income taxes
 
(3,858
)
 
(2.3
)
 
(518
)
 
(0.3
)
Net income (loss)
 
$
4,439

 
2.6
 %
 
$
(3,879
)
 
(2.5
)%

21



REVENUES
(In thousands)
 
March 31, 2015
 
March 31, 2014
 
$ Change
 
% Change
MCE
 
$
153,110

 
$
128,835

 
$
24,275

 
19
 %
MDS
 
16,860

 
25,245

 
(8,385
)
 
(33
)%
Eliminations
 
758

 
971

 
(213
)
 
(22
)%
Total revenues
 
$
170,728

 
$
155,051

 
$
15,677

 
10
 %
Total revenues increased $15.7 million, or 10%, to $170.7 million during the nine months ended March 31, 2015 as compared to the comparable period in fiscal 2014. This increase was driven by higher defense sales of $18.0 million, partially offset by a $2.3 million decrease in commercial sales. The increase in total revenues is primarily attributed to increases in the Patriot, SEWIP, and F-35 programs that were partially offset by lower revenues from the Aegis and Gorgon Stare programs.
Net MCE revenues increased $24.3 million, or 19%, during the nine months ended March 31, 2015 as compared to the same period in the prior fiscal year. This increase was primarily driven by higher defense sales of $26.6 million related to increases in the Aegis, Patriot, F-35, and Global Hawk programs, partially offset by a $2.3 million decrease in commercial sales.
Net MDS revenues decreased $8.4 million, or 33%, during the nine months ended March 31, 2015 as compared to the same period in the prior fiscal year. This decrease was primarily driven by lower revenues related to the Gorgon Stare program.
Eliminations revenue is attributable to development programs where the revenue is recognized in each segment under contract accounting, and reflects the reconciliation to our consolidated results.
GROSS MARGIN
Gross margin was 46.2% for the nine months ended March 31, 2015, as compared to 45.3% gross margin during the same period in fiscal 2014. The higher gross margin between years was due to a favorable product mix, primarily driven by stronger revenues in our higher margin digital processing programs and products within MCE.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses decreased $3.8 million, or 9%, to $36.8 million during the nine months ended March 31, 2015, compared to $40.6 million in the comparable period in fiscal 2014. The decrease was primarily due to lower employee compensation expenses from the completion of our plan to integrate and consolidate facilities, systems, and processes. Selling, general and administrative expenses decreased as a percentage of revenues to 21.6% during the nine months ended March 31, 2015 from 26.2% during the same period in fiscal 2014 due to higher revenues in the first nine months of fiscal 2015 coupled with overall expense reductions, as compared to the same period in fiscal 2014.
RESEARCH AND DEVELOPMENT
Research and development expenses decreased $3.7 million, or 13%, to $24.0 million during the nine months ended March 31, 2015, compared to $27.6 million during the comparable period in fiscal 2014. The decrease was primarily due to higher customer funded development partially offset by increased compensation expenses during fiscal 2015.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets decreased $0.3 million, or 5%, to $5.3 million during the nine months ended March 31, 2015, compared to $5.6 million during the comparable period in fiscal 2014, primarily due to a portion of the Micronetics related intangible assets being fully amortized during the first quarter of fiscal 2014.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges were $2.5 million for the nine months ended March 31, 2015, as compared to $3.6 million during the comparable period in fiscal 2014. In fiscal 2014, we announced a restructuring plan that was implemented as part of the final phase of integration activities relating to our recent acquisitions. This acquisition integration plan included the consolidation of manufacturing facilities, centralization of administrative functions using common information systems and processes, and realignment of research and development resources. During the first nine months of fiscal 2015, the acquisition integration activities were completed and we incurred restructuring and other charges of $2.5 million, primarily associated with the final phases of the Chelmsford, Massachusetts headquarters consolidation and severance costs. In the event that we are unable to sublease the unoccupied portion of our headquarters complex in Chelmsford, Massachusetts, we will incur nominal, periodic restructuring charges through fiscal 2017. The $3.6 million restructuring and other charges for the first nine months of fiscal 2014 were primarily related to the reduction in force incurred in the third quarter of fiscal 2014. We anticipate incurring restructuring charges of

22



approximately $0.7 million in the fourth quarter of fiscal 2015. These charges relate to the consolidation of resources and continued optimization of our advanced microelectronics centers within our MCE operating segment.
OTHER INCOME, NET
Other income, net decreased to $0.4 million during the nine months ended March 31, 2015, as compared to $1.2 million for the same period in fiscal 2014. The decrease was driven by a $0.3 million write off of an escrow receivable, inclusion of $0.2 million bank fees which were classified as selling, general, and administrative expenses in periods prior to the third quarter of fiscal 2015 and a foreign exchange loss of $0.3 million driven by the weakening Japanese yen in the first nine months of fiscal 2015. Other income, net for the nine months ended March 31, 2015 and 2014, also includes $0.9 million in amortization of the gain on the sale leaseback of our corporate headquarters located in Chelmsford, Massachusetts. Interest income and interest expense for both periods were de minimis.
INCOME TAXES
We recorded an income tax provision of $2.5 million during the nine months ended March 31, 2015 as compared to a $2.6 million income tax benefit for the comparable period in the prior fiscal year. Our income taxes for the nine months ended March 31, 2015 differed from the federal statutory tax rate of 35% primarily due to the impact of federal research and development tax credits, domestic manufacturing deduction, stock compensation, state taxes and the realization of previously unrecognized tax benefits. Our income tax benefit during the comparable period in fiscal 2014 differed from the federal statutory rate primarily due to the impact of the federal research and development tax credits,domestic manufacturing deduction, stock compensation and state taxes.
DISCONTINUED OPERATIONS
We incurred a loss from discontinued operations of $3.9 million in the nine months ended in March 31, 2015 compared to loss from discontinued operations of $0.5 million for the same period in fiscal 2014. The loss from discontinued operations during fiscal 2015 included a $2.3 million impairment of goodwill in our MIS operating segment and a $0.9 million loss on disposal of discontinued operations before income taxes from the sale of MIS operating segment, which we completed on January 23, 2015.
SEGMENT OPERATING RESULTS
We use adjusted EBITDA as the profitability measure for our segment reporting. Adjusted EBITDA for MCE increased $16.7 million during the nine months ended March 31, 2015 to $29.9 million as compared to $13.2 million for the comparable period in fiscal 2014. The increase in adjusted EBITDA is primarily driven by higher revenues of $24.3 million primarily from the Patriot, SEWIP and F-35 programs, coupled with higher gross margins and lower selling, general and administrative costs from our restructuring initiatives.
Adjusted EBITDA for MDS decreased $2.0 million during the nine months ended March 31, 2015 to $1.4 million as compared to $3.4 million for the comparable period in fiscal 2014. The decrease in adjusted EBITDA was primarily due to lower revenues from the Gorgon Stare program.
See Note L to our consolidated financial statements included in this report for more information regarding our operating segments.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity comes from existing cash and cash generated from operations. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases and inventory purchase commitments with our contract manufacturers. We currently do not have any material commitments for capital expenditures.
Based on our current plans and business conditions, we believe that existing cash, cash equivalents, available line of credit, cash generated from operations, and financing capabilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.
Senior Unsecured Credit Facility
As of March 31, 2015, there was $126.9 million of borrowing capacity available under our credit agreement with a syndicate of commercial banks, with Key Bank National Association acting as the administrative agent. The credit agreement provides for borrowing up to a maximum $200.0 million based on the Company's consolidated EBITDA for the trailing four quarters and subject to compliance with the financial covenants in the credit agreement. There were no borrowings outstanding on the credit agreement; however, there were outstanding letters of credit of $3.9 million. We were in compliance with all covenants and conditions under the credit agreement.

23



Shelf Registration Statement
On August 15, 2014, we filed a shelf registration statement on Form S-3 with the SEC. The shelf registration statement, which has been declared effective by the SEC, registered up to $500.0 million of debt securities, preferred stock, common stock, warrants and units. We intend to use the proceeds from a financing using the shelf registration statement for general corporate purposes, which may include the following:
the acquisition of other companies or businesses;
the repayment and refinancing of debt;
capital expenditures;
working capital; and
other purposes as described in the prospectus supplement.
CASH FLOWS
 
 
As of and for the nine
month period ended
March 31,
(In thousands)
 
2015
 
2014
Net cash provided by operating activities
 
$
19,520

 
$
11,732

Net cash used in investing activities
 
$
(2,581
)
 
$
(5,367
)
Net cash provided by financing activities
 
$
2,401

 
$
324

Net increase in cash and cash equivalents
 
$
19,233

 
$
6,584

Cash and cash equivalents at end of period
 
$
66,520

 
$
45,710

Our cash and cash equivalents increased by $19.2 million from June 30, 2014 to March 31, 2015, primarily as a result of $19.5 million in cash generated from operating activities, partially offset by $3.5 million in purchases of property and equipment.
Operating Activities
During the nine months ended March 31, 2015, we generated $19.5 million in cash from operating activities compared to $11.7 million in cash generated from operating activities during the same period in fiscal 2014. During the nine months ended March 31, 2015, we generated $8.3 million in higher comparable net income, had a $4.4 million decrease in non-cash deferred tax benefits, a $4.4 million decrease in cash used for payables and accrued expenses, and $3.1 million more cash generated from deferred revenue and customer advances as compared to the same period in the prior year. These increases in cash generated from operations were partially offset by the timing of accounts receivable collections of $4.6 million, $4.5 million in higher prepaid expenses and other current assets, $3.1 million in higher inventory purchases, and $1.4 million lower depreciation and amortization expenses. Our ability to generate cash from operations in future periods will depend in large part on profitability, the rate and timing of collections of accounts receivable, our inventory turns and our ability to manage other areas of working capital.
Investing Activities
During the nine months ended March 31, 2015, we used $2.6 million in investing activities compared to a use of $5.4 million in investing activities during the same period in fiscal 2014. The decrease was primarily driven by higher capital expenditures in fiscal 2014 relating to our advanced microelectronics center in Hudson, New Hampshire offset by $0.9 million net cash proceeds from the sale of MIS in fiscal 2015.
Financing Activities
During the nine months ended March 31, 2015, we generated $2.4 million from financing activities compared to $0.3 million generated from financing activities during the same period in fiscal 2014. The $2.1 million increase in cash from financing activities was primarily due to a $1.2 million increase in proceeds from employee stock plans and a $0.8 million increase in excess tax benefits from stock-based compensation during the nine months ended March 31, 2015.

24



COMMITMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENCIES
The following is a schedule of our commitments and contractual obligations outstanding at March 31, 2015:
(In thousands)
 
Total
 
Less Than
1 Year
 
2-3
Years
 
4-5
Years
 
More Than
5 Years
Purchase obligations
 
$
38,619

 
$
38,619

 
$

 
$

 
$

Operating leases
 
23,071

 
5,000

 
7,025

 
3,900

 
7,146

Capital lease obligations and other
 
63

 
63

 

 

 

 
 
$
61,753

 
$
43,682

 
$
7,025

 
$
3,900

 
$
7,146

We have a liability at March 31, 2015 of $2.3 million for uncertain tax positions that have been taken or are expected to be taken in various income tax returns. We do not know the ultimate resolution on these uncertain tax positions and as such, do not know the ultimate timing of payments related to this liability. Accordingly, these amounts are not included in the above table.
Purchase obligations represent open non-cancelable purchase commitments for certain inventory components and services used in normal operations. The purchase commitments covered by these agreements are for less than one year and aggregated approximately $38.6 million at March 31, 2015.
Our standard product sales and license agreements entered into in the ordinary course of business typically contain an indemnification provision pursuant to which we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with certain intellectual property infringement claims by any third party with respect to our products. Such provisions generally survive termination or expiration of the agreements. The potential amount of future payments we could be required to make under these indemnification provisions is, in some instances, unlimited.
In connection with the sale of our former MIS business, we provided indemnification to the buyer of the business. Our indemnification obligations generally cover the buyer for damages resulting from breaches of representations, warranties and covenants contained in the purchase and sale agreement and generally cover pre-closing tax liabilities of the business. Our indemnification obligations regarding the MIS business are generally subject to caps.
Deferred Tax Assets
As of March 31, 2015, we had approximately $10.4 million in net deferred tax assets. Each quarter, we determine the probability of realizing these assets, using significant judgments and estimates with respect to historical operating results, expectations of future earnings, tax planning strategies and other matters. If we determine in the future that there is not sufficient positive evidence to support the valuation of these assets, we may be required to adjust the valuation allowance accordingly. The Company continues to conclude that it is more likely than not that most domestic deferred tax assets would be realizable based on the current financial performance, projected future taxable income and the reversal of existing deferred tax liabilities.
The Company continues to record a full valuation allowance on certain state research and development and investment tax credits, and capital loss carryforwards as of March 31, 2015 as management continues to believe that it is not more likely than not that these deferred tax assets would be realized. Any future reversals of the valuation allowance will impact income tax expense.
OFF-BALANCE SHEET ARRANGEMENTS
Other than our lease commitments incurred in the normal course of business and certain indemnification provisions, we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.
NON-GAAP FINANCIAL MEASURES
In our periodic communications, we discuss two important measures that are not calculated according to U.S. generally accepted accounting principles (“GAAP”), adjusted EBITDA and free cash flow.
Adjusted EBITDA, the profitability measure for our segment reporting, is defined as income (loss) from continuing operations before interest income and expense, income taxes, depreciation, amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition and financing costs, fair value adjustments from purchase accounting and stock-based compensation costs. We use adjusted EBITDA as an important indicator of the operating performance of our business. We use adjusted EBITDA in internal forecasts and models when establishing internal operating budgets, supplementing the financial results and forecasts reported to our board of directors, determining a component of bonus compensation for executive officers

25



and other key employees based on operating performance and evaluating short-term and long-term operating trends in our operations. We believe the adjusted EBITDA financial measure assists in providing a more complete understanding of our underlying operational measures to manage our business, to evaluate our performance compared to prior periods and the marketplace, and to establish operational goals. We believe that these non-GAAP financial adjustments are useful to investors because they allow investors to evaluate the effectiveness of the methodology and information used by management in our financial and operational decision-making.
Adjusted EBITDA is a non-GAAP financial measure and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. This non-GAAP financial measure may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenses similar to the adjusted EBITDA financial adjustments described above, and investors should not infer from our presentation of this non-GAAP financial measure that these costs are unusual, infrequent or non-recurring.
The following table reconciles our income (loss) from continuing operations, the most directly comparable GAAP financial measure, to our adjusted EBITDA:
 
 
Three Months Ended 
 March 31,
 
Nine Months Ended 
 March 31,
(In thousands)
 
2015
 
2014
 
2015
 
2014
Income (loss) from continuing operations
 
$
4,694

 
$
(270
)
 
$
8,297

 
$
(3,361
)
Interest expense, net
 
1

 
9

 
10

 
31

Tax provision (benefit)
 
1,469

 
(809
)
 
2,516

 
(2,570
)
Depreciation
 
1,510

 
1,923