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EX-31.2 - EXHIBIT 31.2 - MERCURY SYSTEMS INCmrcy-3312016xexx312.htm
EX-31.1 - EXHIBIT 31.1 - MERCURY SYSTEMS INCmrcy-3312016xexx311.htm
EX-32.1 - EXHIBIT 32.1 - MERCURY SYSTEMS INCmrcy-3312016xexx321.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, 2016
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, 2016: 40,028,735 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,
2016
 
June 30,
2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
84,245

 
$
77,586

Accounts receivable, net of allowance for doubtful accounts of $102 and $56 at March 31, 2016 and June 30, 2015, respectively
39,314

 
31,765

Unbilled receivables and costs in excess of billings
29,376

 
22,021

Inventory
34,348

 
31,960

Deferred income taxes
12,788

 
12,407

Prepaid income taxes
1,912

 
3,747

Prepaid expenses and other current assets
4,652

 
8,678

Total current assets
206,635

 
188,164

Restricted cash
264

 
264

Property and equipment, net
13,512

 
13,226

Goodwill
173,741

 
168,146

Intangible assets, net
17,235

 
17,998

Other non-current assets
3,369

 
2,190

Total assets
$
414,756

 
$
389,988

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,412

 
$
6,928

Accrued expenses
12,534

 
9,005

Accrued compensation
11,880

 
9,875

Deferred revenues and customer advances
5,166

 
7,477

Total current liabilities
41,992

 
33,285

Deferred gain on sale-leaseback
61

 
929

Deferred income taxes
2,391

 
3,108

Income taxes payable
1,513

 
1,459

Other non-current liabilities
1,056

 
1,069

Total liabilities
47,013

 
39,850

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; 33,281,436 and 32,570,959 shares issued and outstanding at March 31, 2016 and June 30, 2015, respectively
333

 
326

Additional paid-in capital
260,805

 
254,568

Retained earnings
105,747

 
94,468

Accumulated other comprehensive income
858

 
776

Total shareholders’ equity
367,743

 
350,138

Total liabilities and shareholders’ equity
$
414,756

 
$
389,988


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

3



MERCURY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands, except per share data)
(Unaudited)
 
 
 
Three Months Ended 
 March 31,
 
Nine Months Ended 
 March 31,
 
 
2016
 
2015
 
2016
 
2015
Net revenues
 
$
65,898

 
$
59,578

 
$
184,724

 
$
170,728

Cost of revenues
 
35,407

 
31,660

 
98,126

 
91,776

Gross margin
 
30,491

 
27,918

 
86,598

 
78,952

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
12,687

 
11,842

 
37,396

 
36,809

Research and development
 
7,269

 
8,115

 
23,046

 
23,961

Amortization of intangible assets
 
1,754

 
1,744

 
5,105

 
5,268

Restructuring and other charges
 
409

 
27

 
968

 
2,457

Impairment of long-lived assets
 

 

 
231

 

Acquisition costs and other related expenses
 
1,553

 
33

 
3,533

 
33

Total operating expenses
 
23,672

 
21,761

 
70,279

 
68,528

Income from operations
 
6,819

 
6,157

 
16,319

 
10,424

Interest income
 
39

 
6

 
89

 
13

Interest expense
 
(3
)
 
(7
)
 
(10
)
 
(23
)
Other income, net
 
144

 
7

 
298

 
399

Income from continuing operations before income taxes
 
6,999

 
6,163

 
16,696

 
10,813

Tax provision
 
2,473

 
1,469

 
5,417

 
2,516

Income from continuing operations
 
4,526

 
4,694

 
11,279

 
8,297

Loss from discontinued operations, net of income taxes
 

 
(1,019
)
 

 
(3,858
)
Net income
 
$
4,526

 
$
3,675

 
$
11,279

 
$
4,439

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

 
$
0.14

 
$
0.34

 
$
0.26

Loss from discontinued operations, net of income taxes
 

 
(0.03
)
 

 
(0.12
)
Net income
 
$
0.14

 
$
0.11

 
$
0.34

 
$
0.14

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

 
$
0.14

 
$
0.33

 
$
0.25

Loss from discontinued operations, net of income taxes
 

 
(0.03
)
 

 
(0.12
)
Net income
 
$
0.13

 
$
0.11

 
$
0.33

 
$
0.13

 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
33,251

 
32,298

 
33,052

 
32,001

Diluted
 
33,991

 
33,233

 
33,830

 
32,953

 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
 
Net income
 
$
4,526

 
$
3,675

 
$
11,279

 
$
4,439

Foreign currency translation adjustments
 
93

 

 
82

 
(208
)
Total comprehensive income
 
$
4,619

 
$
3,675

 
$
11,361

 
$
4,231

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,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
11,279

 
$
4,439

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
9,878

 
10,446

Stock-based compensation expense
7,244

 
6,765

Benefit for deferred income taxes
(1,257
)
 
(817
)
Impairment of goodwill and long-lived assets
231

 
2,283

Excess tax benefit from stock-based compensation
(1,384
)
 
(834
)
Loss on sale of discontinued operations

 
892

Other non-cash items
(614
)
 
(234
)
Changes in operating assets and liabilities, net of effects of businesses acquired:
 
 
 
Accounts receivable, unbilled receivables, and costs in excess of billings
(14,850
)
 
(8,373
)
Inventory
(2,351
)
 
(969
)
Prepaid income taxes
1,836

 
(2,499
)
Prepaid expenses and other current assets
4,024

 
49

Other non-current assets
(1,008
)
 
428

Accounts payable and accrued expenses
8,965

 
7,019

Deferred revenues and customer advances
(2,230
)
 
1,853

Income taxes payable
2,107

 
(898
)
Other non-current liabilities
(62
)
 
(30
)
Net cash provided by operating activities
21,808

 
19,520

Cash flows from investing activities:
 
 
 
Acquisition of business, net of cash acquired
(9,756
)
 

Purchases of property and equipment
(4,908
)
 
(3,467
)
Proceeds from sale of discontinued operations

 
885

(Increase) decrease in other investing activities
(567
)
 
1

Net cash used in investing activities
(15,231
)
 
(2,581
)
Cash flows from financing activities:
 
 
 
Proceeds from employee stock plans
2,804

 
2,048

Payments for retirement of common stock
(4,211
)
 

Excess tax benefit from stock-based compensation
1,384

 
834

Payments of capital lease obligations

 
(481
)
Net cash (used in) provided by financing activities
(23
)
 
2,401

Effect of exchange rate changes on cash and cash equivalents
105

 
(107
)
Net increase in cash and cash equivalents
6,659

 
19,233

Cash and cash equivalents at beginning of period
77,586

 
47,287

Cash and cash equivalents at end of period
$
84,245

 
$
66,520

Cash paid during the period for:
 
 
 
Interest
$
10

 
$
23

Income taxes
$
1,717

 
$
5,749

Supplemental disclosures—non-cash activities:
 
 
 
Issuance of restricted stock awards to employees
$
8,241

 
$
9,514

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. (the "Company" or "Mercury") is a leading commercial provider of secure processing subsystems designed and made in the U.S.A. Optimized for customer and mission success, Mercury's solutions power a wide variety of critical defense and intelligence programs. Headquartered in Chelmsford, Massachusetts, Mercury is pioneering a next-generation defense electronics business model specifically designed to meet the industry's current and emerging technology and business needs. The Company delivers affordable 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 affordable secure 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, significant capabilities in signals intelligence ("SIGINT"), electro-optical/infrared ("EO/IR") and secure 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. On January 23, 2015, the Company completed the sale of the MIS operating segment. See Note M to the consolidated financial statements.
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 (“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, 2015 which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on August 13, 2015. The results for the three and nine months ended March 31, 2016 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 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.
BUSINESS COMBINATIONS
The Company utilizes the acquisition method of accounting under FASB ASC 805, Business Combinations, (“FASB ASC 805”), for all transactions and events which it obtains control over one or more other businesses, to recognize the fair value of all assets and liabilities acquired, even if less than one hundred percent ownership is acquired, and in establishing the acquisition date fair value as the measurement date for all assets and liabilities assumed. The Company also utilizes FASB ASC 805 for the initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in business combinations.

6



USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP 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.
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 is 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 39% and 41% of total revenues in the three and nine months ended March 31, 2016, respectively. 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.
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.
The Company's 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. Selling prices will be analyzed 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 generally do not include a general right of return relative to 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

7



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. The risk to the Company on a fixed-price contract is that if estimates to complete the contract change from one period to the next, profit levels will vary from period to period. For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract 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 Company also considers whether contracts should be combined or segmented in accordance with the applicable criteria under GAAP. The Company combines closely related contracts when all the applicable criteria under GAAP are met. The combination of two or more contracts requires judgment in determining whether the intent of entering into the contracts was effectively to enter into a single project, which should be combined to reflect an overall profit rate. Similarly, the Company may separate a project, which may consist of a single contract or group of contracts, with varying rates of profitability, only if the applicable criteria under GAAP are met. Judgment also is involved in determining whether a single contract or group of contracts may be segmented based on how the arrangement was negotiated and the performance criteria. The decision to combine a group of contracts or segment a contract could change the amount of revenue and gross profit recorded in a given period.
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 retrospectively 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.
Contract costs also may include estimated contract recoveries for matters such as contract changes and claims for unanticipated contract costs. The Company records revenue associated with these matters only when the amount of recovery can be estimated reliably and realization is probable.
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. Examples of the Company's service revenues include: analyst services and systems engineering support, consulting, maintenance and other support, testing and installation. The Company combines its product and service revenues into a single class as service revenues are less than 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,
 
2016
 
2015
 
2016
 
2015
Basic weighted-average shares outstanding
33,251

 
32,298

 
33,052

 
32,001

Effect of dilutive equity instruments
740

 
935

 
778

 
952

Diluted weighted-average shares outstanding
33,991

 
33,233

 
33,830

 
32,953

Equity instruments to purchase 26 and 4 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, 2016 because the equity instruments were anti-dilutive. 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.

8



C.Acquisitions
LEWIS INNOVATIVE TECHNOLOGIES ACQUISITION
On December 16, 2015, the Company entered into a share purchase agreement (the “Share Purchase Agreement”) with Lewis Innovative Technologies, Inc. (“LIT”) and the holders of the equity interests of LIT. Pursuant to the Share Purchase Agreement, the Company completed its purchase of all of the equity interests in LIT, and LIT became a wholly-owned subsidiary of the Company. Based in Decatur, Alabama, LIT provides advanced security technology and development services necessary for protecting systems critical to national security while meeting strict Department of Defense (“DoD”) program protection requirements. LIT is included in the MDS operating segment.
The Company acquired LIT for a cash purchase price of $9,756. The Company funded the purchase with cash on hand. The purchase price was subject to a post-closing adjustment based on a determination of LIT's closing net working capital. In accordance with the Share Purchase Agreement, $1,000 of the purchase price was placed into escrow to support the post-closing working capital adjustment and the sellers' indemnification obligations. The escrow is available for indemnification claims through June 16, 2017. The Company acquired LIT free of bank debt.
The following table presents the net purchase price and the preliminary fair values of the assets and liabilities of LIT:
 
Amounts 
Consideration transferred
 

       Cash paid at closing
$
10,290

       Working capital adjustment
(244
)
       Less cash and cash equivalents acquired
(290
)
Net purchase price
$
9,756

 
 

Estimated fair value of tangible assets acquired and liabilities assumed
 

       Cash and cash equivalents
$
290

       Accounts receivable and cost in excess of billings
290

       Other current and non-current assets
175

       Current liabilities
(264
)
Estimated fair value of net tangible assets acquired
491

Estimated fair value of identifiable intangible assets
3,960

Estimated fair value of goodwill
5,595

Estimated fair value of assets acquired
10,046

Less cash and cash equivalents acquired
(290
)
Net purchase price
$
9,756

The amounts above represent the preliminary fair value estimates as of March 31, 2016 and are subject to subsequent adjustment as the Company obtains additional information during the measurement period and finalizes its fair value estimates. The preliminary identifiable intangible asset estimates include completed technology of $3,240, customer relationships of $590 and backlog of $130. Any subsequent adjustments to these fair value estimates occurring during the measurement period will result in an adjustment to goodwill or income, as applicable.
The goodwill of $5,595 arising from the LIT acquisition largely reflects the potential synergies and expansion of the Company's service offerings across product segments and markets complementary to the Company’s existing products and markets. The LIT acquisition provides the Company with additional capabilities and expertise related to secure embedded processing applications. The acquisition is directly aligned with the Company's strategy of assembling critical and differentiated capabilities across the entire sensor processing chain. The goodwill from the LIT acquisition is included in the Company's MDS reporting unit.
The Company and the shareholders of LIT have agreed to treat the acquisition of LIT as an asset purchase for tax purposes by filing the required election forms under IRC Section 338(h)(10). The Company has estimated the tax value of the intangible assets from this transaction and is amortizing the amount over 15 years for tax purposes. As of March 31, 2016, the Company had $5,595 of goodwill deductible for tax purposes.
The Company's consolidated results for the three months ended March 31, 2016 include $759 and $(286) of LIT's revenue and net loss, respectively. The Company's consolidated results for the nine months ended March 31, 2016 include $789 and $(326)

9



of revenue and net loss, respectively, for LIT's operating results between the acquisition date and March 31, 2016. Pursuant to the completion of the LIT acquisition, the Company incurred $231 of impairment expense related to a pre-existing relationship. LIT acquisition costs and other related expenses were immaterial during the three and nine months ended March 31, 2016. Additionally, the Company has not furnished pro forma financial information relating to LIT because such information is not material to the Company's financial results.
CARVE-OUT BUSINESS AQUISITION
On March 23, 2016, the Company and Microsemi Corporation (“Microsemi”) entered into a Stock Purchase Agreement, pursuant to which, Microsemi agreed to sell all the membership interests in its custom microelectronics, RF and microwave solutions and embedded security operations of the Power and Microelectronics Group within Microsemi (“the Carve-Out Business”) to the Company for $300,000 in cash on a cash-free, debt-free basis, subject to a working capital adjustment. On May 2, 2016, the transaction closed and the Company acquired the Carve-Out Business. The Company has not completed its preliminary purchase price allocation for the Carve-Out Business as not all information required for the analysis was available. See Note N "Subsequent Events" to the consolidated financial statements for further discussion.
D.
Fair Value of Financial Instruments
The following table summarizes the Company’s financial assets measured at fair value on a recurring basis at March 31, 2016: 
 
 
Fair Value Measurements
 
 
March 31, 2016
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
54,196

 
$
54,196

 
$

 
$

Certificates of deposit
 
30,049

 

 
30,049

 

Restricted cash
 
264

 
264

 

 

Cost-method investment
 
500

 

 

 
500

Total
 
$
85,009

 
$
54,460

 
$
30,049

 
$
500

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. The value of the certificates of deposit is based on the quoted price for identical or similar instruments in markets that are not active or are directly or indirectly observable. The cost-method investment does not have a readily determinable fair value, as such the Company recorded the investment as a long term asset at cost and will continue to evaluate the asset for impairment.
The change of the fair value of the Company's cost-method investment is as follows:
 
 
Fair Value
Balance at June 30, 2015
 
$
500

Changes in fair value
 

Balance at March 31, 2016
 
$
500


10



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, 2016
 
June 30, 2015
Raw materials
 
$
14,827

 
$
15,864

Work in process
 
14,817

 
11,190

Finished goods
 
4,704

 
4,906

Total
 
$
34,348

 
$
31,960

There are no amounts in inventory relating to contracts having production cycles longer than one year.
F.
Goodwill
The following table sets forth the changes in the carrying amount of goodwill by reporting unit for the nine months ended March 31, 2016:
 
 
MCE
 
MDS
 
Total
Balance at June 30, 2015
 
$
134,378

 
$
33,768

 
$
168,146

Goodwill arising from the LIT acquisition
 

 
5,595

 
5,595

Balance at March 31, 2016
 
$
134,378

 
$
39,363

 
$
173,741

In the nine months ended March 31, 2016, 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
The following table presents the detail of activity for the Company’s restructuring plans:
 
 
Severance &
Related
 
Facilities
& Other
 
Total
Restructuring liability at June 30, 2015
 
$
657

 
$
1,335

 
$
1,992

MCE restructuring and other charges
 
699

 
287

 
986

MDS restructuring and other charges
 
54

 

 
54

Cash paid
 
(867
)
 
(798
)
 
(1,665
)
Reversals(*)
 
(72
)
 

 
(72
)
Restructuring liability at March 31, 2016
 
$
471

 
$
824

 
$
1,295

*)    Reversals result from unused outplacement services.
During the three and nine months ended March 31, 2016, the Company incurred net restructuring and other charges of $409 and $968, respectively. In the event that the Company is unable to sublease the unoccupied portion of its headquarters complex in Chelmsford, Massachusetts, it will incur nominal, periodic restructuring charges through fiscal 2017 in its MCE reportable segment.
All of the restructuring and other charges are classified as operating expenses in the consolidated statements of operations and comprehensive income and any remaining severance obligations are expected to be paid within the next twelve months. The restructuring liability is classified as accrued expenses in the consolidated balance sheets.

11



H.
Income Taxes
The Company recorded an income tax provision of $2,473 and $1,469 on income from continuing operations before income taxes of $6,999 and $6,163 for the three months ended March 31, 2016 and 2015, respectively. The Company recorded an income tax provision of $5,417 and $2,516 on income from continuing operations before income taxes of $16,696 and $10,813 for the nine months ended March 31, 2016 and 2015, respectively. The effective tax rates for the three and nine months ended March 31, 2016 differed from the federal statutory rate primarily due to federal research and development credits, domestic manufacturing deduction, stock compensation, and state taxes. The effective tax rates 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 credits, domestic manufacturing deduction, stock compensation, state taxes, and the realization of previously unrecognized tax benefits.
On December 18, 2015, the Protecting Americans from Tax Hikes Act of 2015 was enacted, which retroactively reinstated and made permanent the federal research and development tax credit effective January 1, 2015. Based on the indefinite extension, the Company estimates that there was an additional $1,572 credit earned during the period January 1, 2015 through June 30, 2016, of which $572 relating to fiscal year 2015 was recognized as a discrete benefit in the nine months ended March 31, 2016.
No material changes in the Company’s unrecognized tax positions occurred during the nine months ended March 31, 2016. 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, 2016. It is reasonably possible that within the next 12 months the Company’s unrecognized tax benefits, exclusive of interest, may decrease by up to $757 at the conclusion of the audit. The Company expects that the decrease, if recognized, would not affect the effective tax rate.
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.
On January 26, 2016, the Company received cash of $175 based on the lapse of the indemnity escrow period associated with the sale of the Company’s former MIS operating segment in January of 2015.
PURCHASE COMMITMENTS
As of March 31, 2016, 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 $31,002.
LEASE COMMITMENTS
On September 1, 2015, the Company entered into a lease agreement for a new headquarters location in Andover, Massachusetts. The Company expects to occupy the new office space by May 2017. The Company's total obligation for the base rent is $21,070 based on utilization of not less than 114 square feet over the twelve year term of the lease. The Company has an option to expand its footprint to 145 square feet, or the entire facility, which would increase its corresponding total base rent obligation. This option must be exercised by the Company on or before December 31, 2018. For accounting purposes the lease commencement date is anticipated to be in August 2016, which will trigger the recognition of rental expense for the Company, although actual cash rent payments will not commence until May 2017 at the stated commencement date of the lease.
OTHER
As part of the Company's strategy for growth, the Company continues to explore acquisitions or strategic alliances. The associated acquisition costs incurred in the form of professional fees and services may be material to the future periods in which they occur, regardless of whether the acquisition is ultimately completed.

12



The Company may elect from time to time to purchase and subsequently retire shares of common stock in order to settle an individual employees’ tax liability associated with vesting of a restricted stock award or exercise of stock options. These transactions would be treated as a use of cash in financing activities in the Company's statement of cash flows.
J.
Debt
SENIOR UNSECURED CREDIT FACILITY
As of March 31, 2016, there was $168,445 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 $4,850. The Company was in compliance with all covenants and conditions under the credit agreement. In connection with the closing of the acquisition of the Carve-Out Business and entering into the new term loan A and revolving credit facilities discussed above, the Company terminated its existing revolving credit agreement with KeyBank on May 2, 2016.
TERM LOAN A AND REVOLVING CREDIT FACILITIES
On March 23, 2016, the Company entered into a debt commitment letter in connection with the acquisition of the Carve-Out Business. On May 2, 2016, the Company entered into a $200,000 senior secured term loan A and $100,000 revolving credit facility with a syndicate of commercial banks which replaced the debt commitment letter signed on March 23, 2016. See Note N "Subsequent Events" to the consolidated financial statements for further discussion.
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 15,252 shares at March 31, 2016. On October 21, 2015, the Company's number of shares authorized for issuance under the 2005 Plan increased 2 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 2,888 shares available for future grant under the 2005 Plan at March 31, 2016.
As part of the Company's ongoing annual equity grant program for employees, the Company grants performance-based restricted stock awards to certain executives pursuant to the 2005 Plan. These performance awards vest over a three or four 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 monitors the probability of achieving the performance targets on a quarterly basis and may adjust periodic stock 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 1,800 shares. On December 8, 2015, the Company's shareholders approved an increase in the number of shares authorized for issuance under the ESPP to 1,800, an increase of 400. 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 46 and 41 shares issued under the ESPP during the nine months ended March 31, 2016 and 2015, respectively. Shares available for future purchase under the ESPP totaled 440 at March 31, 2016.

13



STOCK OPTION AND AWARD ACTIVITY
The following table summarizes activity of the Company’s stock option plans since June 30, 2015:
 
 
Options Outstanding
 
 
Number of
Shares
 
Weighted Average
Exercise Price
 
Weighted Average
Remaining
Contractual Term
(Years)
Outstanding at June 30, 2015
 
830

 
$
13.43

 
1.66
Granted
 

 

 
 
Exercised
 
(212
)
 
10.96

 
 
Cancelled
 
(48
)
 
17.25

 
 
Outstanding at March 31, 2016
 
570

 
$
14.03

 
1.29
The following table summarizes the status of the Company’s non-vested restricted stock awards since June 30, 2015:
 
 
Non-vested Restricted Stock Awards
 
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Outstanding at June 30, 2015
 
1,866

 
$
10.72

Granted
 
518

 
15.90

Vested
 
(719
)
 
10.87

Forfeited
 
(124
)
 
11.70

Outstanding at March 31, 2016
 
1,541

 
$
12.31

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, 2016 and 2015 in accordance with FASB ASC 718. The Company had $114 of capitalized stock-based compensation expense on the consolidated balance sheets as of March 31, 2016. In the prior years, the Company did not capitalize any such costs on the consolidated balance sheets, as such costs 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 from continuing operations included in the Company’s consolidated statements of operations:
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
2016
 
2015
 
2016
 
2015
Cost of revenues
$
152

 
$
110

 
$
307

 
$
375

Selling, general and administrative
1,802

 
1,446

 
5,993

 
5,190

Research and development
196

 
314

 
944

 
1,111

Share-based compensation expense before tax
2,150

 
1,870

 
7,244

 
6,676

Income tax benefit
(805
)
 
(682
)
 
(2,838
)
 
(2,442
)
Share-based compensation expense, net of income taxes
$
1,345

 
$
1,188

 
$
4,406

 
$
4,234


14



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 provides affordable, innovative, commercially designed and developed, specialized processing subsystems for critical defense and intelligence applications. MCE’s technologies and capabilities include secure embedded processing modules and subsystems, RF and microwave multi-function assemblies and subsystems, as well as RF and microwave components. MCE utilizes leading edge, high performance computing technologies and open standards and open architectures to address highly data-intensive applications that include data signal, sensor and image processing, while simultaneously 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 EW, SIGINT and other high bandwidth communications requirements and applications.
Mercury Defense Systems (“MDS”): this operating segment provides significant capabilities relating to pre-integrated, open and affordable EW, EA and ECM subsystems, SIGINT, EO/IR and secure processing technologies, and radar environment test and simulation systems. Recently, MDS gained additional advanced security technology and development services capabilities related to secure embedded processing applications. 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 design and build 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.
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 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, litigation and settlement expenses, and stock-based compensation expense. 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:

15



 
 
MCE
 
MDS
 
Eliminations
 
Total
THREE MONTHS ENDED MARCH 31, 2016
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
57,499

 
$
8,608

 
$
(209
)
 
$
65,898

Intersegment revenues
 
1,652

 
40

 
(1,692
)
 

Net revenues
 
$
59,151

 
$
8,648

 
$
(1,901
)
 
$
65,898

Adjusted EBITDA
 
$
13,948

 
$
768

 
$
(150
)
 
$
14,566

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

NINE MONTHS ENDED MARCH 31, 2016
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
160,520

 
$
24,572

 
$
(368
)
 
$
184,724

Intersegment revenues
 
6,012

 
145

 
(6,157
)
 

Net revenues
 
$
166,532

 
$
24,717

 
$
(6,525
)
 
$
184,724

Adjusted EBITDA
 
$
38,278

 
$
831

 
$
(123
)
 
$
38,986

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

The following table reconciles the Company’s income from continuing operations, the most directly comparable GAAP financial measure, to its adjusted EBITDA:
 
 
Three Months Ended March 31,
 
Nine Months Ended March 31,
 
 
2016
 
2015
 
2016
 
2015
Income from continuing operations
 
$
4,526

 
$
4,694

 
$
11,279

 
$
8,297

Interest (income) expense, net
 
(36
)
 
1

 
(79
)
 
10

Income taxes
 
2,473

 
1,469

 
5,417

 
2,516

Depreciation
 
1,565

 
1,510

 
4,773

 
4,800

Amortization of intangible assets
 
1,754

 
1,744

 
5,105

 
5,268

Restructuring and other charges
 
409

 
27

 
968

 
2,457

Impairment of long-lived assets
 

 

 
231

 

Acquisition and financing costs
 
1,725

 
200

 
4,048

 
200

Fair value adjustments from purchase accounting
 

 

 

 

Litigation and settlement expenses
 

 

 

 

Stock-based compensation expense
 
2,150

 
1,870

 
7,244

 
6,676

Adjusted EBITDA
 
$
14,566

 
$
11,515

 
$
38,986

 
$
30,224


16



The geographic distribution of the Company’s revenues is summarized as follows:
 
 
US
 
Europe
 
Asia Pacific
 
Eliminations
 
Total
THREE MONTHS ENDED MARCH 31, 2016
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
62,675

 
$
1,742

 
$
1,481

 
$

 
$
65,898

Inter-geographic revenues
 
1,598

 
18

 

 
(1,616
)
 

Net revenues
 
$
64,273

 
$
1,760

 
$
1,481

 
$
(1,616
)
 
$
65,898

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

NINE MONTHS ENDED MARCH 31, 2016
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
178,249

 
$
2,852

 
$
3,623

 
$

 
$
184,724

Inter-geographic revenues
 
4,800

 
420

 

 
(5,220
)
 

Net revenues
 
$
183,049

 
$
3,272

 
$
3,623

 
$
(5,220
)
 
$
184,724

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

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:
 
 
US
 
Europe
 
Asia Pacific
 
Eliminations
 
Total
March 31, 2016
 
$
13,422

 
$
66

 
$
24

 
$

 
$
13,512

June 30, 2015
 
$
13,127

 
$
68

 
$
31

 
$

 
$
13,226

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,
 
 
2016
 
2015
 
2016
 
2015
Raytheon Company
 
17
%
 
37
%
 
28
%
 
36
%
Lockheed Martin Corporation
 
26
%
 
19
%
 
23
%
 
22
%
Northrop Grumman Corporation
 
14
%
 
*

 
*

 
*

 
 
57
%
 
56
%
 
51
%
 
58
%
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,
 
 
2016
 
2015
 
2016
 
2015
SEWIP
 
12
%
 
*

 
12
%
 
*

F-35
 
*

 
16
%
 
*

 
13
%
Patriot
 
*

 
20
%
 
11
%
 
19
%
Aegis
 
*

 
13
%
 
*

 
11
%
 
 
12
%
 
49
%
 
23
%
 
43
%
*
Indicates that the amount is less than 10% of the Company’s revenues for the respective period.
M.Discontinued Operations
During the third quarter of fiscal 2015, the Company completed the sale of the MIS operating segment. The MIS operating results have been reported as a discontinued operation for all periods presented. The Company does not have continuing involvement in the operations of MIS after its divestiture.
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
 
2015
Net revenues of discontinued operations
 
$
333

 
$
3,493

Costs of discontinued operations:
 
 
 
 
Cost of revenues
 
209

 
2,385

Selling, general and administrative
 
715

 
1,961

Research and development
 
29

 
305

Amortization of intangible assets
 
32

 
279

Acquisition costs and other related expenses
 
(109
)
 

Impairment of goodwill
 

 
2,283

Loss from discontinued operations before income taxes
 
(543
)
 
(3,720
)
Loss on disposal of discontinued operations before income taxes
 
(892
)
 
(892
)
Tax benefit
 
(416
)
 
(754
)
Loss from discontinued operations, net of income taxes
 
$
(1,019
)
 
$
(3,858
)
There were no balances for the assets and liabilities of the discontinued operations for the periods ending March 31, 2016 and June 30, 2015.

17



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
 
2015
Depreciation
$
11

 
$
100

Amortization of intangible assets
$
32

 
$
279

Impairment of goodwill
$

 
$
2,283

Stock-based compensation expense
$
(38
)
 
$
89

N.
Subsequent Events
CARVE-OUT BUSINESS AQUISITION AND RELATED FINANCING ACTIVITIES
CARVE-OUT BUSINESS AQUISITION
On May 2, 2016, the Company closed its previously announced acquisition of the Carve-Out Business from Microsemi Corporation on a cash-free, debt-free basis for aggregate cash consideration of $300,000, subject to a working capital adjustment.
The acquisition and associated transaction and bank financing related fees and expenses were funded with a combination of a new $200,000 bank term loan A facility and cash on hand, which included net proceeds of approximately $94,392 from the Company’s issuance of 5,175 shares of common stock in an underwritten public offering concluded on April 13, 2016 (See Term Loan A and Revolving Credit Facilities and Equity Offering below). The Company anticipates aggregate transaction and bank financing related fees and expenses to be approximately $9,600.
CARVE-OUT BUSINESS AQUISITION RELATED FINANCING ACTIVITIES
TERM LOAN A AND REVOLVING CREDIT FACILITIES
On May 2, 2016, the Company entered into a $200,000 senior secured term loan A and $100,000 revolving credit facility with a syndicate of commercial banks, with Bank of America, N.A. acting as the administrative agent. The proceeds of the senior secured term loan A facility were used to partially fund the acquisition of the Carve-Out Business, and the revolving credit facility was undrawn at closing. Pursuant to the revolving credit facility the Company can, subject to compliance with the applicable financial covenants, borrow up to $100,000 for working capital acquisitions, and general corporate purposes of the Company and its subsidiaries. A copy of the Credit Agreement relating to the term loan A and revolving credit facility was filed as exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 2, 2016.
EQUITY OFFERING
On April 4, 2016, the Company commenced an offering of 4,500 shares of its common stock pursuant to an underwritten public offering (the “Offering”). In connection with the Offering, the Company granted the underwriters an over-allotment option for 30 days to purchase up to an additional 675 shares of its common stock. The Offering was made pursuant to a shelf registration statement previously filed with the SEC on August 15, 2014. On April 13, 2016, the Company closed the Offering, including the full over-allotment allocation, selling an aggregate of 5,175 shares of common stock for total net proceeds of $94,392 after underwriting fees of $5,230. The Company anticipates additional fees and expenses associated with the equity offering of approximately $1,700.
EXISTING CREDIT FACILITY
In connection with the closing of the acquisition of the Carve-Out Business and entering into the new term loan A and revolving credit facilities discussed above, the Company terminated its existing revolving credit agreement with KeyBank on May 2, 2016.
GENERAL
The Company has evaluated subsequent events from the date of the consolidated balance sheet through the date the consolidated financial statements were issued.

18



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 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, 2015. 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
We are a leading commercial provider of secure processing subsystems designed and made in the U.S.A. Optimized for customer and mission success, our solutions power a wide variety of critical defense and intelligence programs. Headquartered in Chelmsford, Massachusetts, we are pioneering a next-generation defense electronics business model specifically designed to meet the industry's current and emerging technology and business needs. We deliver affordable 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. We believe our total portfolio of services and solutions is unique in the industry for a commercial company. We operate across a broad spectrum of defense programs and deliver our solutions and services via two operating segments: (i) Mercury Commercial Electronics; and (ii) Mercury Defense Systems. During the third quarter of fiscal 2015, we completed the sale of the Mercury Intelligence Systems (“MIS”) operating segment. Consequently, its operating results are included in discontinued operations for all periods presented (see Note M to the consolidated financial statements).
As of March 31, 2016, we had 678 employees. Our consolidated revenues, income from continuing operations, adjusted earnings per share ("adjusted EPS"), and adjusted EBITDA for the three months ended March 31, 2016 were $65.9 million, $4.5 million, $0.25, and $14.6 million, respectively. Our revenue, income from continuing operations, adjusted EPS, and adjusted EBITDA for the nine months ended March 31, 2016 were $184.7 million, $11.3 million, $0.67, and $39.0 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures.
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. Our technologies and capabilities include secure embedded processing modules and subsystems, RF and microwave multi-function assemblies and subsystems, as well as RF and microwave components. MCE utilizes leading edge, high performance computing technologies and open standards and open architectures to address highly data-intensive applications that include data signal, sensor and image processing, while simultaneously 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.
 

19



For the nine months ended March 31, 2016, MCE accounted for 87% of our total net revenues.
Mercury Defense Systems, or MDS, provides significant capabilities relating to pre-integrated, open and affordable EW, electronic attack (“EA”) and electronic counter measure (“ECM”) subsystems, SIGINT, electro-optical/infrared (“EO/IR”) and secure processing technologies, and radar environment test and simulation systems. Recently, MDS gained additional advanced security technology and development services capabilities related to secure embedded processing applications. 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 design and build 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, 2016, MDS accounted for 13% of our total net revenues.
Our two operating segments allow us to deliver capabilities that combine our technology building blocks, deep domain expertise in the defense sector and critical solution area, and specialized skills serving the DoD and the intelligence community.
Since 2011 we have acquired and successfully integrated four businesses, most recently in December 2015 with the acquisition of Lewis Innovative Technologies Inc. (“LIT”). Embedded systems security has become a requirement for new and emerging military programs, and LIT’s security solutions significantly extend our capabilities and leadership in secure embedded computing, a critical differentiator from our traditional competitors. LIT’s solutions combined with our next generation secure Intel server-class product line, together with increasingly frequent mandates from government to secure electronic systems for domestic and foreign military sales, positions us well to capitalize on DoD program protection security requirements.
RESULTS OF OPERATIONS:
Three months ended March 31, 2016 compared to the three months ended March 31, 2015
The following tables set forth, for the three months periods indicated, financial data from the consolidated statements of operations:
(In thousands)
 
March 31, 2016
 
As a % of
Total Net
Revenue
 
March 31, 2015
 
As a % of
Total Net
Revenue
Net revenues
 
$
65,898

 
100.0
%
 
$
59,578

 
100.0
 %
Cost of revenues
 
35,407

 
53.7

 
31,660

 
53.1

Gross margin
 
30,491

 
46.3

 
27,918

 
46.9

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
12,687

 
19.2

 
11,842

 
19.9

Research and development
 
7,269

 
11.0

 
8,115

 
13.6

Amortization of intangible assets
 
1,754

 
2.7

 
1,744

 
2.9

Restructuring and other charges
 
409

 
0.6

 
27

 

Impairment of long-lived assets
 

 

 

 

Acquisition costs and other related expenses
 
1,553

 
2.4

 
33

 
0.1

Total operating expenses
 
23,672

 
35.9

 
21,761

 
36.5

Income from operations
 
6,819

 
10.4

 
6,157

 
10.4

Other income, net
 
180

 
0.3

 
6

 

Income from continuing operations before income taxes
 
6,999

 
10.7

 
6,163

 
10.4

Tax provision
 
2,473

 
3.8

 
1,469

 
2.5

Income from continuing operations
 
4,526

 
6.9

 
4,694

 
7.9

Loss from discontinued operations, net of income taxes
 

 
0.0

 
(1,019
)
 
(1.7
)
Net income
 
$
4,526

 
6.9
%
 
$
3,675

 
6.2
 %

20



REVENUES
(In thousands)
 
March 31, 2016
 
March 31, 2015
 
$ Change
 
% Change
MCE
 
$
57,499

 
$
52,748

 
$
4,751

 
9
 %
MDS
 
8,608

 
6,714

 
1,894

 
28
 %
Eliminations
 
(209
)
 
116

 
(325
)
 
(280
)%
Total revenues
 
$
65,898

 
$
59,578

 
$
6,320

 
11
 %
Total revenues increased $6.3 million, or 11%, to $65.9 million during the three months ended March 31, 2016 as compared to the same period in fiscal 2015. The increase in total revenues is primarily attributed to higher revenues from the SEWIP, SABR, E2D Hawkeye and DEWS programs, partially offset by lower F-35 and Patriot revenues. International revenues, which consist of foreign military sales through prime defense contractor customers and direct sales to non-U.S. based customers, increased $3.8 million to $13.8 million during the three months ended March 31, 2016, compared to $10.0 million in the same period in the prior fiscal year. The increase was primarily driven by higher revenues from the SABR program. International revenues represented 21% and 17% of total revenues during the three months ended March 31, 2016 and 2015, respectively.
Net MCE revenues increased $4.7 million, or 9%, during the three months ended March 31, 2016 as compared to the same period in the prior fiscal year. This increase was primarily driven by higher SEWIP, SABR, E2D Hawkeye and DEWS program revenues, partially offset by lower F-35 and Patriot revenues.
Net MDS revenues increased $1.9 million, or 28%, during the three months ended March 31, 2016 as compared to the same period in the prior fiscal year. This increase was primarily driven by growth in the Filthy Buzzard 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 46.3% for the three months ended March 31, 2016, a decrease of 60 basis points from the 46.9% gross margin achieved during the same period in fiscal 2015. The lower gross margin between years was driven by changes in product mix, with a slight decline in certain higher-margin programs in the three months ended March 31, 2016 as compared to the same period in the prior fiscal year.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased $0.9 million, or 7%, to $12.7 million during the three months ended March 31, 2016, compared to $11.8 million in the same period in fiscal 2015. The increase was primarily due to higher compensation expense due to increased headcount. Selling, general and administrative expenses decreased as a percentage of revenues to 19.2% during the three months ended March 31, 2016 from 19.9% during the same period in fiscal 2015. The decrease was due to higher revenues in the third quarter of fiscal 2016, as compared to the same period in fiscal 2015.
RESEARCH AND DEVELOPMENT
Research and development expenses decreased approximately $0.8 million, or 10%, to $7.3 million during the three months ended March 31, 2016, compared to $8.1 million during the same period in fiscal 2015. The decrease was primarily driven by higher customer funded development.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges increased approximately $0.4 million, to $0.4 million during the three months ended March 31, 2016, compared to less than $0.1 million during the same period in fiscal 2015. We will incur nominal, periodic restructuring charges through fiscal 2017 in our MCE reportable segment if we are unable to sublease the unoccupied portion of our Chelmsford, Massachusetts headquarters.
ACQUISITION COSTS AND OTHER RELATED EXPENSES
We incurred $1.6 million of acquisition costs and other related expenses during the three months ended March 31, 2016, compared to less than $0.1 million during the same period in fiscal 2015. The acquisition costs and other related expenses we incurred during the three months ended March 31, 2016 related to the acquisition of the custom microelectronics, RF and microwave solutions and embedded security operations of the Power and Microelectronics Group within Microsemi Corporation ("the Carve-Out Business") which was completed on May 2, 2016. We expect to incur acquisition costs and other related expenses in connection

21



with completing the acquisition of the Carve-Out Business in the quarter ended June 30, 2016, and periodically in the future as we continue to seek acquisition opportunities to expand our capabilities within the entire sensor processing chain.
OTHER INCOME, NET
Other income, net increased $0.2 million during the three months ended March 31, 2016, as compared to the same period in fiscal 2015. Both periods include $0.3 million related to the amortization of the gain on the sale leaseback of our corporate headquarters partially offset by $0.2 million in bank fees. The increase was driven by a small foreign exchange gain during the three months ended March 31, 2016 as compared to a small foreign exchange loss in the same period of fiscal 2015.
INCOME TAXES
We recorded an income tax provision of $2.5 million during the three months ended March 31, 2016 as compared to $1.5 million for the same period in fiscal 2015. Our effective tax rates for the three months ended March 31, 2016 differed from the federal statutory tax rate of 35% primarily due to federal research and development credits, domestic manufacturing deduction, stock compensation, and state taxes. Our effective tax rate for the three months ended March 31, 2015 differed from the federal statutory tax rate of 35% primarily due to federal research and development tax credits, domestic manufacturing deduction, stock compensation, state taxes, and the realization of previously unrecognized tax benefits.
DISCONTINUED OPERATIONS
We completed the sale of our MIS operating segment during the third quarter of fiscal 2015 and have ceased continuing involvement in the operations of MIS after its divestiture. 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.
SEGMENT OPERATING RESULTS
We use adjusted EBITDA as the profitability measure for our segment reporting. Adjusted EBITDA for MCE increased $1.8 million during the three months ended March 31, 2016 to $13.9 million as compared to $12.1 million for the same period in fiscal 2015. The increase in adjusted EBITDA was driven by higher revenues of $4.7 million primarily from the SEWIP and SABR programs.
Adjusted EBITDA for MDS increased $0.2 million to $0.8 million during the three months ended March 31, 2016 as compared to $0.6 million for the same period in fiscal 2015. The increase in adjusted EBITDA was driven by a $1.9 million increase in revenue primarily from the Filthy Buzzard program.
See Note L to our consolidated financial statements included in this report for more information regarding our operating segments.

22



Nine months ended March 31, 2016 compared to the nine months ended March 31, 2015
The following tables set forth, for the nine months periods indicated, financial data from the consolidated statements of operations:
(In thousands)
 
March 31, 2016
 
As a % of
Total Net
Revenue
 
March 31, 2015
 
As a % of
Total Net
Revenue
Net revenues
 
$
184,724

 
100.0
%
 
$
170,728

 
100.0
 %
Cost of revenues
 
98,126

 
53.1

 
91,776

 
53.8

Gross margin
 
86,598

 
46.9

 
78,952

 
46.2

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
37,396

 
20.3

 
36,809

 
21.6

Research and development
 
23,046

 
12.5

 
23,961

 
14.0

Amortization of intangible assets
 
5,105

 
2.8

 
5,268

 
3.1

Restructuring and other charges
 
968

 
0.5

 
2,457

 
1.4

Impairment of long-lived assets
 
231

 
0.1

 

 

Acquisition costs and other related expenses
 
3,533

 
1.9

 
33

 

Total operating expenses
 
70,279

 
38.1

 
68,528

 
40.1

Income from operations
 
16,319

 
8.8

 
10,424

 
6.1

Other income, net
 
377

 
0.2

 
389

 
0.2

Income from continuing operations before income taxes
 
16,696

 
9.0

 
10,813

 
6.3

Tax provision
 
5,417

 
2.9

 
2,516

 
1.4

Income from continuing operations
 
11,279

 
6.1

 
8,297

 
4.9

Loss from discontinued operations, net of income taxes
 

 

 
(3,858
)
 
(2.3
)
Net income
 
$
11,279

 
6.1
%
 
$
4,439

 
2.6
 %
REVENUES
(In thousands)
 
March 31, 2016
 
March 31, 2015
 
$ Change
 
% Change
MCE
 
$
160,520

 
$
153,110

 
$
7,410

 
5
 %
MDS
 
24,572

 
16,860

 
7,712

 
46
 %
Eliminations
 
(368
)
 
758

 
(1,126
)
 
(149
)%
Total revenues
 
$
184,724

 
$
170,728

 
$
13,996

 
8
 %
Total revenues increased $14.0 million, or 8%, to $184.7 million during the nine months ended March 31, 2016 as compared to the same period in fiscal 2015. The increase in total revenues is primarily attributed to increases in the P8, DEWS, E2D Hawkeye, SEWIP and Reaper programs, partially offset by lower revenues from the Patriot 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, were $34.9 million during the nine months ended March 31, 2016 and 2015. International revenues represented 19% and 21% of total revenues during the nine months ended March 31, 2016 and 2015, respectively.
Net MCE revenues increased $7.4 million, or 5%, during the nine months ended March 31, 2016 as compared to the same period in fiscal 2015. This increase was primarily driven by higher sales in the P8, DEWS, E2D Hawkeye, SEWIP and Reaper programs, partially offset by lower sales in Patriot and F-35 programs.
Net MDS revenues increased $7.7 million, or 46%, during the nine months ended March 31, 2016 as compared to the same period in fiscal 2015. This increase was primarily driven by higher revenues related to Filthy Buzzard, PAC3 and an airborne surveillance 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.

23



GROSS MARGIN
Gross margin was 46.9% for the nine months ended March 31, 2016, an increase of 70 basis points from the 46.2% gross margin during the same period in fiscal 2015. The higher gross margin year over year 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 increased $0.6 million, or 2%, to $37.4 million during the nine months ended March 31, 2016, compared to $36.8 million in the same period in fiscal 2015. The increase was primarily due to higher compensation expense due to increased headcount. Selling, general and administrative expenses decreased as a percentage of revenues to 20.3% during the nine months ended March 31, 2016 from 21.6% during the same period in fiscal 2015. The decrease was due to higher revenues in the first nine months of fiscal 2016, as compared to the same period in fiscal 2015.
RESEARCH AND DEVELOPMENT
Research and development expenses decreased $1.0 million, to $23.0 million during the nine months ended March 31, 2016, compared to $24.0 million during the same period in fiscal 2015. The decrease was primarily due to higher customer funded development partially offset by increased compensation expenses during fiscal 2016.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges were $1.0 million for the nine months ended March 31, 2016, as compared to $2.5 million during the same period in fiscal 2015. The decrease was driven by lower facility costs in the nine months ended March 31, 2016 as our acquisition integration activities were completed during fiscal 2015. Fiscal 2015 restructuring and other charges included the second and final phases of the Chelmsford, Massachusetts headquarters consolidation and related severance activities. We will incur nominal, periodic restructuring charges through fiscal 2017 in our MCE reportable segment if we are unable to sublease the unoccupied portion of our Chelmsford, Massachusetts headquarters.
IMPAIRMENT OF LONG-LIVED ASSETS
We recorded an impairment charge of $0.2 million during the nine months ended March 31, 2016, compared to $0.0 million during the same period in fiscal 2015. Pursuant to the completion of the LIT acquisition, we incurred $0.2 million of impairment expense related to a pre-existing relationship.
ACQUISITION COSTS AND OTHER RELATED EXPENSES
We incurred $3.5 million of acquisition costs and other related expenses during the nine months ended March 31, 2016, compared to less than $0.1 million during the same period in fiscal 2015. We incurred $1.6 million of acquisition costs and other related expenses related to the acquisition of the Carve-Out Business in fiscal 2016. We expect to incur acquisition costs and other related expenses in connection with completing the acquisition of the Carve-Out Business in the quarter ended June 30, 2016, and periodically in the future as we continue to seek acquisition opportunities to expand our capabilities within the entire sensor processing chain.
OTHER INCOME, NET
Other income, net were $0.4 million during the nine months ended March 31, 2016 and 2015, respectively. Both periods include $0.9 million related to the amortization of the gain on the sale leaseback of our corporate headquarters. These gains were partially offset by $0.5 million in bank fees during the nine months ended March 31, 2016 and by $0.2 million in bank fees and a $0.3 million write off of an escrow receivable during the same period in fiscal 2015.
INCOME TAXES
We recorded an income tax provision of $5.4 million during the nine months ended March 31, 2016 as compared to $2.5 million for the same period in fiscal 2015. Our effective tax rates for the nine months ended March 31, 2016 differed from the federal statutory tax rate of 35% primarily due to federal research and development tax credits, domestic manufacturing deduction, stock compensation, and state taxes. Our effective tax rate during the nine months ended March 31, 2015 differed from the federal statutory tax rate of 35% primarily due to federal research and development tax credits, domestic manufacturing deduction, stock compensation, state taxes and the realization of previously unrecognized tax benefits.
DISCONTINUED OPERATIONS
We completed the sale of our MIS operating segment during the third quarter of fiscal 2015 and have ceased continuing involvement in the operations of MIS after its divestiture. The loss from discontinued operation during the nine months ended

24



March 31, 2015 included a $2.3 million goodwill impairment of 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.
SEGMENT OPERATING RESULTS
We use adjusted EBITDA as the profitability measure for our segment reporting. Adjusted EBITDA for MCE increased $8.4 million during the nine months ended March 31, 2016 to $38.3 million as compared to $29.9 million for the same period in fiscal 2015. The increase in adjusted EBITDA is primarily driven by higher revenues of $7.4 million primarily from the P8, DEWS, E2D Hawkeye, SEWIP and Reaper programs, coupled with higher gross margins from a change in product mix.
Adjusted EBITDA for MDS decreased $0.6 million during the nine months ended March 31, 2016 to $0.8 million as compared to $1.4 million for the same period in fiscal 2015. The decrease in adjusted EBITDA was primarily due to a $1.5 million increase in inventory reserves, partially offset by higher revenues related to Filthy Buzzard, PAC3 and an airborne surveillance 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 operating 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.
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.
CARVE-OUT BUSINESS AQUISITION AND RELATED FINANCING ACTIVITIES
CARVE-OUT BUSINESS AQUISITION
On May 2, 2016, we closed our previously announced acquisition of the Carve-Out Business from Microsemi Corporation on a cash-free, debt-free basis for aggregate cash consideration of $300.0 million, subject to a working capital adjustment.
The acquisition and associated transaction and bank financing related fees and expenses were funded with a combination of a new $200.0 million bank term loan A facility and cash on hand, which included net proceeds of approximately $94.4 million from our issuance of 5.2 million shares of common stock in an underwritten public offering concluded on April 13, 2016 (See Term Loan A and Revolving Credit Facilities and Equity Offering below). We anticipate aggregate transaction and bank financing related fees and expenses to be approximately $9.6 million.
CARVE-OUT BUSINESS AQUISITION RELATED FINANCING ACTIVITIES
TERM LOAN AND REVOLVING CREDIT FACILITIES
On May 2, 2016, we entered into a $200.0 million senior secured term loan A and $100.0 million revolving credit facility with a syndicate of commercial banks, with Bank of America, N.A. acting as the administrative agent. The proceeds of the senior secured term loan A facility were used to partially fund the acquisition of the Carve-Out Business, and the revolving credit facility was undrawn at closing. Pursuant to the revolving credit facility we can, subject to compliance with the applicable financial covenants, borrow up to $100.0 million for working capital acquisitions, and general corporate purposes of ours and our subsidiaries. A copy of the Credit Agreement relating to the term loan A and revolving credit facility was filed as exhibit 10.1 to our Current Report on Form 8-K dated May 2, 2016.

25



EQUITY OFFERING
On April 4, 2016, we commenced an offering of 4.5 million shares of our common stock pursuant to an underwritten public offering (the “Offering”). In connection with the Offering, we granted the underwriters an over-allotment option for 30 days to purchase up to an additional 0.7 million shares of its common stock. The Offering was made pursuant to a shelf registration statement previously filed with the SEC on August 15, 2014. On April 13, 2016, we closed the Offering, including the full over-allotment allocation, selling an aggregate of 5.2 million shares of common stock for total net proceeds of $94.4 million after underwriting fees of $5.2 million. The Company anticipates additional fees and expenses associated with the equity offering of approximately $1.7 million.
Existing Credit Facility with KeyBank
As of March 31, 2016, there was $168.4 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 $4.9 million. We were in compliance with all covenants and conditions under the credit agreement. In connection with the closing of the acquisition of the Carve-Out Business and entering into the new term loan A and revolving credit facilities discussed above, we terminated our existing revolving credit agreement with KeyBank on May 2, 2016.
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.
CASH FLOWS
 
 
As Of and For the Nine
Month Period Ended
March 31,
(In thousands)
 
2016
 
2015
Net cash provided by operating activities
 
$
21,808

 
$
19,520

Net cash used in investing activities
 
$
(15,231
)
 
$
(2,581
)
Net cash (used in) provided by financing activities
 
$
(23
)
 
$
2,401

Net increase in cash and cash equivalents
 
$
6,659

 
$
19,233

Cash and cash equivalents at end of period
 
$
84,245

 
$
66,520

Our cash and cash equivalents increased by $6.7 million from June 30, 2015 to March 31, 2016, primarily as a result of $21.8 million in cash generated from operating activities, partially offset by $9.8 million used for the acquisition of LIT, $4.9 million in capital expenditure and $4.2 million in payments for the retirement of common stock.
Operating Activities
During the nine months ended March 31, 2016, we generated $21.8 million in cash from operating activities, an increase of $2.3 million when compared to $19.5 million in cash generated from operating activities during the same period in fiscal 2015. During the nine months ended March 31, 2016, we generated $6.8 million in higher comparable net income, used $8.3 million less cash for prepaid expenses and other current assets, and generated $5.0 million more cash from the timing of payables as compared to the same period in the prior year. These increases were partially offset by $6.5 million growth in accounts receivable, $4.1 million less cash generated from deferred revenues and customer advances, $4.4 million less in non-cash activities, and $1.4 million higher inventory purchases as compared to the same period in fiscal 2015. 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, 2016, we used $15.2 million in investing activities compared to $2.6 million during the same period in fiscal 2015. The increase was primarily driven by $9.8 million used for the acquisition of LIT and $1.4 million of higher capital expenditures in fiscal 2016.

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Financing Activities
During the nine months ended March 31, 2016, we used less than $0.1 million in financing activities compared to $2.4 million generated from financing activities during the same period in fiscal 2015. The $2.4 million increase in cash used in financing activities was primarily due to $4.2 million used for the retirement of common stock, partially offset by a $0.8 million increase in proceeds from our employee stock plan and a $0.6 million increase in excess tax benefits from stock-based compensation during the nine months ended March 31, 2016.
COMMITMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENCIES
The following is a schedule of our commitments and contractual obligations outstanding at March 31, 2016:
(In thousands)
 
Total
 
Less Than
1 Year
 
2-3
Years
 
4-5
Years
 
More Than
5 Years
Purchase obligations
 
$
31,002

 
$
31,002

 
$

 
$

 
$

Operating leases
 
38,999

 
4,683

 
7,551

 
6,805

 
19,960

 
 
$
70,001

 
$
35,685