**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

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**FORM 10-Q**

 

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

 

**For the quarter ended    ****March 31, 2005**

 

**CommissionFile Number 000-02324**

 

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**AEROFLEX INCORPORATED**

 

(Exact name of Registrant as specified in itsCharter)

 
| **DELAWARE**                                                    | ** ** | **11-1974412**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **35 South Service Road   P.O. Box 6022  Plainview, N.Y.**      | ** ** | **11803-0622**                        |
| (Address of principal executive offices)                        |       | (Zip Code)                            |
| * *                                                        | * *   | * *                              |
| **(516) 694-6700**                                              |
| (Registrant’s telephone number, including  area code)      |

 

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*Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months, and (2) has been subject to such filing requirementsfor the past 90 days.

 

| Yes | ý | No | o |
|-----|--------|----|---|

 

*Indicateby check mark whether registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).

 

| Yes | ý | No | o |
|-----|--------|----|---|

 

  Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock as of the latest practicable date.

 
| May 9, 2005 |   | 74,612,777 shares (excluding 4,388 shares held in treasury) |
|-------------|--------|-------------------------------------------------------------|
| (Date)      |   | (Number of Shares)                                          |

 

**NOTE:  THIS ISPAGE 1 OF A DOCUMENT CONSISTING OF 41 PAGES.**

 

 

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**AEROFLEXINCORPORATED**

**ANDSUBSIDIARIES**

 

**INDEX**

 
| **PART  I:    FINANCIAL INFORMATION** |                                                                                                                                                  |
|-----------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                      |                                                                                                                                                  |   |
| Item 1 –                                             | UNAUDITED AND CONDENSED CONSOLIDATED BALANCE SHEETS  March 31, 2005 and June 30, 2004                                                       | 3-4 |
|                                                      |                                                                                                                                                  |   |
|                                                      | UNAUDITED AND CONDENSED CONSOLIDATED  STATEMENTS OF OPERATIONS  Nine and Three Months Ended March 31, 2005 and 2004                              | 5-6 |
|                                                      |                                                                                                                                                  |   |
|                                                      | UNAUDITED AND CONDENSED CONSOLIDATED  STATEMENTS OF CASH FLOWS  Nine Months Ended March 31, 2005 and 2004                                        | 7 |
|                                                      |                                                                                                                                                  |   |
|                                                      | NOTES TO UNAUDITED AND CONDENSED  CONSOLIDATED FINANCIAL STATEMENTS                                                                                   | 8-22 |
|                                                      |                                                                                                                                                  |   |
| Item 2 -                                                  | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS  Nine and Three Months Ended March 31, 2005 and 2004 | 23-34 |
|                                                      |                                                                                                                                                  |   |
| Item 3 -                                                  | QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                              | 35 |
|                                                      |                                                                                                                                                  |   |
| Item 4 -                                                  | CONTROLS AND PROCEDURES                                                                                                                               | 35 |
|                                                      |                                                                                                                                                  |   |
| **PART II:    OTHER  INFORMATION**    |                                                                                                                                                  |
|                                                      |                                                                                                                                                  |   |
| Item 1 -                                                  | LEGAL PROCEEDINGS                                                                                                                                     | 36 |
|                                                      |                                                                                                                                                  |   |
| Item 6 -                                                  | EXHIBITS AND REPORTS ON FORM 8-K                                                                                                                      | 36 |
|                                                      |                                                                                                                                                  |   |
| SIGNATURES                                                | 37                                                                                                                                                    |
|                                                      |                                                                                                                                                  |
| CERTIFICATIONS                                            |                                                                                                                                                  |

 

2

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**AEROFLEX INCORPORATED**

**AND SUBSIDIARIES**

**UNAUDITED AND CONDENSED**

**CONSOLIDATED BALANCE SHEETS**

(In thousands)

 
| ** **                                                                      | ** ** | **March 31,  2005** | ** ** | **June 30,  2004** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Assets**                                                                      |       |                     |       |                    |       |
|                                                                            |       |                     |       |                    |       |
| Current assets:                                                                 |       |                     |       |                    |       |
| Cash and cash equivalents                                                       |       | $                        | 8,186      |                    | $          | 98,502 |   |
| Marketable securities                                                           |       | 117,788                  |       | —                  |       |
| Accounts receivable, less allowance for  doubtful accounts of $1,324 and $1,618 |       | 90,110                   |       | 97,031                  |       |
| Inventories                                                                     |       | 112,361                  |       | 94,617                  |       |
| Deferred income taxes                                                           |       | 18,223                   |       | 16,774                  |       |
| Assets of discontinued operations                                               |       | —                   |       | 11,910                  |       |
| Prepaid expenses and other current assets                                       |       | 8,180                    |       | 8,646                   |       |
| Total current assets                                                            |       | 354,848                  |       | 327,480                 |       |
|                                                                            |       |                     |       |                    |       |
| Property, plant and equipment, net                                              |       | 75,007                   |       | 74,372                  |       |
| Assets of discontinued operations                                               |       | —                   |       | 9,717                   |       |
| Other assets                                                                    |       | 14,965                   |       | 10,932                  |       |
| Intangible assets with definite lives, net                                      |       | 36,434                   |       | 40,602                  |       |
| Goodwill                                                                        |       | 85,329                   |       | 88,288                  |       |
|                                                                            |       |                     |       |                    |       |
| Total assets                                                                    |       | $                        | 566,583    |                    | $          | 551,391 |   |

 

See notes to unaudited and condensed consolidated financial statements.

 

3

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| ** **                                                                                            | ** ** | **March 31,  2005** | ** ** | **June 30,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Liabilities  and Stockholders’ Equity**                                                        |       |                     |       |                    |       |
|                                                                                                  |       |                     |       |                    |       |
| Current liabilities:                                                                                  |       |                     |       |                    |       |
| Current portion of long-term debt                                                                     |       | $                        | 660        |                    | $          | 4,770 |   |
| Accounts payable                                                                                      |       | 28,663                   |       | 25,293                  |       |
| Advance payments by customers                                                                         |       | 11,333                   |       | 11,725                  |       |
| Income taxes payable                                                                                  |       | 2,359                    |       | 1,088                   |       |
| Liabilities of discontinued operations                                                                |       | —                   |       | 4,573                   |       |
| Accrued payroll expenses                                                                              |       | 15,561                   |       | 13,966                  |       |
| Accrued expenses and other current  liabilities                                                       |       | 25,385                   |       | 28,200                  |       |
| Total current liabilities                                                                             |       | 83,961                   |       | 89,615                  |       |
|                                                                                                  |       |                     |       |                    |       |
| Long-term debt                                                                                        |       | 4,607                    |       | 5,505                   |       |
| Deferred income taxes                                                                                 |       | 9,878                    |       | 9,445                   |       |
| Liabilities of discontinued operations                                                                |       | —                   |       | 3,613                   |       |
| Other long-term liabilities                                                                           |       | 18,587                   |       | 16,116                  |       |
| Total liabilities                                                                                     |       | 117,033                  |       | 124,294                 |       |
|                                                                                                  |       |                     |       |                    |       |
| Stockholders’ equity:                                                                            |       |                     |       |                    |       |
| Preferred stock, par value $.10 per share;  authorized 1,000 shares:                                  |       | —                   |       | —                  |       |
| Series A Junior Participating Preferred  Stock, par value $.10 per share, authorized 110; none issued |       |                     |       |                    |       |
| Common Stock, par value $.10 per share;  authorized 110,000 shares; issued 74,615 and 74,282 shares   |       | 7,462                    |       | 7,428                   |       |
| Additional paid-in capital                                                                            |       | 372,772                  |       | 370,491                 |       |
| Accumulated other comprehensive income                                                                |       | 16,614                   |       | 11,387                  |       |
| Retained earnings                                                                                     |       | 52,716                   |       | 37,805                  |       |
|                                                                                                  |       | 449,564                  |       | 427,111                 |       |
|                                                                                                  |       |                     |       |                    |       |
| Less: Treasury stock, at cost (4 shares)                                                              |       | 14                       |       | 14                      |       |
| Total stockholders’ equity                                                                       |       | 449,550                  |       | 427,097                 |       |
|                                                                                                  |       |                     |       |                    |       |
| Total liabilities and stockholders’ equity                                                       |       | $                        | 566,583    |                    | $          | 551,391 |   |

 

See notes to unaudited and condensed consolidated financial statements.

 

4

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**AEROFLEX INCORPORATED**

**AND SUBSIDIARIES**

**UNAUDITED AND CONDENSED**

**CONSOLIDATED STATEMENT OF OPERATIONS**

(In thousands, except per share data)

 
| ** **                                                                                       | ** ** | **Nine Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                                                                       | ** ** | ** **                            | ** ** | **(Note 3)** | ** ** |
|                                                                                             |       |                                  |       |   |   |
| Net sales                                                                                        |       | $                                     | 335,406    |   | $ | 288,792 |   |
| Cost of sales                                                                                    |       | 176,802                               |       | 155,985 |   |
| Gross profit                                                                                     |       | 158,604                               |       | 132,807 |   |
|                                                                                             |       |                                  |       |   |   |
| Selling, general and administrative costs  (including restructuring charges of $1,678 in 2005)   |       | 81,597                                |       | 66,942 |   |
| Research and development costs                                                                   |       | 45,122                                |       | 34,987 |   |
| Amortization of acquired intangibles                                                             |       | 6,164                                 |       | 5,448 |   |
| Acquired in-process research and  development costs                                              |       |                                  |       |   |   |
| (Note 2)                                                                                         |       | —                                |       | 4,220 |   |
|                                                                                             |       | 132,883                               |       | 111,597 |   |
| Operating income                                                                                 |       | 25,721                                |       | 21,210 |   |
|                                                                                             |       |                                  |       |   |   |
| Other income (expense)                                                                           |       |                                  |       |   |   |
| Interest expense                                                                                 |       | (738                                  | )          | (1,075 | ) |
| Other income (expense)                                                                           |       | 1,371                                 |       | (2,120 | ) |
| Total other income (expense)                                                                     |       | 633                                   |       | (3,195 | ) |
|                                                                                             |       |                                  |       |   |   |
| Income from continuing operations before  income taxes                                           |       | 26,354                                |       | 18,015 |   |
| Provision for income taxes                                                                       |       | 9,947                                 |       | 6,523 |   |
| Income from continuing operations                                                                |       | 16,407                                |       | 11,492 |   |
|                                                                                             |       |                                  |       |   |   |
| Discontinued operations                                                                          |       |                                  |       |   |   |
| Income (loss) from discontinued operations,  net of tax provision (benefit) of $(319) and $(843) |       | (538                                  | )          | (1,676 | ) |
| Income (loss) on disposal of operations,  net of tax provision (benefit) of $574 and $(3,153)    |       | (958                                  | )          | (5,947 | ) |
| Income (loss) from discontinued operations,  net of tax                                          |       | (1,496                                | )          | (7,623 | ) |
|                                                                                             |       |                                  |       |   |   |
| Net income                                                                                       |       | $                                     | 14,911     |   | $ | 3,869 |   |
|                                                                                             |       |                                  |       |   |   |
| Income (loss) per common share:                                                                  |       |                                  |       |   |   |
| Basic                                                                                            |       |                                  |       |   |   |
| Continuing operations                                                                            |       | $                                     | 0.22       |   | $ | 0.18 |   |
| Discontinued operations                                                                          |       | (0.02                                 | )          | (0.12 | ) |
| Net income                                                                                       |       | $                                     | 0.20       |   | $ | 0.06 |   |
|                                                                                             |       |                                  |       |   |   |
| Diluted                                                                                          |       |                                  |       |   |   |
| Continuing operations                                                                            |       | $                                     | 0.22       |   | $ | 0.17 |   |
| Discontinued operations                                                                          |       | (0.02                                 | )          | (0.12 | ) |
| Net income                                                                                       |       | $                                     | 0.20       |   | $ | 0.05 |   |
|                                                                                             |       |                                  |       |   |   |
| Weighted average number of common shares outstanding:                                            |       |                                  |       |   |   |
| Basic                                                                                            |       | 74,595                                |       | 65,773 |   |
| Diluted                                                                                          |       | 76,047                                |       | 67,689 |   |

 

See notes to unaudited and condensed consolidated financial statements.

 

5

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| ** **                                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                     | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                                                                     | ** ** | ** **                             | ** ** | **(Note 3)** | ** ** |
|                                                                                           |       |                                   |       |   |   |
| Net sales                                                                                      |       | $                                      | 113,755    |   | $ | 113,117 |   |
| Cost of sales                                                                                  |       | 59,963                                 |       | 59,809 |   |
| Gross profit                                                                                   |       | 53,792                                 |       | 53,308 |   |
|                                                                                           |       |                                   |       |   |   |
| Selling, general and administrative costs  (including restructuring charges of $1,678 in 2005) |       | 30,110                                 |       | 25,185 |   |
| Research and development costs                                                                 |       | 15,379                                 |       | 13,342 |   |
| Amortization of acquired intangibles                                                           |       | 2,063                                  |       | 2,132 |   |
|                                                                                           |       | 47,552                                 |       | 40,659 |   |
| Operating income                                                                               |       | 6,240                                  |       | 12,649 |   |
|                                                                                           |       |                                   |       |   |   |
| Other income (expense)                                                                         |       |                                   |       |   |   |
| Interest expense                                                                               |       | (316                                   | )          | (343 | ) |
| Other income (expense)                                                                         |       | 406                                    |       | (1,906 | ) |
| Total other income (expense)                                                                   |       | 90                                     |       | (2,249 | ) |
|                                                                                           |       |                                   |       |   |   |
| Income from continuing operations before  income taxes                                         |       | 6,330                                  |       | 10,400 |   |
| Provision for income taxes                                                                     |       | 2,464                                  |       | 3,782 |   |
| Income from continuing operations                                                              |       | 3,866                                  |       | 6,618 |   |
|                                                                                           |       |                                   |       |   |   |
| Discontinued operations                                                                        |       |                                   |       |   |   |
| Income (loss) from discontinued operations,  net of tax provision (benefit) of $(66) and $(36) |       | 4                                      |       | (753 | ) |
| Income (loss) on disposal of operations,  net of tax provision (benefit) of $574 and $0        |       | 102                                    |       | — |   |
| Income (loss) from discontinued operations,  net of tax                                        |       | 106                                    |       | (753 | ) |
|                                                                                           |       |                                   |       |   |   |
| Net income                                                                                     |       | $                                      | 3,972      |   | $ | 5,865 |   |
|                                                                                           |       |                                   |       |   |   |
| Income (loss) per common share:                                                                |       |                                   |       |   |   |
| Basic                                                                                          |       |                                   |       |   |   |
| Continuing operations                                                                          |       | $                                      | 0.05       |   | $ | 0.10 |   |
| Discontinued operations                                                                        |       | —                                 |       | (0.01 | ) |
| Net income                                                                                     |       | $                                      | 0.05       |   | $ | 0.09 |   |
|                                                                                           |       |                                   |       |   |   |
| Diluted                                                                                        |       |                                   |       |   |   |
| Continuing operations                                                                          |       | $                                      | 0.05       |   | $ | 0.09 |   |
| Discontinued operations                                                                        |       | —                                 |       | (0.01 | ) |
| Net income                                                                                     |       | $                                      | 0.05       |   | $ | 0.08 |   |
|                                                                                           |       |                                   |       |   |   |
| Weighted average number of common shares outstanding:                                          |       |                                   |       |   |   |
| Basic                                                                                          |       | 74,714                                 |       | 68,804 |   |
| Diluted                                                                                        |       | 75,842                                 |       | 71,436 |   |

 

See notes to unaudited and condensed consolidated financial statements.

 

6

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**AEROFLEXINCORPORATED**

**ANDSUBSIDIARIES**

**UNAUDITEDAND CONDENSED**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

 
| ** **                                                                                                                 | ** ** | **Nine Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Cash Flows From Operating Activities:                                                                                      |       |                                  |       |   |   |
| Net income                                                                                                                 |       | $                                     | 14,911     |   | $ | 3,869 |   |
| Loss from discontinued operations                                                                                          |       | 1,496                                 |       | 7,623 |   |
| Income from continuing operations                                                                                          |       | 16,407                                |       | 11,492 |   |
| Adjustments to reconcile income from  continuing  operations to net cash  provided by (used in) operating activities: |       |                                  |       |   |   |
| Acquired in-process research and  development                                                                              |       | —                                |       | 4,220 |   |
| Depreciation and amortization                                                                                              |       | 17,592                                |       | 15,623 |   |
| Deferred income taxes                                                                                                      |       | (1,222                                | )          | (1,460 | ) |
| Other, net                                                                                                                 |       | (256                                  | )          | (155 | ) |
| Change in operating assets and liabilities,  net of effects from purchases of businesses:                                  |       |                                  |       |   |   |
| Decrease (increase) in accounts receivable                                                                                 |       | 6,568                                 |       | (8,069 | ) |
| Decrease (increase) in inventories                                                                                         |       | (16,454                               | )          | (9,035 | ) |
| Decrease (increase) in prepaid expenses and  other assets                                                                  |       | (1,677                                | )          | (1,167 | ) |
| Increase (decrease) in accounts payable, accrued  expenses and other liabilities                                           |       | 7,944                                 |       | 3,651 |   |
|                                                                                                                       |       |                                  |       |   |   |
| Net Cash Provided By (Used In) Continuing  Operations                                                                      |       | 28,902                                |       | 15,100 |   |
| Net Cash Provided By (Used In) Discontinued  Operations                                                                    |       | (1,127                                | )          | 2,641 |   |
| Net Cash Provided By Operating Activities                                                                                  |       | 27,775                                |       | 17,741 |   |
|                                                                                                                       |       |                                  |       |   |   |
| Cash Flows From Investing Activities:                                                                                      |       |                                  |       |   |   |
| Payment for purchase of businesses, net of  cash acquired                                                                  |       | —                                |       | (61,462 | ) |
| Capital expenditures                                                                                                       |       | (11,163                               | )          | (7,275 | ) |
| Purchase of marketable securities                                                                                          |       | (514,978                              | )          | — |   |
| Sale of marketable securities                                                                                              |       | 397,190                               |       | — |   |
| Other, net                                                                                                                 |       | 11                                    |       | 30 |   |
|                                                                                                                       |       |                                  |       |   |   |
| Net Cash Provided By (Used In) Continuing  Operations                                                                      |       | (128,940                              | )          | (68,707 | ) |
| Net Cash Provided By (Used In) Discontinued  Operations                                                                    |       | 14,186                                |       | (282 | ) |
| Net Cash Provided By (Used In) Investing  Activities                                                                       |       | (114,754                              | )          | (68,989 | ) |
|                                                                                                                       |       |                                  |       |   |   |
| Cash Flows From Financing Activities:                                                                                      |       |                                  |       |   |   |
| Net proceeds from issuance of common stock                                                                                 |       | —                                |       | 91,251 |   |
| Borrowings under debt agreements                                                                                           |       | 37                                    |       | 26,115 |   |
| Debt repayments                                                                                                            |       | (5,045                                | )          | (27,341 | ) |
| Proceeds from the exercise of stock options                                                                                |       | 1,548                                 |       | 4,393 |   |
|                                                                                                                       |       |                                  |       |   |   |
| Net Cash Provided By (Used In) Financing  Activities                                                                       |       | (3,460                                | )          | 94,418 |   |
| Effect of Exchange Rate Changes on Cash and  Cash Equivalents                                                              |       | 123                                   |       | (669 | ) |
|                                                                                                                       |       |                                  |       |   |   |
| Net Increase (Decrease) In Cash and Cash  Equivalents                                                                      |       | (90,316                               | )          | 42,501 |   |
| Cash And Cash Equivalents At Beginning Of  Period                                                                          |       | 98,502                                |       | 51,307 |   |
| Cash And Cash Equivalents At End Of Period                                                                                 |       | $                                     | 8,186      |   | $ | 93,808 |   |

 

See notes to unaudited and condensed consolidated financial statements.

 

7

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**AEROFLEXINCORPORATED**

**ANDSUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

1.               Basis of Presentation

 

Thecondensed consolidated balance sheet of Aeroflex Incorporated and Subsidiaries(“the Company”) as of March 31, 2005, the related condensed consolidatedstatements of operations for the nine and three months ended March 31, 2005and 2004, and the condensed consolidated statements of cash flows for the ninemonths ended March 31, 2005 and 2004 have been prepared by the Company andare unaudited.  In the opinion ofmanagement, all adjustments (which include normal recurring adjustments)necessary to present fairly the financial position, results of operations andcash flows at March 31, 2005 and for all periods presented have beenmade.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been omitted.  It is suggested thatthese condensed consolidated financial statements be read in conjunction withthe financial statements and notes thereto included in the Company’s June 30,2004 annual report to shareholders. There have been no changes of significant accounting policies since June 30,2004.

 

Resultsof operations for the nine and three month periods are not necessarilyindicative of results of operations for the corresponding years.

 

**Revenue Recognition**

 

TheCompany recognizes revenue when persuasive evidence of an arrangement exists,delivery has occurred or services have been rendered, the selling price isfixed or determinable and collectibility of the resulting receivable isreasonably assured.

 

Forarrangements other than certain long-term contracts, revenue (includingshipping and handling fees) is recognized when products are shipped and titlehas passed to the customer.  If titledoes not pass until the product reaches the customer’s delivery site, thenrecognition of the revenue is deferred until that time.  Revenues associated with certain long-termcontracts are recognized in accordance with Statement of Position No. 81-1 “Accountingfor Performance of Construction-Type and Certain Production-Type Contracts” (“SOP81-1”).  Under SOP 81-1, the Company usesthe percentage-of-completion method, whereby revenues and associated costs arerecognized as work on a contract progresses. The Company measures the extent of progress toward completion generallybased upon one of the following (based upon an assessment of which method mostclosely aligns to the underlying earnings process): (i) the units-of-deliverymethod, (ii) the cost-to-cost method, using the ratio of contract costsincurred as a percentage of total estimated costs at contract completion (basedupon engineering and production estimates), or (iii) the achievement ofcontractual milestones.  Provisions foranticipated losses or revisions in estimated profits on contracts-in-processare recorded in the period in which such anticipated losses or revisions becomeevident.  Revenue from software supportand maintenance contracts is recognized ratably over the term of the contractin accordance with SOP-97-2, “Software Revenue Recognition.”

 

Certainof the Company’s sales are to distributors which have a right to return someportion of product within eighteen months of sale.  The Company recognizes revenue on these salesat the time of shipment to the distributor as these sales meet all of thecriteria of Statement of Financial Accounting Standards (“SFAS”) No. 48, “RevenueRecognition When Right of Return Exists.” Historically, the returns under these arrangements have beeninsignificant and can be reasonably estimated. An estimate of such returns is recorded at the time sales are recognized.

 

8

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**Financial Instruments**

 

Foreigncurrency contracts are used to protect the Company from fluctuations inexchange rates.  The Company entered intoforeign currency contracts, which are not designated as hedges, and the changein fair value is included in income currently, within other income (expense).  As of March 31, 2005, the Company had $2.6million of notional value foreign currency forward contracts maturing through June 2005.  Notional amounts do not quantify risk or representassets or liabilities of the Company, but are used in the calculation of cashsettlements under the contracts.  Thefair value of these contracts at March 31, 2005 was $19,000 less than thenotional value.

 

TheCompany accounts for its interest rate swap derivatives in accordance with SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended.  This statement requirescompanies to record derivatives on the balance sheet as assets or liabilitiesat their fair value.  For derivativesdesignated and qualifying as effective cash flow hedges under SFAS No. 133,changes in the fair value of such derivatives are recorded as components ofother comprehensive income.  Forderivatives that are deemed ineffective, the changes are recorded as gains orlosses in other income (expense).

 

**Marketable Securities**

 

Marketablesecurities are classified as available-for-sale and are recorded at fair marketvalue with unrealized gains and losses, net of taxes, reported as a separatecomponent of shareholders’ equity. Realized gains and losses and declines in market value judged to beother than temporary, of which there were none, are included in otherincome.  Interest and dividends are alsoincluded in other income.  Marketablesecurities consist solely of auction rate bonds.

 

**Accounting for Stock-Based Compensation**

 

TheCompany records compensation expense for employee and director stock optionsonly if the current market price of the underlying stock exceeds the exerciseprice on the date of the grant.  TheCompany has chosen not to implement the fair value based accounting method foremployee and director stock options, but has elected to disclose the pro formaincome and income per share as if such method had been used to account forstock-based compensation costs as described in SFAS No. 123 as amended bySFAS 148.

 

Theper share weighted average fair value of stock options granted during the ninemonths ended March 31, 2005 was $5.05 on the date of grant.  The fair value was determined using the BlackScholes option-pricing model with the following weighted average assumptions:expected dividend yield of 0%, risk free interest rate of 4.3%, expectedvolatility of 46%, and an expected life of 6.1 years.  The per share weighted average fair value ofstock options granted during the nine months ended March 31, 2004 was $6.82on the date of grant.  The fair value wasdetermined using the Black Scholes option-pricing model with the followingweighted average assumptions: expected dividend yield of 0%, risk free interestrate of 4.4%, expected volatility of 77% and an expected life of 5.2 years.

 

TheCompany’s net income and net income per share using the pro forma fair valuecompensation cost method would have been:

 

9

----

 
| ** **                                                                                                                    | ** ** | **Nine Months Ended  March 31,**      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2005**                                   | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                    | ** ** | **(In thousands, except per share  data)** | ** ** |
|                                                                                                                          |       |                                       |       |                                   |       |   |   |   |   |
| Net income                                                                                                                    |       | $                                          | 14,911     |                                   | $          | 3,869 |   | $ | 3,972 |   | $ | 5,865 |   |
|                                                                                                                          |       |                                       |       |                                   |       |   |   |   |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all grants, net of tax |       | (9,545                                     | )          | (8,539                                 | )          | (3,070 | ) | (3,241 | ) |
|                                                                                                                          |       |                                       |       |                                   |       |   |   |   |   |
| Pro forma  net income (loss)                                                                                                  |       | $                                          | 5,366      |                                   | $          | (4,670 | ) | $ | 902 |   | $ | 2,624 |   |
|                                                                                                                          |       |                                       |       |                                   |       |   |   |   |   |
| Net income  per share:                                                                                                        |       |                                       |       |                                   |       |   |   |   |   |
| Basic -  as reported                                                                                                          |       | $                                          | 0.20       |                                   | $          | 0.06 |   | $ | 0.05 |   | $ | 0.09 |   |
| Basic -  pro forma                                                                                                            |       | $                                          | 0.07       |                                   | $          | (0.07 | ) | $ | 0.01 |   | $ | 0.04 |   |
|                                                                                                                          |       |                                       |       |                                   |       |   |   |   |   |
| Diluted -  as reported                                                                                                        |       | $                                          | 0.20       |                                   | $          | 0.05 |   | $ | 0.05 |   | $ | 0.08 |   |
| Diluted -  pro forma                                                                                                          |       | $                                          | 0.07       |                                   | $          | (0.07 | ) | $ | 0.01 |   | $ | 0.04 |   |

 

**Recently Issued Accounting Standards**

 

In April 2005, the  Financial Accounting Standards Board (“FASB”)issued FASB Interpretation No. 47 (“FIN 47”),“Accounting for Conditional Asset Retirement Obligations – An Interpretation ofFASB Statement No. 143.”  FIN 47clarifies the terms of FASB Statement No. 143 and requires an entity torecognize a liability for a conditional asset retirement obligation if theentity has sufficient information to reasonably estimate its fair value.  FIN 47 is effective no later than the end offiscal years ending after December 15, 2005.  The Company is currently evaluating theimpact of this standard on its financial statements.

 

OnDecember 31, 2004, the FASB issuedFASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004” (“FSP No. 109-1”),and FASB Staff Position No. FAS 109-2, “Accounting and Disclosure Guidance forthe Foreign Earnings Repatriation Provision within the American Jobs CreationAct of 2004” (“FSP No. 109-2”).  Thesestaff positions provide accounting guidance on how companies should account forthe effects of the American Jobs Creation Act of 2004 (“AJCA”) that was signedinto law on October 22, 2004.  FSPNo. 109-1 states that the tax relief (special tax deduction for domesticmanufacturing) from this legislation should be accounted for as a “specialdeduction” instead of a tax rate reduction. FSP No. 109-2 gives a company additional time to evaluate the effects ofthe legislation on any plan for reinvestment or repatriation of foreignearnings for purposes of applying FASB Statement No. 109.  The Company is investigating the repatriationprovision to determine whether it might repatriate extraordinary dividends, asdefined in the AJCA.  The Company iscurrently evaluating all available U.S. Treasury guidance, as well as awaitinganticipated further guidance.  TheCompany expects to complete this evaluation within a reasonable amount of timeafter additional guidance is published.

 

10

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InDecember 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment” (“SFASNo. 123(R)”).  This statement replacesSFAS No. 123, “Accounting for Stock-Based Compensation” and supersedesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees.”  SFAS 123(R) requires allstock-based compensation to be recognized as an expense in the financialstatements and that such cost be measured according to the fair value of stockoptions.  SFAS 123(R) will be effectivefor fiscal years beginning after June 15, 2005, which is the Company’sfirst quarter of fiscal 2006.  While theCompany currently provides the pro forma disclosures required by SFAS No. 148, “Accountingfor Stock-Based Compensation - Transition and Disclosure,” on a quarterly basis(see Note 1 - “Accounting for Stock-Based Compensation”), it is currentlyevaluating the impact this statement will have on its consolidated financialstatements.

 

InNovember 2004, the FASB issued SFAS No. 151, “Inventory Costs - anamendment of Accounting Research Bulletin No. 43, Chapter 4,” (“SFAS No. 151”).  SFAS No. 151 requires all companies torecognize a current period charge for abnormal amounts of idle facilityexpense, freight, handling costs and wasted materials.  This statement also requires that theallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities.  SFAS No. 151 will be effective for fiscalyears beginning after June 15, 2005. The Company is currently evaluating the effect that this statement willhave on its consolidated financial statements.

 

2.               Acquisition of Businesses and IntangibleAssets

 

**Acquisition of Racal Instruments Wireless SolutionsGroup**

 

OnJuly 31, 2003, the Company acquired the Racal Instruments WirelessSolutions Group (“RIWS”) for cash of $38 million and a deferred payment of upto $16.5 million in either cash or Aeroflex common stock, at the Company’soption, depending on RIWS achieving certain performance goals for the yearending July 31, 2004.  The Companydid not include this contingent consideration in the purchase price allocationas the payment of this consideration was not considered to be certain beyond areasonable doubt at the date of acquisition. Although the Company believes thatthe performance goals have not been met, the determination is not final.

 

RIWSdevelops, manufactures and integrates digital wireless testing and measurementsolutions. The addition of RIWS testing solutions products and technologies hasenabled the Company to provide a full spectrum of wireless testing solutionsfrom development to production and services primarily for infrastructuretesting and mobile handset testing.

 

TheCompany evaluated the acquired tangible and identifiable intangible assets toserve as a basis for allocation of the purchase price.  The Company allocated the purchase price,including acquisition costs of approximately $2.6 million, based on theestimated fair value of the assets acquired and liabilities assumed as follows:

 
| ** **                                       | ** ** | **(In thousands)** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|
|                                             |       |               |       |
| Current  assets (excluding cash of $5.9 million) |       | $                  | 21,321     |   |
| Property,  plant and equipment                   |       | 8,672              |       |
| Developed  technology                            |       | 15,600             |       |
| Customer  related intangibles                    |       | 1,700              |       |
| Tradenames                                       |       | 200                |       |
| Goodwill                                         |       | 17,674             |       |
| In-process  research and development             |       | 2,700              |       |
| Total  assets acquired                           |       | 67,867             |       |
| Current  liabilities                             |       | (27,924            | )          |
| Deferred  taxes                                  |       | (5,250             | )          |
| Total  liabilities assumed                       |       | (33,174            | )          |
| Net  assets acquired                             |       | $                  | 34,693     |   |

 

11

----

 

Thedeveloped technology, tradenames and customer related intangibles are beingamortized on a straight-line basis over a range of 1 to 8 years. Approximately$5.4 million of the goodwill is deductible for tax purposes.  At the acquisition date, the acquiredin-process research and development was not considered to have reachedtechnological feasibility and had no alternative future uses.  Therefore, in accordance with accountingprinciples generally accepted in the United States of America, the value ofsuch has been expensed in the quarter ended September 30, 2003 inoperating costs.  The allocation toin-process research and development represents the estimated fair value of suchincomplete research and development, at the acquisition date, based on futurecash flows that have been adjusted by the respective projects’ completionpercentage.  As of the acquisition date,cash flows from these projects were expected to commence in calendar year2004.  A 35% risk adjusted discount ratewas applied to the projects’ cash flows in determining fair value. At theacquisition date, RIWS was conducting design, development, engineering andtesting activities associated with the completion of new 2.5G and 3G protocoland conformance testers.

 

**Acquisition of MCE Technologies,Inc.**

 

OnSeptember 3, 2003, the Company acquired all of the outstanding stock ofMCE Technologies, Inc. (“MCE”) for approximately 5.8 million shares of Aeroflexcommon stock with a fair value of approximately $43.5 million.  In addition, the Company discharged $22.8million of MCE outstanding bank debt, other indebtedness and preferred stock.Further, the Company issued fully vested stock options for 315,000 shares ofAeroflex common stock with exercise prices ranging from $2.88 to $9.59 inexchange for fully vested outstanding options of MCE. The fair value of theseoptions was approximately $2.4 million utilizing the Black-Scholes optionpricing model. MCE designs, manufactures and markets a broad range ofmicroelectronic devices, components and multi-function modules servicingwireless, broadband infrastructure, satellite communications and defensemarkets.  These product offeringscomplement the existing product lines of the Company.

 

TheCompany evaluated the acquired tangible and identifiable intangible assets toserve as a basis for allocation of the purchase price.  The Company allocated the purchase price,including acquisition costs of approximately $2.0 million, based on theestimated fair value of the assets acquired and liabilities assumed as follows:

 
| ** **                                       | ** ** | **(In thousands)** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|
|                                             |       |               |       |
| Current  assets (excluding cash of $1.8 million) |       | $                  | 19,020     |   |
| Property,  plant and equipment                   |       | 12,517             |       |
| Developed  technology                            |       | 8,850              |       |
| Tradenames                                       |       | 1,100              |       |
| Customer  related intangibles                    |       | 2,520              |       |
| Goodwill                                         |       | 42,638             |       |
| In-process  research and development             |       | 420                |       |
| Other                                            |       | 459                |       |
| Total  assets acquired                           |       | 87,524             |       |
| Current  liabilities                             |       | (12,551            | )          |
| Long-term  debt                                  |       | (89                | )          |
| Deferred  taxes                                  |       | (5,963             | )          |
| Other  long-term liabilities                     |       | (11                | )          |
| Total  liabilities assumed                       |       | (18,614            | )          |
| Net  assets acquired                             |       | $                  | 68,910     |   |

 

12

----

 

Thedeveloped technology, customer related intangibles, and tradenames are beingamortized on a straight-line basis over a range of 1 to 15 years. The goodwillis not deductible for tax purposes.  Atthe acquisition date, the acquired in-process research and development was notconsidered to have reached technological feasibility and had no alternativefuture uses.  Therefore, in accordancewith accounting principles generally accepted in the United States of America,the value of such has been expensed in the quarter ended September 30,2003 in operating costs.  The allocationto in-process research and development represents the estimated fair value ofsuch incomplete research and development, at the acquisition date, based onfuture cash flows that have been adjusted by the respective projects’completion percentage.  As of theacquisition date, cash flows from these projects were expected to commence infiscal year 2004.  A 30% risk adjusteddiscount rate was applied to the projects’ cash flows in determining fairvalue.  At the acquisition date, MCE wasconducting development activities associated with the completion of certainhigh frequency component technology.

 

**Acquisition of the Business of Celerity Systems Inc.(CA)**

 

OnOctober 31, 2003, the Company acquired the business of Celerity SystemsInc. (CA) (“Celerity”) for $4.0 million of cash, 428,000 shares of Aeroflexcommon stock with a fair market value of approximately $4.2 million and arelease of certain liabilities totaling $1.8 million.  Celerity designs, develops and manufacturesmodular digital test and measurement solutions for the communications,satellite, wireless and broadband test markets, including broadband signalgenerators.  Celerity’s technologyenhances the Company’s automatic systems capability.

 

TheCompany evaluated the acquired tangible and identifiable intangible assets toserve as a basis for allocation of the purchase price.  The Company allocated the purchase price,including acquisition costs of approximately $106,000, based on the estimatedfair value of the assets acquired and liabilities assumed as follows:

 
| ** **                           | ** ** | **(In thousands)** | ** ** |
|--------------------------------------|------------|--------------------|------------|
|                                 |       |               |       |
| Current  assets                      |       | $                  | 2,137      |   |
| Property,  plant and equipment       |       | 737                |       |
| Developed  technology                |       | 3,405              |       |
| Goodwill                             |       | 2,220              |       |
| In-process  research and development |       | 1,100              |       |
| Total  assets acquired               |       | 9,599              |       |
| Current  liabilities assumed         |       | (1,291             | )          |
| Net  assets acquired                 |       | $                  | 8,308      |   |

 

Thedeveloped technology is being amortized on a straight-line basis over 7years.  The goodwill is fully deductiblefor tax purposes.  At the acquisitiondate, the acquired in-process research and development was not considered tohave reached technological feasibility and had no alternative future uses.  Therefore, in accordance with accountingprinciples generally accepted in the United States of America, the value ofsuch has been expensed in the quarter ended December 31, 2003 in operatingcosts.  The allocation to in-processresearch and development represents the estimated fair value of such incompleteresearch and development, at the acquisition date, based on future cash flowsthat have been adjusted by the respective projects’ completion percentage.  As of the acquisition date, cash flows fromthese projects were expected to commence in fiscal year 2005.  A 35% risk adjusted discount rate was appliedto the projects’ cash flows in determining fair value.  At the acquisition date, Celerity wasconducting development activities associated with the completion of its nextgeneration modular technology.

 

13

----

 

**Pro Forma Results of Operations -RIWS, MCE and Celerity**

 

Summarizedbelow are the unaudited pro forma results of operations of the Company as ifRIWS, MCE and Celerity had been acquired at the beginning of the fiscal periodpresented.  The $4.2 million write-off ofin-process research and development has been included in the March 31, 2004pro forma income in order to provide comparability to the respective historicalperiod.

 
| ** **            | ** ** | ** **                                             | ** ** |
|-----------------------|------------|--------------------------------------------------------|------------|
| ** **            | ** ** | **Pro forma  Nine Months Ended  March 31,  2004** | ** ** |
| ** **            | ** ** | **(In thousands)**                                     | ** ** |
|                  |       |                                                   |       |
| Net sales             |       | $                                                      | 302,138    |   |
| Net  income           |       | 763                                                    |       |
| Net income  per share |       |                                                   |       |
| Basic                 |       | $                                                      | 0.01       |   |
| Diluted               |       | $                                                      | 0.01       |   |

 

Thepro forma financial information presented above is not necessarily indicativeof either the results of operations that would have occurred had theacquisitions taken place at the beginning of the period presented or of futureoperating results of the combined companies. The operating results of RIWS, MCE and Celerity have been included inthe consolidated statement of operations from their respective acquisitiondates.  RIWS and Celerity are included inthe Test Solutions segment and MCE is included in the Microelectronic Solutionssegment.

 

**Intangibles with Definite Lives**

Thecomponents of amortizable intangible assets are as follows:

 
| ** **                    | ** ** | **As of March 31, 2005** | ** ** |
|-------------------------------|------------|-------------------------------|------------|
| ** **                    | ** ** | **Gross Carrying  Amount**    | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
| ** **                    | ** ** | **(In thousands)**            | ** ** |
|                          |       |                          |       |   |   |   |   |
| Existing  technology          |       | $                             | 50,878     |   | $ | 18,811 |   | $ | 32,067 |   |
| Tradenames                    |       | 2,334                         |       | 1,327 |   | 1,007 |   |
| Customer  related intangibles |       | 4,507                         |       | 1,147 |   | 3,360 |   |
| Total                         |       | $                             | 57,719     |   | $ | 21,285 |   | $ | 36,434 |   |

 

Theestimated aggregate amortization expense for each of the twelve-month periodsending March 31, is as follows:

 
| ** ** | ** ** | **(In thousands)** | ** ** |
|------------|------------|--------------------|------------|
|       |       |               |       |
| 2006       |       | $                  | 8,102      |   |
| 2007       |       | 7,403              |       |
| 2008       |       | 6,778              |       |
| 2009       |       | 4,649              |       |
| 2010       |       | 3,466              |       |
|            |            |                    |            |  |

 

14

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**Goodwill**

Thecarrying amount of goodwill is as follows:

 
| ** **                         | ** ** | **Balance  as of  July 1, 2004** | ** ** | **Adjustment  (Note a)** | ** ** | **Adjustment  (Note b)** | ** ** | **Adjustment  (Note c)** | ** ** | **Balance  as of  March 31, 2005** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|-----------------------------------------|------------|
| ** **                         | ** ** | **(In thousands)**                    | ** ** |
|                               |       |                                  |       |                     |       |                     |       |                     |       |                                    |       |
| Microelectronic  solutions segment |       | $                                     | 46,371     |                     | $          | 317                      |       | $                        | —     |                                    | $          | — |   | $ | 46,688 |   |
| Test  solutions segment            |       | 41,917                                |       | (2,059                   | )          | (1,912                   | )          | 695                      |       | 38,641                                  |       |
| Total                              |       | $                                     | 88,288     |                     | $          | (1,742                   | )          | $                        | (1,912     | )                                       | $          | 695 |   | $ | 85,329 |   |

 

Note a -                                                      These adjustments to goodwill recorded duringthe period pertain to final adjustments to the fair value of assets andliabilities assumed in the acquisitions of MCE in the Microelectronic Solutionssegment and of RIWS and Celerity in the Test Solutions segment.

Note b -                                                     This adjustment to goodwill is a result of areduction in the purchase price of RIWS in connection with the amount of actualworking capital acquired as of acquisition date.

Note c -                                                      The goodwill increased due to changes inforeign currency exchange rates.

 

3.               Discontinued Operations

 

Asa result of continued operating losses, the Board of Directors of the Company,in February 2004, approved a formal plan to divest the Company’s thin filminterconnect manufacturing operation (“MIC”) and to seek a strategicbuyer.  This operation had previouslybeen included in the Microelectronic Solutions segment.  As a result of this decision, the Companyrecorded a $9.1 million ($5.9 million, net of tax) loss on disposal in thequarter ended December 31, 2003. This charge included a cash requirement of $2.6 million primarily forexisting equipment leases, and a non-cash charge of $6.5 million for the writedown of goodwill, other intangibles and owned equipment.

 

InSeptember 2004, the Company sold the stock of MIC for $8.8 million andrecorded an additional net loss on disposal of $1.3 million.  Since the sale of the stock created a capitalloss for tax purposes and the Company has no current capital gains to offsetit, the Company recorded a full valuation allowance against the taxbenefit.  Under the terms of the sale agreements,the Company has retained certain liabilities relating to potential adverseenvironmental conditions that may exist as of the date of sale, litigationpending against MIC as of the date of sale and product defects in productsdesigned, developed, manufactured or sold by MIC prior to the sale date whichresult in a recall, withdrawal or market suspension of the product or result ininjury to persons or property. Management believes these contingencies will nothave a material adverse effect on the Company’s consolidated financialstatements.

 

InJune 2004, the Board of Directors of the Company approved a formal plan todivest the Company’s shock and vibration control device manufacturing business(“VMC”) and to seek a strategic buyer. This operation had previously comprised the Isolator Products segment.  In March 2005, the Company sold the netassets of VMC for $8.4 million in cash. The Company recorded a $300,000 net gain on disposition.  Under the terms of the sale agreements, theCompany has retained certain liabilities relating to adverse environmentalconditions that currently exist at the premises occupied by VMC, litigationpending against VMC as of the date of sale, and to the extent covered byinsurance, for product liability for products sold prior to the closing date. TheCompany has recorded a reserve for the estimated remediation costs related toadverse environmental conditions that currently exist at the premises occupiedby VMC.

 

15

----

 

Inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets”, these business units and TriLink (which was discontinued inDecember 2002) have been reported as discontinued operations and,accordingly, income and losses from operations and the losses on disposal havebeen reported separately from continuing operations.  Net sales and income (loss) from discontinuedoperations (including loss on disposal) for the nine months ended March 31,2005 and 2004 were as follows:

 
| ** **                                  | ** ** | **Nine Months Ended March 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                   | ** ** |
|                                        |       |                                 |       |   |   |
| Net sales                                   |       |                                 |       |   |   |
| MIC                                         |       | $                                    | 3,313      |   | $ | 7,150 |   |
| VMC                                         |       | 12,406                               |       | 11,393 |   |
| TriLink                                     |       | —                               |       | — |   |
|                                        |       | $                                    | 15,719     |   | $ | 18,543 |   |
|                                        |       |                                 |       |   |   |
| Income  (loss) from discontinued operations |       |                                 |       |   |   |
| MIC                                         |       | $                                    | (1,081     | ) | $ | (7,915 | ) |
| VMC                                         |       | (429                                 | )          | 292 |   |
| TriLink                                     |       | 14                                   |       | — |   |
|                                        |       | $                                    | (1,496     | ) | $ | (7,623 | ) |

 

Toconform with this presentation, all prior periods have been restated.  As a result, the assets and liabilities ofthe discontinued operations have been reclassified on the balance sheet fromthe historical classifications and presented under the captions “assets ofdiscontinued operations” and “liabilities of discontinued operations,”respectively.  As of March 31, 2005and June 30, 2004, the net assets of the discontinued operations consistedof the following:

 
| ** **                            | ** ** | **March 31,  2005** | ** ** | **June 30,  2004** | ** ** |
|---------------------------------------|------------|--------------------------|------------|-------------------------|------------|
|                                  |       | **(In thousands)**       |       |
| Accounts  receivable                  |       | $                        | —     |                    | $          | 5,133 |   |
| Inventory                             |       | —                   |       | 5,247                   |       |
| Prepaid  and other current assets     |       | —                   |       | 1,530                   |       |
| Current  assets                       |       | —                   |       | 11,910                  |       |
| Property,  plant & equipment, net |       | —                   |       | 5,543                   |       |
| Other  assets                         |       | —                   |       | 2,624                   |       |
| Intangibles                           |       | —                   |       | 1,550                   |       |
| Non-current  assets                   |       | —                   |       | 9,717                   |       |
| Total  assets                         |       | —                   |       | 21,627                  |       |
|                                  |       |                     |       |                    |       |
| Accounts  payable                     |       | —                   |       | 704                     |       |
| Accrued  expenses                     |       | —                   |       | 3,869                   |       |
| Current  liabilities                  |       | —                   |       | 4,573                   |       |
| Long term  debt                       |       | —                   |       | 3,565                   |       |
| Other  long term liabilities          |       | —                   |       | 48                      |       |
| Long term  liabilities                |       | —                   |       | 3,613                   |       |
| Total  liabilities                    |       | —                   |       | 8,186                   |       |
|                                  |       |                     |       |                    |       |
| Net  assets                           |       | $                        | —     |                    | $          | 13,441 |   |
|                                       |            |                          |            |                         |            |  |  |  |

 

16

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4.                     Earnings Per Share

Inaccordance with SFAS No. 128 “Earnings Per Share,” net income per common share(“Basic EPS”) is computed by dividing net income by the weighted average commonshares outstanding.  Net income percommon share, assuming dilution (“Diluted EPS”) is computed by dividing netincome by the weighted average common shares outstanding plus potentialdilution from the exercise of stock options. A reconciliation of the numeratorsand denominators of the Basic EPS and Diluted EPS calculations for continuingoperations is as follows:

 
| ** **                                                                                                       | ** ** | **Nine Months  Ended March 31,**      | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                                                                       | ** ** | **(In thousands, except per share  data)** | ** ** |
|                                                                                                             |       |                                       |       |   |   |
| Income  from continuing operations                                                                               |       | $                                          | 16,407     |   | $ | 11,492 |   |
|                                                                                                             |       |                                       |       |   |   |
| Computation  of adjusted weighted average shares outstanding:                                                    |       |                                       |       |   |   |
| Weighted  average shares outstanding                                                                             |       | 74,595                                     |       | 65,773 |   |
| Add:  Effect of dilutive options outstanding                                                                     |       | 1,452                                      |       | 1,916 |   |
| Weighted  average shares and common share equivalents used for computation of diluted  earnings per common share |       | 76,047                                     |       | 67,689 |   |
|                                                                                                             |       |                                       |       |   |   |
| Income  from continuing operations per share:                                                                    |       |                                       |       |   |   |
| - Basic                                                                                                          |       | $                                          | 0.22       |   | $ | 0.18 |   |
| - Diluted                                                                                                        |       | $                                          | 0.22       |   | $ | 0.17 |   |
|                                                                                                                  |            |                                            |            |  |  |  |  |  |

 
| ** **                                                                                                       | ** ** | **Three Months  Ended March 31,**     | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                                                                       | ** ** | **(In thousands, except per share  data)** | ** ** |
|                                                                                                             |       |                                       |       |   |   |
| Income  from continuing operations                                                                               |       | $                                          | 3,866      |   | $ | 6,618 |   |
|                                                                                                             |       |                                       |       |   |   |
| Computation  of adjusted weighted average shares outstanding:                                                    |       |                                       |       |   |   |
| Weighted  average shares outstanding                                                                             |       | 74,714                                     |       | 68,804 |   |
| Add:  Effect of dilutive options outstanding                                                                     |       | 1,128                                      |       | 2,632 |   |
| Weighted  average shares and common share equivalents used for computation of diluted  earnings per common share |       | 75,842                                     |       | 71,436 |   |
|                                                                                                             |       |                                       |       |   |   |
| Income  from continuing operations per share:                                                                    |       |                                       |       |   |   |
| - Basic                                                                                                          |       | $                                          | 0.05       |   | $ | 0.10 |   |
| - Diluted                                                                                                        |       | $                                          | 0.05       |   | $ | 0.09 |   |

 

Optionsto purchase 9.6 million shares at exercise prices ranging between $10.66 and $34.41per share were outstanding as of March 31, 2005 but were not included inthe computation of diluted EPS because the exercise prices of these optionswere greater than the average market price of the common shares.

 

17

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5.                     Comprehensive Income

Thecomponents of comprehensive income are as follows:

 
| ** **                                                           | ** ** | **Nine Months Ended  March 31,** | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                              | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                           | ** ** | **(In thousands)**                    | ** ** |
|                                                                 |       |                                  |       |                                   |       |   |   |   |   |
| Net  income                                                          |       | $                                     | 14,911     |                                   | $          | 3,869 |   | $ | 3,972 |   | $ | 5,865 |   |
|                                                                 |       |                                  |       |                                   |       |   |   |   |   |
| Unrealized  gain (loss) on interest rate swap agreements, net of tax |       | 57                                    |       | 63                                     |       | 37 |   | (15 | ) |
|                                                                 |       |                                  |       |                                   |       |   |   |   |   |
| Foreign  currency translation adjustment                             |       | 5,170                                 |       | 9,341                                  |       | (1,894 | ) | 6,066 |   |
|                                                                 |       |                                  |       |                                   |       |   |   |   |   |
| Total  comprehensive income                                          |       | $                                     | 20,138     |                                   | $          | 13,273 |   | $ | 2,115 |   | $ | 11,916 |   |

 

Accumulatedother comprehensive income (loss) is as follows:

 
| ** **                    | ** ** | **Gain (Loss)  on Interest  Rate Swap  Agreements  (net of tax)** | ** ** | **Minimum  Pension  Liability  Adjustment  (net of tax)** | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Total  (net of tax)** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **(In thousands)**                                                | ** ** |
|                          |       |                                                              |       |                                                      |       |                                           |       |                    |       |
| Balance, July 1,  2004   |       | $                                                                 | (129       | )                                                         | $          | (2,208                                         | )          | $                       | 13,724     |   | $ | 11,387 |   |
| Nine  months activity         |       | 57                                                                |       | —                                                    |       | 5,170                                          |       | 5,227                   |       |
| Balance, March 31,  2005 |       | $                                                                 | (72        | )                                                         | $          | (2,208                                         | )          | $                       | 18,894     |   | $ | 16,614 |   |
|                               |            |                                                                   |            |                                                           |            |                                                |            |                         |            |  |  |  |  |  |

 

6.                     Bank Loan Agreements

OnFebruary 14, 2003, the Company executed an amended and restated revolvingcredit and security agreement with two banks which replaced a previous loanagreement. The amended and restated loan agreement increased the line of creditto $50 million through February 2007, continued the mortgage on theCompany’s Plainview property for $2.6 million and is secured by the pledge ofthe stock of certain of the Company’s subsidiaries.  The interest rate on revolving creditborrowings under this agreement is at various rates depending upon certainfinancial ratios, with the current rate substantially equivalent to prime (5.75%at March 31, 2005). The Company paid a facility fee of $125,000 and isrequired to pay a commitment fee of .25% per annum of the average unusedportion of the credit line.  At March 31,2005, the Company’s available unused line of credit was approximately $41.8million after consideration of letters of credit. The mortgage is payable inmonthly installments of approximately $26,000 through March 2008 and aballoon payment of $1.6 million in April 2008.  The Company has entered into interest rateswap agreements for the outstanding amount under the mortgage agreement atapproximately 7.6% in order to reduce the interest rate risk associated withthese borrowings.

 

18

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Theseinstruments have been designated and qualify as effective cash flow hedges. Thefair market value of the interest rate swap agreements was $114,000 as of March 31,2005 in favor of the banks.  If thismortgage was prepaid, although the Company has no intention of doing so, the$114,000 would be charged to the statement of operations at that time.

 

Theterms of the loan agreement require compliance with certain covenants includingminimum consolidated tangible net worth and pretax earnings, maintenance ofcertain financial ratios, limitations on indebtedness and prohibition of thepayment of cash dividends.  The Companyis currently in full compliance with all of the covenants contained in the loanagreement, as amended.

 

7.               Inventories

Inventoriesconsist of the following:

 
| ** **       | ** ** | **March 31,  2005** | ** ** | **June 30,  2004** | ** ** |
|------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **       | ** ** | **(In thousands)**       | ** ** |
|             |       |                     |       |                    |       |
| Raw  materials   |       | $                        | 41,310     |                    | $          | 35,228 |   |
| Work in  process |       | 48,547                   |       | 40,248                  |       |
| Finished  goods  |       | 22,504                   |       | 19,141                  |       |
|             |       | $                        | 112,361    |                    | $          | 94,617 |   |

 

8.               Product Warranty

TheCompany warrants its products against defects in design, materials andworkmanship, generally for one year from their date of shipment.  A provision for estimated future costs relatingto these warranties is recorded when revenue is recorded and is included incost of goods sold.

 

Activityrelated to the Company’s product warranty liability was as follows:

 
| ** **                          | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|
| ** **                          | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **(In thousands)**                    | ** ** |
|                                |       |                                  |       |   |   |
| Balance  at beginning of period     |       | $                                     | 1,702      |   | $ | 1,308 |   |
| Provision  for warranty obligations |       | 1,537                                 |       | 1,010 |   |
| Charges  incurred                   |       | (1,377                                | )          | (1,026 | ) |
| Acquired  warranty obligations      |       | (194                                  | )          | 187 |   |
|                                |       |                                  |       |   |   |
| Balance  at end of period           |       | $                                     | 1,668      |   | $ | 1,479 |   |

 

9.               Defined Benefit Pension Plans

EffectiveJanuary 1, 1994, the Company established a Supplemental ExecutiveRetirement Plan (the “SERP”) which provides retirement, death and disabilitybenefits to certain of its officers.  On September 3,2003, the Company acquired MCE, including its defined benefit pension plan (the“MCE Plan”).  The MCE Plan has beenfrozen since December 31, 1993.

 

19

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**Components of Net Periodic Benefit Cost**

 
| ** **                                         | ** ** | **Nine Months Ended  March 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                    | ** ** |
|                                               |       |                                  |       |   |   |
| Service  cost                                      |       | $                                     | 403        |   | $ | 313 |   |
| Interest  cost                                     |       | 509                                   |       | 484 |   |
| Expected  return on plan assets                    |       | (93                                   | )          | (73 | ) |
| Amortization  of net transition (asset) obligation |       | 28                                    |       | 28 |   |
| Recognized  actuarial (gain) loss                  |       | 150                                   |       | 150 |   |
| Net periodic  benefit cost                         |       | $                                     | 997        |   | $ | 902 |   |

 

TheCompany previously disclosed in its financial statements for the year ended June 30,2004, that it expected to contribute $253,000 to its pension plan in the fiscalyear ended June 30, 2005.  As of March 31,2005, $339,000 of actual contributions have been made.  The Company does not anticipate making anymore contributions in the fiscal year ending June 30, 2005.

 

10.         IncomeTaxes

TheCompany recorded credits of $766,000 and $2.2 million to additional paid-in capitalduring the nine months ended March 31, 2005 and 2004, respectively, inconnection with the tax benefit related to compensation deductions on theexercise of stock options. The Company made income tax payments of $8.3 millionand $6.0 million and received refunds of $8,000 and $72,000 for the nine monthsended March 31, 2005 and 2004, respectively.

 

11.         Contingencies

TheCompany recently has learned that it inadvertently may have violated certainInternational Traffic in Arms Regulations (ITAR) by exporting certain products andservices without licenses.  These exportsresulted from an error in classifying the products and services as commercialrather than military.  The Company hasprepared and filed a voluntary disclosure with the State Department in whichthe details of the exports and erroneous classifications are described.  At this time, it is not possible to determinewhether any fines or other penalties will be asserted against the Company, orthe materiality of any outcome.

 

Weare involved in various other legal matters. We believe the outcome of these other legal matters will not have amaterial effect upon us.

 

12.         BusinessSegments

TheCompany’s business segments and major products included in each segment, are asfollows:

 
| **Microelectronic  Solutions:**           | ** ** | **Test Solutions:**       |
|-------------------------------------------|------------|---------------------------|
| a)Microelectronic  Modules and Components |       | a)Instrument  Products    |
| b)Integrated  Circuits                    |       | b)Motion  Control Systems |

 

20

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| ** **                                             | ** ** | **For the Nine Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                            | ** ** |
| **Business Segment Data:**                             |       |                                          |       |   |   |
| Net  sales:                                            |       |                                          |       |   |   |
| Microelectronic  solutions                             |       | $                                             | 140,527    |   | $ | 114,083 |   |
| Test  solutions                                        |       | 194,879                                       |       | 174,709 |   |
| Net sales                                              |       | $                                             | 335,406    |   | $ | 288,792 |   |
|                                                   |       |                                          |       |   |   |
| Segment  adjusted operating income (1):                |       |                                          |       |   |   |
| Microelectronic  solutions                             |       | $                                             | 32,436     |   | $ | 28,487 |   |
| Test  solutions                                        |       | 15,745                                        |       | 10,776 |   |
| General  corporate expense                             |       | (14,618                                       | )          | (8,385 | ) |
|                                                   |       | 33,563                                        |       | 30,878 |   |
| Amortization  of acquired intangibles                  |       |                                          |       |   |   |
| - AMS                                                  |       | (1,621                                        | )          | (1,419 | ) |
| - ATS                                                  |       | (4,543                                        | )          | (4,029 | ) |
| Restructuring  charges (2)                             |       | (1,678                                        | )          | — |   |
| Acquired  in-process research and development (3)      |       | —                                        |       | (4,220 | ) |
| Interest  expense                                      |       | (738                                          | )          | (1,075 | ) |
| Other  income (expense), net                           |       | 1,371                                         |       | (2,120 | ) |
| Income  from continuing operations before income taxes |       | $                                             | 26,354     |   | $ | 18,015 |   |

 
| ** **                                             | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                             | ** ** |
| Net  sales:                                            |       |                                           |       |   |   |
| Microelectronic  solutions                             |       | $                                              | 47,882     |   | $ | 45,364 |   |
| Test  solutions                                        |       | 65,873                                         |       | 67,753 |   |
| Net sales                                              |       | $                                              | 113,755    |   | $ | 113,117 |   |
|                                                   |       |                                           |       |   |   |
| Segment  adjusted operating income (1):                |       |                                           |       |   |   |
| Microelectronic  solutions                             |       | $                                              | 11,862     |   | $ | 11,998 |   |
| Test  solutions                                        |       | 4,828                                          |       | 6,507 |   |
| General  corporate expense                             |       | (6,709                                         | )          | (3,724 | ) |
|                                                   |       | 9,981                                          |       | 14,781 |   |
| Amortization  of acquired intangibles                  |       |                                           |       |   |   |
| - AMS                                                  |       | (534                                           | )          | (564 | ) |
| - ATS                                                  |       | (1,529                                         | )          | (1,568 | ) |
| Restructuring  charges (2)                             |       | (1,678                                         | )          | — |   |
| Interest  expense                                      |       | (316                                           | )          | (343 | ) |
| Other  income (expense), net                           |       | 406                                            |       | (1,906 | ) |
| Income  from continuing operations before income taxes |       | $                                              | 6,330      |   | $ | 10,400 |   |

 

----

(1)Management evaluates the operating results of thetwo segments based upon reported operating income, before costs related torestructuring, in-process research and development charges, and amortization ofacquired intangibles..

(2)For the three and nine months ended March 31,2005, the operating income of the Test Solutions segment has been adjusted toexclude the restructuring charges of $1.7 million for the reorganization ofcertain of the company’s European operations.

(3)For the nine months ended March 31, 2004, thecharges for the write-off of in-process research and development acquired inthe purchase of RIWS ($2.7 million) and Celerity ($1.1 million) are allocableto the Test Solutions segment and the charge for MCE ($420,000) is allocable tothe Microelectronic Solutions segment.

 

21

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TheCompany is a manufacturer of advanced technology systems and components forcommercial industry, government and defense contractors.  Approximately 32% and 33% of the Company’ssales for the nine months ended March 31, 2005 and 2004, respectively,were to agencies of the United States government or to prime defensecontractors or subcontractors of the United States government.  No one customer constituted more than 10% ofthe Company’s sales during any year in the periods presented.  Inter-segment sales were not material andhave been eliminated from the tables below.

 

Mostof the Company’s operations are located in the United States, however, it alsohas operations in Europe and Asia.  BothIFR, which was acquired in May 2002, and RIWS, which was acquired in July 2003have significant operations in the United Kingdom.  Specifically, net sales from facilitieslocated in the United Kingdom were approximately $98.1 million for the ninemonths ended March 31, 2005.  Totalassets of the United Kingdom operations were $116.8 million as of March 31,2005.

 

Revenues,based on the customers’ locations, attributed to the United States and otherregions are as follows:

 
| ** **                | ** ** | **For the Nine Months Ended  March 31,** | ** ** |
|---------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| ** **                | ** ** | **(In thousands)**                            | ** ** |
|                      |       |                                          |       |   |   |
| United  States of America |       | $                                             | 197,917    |   | $ | 184,560 |   |
| Europe  and Middle East   |       | 89,057                                        |       | 76,373 |   |
| Asia and  Australia       |       | 44,019                                        |       | 23,483 |   |
| Rest of  World            |       | 4,413                                         |       | 4,376 |   |
|                      |       | $                                             | 335,406    |   | $ | 288,792 |   |

 
| ** **                | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|---------------------------|------------|------------------------------------------------|------------|
| ** **                | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                | ** ** | **(In thousands)**                             | ** ** |
|                      |       |                                           |       |   |   |
| United  States of America |       | $                                              | 62,560     |   | $ | 70,545 |   |
| Europe  and Middle East   |       | 29,716                                         |       | 29,764 |   |
| Asia and  Australia       |       | 19,907                                         |       | 10,359 |   |
| Rest of  World            |       | 1,572                                          |       | 2,449 |   |
|                      |       | $                                              | 113,755    |   | $ | 113,117 |   |

 

13.         RestructuringCharges

In March 2005, the Company initiated strategicplans to reorganize certain of its European operations in its Test Solutionsbusiness segment.  The Company recorded acharge of $1.7 million ($1.0 million, net of taxes) for workforce reductionsprimarily in management, sales, and engineering.  At March 31, 2005, approximately $1.0million remains to be paid and is included in accrued liabilities.  The restructuring charge was allocatedentirely to selling, general and administrative costs and is expected togenerate a savings of approximately $2.0 million per year.

 

14.         Subsequent Event

In April 2005, the Company acquired all of theoutstanding stock of JcAIR, Inc. (“JcAIR”) for $35 million in cash. JcAIR,which will be included in the Test Solutions segment, provides customizedavionics test solutions for manufacturing, repair, and ground supportoperations.

 

22

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**ITEM 2** - **MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

 

Weuse our advanced design, engineering and manufacturing capabilities to producemicroelectronic and test solutions that we sell primarily into the broadbandcommunications, aerospace and defense markets. We also design and manufacture motion control systems which are used forindustrial and defense applications.

 

**Microelectronic Solutions**

 

Wehave been a designer and supplier of microelectronics for more than 20years.  Our products include(i) custom and standard integrated circuits, such as databuses, transceivers,microcontrollers, microprocessors and memories and (ii) components,sub-assemblies and modules for military and commercial communication systems.

 

InSeptember 2003, we acquired MCE Technologies, Inc.  MCE designs, manufactures and markets a broadrange of devices, components and subsystems that are used in wireless broadbandaccess, cable head-end systems, fiber optic networking and satelliteapplications.

 

**Test Solutions**

 

Wedesign, develop and manufacture a broad line of test equipment which includes:

 

•                  WirelessTest Equipment

•                  FrequencySynthesizers

•                  RadioTest Equipment

•                  SyntheticTest Systems

•                  AvionicsTest Equipment

•                  OtherGeneral Purpose Test Equipment

 

Werecently acquired three businesses in this segment:

 

•                  In July 2003, we acquired RacalInstruments Wireless Solutions Group (“RIWS”) which added the bulk of thewireless test equipment capabilities referred to above.

 

•                  In October 2003, we acquired thebusiness of Celerity Systems, Inc., which designs, develops andmanufactures modular digital test and measurement solutions for thecommunications, satellite, wireless and broadband test markets, includingbroadband signal generators.

 

•                  In April 2005, we acquiredJcAIR, Inc., which provides customized avionics test solutions, both manualand automated, for manufacturing, repair, and ground support operations.

 

Wealso design, develop and produce motion control systems including stabilizationand tracking devices, magnetic motors and scanning devices.

 

Ouroperating strategy is based on the following key objectives:

 

•                  to strengthen and expand our portfolio ofproprietary technologies;

•                  to broaden the applications and targetmarkets for our existing products;

•                  to expand the scope of our content in ourcustomers’ products;

•                  to increase our operating efficiencies;

•                  to maintain a conservative capital structure;and

•                  to opportunistically pursue strategicacquisitions.

 

23

----

 

Asa result of continued operating losses, our Board of Directors, in February 2004,approved a plan to divest our thin film interconnect manufacturing operation (“MIC”)and to seek a strategic buyer.  As aresult of this decision, we recorded a $9.1 million ($5.9 million, net of tax)loss on disposal in December 2003.  Thischarge included a cash requirement of $2.6 million primarily for existingequipment leases, and a non-cash charge of $6.5 million for the write down ofgoodwill, other intangibles and owned equipment.  In accordance with SFAS 144, we have reportedthe loss on disposal and the results of operations of this business as income(loss) from discontinued operations and all prior periods have been restated inorder to conform to this presentation. MIC designs, develops, manufactures andmarkets microelectronic products in the form of passive thin film circuits andinterconnects.** **In September 2004, we soldthe stock of MIC for $8.8 million and recorded an additional loss on disposalof $1.3 million.****Under the termsof the sale agreements, we have retained certain liabilities relating topotential adverse environmental conditions that may exist as of the date ofsale, litigation pending against MIC as of the date of sale and product defectsin products designed, developed, manufactured or sold by MIC prior to the saledate which result in a recall, withdrawal or market suspension of the productor result in injury to persons or property. We believe these contingencies will not have a material adverse effecton our consolidated financial statements.

 

InJune 2004, our Board of Directors approved a formal plan to divest ourshock and vibration control device manufacturing business (“VMC”), and to seeka strategic buyer.  This operation hadpreviously comprised the Isolator Products segment.  In accordance with SFAS 144, we have reportedthe results of operations of this business as income (loss) from discontinuedoperations and all prior periods have been restated in order to conform to thispresentation.  In March 2005, wesold the net assets of VMC  for $8.4million in cash.  We recorded a $300,000net gain on disposition.   We retainedliabilities relating to adverse environmental conditions that currently existat the premises occupied by VMC, litigation pending against VMC as of the dateof sale and, to the extent covered by insurance, for product liability forproducts sold prior to the clsing date. The Company has recorded a reserve for the estimated remediation costsduring the quarter ended December 31, 2004.

 

Ourproduct development efforts primarily involve engineering and design relatingto:

 

•     developingnew products

•                  improvingexisting products

•                  adaptingexisting products to new applications

•                  developingprototype components to bid on specific programs

 

Someof our development efforts are reimbursed under contractual arrangements.  Product development and similar costs whichare not reimbursed under contractual arrangements are expensed in the periodincurred.

 

**Nine Months Ended March 31, 2005 Compared to Nine MonthsEnded March 31, 2004**

 

*Net Sales.*  Net sales increased 16% to$335.4 million for the nine months ended March 31, 2005 from $288.8million for the nine months ended March 31, 2004.  Net sales in the microelectronic solutions (“AMS”)segment increased 23% to $140.5 million for the nine months ended March 31,2005 from $114.1 million for the nine months ended March 31, 2004 due tothe acquisition of MCE in September 2003, organic growth in MCE since lastyear and also as a result of increased sales of our microelectronic modules andintegrated circuits.  Net sales in thetest solutions (“ATS”) segment increased 12% to $194.9 million for the ninemonths ended March 31, 2005 from $174.7 million for the nine months ended March 31,2004 due to increased sales of our communication test products business,organic growth in RIWS which was acquired in July 2003 and the effect of afavorable foreign currency exchange rate on sales of our foreign operations.

 

24

----

 

*Gross Profit. * Costof sales includes materials, direct labor and overhead expenses such asengineering labor, fringe benefits, allocable occupancy costs, depreciation andmanufacturing supplies.

 
| **Nine Months  Ended  March 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except percentages)** | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
|                                   |       |       |       |            |       |       |       |            |       |       |       |            |       |
| 2005                                   |       | $          | 70,851     |            | 50.4       | %          | $          | 87,753          |       | 45.0       | %          | $               | 158,604    |   | 47.3 | % |
| 2004                                   |       | 57,271     |       | 50.2            | %          | 75,536     |       | 43.2            | %          | 132,807    |       | 46.0            | %          |
|                                        |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

Grossprofit increased $13.6 million, or 24%, in the AMS segment as a result of theeffect of the acquisition of MCE in September 2003, organic growth in MCEsince last year in volume  and increasedsales in our microelectronic modules and integrated circuits businesses.  Gross profit increased $12.2 million, or 16%,in the ATS segment as a result of organic growth in RIWS since last year involume, favorable foreign currency exchange rates, and increased sales andmargins in our communications test products business due to improved factoryutilization and a favorable sales mix.

 

*Selling, General and Administrative Costs.* Selling, general and administrative costs include office and managementsalaries, fringe benefits, commissions, insurance and professional fees.

 
| **Nine Months  Ended  March 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Corporate** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|---------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except percentage)**  | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | ** **      | ** ** |
|                                   |       |       |       |            |       |       |       |            |       |          |       |       |       |            |       |
| 2005                                   |       | $          | 21,807     |            | 15.5       | %          | $          | 45,172          |       | 23.2          | %          | $          | 14,618     |            | $          | 81,597 |   | 24.3 | % |
| 2004                                   |       | 18,038     |       | 15.8            | %          | 40,519     |       | 23.2            | %          | 8,385         |       | 66,942     |       | 23.2            | %          |
|                                        |            |            |            |                 |            |            |            |                 |            |               |            |            |            |                 |            |  |  |  |  |

 

Selling,general and administrative costs increased $3.8 million, or 21%, in the AMSsegment due to the addition of the expenses of MCE and increasedcommissions.  Selling, general andadministrative costs increased $4.7 million, or 11% in the ATS segment due tothe effect of an unfavorable foreign currency exchange rate on the expenses ofour foreign operations and increased commissions on higher sales and $1.7million of restructuring charges in certain of our foreign subsidiaries for theconsolidation of certain of our European operations.  Corporate selling, general and administrativeexpenses increased $6.2 million due primarily to increased professional fees($3.7 million), including $3.9 million related to compliance with Section 404of the Sarbanes-Oxley Act and compensation expense of $2.1 million.

 

*Research and*Development*Costs.*  Research and development costs includematerial, engineering labor and allocated overhead.

 
| **Nine Months  Ended  March 31.** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except percentages)** | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
|                                   |       |       |       |            |       |       |       |            |       |       |       |            |       |
| 2005                                   |       | $          | 16,609     |            | 11.8       | %          | $          | 28,513          |       | 14.6       | %          | $               | 45,122     |   | 13.5 | % |
| 2004                                   |       | 10,744     |       | 9.4             | %          | 24,243     |       | 13.9            | %          | 34,987     |       | 12.1            | %          |
|                                        |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

25

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Self-fundedresearch and development costs increased $5.9 million, or 55%, in the AMSsegment primarily due to the increased development efforts in integratedcircuits ($2.9 million) and microelectronic modules ($1.7 million) and theacquisition of MCE in September 2003. Research and development costs increased $4.3 million, or 18%, in theATS segment primarily due to the addition of the expenses of RIWS and theeffect of an unfavorable foreign currency exchange rate on the expenses of ourforeign operations.

 

*Amortization of*Acquired*Intangibles.*  Amortization increased $716,000, or 13%, dueto the acquisitions of MCE, RIWS and Celerity.

 

*Acquired In-Process Research and Development.*  Inconnection with the acquisition of RIWS, we allocated $2.7 million of thepurchase price to incomplete research and development projects.  In connection with the acquisition of MCE, weallocated $420,000 of the purchase price to incomplete research and developmentprojects. In connection with the acquisition of Celerity, we allocated $1.1million of the purchase price to incomplete research and developmentprojects.  These allocations representthe estimated fair value of such incomplete research and development based onfuture cash flows that have been adjusted by the respective projects'completion percentage. At the respective acquisition dates, the development ofthese projects had not yet reached technological feasibility and the researchand development in progress had no alternative future uses.  Accordingly, for the nine months ended March 31,2004, we expensed these costs as of the respective acquisition dates inaccordance with accounting principles generally accepted in the United Statesof America.

 

*Other Income (Expense).* Interest expense decreased to $738,000 for the nine months ended March 31,2005 from $1.1 million for the nine months ended March 31, 2004 due tolower debt levels.  Other income of $1.4million million for the nine months ended March 31, 2005 consisted ofinterest income of $1.4 million. Other expense of $2.1 million for the ninemonths ended March 31, 2004 consisted primarily of $2.0 million of foreigncurrency transaction losses, a $556,000 charge to adjust the fair value ofproperty held for sale to its fair value, partially offset by $197,000 ofincome on investments, a $91,000 increase in the fair value of our interestrate swap agreements and $183,000 of interest income.  Interest income increased primarily due tohigher average levels of cash, cash equivalents and marketable securities andhigher market interest rates in the 2005 period.

 

*Provision for Income Taxes.* The income tax provision was $9.9 million(an effective income tax rate of 37.7%) for the nine months ended March 31,2005 and the income tax provision was $6.5 million (an effective income taxrate of 36.2%) for the nine months ended March 31, 2004. The effectiveincome tax rate for the two periods differed from the amount computed byapplying the U.S. Federal income tax rate to income before income taxesprimarily due to foreign, state and local income taxes and research and developmentcredits.

 

*Income From*Continuing*Operations.*  The income from continuing operations for thenine months ended March 31, 2005 was $16.4 million, or $.22 per dilutedshare, versus income from continuing operations of $11.5 million, or $.17 perdiluted share, for the nine months ended March 31, 2004.

 

*Discontinued Operations. *Discontinuedoperations includes the results of operations of MIC, VMC and TriLink. In September 2004,we sold the stock of MIC for $8.8 million and recorded a loss on disposal of$1.3 million.  In March 2005, wesold substantially all of VMC’s net assets for $8.4 million in cash andrecorded a $300,000 net gain on disposition.

 

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**Three Months Ended March 31, 2005 Compared to ThreeMonths Ended March 31, 2004**

 

*Net Sales.*  Net sales increased to $113.8million for the three months ended March 31, 2005 from $113.1 million forthe three months ended March 31, 2004. Net sales in the AMS segment increased 6% to $47.9 million for the threemonths ended March 31, 2005 from $45.4 million for the three months ended March 31,2004 primarily due to increased sales of our microelectronic modules,components and integrated circuits.  Netsales in the ATS segment decreased to $65.9 million for the three months ended March 31,2005 from $67.8 million for the three months ended March 31, 2004 dueprimarily to decreased sales volume of our military test products and wirelesstest products offset in part by an increase in volume of communication testproducts business and by  the effect of afavorable foreign currency exchange rate on the sales of our foreignoperations.

 

*Gross Profit.*

 
| **Three Months  Ended March 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except percentages)** | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
|                                   |       |       |       |            |       |       |       |            |       |       |       |            |       |
| 2005                                   |       | $          | 24,498     |            | 51.2       | %          | $          | 29,294          |       | 44.5       | %          | $               | 53,792     |   | 47.3 | % |
| 2004                                   |       | 23,253     |       | 51.3            | %          | 30,055     |       | 44.4            | %          | 53,308     |       | 47.1            | %          |
|                                        |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

Grossprofit increased $1.2 million, or 5%, in the AMS segment primarily as a resultof increased margins and sales in our integrated circuits business.  Gross profit decreased $761,000, or 3%, inthe ATS segment primarily as a result of decreased sales and margins in our militarytest products and wireless test products offset in part by an increase in salesand margin of communications test products and a favorable foreign exchangerate.

 

Selling,General and A*dministrative Costs.*

 
| **Three Months  Ended  March 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Corporate** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|-----------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|---------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except percentages)**  | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | ** **      | ** ** |
|                                    |       |       |       |            |       |       |       |            |       |          |       |       |       |            |       |
| 2005                                    |       | $          | 6,701      |            | 14.0       | %          | $          | 16,700          |       | 25.4          | %          | $          | 6,709      |            | $          | 30,110 |   | 26.5 | % |
| 2004                                    |       | 7,053      |       | 15.5            | %          | 14,408     |       | 21.3            | %          | 3,724         |       | 25,185     |       | 22.3            | %          |
|                                         |            |            |            |                 |            |            |            |                 |            |               |            |            |            |                 |            |  |  |  |  |

 

 Selling, general and administrative costsdecreased $352,000 or 5% in the AMS segment primarily due to a $512,000reversal of a reserve for an uncollectible receivable related to Space SystemLoral (“Loral”). Loral has filed a petition with the bankrupcy court to payunsecured creditors all amounts due. Selling, general and administrative costsincreased $2.3 million, or 16% in the ATS segment due primarily to the effectof an unfavorable foreign currency exchange rate on the expenses of our foreignoperations and restructuring charges of $1.7 million in certain of our foreignsubsidiaries.  Corporate selling, generaland administrative expenses increased $3.0 million primarily due to increasedprofessional fees pertaining to the ongoing implementation of theSarbanes-Oxley requirements ($3.4 million).

 

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*Research and Development*Costs*.*

 
| **Three Months  Ended  March 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|-----------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except percentages)**  | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
|                                    |       |       |       |            |       |       |       |            |       |       |       |            |       |
| 2005                                    |       | $          | 5,935      |            | 12.4       | %          | $          | 9,444           |       | 14.3       | %          | $               | 15,379     |   | 13.5 | % |
| 2004                                    |       | 4,202      |       | 9.3             | %          | 9,140      |       | 13.5            | %          | 13,342     |       | 11.8            | %          |
|                                         |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

Self-fundedresearch and development costs increased $1.7 million, or 41%, in the AMSsegment primarily due to increased development efforts in integrated circuits($1.2 million) and microelectronic modules ($520,000). Research and developmentcosts increased $304,000, or 3%, in the ATS segment primarily due to the effectof an unfavorable foreign currency exchange rate on the expenses of our foreignoperations.

 

*Amortization of Acquired Intangibles.*  Amortizationdecreased $69,000.

 

*Other Income (Expense).* Interest expense decreased to $316,000 for the three months ended March 31,2005 from $343,000 for the three months ended March 31, 2004 due todecreased debt levels.  Other income of$406,000 for the three months ended March 31, 2005 consisted primarily ofinterest income of $545,000, partially offset by foreign currency transactionlosses of $116,000. Other expense of $1.9 million for the three months ended March 31,2004 consisted primarily of $1.7 million of foreign currency transaction lossesand a $200,000 charge to adjust the fair value of property held for sale to itsfair value partially offset by $62,000 of interest income.  Interest income increased primarily due tohigher average levels of cash, cash equivalents and marketable securities andhigher market interest rates during the 2005 period.

 

*Provision for Income Taxes.* The income tax provision was $2.5 million(an effective income tax rate of 38.9%) for the three months ended March 31,2005 and the income tax provision was $3.8 million (an effective income taxrate of 36.4%) for the three months ended March 31, 2004. The effectiveincome tax rate for the two periods differed from the amount computed byapplying the U.S. Federal income tax rate to income before income taxesprimarily due to foreign, state and local income taxes and research anddevelopment credits.

 

*Income From Continuing Operations.*  Theincome from continuing operations for the three months ended March 31,2005 was $3.9 million, or $.05 per diluted share, versus income from continuingoperations of $6.6 million, or $.09 per diluted share, for the three monthsended March 31, 2004.

 

*Discontinued Operations. *Discontinuedoperations includes the results of operations of VMC and a $300,000 net gain onsale of VMC.

 

**Off-Balance Sheet Arrangements**

 

Weare not a party to any off-balance sheet arrangements other than letters ofcredit totaling $6.4 million to guarantee our performance under certaingovernment contracts.

 

**Liquidity and Capital Resources**

 

Asof March 31, 2005, we had $270.9 million in working capital.  Our current ratio was 4.2 to 1 at March 31,2005. On February 14, 2003, we executed an amended and restated revolvingcredit and security agreement with two banks which replaced a previous loanagreement. The amended and restated loan agreement increased the line of creditto $50 million through February 2007, continued the mortgage on ourPlainview property for $2.6 million and is secured by the pledge of the stockof certain of our subsidiaries.  Theinterest rate on revolving credit borrowings under this agreement is at variousrates depending upon certain financial ratios, with the current ratesubstantially equivalent to prime (5.75% at March 31, 2005). The mortgageis payable in monthly installments of approximately $26,000 through March 2008and a balloon payment of $1.6 million in April 2008.  We have entered into interest rate swapagreements for the outstanding amount under the mortgage agreement atapproximately 7.6% in order to reduce the interest rate risk associated withthese borrowings.

 

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Theterms of the loan agreement require compliance with certain covenants includingminimum consolidated tangible net worth and pretax earnings, maintenance ofcertain financial ratios, limitations on indebtedness and prohibition of thepayment of cash dividends.  We arecurrently in full compliance with all of the covenants contained in our loanagreement, as amended to date.  We expectto be in compliance with all covenants for the foreseeable future.

 

OnJuly 31, 2003, we acquired RIWS for cash of $38 million and a deferredpayment of up to $16.5 million depending on RIWS achieving certain performancegoals for the year ending July 31, 2004. Although the Company believes that the performance goals have not beenmet, the determination is not final.

 

OnSeptember 3, 2003, we acquired MCE for approximately 5.8 million shares ofAeroflex common stock.  In addition, wedischarged $22.8 million of MCE outstanding bank debt, other indebtedness andpreferred stock and issued stock options for 315,000 shares of Aeroflex commonstock with exercise prices ranging from $2.88 to $9.59 in exchange foroutstanding options of MCE.

 

OnOctober 31, 2003, we acquired the business of Celerity for approximately$4.0 million in cash, 428,000 shares of Aeroflex common stock and release ofcertain liabilities totaling $1.8 million.

 

OnMarch 10, 2004, we completed the sale of 7,000,000 shares of our commonstock at $13.75 per share.  We received$91.2 million, net of commission and expenses. These net proceeds are intended to be used for working capital and othergeneral corporate purposes including research and development and potentialacquisitions.

 

Forthe nine months ended March 31, 2005, our operations provided cash fromcontinuing operations of $28.9 million. For the nine months ended March 31, 2005, our investing activitiesused cash of $128.9 million, primarily for purchases of marketable securities,net of sales, of $117.8 million and for capital expenditures of $11.2 million.In addition, the sale of the stock of our thin film interconnect manufacturingoperation and the sale of our shock and vibration subsidiary resulted in netcash provided by discontinued operations of $14.2 million consisting of $16.0million of proceeds, net of expenses, offset by $1.8 million used primarily tobuy out leases of these discontinued operations.  For the nine months ended March 31,2005, our financing activities used cash of $3.5 million, including debtrepayments of $5.0 million offset by stock option exercise proceeds of $1.5million.

 

OnApril 19, 2005, we purchased JcAIR for $35 million in cash. We believe ourremaining cash, cash equivalents and marketable securities coupled withinternally generated funds and available lines of credit will be sufficient forour working capital requirements, capital expenditure needs and the servicingof our debt for the foreseeable future. One of our pension plans currently is unfunded, but is expected to befunded from the cash surrender value of life insurance policies that are beingheld in a rabbi trust.  We do not believethat the amount of the pension obligations remaining after application of suchpolicy proceeds will be material. Our cash, cash equivalents and marketablesecurities, coupled with our available lines of credit, are available to fundacquisitions and other potential large cash needs that may arise.  At March 31, 2005, our available unusedline of credit was $41.8 million after consideration of letters of credit.

 

Thefollowing table summarizes, as of March 31, 2005, our obligations andcommitments to make future payments under debt and operating lease agreements:

 
| ** **        | ** ** | **Payments due by period** | ** ** |
|-------------------|------------|----------------------------|------------|
| ** **        | ** ** | **Total**                  | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After  5 Years** | ** ** |
| ** **        | ** ** | **(In thousands)**         | ** ** |
|              |       |                       |       |   |   |   |   |   |   |   |   |
| Long-term  debt   |       | $                          | 5,267      |   | $ | 660 |   | $ | 1,261 |   | $ | 2,261 |   | $ | 1,085 |   |
| Operating  leases |       | 39,240                     |       | 7,715 |   | 11,225 |   | 6,750 |   | 13,550 |   |
| Total             |       | $                          | 44,507     |   | $ | 8,375 |   | $ | 12,486 |   | $ | 9,011 |   | $ | 14,635 |   |

 

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Theoperating lease commitments shown in the above table have not been reduced byfuture minimum sub-lease rentals of $16.9 million.

 

Inthe normal course of business, we routinely enter into binding and non-bindingpurchase obligations primarily covering anticipated purchases of inventory andequipment.  None of these obligations areindividually significant.  We do notexpect that these commitments, as of March 31, 2005, will have a materialadverse affect on our liquidity.

 

**Accounting Policies Involving Significant Estimates**

 

Thepreparation of financial statements and related disclosures in conformity withaccounting principles generally accepted in the United States of Americarequires us to make estimates and assumptions that affect the reported amountsof assets and liabilities, the disclosure of contingent assets and liabilitiesat the date of the financial statements and the recognition of revenue andexpenses during the period reported.  Thefollowing accounting policies require us to make estimates and assumptionsbased on the circumstances, information available and our experience andjudgment.  These estimates andassumptions are reviewed periodically and the effects of revisions arereflected in the period that they are determined to be necessary.  If actual results differ significantly fromour estimates, our financial statements could be materially impacted.

 

Revenueand Cost Recognition Under Long-Term Contracts

 

Werecognize revenue when persuasive evidence of an arrangement exists, deliveryhas occurred or services have been rendered, the selling price is fixed ordeterminable and collectibility of the resulting receivable is reasonablyassured.  For arrangements other thancertain long-term contracts, revenue (including shipping and handling fees) isrecognized when products are shipped and title is passed to the customer.  If title does not pass until the productreaches the customer's delivery site, then recognition of the revenue isdeferred until that time.  Revenuesassociated with certain long-term contracts are recognized in accordance withStatement of Position No. 81-1 “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts” (“SOP 81-1”).  Under SOP 81-1, we use thepercentage-of-completion method, whereby revenues and associated costs arerecognized as work on a contract progresses. We measure the extent of progress toward completion generally based uponone of the following (based upon an assessment of which method most closelyaligns to the underlying earnings process): (i) the units-of-deliverymethod, (ii) the cost-to-cost method, using the ratio of contract costsincurred as a percentage of total estimated costs at contract completion (basedupon engineering and production estimates), or (iii) the achievement ofcontractual milestones.  Provisions foranticipated losses or revisions in estimated profits on contracts-in-processare recorded in the period in which such anticipated losses or revisions becomeevident.  Revenue from software supportand maintenance contracts is recognized ratably over the term of the contractin accordance with SOP-97-2, “Software Revenue Recognition.”

 

Certainof our sales are to distributors which have a right to return some portion ofproduct within eighteen months of sale. We recognize revenue on these sales at the time of shipment to thedistributor as these sales meet all of the criteria of Statement of FinancialAccounting Standards (“SFAS”) No. 48, “Revenue Recognition When Right ofReturn Exists.”  Historically, thereturns under these arrangements have been insignificant and can be reasonablyestimated.  An estimate of such returnsis recorded at the time sales are recognized.

 

Inventories

 

Inventoriesare stated at the lower of cost (first-in, first-out) or market.   Inventory levels are maintained in relationto the expected sales volume.  Weperiodically evaluate the net realizable value of our inventory.  Numerous analyses are applied including lowerof cost or market analysis, forecasted sales requirements and forecastedwarranty requirements.  After takingthese and other factors into consideration, such as technological changes, ageand physical condition, appropriate adjustments are recorded to the inventorybalance.  If actual conditions differfrom our expectations, then inventory balances may be over or under valued,which could have a material effect on our results of operations and financialcondition.

 

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Recoverabilityof Long-Lived and Intangible Assets

 

Property,plant and equipment are stated at cost less accumulated depreciation computedon a straight-line basis over the estimated useful lives of the relatedassets.  Leasehold improvements areamortized over the life of the lease or the estimated life of the asset,whichever is shorter.  Changes incircumstances such as technological advances or changes to our business modelcan result in the actual useful lives differing from our estimates.   To the extent the estimated useful lives areincorrect, the value of these assets may be over or under stated, which in turncould have a material effect on our results of operations and financialcondition.

 

Long-livedassets other than goodwill, are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying value of any such asset maybe impaired.  We evaluate therecoverability of such assets by estimating future cash flows.  If the sum of the undiscounted cash flowsexpected to result from the use of the assets and their eventual disposition isless than the carrying amount of the assets, we will recognize an impairmentloss to the extent of the excess of the carrying amount of the assets over thediscounted cash flow.

 

SFASNo. 142 requires that we perform an assessment of whether there is anindication that goodwill is impaired on an annual basis unless events orcircumstances warrant a more frequent assessment.  The impairment assessment involves, amongother things, an estimation of the fair value of each of our reporting units(as defined in SFAS No. 142).  Suchestimations are inherently subjective, and subject to change in future periods.

 

Ifthe impairment review of goodwill, intangible assets and other long-livedassets differ significantly from actual results, it could have a materialeffect on our results of operations and financial condition.

 

IncomeTaxes

 

Thecarrying value of our net deferred tax assets assumes that we will be able to generatesufficient future taxable income in certain tax jurisdictions.  If this assumption changes in the future, wemay be required to record additional valuation allowances against our deferredtax assets resulting in additional income tax expense in our consolidatedstatement of operations.  We evaluate therealizability of the deferred tax assets and assess the adequacy of thevaluation allowance quarterly.

 

**Recently Issued Accounting Standards**

 

In April 2005, the Financial Accounting Standards Board (“FASB”)issued FASB Interpretation No. 47(“FIN 47”), “Accounting for Conditional Asset Retirement Obligations – AnInterpretation of FASB Statement No. 143.” FIN 47 clarifies the terms of FASB Statement No. 143 and requiresan entity to recognize a liability for a conditional asset retirementobligation if the entity has sufficient information to reasonably estimate itsfair value.  FIN 47 is effective no laterthan the end of fiscal years ending after December 15, 2005.  The Company is currently evaluating theimpact of this standard on its financial statements.

 

OnDecember 31, 2004, the FASB issuedFASB Staff Position No. FAS 109-1, “Application of FASB StatementNo. 109, Accounting for Income Taxes, to the Tax Deduction on QualifiedProduction Activities Provided by the American Jobs Creation Act of 2004” (“FSPNo. 109-1”), and FASB Staff Position No. FAS 109-2, “Accounting andDisclosure Guidance for the Foreign Earnings Repatriation Provision within theAmerican Jobs Creation Act of 2004” (“FSP No. 109-2”).  These staff positions provide accountingguidance on how companies should account for the effects of the American JobsCreation Act of 2004 (“AJCA”) that was signed into law on October 22,2004.  FSP No. 109-1 states that thetax relief (special tax deduction for domestic manufacturing) from thislegislation should be accounted for as a “special deduction” instead of a taxrate reduction.  FSP No. 109-2 givesa company additional time to evaluate the effects of the legislation on anyplan for reinvestment or repatriation of foreign earnings for purposes ofapplying FASB Statement No. 109. The Company is investigating the repatriation provision to determinewhether it might repatriate extraordinary dividends, as defined in theAJCA.  The Company is currentlyevaluating all available U.S. Treasury guidance, as well as awaitinganticipated further guidance.  TheCompany expects to complete this evaluation within a reasonable amount of timeafter additional guidance is published.

 

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InDecember 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”(“SFAS No. 123(R)”).  This statementreplaces SFAS No. 123, “Accounting for Stock-Based Compensation” andsupersedes Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees.”  SFAS 123(R)requires all stock-based compensation to be recognized as an expense in thefinancial statements and that such cost be measured according to the fair valueof stock options.  SFAS 123(R) will beeffective for fiscal years beginning after June 15, 2005, which is theCompany’s first quarter of fiscal 2006. While the Company currently provides the pro forma disclosures requiredby SFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure,” on a quarterly basis (see Note 1 - “Accounting for Stock-BasedCompensation”), it is currently evaluating the impact this statement will haveon its consolidated financial statements.

 

InNovember 2004, the FASB issued SFAS No. 151, “Inventory Costs - anamendment of Accounting Research Bulletin No. 43, Chapter 4” (“SFASNo. 151”).  SFAS No. 151requires all companies to recognize a current period charge for abnormalamounts of idle facility expense, freight, handling costs and wasted materials.  This statement also requires that theallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities.  SFAS No. 151 will be effective forfiscal years beginning after June 15, 2005.  The Company is currently evaluating the effectthat this statement will have on its consolidated financial statements.

 

**Risks Relating to Our Business**

 

*General economic conditions could adversely affect ourrevenues, gross margins and expenses.*

 

Ourrevenues and gross margins will depend significantly on the overall demand formicroelectronic products and test solutions, particularly in the product andservice segments in which we compete. Weaker demand for our products and services caused by economic weaknessmay result in decreased revenues, earnings levels or growth rates and problemswith the saleability of inventory and realizability of customerreceivables.  In the past, we haveobserved effects of the global economic downturn in many areas of our business.Delays or reductions in spending for our products could have a material adverseeffect on our business, results of operations and financial condition.

 

*Our operating results may fluctuate significantly on aquarterly basis.*

 

Oursales and other operating results have fluctuated significantly in the past,and we expect this trend will continue. Factors which affect our results include:

 

•                  the timing, cancellation or rescheduling ofcustomer estimates, orders and shipments;

•                  the pricing and mix of products sold;

•                  new product introductions;

•                  our ability to obtain components andsubassemblies from contract manufacturers and suppliers; and

•                  variations in manufacturing efficiencies.

 

Manyof these factors are beyond our control. Our performance in any one fiscal quarter is not necessarily indicativeof any financial trends or future performance.

 

*In the event that any of our customers encounterfinancial difficulties and fails to pay us, it could adversely effect ourresults of operations and financial condition.*

 

Wemanufacture products to customer specifications and purchase products inresponse to customer orders.  Inaddition, we may commit significant amounts to maintain inventory inanticipation of customer orders.  In theevent that any customer for whom we maintain inventory experiences financialdifficulties, we may be unable to sell such inventory at its current profitmargin, if at all. In such event, our gross margins would decline.  In addition, if the financial condition ofany customer deteriorates resulting in an impairment of that customer’s abilityto pay to us amounts owed in respect of a significant amount of outstandingreceivables, our financial condition would be adversely effected.

 

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*If we cannot continue to develop, manufacture and marketinnovative products and services rapidly that meet customer requirements forperformance and reliability, we may lose market share and our revenues maysuffer.*

 

Theprocess of developing new high technology products and services is complex anduncertain, and failure to anticipate customers' changing needs and emergingtechnological trends accurately and to develop or obtain appropriateintellectual property could significantly harm our results of operations.   We must make long-term investments andcommit significant resources before knowing whether our predictions willeventually result in products that the market will accept.  We must accurately forecast volumes, mix ofproducts and configurations that

meetcustomer requirements, and we may not succeed.

 

*Due to the international nature of our business,political or economic changes could harm our future revenues, costs andexpenses and financial condition.*

 

Ourfuture revenues, costs and expenses could be adversely affected by a variety ofinternational factors, including:

 

•                  changes in a country's or region's politicalor economic conditions;

•                  longer accounts receivable cycles;

•                  trade protection measures;

•                  unexpected changes in regulatory requirements;

•                  differing technology standards and/orcustomer requirements; and

•                  importor export licensing requirements, which could affect our ability to obtainfavorable terms for components or lead to penalties or restrictions.

 

Aportion of our product and component manufacturing, along with key suppliers,is located outside of the United States, and also could be disrupted by some ofthe international factors described above.

 

*We are exposed to foreign currency exchange raterisks that could adversely affect our business, results of operations andfinancial condition.*

 

Weare exposed to foreign currency exchange rate risks that are inherent in oursales commitments, anticipated sales, and assets and liabilities that aredenominated in currencies other than the United States dollar.  Failure to manage or hedge foreign currency risks properly could adversely affectour business, results of operations and financial condition.

 

*As part of our business strategy, we may completeacquisitions or divest non-strategic businesses and product lines.  These actions could adversely affect ourbusiness, results of operations and financial condition.*

 

Aspart of our business strategy, we engage in discussions with third partiesregarding, and enter into agreements relating to, possible acquisitions,strategic alliances, ventures and divestitures in order to manage our productand technology portfolios and further our strategic objectives.  In order to pursue this strategy successfully,we must identify suitable acquisition, alliance or divestiture candidates,complete these transactions, some of which may be large and complex, andintegrate acquired companies. Integration and other risks of acquisitions andstrategic alliances can be more pronounced for larger and more complicatedtransactions, or if multiple acquisitions are pursued simultaneously.  However, if we fail to identify and completethese transactions, we may be required to expend resources to internallydevelop products and technology or may be at a competitive disadvantage or maybe adversely affected by negative market perceptions, which may have a materialeffect on our revenues and selling, general and administrative expenses takenas a whole.

 

Acquisitionsand strategic alliances may require us to integrate with a different companyculture, management team and business infrastructure and otherwise manageintegration risks. Even if an acquisition or alliance is successfullyintegrated, we may not receive the expected benefits of the transaction.Managing acquisitions, alliances and divestitures requires varying levels ofmanagement resources, which may divert management's attention from otherbusiness operations.  Acquisitions,including abandoned acquisitions, also may result in significant costs andexpenses and charges to earnings. As a result, any completed, pending or futuretransactions may contribute to our financial results differing from theinvestment community's expectations in a given quarter.

 

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*In order to be successful, we must retain andmotivate key employees, and failure to do so could seriously harm us.*

 

Inorder to be successful, we must retain and motivate executives and other keyemployees, including those in managerial, technical, marketing and informationtechnology support positions. In particular, our product generation effortsdepend on hiring and retaining qualified engineers. Attracting and retainingskilled workers and qualified sales representatives is also critical to us.  Experienced management and technical,marketing and support personnel in the microelectronics and test solutionsindustries are in demand and competition for their talents is intense. Employeeretention may be a particularly challenging issue following our recent acquisitionssince we also must continue to motivate employees and keep them focused on ourstrategies and goals, which may be particularly difficult due to the potentialdistractions related to integrating the acquired operations.

 

*Terrorist acts and acts of war may seriously harm ourbusiness, results of  operations andfinancial condition.*

 

Terroristacts or acts of war (wherever located around the world) may cause damage ordisruption to us, our employees, facilities, partners, suppliers, distributorsand resellers, and customers, which could significantly impact our revenues,expenses and financial condition. The terrorist attacks that took place in theUnited States on September 11, 2001 were unprecedented events that havecreated many economic and political uncertainties.  The potential for future terrorist attacks,the national and international responses to terrorist attacks, and other actsof war or hostility have created many economic and political uncertainties,which could adversely affect our business and results of operations in waysthat cannot presently be predicted. In addition, as a company with headquartersand significant operations located in the United States, we may be impacted byactions against the United States.  Wewill be predominantly uninsured for losses and interruptions caused byterrorist acts or acts of war.

 

*Our stock price has historically fluctuated and maycontinue to fluctuate.*

 

Ourstock price, like that of other technology companies, can be volatile.  Some of the factors that can affect our stockprice are:

 

•   the announcement of new products, services ortechnological innovations by us or our competitors;

•   quarterly increases or decreases in ourrevenue or earnings;

•   changes in quarterly revenue or earningsestimates by the investment community; and

•  speculation in the press or investmentcommunity about our strategic position, financial condition, results ofoperations, business or significant transactions.

 

Generalmarket conditions and domestic or international macroeconomic and geopoliticalfactors unrelated to our performance may also affect our stock price.  In addition, following periods of volatilityin a company's securities, securities class action litigation against a companyis sometimes instituted. This type of litigation could result in substantialcosts and the diversion of management time and resources.

 

**Forward-Looking Statements**

 

Allstatements other than statements of historical fact included in this Report onForm 10-Q, including without limitation, statements under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”regarding our financial position, business outlook, business strategy and plansand objectives of our management for future operations, are forward-lookingstatements.  When used in this Report onForm 10-Q, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend”and similar expressions, as they relate to us or our management, identifyforward-looking statements.  Suchforward-looking statements are based on the current beliefs of our management,as well as assumptions made by and information currently available to ourmanagement.  Actual results could differmaterially from those contemplated by the forward-looking statements, as aresult of certain factors, including but not limited to, competitive factorsand pricing pressures, the integration of the business of JcAIR, Inc.,changes in legal and regulatory requirements, technological change ordifficulties, product development risks, commercialization difficulties andgeneral economic conditions and those described under “Risk Factors”above.  Such statements reflect ourcurrent views with respect to the future and are subject to these and otherrisks, uncertainties and assumptions relating to our financial condition,results of operations, growth strategy and liquidity.  We undertake no obligation to update suchforward-looking statements which are made as of the date of this Report.

 

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**ITEM 3**- **QUANTITIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Weare exposed to market risk related to changes in interest rates and to foreigncurrency exchange rates.  Most of ourdebt is at fixed rates of interest or at a variable rate with an interest rateswap agreement which effectively converts the variable rate debt into fixedrate debt. Therefore, if market interest rates increase by 10 percent fromlevels at March 31, 2005, the effect on our net income would beinsignificant.  Most of our investedcash, cash equivalents and marketable securities are at variable rates ofinterest.  If market interest ratesdecrease by 10 percent from levels at March 31, 2005, the effect on ournet income would be a decrease of approximately $244,000 per year.

 

Weoperate businesses that are located outside of the United States, which exposesus to the fluctuation of foreign currency exchange rates (primarily the BritishPound and the Euro).  If foreign currencyexchange rates change by 10% from levels at March 31, 2005, the effect onour total comprehensive income would be approximately $9.1 million. Weperiodically enter into foreign currency forward contracts to protect us fromfluctuations in exchange rates. As of March 31, 2005, we had $2.6 millionof notional value foreign currency forward contracts maturing through June 2005.  Notional amounts do not quantify risk orrepresent our assets or liabilities,  butare used in the calculation of cash settlements under the contracts.  The fair value of these contracts at March 31,2005 was $19,000 less than the notional value.

 

**ITEM 4**- **CONTROLS AND PROCEDURES**

 

Basedon their evaluation as of the end of the period covered by this Form 10-Q,our management, with the participation of our Chief Executive Officer and ChiefFinancial Officer, conducted an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures, as required byExchange Act Rule 13a-15.  Based onthat evaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures were effective to ensurethat information required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwith the time periods specified by the SEC's rules and forms.

 

**Changes in Internal Controls**

 

Therewere no changes in our internal controls over financial reporting that occurredduring the quarter ended March 31, 2005 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

**Limitations on the Effectiveness of Controls**

 

Webelieve that a control system, no matter how well designed and operated, cannotprovide absolute assurance that the objectives of the control system are met,and no evaluation of controls can provide absolute assurance that all controlissues and instances of fraud, if any, within a company have beendetected.  Our disclosure controls andprocedures are designed to provide reasonable assurance of achieving theirobjectives and our Chief Executive Officer and Chief Financial Officer haveconcluded that such controls and procedures are effective at the “reasonableassurance” level.

 

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**AEROFLEXINCORPORATEDAND SUBSIDIARIESPART II - OTHER INFORMATION**

 

Item1.             LegalProceedings

 

TheCompany recently has learned that it inadvertently may have violated certainInternational Traffic in Arms Regulations (ITAR) by exporting certain products andservices without licenses.  These exportsresulted from an error in classifying the products and services as commercialrather than military.  The Company hasprepared and filed a voluntary disclosure with the State Department in whichthe details of the exports and erroneous classifications aredescribed.  At this time, it is notpossible to determine whether any fines or other penalties will be asserted against the Company, or themateriality of any outcome.

 

Weare involved in various other legal matters. We believe the outcome of these other legal matters will not have amaterial effect upon us.

 

Item2.             Unregistered Sales of Securities and Use ofProceeds

 

None

 

Item3.             Defaults upon Senior Securities

 

None

 

Item4.             Submission of Matters to a Vote of SecurityHolders

 

None

 

Item5.             Other Information

 

None

 

Item6.             Exhibits

 

Exhibits

 

31.1                           Certification of Chief Executive Officerpursuant to Section 302 of Sarbanes-Oxley Act of 2002.

 

31.2                           Certification of Chief Financial Officerpursuant to Section 302 of Sarbanes-Oxley Act of 2002.

 

31.3                           Certification of Chief Operating Officerpursuant to Section 302 of Sarbanes-Oxley Act of 2002.

 

32.1                           Certification of Chief Executive Officer and of Chief Financial Officerpursuant to Section 906 of Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|              |   | AEROFLEX  INCORPORATED

(REGISTRANT)   |                                                                          |
|-------------------|--------|----------------------------------------|-------------------------------------------------------------------------------|
|              |   |                                   |
| May 9,  2005 |   | By:                               |           /s/Michael  Gorin |   |
|              |   | Michael Gorin                          |                                                                          |
|              |   | Vice Chairman, Chief Financial Officer |                                                                          |
|              |   | and Principal Accounting Officer       |                                                                          |
|                   |        |                                        |                                                                               |  |

 

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