**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

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**FORM10-Q**

 

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

 

**For thequarter ended December 31, 2005**

** **

**Commission File Number 000-02324**

 

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**AEROFLEXINCORPORATED**

(Exactname of Registrant as specified in its Charter)

 
| **DELAWARE**                                               | ** ** | **11-1974412**       |
|------------------------------------------------------------|------------|----------------------|
| (State  or other jurisdiction                              |       | (I.R.S.  Employer    |
| of  incorporation or organization)                         |       | 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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Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months, and (2) hasbeen subject to such filing requirements for the past 90 days.

 
|                                                                                                                                                                                                                                                         | Yes                     |   | ý |              | No     | o                     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------|--------|--------|-------------------|--------|-----------------------|
|                                                                                                                                                                                                                                                         |                    |   |   |              |   |
| Indicate by check mark whether the registrant is a large accelerated  filer, an accelerated filer, or a non-accelerated filer. See definition of  "accelerated filer and large accelerated filer" in Rule 12b-2 of  the Exchange Act. (Check one): |
|                                                                                                                                                                                                                                                         |                    |   |   |              |   |
|                                                                                                                                                                                                                                                         | Large accelerated filer | o      |   | Accelerated filer | ý | Non-accelerated filer | o |   |
|                                                                                                                                                                                                                                                         |                    |   |   |              |   |                  |
| Indicate by check mark whether the registrant is a shell company (as  defined in Rule 12b-2 of the Exchange Act).                                                                                                                                            |
|                                                                                                                                                                                                                                                         |                    |   |   |              |   |
|                                                                                                                                                                                                                                                         | Yes                     |   | o      |              | No     | ý                |
|                                                                                                                                                                                                                                                              |                         |        |        |                   |        |                       |  |  |  |  |  |  |  |  |  |  |  |

 

Indicate by the number of shares outstandingof each of the issuer’s classes of common stock as of the latest practicable date.

 
|   |   | **February 8, 2006** | ** ** | **74,911,662**      | ** ** |
|--------|--------|----------------------|------------|---------------------|------------|
|   |   | (Date)               |       | (Number  of Shares) |       |

 

 

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**AEROFLEXINCORPORATED**

**ANDSUBSIDIARIES**

 

 

**INDEX**

 
|           | ** **                                                                                                               |                                                            |   |   |
|----------------|--------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------|--------|--------|
|           |                                                                                                                     |                                                            |   |   |
|           | **PART I:**                                                                                                              | **FINANCIAL INFORMATION**                                       |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 1 -       |                                                                                                                     | UNAUDITED  CONDENSED CONSOLIDATED BALANCE SHEETS                |   |   |
|           |                                                                                                                     | December 31, 2005 and June 30, 2005                             |   |   |
|           |                                                                                                                     |                                                            |   |   |
|           |                                                                                                                     | UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS        |   |   |
|           |                                                                                                                     | Three Months Ended December 31, 2005 and  2004                  |   |   |
|           |                                                                                                                     |                                                            |   |   |
|           |                                                                                                                     | UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS        |   |   |
|           |                                                                                                                     | Six Months Ended December  31, 2005 and 2004                    |   |   |
|           |                                                                                                                     |                                                            |   |   |
|           |                                                                                                                     | UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS      |   |   |
|           |                                                                                                                     | Six Months Ended December 31, 2005 and  2004                    |   |   |
|           |                                                                                                                     |                                                            |   |   |
|           |                                                                                                                     | NOTES TO  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 2 -       |                                                                                                                     | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL         |   |   |
|           |                                                                                                                     | CONDITION AND  RESULTS OF OPERATIONS                            |   |   |
|           |                                                                                                                     | Three and Six  Months Ended December 31, 2005 and 2004          |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 3 -       |                                                                                                                     | QUANTITIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK       |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 4 -       |                                                                                                                     | CONTROLS AND  PROCEDURES                                        |   |   |
|           |                                                                                                                     |                                                            |   |   |
|           | **PART II:                OTHER INFORMATION** |                                                            |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 1 -       |                                                                                                                     | LEGAL PROCEEDINGS                                               |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item  1A-      |                                                                                                                     | RISK  FACTORS                                                   |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 2 -       |                                                                                                                     | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS    |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 3 -       |                                                                                                                     | DEFAULTS  UPON SENIOR SECURITIES                                |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 4 -       |                                                                                                                     | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS            |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item 5 -       |                                                                                                                     | OTHER INFORMATION                                               |   |   |
|           |                                                                                                                     |                                                            |   |   |
| Item  6 -      |                                                                                                                     | EXHIBITS                                                        |   |   |
|           |                                                                                                                     |                                                            |   |   |
| SIGNATURES     |                                                                                                                     |                                                            |
|           |                                                                                                                     |                                                            |
| EXHIBIT  INDEX |                                                                                                                     |                                                            |
|           |                                                                                                                     |                                                            |
| CERTIFICATIONS |                                                                                                                     |                                                            |
|                |                                                                                                                          |                                                                 |        |        |  |

 

2

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**AeroflexIncorporated**

**andSubsidiaries**

** **

**UnauditedCondensed Consolidated Balance Sheets**

(In thousands)

 
| ** **                                                                      | ** ** | **December 31,  2005** | ** ** | **June 30,  2005** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| Assets                                                                          |       |                   |       |               |       |
|                                                                            |       |                   |       |               |       |
| Current assets:                                                                 |       |                   |       |               |       |
| Cash and cash  equivalents                                                      |       | $                      | 15,511     |               | $          | 12,974 |   |
| Marketable  securities                                                          |       | 7,003                  |       | —             |       |
| Accounts  receivable, less allowance for doubtful accounts of $1,327 and $1,210 |       | 103,031                |       | 101,317            |       |
| Inventories                                                                     |       | 126,275                |       | 118,906            |       |
| Deferred income  taxes                                                          |       | 18,339                 |       | 18,499             |       |
| Prepaid expenses  and other current assets                                      |       | 12,785                 |       | 11,107             |       |
|                                                                            |       |                   |       |               |       |
| Total current  assets                                                           |       | 282,944                |       | 262,803            |       |
|                                                                            |       |                   |       |               |       |
| Property, plant  and equipment, net                                             |       | 76,539                 |       | 78,195             |       |
| Other assets                                                                    |       | 13,249                 |       | 13,537             |       |
| Intangible  assets with definite lives, net                                     |       | 59,257                 |       | 67,266             |       |
| Goodwill                                                                        |       | 165,403                |       | 168,048            |       |
|                                                                            |       |                   |       |               |       |
| Total assets                                                                    |       | $                      | 597,392    |               | $          | 589,849 |   |

 

See notes to unauditedcondensed consolidated financial statements.

 

3

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**AeroflexIncorporated**

**andSubsidiaries**

** **

**UnauditedCondensed Consolidated Balance Sheets**

**(continued)**

(In thousands, except pershare data)

 
| ** **                                                                                                                                                                 | ** ** | **December 31,  2005** | ** ** | **June 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| Liabilities and  Stockholders’ Equity                                                                                                                                 |       |                   |       |               |       |
|                                                                                                                                                                       |       |                   |       |               |       |
| Current  liabilities:                                                                                                                                                      |       |                   |       |               |       |
| Current portion  of long-term debt                                                                                                                                         |       | $                      | 628        |               | $          | 634 |   |
| Accounts payable                                                                                                                                                           |       | 26,754                 |       | 35,907             |       |
| Advance payments  by customers                                                                                                                                             |       | 24,793                 |       | 15,183             |       |
| Income taxes  payable                                                                                                                                                      |       | 4,864                  |       | 3,657              |       |
| Accrued payroll  expenses                                                                                                                                                  |       | 15,057                 |       | 15,222             |       |
| Accrued expenses  and other current liabilities                                                                                                                            |       | 31,302                 |       | 30,451             |       |
| Total current  liabilities                                                                                                                                                 |       | 103,398                |       | 101,054            |       |
|                                                                                                                                                                       |       |                   |       |               |       |
| Long-term debt                                                                                                                                                             |       | 4,004                  |       | 4,190              |       |
| Deferred income  taxes                                                                                                                                                     |       | 12,734                 |       | 17,146             |       |
| Other long-term  liabilities                                                                                                                                               |       | 20,459                 |       | 23,479             |       |
| Total  liabilities                                                                                                                                                         |       | 140,595                |       | 145,869            |       |
|                                                                                                                                                                       |       |                   |       |               |       |
| 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 74,875 and 74,618  shares                                                                       |       | 7,488                  |       | 7,462              |       |
| Additional  paid-in capital                                                                                                                                                |       | 378,137                |       | 372,666            |       |
| Accumulated  other comprehensive income                                                                                                                                    |       | 4,024                  |       | 9,020              |       |
| Retained  earnings                                                                                                                                                         |       | 67,148                 |       | 54,846             |       |
|                                                                                                                                                                       |       | 456,797                |       | 443,994            |       |
|                                                                                                                                                                       |       |                   |       |               |       |
| Less: Treasury  stock, at cost (4 shares)                                                                                                                                  |       | —                 |       | 14                 |       |
|                                                                                                                                                                       |       |                   |       |               |       |
| Total  stockholders’ equity                                                                                                                                           |       | 456,797                |       | 443,980            |       |
|                                                                                                                                                                       |       |                   |       |               |       |
| Total  liabilities and stockholders’ equity                                                                                                                           |       | $                      | 597,392    |               | $          | 589,849 |   |

 

See notes to unauditedcondensed consolidated financial statements.

 

4

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**Aeroflex Incorporated**

**andSubsidiaries**

**Unaudited Condensed ConsolidatedStatements of Earnings**

(In thousands, except pershare data)

 
| ** **                                                                                   | ** ** | **Three Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                             | ** ** | **2004** | ** ** |
|                                                                                         |       |                                 |       |   |   |
| Net sales                                                                                    |       | $                                    | 135,156    |   | $ | 112,469 |   |
| Cost of sales                                                                                |       | 70,602                               |       | 58,988 |   |
| Gross profit                                                                                 |       | 64,554                               |       | 53,481 |   |
|                                                                                         |       |                                 |       |   |   |
| Selling, general  and administrative costs                                                   |       | 30,556                               |       | 26,719 |   |
| Research and  development costs                                                              |       | 18,290                               |       | 15,199 |   |
| Amortization of  acquired intangibles                                                        |       | 3,433                                |       | 2,042 |   |
|                                                                                         |       | 52,279                               |       | 43,960 |   |
| Operating income                                                                             |       | 12,275                               |       | 9,521 |   |
|                                                                                         |       |                                 |       |   |   |
| Other income  (expense)                                                                      |       |                                 |       |   |   |
| Interest expense                                                                             |       | (147                                 | )          | (162 | ) |
| Other income  (expense)                                                                      |       | 661                                  |       | 541 |   |
| Total other  income (expense)                                                                |       | 514                                  |       | 379 |   |
|                                                                                         |       |                                 |       |   |   |
| Income from  continuing operations before income taxes                                       |       | 12,789                               |       | 9,900 |   |
| Provision for  income taxes                                                                  |       | 5,015                                |       | 3,758 |   |
| Income from  continuing operations                                                           |       | 7,774                                |       | 6,142 |   |
|                                                                                         |       |                                 |       |   |   |
| Discontinued  operations                                                                     |       |                                 |       |   |   |
| Income (loss)  from discontinued operations, net of tax provision (benefit) of $0 and $(457) |       | —                               |       | (892 | ) |
| Income (loss) on  disposal of operations, net of tax provision (benefit) of $0 and $0        |       | —                               |       | 73 |   |
| Income (loss)  from discontinued operations, net of tax                                      |       | —                               |       | (819 | ) |
|                                                                                         |       |                                 |       |   |   |
| Net income                                                                                   |       | $                                    | 7,774      |   | $ | 5,323 |   |
|                                                                                         |       |                                 |       |   |   |
| Income (loss)  per common share:                                                             |       |                                 |       |   |   |
| Basic                                                                                        |       |                                 |       |   |   |
| Continuing  operations                                                                       |       | $                                    | 0.10       |   | $ | 0.08 |   |
| Discontinued  operations                                                                     |       | —                               |       | (0.01 | ) |
| Net income                                                                                   |       | $                                    | 0.10       |   | $ | 0.07 |   |
|                                                                                         |       |                                 |       |   |   |
| Diluted                                                                                      |       |                                 |       |   |   |
| Continuing  operations                                                                       |       | $                                    | 0.10       |   | $ | 0.08 |   |
| Discontinued  operations                                                                     |       | —                               |       | (0.01 | ) |
| Net income                                                                                   |       | $                                    | 0.10       |   | $ | 0.07 |   |
|                                                                                         |       |                                 |       |   |   |
| Weighted average  number of common shares outstanding:                                       |       |                                 |       |   |   |
| Basic                                                                                        |       | 74,875                               |       | 74,625 |   |
| Diluted                                                                                      |       | 75,990                               |       | 76,310 |   |

 

See notes to unauditedcondensed consolidated financial statements.

 

5

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**Aeroflex Incorporated andSubsidiaries**

**UnauditedCondensed Consolidated Statements of Earnings**

** **

(In thousands, except pershare data)

 
| ** **                                                                                   | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                                         |       |                               |       |   |   |
| Net sales                                                                                    |       | $                                  | 260,804    |   | $ | 221,651 |   |
| Cost of sales                                                                                |       | 137,324                            |       | 116,839 |   |
| Gross profit                                                                                 |       | 123,480                            |       | 104,812 |   |
|                                                                                         |       |                               |       |   |   |
| Selling, general  and administrative costs                                                   |       | 60,808                             |       | 51,486 |   |
| Research and  development costs                                                              |       | 36,254                             |       | 29,743 |   |
| Amortization of  acquired intangibles                                                        |       | 6,889                              |       | 4,101 |   |
|                                                                                         |       | 103,951                            |       | 85,330 |   |
| Operating income                                                                             |       | 19,529                             |       | 19,482 |   |
|                                                                                         |       |                               |       |   |   |
| Other income  (expense)                                                                      |       |                               |       |   |   |
| Interest expense                                                                             |       | (307                               | )          | (422 | ) |
| Other income  (expense)                                                                      |       | 752                                |       | 965 |   |
| Total other  income (expense)                                                                |       | 445                                |       | 543 |   |
|                                                                                         |       |                               |       |   |   |
| Income from  continuing operations before income taxes                                       |       | 19,974                             |       | 20,025 |   |
| Provision for  income taxes                                                                  |       | 7,672                              |       | 7,484 |   |
| Income from  continuing operations                                                           |       | 12,302                             |       | 12,541 |   |
|                                                                                         |       |                               |       |   |   |
| Discontinued  operations                                                                     |       |                               |       |   |   |
| Income (loss)  from discontinued operations, net of tax provision (benefit) of $0 and $(253) |       | —                             |       | (542 | ) |
| Income (loss) on  disposal of operations, net of tax provision (benefit) of $0 and $0        |       | —                             |       | (1,060 | ) |
| Income (loss)  from discontinued operations, net of tax                                      |       | —                             |       | (1,602 | ) |
|                                                                                         |       |                               |       |   |   |
| Net income                                                                                   |       | $                                  | 12,302     |   | $ | 10,939 |   |
|                                                                                         |       |                               |       |   |   |
| Income (loss)  per common share:                                                             |       |                               |       |   |   |
| Basic                                                                                        |       |                               |       |   |   |
| Continuing  operations                                                                       |       | $                                  | 0.16       |   | $ | 0.17 |   |
| Discontinued  operations                                                                     |       | —                             |       | (0.02 | ) |
| Net income                                                                                   |       | $                                  | 0.16       |   | $ | 0.15 |   |
|                                                                                         |       |                               |       |   |   |
| Diluted                                                                                      |       |                               |       |   |   |
| Continuing  operations                                                                       |       | $                                  | 0.16       |   | $ | 0.16 |   |
| Discontinued  operations                                                                     |       | —                             |       | (0.02 | ) |
| Net income                                                                                   |       | $                                  | 0.16       |   | $ | 0.14 |   |
|                                                                                         |       |                               |       |   |   |
| Weighted average  number of common shares outstanding:                                       |       |                               |       |   |   |
| Basic                                                                                        |       | 74,816                             |       | 74,536 |   |
| Diluted                                                                                      |       | 75,845                             |       | 76,149 |   |

 

See notes tounaudited condensed consolidated financial statements.

 

6

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**AEROFLEXINCORPORATED**

**ANDSUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

 
| ** **                                                                                                           | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                                                                 |       |                               |       |   |   |
| Cash flows from  operating activities:                                                                               |       |                               |       |   |   |
| Net income                                                                                                           |       | $                                  | 12,302     |   | $ | 10,939 |   |
| Loss from  discontinued operations                                                                                   |       | —                             |       | 1,602 |   |
| Income from  continuing operations                                                                                   |       | 12,302                             |       | 12,541 |   |
| Adjustments to  reconcile income from continuing operations to net cash provided by (used in)  operating activities: |       |                               |       |   |   |
| Depreciation and  amortization                                                                                       |       | 15,197                             |       | 11,842 |   |
| Deferred income  taxes                                                                                               |       | (3,837                             | )          | (967 | ) |
| Non - cash stock  based compensation                                                                                 |       | 3,458                              |       | — |   |
| Excess tax  benefits from stock based compensation arrangements                                                      |       | (401                               | )          | — |   |
| Other, net                                                                                                           |       | 204                                |       | 11 |   |
| Change in  operating assets and liabilities, net of effects from purchases of  businesses:                           |       |                               |       |   |   |
| Decrease  (increase) in accounts receivable                                                                          |       | (2,952                             | )          | 5,629 |   |
| Decrease  (increase) in inventories                                                                                  |       | (7,805                             | )          | (10,588 | ) |
| Decrease  (increase) in prepaid expenses and other assets                                                            |       | (1,639                             | )          | (2,183 | ) |
| Increase (decrease)  in accounts payable, accrued expenses and other liabilities                                     |       | 311                                |       | (48 | ) |
|                                                                                                                 |       |                               |       |   |   |
| Net cash  provided by (used in) continuing operations                                                                |       | 14,838                             |       | 16,237 |   |
| Net cash  provided by (used in) discontinued operations                                                              |       | —                             |       | (1,353 | ) |
| Net cash  provided by operating activities                                                                           |       | 14,838                             |       | 14,884 |   |
|                                                                                                                 |       |                               |       |   |   |
| Cash flows from  investing activities:                                                                               |       |                               |       |   |   |
| Capital  expenditures                                                                                                |       | (7,504                             | )          | (8,030 | ) |
| Purchase of  marketable securities                                                                                   |       | (74,555                            | )          | (394,284 | ) |
| Sale of  marketable securities                                                                                       |       | 67,552                             |       | 296,618 |   |
| Other, net                                                                                                           |       | 96                                 |       | — |   |
|                                                                                                                 |       |                               |       |   |   |
| Net cash  provided by (used in) continuing operations                                                                |       | (14,411                            | )          | (105,696 | ) |
| Net cash  provided by (used in) discontinued operations                                                              |       | —                             |       | 6,277 |   |
| Net cash  provided by (used in) investing activities                                                                 |       | (14,411                            | )          | (99,419 | ) |
|                                                                                                                 |       |                               |       |   |   |
| Cash flows from  financing activities:                                                                               |       |                               |       |   |   |
| Purchase of  treasury stock                                                                                          |       | (153                               | )          | — |   |
| Borrowings under  debt agreements                                                                                    |       | —                             |       | 38 |   |
| Debt repayments                                                                                                      |       | (192                               | )          | (4,944 | ) |
| Excess tax  benefits from stock based compensation arrangements                                                      |       | 401                                |       | — |   |
| Proceeds from  the exercise of stock options                                                                         |       | 1,805                              |       | 1,506 |   |
| Withholding  taxes paid for stock options                                                                            |       | (145                               | )          | (220 | ) |
| Withholding  taxes collected for stock options                                                                       |       | 145                                |       | 220 |   |
| Net cash  provided by (used in) financing activities                                                                 |       | 1,861                              |       | (3,400 | ) |
| Effect of  exchange rate changes on cash and cash equivalents                                                        |       | 249                                |       | 991 |   |
|                                                                                                                 |       |                               |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                                |       | 2,537                              |       | (86,944 | ) |
| Cash and cash  equivalents at beginning of period                                                                    |       | 12,974                             |       | 98,502 |   |
| Cash and cash  equivalents at end of period                                                                          |       | $                                  | 15,511     |   | $ | 11,558 |   |

 

See notes to unauditedcondensed consolidated financial statements

 

7

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**AEROFLEXINCORPORATED**

**ANDSUBSIDIARIES**

 

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

 

**1.****                                     ****Basis of Presentation**

 

The condensed consolidated financialstatements of Aeroflex Incorporated and Subsidiaries (the “Company”) presentedherein have been prepared by the Company and are unaudited.  In the opinion of management, all adjustments(which include normal recurring adjustments) necessary to present fairly thefinancial position, results of operations and cash flows at December 31, 2005and for all periods presented have been made. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been omitted.  It is suggested that these condensedconsolidated financial statements be read in conjunction with the auditedfinancial statements and notes thereto included in the Company’s June 30, 2005annual report to shareholders.

 

Results of operations for thethree and six month periods are not necessarily indicative of results ofoperations for the corresponding full fiscal years.

 

**RevenueRecognition**

 

The Company recognizesrevenue when persuasive evidence of an arrangement exists, delivery hasoccurred or services have been rendered (except as described below), theselling price is fixed or determinable and collectibility of the resulting receivableis reasonably assured.

 

For arrangements other thancertain long-term contracts, revenue (including shipping and handling fees) isrecognized when products are shipped and title has passed to the customer.  If title does not pass until the product reachesthe customer’s delivery site, then recognition of the revenue is deferred untilthat time.  Revenues associated withcertain long-term contracts are recognized in accordance with Statement ofPosition No. 81-1 “Accounting for Performance of Construction-Type and CertainProduction-Type Contracts” (“SOP 81-1”). Under SOP 81-1, the Company uses the percentage-of-completion method,whereby revenues and associated costs are recognized as work on a contractprogresses.  The Company measures theextent of progress toward completion generally based upon one of the followingmethods (based upon an assessment of which method most closely aligns to theunderlying earnings process): (i) the units-of-delivery method, (ii) thecost-to-cost method, using the ratio of contract costs incurred as a percentageof total estimated costs at contract completion (based upon engineering andproduction estimates), or (iii) the achievement of contractual milestones.  Provisions for anticipated losses orrevisions in estimated profits on contracts-in-process are recorded in theperiod in which such anticipated losses or revisions become evident.  Revenue from sales of products where softwareis other than incidental to their performance, including related softwaresupport and maintenance contracts is recognized in accordance with SOP-97-2, “SoftwareRevenue Recognition.”

 

Certain of the Company’ssales are to distributors which have a right to return some portion of productwithin eighteen months of sale.  TheCompany recognizes 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 of ReturnExists.”  Historically, the returns underthese arrangements have been insignificant and can be reasonablyestimated.  An estimate of such returnsis recorded at the time sales are recognized.

 

8

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**FinancialInstruments and Derivatives**

 

Foreign currency contractsare used to protect the Company from fluctuations in exchange rates.  The Company entered into foreign currencycontracts, which are not designated as hedges, and the change in fair value isincluded in income currently, within other income (expense).  As of December 31, 2005, the Company had $2.1million of notional value foreign currency forward contracts maturing through March2006.  Notional amounts do not quantifyrisk or represent assets or liabilities of the Company, but are used in the calculationof cash settlements under the contracts. The fair value of these contracts at December 31, 2005 was $34,000 lessthan the notional value.

 

The Company accounts for itsinterest rate swap derivatives in accordance with SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended by SFAS No. 138, “Accountingfor Certain Derivative Instruments and Hedging Activities.”  This statement requires companies to recordderivatives on the balance sheet as assets or liabilities at their fairvalue.  The Company’s derivatives aredesignated as cash flow hedges under SFAS No. 133, with changes in the fairvalue of such derivatives being recorded as components of other comprehensiveincome.  For derivatives that are deemedineffective, the changes are recorded as gains or losses in other income(expense).

 

**MarketableSecurities**

 

Marketable securities areclassified as available-for-sale and are recorded at fair market value withunrealized gains and losses, net of taxes, reported as a separate component ofshareholders’ equity.  Realized gains andlosses and declines in market value judged to be other than temporary, of whichthere were none, are included in other income. Interest and dividends are also included in other income.  Marketable securities consist solely ofauction rate bonds.

 

**Accountingfor Stock Based Compensation**

 

Prior to fiscal 2006, theCompany applied the intrinsic value method as outlined in Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”)and related interpretations in accounting for stock options granted.  Under the intrinsic value method, nocompensation expense was recognized if the exercise price of the Company’semployee stock options equaled the market price of the underlying stock on thedate of the grant.  Accordingly, nocompensation cost was recognized in the accompanying consolidated statements ofearnings prior to fiscal year 2006 on stock options granted to employees, sinceall options granted under the Company’s share incentive programs had anexercise price equal to the market value of the underlying common stock on thedate of grant.

 

Effective July 1, 2005, theCompany adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”).  This statement replaces SFAS No. 123, “Accountingfor Stock-based Compensation”  andsupersedes APB No. 25.  SFAS No. 123(R)requires that all stock based compensation be recognized as an expense in thefinancial statements and that such cost be measured at the fair value of theaward.  This statement was adopted usingthe modified prospective method of application, which requires us to recognizecompensation expense on a prospective basis. Therefore, prior period financial statements have not beenrestated.  Under this method, in additionto reflecting compensation expense for new share based awards, expense is alsorecognized to reflect the remaining service period of outstanding awards thathad been included in pro forma disclosures in prior periods.  SFAS No. 123(R) also requires that excess taxbenefits related to stock option exercises be reflected as financing cashinflows instead of operating cash inflows. The adoption of this pronouncement resulted in compensation expense of $1.4million and $3.5 million for the three and six months ended December 31, 2005,respectively, as well as cash flows from financing activities of $401,000 whichreduced cash flows from operating activities by the same amount.

 

9

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SFAS 123(R) required optionsto be classified as liabilities if the issuer could be required under anycircumstances to settle the option in cash. In February 2006, the Financial Accounting Standards Board (“FASB”) issuedFASB Staff Position (“FSP”) No. FAS 123(R)-4 “Classification of Options andSimilar Instruments Issued as Employee Compensation That Allow for CashSettlement upon the Occurrence of a Contingent Event” which amends FASB 123(R)by stipulating that if a cash settlement feature can be exercised only upon theoccurrence of a contingent event that is outside the employee’s control then itshould be treated as an equity award until it becomes probable that the eventwill occur.  The Company has applied theprinciples set forth in this FSP since its adoption of FASB 123(R) on July 1,2005.

 

In November 2005, the FASBpublished FSP No. FAS 123(R)-3, “Transition Election Related to Accounting forthe Tax Effects of Share-Based Payment Awards,” to provide an alternativetransition method for accounting for the tax effects of share-based paymentawards to employees.  The FASB learned,subsequent to adoption of SFAS No. 123(R), that a number of constituents didnot have the information necessary to comply with the transition requirementsof SFAS No. 123(R), and has provided an elective alternative transition methodin FSP No. FAS 123(R)-3.  Entities canchoose to follow either the transition guidance of SFAS No. 123(R) or thealternative transition method described in FSP No. FAS 123(R)-3.  The guidance in FSP No. FAS 123(R)-3 becameeffective upon publication.  The Companyhas applied the principles originally set forth in SFAS No. 123(R).  Therefore the guidance set forth in this FSP isnot applicable to the Company.

 

In October 2005, the FASBissued FSP No. FAS 123(R)-2, “Practical Accommodation to the Application of theGrant Date as Defined in FASB Statement No. 123(R),” to provide guidance ondetermining the grant date for an award as defined in SFAS No. 123(R).  This FSP stipulates that assuming all other criteriain the grant date definition are met, a mutual understanding of the key termsand conditions of an award to an individual employee is presumed to exist uponthe award’s approval in accordance with the relevant corporate governancerequirements, provided that the key terms and conditions of an award (a) cannotbe negotiated by the recipient with the employer because the award is aunilateral grant, and (b) are expected to be communicated to an individualrecipient within a relatively short time period from the date of approval.  The Company has applied the principles setforth in this FSP upon its adoption of SFAS No. 123(R).

 

**Reclassifications**

 

Certain reclassificationshave been made to the 2005 consolidated financial statements to conform to the2006 presentation.

 

**RecentlyIssued Accounting Standards Not Yet Adopted**

 

In May 2005, the FASB issuedSFAS No. 154, “Accounting Changes and Error Corrections,” (“SFAS No. 154”)which establishes, unless impracticable, retrospective application as therequired method for reporting a change in accounting principle in the absenceof explicit transition requirements specific to the newly adopted accountingprinciple.  The statement providesguidance for determining whether retrospective application of a change inaccounting principle is impracticable. The statement also addresses the reporting of a correction of an errorby restating previously issued financial statements.  SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December15, 2005.  The adoption of this statementis not expected to have any effect on the Company’s consolidated financialstatements.

 

10

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In April 2005, the FASBissued FASB Interpretation No. 47 (“FIN 47”), “Accounting for Conditional AssetRetirement Obligations – An Interpretation of FASB Statement No. 143.”  FIN 47 clarifies the terms of FASB StatementNo. 143 and requires an entity to recognize a liability for a conditional assetretirement obligation if the entity has sufficient information to reasonablyestimate its fair value.  FIN 47 iseffective no later than the end of fiscal years ending after December 15, 2005.  The Company is currently evaluating theimpact of this standard on its consolidated financial statements.

 

On December 31, 2004, theFASB issued FASB Staff Position 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”).  These staffpositions provide accounting guidance on how companies should account for theeffects of the American Jobs Creation Act of 2004 (“AJCA”) that was signed intolaw on October 22, 2004.  FSP No. 109-1states that the tax relief (special tax deduction for domestic manufacturing)from this legislation should be accounted for as a “special deduction” insteadof a tax rate reduction.  FSP No. 109-2gives a company additional time to evaluate the effects of the legislation onany plan for reinvestment or repatriation of foreign earnings for purposes ofapplying FASB Statement No. 109.  TheCompany is investigating the repatriation provision to determine whether itmight repatriate extraordinary dividends, as defined in the AJCA.

 

**2.**      **  Acquisition of Businesses and IntangibleAssets**

 

**JcAIRTest Systems**

 

OnApril 19, 2005, the Company acquired all of the outstanding stock of JcAIR TestSystems (“JcAIR”) for cash of $35 million. JcAIR provides customized avionics test solutions in all areas of manualand automatic test equipment for manufacturing, repair and ground supportoperation.  The addition of JcAIR hasenhanced the Company’s avionics product portfolio and provides more completetesting solutions for the avionics system test market.

 

TheCompany evaluated the acquired tangible and identifiable intangible assets toserve as a basis for allocation of the purchase price.  The Company preliminarily allocated thepurchase price, including the acquisition costs of approximately $445,000,based on the estimated fair value of the assets acquired and liabilitiesassumed as follows:

 

| ** **                                   | ** ** | **In thousands** | ** ** |
|----------------------------------------------|------------|------------------|------------|
|                                         |       |             |       |
| Current assets  (excluding cash of $568,000) |       | $                | 9,897      |   |
| Property, plant  and equipment               |       | 1,525            |       |
| Developed  technology                        |       | 12,000           |       |
| Customer related  intangibles                |       | 1,100            |       |
| Goodwill                                     |       | 20,561           |       |
| In-process  research and development         |       | 200              |       |
| Total assets  acquired                       |       | 45,283           |       |
| Current  liabilities                         |       | (6,037           | )          |
| Deferred taxes                               |       | (4,369           | )          |
| Total  liabilities assumed                   |       | (10,406          | )          |
| Net assets  acquired                         |       | $                | 34,877     |   |

 

11

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Asof December 31, 2005, the Company is completing its assessment of the fairvalue of certain assets and liabilities as of the date of acquisition which isexpected to be finalized upon the receipt and completion of additional informationand analysis during fiscal 2006.

 

Thedeveloped technology and customer related intangibles are being amortized on astraight-line basis over a range of 3 to 15 years.  The goodwill is not deductible for taxpurposes.  At the acquisition date, theacquired in-process research and development was not considered to have reachedtechnological feasibility and had no alternative future uses. Therefore, inaccordance with accounting principles generally accepted in the United Statesof America, the value of such was expensed at the time of the acquisition inoperating costs. The allocation to in-process research and developmentrepresents the estimated fair value of such incomplete research anddevelopment, at the acquisition date, based on future cash flows that have beenadjusted by the respective projects’ completion percentage.  As of the acquisition date, cash flows fromthese projects were expected to commence in fiscal 2006.  A 24% risk adjusted discount rate was appliedto the projects’ cash flows in determining fair value.   At the acquisition date, JcAIR wasconducting development activities associated with the completion of the Mode 5General Avionic Test Equipment sets.

 

**SPGDivision of UbiNetics Holdings Limited**

 

OnMay 23, 2005, the Company acquired all of the stock of UbiNetics Limited, aswell as certain assets located in India, Japan and Hong Kong, all of whichconstituted UbiNetics Holdings Limited’s SPG test and measurement business (“SPG”)for cash of $84 million and a deferred payment of up to approximately $4million depending on SPG achieving certain performance goals for the yearending June 30, 2006.  The Company didnot include this contingent consideration in its initial purchase price allocationas the payment of this consideration was not considered to be certain beyond areasonable doubt at the date of acquisition. As a result, the Company will adjust goodwill for any contingentconsideration in the future if and when it is earned.  SPG develops, manufactures and integrates wirelesstest and measurement solutions specific to commercial wireless productdevelopment organizations and service operators.  The addition of SPG’s wireless test andmeasurement products and technologies has enhanced the Company’s wirelessproduct portfolio and enabled the Company to provide more complete testingsolutions for the development, manufacturing and service markets.

 

TheCompany evaluated the acquired tangible and identifiable intangible assets toserve as a basis for allocation of the purchase price. The Companypreliminarily allocated the purchase price, including the acquisition costs ofapproximately $3.0 million, based on the estimated fair value of the assetsacquired and liabilities assumed as follows:

 

| ** **                                       | ** ** | **In thousands** | ** ** |
|--------------------------------------------------|------------|------------------|------------|
|                                             |       |             |       |
| Current assets  (excluding cash of $4.0 million) |       | $                | 5,320      |   |
| Property, plant  and equipment                   |       | 2,300            |       |
| Developed  technology                            |       | 21,000           |       |
| Customer related  intangibles                    |       | 750              |       |
| Goodwill                                         |       | 64,058           |       |
| In-process  research and development             |       | 2,800            |       |
| Total assets  acquired                           |       | 96,228           |       |
| Current  liabilities                             |       | (5,786           | )          |
| Deferred taxes                                   |       | (7,026           | )          |
| Other long term  liabilities                     |       | (468             | )          |
| Total  liabilities assumed                       |       | (13,280          | )          |
| Net assets  acquired                             |       | $                | 82,948     |   |

 

12

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Asof December 31, 2005, the Company is completing its assessment of the fairvalue of certain assets and liabilities as of the date of acquisition which isexpected to be finalized upon the receipt and completion of additionalinformation and analysis during fiscal 2006.

 

Thedeveloped technology and customer related intangibles are being amortized on astraight-line basis over a range of 1 to 5 years.  The goodwill is not deductible for taxpurposes.  At the acquisition date, theacquired in-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 was expensed at the time of the acquisition in operating costs.  The allocation to in-process research anddevelopment represents the estimated fair value of such incomplete research anddevelopment, at the acquisition date, based on future cash flows that have beenadjusted by the respective projects’ completion percentage.  As of the acquisition date, cash flows fromthese projects were expected to commence in fiscal year 2006.  As of the acquisition date, cash flows wereexpected under two scenarios — base case (assumes the contingent payment is notearned) and earnout case (assumes the contingent payment is earned).  In determining fair value, a 24% riskadjusted discount rate was applied to the projects’ cash flows under the basecase, and a 40% risk adjusted discount rate was applied to the projects’ cash flowsunder the earnout case.   At theacquisition date, SPG was conducting development activities associated with thecompletion of test mobile products used to test evolving 3G (third-generation)mobile communications networks and equipment that tests the functionality andperformance of Wide-Band-Code-Division-Multiple-Access technology.

 

Theoperating results of JcAIR and SPG have been included in the consolidatedstatement of earnings from their respective acquisition dates.  JcAIR and SPG are included in the TestSolutions segment.

 

Summarizedbelow are the unaudited pro forma results of operations of the Company as ifJcAIR and SPG had been acquired at the beginning of the six month period presented.  The in-process research and development write-offsfor JcAIR and SPG have been excluded from the December 31, 2004 pro formaincome in order to provide comparability to the respective historical period.

 

| ** **            | ** ** | **Pro  Forma  Six Months Ended  December 31, 2004** | ** ** |
|-----------------------|------------|-----------------------------------------------------|------------|
| ** **            | ** ** | **(In thousands, except per share data)**           | ** ** |
| ** **            | ** ** | ** **                                          | ** ** |
| Net sales             |       | $                                                   | 254,468    |   |
| Net income            |       | $                                                   | 19,131     |   |
| Net income per  share |       |                                                |       |
| Basic                 |       | $                                                   | 0.26       |   |
| Diluted               |       | $                                                   | 0.25       |   |

 

Thepro forma financial information presented above is not necessarily indicativeof either the results of operations that would have occurred had the acquisitionstaken place at the beginning of the six month period presented or of futureoperating results of the combined companies.

 

13

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**Intangibleswith Definite Lives**

 

The components ofamortizable intangible assets are as follows:

 
| ** **                    | ** ** | **December 31, 2005**      | ** ** |
|-------------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **(In thousands)**         | ** ** |
| ** **                    | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
|                          |       |                       |       |   |   |   |   |
| Existing  technology          |       | $                          | 80,742     |   | $ | 26,212 |   | $ | 54,530 |   |
| Tradenames                    |       | 2,314                      |       | 1,724 |   | 590 |   |
| Customer related  Intangibles |       | 6,156                      |       | 2,019 |   | 4,137 |   |
| Total                         |       | $                          | 89,212     |   | $ | 29,955 |   | $ | 59,257 |   |

 

The aggregate amortizationexpense for amortized intangible assets was $3.4 million and $2.0 million forthe three months ended December 31, 2005 and 2004, respectively, and $6.9million and $4.1 million for the six months ended December 31, 2005 and 2004,respectively.

 

The estimated aggregateamortization expense for each of the twelve month periods ending December 31, isas follows:

 

| ** ** | ** ** | **(In thousands)** | ** ** |
|------------|------------|--------------------|------------|
| 2006       |       | $                  | 12,771     |   |
| 2007       |       | 11,811             |       |
| 2008       |       | 9,838              |       |
| 2009       |       | 8,343              |       |
| 2010       |       | 5,361              |       |
|            |            |                    |            |  |

 

**Goodwill**

 

The carrying amount ofgoodwill is as follows:

 
| ** **                         | ** ** | **Balance  as of  July 1, 2005** | ** ** | **Effect of  Foreign  Currency** | ** ** | **Balance  as of  December 31, 2005** | ** ** |
|------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | ** **                       | ** ** | **(In thousands)**          | ** ** | ** **                            | ** ** |
|                               |       |                             |       |                             |       |                                  |       |
| Microelectronic solutions  segment |       | $                                | 46,688     |                             | $          | —                                |       | $ | 46,688 |   |
| Test solutions segment             |       | 121,360                          |       | (2,645                           | )          | 118,715                               |       |
| Total                              |       | $                                | 168,048    |                             | $          | (2,645                                | )          | $ | 165,403 |   |

 

14

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**3.****    ****Discontinued Operations**

 

As a result of continued operatinglosses, in February 2004, the Board of Directors of the Company approved aformal plan to divest the Company’s thin film interconnect manufacturingoperation (“MIC”) and to seek a strategic buyer.  This operation had previously been includedin the Microelectronic Solutions segment. As a result of this decision, the Company recorded a $9.1 million ($6.2million, net of tax) loss on disposal in the quarter ended December 31,2003.  This charge included a cashrequirement of $2.6 million primarily for existing equipment leases, and anon-cash charge of $6.5 million for the write down of goodwill, otherintangibles and owned equipment.

 

In September 2004, theCompany sold the stock of MIC for $8.8 million and recorded an additional netloss on disposal of $1.3 million ($1.3 million, net of tax).  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 saleagreements, the Company has retained certain liabilities relating to potentialadverse environmental conditions that may exist as of the date of sale,litigation pending against MIC as of the date of sale and product defects inproducts 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. Management believes these contingencies will not have a material adverseeffect on the Company’s consolidated financial statements.

 

In June 2004, the Board ofDirectors of the Company approved a formal plan to divest the Company’s shockand vibration control device manufacturing business (“VMC”) and to seek astrategic buyer.  This operation hadpreviously comprised the Isolator Products segment.  In March 2005, the Company sold the netassets of VMC for $8.4 million in cash. The Company recorded an $860,000 ($505,000 net of tax) gain ondisposition.  Under the terms of the saleagreements, the Company has retained certain liabilities relating to adverseenvironmental conditions that currently exist at the premises occupied by VMC,litigation pending against VMC as of the date of sale, and to the extentcovered by insurance, for product liability for products sold prior to theclosing date.  The Company has recorded areserve for the estimated remediation costs related to adverse environmentalconditions that currently exist at the VMC premises which was sold.

 

In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, thesebusiness units and TriLink (which was discontinued in December 2002) have beenreported as discontinued operations and, accordingly, income and losses fromoperations and the net loss on disposal have been reported separately fromcontinuing operations.  Net sales andincome (loss) from discontinued operations (including the net loss on disposal)for the six months ended December 31, 2004:

 

| ** **

** **                      | ** ** | **Six Months Ended  December 31, 2004** | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **(In thousands)**                      | ** ** |
|                                        |       |                                    |       |
| Net Sales                                   |       |                                    |       |
| MIC                                         |       | $                                       | 3,313      |   |
| VMC                                         |       | 9,093                                   |       |
| TriLink                                     |       | —                                  |       |
|                                        |       | $                                       | 12,406     |   |
|                                        |       |                                    |       |
| Income (Loss)  From Discontinued Operations |       |                                    |       |
| MIC                                         |       | $                                       | (884       | ) |
| VMC                                         |       | (732                                    | )          |
| TriLink                                     |       | 14                                      |       |
|                                        |       | $                                       | (1,602     | ) |

 

15

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**4.****                                     ****Earnings Per Share**

 

In accordance with SFAS No. 128, “Earnings PerShare,” net income per common share (“Basic EPS”) is computed by dividing netincome by the weighted average common shares outstanding.  Net income per common share, assumingdilution (“Diluted EPS”) is computed by dividing net income by the weightedaverage common shares outstanding plus potential dilution from the exercise ofstock options and restricted stock.  Asof July 1, 2005, the Company adopted SFAS 123(R) and did not restate priorperiods (see note 1 “Accounting for Stock-based Compensation”).  A reconciliation of the denominators of theBasic EPS and Diluted EPS calculations for continuing operations is as follows:

 
| ** **                                                                                                      | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                      | ** ** | **2005**                                  | ** ** | **2004**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                      | ** ** | **(In thousands)**                        | ** ** |
| Computation of Adjusted Weighted Average Shares  Outstanding:                                                   |       |                                      |       |                                    |       |   |   |   |   |
| Weighted average  shares outstanding                                                                            |       | 74,875                                    |       | 74,625                                  |       | 74,816 |   | 74,536 |   |
| Add: Effect of  dilutive options                                                                                |       | 1,115                                     |       | 1,685                                   |       | 1,029 |   | 1,613 |   |
| Weighted average shares and common share equivalents  used for computation of diluted earnings per common share |       | 75,990                                    |       | 76,310                                  |       | 75,845 |   | 76,149 |   |

 

Options to purchase 10.1 million shares at exerciseprices ranging between $8.16 and $34.41 per share were not included in thecomputation of diluted EPS as their effect would have been anti-dilutive, asper the provisions of SFAS 128.

 

16

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**5.****                                     ****Comprehensive Income**

 

The components of comprehensive income are asfollows:

 
| ** **                                                           | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                  | ** ** | **2004**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                           | ** ** | **(In thousands)**                        | ** ** |
|                                                                 |       |                                      |       |                                    |       |   |   |   |   |
| Net income                                                           |       | $                                         | 7,774      |                                    | $          | 5,323 |   | $ | 12,302 |   | $ | 10,939 |   |
|                                                                 |       |                                      |       |                                    |       |   |   |   |   |
| Accrued pension liability, net of tax                                |       | —                                    |       | —                                  |       | 16 |   | — |   |
|                                                                 |       |                                      |       |                                    |       |   |   |   |   |
| Unrealized gain (loss) on interest rate swap agreements,  net of tax |       | 13                                        |       | 23                                      |       | 37 |   | 21 |   |
|                                                                 |       |                                      |       |                                    |       |   |   |   |   |
| Foreign currency translation adjustment                              |       | (2,795                                    | )          | 5,610                                   |       | (5,049 | ) | 7,064 |   |
|                                                                 |       |                                      |       |                                    |       |   |   |   |   |
| Total comprehensive income                                           |       | $                                         | 4,992      |                                    | $          | 10,956 |   | $ | 7,306 |   | $ | 18,024 |   |

 

Accumulated other comprehensive income (loss) is asfollows:

 
| ** **                       | ** ** | **Minimum  Pension  Liability  Adjustment  (net of tax)** | ** ** | **Gain (Loss)  on Interest  Rate Swap  Agreements  (net of tax)** | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Total  (net of tax)** | ** ** |
|----------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **(In thousands)**                                        |
|                             |       |                                                      |       |                                                              |       |                                           |       |                    |       |
| Balance, July 1,  2005      |       | $                                                         | (3,632     | )                                                                 | $          | (75                                            | )          | $                       | 12,727     |   | $ | 9,020 |   |
| Six months  activity             |       | 16                                                        |       | 37                                                                |       | (5,049                                         | )          | (4,996                  | )          |
| Balance, December 31,  2005 |       | $                                                         | (3,616     | )                                                                 | $          | (38                                            | )          | $                       | 7,678      |   | $ | 4,024 |   |

 

17

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**6.****                                     ****Inventories**

 

Inventories consist of the following:

 
| ** **      | ** ** | **December 31,  2005** | ** ** | **June 30,  2005** | ** ** |
|-----------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **      | ** ** | **(In thousands)**          | ** ** |
|            |       |                        |       |                    |       |
| Raw materials   |       | $                           | 47,469     |                    | $          | 43,158 |   |
| Work in process |       | 56,321                      |       | 53,115                  |       |
| Finished goods  |       | 22,485                      |       | 22,633                  |       |
|            |       | $                           | 126,275    |                    | $          | 118,906 |   |

 

**7.****                                     ****Product Warranty**

 

The Company warrants its products against defects indesign, materials and workmanship, generally for one year from their date ofshipment.  A provision for estimatedfuture costs relating to these warranties is recorded when revenue is recognizedand is included in cost of goods sold.

 

Activity related to the Company’s product warrantyliability was as follows:

 
| ** **                          | ** ** | **Six Months Ended  December 31,** |
|-------------------------------------|------------|-----------------------------------------|
| ** **                          | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **(In thousands)**                      | ** ** |
|                                |       |                                    |   |   |   |
| Balance at  beginning of period     |       | $                                       | 2,056 |   | $ | 1,702 |   |
| Provision for  warranty obligations |       | 1,780                                   |   | 1,234 |   |
| Charges incurred                    |       | (1,379                                  | ) | (1,061 | ) |
| Acquired  warranty obligations      |       | —                                  |   | (194 | ) |
| Foreign currency  impact            |       | (19                                     | ) | 43 |   |
|                                |       |                                    |   |   |   |
| Balance at end  of period           |       | $                                       | 2,438 |   | $ | 1,724 |   |

 

 

**8.****                                     ****Defined Benefit Pension Plans**

 

Effective January 1, 1994, the Companyestablished a Supplemental Executive Retirement Plan (the “SERP”) whichprovides retirement, death and disability benefits to certain of itsofficers.  On September 3, 2003, theCompany acquired MCE, including its defined benefit pension plan (the “MCE Plan”).  The MCE Plan has been frozen since December 31,1993.

 

**Components of Net Periodic Benefit Cost**

 
| ** **                                        | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | **(In thousands)**                      | ** ** |
|                                              |       |                                    |       |   |   |
| Service cost                                      |       | $                                       | 257        |   | $ | 268 |   |
| Interest cost                                     |       | 495                                     |       | 340 |   |
| Expected return  on plan assets                   |       | (73                                     | )          | (62 | ) |
| Amortization of net transition (asset) obligation |       | 19                                      |       | 19 |   |
| Recognized  actuarial (gain) loss                 |       | 225                                     |       | 100 |   |
| Net periodic  benefit cost                        |       | $                                       | 923        |   | $ | 665 |   |
|                                                   |            |                                         |            |  |  |  |  |  |

 

18

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The Company previously disclosed in its financialstatements for the year ended June 30, 2005, that it expected tocontribute $164,000 to its pension plan in the fiscal year ended June 30,2006.   As of December 31, 2005, $100,000 of thecontributions had been made.

 

Due to the retirement of one of its officers, theCompany is required to make payments of $267,000 in the fiscal year ended June 30,2006, $674,000 in fiscal year ended June 30, 2007 and $628,000 each fiscalyear thereafter pursuant to the SERP. Payments shall cease December 31, 2015 or upon death, whichever islater.

 

**9.****            ****Stock Options and Warrants**

 

The Company has several stock option plans that aredescribed under the caption “Stock Option Plans” in footnote 9 to the consolidatedfinancial statements included in the Company’s June 30, 2005 Securitiesand Exchange Commission Form 10K. In November 2005, the shareholders approved an amendment to the2002 Directors’ Plan to increase the number of shares covered to 1.1 millionshares.  Options under all plans shallexpire not later than ten years from the date of grant.  As of December 31, 2005, 3.2 millionshares of the Company’s Common Stock were reserved and available to be grantedpursuant to these plans.

 

Stock based compensation expense is attributable tothe granting, and the remaining requisite service periods, of stock options.  Compensation expense attributable to stockbased compensation in the three and six months ended December 31, 2005 was$1.4 million ($860,000 after tax), or $.01 for both basic and diluted earningsper share, and $3.5 million ($2.1 million after tax), or $.03 for both basicand diluted earnings per share, respectively. As of December 31, 2005, the total unrecognized compensation costrelated to nonvested stock awards was $8.0 million and the related weighted averageperiod over which it is expected to be recognized is approximately 2.7 years.

 

Prior to the Company’s adoption of SFAS No. 123(R),SFAS No. 123 required that the Company provide pro forma informationregarding net earnings and net earnings per common share as if compensationcost for the Company’s stock based awards had been determined in accordancewith the fair value method prescribed therein. The Company had previously adopted the disclosure portion of SFAS No. 148,“Accounting for Stock Based Compensation – Transition and Disclosure,”requiring quarterly SFAS No. 123 pro forma disclosure.  The pro forma charge for compensation costrelated to stock based awards granted was recognized over the serviceperiod.  For stock options, the serviceperiod represents the period of time between the date of grant and the dateeach option becomes exercisable without consideration of certain accelerationprovisions (e.g., change of control).

 

19

----

 

The following table illustrates the effect on thenet earnings per common share as if the fair value method had been applied toall outstanding awards for the three and six months ended December 31,2004:

 
| ** **                                                                                                                    | ** ** | **Three Months Ended  December 31, 2004** | ** ** | **Six Months Ended  December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **(In thousands)**                             | ** ** |
|                                                                                                                          |       |                                           |       |                                         |       |
| Net income, as  reported                                                                                                      |       | $                                              | 5,323      |                                         | $          | 10,939 |   |
| Deduct: Total stock based compensation expense determined  under fair value method for all awards, net of related tax effects |       | (3,189                                         | )          | (6,475                                       | )          |
|                                                                                                                          |       |                                           |       |                                         |       |
| Pro forma net  income                                                                                                         |       | $                                              | 2,134      |                                         | $          | 4,464 |   |
| Net income per  share:                                                                                                        |       |                                           |       |                                         |       |
| Basic, as reported                                                                                                            |       | $                                              | 0.07       |                                         | $          | 0.15 |   |
|                                                                                                                          |       |                                           |       |                                         |       |
| Basic, pro forma                                                                                                              |       | $                                              | 0.03       |                                         | $          | 0.06 |   |
|                                                                                                                          |       |                                           |       |                                         |       |
| Diluted, as reported                                                                                                          |       | $                                              | 0.07       |                                         | $          | 0.14 |   |
|                                                                                                                          |       |                                           |       |                                         |       |
| Diluted, pro forma                                                                                                            |       | $                                              | 0.03       |                                         | $          | 0.06 |   |

 

A summary of the Company’s stock option plans as of December 31,2005 and changes during the six month period then ended, is presented below:

 
| ** **                             | ** ** | **Shares**         | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value (1)** | ** ** | **Weighted-Average  Contractual Life  Remaining in  Years** | ** ** |
|----------------------------------------|------------|--------------------|------------|----------------------------------------|------------|-------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                             | ** ** | **(In thousands)** | ** ** | ** **                             | ** ** | **(In thousands)**                  | ** ** | ** **                                                  | ** ** |
|                                   |       |               |       |                                   |       |                                |       |                                                        |       |
| Outstanding at July 1,  2005      |       | 15,384             |       | $                                      | 11.72      |                                |       |                                                        |       |   |
| Granted at fair value                  |       | 313                |       | 10.48                                  |       |                                |       |                                                        |       |
| Exercised                              |       | (276               | )          | 6.53                                   |       |                                |       |                                                        |       |
| Expired                                |       | —             |       | —                                 |       |                                |       |                                                        |       |
| Forfeited                              |       | (284               | )          | 11.72                                  |       |                                |       |                                                        |       |
|                                   |       |               |       |                                   |       |                                |       |                                                        |       |
| Outstanding at December 31,  2005 |       | 15,137             |       | $                                      | 11.79      |                                | $          | 23,153                                                      |       | 5.8 |   |
|                                   |       |               |       |                                   |       |                                |       |                                                        |       |
| Exercisable at December 31,  2005 |       | 13,593             |       | $                                      | 12.04      |                                | $          | 21,148                                                      |       | 5.5 |   |

 

----

(1) The intrinsic value of a stock option is theamount by which the current market value of the underlying stock exceeds theexercise price of the option.

 

The exercise period for all stock options does notexceed ten years from the date of grant. Stock option grants to individuals generally become exercisable in substantivelyequal tranches over a service period of up to five years.

 

20

----

 

The weighted average grant date fair value of stockoptions granted for the three months ended December 31, 2005 and 2004 was$8.49 and $6.19, respectively.  Theweighted average grant date fair value of stock options granted for the sixmonths ended December 31, 2005 and 2004 was $8.30 and $5.91, respectively.  The total intrinsic value of stock optionsexercised for the three months ended December 31, 2005 and 2004 was$707,000 and $882,000, respectively.  Thetotal intrinsic value of stock options exercised for the six months ended December 31,2005 and 2004 was $1.1 million and $1.9 million, respectively.

 

The fair value of each option grant was estimated onthe date of grant using the Black-Scholes option-pricing model with thefollowing weighted average assumptions:

 
| ** **                                        | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                  | ** ** | **2004**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                              |       |                                      |       |                                    |       |   |   |   |   |
| Weighted average  expected stock price volatility |       | 94                                        | %          | 77                                      | %          | 94 | % | 79 | % |
| Weighted average  expected option life            |       | 6.2 years                                 |       | 3 years                                 |       | 6.2 years |   | 3 years |   |
| Average risk  free interest rate                  |       | 4.6                                       | %          | 3.1                                     | %          | 4.5 | % | 3.0 | % |
| Average dividend  yield                           |       | —                                    |       | —                                  |       | — |   | — |   |

 

Cash received from share option exercises for thethree months ended December 31, 2005 and 2004 was $1.5 million and$710,000, respectively.  The cashreceived from share option exercises for the six months ended December 31,2005 and 2004 was $1.8 million and $1.5 million, respectively.

 

The Company recorded credits to additional paid-incapital during the three months ended December 31, 2005 and 2004 of$262,000 and $322,000, respectively, and for the six months ended December 31,2005 and 2004 of $401,000 and $688,000, respectively, in connection with the actualtax benefit related to compensation deductions on the exercise of stock optionsin excess of related deferred tax assets.

 

**10.****                              ****Stock Repurchase Program**

 

During fiscal 2005, the Company’s Board of Directorsauthorized a stock repurchase program of up to 3.0 million shares of its CommonStock, subject to certain limitations imposed by the Company’s lendingbanks.  Purchases will be made from timeto time, depending upon market conditions at prices deemed appropriate bymanagement.  During the six months offiscal 2006, a total of 15,000 shares were repurchased and retired for $153,000.  As of December 31, 2005, 65,000 shareshave been repurchased and retired since the inception of this program for$569,000.

 

**11.****                              ****Contingencies**

 

In fiscal 2005, the Company learned that itinadvertently may have violated certain International Traffic in ArmsRegulations (ITAR) by exporting certain products and services withoutlicenses.  These violations resulted froman error in classifying the products and services as commercial rather thanmilitary.  The Company has prepared andfiled a voluntary disclosure with the State Department in which the details ofthe 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.

 

On July 31, 2003, the Company acquired theRacal Instruments Wireless Solutions Group (“RIWS”) for cash of $38 million anda deferred payment of up to $16.5 million in either cash or Aeroflex commonstock, at the Company’s option, 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.

 

21

----

 

We are involved in various other legal matters.  We believe the outcome of these other legalmatters will not have a material effect upon us.

 

**12.****                              ****Business Segments**

 

The Company’s business segments and major productsincluded in each segment, are as follows:

 

**Microelectronic Solutions (“AMS”)**

a) MicroelectronicComponents, Sub-assemblies and Modules

b) Integrated Circuits

c) Motion Control Systems

 

**Test Solutions (“ATS”)**

a) Instrument Products andTest Systems

 

The Company is a manufacturer of advanced technologysystems and components for commercial industry, government and defensecontractors.  Approximately 30% and 33%of the Company’s sales for the three months ended December 31, 2005 and2004, and 28% and 33% for the six months ended December 31, 2005 and 2004,respectively, were to agencies of the United States government or to primedefense contractors or subcontractors of the United States government.  No one customer constituted more than 10% ofthe Company’s sales during any of the periods presented.  Inter-segment sales were not material andhave been eliminated from the tables below.

 

Most of the Company’s operations are located in theUnited States, however, it also has operations in Europe and Asia.  Each of Aeroflex International Limited, whichwas acquired in May 2002, RIWS, which was acquired in July 2003, and SPG,which was acquired in May 2005, have significant operations in the UnitedKingdom.  Specifically, net sales fromfacilities located in the United Kingdom were approximately $71 million for thesix months ended December 31, 2005. Total assets of the United Kingdom operations were $241 million as of December 31,2005.

 

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

 
| ** **                | ** ** | **For the Three Months Ended  December 31,** | ** ** |
|---------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **                | ** ** | **(In thousands)**                                | ** ** |
|                      |       |                                              |       |   |   |
| United States of  America |       | $                                                 | 82,593     |   | $ | 67,410 |   |
| Europe and  Middle East   |       | 31,080                                            |       | 32,118 |   |
| Asia and  Australia       |       | 20,216                                            |       | 11,250 |   |
| Other regions             |       | 1,267                                             |       | 1,691 |   |
|                      |       | $                                                 | 135,156    |   | $ | 112,469 |   |

 
| ** **                | ** ** | **For the Six Months Ended  December 31,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|
| ** **                | ** ** | **2005**                                        | ** ** | **2004** | ** ** |
| ** **                | ** ** | **(In thousands)**                              | ** ** |
|                      |       |                                            |       |   |   |
| United States of  America |       | $                                               | 158,859    |   | $ | 135,357 |   |
| Europe and  Middle East   |       | 60,967                                          |       | 59,341 |   |
| Asia and  Australia       |       | 38,495                                          |       | 24,112 |   |
| Other regions             |       | 2,483                                           |       | 2,841 |   |
|                      |       | $                                               | 260,804    |   | $ | 221,651 |   |

 

22

----

 

Selected financial data by segment is as follows:

 
| ** **                                                                  | ** ** | **For the Three Months Ended  December 31,** | ** ** | **For the Six Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                                          | ** ** | **2004**                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                  | ** ** | **(In thousands)**                                | ** ** |
| ** **                                                                  | ** ** | ** **                                        | ** ** | **(Restated)(1)**                               | ** ** | ** ** | ** ** | **(Restated)(2)** | ** ** |
| Net sales:                                                                  |       |                                              |       |                                            |       |   |   |   |   |
| Microelectronic solutions                                                   |       | $                                                 | 58,869     |                                            | $          | 48,954 |   | $ | 113,692 |   | $ | 100,137 |   |
| Test solutions                                                              |       | 76,287                                            |       | 63,515                                          |       | 147,112 |   | 121,514 |   |
| Net sales                                                                   |       | $                                                 | 135,156    |                                            | $          | 112,469 |   | $ | 260,804 |   | $ | 221,651 |   |
|                                                                        |       |                                              |       |                                            |       |   |   |   |   |
| Segment adjusted  operating income (3):                                     |       |                                              |       |                                            |       |   |   |   |   |
| Microelectronic solutions                                                   |       | $                                                 | 15,395     |                                            | $          | 9,724 |   | $ | 28,924 |   | $ | 20,592 |   |
| Test solutions                                                              |       | 5,900                                             |       | 6,207                                           |       | 10,152 |   | 10,899 |   |
| General corporate expense                                                   |       | (4,145                                            | )          | (4,368                                          | )          | (8,112 | ) | (7,908 | ) |
|                                                                        |       | 17,150                                            |       | 11,563                                          |       | 30,964 |   | 23,583 |   |
|                                                                        |       |                                              |       |                                            |       |   |   |   |   |
| Amortization of  acquired intangibles                                       |       |                                              |       |                                            |       |   |   |   |   |
| • AMS                                                                  |       | (533                                              | )          | (534                                            | )          | (1,067 | ) | (1,088 | ) |
| • ATS                                                                  |       | (2,900                                            | )          | (1,508                                          | )          | (5,822 | ) | (3,013 | ) |
| Stock based  compensation                                                   |       |                                              |       |                                            |       |   |   |   |   |
| • AMS                                                                  |       | (373                                              | )          | —                                          |       | (726 | ) | — |   |
| • ATS                                                                  |       | (377                                              | )          | —                                          |       | (811 | ) | — |   |
| • Corporate                                                            |       | (692                                              | )          | —                                          |       | (1,921 | ) | — |   |
| Current period impact of acquisition related adjustment  to inventory - ATS |       | —                                            |       | —                                          |       | (1,088 | ) | — |   |
| Operating income  (GAAP)                                                    |       | 12,275                                            |       | 9,521                                           |       | 19,529 |   | 19,482 |   |
| Interest expense                                                            |       | (147                                              | )          | (162                                            | )          | (307 | ) | (422 | ) |
| Other income  (expense), net                                                |       | 661                                               |       | 541                                             |       | 752 |   | 965 |   |
| Income from continuing operations before income  taxes                      |       | $                                                 | 12,789     |                                            | $          | 9,900 |   | $ | 19,974 |   | $ | 20,025 |   |

 

----

(1) Restated for the transfer of the MotionControl Systems business from ATS to AMS. Sales and operating income (loss) forthe Motion Control Systems business was $3.7 million and $256,000, respectivelyfor the three months ended December 31, 2004.

(2) Restated for the transfer of the MotionControl Systems business from ATS to AMS. Sales and operating income (loss) forthe Motion Control Systems business was $7.5 million and and $18,000,respectively for the six months ended December 31, 2004.

(3) Management evaluates the operating results ofthe two segments based upon pre-tax operating income, before costs related toamortization of acquired intangibles, stock based compensation and the impactof any acquisition related adjustments to inventory.

 

23

----

 

**ITEM 2****– MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION 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) customand standard integrated circuits, such as databuses, transceivers,microcontrollers, microprocessors and memories and (ii) components,sub-assemblies and modules for military and commercial communicationsystems.  We also design, develop andproduce motion control systems including stabilization and tracking devices,magnetic motors and scanning devices.

 

**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

 

Ouroperating strategy is based on the following key objectives:

 

•                  tostrengthen and expand our portfolio of proprietary technologies;

•                  tobroaden the applications and target markets for our existing products;

•                  toexpand the scope of our content in our customers’ products;

•                  toincrease our operating efficiencies;

•                  tomaintain a conservative capital structure; and

•                  toopportunistically pursue strategic acquisitions.

 

InApril 2005, we acquired JcAIR Test Systems, which manufactures customizedavionics test solutions, both manual and automated, for manufacturing, repairand ground support operations.

 

InMay 2005, we acquired the SPG division of UbiNetics Holdings Limited,which is a developer, manufacturer and integrator of wireless test andmeasurement solutions specific to commercial wireless development organizationsand service operators.

 

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.

 

24

----

 

**Three Months ended December 31, 2005 Compared to Three MonthsEnded December 31, 2004**

 

*Net Sales. *Net sales increased 20% to $135.2 million forthe three months ended December 31, 2005 from $112.5 million for the threemonths ended December 31, 2004.  Netsales in the microelectronic solutions (“AMS”) segment increased 20% to $58.9 million for the threemonths ended December 31, 2005 from $49.0 million for the three monthsended December 31, 2004 primarily as a result of increased sales volume ofour integrated circuits, microelectronic modules and components businesses.   Net sales in the test solutions (“ATS”) segmentincreased 20% to $76.3 million for the three months ended December 31,2005 from $63.5 million for the three months ended December 31, 2004 as aresult of the addition of sales from our fiscal 2005 acquisitions of JcAIR andSPG and increased sales volume of frequency synthesizers offset, in part, byreduced sales of wireless test solutions.

 

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

 
| **Three Months  Ended  December 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | %**of  sales** | ** ** |
|--------------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|----------------|------------|
| **(In thousands, except  percentages)**    | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
| 2005                                       |       | $          | 30,202     |            | 51.3       | %          | $          | 34,352          |       | 45.0       | %          | $              | 64,554     |   | 47.8 | % |
| 2004                                       |       | 23,791     |       | 48.6            | %          | 29,690     |       | 46.7            | %          | 53,481     |       | 47.6           | %          |
|                                            |            |            |            |                 |            |            |            |                 |            |            |            |                |            |  |  |  |

 

Grossprofit increased $6.4 million, or 27%, in the AMS segment primarily due to theincreased sales volume and increased margin percentages.  Margin percentages increased 2.7% to 51.3%primarily due to operating efficiencies realized on higher volume in ourintegrated circuits and microelectronic module businesses.

 

Grossprofit increased $4.7 million, or 16%, in the ATS segment primarily as a resultof the increased sales volume offset, in part, by reduced marginpercentages.  Margin percentagesdecreased 1.7% to 45.0% primarily due to the lower margin of JcAIR’s avionicsproducts and decreased margins in wireless test solutions, as fixed costs werespread over lower sales, partially offset by the higher SPG margins.

 

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

 
| **Three Months  Ended  December 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Corporate** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|--------------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|---------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except  percentages)**    | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| 2005                                       |       | $          | 9,633      |            | 16.4       | %          | $          | 16,086          |       | 21.1          | %          | $          | 4,837      |            | $          | 30,556 |   | 22.6 | % |
| 2004                                       |       | 8,146      |       | 16.6            | %          | 14,205     |       | 22.4            | %          | 4,368         |       | 26,719     |       | 23.8            | %          |
|                                            |            |            |            |                 |            |            |            |                 |            |               |            |            |            |                 |            |  |  |  |  |

 

Selling,general and administrative costs increased by $1.5 million, or 18%, in the AMS segment primarily dueto general increases in expenses related to the increase in sales and the recognition of stock based compensation of $345,000. Stock based compensation wasinitially recognized as an expense as of July 1, 2005 pursuant to SFAS123(R).  Selling, general and administrative costs increased by $1.9million, or 13%, in the ATS segment primarily as a result of our fiscal 2005fourth quarter acquisitions of JcAIR and SPG and stock based compensation of $222,000.  Corporate selling, general and administrativeexpenses increased by $469,000 primarily due to stock based compensation.

 

25

----

 

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

 
| **Three Months  Ended  December 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|--------------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except  percentages)**    | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
| 2005                                       |       | $          | 5,546      |            | 9.4        | %          | $          | 12,744          |       | 16.7       | %          | $               | 18,290     |   | 13.5 | % |
| 2004                                       |       | 5,921      |       | 12.1            | %          | 9,278      |       | 14.6            | %          | 15,199     |       | 13.5            | %          |
|                                            |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

Selffunded research and development costs decreased $375,000, or 6%, in the AMSsegment primarily due to the timing of available resources allocated to supportincreased revenue.  Research anddevelopment costs increased $3.5 million, or 37%, in the ATS segment mainly dueto the acquisition of SPG which spent $2.4 million in the quarter ended December 31,2005 and a $1.0 million increase in our radar systems business primarily forthe development of a radar tracking system. We expect the development of the radar tracking system to besubstantially complete in fiscal year 2006.

 

*Amortization of Acquired Intangibles.* Amortization increased $1.4 million, or 68%,primarily due to the acquisitions of JcAIR and SPG.

 

*Other Income (Expense). *Interest expense decreased $15,000 to$147,000 for the three months ended December 31, 2005 from $162,000 forthe three months ended December 31, 2004 due to lower outstandingdebt.  Other income of $661,000 for thethree months ended December 31, 2005 consisted primarily of a favorablebuilding lease termination gain of $459,000 and interest income of$249,000.  Other income of $541,000 forthe three months ended December 31, 2004 consisted primarily of interestincome of $470,000.  The decline ininterest income was due to the lower balances in cash, cash equivalents andmarketable securities due to our fourth quarter 2005 acquisitions.

 

*Provision for Income Taxes. *The income tax provision was $5.0 million (aneffective income tax rate of 39.2%) for the three months ended**December 31, 2005 and $3.8 million (an effectiveincome tax rate of 38.0%) for the three months ended December 31,2004.  The effective income tax rate forthe two periods differed from the amount computed by applying the U.S. Federalincome tax rate to income before income taxes primarily due to foreign, stateand local income taxes, and, for the three months ended December 31, 2005,a state rate change and a tax audit adjustment, both of which were fullyreflected in the current quarter.  Weanticipate the rate to be 37% for the balance of the year.

 

*Income from Continuing Operations. *The incomefrom continuing operations for the three months ended December 31, 2005was $7.8 million, or 5.8% of sales, versus $6.1 million, or 5.5% of sales, forthe three months ended December 31, 2004. The three months ended December 31, 2005, reflect additionalintangible amortization expense of $1.4 million due to our fourth quarter 2005acquisitions and stock based compensation expense of $1.4 million not requiredto be recognized in the prior year.

 

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**Six Months ended December 31, 2005 Compared to Six Months Ended December 31,2004**

 

*Net Sales. *Net sales increased 18% to $260.8 million forthe six months ended December 31, 2005 from $221.7 million for the sixmonths ended December 31, 2004.  Netsales in the AMS segment increased 14%to $113.7 million for the six months ended December 31, 2005 from$100.1 million for the six months ended December 30, 2004 as a result ofincreased sales volume of our integrated circuits, microelectronic modules andcomponents businesses.   Net sales in theATS segment increased 21% to $147.1 million for the six months ended December 31,2005 from $121.5 million for the six months ended December 31, 2004 as aresult of the addition of sales from our fiscal 2005 acquisitions of JcAIR andSPG and increased sales volume of communication test products offset, in part,by reduced sales of wireless test solutions.

 

*Gross Profit.*

 
| **Six Months  Ended  December 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|------------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except  percentages)**  | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
| 2005                                     |       | $          | 58,203     |            | 51.2       | %          | $          | 65,277          |       | 44.4       | %          | $               | 123,480    |   | 47.3 | % |
| 2004                                     |       | 48,209     |       | 48.1            | %          | 56,603     |       | 46.6            | %          | 104,812    |       | 47.3            | %          |
|                                          |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

AMSgross profit increased approximately $10 million, or 21%, due to the increasedsales volume and increased margin percentages.  Margin percentages increased 3.1% to 51.2% largely due to operatingefficiencies realized on higher volume and a favorable product mix in ourintegrated circuits and microelectronic modules businesses.

 

ATSgross profit increased $8.7 million, or 15%, due to the increased sales volume offset,in part, by reduced margins.  Marginpercentages decreased 2.2% to 44.4% primarily due to the lower margins on JcAIR’savionics products and decreased margins in wireless test solutions, as fixedcosts were spread over lower sales, partially offset by higher SPG marginpercentages.

 

*Selling, General and Administrative Costs.*

 
| **Six Months  Ended  December 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Corporate** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|------------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|---------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except  percentages)**  | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| 2005                                     |       | $          | 18,385     |            | 16.2       | %          | $          | 32,390          |       | 22.0          | %          | $          | 10,033     |            | $          | 60,808 |   | 23.3 | % |
| 2004                                     |       | 16,585     |       | 16.6            | %          | 26,993     |       | 22.2            | %          | 7,908         |       | 51,486     |       | 23.2            | %          |
|                                          |            |            |            |                 |            |            |            |                 |            |               |            |            |            |                 |            |  |  |  |  |

 

Selling,general and administrative costs increased by $1.8 million, or 11%, in the AMSsegment primarily due to general increases in expenses related to the increasein sales and the recognition of stock based compensation of $669,000.  Selling, general and administrative costsincreased by $5.4 million, or 20% in the ATS segment primarily as a result ofour fiscal 2005 fourth quarter acquisitions of JcAIR and SPG and stock basedcompensation of $497,000.  Corporateselling, general and administrative expenses increased by $2.1 millionprimarily due to stock based compensation.

 

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*Research and Development Costs.*

 
| **Six Months  Ended  December 31,** | ** ** | **AMS**    | ** ** | **% of  sales** | ** ** | **ATS**    | ** ** | **% of  sales** | ** ** | **Total**  | ** ** | **% of  sales** | ** ** |
|------------------------------------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|------------|------------|-----------------|------------|
| **(In thousands, except  percentages)**  | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** |
| 2005                                     |       | $          | 11,620     |            | 10.2       | %          | $          | 24,634          |       | 16.7       | %          | $               | 36,254     |   | 13.9 | % |
| 2004                                     |       | 11,032     |       | 11.0            | %          | 18,711     |       | 15.4            | %          | 29,743     |       | 13.4            | %          |
|                                          |            |            |            |                 |            |            |            |                 |            |            |            |                 |            |  |  |  |

 

Selffunded research and development costs increased $588,000, or 5%, in the AMSsegment primarily due to development of integrated circuit products.  Research and development increased $5.9million, or 32%, in the ATS segment primarily due to the addition of theexpense of SPG of $5.3 million and a $1.4 million increase in our radar systemsbusiness, primarily for the development of a radar tracking system, partiallyoffset by reduced development expenses relating to wireless test solutions of$945.000.

 

*Amortization of Acquired Intangibles.* Amortization increased $2.8 million, or 68%,primarily due to the acquisitions of JcAIR and SPG in the fourth quarter offiscal 2005.

 

*Other Income (Expense).*   Interest expense decreased to$307,000 for the six months ended December 31, 2005 from $422,000 for thesix months ended December 31, 2004 due to lower outstanding debt.  Other income of $752,000 for the six monthsended December 31, 2005 consisted primarily of interest income of $337,000and a favorable building lease termination gain of $459,000.  Other income of $965,000 for the six monthsended December 31, 2004 consisted primarily of interest income of$819,000.   The decline in interestincome was due to the lower balances in cash, cash equivalents and marketablesecurities due to our fourth quarter fiscal 2005 acquisitions.

 

*Provision for Income Taxes. *The income tax provision was $7.7 million (aneffective income tax rate of 38.4%) for the six months ended**December 31, 2005 and $7.5 million (an effectiveincome tax rate of 37.4%) for the six months ended December 31, 2004.  The effective income tax rate for the twoperiods differed from the amount computed by applying the U.S. Federal incometax rate to income before income taxes primarily due to foreign, state andlocal income taxes, and, for the six months ended December 31, 2005, astate rate change and a tax audit adjustment, both of which were fullyreflected in the current period.  Weanticipate the rate to be 37% for the balance of the year.

 

*Income from Continuing Operations. *The incomefrom continuing operations for the six months ended December 31, 2005 was$12.3 million, or 4.7% of sales, versus $12.5 million, or 5.7% of sales, forthe six months ended December 31, 2004. The decline in income as a percentage of sales reflects the additionalintangible amortization expense of $2.8 million due to our fourth quarterfiscal 2005 acquisitions and stock based compensation expense of $3.5 million,not required to be recognized in the prior year.

 

**Off-Balance Sheet Arrangements**

 

Weare not a party to any off-balance sheet arrangements other than letters ofcredit totaling $10.4 million to guarantee our performance under certaingovernment contracts.

 

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**Liquidity and Capital Resources**

 

Asof December 31, 2005, we had $180 million in working capital and ourcurrent ratio was 2.7 to 1.  The Company’savailable unused line of credit under a $50 million revolving credit facilitythat expires February 2007 is approximately $39.6 million at December 31,2005, after consideration of letters of credit. The facility continued the mortgage on our Plainview property for $2.3million and is secured by the pledge of the stock of certain of oursubsidiaries.  The interest rate onrevolving credit borrowings under this agreement is at various rates dependingupon certain financial ratios, with the current rate substantially equivalentto LIBOR plus 1% (5.4% at December 31, 2005).  The mortgage is payable in monthlyinstallments of approximately $26,000 through March 2008 and a balloonpayment of $1.6 million in April 2008. We have entered into interest rate swap agreements for the outstandingamount under the mortgage agreement at approximately 7.6% in order to reducethe interest rate risk associated with these borrowings. The fair market valueof the interest rate swap agreements was $60,000 as of December 31, 2005in favor of the banks.  If this mortgagewas prepaid, although the Company has no intention of doing so, the $60,000would 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.  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.

 

InJanuary 2006, we entered into a non binding commitment to replace ourexisting $50 million revolving credit facility with a new five year, $100million revolving credit facility that includes a $50 million expansionfeature.  While we anticipate that thenew loan will close in March 2006, there can be no assurances it will.

 

OnJuly 31, 2003, we acquired the Racal Instruments Wireless Solutions Group(“RIWS”) for cash of $38 million and a deferred payment of up to $16.5 millionin either cash or Aeroflex common stock, at our option, depending on RIWSachieving certain performance goals for the year ending July 31,2004.  Although we believe that theperformance goals have not been met, the determination is not final.

 

OnMay 23, 2005, we acquired SPG for $84 million in cash and a contingentpayment of up to $4 million in cash depending on SPG achieving certainperformance goals for the year ending June 30, 2006.

 

Forthe six months ended December 31, 2005, our operations provided cash fromcontinuing operations of $14.8 million, our investing activities used cash of $14.4million, primarily for capital expenditures and the purchase of marketablesecurities, (net of sales) and our financing activities provided cash of $1.9million, primarily due to the proceeds from stock option exercises.

 

Webelieve our 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.  Ourcash, cash equivalents and marketable securities coupled with our availablelines of credit, are available to fund acquisitions and other potential largecash needs that may arise.

 

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

 

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| ** **                           | ** ** | **Payments due by period** | ** ** |
|--------------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **Total**                  | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After  5 Years** | ** ** |
| ** **                           | ** ** | **(In thousands)**         |
|                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Long-term debt                       |       | $                          | 4,632      |   | $ | 628 |   | $ | 2,593 |   | $ | 666 |   | $ | 745 |   |
| Operating leases                     |       | 34,832                     |       | 8,009 |   | 10,616 |   | 5,233 |   | 10,974 |   |
| Employment  consulting and contracts |       | 7,696                      |       | 3,053 |   | 3,456 |   | 1,187 |   | — |   |
| Total                                |       | $                          | 47,160     |   | $ | 11,690 |   | $ | 16,665 |   | $ | 7,086 |   | $ | 11,719 |   |

 

Theoperating lease commitments shown in the above table have not been reduced byfuture minimum sub-lease rentals of $15.0 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 December 31, 2005, will have amaterial adverse 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.

 

Revenue and Cost Recognition Under Long-Term Contracts

 

Werecognize revenue when persuasive evidence of an arrangement exists, deliveryhas occurred or services have been rendered (except as described below), theselling price is fixed or determinable and collectibility of the resultingreceivable is reasonably 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“Accounting for Performance of Construction-Type and Certain Production-TypeContracts” (“SOP 81-1”).  Under SOP 81-1,we use the percentage-of-completion method, whereby revenues and associatedcosts are recognized as work on a contract progresses.  We measure the extent of progress towardcompletion generally based upon one of the following methods (based upon anassessment of which method most closely aligns to the underlying earningsprocess): (i) the units-of-delivery method, (ii) the cost-to-costmethod, using the ratio of contract costs incurred as a percentage of totalestimated costs at contract completion (based upon engineering and productionestimates), or (iii) the achievement of contractual milestones.  Provisions for anticipated losses orrevisions in estimated profits on contracts-in-process are recorded in theperiod in which such anticipated losses or revisions become evident.  Revenue from sales of products where softwareis other than incidental to their performance, including related softwaresupport and maintenance contracts is recognized in accordance with SOP-97-2, “SoftwareRevenue Recognition.”

 

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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 expectation, then inventory balances may be over or under valued,which could have a material effect on our results of operations and financialcondition.

 

Recoverability of 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 impairment lossto 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).  Suchestimates 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.

 

Income Taxes

 

Thecarrying value of our net deferred tax assets assumes that we will be able togenerate sufficient 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.

 

Stock Based Compensation

 

Withthe adoption of SFAS No. 123(R) on July 1, 2005, we are required torecord the fair value of stock based compensation awards as an expense.  In order to determine the fair value of stockoptions on the date of grant, the Company utilizes the Black-Scholesoption-pricing model.  Inherent in thismodel are assumptions related to expected stock price volatility, option life,risk-free interest rate and dividend yield. While the risk-free interest rate and dividend yield are less subjectiveassumptions, typically based on factual data derived from public sources, theexpected stock price volatility and option life assumptions require a greaterlevel of judgment which makes them critical accounting estimates.

 

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**Recently Issued Accounting Standards Not Yet Adopted**

 

InMay 2005, the Financial Accounting Standard Board (“FASB”) issued SFAS No. 154,“Accounting Changes and Error Corrections,” (“SFAS No. 154”) whichestablishes, unless impracticable, retrospective application as the requiredmethod for reporting a change in accounting principle in the absence ofexplicit transition requirements specific to the newly adopted accountingprinciple.  The statement providesguidance for determining whether retrospective application of a change inaccounting principle is impracticable. The statement also addresses the reporting of a correction of an errorby restating previously issued financial statements.  SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005.  The adoption of this statement isnot expected to have any effect on our consolidated financial statements.

 

InApril 2005, the FASB issued FASB Interpretation No. 47 (“FIN 47”), “Accountingfor Conditional Asset Retirement Obligations – An Interpretation of FASBStatement 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.  We are currently evaluating the impact of thisstandard on our consolidated financial statements.

 

OnDecember 31, 2004, the FASB issued FASB Staff Position FAS 109-1, “Applicationof FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deductionon Qualified Production Activities Provided by the American Jobs Creation Actof 2004,” (“FSP No. 109-1”), and FASB Staff Position No. FAS 109-2, “Accountingand Disclosure Guidance for the Foreign Earnings Repatriation Provision withinthe American 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.  Weare investigating the repatriation provision to determine whether we mightrepatriate extraordinary dividends, as defined in the AJCA.

 

**Risks Relating to our Business**

 

*General economic conditions could adversely affect our revenues, grossmargins and expenses*.

 

Ourrevenues and gross margins will depend significantly on the overall demand formicroelectronic products and testing 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 ourbusiness.  Delays or reductions inspending for our products could have a material adverse effect on our business,results of operations and financial condition.

 

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*Our operating results may fluctuate significantly on a quarterly 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:

 

•                  thetiming, cancellation or rescheduling of customer estimates, orders andshipments;

•                  thepricing and mix of products sold;

•                  newproduct introductions;

•                  ourability to obtain components and subassemblies from contract manufacturers andsuppliers; and

•                  variationsin 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 certain of our customers encounter financialdifficulties and fail to pay us, it could adversely affect our results ofoperations 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 an event, ourgross margins would decline.  Inaddition, if the financial condition of any customer deteriorates, resulting inan impairment of that customer’s ability to pay us amounts owed in respect of asignificant amount of outstanding receivables, our financial condition would beadversely affected.

 

*If we cannot continue to develop, manufacture and market innovativeproducts and services rapidly that meet customer requirements for performanceand reliability, we may lose market share and our revenues may suffer*.

 

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 and commitsignificant resources before knowing whether our predictions will eventuallyresult in products that the market will accept. We must accurately forecast volumes, mix of products and configurationsthat meet customer requirements, and we may not succeed.

 

*Due to the international nature of our business, political or economicchanges could harm our future revenues, costs and expenses and financialcondition.*

 

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

 

•                  changesin a country’s or region’s political or economic conditions;

•                  longeraccounts receivable cycles;

•                  tradeprotection measures;

•                  unexpectedchanges in regulatory requirements;

•                  differingtechnology standards and/or customer requirements; and

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

 

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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 rate risks that couldadversely affect our business, results of operations and financial 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 sufficiently hedge or otherwisemanage foreign currency risks properly could adversely affect our business,results of operations and financial condition.

 

*As part of our business strategy, we may complete acquisitions ordivest 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 strategysuccessfully, we must identify suitable acquisition, alliance or divestiturecandidates, complete these transactions, some of which may be large andcomplex, and integrate acquired companies. Integration and other risks of acquisitions and strategic alliances canbe more pronounced for larger and more complicated transactions, or if multipleacquisitions are pursued simultaneously.

 

Theintegration of acquisitions may make the completion and integration ofsubsequent acquisitions more difficult. However, if we fail to identify and complete these transactions, we maybe required to expend resources to internally develop products and technologyor may be at a competitive disadvantage or may be adversely affected bynegative market perceptions, which may have a material effect on our revenuesand selling, general and administrative expenses taken as 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 anacquisition or alliance is successfully integrated, we may not receive theexpected benefits of the transaction. Managing acquisitions, alliances and divestitures requires varyinglevels of management resources, which may divert management’s attention fromthe other business operations. Acquisitions, including abandoned acquisitions, also may result insignificant costs and expenses 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.

 

*In order to be successful, we must retain and motivate 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.  Inparticular, our product generation efforts depend on hiring and retainingqualified engineers.  Attracting andretaining skilled workers and qualified sales representatives is also criticalto us.  Experienced management andtechnical, marketing and support personnel in the microelectronics and testsolutions industries are in demand and competition for their talents is intense.  Employee retention may be a particularlychallenging issue following our recent acquisitions since we also must continueto motivate employees and keep them focused on our strategies and goals, whichmay be particularly difficult due to the potential distractions related tointegrating the acquired operations.

 

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*Terrorist acts or acts of war may seriously harm our business, resultsof operations and financial 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 potentialfor future terrorist attacks, the national and international responses toterrorist attacks, and other acts of war or hostility have created manyeconomic and political uncertainties, which could adversely affect our businessand results of operations in ways that 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 may continue tofluctuate.*

 

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

 

•                  theannouncement of new products, services or technological innovations by us orour competitors;

•                  quarterlyincreases or decreases in our revenue or earnings;

•                  changesin quarterly revenue or earnings estimates by the investment community; and

•                  speculationin the press or investment community about our strategic position, financialcondition, results of operations, 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 Registrant’s securities, securities class action litigation against aRegistrant is sometimes instituted.  Thistype of litigation could result in substantial costs and the diversion ofmanagement time and resources.

 

**Forward-Looking Statements**

 

Allstatements other than statements of historical fact included in this Quarterly Report,including without limitation statements under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” regarding ourfinancial position, business strategy and plans and objectives of ourmanagement for future operations, are forward-looking statements.  When used in this Quarterly Report, wordssuch as “anticipate,” “believe,” “estimate,” “expect,” “intend” and similarexpressions, as they relate to us or our management, identify forward-lookingstatements.  Such forward-lookingstatements are based on the current beliefs of our management, as well asassumptions made by and information currently available to our management.  Actual results could differ materially fromthose contemplated by the forward-looking statements as a result of certainfactors, including but not limited to those set forth above.  Such statements reflect our current viewswith respect to the future and are subject to these and other risks,uncertainties and assumptions relating to our financial condition, results ofoperation, growth strategy and liquidity. We do not undertake any obligation to update such forward-lookingstatements.

 

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**ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 interestrates increase by 10% from levels at December 31, 2005, the effect on ournet income as well as the fair value of our swap would be insignificant.  Most of our invested cash, cash equivalentsand marketable securities are at variable rates of interest.  If market interest rates decrease by 10percent from levels at December 31, 2005, the effect on our net incomewould be insignificant.  If foreigncurrency exchange rates (primarily the British Pound and the Euro) change by10% from levels at December 31, 2005, the effect on our other comprehensiveincome would be approximately $17.9 million. Foreign currency contracts are used to protect us from short-term fluctuationsin exchange rates principally related to outstanding trade receivables.  We periodically enter into foreign currencycontracts, which are not designated as hedges, and the change in fair value isincluded in income currently, within other income (expense).  As of December 31, 2005, we had $2.1million of notional value foreign currency forward contracts maturing through March 2006.  Notional amounts do not quantify risk orrepresent assets or liabilities, but are used in the calculation of cashsettlements under the contracts.  Thefair value of these contracts at December 31, 2005 was $34,000 less thanthe 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 to be disclosed by us in the reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe 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 six months ended December 31, 2005 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

**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.

 

36

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**AEROFLEX INCORPORATED**

**AND SUBSIDIARIES**

**PART II – OTHER INFORMATION**

 

Item1                Legal Proceedings

 

Not applicable.

 

Item1A.   Risk Factors

 

Not applicable.

 

Item2.             Unregistered Sales of Equity Securities andUse of Proceeds

 
| **Issuer purchases of equity  securities (1)** | ** ** | ** **                                             | ** ** | ** **                                          | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **Total Number of  Shares Purchased  as Part of** | ** ** | **Maximum Number  of Shares that  May Yet be** | ** ** |
| **Period**                                     | ** ** | **Total Number of  Shares  Purchased (2)**             | ** ** | **Average Price  Paid Per Share**                   | ** ** | **Publicly  Announced Plans  or Programs** | ** ** | **Purchased under  the Plans or  Programs** | ** ** |
|                                           |       |                                                   |       |                                                |       |   |   |   |   |
| October 2005                              |       | 0                                                      |       | —                                              |       | 55,000 |   | 2,945,000 |   |
| November 2005                             |       | 5,000                                                  |       | $                                                   | 10.69      |   | 60,000 |   | 2,940,000 |   |
| December 2005                             |       | 5,000                                                  |       | $                                                   | 10.90      |   | 65,000 |   | 2,935,000 |   |

 

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(1)               For description of plans, see Note 10 to theUnaudited Condensed Consolidated Financial Statements.

 

(2)               All purchases were made in open market transactions.Our 3.0 million share stock buyback program has been in effect since May 23,2005. There is no time limit on the repurchases to be made under the Plan.

 

Item3.             Defaults upon Senior Securities

 

 None

 

Item4.  Submission of Matters to a Vote ofSecurity Holders

 
| Item 4. |   | Submission of Matters to a Vote of Security Holders                                |
|---------|--------|------------------------------------------------------------------------------------|
|    |   |                                                                               |
| (a)     |   | The Registrant held its Annual Meeting of Stockholders on November 10,  2005. |
|    |   |                                                                               |
| (b)     |   | Not applicable.                                                                    |

 

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| (c) |   | (1) |   | Three directors were elected at the Annual Meeting to serve until the  Annual Meeting of Stockholders in 2008. The names of these directors and  votes cast in favor of their election and shares withheld are as follows: |
|-----|--------|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| **Name**            | ** ** | **Votes For** | ** ** | **Votes Withheld** |
|---------------------|------------|---------------|------------|--------------------|
|                |       |          |       |               |
| John F. Benedik     |       | 54,610,326    |       | 4,263,248          |
|                |       |          |       |               |
| Ernest E. Courchene |       | 53,601,223    |       | 5,272,351          |
|                |       |          |       |               |
| Barton D. Strong    |       | 56,216,685    |       | 2,656,889          |

 
|   | (2) |   | The Stockholders approved to amend the 2002 Outside Directors’ Stock  Option Plan to increase the number of shares available for grant from 500,000  to 1,100,000. |
|--------|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| Votes for: 46,512,860; |   | Votes against: 12,197,119; |   | Abstentions: 163,595 |
|------------------------|--------|----------------------------|--------|----------------------|

 

Item5.             Other Information

 

None

 

Item 6.             Exhibits

 

Exhibits

 
| 10.1   |   | Employment Agreement between Aeroflex Incorporated and John Adamovich, Jr.,  dated November 9, 2005 (incorporated by reference on Exhibit 10.1  to the registrant’s Current Report on Form 8-K filed with the Securities  and Exchange Commission on November 15, 2005). |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                   |   |   |   |   |
| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302  of Sarbanes Oxley Act of 2002.                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                   |   |   |   |   |
| 31.2   |   | Certification of Chief Financial Officer pursuant to Section 302  of Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                   |   |   |   |   |
| 31.3   |   | Certification of Chief Operating Officer pursuant to Section 302  of Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                   |   |   |   |   |
| 31.4   |   | Certification of Principal Accounting Officer pursuant to Section 302  of Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                   |   |   |   |   |
| 32.1   |   | Certification of Chief Executive Officer and of Chief Financial  Officer pursuant 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)                       |   |
|                  |   |                               |
|                  |   |                               |
| February 9, 2006 |   | By:                                | /s/John Adamovich, Jr. |   |
|                  |   |                               | John Adamovich, Jr. |   |
|                  |   |                               | Sr. Vice President and |   |
|                  |   |                               | Chief Financial Officer |   |
|                       |        |                                    |  |  |  |

 

39

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EXHIBIT INDEX

 
| 10.1   |   | Employment Agreement between Aeroflex Incorporated and John Adamovich, Jr.,  dated November 9, 2005 (incorporated by reference to the registrant’s  Current Report on Form 8-K filed with the Securities and Exchange  Commission on November 15, 2005) |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                             |
| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302  of Sarbanes Oxley Act of 2002.                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                             |
| 31.2   |   | Certification of Chief Financial Officer pursuant to Section 302  of Sarbanes-Oxley Act of 2002.                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                             |
| 31.3   |   | Certification of Chief Operating Officer pursuant to Section 302  of Sarbanes-Oxley Act of 2002.                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                             |
| 31.4   |   | Certification of Principal Accounting Officer pursuant to Section 302  of Sarbanes-Oxley Act of 2002.                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                             |
| 32.1   |   | Certification of Chief Executive Officer and of Chief Financial  Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                             |

 

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