UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended March 31, 2003 --------------------------------------------- Commission File Number 000-02324 -------------------- AEROFLEX INCORPORATED (Exact name 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 Plainview, N.Y. 11803 11803 (Address of principal executive offices) (Zip Code) (516) 694-6700 (Registrant's telephone number, including area code) *Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------------------- -------------------- *Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No -------------------- -------------------- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. May 15, 2003 60,113,092 shares (excluding 4,388 shares held in treasury) - -------------------------------------------------------------------------------- (Date) (Number of Shares) NOTE: THIS IS PAGE 1 OF A DOCUMENT CONSISTING OF 33 PAGES. ---- AEROFLEX INCORPORATED AND SUBSIDIARIES INDEX ----- PAGE ---- PART I: FINANCIAL INFORMATION ------ --------------------- Item 1 - CONSOLIDATED BALANCE SHEETS 3-4 March 31, 2003 and June 30, 2002 CONSOLIDATED STATEMENTS OF OPERATIONS 5-6 Nine and Three Months Ended March 31, 2003 and 2002 CONSOLIDATED STATEMENTS OF CASH FLOWS 7 Nine Months Ended March 31, 2003 and 2002 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8-18 Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 19-26 Nine and Three Months Ended March 31, 2003 and 2002 Item 3 - QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26 Item 4 - CONTROLS AND PROCEDURES 27 PART II: OTHER INFORMATION ------- ----------------- Item 1 - LEGAL PROCEEDINGS 28 Item 6 - EXHIBITS AND REPORTS ON FORM 8-K 28 SIGNATURES 29 CERTIFICATIONS 30-33 AEROFLEX INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS March 31, June 30, 2003 2002 ------------- ------------ (Unaudited) (Note 3) (In thousands) ASSETS Current assets: Cash and cash equivalents $ 42,705 $ 38,559 Accounts receivable, less allowance for doubtful accounts of $500,000 and $636,000 64,053 63,384 Income taxes receivable 870 4,432 Inventories 74,456 72,040 Deferred income taxes 12,956 12,259 Assets of discontinued operations - 1,367 Prepaid expenses and other current assets 6,796 3,360 --------- --------- Total current assets 201,836 195,401 Property, plant and equipment, net 68,817 73,473 Intangible assets with definite lives, net 15,778 17,815 Goodwill 22,476 20,179 Deferred income taxes 867 2,477 Other assets 11,636 9,120 --------- --------- Total assets $321,410 $318,465 ========= ========= See notes to consolidated financial statements. AEROFLEX INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (continued) March 31, June 30, 2003 2002 ---------- ---------- (Unaudited) (Note 3) (In thousands) LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Current liabilities: Current portion of long-term debt $ 1,844 $ 2,171 Accounts payable 16,490 18,356 Advance payments by customers 2,816 1,775 Liabilities of discontinued operations 1,074 366 Accrued expenses and other current liabilities 24,130 26,637 --------- -------- Total current liabilities 46,354 49,305 Long-term debt 11,603 12,638 Other long-term liabilities 8,348 7,040 --------- --------- Total liabilities 66,305 68,983 --------- --------- Stockholders' equity: Preferred Stock, par value $.10 per share; authorized 1,000,000 shares: Series A Junior Participating Preferred Stock, par value $.10 per share, authorized 110,000; none issued - - Common Stock, par value $.10 per share; authorized 110,000,000 shares; issued 60,117,000 and 60,006,000 shares 6,012 6,001 Additional paid-in capital 222,921 222,351 Accumulated other comprehensive income 3,578 1,881 Retained earnings 22,608 19,263 --------- --------- 255,119 249,496 Less: Treasury stock, at cost (4,000 shares) 14 14 --------- --------- Total stockholders' equity 255,105 249,482 --------- --------- Total liabilities and stockholders' equity $321,410 $318,465 ========= ========= See notes to consolidated financial statements. AEROFLEX INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Nine Months Ended March 31, 2003 2002 ------- --------- (Note 3) (Unaudited) Net sales $213,139 $135,875 Cost of sales 131,343 87,453 --------- --------- Gross profit 81,796 48,422 --------- --------- Selling, general and administrative costs 50,003 33,229 Research and development costs 22,751 14,965 --------- --------- 72,754 48,194 --------- --------- Operating income 9,042 228 --------- --------- Other expense (income) Interest expense 1,023 1,138 Other expense (income) (284) (1,666) --------- --------- Total other expense (income) 739 (528) --------- --------- Income before income taxes 8,303 756 Provision for income taxes 2,820 282 --------- --------- Income from continuing operations 5,483 474 --------- --------- Discontinued operations (Note 3) Loss from discontinued operations, net of tax benefit of $208 and $757 404 1,485 Loss on abandonment of operations, net of tax benefit of $892 1,734 - --------- --------- Loss from discontinued operations, net of tax 2,138 1,485 --------- --------- Net income (loss) $ 3,345 $ (1,011) ========= ========= Income (loss) per common share: Basic Continuing operations $ .09 $ .01 Discontinued operations (.03) (.03) ----- ----- Net income (loss) $ .06 $(.02) ===== ===== Diluted Continuing operations $ .09 $ .01 Discontinued operations (.03) (.03) ----- ----- Net income (loss) $ .06 $(.02) ===== ===== Weighted average number of common shares outstanding: Basic 60,180 59,926 ========= ========= Diluted 60,739 61,992 ========= ========= See notes to consolidated financial statements. AEROFLEX INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Three Months Ended March 31, ------------------ 2003 2002 --------- --------- (Note 3) (Unaudited) Net sales $ 74,942 $ 50,571 Cost of sales 45,208 32,314 --------- --------- Gross profit 29,734 18,257 --------- --------- Selling, general and administrative costs 17,540 13,951 Research and development costs 7,757 5,901 --------- --------- 25,297 19,852 --------- --------- Operating income (loss) 4,437 (1,595) --------- --------- Other expense (income) Interest expense 310 479 Other expense (income) (293) (578) --------- --------- Total other expense (income) 17 (99) --------- --------- Income (loss) before income taxes 4,420 (1,496) Provision (benefit) for income taxes 1,495 (483) --------- --------- Income (loss) from continuing operations 2,925 (1,013) --------- --------- Discontinued operations (Note 3) Loss from discontinued operations, net of tax benefit of $5 and $316 8 616 Loss on abandonment of operations - - --------- --------- Loss from discontinued operations, net of tax 8 616 --------- --------- Net income (loss) $ 2,917 $ (1,629) ========= ========= Income (loss) per common share: Basic Continuing operations $ .05 $(.02) Discontinued operations - (.01) ----- ----- Net income (loss) $ .05 $(.03) ===== ===== Diluted Continuing operations $ .05 $(.02) Discontinued operations - (.01) ----- ----- Net income (loss) $ .05 $(.03) ===== ===== Weighted average number of common shares outstanding: Basic 60,229 60,088 ========= ========= Diluted 60,831 60,088 ========= ========= See notes to consolidated financial statements. AEROFLEX INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Nine Months Ended March 31, 2003 2002 ---------- ---------- (Note 3) (Unaudited) Cash Flows From Operating Activities: Net income (loss) $ 3,345 $ (1,011) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Loss from discontinued operations 3,238 2,242 Depreciation and amortization 11,410 8,289 Restructuring charge - 5,050 Deferred income taxes 1,191 (466) Other, net (132) 274 Change in operating assets and liabilities: Decrease (increase) in accounts receivable (460) (1,529) Decrease (increase) in inventories (2,011) (830) Decrease (increase) in prepaid expenses and other assets (1,489) (262) Increase (decrease) in accounts payable, accrued expenses and other liabilities (4,546) (8,108) --------- --------- Net Cash Provided By (Used In) Operating Activities 10,546 3,649 --------- --------- Cash Flows From Investing Activities: Payment for purchase of business (1,039) (283) Capital expenditures (4,100) (3,169) Cash flow provided by (used in) discontinued operations (1,163) (1,611) Purchase of marketable securities - (5,938) Proceeds from sale of marketable securities - 11,994 Other, net 40 - --------- --------- Net Cash Provided By (Used In) Investing Activities (6,262) 993 --------- --------- Cash Flows From Financing Activities: Borrowings under debt agreements - 89 Debt repayments (1,362) (1,516) Proceeds from the exercise of stock options 485 1,640 Amounts paid for withholding taxes on stock option exercises (84) (1,485) Withholding taxes collected for stock option exercises 84 1,485 --------- --------- Net Cash Provided By (Used In) Financing Activities (877) 213 --------- --------- Effect of exchange rate changes on cash and cash equivalents 739 - --------- --------- Net Increase (Decrease) In Cash And Cash Equivalents 4,146 4,855 Cash And Cash Equivalents At Beginning Of Period 38,559 69,896 --------- --------- Cash And Cash Equivalents At End Of Period $ 42,705 $ 74,751 ========= ========= See notes to consolidated financial statements. AEROFLEX INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation --------------------- The consolidated balance sheet of Aeroflex Incorporated and Subsidiaries ("the Company") as of March 31, 2003, the related consolidated statements of operations for the nine and three months ended March 31, 2003 and 2002, and the consolidated statements of cash flows for the nine months ended March 31, 2003 and 2002 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 the financial position, results of operations and cash flows at March 31, 2003 and for all periods presented have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. It is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company's June 30, 2002 annual report to shareholders. There have been no changes of significant accounting policies since June 30, 2002, except as disclosed in Note 2. Certain reclassifications have been made to previously reported financial statements to conform to current classifications. Results of operations for the nine and three month periods are not necessarily indicative of results of operations for the corresponding years. 2. Recent Accounting Pronouncements -------------------------------- In October 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company adopted SFAS No. 144 effective July 1, 2002. The adoption did not have any impact on the consolidated financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which will be effective for exit and disposal activities initiated after December 31, 2002. SFAS No. 146 provides that an exit cost liability should not always be recorded at the date of an entity's commitment to an exit plan, but instead should be recorded when the obligation is incurred and measured at fair value. An entity's commitment to a plan, by itself, does not create an obligation that meets the definition of a liability. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires certain guarantees to be recorded at fair value regardless of the probability of the loss. FIN 45 has been adopted prospectively by the Company as of January 1, 2003. The adoption did not have any impact on the consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as originally provided by SFAS No. 123 "Accounting for Stock-Based Compensation." Additionally, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 in both annual and interim financial statements. The Company has adopted the disclosure portion of this statement for the fiscal quarter ended March 31, 2003. The adoption did not have any impact on the Company's consolidated financial position or results of operations. In November 2002, the Emerging Issues Task Force ("EITF") finalized EITF Issue 00- 21, "Revenue Arrangements with Multiple Deliverables", which provides guidance on the timing and method of revenue recognition for sales arrangements that include the delivery of more than one product or service. EITF Issue 00-21 is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. The Company is currently analyzing the impact of its adoption on its consolidated financial statements. 3. Discontinued Operation ---------------------- In December 2002, the Board of Directors of the Company approved a formal plan to discontinue the Company's fiber optic lithium niobate modulator operation. The plan called for an immediate cessation of operations and disposal of existing assets. The abandonment of the operation resulted in a charge of $2.6 million ($1.7 million, net of tax) in the quarter ended December 31, 2002. The charge included a cash requirement of $1.4 million, primarily for equipment leases and payroll costs, and a non-cash charge of $1.2 million primarily for the write-off of owned equipment. In accordance with SFAS No. 144, the abandonment has been reported as a discontinued operation and, accordingly, losses from operations and the loss on abandonment have been reported separately from continuing operations. To conform with this presentation, all periods have been restated. As a result, the assets and liabilities of the discontinued operation have been reclassified on the balance sheet from the historical classifications and presented under the captions "assets of discontinued operations" and "liabilities of discontinued operations," respectively. 4. Acquisition of Business and Intangible Assets --------------------------------------------- Acquisition of IFR Systems On May 20, 2002, the Company acquired 75.1% of the outstanding stock of IFR Systems, Inc. ("IFR"). Effective June 19, 2002, IFR was merged into a wholly- owned subsidiary of the Company, with IFR as the surviving wholly-owned subsidiary. The Company paid $61.9 million from its available cash and marketable securities, including $48.8 million which was advanced to IFR to satisfy IFR's bank indebtedness. IFR designs and manufactures advanced test solutions for communications, avionics and general test and measurement applications. As a result of the acquisition, the Company has broadened its Test Solutions Segment product portfolio and its international sales network. The Company evaluated the acquired tangible and identifiable intangible assets to serve as a basis for allocation of the purchase price. The Company allocated the purchase price, including acquisition costs of approximately $1.9 million, based on the estimated fair value of the assets acquired and liabilities assumed, as follows: (In thousands) ------------ Current assets (excluding cash of $8.0 million).... $ 44,209 Property, plant and equipment...................... 20,242 Developed technology............................... 8,230 Goodwill........................................... 5,058 In-process research and development................ 1,100 Other.............................................. 62 --------- Total assets acquired............................ 78,901 --------- Current liabilities................................ (22,208) Long-term debt..................................... (2,814) --------- Total liabilities assumed........................ (25,022) --------- Net assets acquired.............................. $ 53,879 ========= The developed technology is being amortized on a straight-line basis over 6 years. The goodwill is not deductible for tax purposes. At the acquisition date, the acquired in-process research and development was not considered to have reached technological feasibility and had no alternative future uses. Therefore, in accordance with accounting principles generally accepted in the United States of America, the value of such was expensed in the quarter ended June 30, 2002 in operating costs. At the acquisition date, IFR was conducting design, development, engineering and testing activities associated with the completion of new technologies for its radio test set product line. Summarized below are the unaudited pro forma results of operations of the Company as if IFR had been acquired at the beginning of the fiscal period presented. The $1.1 million write-off has not been included in the March 31, 2002 pro forma results of operations in order to provide comparability to the respective historical period. Pro Forma Nine Months Ended March 31, 2002 ----------------- (In thousands, except per share data) Net sales......................... $221,771 Income (loss) from continuing operations...................... (6,777) Income (loss) from continuing operations per share: Basic......................... $ (.11) Diluted....................... $ (.11) The pro forma financial information presented above is not necessarily indicative of either the results of operations that would have occurred had the acquisition taken place at the beginning of the period presented or of future operating results of the combined companies. Intangibles with Definite Lives The components of amortizable intangible assets are as follows: As of March 31, 2003 -------------------- Gross Carrying Accumulated Net Book Amount Amortization Value -------------- ------------ -------- (In thousands) Existing technology...... $ 23,769 $ 8,583 $ 15,186 Tradenames............... 1,000 408 592 --------- --------- --------- Total................ $ 24,769 $ 8,991 $ 15,778 ========= ========= ========= The aggregate amortization expense for the amortized intangible assets was $2.3 million for the nine months ended March 31, 2003. The estimated aggregate amortization expense for each of the twelve month periods ending March 31, is as follows: (In thousands) 2004.................... $ 3,003 2005.................... 3,000 2006.................... 3,000 2007.................... 3,000 2008.................... 2,886 Goodwill The carrying amount of goodwill is as follows: Balance Balance as of as of July 1, Adjustment March 31, 2002 (Note a) 2003 ---------- ------------ ------------ (In thousands) Microelectronic solutions segment............... $ 5,367 $ - $ 5,367 Test solutions segment............... 14,023 2,297 16,320 Isolator products segment............... 789 - 789 -------- --------- -------- Total............... $20,179 $ 2,297 $22,476 ======== ========= ======== Note a - The additional goodwill recorded during the period is a result of adjustments to the fair value of assets and liabilities assumed in the acquisition of IFR and contingent payments pursuant to a purchase agreement. 5. Restructuring Charges --------------------- In fiscal 2002, the Company initiated strategic plans to consolidate three of its manufacturing operations to take advantage of excess manufacturing capacity in certain of its facilities and reduce operating costs. The Company recorded charges to eliminate excess equipment capacity, primarily in its microelectronics segment, and for personnel related costs. These consolidations are substantially complete. In connection with these restructurings, the Company recorded charges of $5.0 million and $4.1 million during the quarters ended March 31, 2002 and June 30, 2002, respectively, or $3.4 million and $2.9 million, net of tax, respectively. The following table sets forth the charges and payments related to the restructuring reserve for the nine months ended March 31, 2003: Balance Balance July 1, Nine Months Ended March 31, 2002 March 31, 2003 2003 ------------- ----------------------- ------------ Adjustments to Restructuring Restructuring Cash Restructuring Reserve Reserve Payments Reserve ----------- -------------- ---------- ------------- (In thousands) Workforce reduction..... $ 1,406 $ 58 $ (1,271) $ 193 Lease payments.......... 864 (35) (670) 159 Plant shutdown.......... 106 99 (84) 121 ---------- --------- --------- --------- Total operating costs. $ 2,376 $ 122 $ (2,025) $ 473 ========== ========= ========= ========= The amounts above exclude $11.0 million of restructuring charges recorded during the quarter ended June 30, 2002 for the Company's fiber optic lithium niobate modulator operation which, as of December 2002, has been reclassified as a discontinued operation. The charges related to such discontinuance were primarily due to the impairment of goodwill and other intangibles. 6. Earnings Per Share ------------------ In accordance with SFAS No. 128 "Earnings Per Share," net income per common share ("Basic EPS") is computed by dividing net income by the weighted average common shares outstanding. Net income per common share, assuming dilution ("Diluted EPS") is computed by dividing net income by the weighted average common shares outstanding plus potential dilution from the exercise of stock options. A reconciliation of the numerators and denominators of the Basic EPS and Diluted EPS calculations is as follows: Nine Months Ended March 31, ------------------------ 2003 2002 ---- ---- (In thousands, except per share data) Income from continuing operations $ 5,483 $ 474 ======== ======== Computation of adjusted weighted average shares outstanding: Weighted average shares outstanding 60,180 59,926 Add: Effect of dilutive options outstanding 559 2,066 -------- -------- Weighted average shares and common share equivalents used for computation of diluted earnings per common share 60,739 61,992 ======== ======== Income from continuing operations per share - Basic $ .09 $ .01 ====== ====== - Diluted $ .09 $ .01 ====== ====== Three Months Ended March 31, ------------------------ 2003 2002 ---- ---- (In thousands, except per share data) Income (loss) from continuing operations $ 2,925 $(1,013) ======== ======== Computation of adjusted weighted average shares outstanding: Weighted average shares outstanding 60,229 60,088 Add: Effect of dilutive options outstanding 602 - -------- -------- Weighted average shares and common share equivalents used for computation of diluted earnings per common share 60,831 60,088 ======== ======== Income (loss) from continuing operations per share - Basic $ .05 $(.02) ====== ====== - Diluted $ .05 $(.02) ====== ====== Options to purchase 11.3 million shares at exercise prices ranging between $6.85 and $34.41 per share were outstanding as of March 31, 2003 but were not included in the computation of diluted EPS because the exercise prices of these options were greater than the average market price of the common shares 7. Accounting for Stock-Based Compensation --------------------------------------- The Company records compensation expense for employee and director stock options only if the current market price of the underlying stock exceeds the exercise price on the date of the grant. The Company has chosen not to implement the fair value based accounting method for employee and director stock options, but has elected to disclose the pro forma income and income per share as if such method had been used to account for stock-based compensation costs as described in SFAS No. 123. The per share weighted average fair value of stock options granted during the nine months ended March 31, 2003 and 2002 was $5.36 and $7.12, respectively, on the date of grant. These fair values were determined using the Black Scholes option-pricing model with the following weighted average assumptions: 2003 - expected dividend yield of 0%, risk free interest rate of 3.9%, expected volatility of 112%, and an expected option life of 5.4 years; 2002 - expected dividend yield of 0%, risk free interest rate of 4.9%, expected volatility of 122%, and an expected option life of 5.3 years. The per share weighted average fair value of stock options granted during the quarter ended March 31, 2003 and 2002 was $5.40 and $9.11, respectively, on the date of grant. These fair values were determined using the Black Scholes option-pricing model with the following weighted average assumptions: 2003 - expected dividend yield of 0%, risk free interest rate of 3.7%, expected volatility of 112%, and an expected life of 7.4 years; 2002 - expected dividend yield of 0%, risk free interest rate of 5.0%, expected volatility of 122%, and an expected life of 7.5 years. The Company's income (loss) from continuing operations and income (loss) from continuing operations per share using the pro forma compensation cost would have been: Nine Months Ended Three Months Ended March 31, March 31, ------------------ --------------------- 2003 2002 2003 2002 ------ ------ ------ ------ (In thousands) Income (loss) from continuing operations $ 5,483 $ 474 $ 2,925 $ (1,013) Deduct: Total stock-based employee compensation expense determined under fair value based method for all grants, net of tax (23,588) (32,484) (5,850) (11,010) --------- --------- --------- --------- Pro forma income (loss) from continuing operations $(18,105) $(32,010) $ (2,925) $(12,023) ========= ========= ========= ========= Earnings per share: Basic - as reported $ 0.09 $ 0.01 $ 0.05 $(0.02) ======= ======= ======= ======= Basic - pro forma $(0.30) $(0.53) $(0.05) $(0.20) ======= ======= ======= ======= Diluted - as reported $ 0.09 $ 0.01 $ 0.05 * ======= ======= ======= ======= Diluted - pro forma * * * * ======= ======= ======= ======= * As a result of the loss, all options are anti-dilutive. 8. Comprehensive Income -------------------- The components of comprehensive income are as follows: Nine Months Three Months Ended March 31, Ended March 31, ---------------------- --------------------- 2003 2002 2003 2002 ------ ------ ------ ------ (In thousands) Net income (loss) $ 3,345 $(1,011) $ 2,917 $(1,629) Unrealized gain (loss) on interest rate swap agreements, net of tax (97) (37) 7 36 Unrealized investment gain (loss), net of tax - (8) - (3) Foreign currency translation adjustment 1,794 61 109 (28) -------- -------- -------- -------- Total comprehensive income (loss) $ 5,042 $ (995) $ 3,033 $(1,624) ======== ======== ======== ======== 9. Bank Loan Agreements -------------------- On February 14, 2003, the Company executed an amended and restated revolving credit and security agreement with two banks which replaced a previous loan agreement. The amended and restated loan agreement increased the line of credit to $50 million through February 2007, continues the mortgage on the Company's Plainview property for $3.3 million and is secured by the pledge of the stock of certain of the Company's subsidiaries. The interest rate on revolving credit borrowings under this agreement is at various rates depending upon certain financial ratios, with the current rate substantially equivalent to prime (4.25% at March 31, 2003). The Company paid a facility fee of $125,000 and is required to pay a commitment fee of .25% per annum of the average unused portion of the credit line. The mortgage is payable in monthly installments of approximately $26,000 through March 2008 and a balloon payment of $1.6 million in April 2008. The Company has entered into interest rate swap agreements for the outstanding amount under the mortgage agreement at approximately 7.6% in order to reduce the interest rate risk associated with these borrowings. The fair market value of the interest rate swap agreements was $376,000 as of March 31, 2003 in favor of the banks. The terms of the loan agreement require compliance with certain covenants including minimum consolidated tangible net worth and pretax earnings, maintenance of certain financial ratios, limitations on indebtedness and prohibition of the payment of cash dividends. In connection with the purchase of certain materials for use in manufacturing, the Company has a letter of credit of $2.0 million. At March 31, 2003, the Company's available unused line of credit was approximately $46.2 million after consideration of this and other letters of credit. 10. Inventories ----------- Inventories consist of the following: March 31, June 30, 2003 2002 ------------- ------------- (In thousands) Raw materials $ 33,994 $ 34,702 Work in process 26,413 21,939 Finished goods 14,049 15,399 --------- --------- $ 74,456 $ 72,040 ========= ========= 11. Product Warranty ---------------- The Company warrants its products against defects in design, materials and workmanship, generally for one year from their date of shipment. A provision for estimated future costs relating to these warranties is recorded when revenue is recorded and is included in cost of goods sold. Changes in the Company's product warranty liability during the nine months ended March 31, 2003 were as follows: Nine Months Ended March 31, 2003 2002 ---------- ---------- (In thousands) Balance at beginning of period $ 1,500 $ 270 Provision for warranty obligations 1,369 547 Charges incurred (1,552) (527) -------- -------- Balance at end of period $ 1,317 $ 290 ======== ======== 12. Income Taxes ------------ The Company is undergoing routine audits by various taxing authorities of several of its Federal and state income tax returns covering periods from 1997 to 2001. Management believes that the probable outcome of these various audits should not materially affect the consolidated financial statements of the Company. The Company recorded credits of $84,000 and $1.3 million to additional paid-in capital during the nine months ended March 31, 2003 and 2002, respectively, in connection with the tax benefit related to compensation deductions on the exercise of stock options. 13. Contingencies ------------- The Company was served recently with an action commenced by Ricoh Company, Ltd. ("Ricoh"). The action, which is pending in the United States District Court for the District of Delaware, alleges that the Company and several other unrelated defendants are infringing a certain patent owned by Ricoh which purportedly describes a method for designing an application specific integrated circuit. The supplier of software used by the Company in the design of the application specific integrated circuits has agreed to assume the defense of this action pursuant to the supplier's contractual obligation to indemnify the Company against such claims. Accordingly, the Company does not believe that the outcome of the lawsuit will have a materially adverse effect upon its consolidated financial statements. The Company is involved in various other routine legal matters. Management believes the outcome of these matters will not have a materially adverse effect on the Company's consolidated financial statements. 14. Business Segments ----------------- The Company's business segments and major products included in each segment, are as follows: Microelectronic Solutions: Test Solutions: a)Microelectronic Modules a)Instrument Products b)Thin Film Interconnects b)Motion Control Systems c)Integrated Circuits Isolator Products For The Nine Months Ended March 31, Business Segment Data: 2003 2002 ----------- ----------- (In thousands) Net sales: Microelectronic solutions $ 76,668 $ 75,235 Test solutions 124,616 48,983 Isolator products 11,855 11,657 ----------- ----------- Net sales $ 213,139 $ 135,875 =========== =========== Operating income: Microelectronic solutions $ 10,463 $ 8,083 Test solutions 2,928 (106) Isolator products 424 620 General corporate expenses (4,773) (3,319) ----------- ----------- 9,042 5,278 Restructuring charge (1) - (5,050) Interest expense (1,023) (1,138) Other income (expense), net 284 1,666 ----------- ----------- Income before income taxes $ 8,303 $ 756 =========== =========== For The Three Months Ended March 31, 2003 2002 ----------- ----------- (In thousands) Net sales: Microelectronic solutions $ 26,810 $ 27,259 Test solutions 43,934 19,580 Isolator products 4,198 3,732 ----------- ----------- Net sales $ 74,942 $ 50,571 =========== =========== Operating income (loss): Microelectronic solutions $ 4,209 $ 3,144 Test solutions 1,909 1,335 Isolator products 204 78 General corporate expenses (1,885) (1,102) ----------- ----------- 4,437 3,455 Restructuring charge (1) - (5,050) Interest expense (310) (479) Other income (expense), net 293 578 ----------- ----------- Income (loss) before income taxes $ 4,420 $ (1,496) =========== =========== (1) The Microelectronic Solutions segment operating income has been adjusted to exclude the restructuring charge of $5.1 million from the periods ended March 31, 2002 for the closing of the Company's Richardson, Texas facility. Revenues, based on the customers' locations, attributed to the United States and other regions are as follows: For the Nine Months Ended March 31, 2003 2002 -------- -------- (In thousands) United States of America $137,759 $117,115 Europe and Middle East 57,153 12,247 Asia and Australia 14,341 5,249 Rest of World 3,886 1,264 --------- --------- $213,139 $135,875 ========= ========= ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------ ----------------------------------------------------------- AND RESULTS OF OPERATIONS ------------------------- Overview We use our advanced design, engineering and manufacturing abilities to produce microelectronic and testing solutions. Our products are used in the aerospace, defense and broadband communications markets. We also design and manufacture motion control systems and shock and vibration isolation systems which are used for commercial, industrial and defense applications. Our operations are grouped into three segments: o microelectronic solutions o test solutions o isolator products Our consolidated financial statements include the accounts of Aeroflex Incorporated and all of our subsidiaries. All of our subsidiaries are wholly-owned. Our microelectronic solutions segment has been designing, manufacturing and selling state-of-the-art microelectronics for the electronics industry since 1974. In January 1994, we acquired substantially all of the net operating assets of the microelectronics division of Marconi Circuit Technology Corporation, which manufactures a wide variety of microelectronic assemblies. In March 1996, we acquired MIC Technology Corporation which designs, develops, manufactures and markets microelectronic products in the form of passive thin film circuits and interconnects. Effective July 1, 1997, MIC Technology acquired certain equipment, inventory, licenses for technology and patents of two of Lucent Technologies' telecommunications component units - multi-chip modules and film integrated circuits. These units manufacture microelectronic modules and interconnect products. In February 1999, we acquired all of the outstanding stock of UTMC Microelectronic Systems, Inc., consisting of UTMC's integrated circuit business. UTMC designs and supplies radiation tolerant integrated circuits for defense and aerospace communications. Our test solutions segment consists of two divisions: (1) instruments and (2) motion control products, including the following product lines: o Comstron, which we acquired in November 1989. Comstron is a leader in radio frequency and microwave technology used in the manufacture of fast switching frequency signal generators and components. Comstron is currently an operating division of Aeroflex Laboratories Incorporated, one of our wholly-owned subsidiaries. o Lintek, which we acquired in January 1995. Lintek is a leader in high speed instrumentation antenna measurement systems, radar systems and satellite test systems. o Europtest, which we acquired in September 1998. Europtest develops and sells specialized software-driven test equipment used primarily in cellular, satellite and other communications applications. o Altair, which we acquired in October 2000. Altair designs and develops advanced object-oriented control systems software based upon a proprietary software engine. o RDL, which we acquired in October 2000. RDL designs, develops and manufactures advanced commercial communications test and measurement products and defense subsystems. o IFR, which we acquired in May 2002. IFR designs and manufactures advanced test solutions for communications, avionics and general test and measurement applications. o Our motion control products division has been engaged in the development and manufacture of electro-optical scanning devices used in infra-red night vision systems since 1975. Additionally, it is engaged in the design, development and production of stabilization tracking devices and systems and magnetic motors used in satellites and other high reliability applications. Our isolator products segment has been designing, developing, manufacturing and selling severe service shock and vibration isolation systems since 1961. These devices are primarily used in defense applications. In October 1983, we acquired Vibration Mountings & Controls, Inc., which manufactures a line of off-the-shelf rubber and spring shock, vibration and structure borne noise control devices used in commercial and industrial applications. In December 1986, we acquired the operating assets of Korfund Dynamics Corporation, a manufacturer of an industrial line of heavy duty spring and rubber shock mounts. In December 2002, our Board of Directors approved a formal plan to discontinue our fiber optic lithium niobate modulator operation. The plan called for an immediate cessation of operations and disposal of existing assets. The abandonment of the operation resulted in a charge of $2.6 million ($1.7 million, net of tax) in the quarter ended December 31, 2002. The charge included a cash requirement of $1.4 million, primarily for equipment leases and payroll costs, and a non-cash charge of $1.2 million, primarily for the write-off of owned equipment. In accordance with SFAS No. 144, the abandonment has been reported as a discontinued operation and, accordingly, losses from operations and the loss on abandonment have been reported separately from continuing operations. Approximately 35% of our sales for the nine months ended March 31, 2003, 43% of our sales for fiscal 2002 and 29% of our sales for fiscal 2001 were to agencies of the United States government or to prime defense contractors or subcontractors of the United States government. The decrease from fiscal 2002 is primarily due to the acquisition in May 2002 of IFR, which has predominantly commercial customers. As used in this report, "we," "us" and "our" mean Aeroflex Incorporated and its subsidiaries (unless the content indicates otherwise). Nine Months Ended March 31, 2003 Compared to Nine Months Ended March 31, 2002 Net Sales. Net sales increased 56.9% to $213.1 million for the nine months ended March 31, 2003 from $135.9 million for the nine months ended March 31, 2002. Net sales in the microelectronic solutions segment increased 1.9% to $76.7 million for the nine months ended March 31, 2003 from $75.2 million for the nine months ended March 31, 2002 due primarily to increased sales volume of integrated circuits, primarily in the aerospace and defense markets, offset, in part, by decreased sales volume in microelectronic modules and thin film interconnects due to the continuing slowdown of the fiber optic market. Net sales in the test solutions segment increased 154.4% to $124.6 million for the nine months ended March 31, 2003 from $49.0 million for the nine months ended March 31, 2002 due to the acquisition of IFR in May 2002 partially offset by decreased sales volume of communications test and measurement products and satellite test equipment. Net sales in the isolator products segment increased 1.7% to $11.9 million for the nine months ended March 31, 2003 from $11.7 million for the nine months ended March 31, 2002. Gross Profit. Cost of sales includes materials, direct labor and overhead expenses such as engineering labor, fringe benefits, allocable occupancy costs, depreciation and manufacturing supplies. Gross profit increased 66.3% to $81.8 million (38.4% of net sales) for the nine months ended March 31, 2003 from $49.2 million (36.2% of net sales) for the nine months ended March 31, 2002 (excluding a $750,000 restructuring charge. See Note 5 of the Consolidated Financial Statements). The increases were primarily a result of the effect of the acquisition of IFR, which has higher gross margins than our historical average. Selling, General and Administrative Costs. Selling, general and administrative costs include office and management salaries, fringe benefits and commissions. Selling, general and administrative costs increased 72.8% to $50.0 million (23.5% of net sales) for the nine months ended March 31, 2003 from $28.9 million (21.3% of net sales) for the nine months ended March 31, 2002 (excluding a $4.3 million restructuring charge. See Note 5 to the Consolidated Financial Statements). The increase in such expenses was due primarily to the addition of the expenses of IFR. Other Expense (Income). Interest expense was $1.0 million for the nine months ended March 31, 2003 and $1.1 million for the nine months ended March 31, 2002. Other income of $284,000 for the nine months ended March 31, 2003 consists primarily of interest income of $801,000 and other miscellaneous income, partially offset by foreign currency transaction losses of $570,000 and a $180,000 decrease in the fair value of our interest rate swap agreements. Other income of $1.7 million for the nine months ended March 31, 2002 consisted primarily of interest income. Interest income decreased primarily due to lower levels of cash and marketable securities, which were used to acquire IFR, and lower market interest rates. Provision for Income Taxes. The income tax provision was $2.8 million (an effective income tax rate of 34.0%) for the nine months ended March 31, 2003 and $282,000 (an effective income tax rate of 37.3%) for the nine months ended March 31, 2002. The income tax provision for the two periods differed from the amount computed by applying the U.S. Federal income tax rate to income before income taxes primarily due to foreign, state and local income taxes and research and development credits. Income From Continuing Operations. Income from continuing operatons for the nine months ended March 31, 2003 was $5.5 million or $.09 per diluted share, versus $474,000, or $.01 per diluted share, for the nine months ended March 31, 2002. The 2002 amounts include a restructuring charge for the closing of our Richardson, Texas facility of $5.0 million ($3.4 million, net of tax), or $.06 per diluted share. Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002 Net Sales. Net sales increased 48.2% to $74.9 million for the three months ended March 31, 2003 from $50.6 million for the three months ended March 31, 2002. Net sales in the microelectronic solutions segment decreased 1.6% to $26.8 million for the three months ended March 31, 2003 from $27.3 million for the three months ended March 31, 2002 due primarily to decreased sales volume in microelectronic modules and thin film interconnects due to the continuing slowdown of the fiber optic market, offset, in part, by increased sales volume of integrated circuits, primarily in the aerospace and defense markets. Net sales in the test solutions segment increased 124.4% to $43.9 million for the three months ended March 31, 2003 from $19.6 million for the three months ended March 31, 2002 due to the acquisition of IFR in May 2002 partially offset by decreased sales volume of communications test and measurement products and frequency synthesizers. Net sales in the isolator products segment increased 12.5% to $4.2 million for the three months ended March 31, 2003 from $3.7 million for the three months ended March 31, 2002 due to higher sales volume of military isolators. Gross Profit. Gross profit increased 56.4% to $29.7 million (39.7% of net sales) for the three months ended March 31, 2003 from $19.0 million (37.6% of net sales) for the three months ended March 31, 2002 (excluding a $750,000 restructuring charge. See Note 5 to the Consolidated Financial Statements). The increases were primarily a result of the effect of the acquisition of IFR, which has higher gross margins than our historical average. Income From Continuing Operations. Income from continuing operatons for the three months ended March 31, 2003 was $2.9 million or $.05 per diluted share, versus a loss from continuing operations of $(1.0) million, or $(.02) per share, for the three months ended March 31, 2002. The 2002 amounts include a restructuring charge for the closing of our Richardson, Texas facility of $5.0 million ($3.4 million, net of tax), or $.06 per share. Liquidity and Capital Resources As of March 31, 2003, we had $155.5 million in working capital. Our current ratio was 4.4 to 1 at March 31, 2003. On February 14, 2003, we executed an amended and restated revolving credit and security agreement with two banks which replaced a previous loan agreement. The amended and restated loan agreement increased the line of credit to $50 million through February 2007, continues the mortgage on our Plainview property for $3.3 million and is secured by the pledge of the stock of certain of our subsidiaries. The interest rate on revolving credit borrowings under this agreement is at various rates depending upon certain financial ratios, with the current rate substantially equivalent to prime (4.25% at March 31, 2003). The mortgage is payable in monthly installments of approximately $26,000 through March 2008 and a balloon payment of $1.6 million in April 2008. We have entered into interest rate swap agreements for the outstanding amount under the mortgage agreement at approximately 7.6% in order to reduce the interest rate risk associated with these borrowings. The terms of the loan agreement require compliance with certain covenants including minimum consolidated tangible net worth and pretax earnings, maintenance of certain financial ratios, limitations on indebtedness and prohibition of the payment of cash dividends. In connection with the purchase of certain materials for use in manufacturing, we have a letter of credit of $2.0 million. We are currently in full compliance with all of the covenants contained in our loan agreement. For the nine months ended March 31, 2003, our operations provided cash of $10.5 million primarily due to the profitability of operations partially offset by reductions in accounts payable and accrued expenses. For the nine months ended March 31, 2003, our investing activities used cash of $6.3 million primarily for capital expenditures. For the nine months ended March 31, 2003, our financing activities used cash of $877,000 primarily for debt repayments offset, in part, by the proceeds from the exercise of stock options. On May 20, 2002, we acquired 75.1% of the outstanding stock of IFR. Effective June 19, 2002, IFR was merged into a wholly owned subsidiary with IFR as the surviving wholly owned subsidiary. The purchase price was approximately $61.9 million of which $48.8 million was used to fully satisfy IFR's bank indebtedness. The balance was used to purchase IFR's outstanding shares and for various acquisition related costs. The purchase price was paid from available cash and marketable securities. The acquired company's net sales were approximately $117.8 million for the year ended March 31, 2002. During fiscal year 2002, we announced certain strategic consolidations of our manufacturing operations. The total restructuring charges are expected to be $9.3 million with a cash cost of $4.3 million. These restructurings are substantially complete and are expected to reduce annual operating costs by approximately $6.3 million and result in annual cash savings of approximately $5.3 million. The restructuring charges included the elimination of excess equipment capacity (primarily in the microelectronics segment), severance and other employee related expenses. We believe that existing cash and cash equivalents coupled with internally generated funds will be sufficient for our working capital requirements, restructuring charges, capital expenditure needs and the servicing of our debt for the foreseeable future. Our cash and cash equivalents are available to fund acquisitions and other potential large cash needs that may arise. At March 31, 2003, our available unused line of credit was $46.2 million after consideration of letters of credit. The following table summarizes, as of March 31, 2003, our obligations and commitments to make future payments under debt and operating leases: Payments due by period ------------------------------------------------------ Less Than After Total 1 Year 1-3 Years 4-5 Years 5 Years --------- ---------- --------- --------- ------- (In thousands) Long-term debt...... $13,447 $ 1,844 $ 3,154 $ 1,550 $ 6,899 Operating leases.... 32,788 6,021 8,606 4,943 13,218 -------- -------- -------- -------- -------- Total............... $46,235 $ 7,865 $11,760 $ 6,493 $20,117 ======== ======== ======== ======== ======== The operating lease commitments shown in the above table have not been reduced by future minimum sub-lease rentals of $16.3 million. In the normal course of business, we routinely enter into binding and non-binding purchase obligations primarily covering anticipated purchases of inventory and equipment. None of these obligations are individually significant. We do not expect that these commitments as of March 31, 2003 will materially adversely affect our liquidity. Accounting Policies Involving Significant Estimates The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the recognition of revenue and expenses during the period reported. The following accounting policies require us to make estimates and assumptions based on the circumstances, information available and our experience and judgment. These estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the period that they are determined to be necessary. If actual results differ significantly from our estimates, our financial statements could be materially impacted. Revenue and Cost Recognition Under Long-Term Contracts - ------------------------------------------------------ Our revenue is generally recognized based upon shipments. Revenues associated with certain long-term contracts are recognized under the units-of-delivery method that includes shipments and progress billings, in accordance with Statement of Position 81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts." We record costs on our long-term contracts using percentage-of-completion accounting. Under percentage of completion accounting, costs are recognized on revenues in the same relation that total estimated manufacturing costs bear to the total contract value. Estimated costs at completion are based on engineering and production estimates. Estimates are reviewed on a regular basis throughout the life of these contracts. Provisions for estimated losses or revisions in estimated profits on contracts-in-process are recorded in the period in which such losses or revisions are first determined. Revisions to profits recognized to date could be required in future periods and may have a material effect on our results of operations and financial condition. Inventories - ----------- Inventories are stated at the lower of cost (first-in, first-out) or market. Inventory levels are maintained in relation to the expected sales volume. We periodically evaluate the net realizable value of our inventory. Numerous analyses are applied including lower of cost or market analysis, forecasted sales requirements and forecasted warranty requirements. After taking these and other factors into consideration, such as technological changes, age and physical condition, appropriate adjustments are recorded to the inventory balance. If actual conditions differ from our expectations, then inventory balances may be over or under valued, which could have a material effect on our results of operations and financial condition. Recoverability of Long-Lived and Intangible Assets - -------------------------------------------------- Property, plant and equipment are stated at cost less accumulated depreciation computed on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the life of the lease or the estimated life of the asset, whichever is shorter. Changes in circumstances such as technological advances or changes to the Company's business model can result in the actual useful lives differing from the Company's estimates. To the extent the estimated useful lives are incorrect, the value of these assets may be over or under stated which in turn could have a material effect on our results of operations and financial condition. Long-lived assets, other than goodwill, are reviewed for impairment periodically and whenever events or changes in circumstances indicate that the carrying value of any such asset may be impaired. We evaluate the recoverability of such assets by estimating future cash flows. If the sum of the undiscounted cash flows expected to result from the use of the assets and their eventual disposition is less than the carrying amount of the assets, we will recognize an impairment loss to the extent of the excess of the carrying amount of the assets over the discounted cash flow. SFAS 142 requires that we perform an annual assessment of whether there is an indication that goodwill is impaired unless events or circumstances warrant a more frequent assessment. The impairment assessment involves, among other things, an estimate of the fair value of each of the Company's reporting units (as defined in SFAS 142). Such estimates involve forward looking assessments, are inherently subjective, and are subject to change in future periods. If the impairment review of goodwill, intangible assets and other long-lived assets differ significantly from actual results, it could have a material effect on our results of operations and financial condition. Restructuring - ------------- When circumstances warrant a restructuring charge, we estimate and record all appropriate expenses. These expenses include severance, fringe benefits, asset impairment, buyout of leases and inventory write-downs. To the extent that our estimates differ from actual expenses incurred, there could be significant additional expenses or reversals of previously recorded charges in the future. Income Taxes - ------------ The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions. If this assumption changes in the future, we may be required to record additional valuation allowances against our deferred tax assets resulting in additional income tax expense in our consolidated statement of operations. We evaluate the realizability of the deferred tax assets and assess the adequacy of the valuation allowance quarterly. Recent Accounting Pronouncements In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. We adopted SFAS No. 144 effective July 1, 2002. The adoption did not have any impact on our consolidated financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which will be effective for exit and disposal activities initiated after December 31, 2002. SFAS No. 146 provides that an exit cost liability should not always be recorded at the date of an entity's commitment to an exit plan, but instead should be recorded when the obligation is incurred and measured at fair value. An entity's commitment to a plan, by itself, does not create an obligation that meets the definition of a liability. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires certain guarantees to be recorded at fair value regardless of the probability of the loss. We have adopted FIN 45 prospectively as of January 1, 2003. The adoption did not have any impact on the consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock- based employee compensation as originally provided by SFAS No. 123 "Accounting for Stock-Based Compensation." Additionally, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 in both annual and interim financial statements. We have adopted the disclosure portion of this statement for the fiscal quarter ended March 31, 2003. The adoption did not have any impact on our consolidated financial position or results of operations. In November 2002, the Emerging Issues Task Force (EITF) finalized EITF Issue 00-21, "Revenue Arrangements with Multiple Deliverables", which provides guidance on the timing and method of revenue recognition for sales arrangements that include the delivery of more than one product or service. EITF Issue 00-21 is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. We are currently analyzing the impact of its adoption on our consolidated financial statements. Forward-Looking Statements All statements other than statements of historical fact included in this Report on Form 10-Q, including without limitation, statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding our financial position, business outlook, business strategy and plans and objectives of our management for future operations, are forward-looking statements. When used in this Report on Form 10-Q, words such as "anticipate," "believe," "estimate," "expect," "intend" and similar expressions, as they relate to us or our management, identify forward-looking statements. Such forward-looking statements are based on the current beliefs of our management, as well as assumptions made by and information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements, as a result of certain factors, including but not limited to, competitive factors and pricing pressures, the integration of the business of IFR, changes in legal and regulatory requirements, technological change or difficulties, product development risks, commercialization difficulties and general economic conditions. Such statements reflect our current views with respect to the future and are subject to these and other risks, uncertainties and assumptions relating to our financial condition, results of operations, growth strategy and liquidity. We undertake no obligation to update such forward-looking statements which are made as of the date of this Report. ITEM 3 - QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - ------ -------------------------------------------------------- We are exposed to market risk related to changes in interest rates and to foreign currency exchange rates. Most of our debt is at fixed rates of interest or at a variable rate with an interest rate swap agreement which effectively converts the variable rate debt into fixed rate debt. Therefore, if market interest rates increase by 10 percent from levels at March 31, 2003, the effect on our net income would be a reduction of approximately $17,000 per year. Most of our invested cash and cash equivalents are at variable rates of interest. If market interest rates decrease by 10 percent from levels at March 31, 2003, the effect on our net income would be a decrease of approximately $36,000 per year. We operate businesses that are located outside of the United States, which exposes us to the fluctuation of foreign currency exchange rates (primarily the British Pound and the Euro). If foreign currency exchange rates change by 10% from levels at March 31, 2003, the effect on our other comprehensive income would be approximately $4.1 million. ITEM 4 - CONTROLS AND PROCEDURES - ------ ----------------------- On May 5, 2003, there were meetings held under the supervision of our management, including our Chairman of the Board, who is our Chief Executive Officer, and our President, who is our Chief Financial Officer, during which there was an evaluation of the effectiveness of our disclosure controls and procedures. Our Chairman and President have advised us that based on such evaluation, they believe such controls and procedures are effective. Our Chairman of the Board and our President are involved in ongoing evaluations of internal controls. In May 2003, in anticipation of the filing of this Form 10-Q, they reviewed the most recent evaluation of our internal controls prepared by our internal audit department. There have been no significant changes in our internal controls or in other factors that would significantly affect our internal controls subsequent to such evaluation. AEROFLEX INCORPORATED AND SUBSIDIARIES PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company was served recently with an action commenced by Ricoh Company, Ltd. ("Ricoh"). The action, which is pending in the United States District Court for the District of Delaware, alleges that the Company and several other unrelated defendants are infringing a certain patent owned by Ricoh which purportedly describes a method for designing an application specific integrated circuit. The supplier of software used by the Company in the design of the application specific integrated circuits has agreed to assume the defense of this action pursuant to the supplier's contractual obligation to indemnify the Company against such claims. Accordingly, the Company does not believe that the outcome of the lawsuit will have a materially adverse effect upon its consolidated financial statements. Item 2. Changes in Securities None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 99.1 Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AEROFLEX INCORPORATED (REGISTRANT) May 15, 2003 By: /s/Michael Gorin -------------------------------- Michael Gorin President, Chief Financial Officer and Principal Accounting Officer CERTIFICATION I, Harvey R. Blau, Chairman of the Board of Aeroflex Incorporated, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Aeroflex Incorporated; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/Harvey R. Blau ---------------------------- Harvey R. Blau Chairman of the Board (Principal Executive Officer) CERTIFICATION I, Michael Gorin, President of Aeroflex Incorporated, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Aeroflex Incorporated; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/Michael Gorin --------------------------- Michael Gorin President (Principal Financial Officer)