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EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - API Technologies Corp.d216030dex321.htm
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EX-31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF CHIEF FINANCIAL OFFICER - API Technologies Corp.d216030dex312.htm
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EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - API Technologies Corp.d216030dex322.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended August 31, 2011

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-35214

 

 

API TECHNOLOGIES CORP.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   98-0200798

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

4705 S. Apopka Vineland Rd. Suite 210

Orlando, FL 32819

(Address of Principal Executive Offices)

(407) 876-0279

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant: (1) filed all reports required to be filed by Section 13 and 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined Rule 12b-2 of the Exchange Act).

 

Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   ¨    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

State the number of shares outstanding of each of the issuer’s class of common equity as of the latest practicable date:

54,566,786 shares of common stock with a par value of $0.001 per share at October 1, 2011.

 

 

 


Table of Contents

API TECHNOLOGIES CORP. AND SUBSIDIARIES

Report on Form 10-Q

Quarter Ended August 31, 2011

Table of Contents

 

          Page  

PART I—FINANCIAL INFORMATION

  
Item 1.    Financial Statements   
  

Consolidated Balance Sheets (unaudited) at August 31, 2011 and May 31, 2011

     3   
  

Consolidated Statements of Operations (unaudited) for the three months ended August 31, 2011 and
August 31, 2010

     4   
  

Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the three months ended
August 31, 2011

     5   
  

Consolidated Statements of Cash Flows (unaudited) for the three months ended August 31, 2011 and
August 31, 2010

     6   
  

Notes to Consolidated Financial Statements (unaudited)

     7   
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   
  

Forward Looking Statements

     27   
Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     28   

Item 4.

  

Controls and Procedures

     29   
PART II—OTHER INFORMATION   
Item 1.   

Legal Proceedings

     30   
Item 1A.   

Risk Factors

     30   
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     30   
Item 3.   

Defaults Upon Senior Securities

     30   
Item 4.   

Removed and Reserved

     30   
Item 5.   

Other Information

     30   
Item 6.   

Exhibits

     30   
Signatures      32   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

API TECHNOLOGIES CORP.

Consolidated Balance Sheets

Unaudited

 

     Aug. 31,
2011
    May 31,
2011
 

Assets

    

Current

    

Cash and cash equivalents

   $ 16,155,080      $ 108,417,312   

Accounts receivable, less allowance for doubtful accounts of $1,325,491 and $173,002 at August 31, 2011 and May 31, 2011, respectively

     47,053,349        16,823,884   

Inventories, net (note 6)

     74,481,387        31,629,092   

Deferred income taxes

     6,216,500        —     

Prepaid expenses and other current assets

     2,753,114        1,012,326   
  

 

 

   

 

 

 
     146,659,430        157,882,614   

Fixed assets, net

     45,138,634        16,430,972   

Fixed assets held for sale (note 2)

     3,216,082        150,000   

Goodwill

     234,860,957        90,300,834   

Intangible assets, net

     73,284,882        8,407,302   

Other non-current assets

     8,275,452        —     
  

 

 

   

 

 

 

Total assets

   $ 511,435,437      $ 273,171,722   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Current

    

Short-term debt (note 8)

   $ —        $ 4,372,025   

Accounts payable and accrued expenses

     41,920,520        24,351,331   

Deferred revenue

     1,277,771        546,234   

Current portion of long-term debt (note 10)

     2,528,151        243,957   
  

 

 

   

 

 

 
     45,726,442        29,513,547   

Deferred income taxes

     15,958,129        —     

Long-term debt, net of current portion (note 10)

     165,701,435        1,931,973   
  

 

 

   

 

 

 
     227,386,006        31,445,520   
  

 

 

   

 

 

 

Commitments and contingencies (note 15)

    

Shareholders’ equity

    

Common stock, ($0.001 par value, 100,000,000 authorized shares, 54,566,786 and 49,142,278 shares issued and outstanding at August 31, 2011 and May 31, 2011, respectively)

     54,567        49,142   

Special voting stock ($0.01 par value, 1 share authorized, issued and outstanding at August 31, 2011 and May 31, 2011, respectively)

     —          —     

Additional paid-in capital

     322,547,640        290,712,580   

Common stock subscribed but not issued

     2,373,000        2,373,000   

Accumulated deficit

     (41,322,351     (51,694,233

Accumulated other comprehensive income

     396,575        285,713   
  

 

 

   

 

 

 
     284,049,431        241,726,202   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 511,435,437      $ 273,171,722   
  

 

 

   

 

 

 

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

 

3


Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statements of Operations

 

     Three Months Ended
August 31,
 
     2011
(Unaudited)
    2010
(Unaudited)
 

Revenue, net

   $ 69,231,222      $ 29,123,545   

Cost of revenues

    

Cost of revenues

     52,613,851        21,892,977   

Restructuring charges (note 17)

     9,380        299,651   
  

 

 

   

 

 

 

Total cost of revenues

     52,623,231        22,192,628   
  

 

 

   

 

 

 

Gross profit

     16,607,991        6,930,917   

Operating expenses

    

General and administrative

     7,499,305        3,460,251   

Selling expenses

     4,450,159        1,112,618   

Research and development

     2,405,514        531,494   

Business acquisition and related charges

     —          94,081   

Restructuring charges

     671,224        604,573   
  

 

 

   

 

 

 
     15,026,202        5,803,017   
  

 

 

   

 

 

 

Operating income

     1,581,789        1,127,900   

Other (income) expenses, net

    

Interest expense, net

     4,259,495        1,268,874   

Other income, net

     (51,825     (771,513
  

 

 

   

 

 

 
     4,207,670        497,361   
  

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     (2,625,881     630,539   

Provision (benefit) for income taxes

     (12,997,763     3,112   
  

 

 

   

 

 

 

Income from continuing operations

     10,371,882        627,427   

Income from discontinued operations, net of tax

     —          129,667   
  

 

 

   

 

 

 

Net Income

   $ 10,371,882      $ 757,094   
  

 

 

   

 

 

 

Income per share from continuing operations—Basic and diluted

   $ 0.20      $ 0.07   

Income per share from discontinued operations—Basic and diluted

   $ 0.00      $ 0.01   
  

 

 

   

 

 

 

Net income per share—Basic and diluted

   $ 0.20      $ 0.08   
  

 

 

   

 

 

 

Weighted average shares outstanding

    

Basic

     52,404,074        8,908,172   

Diluted

     52,416,071        9,394,839   

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

 

4


Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited)

 

    Common
stock-
number
of shares
    Common
stock

amount
    Additional
paid-in capital
    Common
stock
subscribed

but not issued
    Accumulated
deficit
    Accumulated
other
comprehensive
income
    Total
shareholders’
equity
 

Balance at May 31, 2011

    49,142,278      $ 49,142      $ 290,712,580      $ 2,373,000      $ (51,694,233   $ 285,713      $ 241,726,202   

Stock-based compensation expense

    —          —          45,363        —          —          —          45,363   

Stock issued as part of private placement (Note 11)

    5,091,958        5,092        29,942,684        —          —          —          29,947,776   

Stock issued from stock option exercises (Note 12)

    332,550        333        1,847,013        —          —          —          1,847,346   

Net income for the period

    —          —          —          —          10,371,882        —          10,371,882   

Foreign currency translation adjustment

    —          —          —          —          —          110,862        110,862   

Total comprehensive loss

    —          —          —          —          —          —          10,482,744   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at August 31, 2011

    54,566,786      $ 54,567      $ 322,547,640      $ 2,373,000      $ (41,322,351   $ 396,575      $ 284,049,431   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

5


Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statements of Cash Flows

 

     Three Months Ended
August 31,
 
     2011     2010  

Cash flows from operating activities

    

Net income

   $ 10,371,882      $ 757,094   

Less: Income from discontinued operations

     —          (129,667

Adjustments to reconcile net income to net cash used by operating activities:

    

Depreciation and amortization

     4,445,665        392,855   

Amortization of deferred financing costs

     600,422        —     

Amortization of note discounts

     —          249,764   

Write down of fixed assets held for sale

     —          451,745   

Stock based compensation

     45,363        341,137   

Gain on sale of fixed assets

     —          (761,354

Deferred income taxes

     (13,514,367     219   

Changes in operating asset and liabilities, net of business acquisitions

    

Accounts receivable

     (6,002,174     439,142   

Inventories

     (7,088,829     5,824,149   

Prepaid expenses and other current assets

     314,025        14,308   

Accounts payable and accrued expenses

     (1,155,361     (4,028,475

Deferred revenue

     478,034        (4,120,493
  

 

 

   

 

 

 

Net cash used by continuing activities

     (11,505,340     (569,576

Net cash provided (used) by discontinued operations

     —          2,176,314   
  

 

 

   

 

 

 

Net cash provided (used) by operating activities

     (11,505,340     1,606,738   

Cash flows from investing activities

    

Purchase of long-lived assets

     (667,917     (700,654

Proceeds from disposal of fixed assets

     —          1,569,208   

Business acquisitions net of cash acquired of $4,141,305, and $0 (note 4a)

     (266,122,767     —     
  

 

 

   

 

 

 

Net cash provided (used) by investing activities

     (266,790,684     868,554   

Cash flows from financing activities

    

Proceeds on issuance of common shares

     31,795,122        —     

Repurchase and retirement of common shares

     —          (51,641

Short-term borrowings advances (repayments), net

     (4,372,025     76,967   

Repayment of long-term debt (note 10)

     (7,193     (1,065,823

Net proceeds—long-term debt (note 10)

     158,643,281        —     
  

 

 

   

 

 

 

Net cash provided (used) by financing activities

     186,059,185        (1,040,497

Effect of exchange rate on cash and cash equivalents

     (25,393     (165,926
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (92,262,232     1,268,869   

Cash and cash equivalents, beginning of period—continuing operations

     108,417,312        4,496,025   

Cash and cash equivalents, beginning of period—discontinued operations

     —          15,593   
  

 

 

   

 

 

 

Cash and cash equivalents, beginning of period

     108,417,312        4,511,618   

Cash and cash equivalents, end of period

   $ 16,155,080      $ 5,780,487   

Less: cash and cash equivalents of discontinued operations, end of period

     —          10,100   
  

 

 

   

 

 

 

Cash and cash equivalents of continuing operations, end of period

   $ 16,155,080      $ 5,770,387   
  

 

 

   

 

 

 

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

 

6


Table of Contents

API Technologies Corp.

Notes to Consolidated Financial Statements

(Unaudited)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Nature of Business

API Technologies Corp. (“API”, and together with its subsidiaries, the “Company”), designs, develops and manufactures high reliability engineered solutions, RF, sensors and measurement, power systems management technology, systems, secure communications and electronic components for military and aerospace applications, including mission critical information systems and technologies.

On June 1, 2011, the Company completed the acquisition of Spectrum Control Inc. (“the Spectrum Merger”) provided for in the Agreement and Plan of Merger (the “Spectrum Agreement”), entered into on March 28, 2011 by the Company, Spectrum Control, Inc. (“Spectrum”), and Erie Merger Corp. (“Merger Sub”), a wholly owned subsidiary of the Company. Spectrum is a leading designer and manufacturer of high performance, custom solutions for the defense, aerospace, industrial, and medical industries headquartered in Fairview, Pennsylvania. Pursuant to the terms and conditions of the Spectrum Agreement, Merger Sub was merged with and into Spectrum. Upon effectiveness of the Spectrum Merger, each outstanding share of common stock of Spectrum, other than shares owned by Spectrum or their subsidiaries, was converted into the right to receive $20.00 in cash, without interest. Also upon the effectiveness of the Spectrum Merger, each outstanding option to purchase shares of common stock of Spectrum was accelerated so that it became fully vested and received in cash the product of the excess, if any, of $20.00 less the exercise price per option multiplied times the number of shares of Spectrum common stock issuable upon exercise of such option. The total purchase price was approximately $270,264,000 (see Note 4a).

On January 9, 2011, API entered into an Agreement and Plan of Merger, (the “Merger Agreement”) with Vintage Albany Acquisition, LLC, a Delaware limited liability company (“Vintage”), and API Merger Sub, Inc., a New York corporation (“Sub”), pursuant to which the Company acquired SenDEC Corp., a New York corporation (“SenDEC”) (the “Merger”). SenDEC is a leading defense electronics manufacturing services company headquartered in Fairport, New York. In the Merger, API acquired all of the equity of SenDEC, which included SenDEC’s electronics manufacturing operations and approximately $30 million of cash, in exchange for the issuance of 22,000,000 shares of API Common Stock to Vintage (see Note 4b).

The Merger closed on January 21, 2011, immediately after the January 21, 2011 closing of the acquisition by Vintage of SenDEC, pursuant to the Agreement and Plan of Merger, entered into on January 9, 2011 and amended on January 19, 2011 (the “First Merger Agreement”) among Vintage, SenDEC, and South Albany Acquisition Corp., and Kenton W. Fiske, as Stockholder Representative, (the “First Merger”). API succeeded to the rights, and assumed the obligations, of Vintage under the First Merger Agreement among Vintage, including without limitation, the obligation to pay former SenDEC shareholders up to $14 million in earn-out payments, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC (the “Earn-Out Payment”). In addition to the Earn-Out Payment, under the First Merger Agreement, the Company has the obligation to pay the former shareholders of SenDEC on or before July 31, 2011 an amount relating to certain tax benefits realized by SenDEC relating to the payment of certain bonuses and the conversion of SenDEC’s options in connection with the First Merger (the “Special Payment”). In addition, certain SenDEC employees will be eligible for a bonus under a management bonus plan of up to $11 million, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC.

On December 28, 2010, API effected a 1-for-4 reverse stock split of its common stock. Each stockholder of record at the close of business on December 28, 2010 received one share for every four outstanding shares held on that date. All the references to number of shares, options and warrants presented in these consolidated financial statements have been adjusted to reflect the post split number of shares.

The unaudited consolidated financial statements include the accounts of API and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. There are no other entities controlled by the Company, either directly or indirectly. The financial statements have been prepared in accordance with the requirements of Form 10-Q and Regulation S-X of the Securities and Exchange Commission (the “SEC”).

Accordingly, certain information and footnote disclosures required in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. On June 3, 2011, our Board of Directors approved a change in our fiscal year end from May 31 to November 30, with the change to the reporting cycle beginning December 1, 2011. Statements are subject to possible adjustments in connection with the audit of the Company’s accounts for the six months ended November 30, 2011. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for the fair presentation of the Company’s consolidated financial position as of August 31, 2011 and the results of its operations and cash flows for the three month period ended August 31, 2011. Results for the interim period are not necessarily indicative of results that may be expected for the entire year or for any other interim periods. The unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements of the Company and the notes thereto as of and for the fiscal year ended May 31, 2011 included in the Company’s Form 10-K filed with the SEC on August 26, 2011.

 

7


Table of Contents

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts in the consolidated financial statements, and the disclosures made in the accompanying notes. Examples of estimates include the provisions made for bad debts and obsolete inventory, estimates associated with annual goodwill impairment tests, and estimates of deferred income tax and liabilities. The Company also uses estimates when assessing fair values of assets and liabilities acquired in business acquisitions as well as any fair value and any related impairment charges related to the carrying value of machinery and equipment, other long-lived assets, fixed assets held for sale and discontinued operations. The Company also uses estimates in determining the remaining economic lives of long-lived assets. In addition, the Company uses assumptions when employing the Black-Scholes valuation model to estimate the fair value of share options. Despite the Company’s intention to establish accurate estimates and use reasonable assumptions, actual results may differ from these estimates.

Inventories

Inventories, which include materials, labor, and manufacturing overhead, are stated at the lower of cost (on a first-in, first-out basis) or net realizable value. The Company records a provision for both excess and obsolete inventory when write-downs or write-offs are identified. The inventory valuation is based upon assumptions about future demand, product mix and possible alternative uses.

The Company periodically reviews and analyzes its inventory management systems, and conducts inventory impairment testing on an annual basis.

Fixed Assets

Fixed assets are recorded at cost less accumulated depreciation and are depreciated using the following methods over the following periods:

 

Straight line basis

    

Buildings and leasehold improvements

   5-40 years

Computer equipment

   3 years

Furniture and fixtures

   5 years

Machinery and equipment

   5-10 years

Vehicles

   3 years

Betterments are capitalized and amortized by the Company, using the same amortization basis as the underlying assets over the remaining useful life of the original asset. Betterments include renovations, major repairs and upgrades that increase the service of a fixed asset and extend the useful life. Gains and losses on depreciable assets retired or sold are recognized in the consolidated statements of operations in the year of disposal. Repairs and maintenance expenditures are expensed as incurred.

Fixed Assets Held for Sale

Fixed assets held for sale have been classified as held for sale in the consolidated balance sheets. The Company estimated the fair value of the net assets to be sold at approximately $3,216,000 at August 31, 2011 compared to $150,000 at May 31, 2011. The increase is attributed to the classification of two buildings from the Spectrum acquisition as held for sale as a result of initiatives to consolidate operational activities.

Discontinued Operations

Components of the Company that have been disposed of are reported as discontinued operations. The assets and liabilities relating to API Nanofabrication and Research Corporation (“NanoOpto”) have been reclassified as discontinued operations in the consolidated balance sheets for fiscal 2011 and the results of operations of NanoOpto for the current and prior periods are reported as discontinued operations (Note 5) and not included in the continuing operations figures.

Goodwill and Intangible Assets

Goodwill and intangible assets result primarily from business acquisitions accounted for under the purchase method. Goodwill and intangible assets with indefinite lives are not amortized but are subject to impairment by applying a fair value based test.

 

8


Table of Contents

The Company has two reporting units: (i) Systems & Subsystems and (ii) Secure Systems & Information Assurance. The goodwill in the consolidated financial statements relates to the acquisition of Spectrum in June 2011, the acquisition of SenDEC in January 2011the acquisition of the assets of Kuchera Defense Systems, Inc. (“KDS”), KII, Inc. (“KII”) and Kuchera Industries, LLC (“KI Industries” and collectively with KDS and KII, the “KGC Companies”) in January 2010, and the acquisition of the Filtran Group companies, which was completed in 2002. All of the goodwill relates to our Systems & Subsystems reporting unit. Goodwill represents the excess of the purchase price of acquired companies over the estimated fair value assigned to the individual assets acquired and liabilities assumed. The Company does not amortize goodwill but instead tests goodwill for impairment annually (on August 31) or more frequently if impairment indicators arise under the applicable accounting guidance.

A two-step test is performed to assess goodwill impairment. First, the fair value of each reporting unit is compared to its carrying value. The fair value is based on the discounted future cash flows of the subsidiary carrying the goodwill. If discounted future cash flows exceed the carrying value of the assets, goodwill is not impaired and no further testing is performed. The second step is performed if the carrying value exceeds the fair value of the goodwill. If the carrying value of the reporting unit’s goodwill exceeds its implied fair value, an impairment loss equal to the difference is recorded.

Following the required accounting guidance, the Company performed the first step of the two-step test method based on discounted future cash flows on September 1, 2011. The respective reporting units’ future cash flows exceeded the carrying value of the underlying assets and therefore goodwill was not impaired and no further testing was required.

Intangible assets that have a finite life are amortized using the following basis over the following periods:

 

Non-compete agreements    Straight line over 5 years
Computer software    Straight line over 3-5 years
Customer related intangibles    Straight line or the pattern in which the
economic benefits are expected to be
realized, over an estimated life of
4-15 years
Marketing related intangibles    The pattern in which the economic benefits
are expected to be realized, over an
estimated life of 3-10 years
Technology related intangibles    The pattern in which the economic benefits
are expected to be realized, over an
estimated life of 10 years

Long-Lived Assets

The Company periodically evaluates the net realizable values of long-lived assets, principally identifiable intangibles and capital assets, for potential impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, as determined based on the estimated future undiscounted cash flows. If such assets were considered to be impaired, the carrying value of the related assets would be reduced to their estimated fair value.

Income Taxes

Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial reporting and tax bases of assets and liabilities and available net operating loss carry forwards. A valuation allowance is established to reduce tax assets if it is more likely than not that all or some portions of such tax assets will not be realized.

The Company’s valuation allowance was recorded on the deferred tax assets to provide for a reasonable provision, which in the Company’s estimation is more likely than not that all or some portions of such tax assets will not be realized. In determining the adequacy of the valuation allowance, the Company applied the authoritative guidance, and considered such factors as (i) which subsidiaries were producing income and which subsidiaries were producing losses and (ii) temporary differences occurring from depreciation and amortization which the Company expects to increase the taxable income over future periods.

The Company follows the guidance concerning accounting for uncertainty in income taxes, which clarifies the accounting and disclosure for uncertainty in tax positions. The guidance requires that the Company determine whether it is more likely than not that a tax position will not be sustained upon examination by the appropriate taxing authority. If a tax position does not meet the more likely than not recognition criterion, the guidance requires that the tax position be measured at the largest amount of benefit greater than 50 percent not likely of being sustained upon ultimate settlement.

Based on the Company’s evaluation, management has concluded that there are no significant uncertain tax positions requiring recognition in the consolidated financial statements or adjustments to deferred tax assets and related valuation allowance. Open tax years include the tax years ended May 31, 2006 through 2011.

 

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The Company from time to time has been assessed interest or penalties by major tax jurisdictions, however such assessments historically have been minimal and immaterial to our financial results. If the Company receives an assessment for interest and/or penalties, it would be classified in the consolidated financial statements as general and administrative expense.

Revenue Recognition

The Company recognizes non-contract revenue when it is realized or realizable and earned. The Company considers non-contract revenue realized or realizable and earned when it has persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. Delivery is not considered to have occurred until products have been shipped and risk of loss and ownership has transferred to the client. Revenue from contracts is recognized using the percentage of completion method. The degree of completion is determined based on costs incurred, excluding costs that are not representative of progress to completion, as a percentage of total costs anticipated for each contract. A provision is made for losses on contracts in progress when such losses first become known. Revisions in cost and profit estimates, which can be significant, are reflected in the accounting period in which the relevant facts become known. Revenue from contracts under the percentage of completion method is not significant to the financial statements.

Deferred Revenue

The Company defers revenue when payment is received in advance of the service or product being shipped or delivered. For some of the larger government contracts, the Company will bill upon meeting certain milestones. These milestones are established by the customer and are specific to each contract. Unearned revenue is recorded as deferred revenue. The Company generally recognizes revenue on the contracts when items are shipped.

Research and Development

Research and development costs are expensed when incurred.

Stock-Based Compensation

The Company follows the authoritative guidance for accounting for stock-based compensation. The guidance requires that new, modified and unvested stock-based payment transactions with employees, such as grants of stock options, restricted stock units (“RSUs”) and restricted stock, be recognized in the financial statements based on their fair value at the grant date and recognized as compensation expense over their vesting periods. Stock-based compensation cost for RSUs is measured based on the closing fair market value of the Company’s common stock on the date of grant. The fair value of each option granted is estimated on the grant date using the Black-Scholes option pricing model which takes into account as of the grant date the exercise price and expected life of the option, the current price of the underlying shares and its expected volatility, expected dividends on the shares and the risk-free interest rate for the term of the option.

Foreign Currency Translation and Transactions

The Company’s functional currency is United States dollars and the consolidated financial statements are stated in United States dollars, “the reporting currency.” Integrated operations have been translated from various foreign currencies (Canadian dollars, British Pounds Sterling, Chinese Yuan, Euros, and Mexican Pesos) into United States dollars at the period-end exchange rate for monetary balance sheet items, the historical rate for fixed assets and shareholders’ equity, and the average exchange rate for the year for revenues, expenses, gains and losses. The gains or losses on translation are included as a component of other comprehensive income (loss) for the period.

Financial Instruments

The fair values of financial instruments including cash and cash equivalents, marketable securities, accounts receivable, accounts payable, and short-term borrowings approximate their carrying values due to the short-term nature of these instruments. Unless otherwise noted, it is management’s opinion that the Company is not exposed to significant interest rate, currency or credit risks arising from its financial instruments. Marketable securities are included at fair value based on quoted market prices in active markets. The recorded value of long-term debt approximates the fair value of the debt as the terms and rates approximate market rates.

In the ordinary course of business, the Company carries out transactions in various foreign currencies (Canadian Dollars, British Pounds Sterling, Chinese Yuan, Euros, and Mexican Pesos) included in the Company’s cash, accounts receivable, accounts payable, bank indebtedness, as well as a mortgage loan. The translation adjustments related to these accounts have been reflected as a component of comprehensive income. Currently, the Company does not maintain a foreign currency hedging program.

 

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Debt Issuance Costs and Long-term Debt Discount

Fees paid to obtain debt financing or amendments under such debt financing are treated as debt issuance costs and are capitalized and amortized over the life of the debt using the effective interest method. These payments are shown as a financing activity on the consolidated statement of cash flows and are shown as Other non-current assets in the consolidated balance sheets.

In accordance with accounting standards the Company recognized the value of detachable warrants issued in conjunction with the issuance of the secured promissory notes and the modification of the convertible promissory notes. The Company valued the warrants using the Black-Scholes pricing model. The Company recorded the warrant relative fair value as an increase to additional paid-in capital and a discount against the related debt. The discount attributed to the value of the warrants was being amortized over the term of the underlying debt using the effective interest method. During the year ended May 31, 2011, following the repayment of the secured promissory notes and the conversion of the convertible promissory notes, the remaining discount attributed to the value of the warrants was recorded in Other income, net.

Concentration of Credit Risk

The Company maintains cash balances, at times, with financial institutions, which are in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC), Canadian Deposit Insurance Corporation (CDIC) and Financial Services Compensation Scheme (FSCS in the United Kingdom). Management monitors the soundness of these institutions and has not experienced any collection losses with these institutions.

The US, Canadian and United Kingdom Governments’ Departments of Defense (directly and through subcontractors) accounts for approximately 52%, 1% and 5% of the Company’s revenues for the three months ended August 31, 2011 (72%, 5% and 4% for the three months ended August 31, 2010), respectively. One of the US customers, a defense prime contractor, represented approximately 8% of revenues for the three months ended August 31, 2011 (42% of revenues for the three months ended August 31, 2010). A loss of a significant customer could adversely impact the future operations of the Company.

Earnings per Share of Common Stock

Basic earnings per share of common stock is computed by dividing income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share of common stock gives effect to all dilutive potential shares of common stock outstanding during the period. The computation of diluted earnings per share does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on earnings per share (Note 14).

Comprehensive Income (Loss)

Comprehensive income (loss), which includes foreign currency translation adjustments and unrealized gains on marketable securities, is shown in the Consolidated Statement of Changes in Shareholders’ Equity.

Comparative Reclassifications

Certain amounts from May 31, 2011 have been reclassified to conform to the August 31, 2011 financial statement presentation. The reclassifications include the income per share amounts due to the one-for-four reverse stock split of the Company’s outstanding common shares and exchangeable shares (see note 11).

3. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS

Recently Adopted Accounting Pronouncements

In October 2009, the FASB issued guidance related to revenue recognition for arrangements with multiple deliverables. This guidance eliminates the residual method of allocation and requires the relative selling price method when allocating deliverables of a multiple-deliverable revenue arrangement. The determination of the selling price for each deliverable requires the use of a hierarchy designed to maximize the use of available objective evidence including, vendor specific objective evidence, third party evidence of selling price, or estimated selling price. The guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and must be adopted in the same period using the same transition method. If adoption is elected in a period other than the beginning of a fiscal year, the amendments in these standards must be applied retrospectively to the beginning of the fiscal year. Full retrospective application of these amendments to prior fiscal years is optional. Early adoption of these standards may be elected. The adoption of this accounting guidance, effective June 1, 2011, did not have any impact on the Company’s consolidated financial condition, results of operations, and cash flows for the three months ended August 31, 2011.

 

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4. ACQUISITIONS

a) Spectrum Control

On June 1, 2011, the Company completed the acquisition of Spectrum (“the Spectrum Merger”) provided for in the Agreement and Plan of Merger (the “Spectrum Agreement”), entered into on March 28, 2011 by the Company, Spectrum Control, Inc. (“Spectrum”), and Erie Merger Corp. (“Merger Sub”), a wholly owned subsidiary of the Company. Spectrum is a leading designer and manufacturer of high performance, custom solutions for the defense, aerospace, industrial, and medical industries headquartered in Fairview, Pennsylvania.

Pursuant to the terms and conditions of the Spectrum Agreement, Merger Sub was merged with and into Spectrum. Upon effectiveness of the Spectrum Merger, each outstanding share of common stock of Spectrum, other than shares owned by Spectrum or their subsidiaries, was converted into the right to receive $20.00 in cash, without interest. Also upon the effectiveness of the Spectrum Merger, each outstanding option to purchase shares of common stock of Spectrum was accelerated so that it became fully vested and received in cash the product of the excess, if any, of $20.00 less the exercise price per option multiplied times the number of shares of Spectrum common stock issuable upon exercise of such option.

The Company has accounted for the acquisition using the purchase method of accounting in accordance with the guidance on business combinations. The Company also incurred legal costs, reorganization charges and professional fees in connection with the acquisition of approximately $4,841,000. These expenses have been accounted for as operating expenses, primarily as at May 31, 2011. Also in connection with this acquisition, the Company incurred approximately $11,253,000 of deferred financing costs and discounts related to the term loans (see Note 10a) that are being amortized to interest expense using the effective interest method. The results of operations of Spectrum have been included in the Company’s results of operations beginning on June 1, 2011.

Accounting guidance requires that identifiable assets acquired and liabilities assumed be reported at fair value as of the acquisition date of a business combination. Assets and liabilities acquired were as follows:

 

Cash, net

   $ 4,141,305   

Accounts receivable and other current assets

     32,558,927   

Inventory

     35,770,543   

Fixed assets

     33,245,288   

Customer related intangibles

     22,500,000   

Marketing related intangibles

     20,000,000   

Technology related intangibles

     25,000,000   

Goodwill

     144,560,123   

Current liabilities

     (19,230,451

Deferred revenue

     (200,000

Long-term liabilities

     (28,081,662
  

 

 

 

Fair value of net assets acquired

   $ 270,264,073   
  

 

 

 

The fair value of Spectrum exceeded the underlying fair value of all net assets acquired, giving rise to the goodwill. Customer, marketing and technology related intangibles are amortized based on the pattern in which the economic benefits are expected to be realized, over an estimated life of 10 years.

The fair value of the assets acquired and liabilities assumed remain subject to potential adjustments. The purchase accounting is preliminary subject to the completion of the independent third party fair value assessment of the acquired intangible assets, independent third party valuation of acquired fixed assets, completion of income tax accounting and the fair value assessment of certain liabilities. Material adjustments, if any, to provisional amounts in subsequent periods, will be reflected retrospectively as required.

Revenues and net income from the acquisition date, June 1, 2011 to August 31, 2011 were approximately $40,193,000 and $3,537,000, respectively.

Fixed assets acquired in this transaction consist of the following:

 

Land

   $ 1,823,155   

Buildings and leasehold improvements

     17,258,271   

Computer equipment

     2,345,521   

Furniture and fixtures

     1,108,635   

Machinery and equipment

     10,658,730   

Vehicles

     50,976   
  

 

 

 

Total fixed assets acquired

   $ 33,245,288   
  

 

 

 

 

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b) SenDEC Corp.

On January 9, 2011, API entered into the Merger Agreement with Vintage and Sub, pursuant to which the Company acquired SenDEC. SenDEC is a leading defense electronics manufacturing services company headquartered in Fairport, New York. In the Merger, API acquired all of the equity of SenDEC, which included SenDEC’s electronics manufacturing operations and approximately $30 million of cash, in exchange for the issuance of 22,000,000 shares of API Common Stock to Vintage.

The Merger closed on January 21, 2011, immediately after the January 21, 2011 closing of the acquisition by Vintage of SenDEC, pursuant to the First Merger Agreement among Vintage, SenDEC, and South Albany Acquisition Corp., and Kenton W. Fiske, as Stockholder Representative. API succeeded to the rights, and assumed the obligations, of Vintage under the First Merger Agreement among Vintage, including the obligation to pay former SenDEC shareholders up to $14 million in earnout payments, payable in three installments through July 31, 2013, based on achievement of certain financial milestones. The fair value of this obligation of $2.2 million is recorded in Accounts payable and accrued expenses. In addition, certain SenDEC employees will be eligible for a bonus under a management bonus plan of up to $11 million, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC. As of August 31, 2011 no amount has been recorded related to this bonus plan.

The Company has accounted for the acquisition using the purchase method of accounting in accordance with the guidance on business combinations. The Company also incurred legal costs, reorganization charges, professional fees and accelerated share option expense in connection with the acquisition of approximately $6,039,000. The expenses have been accounted for as operating expenses. The results of operations of SenDEC have been included in the Company’s results of operations beginning on January 21, 2011.

Accounting guidance requires that identifiable assets acquired and liabilities assumed be reported at fair value as of the acquisition date of a business combination. Assets and liabilities acquired were as follows:

 

Cash

   $ 32,353,419   

Accounts receivable and other current assets

     7,897,276   

Inventory

     16,165,464   

Fixed assets

     5,389,155   

Customer related intangibles

     3,738,000   

Marketing related intangibles

     2,138,000   

Goodwill

     81,838,945   

Current liabilities

     (9,918,446

Deferred revenue

     (758,317
  

 

 

 

Fair value of net assets acquired

   $ 138,843,496   
  

 

 

 

The fair value of shares issued to Vintage, options issued to SenDEC management and the earn-out payments exceeded the underlying fair value of all net assets acquired, giving rise to the goodwill. Customer and marketing related intangibles are amortized based on the pattern in which the economic benefits are expected to be realized, over an estimated life of 4 years.

The fair value of the consideration, assets acquired and liabilities assumed remain subject to potential adjustments. The purchase accounting is preliminary subject to the completion of the independent third party fair value assessment of the acquired intangible assets, completion of income tax accounting and the fair value assessment of certain liabilities. Material adjustments, if any, to provisional amounts in subsequent periods, will be reflected retrospectively as required.

Revenues and net loss of SenDEC for the quarter ending August 31, 2011 were approximately $7,968,000 and $(1,112,000), respectively.

Fixed assets acquired in this transaction consist of the following:

 

Buildings and leasehold improvements

   $ 515,447   

Computer equipment

     199,616   

Furniture and fixtures

     105,567   

Machinery and equipment

     4,568,525   
  

 

 

 

Total fixed assets acquired

   $ 5,389,155   
  

 

 

 

 

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The following unaudited pro forma summary presents the combined results of operations as if the Spectrum and SenDEC acquisitions described above had occurred at the beginning of the three month periods ended August 31, 2010.

 

     Three months
ended

August  31,
2010
 

Revenues

   $ 109,618,191   

Net income from continuing operations

   $ 6,252,866   

Net income

   $ 6,379,421   

Net income from continuing operations per share – basic and diluted

   $ 0.11   

Net income per share – basic and diluted

   $ 0.12   

 

5. DISCONTINUED OPERATIONS

On February 20, 2010 the Company announced that it closed its nanotechnology research and development subsidiary, NanoOpto, which was previously included in the Systems & Subsystems segment. NanoOpto was acquired by API in 2007 and is located in Somerset, New Jersey. During the quarter ended August 31, 2010, the Company sold the assets of NanoOpto for gross cash proceeds of approximately $2,300,000.

The operating results of NanoOpto are summarized as follows:

 

$129,667 $129,667
     Three months ended August 31,  
     2011      2010  

Revenue, net

   $ —         $ —     

Cost of revenues

     —           —     
  

 

 

    

 

 

 

Gross Profit

     —           —     

General and administrative

     —           66,870   

Research and development

     —           40,414   

Other income

     —           236,951   
  

 

 

    

 

 

 

Income from discontinued operations, net of tax

   $ —         $ 129,667   
  

 

 

    

 

 

 

The assets and liabilities relating to NanoOpto consist of accounts payable of $141,311 at August 31, 2011 and May 31, 2011. These amounts are presented within accounts payable and accrued liabilities on the balance sheet.

6. INVENTORIES

Inventories consisted of the following:

 

     August 31,
2011
     May 31,
2011
 

Raw materials

   $ 35,803,546       $ 16,022,954   

Work in progress

     31,893,703         14,364,908   

Finished goods

     6,784,138         1,241,230   
  

 

 

    

 

 

 

Total

   $ 74,481,387       $ 31,629,092   
  

 

 

    

 

 

 

Inventories are presented net of valuation allowances.

7. GOODWILL AND INTANGIBLE ASSETS

Changes in the carrying amount of Goodwill were as follows:

 

Balance, May 31, 2011

   $ 90,300,834   

Goodwill from Spectrum business acquisition (note 4a)

     144,560,123   
  

 

 

 

Balance, August 31, 2011

   $ 234,860,957   
  

 

 

 

 

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Changes in the carrying amount of Intangible assets were as follows:

 

Balance, May 31, 2011

   $ 8,407,302   

Intangible assets from Spectrum business acquisition (note 4a)

     67,500,000   

Less: Amortization

     (2,622,420
  

 

 

 

Balance, August 31, 2011

   $ 73,284,882   
  

 

 

 

8. SHORT-TERM DEBT

On April 20, 2011, the Company entered into a Loan and Security Agreement, (the “Loan Agreement”) with the RBC Bank (USA) (“RBC Bank”). The Loan Agreement was for a two-year senior secured line of credit facility (the “Revolving Credit Facility”), in the aggregate principal amount of up to $20,000,000, which replaced the previous line of credit facility in the amount of approximately $1,022,000 ($1,000,000 CAD) at its Emcon Emanation Control subsidiary in Canada. The Revolving Credit Facility included a letter of credit subfacility of up to $4 million.

In connection with its entry into the secured revolving credit facility from Morgan Stanley on June 1, 2011, the line of credit facility from RBC Bank was repaid and terminated (see Note 10a).

The Company also has a credit facility in place for its U.K. subsidiary for approximately $409,000 (250,000 GBP), which renews in July 2012. This line of credit is tied to the prime rate in the United Kingdom and is secured by the subsidiaries’ assets. This facility was undrawn as of August 31, 2011.

9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consisted of the following:

 

     August 31,
2011
     May 31,
2011
 

Trade accounts payable

   $ 27,437,785       $ 16,533,820   

Accrued expenses

     7,731,565         5,773,653   

Wage and vacation accrual

     6,751,170         2,043,858   
  

 

 

    

 

 

 

Total

   $ 41,920,520       $ 24,351,331   
  

 

 

    

 

 

 

10. LONG-TERM DEBT

The Company has the following long-term debt obligations:

 

     August 31,
2011
    May 31,
2011
 

Term loan, due June 1, 2016, base rate plus 5.25% interest or LIBOR plus 6.25%, (a)

   $ 169,500,000      $ —     

Mortgage loan, due 2027, 1.35% above Barclays fixed bank rate (b)

     1,617,187        1,662,081   

Capital leases payable

     548,404        513,849   

Environmental liability (c)

     587,257        —     
  

 

 

   

 

 

 
   $ 172,252,848      $ 2,175,930   

Less: Current portion of long-term debt

     (2,528,151     (243,957

Discount on term loan

     (4,023,262     —     
  

 

 

   

 

 

 

Long-term portion

   $ 165,701,435      $ 1,931,973   
  

 

 

   

 

 

 

 

a)

In connection with the acquisition of Spectrum, on June 1, 2011, API entered into a credit agreement with Morgan Stanley Senior Funding, Inc. (“Morgan Stanley”) as lead arranger, sole book runner and administrative agent, and with other lenders from time to time parties thereto. The Credit Agreement provided for a secured term loan in the principal amount of $200 million and a $15 million secured revolving credit facility, with an option for the Company to request an increase in the revolving credit facility commitment of up to an aggregate of $5 million. A portion of the proceeds from the secured term loan was used to repay the line of credit facility from RBC Bank, which was then terminated (see Note 8). On June 27, 2011, API entered into an Amended and Restated Credit Agreement, which amends and restates the Credit Agreement in its entirety and provides for a secured term loan facility in the principal amount of $170 million and a $15 million secured revolving credit facility, with an option for the Company to request an increase in the revolving credit facility commitment of up to an aggregate of $5 million. The borrowings

 

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  under the new senior credit facilities are secured by substantially all of the Company’s assets and are guaranteed by the Company’s U.S. and Canadian subsidiaries, which guaranty obligations are secured by a security interest on substantially all of the assets of such subsidiaries, including certain material real property.

At the Company’s option, revolving loans and the term loans accrue interest at a per annum rate based on either:

 

   

the base rate plus a margin equal to 5.25%, subject to adjustment as noted below; or

 

   

the LIBOR rate plus a margin equal to 6.25%, subject to adjustment as noted below.

The “base rate” means the highest of (i) the administrative agent’s prime lending rate, (ii) the federal funds rate plus a margin equal to 0.50%, (iii) the one month LIBOR rate plus a margin equal to 1.00% and (iv) 2.50%. The “LIBOR rate” means the higher of (i) a floating per annum rate based upon the LIBOR rate for the applicable interest period and (ii) 1.50%. If the interest rate margin for incremental revolving loans is higher than the interest rate margin for existing revolving loans, then:

 

   

the interest rate margin for all revolving loans shall be increased to the higher applicable interest rate margin for incremental revolving loans; and

 

   

the interest rate margin for all term loans shall be increased to the extent necessary so that such interest rate margin is 0.25% less than the interest rate margin applicable to such incremental revolving loans.

Accrued interest on the revolving loans and term loans is due and payable in arrears at the end of each of our fiscal quarters, provided that revolving loans and term loans accruing interest based upon the LIBOR rate are due and payable at the end of each applicable interest period (or at each three month interval in the case of loans with interest periods greater than three months).

Revolving loans may be borrowed, repaid and reborrowed until June 1, 2014, at which time all amounts borrowed pursuant to the revolving credit facility must be repaid. The term loans are to be repaid quarterly at the end of each of API’s fiscal quarters, with each quarterly installment equaling one quarter of 1% of the aggregate initial principal amount of the term loans, with the remaining balance to be paid on the maturity date of June 1, 2016. The term loans are subject to mandatory prepayment under certain circumstances, including in connection with API’s receipt of net proceeds from certain issuances of indebtedness, sales of assets, casualty events, annual excess cash flow and capital contributions resulting from the exercise of its equity cure rights with respect to financial covenants. In the event that the term loans are refinanced or repriced prior to June 1, 2012, and the effective interest rate margin or weighted average yield is less than the applicable interest rate margin or weighted average yield, then a fee will be due in an amount equal to 1.0% of the principal amount of such term loans prepaid or 1.0% of the principal amount of such term loans outstanding after giving effect to such repricing.

The Amended and Restated Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants applicable to API and its subsidiaries, including covenants that limit the ability of API and its subsidiaries to grant liens, merge or consolidate, dispose of assets, pay dividends or distributions, repurchase shares, incur indebtedness, make loans, make investments or acquisitions, enter into certain transactions with affiliates, make capital expenditures, enter into certain restrictive agreements affecting its subsidiaries, and enter into certain negative pledge arrangements, in each case subject to customary exceptions for a credit agreement of this size and type. The Company is also required to maintain compliance with a consolidated total leverage ratio and a consolidated interest expense coverage ratio. The Amended and Restated Credit Agreement also includes customary events of default that include, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, non-compliance with ERISA laws and regulations, defaults under the security documents or guaranties, material judgment defaults, and a change of control default. Under certain circumstances, the occurrence of an event of default could result in an increased interest rate equal to 2.0% above the applicable interest rate for loans, the acceleration of the Company’s obligations pursuant to the Amended and Restated Credit Agreement and an obligation of the subsidiary guarantors to repay the full amount of the Company’s borrowings under the Amended and Restated Credit Agreement.

After giving effect to i) the application of the proceeds of the June 2011 equity financing discussed in Note 11 to the repayment of $30 million aggregate principal amount of term loans, and ii) $500,000 quarterly repayment, $169,500,000 aggregate principal amount of term loans remained outstanding under the Amended and Restated Credit Agreement as of August 31, 2011.

 

b) A subsidiary of the Company in the United Kingdom entered into a 20 year term mortgage agreement in 2007, under which interest is charged at a margin of 1.35% over Barclays Fixed Base Rate of 0.5% at August 31, 2011. The mortgage is secured by the subsidiaries’ land and building.

 

c) Through the acquisition of Spectrum on June 1, 2011, the Company owns certain land and manufacturing facilities in State College, Pennsylvania. The property, which was acquired by Spectrum from Murata Electronics North America (“Murata”) in December 2005, consists of approximately 53 acres of land and 250,000 square feet of manufacturing facilities. Among other uses, the acquired facilities have become the design and manufacturing center for Spectrum’s ceramic operations.

 

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Spectrum’s purchase price for the acquired property included the assumption of, and indemnification of Murata against, all environmental liabilities related to the property. The acquired property has known environmental conditions that require remediation, and certain hazardous materials previously used on the property have migrated into neighboring third party areas. These environmental issues arose from the use of chlorinated organic solvents including tetrachloroethylene (“PCE”) and trichloroethylene (“TCE”). As a condition to the purchase, Spectrum entered into an agreement with the Pennsylvania Department of Environmental Protection (“PADEP”) pursuant to which: (a) Spectrum agreed to remediate all known environmental conditions relating to the property to a specified industrial standard, with Spectrum’s costs for remediating such conditions being capped at $4,000,000; (b) PADEP released Murata from further claims by Pennsylvania under specified state laws for the known environmental conditions; and (c) Spectrum purchased an insurance policy providing clean-up cost cap coverage (for known and unknown pollutants) with a combined coverage limit of approximately $8,200,000, and pollution legal liability coverage (for possible third party claims) with an aggregate coverage limit of $25,000,000. The total premium cost for the insurance policy, which has a ten year term and an aggregate deductible of $650,000, was $4,762,000. The cost of the insurance associated with the environmental clean-up ($3,604,000) is being charged to general and administrative expense in direct proportion to the actual remediation costs incurred. The cost of the insurance associated with the pollution legal liability coverage ($1,158,000) is being charged to general and administrative expense on a pro rata basis over the ten year policy term. At August 31, 2011, the non-current portion of prepaid environmental insurance, related solely to this matter, amounted to $1,526,039.

Based upon Spectrum’s environmental review of the property, Spectrum recorded a liability of $2,888,000 to cover probable future environmental expenditures related to the remediation, the cost of which is expected to be entirely covered by the insurance policy. As of August 31, 2011, remediation expenditures of $2,300,743 have been incurred and charged against the environmental liability, with all such expenditures being reimbursed by the insurance carrier. The remaining aggregate undiscounted expenditures of $587,257 which are anticipated to be incurred over the next five years, principally consist of: (a) continued operation and monitoring of the existing on-site groundwater extraction, treatment, and recharge system; (b) completion of soil investigations to determine the extent of potential soil contamination; (c) excavation and off-site disposal of soil containing contaminates above acceptable standards; and (d) implementation of soil vapor extraction systems in certain areas. Depending upon the results of future environmental testing and remediation actions, it is possible that the ultimate costs incurred could exceed the current aggregate estimate of $2,888,000. The Company expects such increase, if any, to be entirely covered by the insurance policy. Insurance recoveries for actual environmental remediation costs incurred are recorded when it is probable that such insurance reimbursement will be received and the related amounts are determinable. Such insurance recoveries are credited to the Company’s general and administrative expense. Based on the current remediation plan, $280,292 of the total remediation costs are expected to be incurred during the next twelve months.

11. SHAREHOLDERS’ EQUITY

On June 27, 2011, API entered into a Common Stock Purchase Agreement, by and among API and the Purchasers (as defined therein), pursuant to which API issued 4,791,958 shares of its common stock in a private placement for a purchase price of $6.50 per share. API received aggregate gross proceeds of approximately $31,147,727 from the private placement. In connection with the private placement, API also issued 300,000 shares of common stock to certain Purchasers in consideration for a backstop commitment provided by such Purchasers.

On March 18, 2011, API entered into a Common Stock Purchase Agreement, by and among API and the Purchasers (as defined therein), pursuant to which API has issued 17,095,102 shares of its common stock in a private placement for a purchase price of $6.00 per share.

On March 28, 2011, API issued, to an officer of the Company as part of his appointment as President and Chief Operating Officer, 300,000 shares of API’s common stock, 140,019 of which shares were reacquired through the withholding of shares to pay employee tax obligations incurred upon the issuance of the shares. These shares were issued under the Company’s 2006 Amended and Restated Equity Incentive Plan.

On January 31, 2011, the Company issued 1,216,667 shares of its common stock to the holders of the $3,650,000 Convertible Notes for a price equal to $3.00 per share.

On January 21, 2011, API acquired all of the equity of SenDEC, which included SenDEC’s electronics manufacturing operations and approximately $30 million of cash, in exchange for the issuance of 22,000,000 API common shares to Vintage (see Note 4b).

On December 28, 2010, the Company filed a Certificate of Amendment of Amended and Restated Certificate of Incorporation, which effected a one-for-four reverse stock split of the Company’s outstanding common shares. A one-for-four reverse stock split was also effected for the exchangeable shares. All the references to number of shares, options and warrants presented in these financial statements have been adjusted to reflect the post split number of shares.

 

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On January 20, 2010 the Company agreed to issue 800,000 shares of API common stock payable as part of the compensation to the KGC Companies or their designees. 250,000 shares were issued and delivered at closing, with 550,000 shares remaining to be issued and delivered. The Company has issued 126,250 shares in escrow from the 550,000 shares remaining to be delivered. The API subsidiaries that purchased the KGC Companies’ assets may claim and have claimed a right of set off against the escrowed shares under the asset purchase agreement with respect to claimed amounts due to the Company under the indemnification provisions of the asset purchase agreement. The unissued shares have been accounted for as common stock subscribed but not issued.

In connection with the Plan of Arrangement that occurred on November 6, 2006, the Company was obligated to issue 2,354,505 shares of either API common stock or exchangeable shares of API Nanotronics Sub, Inc. in exchange for the API Electronics Group Corp. common shares previously outstanding. As of August 31, 2011, API is obligated to issue a remaining approximately 625,900 shares of its common stock under the Plan of Arrangement either directly for API common shares or in exchange for API Nanotronics Sub, Inc. exchangeable shares not held by API or its affiliates. There are 584,631 exchangeable shares outstanding (excluding exchangeable shares held by the Company). Exchangeable shares are substantially equivalent to our common stock.

On March 9, 2010, the Company’s Board of Directors authorized a program to repurchase approximately 10% of its common shares (approximately 831,250 shares) over the next 12 months. As of May 31, 2011, the Company repurchased and retired 137,728 of its common shares under this program for net outlay of approximately $716,000. In fiscal year 2011, the Company repurchased approximately 35,544 shares for net outlay of approximately $148,000. No shares were repurchased under the program in the three months ended August 31, 2011.

The Company issued 181,000 options during the three months ended August 31, 2011 (Note 12). During the year ended May 31, 2011 the Company issued 1,043,334 options related to employment arrangements, including 750,000 to SenDEC employees and consultants as part of the Merger. These option grants were valued using the Black-Scholes option-pricing model.

12. STOCK-BASED COMPENSATION

On October 26, 2006, the Company adopted its 2006 Equity Incentive Plan (the “Equity Incentive Plan”), which was approved at the 2007 Annual Meeting of Stockholders of the Company. All the prior options issued by API were carried over to this plan under the provisions of the Plan of Arrangement. On October 22, 2009, the Company amended the 2006 Equity Compensation Plan to increase the number of shares of common stock under the plan from 1,250,000 to 2,125,000. On January 21, 2011, the Company amended the 2006 Equity Compensation Plan to increase the number of shares of common stock under the plan from 2,125,000 to 5,875,000, and further amended the plan on June 3, 2011 to permit the issuance of RSUs. Of the 5,875,000 shares authorized under the Equity Incentive Plan, 3,363,212 shares are available for issuance pursuant to options, RSUs, or stock as of August 31, 2011. Under the Company’s Equity Incentive Plan, incentive options and non-statutory options may have a term of up to ten years from the date of grant. The stock option exercise prices are equal to at least 100 percent of the fair market value of the underlying shares on the date the options are granted.

As of August 31, 2011, there was $1,557,052 of total unrecognized compensation related to non-vested stock options and RSUs, which are not contingent upon attainment of certain milestones. For options with certain milestones necessary for vesting, the fair value is not calculated until the conditions become probable. The cost is expected to be recognized over the remaining periods of the options, which are expected to vest from 2012 to 2016.

During the three months ended August 31, 2011 and 2010, $45,363 and $341,137, respectively, has been recognized as stock-based compensation expense in cost of revenues, selling expense, general and administrative expense and business acquisition and related charges.

The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model based on the assumptions detailed below:

 

     August 31, 2011     August 31, 2010  

Expected volatility

     93.6     110.2

Expected dividends

     0     0

Expected term

     6 years        10 years   

Risk-free rate

     1.91     2.30

 

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The summary of the common stock options granted, cancelled, exchanged or exercised under the Plan:

 

     Options     Weighted
Average
Exercise
Price
 

Stock Options outstanding—May 31, 2010

     1,479,156      $ 5.708   

Less forfeited

     (236,491   $ 5.002   

Exercised

     —        $ —     

Issued

     1,043,334      $ 5.710   
  

 

 

   

Stock Options outstanding—May 31, 2011

     2,285,999      $ 5.738   

Less forfeited

     (113,108   $ 5.698   

Exercised

     (332,550   $ 5.528   

Issued

     145,000      $ 5.496   
  

 

 

   

Stock Options outstanding—August 31, 2011

     1,985,341      $ 5.750   
  

 

 

   

Stock Options exercisable—August 31, 2011

     1,480,343      $ 5.850   
  

 

 

   

Restricted stock unit activity under the 2006 Equity Compensation Plan, for the three month period ended August 31, 2011 is presented below:

 

     Units      Weighted
Average
Grant
Date Fair
Value
 

RSUs outstanding—May 31, 2011

     —         $ —     

Issued

     36,000       $ 7.400   
  

 

 

    

RSUs outstanding—August 31, 2011

     36,000       $ 7.400   
  

 

 

    

RSUs exercisable—August 31, 2011

     11,997       $ 7.400   
  

 

 

    

The weighted average grant price of stock options granted during the three months ended August 31, 2011 and August 31, 2010 was $5.50 and $5.08, respectively.

 

RSUs and Options Outstanding     RSUs and Options Exercisable  

Range of

Exercise Price

    Number of
Outstanding
at August 31,
2011
    Weighted
Average
Exercise
Price
    Weighted
Average
Remaining
Life
(Years)
    Aggregate
Intrinsic
Value
    Number
Exercisable
at August 31,
2011
    Weighted
Average
Exercise
Price
    Aggregate
Intrinsic
Value
 
  $0.00 – $  3.55        36,000      $ 0.000        9.764      $ 170,640        11,997      $ 0.000      $ 56,866   
  $3.56 – $  4.99        47,084      $ 3.560        9.148      $ 55,559        —        $ 0.000      $ —     
  $5.00 – $  6.99        1,914,502      $ 5.830        7.264      $ —          1,461,586      $ 5.810      $ —     
  $7.00 – $20.00        23,755      $ 12.550        6.125      $ —          18,757      $ 12.920      $ —     
 

 

 

       

 

 

   

 

 

     

 

 

 
    2,021,341          7.339      $ 226,199        1,492,340        $ 56,866   
 

 

 

       

 

 

   

 

 

     

 

 

 

The intrinsic value is calculated as the excess of the market value as of August 31, 2011 over the exercise price of the shares. The market value as of August 31, 2011 was $4.74 as reported by the NASDAQ Stock Market.

13. SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information for the three months ended August 31:

 

     2011      2010  

Supplemental Cash Flow Information

     

Cash paid for income taxes

   $ 269,153       $ 2,892   

Cash paid for interest

   $ 1,159,227       $ 1,052,003   

14. EARNINGS PER SHARE OF COMMON STOCK

The following table sets forth the computation of weighted-average shares outstanding for calculating basic and diluted earnings per share (EPS):

 

     Three months ended August 31,  
     2011      2010  

Weighted average shares-basic

     52,404,074         8,908,172   

Effect of dilutive securities

     11,997         486,667   
  

 

 

    

 

 

 

Weighted average shares—diluted

     52,416,071         9,394,839   
  

 

 

    

 

 

 

 

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Basic EPS and diluted EPS for the three months ended August 31, 2011 and 2010 have been computed by dividing the net income by the weighted average shares outstanding. The weighted average numbers of shares of common stock outstanding includes exchangeable shares and shares to be issued under the Plan of Arrangement.

15. COMMITMENTS

From time to time the Company may be a party to lawsuits in the normal course of our business. Litigation can be unforeseeable, expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on the Company’s business, operating results, or financial condition. As of August 31, 2011 there were no material pending legal proceedings to which the Company was a party or to which any of its property was subject.

16. INCOME TAXES

The Company has identified several tax jurisdictions because it has operations in United States, Canada, the United Kingdom, Mexico and China. Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s consolidated financial statements. The income tax expense for the three months ended August 31, 2011 and 2010, reflects a year to date effective tax rate of 494.9% and 0.49% respectively. These estimated effective tax rates differ from the statutory rate of 35% primarily due to the impact of the Spectrum acquisition in 2011 and the Company’s recognition of the tax benefit of historic losses in 2010.

17. RESTRUCTURING CHARGES RELATED TO CONSOLIDATION OF OPERATIONS

In accordance with accounting guidance for costs associated with asset exit or disposal activities, restructuring costs are recorded as incurred. Restructuring charges for employee workforce reductions are recorded upon employee notification.

During the three months ended August 31, 2011 restructuring expenses included charges of approximately $681,000 related to workforce reductions and other expenses related to consolidating certain parts of its microwave operations from Palm Bay, Florida to its owned facility in State College, P.A. and from consolidating certain parts of its operations from Ronkonkoma, N.Y. and Hauppauge, N.Y. to its leased facility in Windber, P.A. Management continues to evaluate whether other related assets have been impaired, and has concluded that there should be no additional impairment charges as of August 31, 2011.

As of August 31, 2011, the following table represents the details of restructuring charges:

 

     Workshare
Reduction Cost
 

Balance, May 31, 2011

   $ 459,810   

Restructuring charges

     680,604   
  

 

 

 

Total accumulated restructuring charges at August 31, 2011

     1,140,414   

Cash payments

     926,788   

Non-cash charges

     —     
  

 

 

 

Balance, August 31, 2011

   $ 213,626   
  

 

 

 

The remaining balance at August 31, 2011 is included in accounts payable and accrued liabilities.

18. SEGMENT INFORMATION

The Company follows the authoritative guidance on the required disclosures for segments which establish standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in financial reports. The guidance also establishes standards for related disclosures about products and services, geographic areas and major customers.

The guidance uses a management approach for determining segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable segments. The Company’s operations are conducted in two principal business segments: Systems & Subsystems and Secure Systems & Information Assurance. Inter-segment sales are presented at their market value for disclosure purposes.

 

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Three months ended August 31, 2011

   Systems &
Subsystems
    Secure
Systems &
Information
Assurance
    Corporate     Inter Segment
Eliminations
     Total  

Sales to external customers

   $ 63,164,620      $ 6,066,602      $ —        $ —         $ 69,231,222   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total revenue

     63,164,620        6,066,602          —           69,231,222   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating income before expenses below:

     7,138,048        573,615        —          —           7,711,663   

Corporate – head office expenses

     —          —          1,684,209        —           1,684,209   

Depreciation and amortization

     4,343,529        91,511        10,625        —           4,445,665   

Other expense

     26,420        17,003        4,164,247        —           4,207,670   

Income tax expense (recovery)

     (13,202,898     175,135        30,000        —           (12,997,763
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) from continuing operations

     15,970,997        289,966        (5,889,081     —           10,371,882   

Income from discontinued operations, net of tax

     —          —          —          —           —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 15,970,997      $ 289,966      $ (5,889,081   $ —         $ 10,371,882   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Segment assets—as at August 31, 2011

   $ 491,279,727      $ 13,398,446      $ 6,757,264      $ —         $ 511,435,438   

Goodwill included in assets—as at August 31, 2011

   $ 234,860,957      $ —        $ —        $ —         $ 234,860,957   

Purchase of long-lived assets, to August 31, 2011

   $ 556,314      $ 111,603      $ —        $ —         $ 667,917   

Three months ended August 31, 2010

   Systems &
Subsystems
    Secure
Systems &
Information
Assurance
    Corporate     Inter Segment
Eliminations
     Total  

Sales to external customers

   $ 24,934,434      $ 4,189,111      $ —        $ —         $ 29,123,545   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total revenue

     24,934,434        4,189,111        —          —           29,123,545   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating income (loss) before expenses below:

     2,748,309        (435,485     —          —           2,312,824   

Corporate - head office expenses

     —          —          687,481        —           687,481  

Corporate - acquisition related charges

     —          —          —          —           —     

Depreciation and amortization

     265,481        126,552        822        —           392,855   

Other (income) expenses

     (548,849     31,392        1,119,406        —           601,949   

Income tax expense

     3,112        —          —          —           3,112   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) from continuing operations

     3,028,565        (593,429     (1,807,709     —           627,427   

Income from discontinued operations, net of tax

     129,667        —          —          —           129,667   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 3,158,232      $ (593,429   $ (1,807,709   $ —         $ 757,094   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Segment assets—as at May 31, 2011

   $ 158,260,989      $ 11,083,103      $ 103,827,630      $ —         $ 273,171,722   

Goodwill included in assets—as at May 31, 2011

   $ 90,300,834      $ —        $ —        $ —         $ 90,300,834   

Purchase of long-lived assets, to August 31, 2010

   $ 587,286      $ 76,488      $ 36,880      $ —         $ 700,654   

19. SUBSEQUENT EVENTS

The Company has evaluated subsequent events through October 17, 2011, the date the financial statements were issued, and up to the time of filing of the financial statements with the Securities and Exchange Commission.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Business Overview of API Technologies Corp.

We design, develop and manufacture electronic systems, subsystems, RF and secure solutions for technically demanding defense, aerospace and commercial applications. We own and operate several state-of-the-art manufacturing facilities in North America and the United Kingdom. With the Spectrum acquisition, we now also have manufacturing facilities in China and Mexico. Our customers, which include military prime contractors, and the contract manufacturers who work for them, in the United States, Canada, the United Kingdom and various other countries in the world, outsource many of their defense electronic components and systems to us as a result of the combination of our design, development and manufacturing expertise.

Operating through two segments, Systems & Subsystems, and Secure Systems & Information Assurance, we are positioned as a total engineered solution provider to various world governments, as well as military, defense, aerospace and homeland security contractors. We provide a wide range of electronic manufacturing services from prototyping to high volume production, with specialization in high speed surface mount circuit card assembly for military and commercial organizations. Our manufacturing and design products include secure communication products, including ruggedized computers and peripherals, network security appliances, and TEMPEST Emanation prevention products.

On June 1, 2011, API completed the acquisition of Spectrum Control, Inc. (“Spectrum”) through the merger of Erie Merger Corp., a wholly owned subsidiary of API, with and into Spectrum (“the Spectrum Merger”), as provided for in the Agreement and Plan of Merger (the “Spectrum Agreement”), entered into on March 28, 2011 by API, Spectrum, and Erie Merger Corp. Spectrum is a leading designer and manufacturer of high performance, custom solutions for the defense, aerospace, industrial, and medical industries headquartered in Fairview, Pennsylvania. Pursuant to the Spectrum Agreement, each share of common stock of Spectrum, other than shares owned by Spectrum or their subsidiaries, was converted into the right to receive $20.00 in cash, without interest. The total transaction value was approximately $270 million, including the value of stock options cashed-out as a result of the Spectrum Merger. The Spectrum acquisition has significantly expanded our Systems & Subsystems revenues, including approximately $40,193,000 to net sales for the three months ended August 31, 2011. In addition, we now have additional manufacturing facilities in Fairview, Pennsylvania; State College, Pennsylvania; Philadelphia, Pennsylvania; Grass Valley, California; Marlborough, Massachusetts; Hudson, New Hampshire; Auburn, New York; Wesson, Mississippi; Juarez, Mexico; and Guang Dong Province, China.

In addition, on June 1, 2011, API entered into a credit facility with Morgan Stanley Senior Funding, Inc., as lead arranger, sole book-runner and administrative agent (“Morgan Stanley”), providing for a secured term loan in the principal amount of $200 million and a $15 million secured revolving credit facility. On June 27, 2011, the Company amended the credit facility to provide for a secured term loan facility in the principal amount of $170 million and a $15 million secured revolving credit facility, with an option for API to request an increase in the revolving credit facility commitment of up to an aggregate of $5 million. API also on June 27, 2011 completed a private placement of approximately $31 million of common stock at a price of $6.50 per share.

On January 9, 2011, API entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Vintage Albany Acquisition, LLC (“Vintage”) and API Merger Sub, Inc., pursuant to which we acquired SenDEC Corp., a New York corporation (“SenDEC”) (the “Merger”). SenDEC is a leading defense electronics manufacturing services company headquartered in Fairport, New York. In the Merger, we acquired all of the equity of SenDEC, which included SenDEC’s electronics manufacturing operations and approximately $30 million of cash, in exchange for the issuance of 22,000,000 shares of API shares of common stock to Vintage.

The Merger closed on January 21, 2011, immediately after the January 21, 2011 closing of the acquisition by Vintage of SenDEC, pursuant to the First Merger Agreement among Vintage, SenDEC, and South Albany Acquisition Corp., and Kenton W. Fiske, as Stockholder Representative. API succeeded to the rights, and assumed the obligations, of Vintage under the First Merger Agreement among Vintage, including without limitation, certain earn-out payments, and payments in an amount relating to certain tax benefits realized by SenDEC relating to the payment of certain bonuses and the conversion of SenDEC’s options in connection with the First Merger. In addition, certain SenDEC employees will be eligible for a bonus under a management bonus plan of up to $11 million, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC. The first installment is based on financial results for the trailing twelve months ending July 31, 2012.

The acquired product lines from SenDEC in January 2011 significantly expanded our Systems & Subsystems revenues, including approximately $7,968,000 to net sales for the three months ended August 31, 2011.

Following the acquisitions of SenDEC and Spectrum in January 2011 and June 2011, respectively, we significantly expanded our operating facilities throughout North America and added to our international footprint by adding Mexico and China. Commencing in June 2011, we began cost reduction initiatives to rationalize the number of facilities and personnel which will result in us consolidating certain parts of our manufacturing operations.

 

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Table of Contents

Operating Revenues

We derive operating revenues from the sales in our two principal business segments: Systems & Subsystems, and Secure Systems & Information Assurance. The acquisitions of Spectrum on June 1, 2011, SenDEC on January 21, 2011 and the asset acquisition of the KGC Companies on January 20, 2010 significantly expanded our Systems & Subsystems revenues. The asset acquisition of Cryptek on July 7, 2009 resulted in the creation of our Secure Systems & Information Assurance segment. Our customers are located primarily in the United States, Canada and the United Kingdom, but we also sell products to customers located throughout the world, including NATO and European Union countries.

Systems & Subsystems Revenue includes high-performance RF, microwave and millimeterwave solutions, high speed surface mount circuit card assembly for military prime contractors and advanced weapon systems including missiles, counter-IED RF jamming devices, unmanned air, ground and robotic systems. Other products include naval aircraft landing and launching systems, radar systems alteration, aircraft ground support equipment, Aircraft Radar Indication Systems using Liquid Crystal Display (LCD) technology and other mission critical systems and components. The main demand today for our Systems & Subsystems products come from various world governments, including militaries, defense organizations, aerospace, homeland security and prime defense contractors.

Secure Systems & Information Assurance Revenue includes revenues derived from the manufacturing of TEMPEST and Emanation products and services, ruggedized computers and peripherals, network security appliances and software. The principal market for these products are the defense industries of the United States, Canada and the United Kingdom and other NATO and European Union countries. These products and systems include: TEMPEST and Emanation products and services, ruggedized computers and peripherals, network security appliances and software.

Cost of Revenue

We conduct all of our design and manufacturing efforts in the United States, Canada, United Kingdom, Mexico and China. Cost of goods sold primarily consists of costs that were incurred to design, manufacturer, test and ship the products. These costs include raw materials, including freight, direct labor, tooling required to design and build the parts, and the cost of testing (labor and equipment) the products throughout the manufacturing process and final testing before the parts are shipped to the customer. Other costs include provision for obsolete and slow moving inventory, and restructuring charges related to the consolidation of operations.

Operating Expenses

Operating expenses consist of selling, general, administrative expenses, research and development, business acquisition and related charges and other income or expenses.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses include compensation and benefit costs for all employees, including sales and customer service, sales commissions, executive, finance and human resource personnel. Also included in SG&A is compensation related to stock-based awards to employees and directors, professional services for accounting, legal and tax, information technology, rent and general corporate expenditures.

Research and Development Expenses

Research and development (“R&D”) expenses represent the cost of our development efforts. R&D expenses include salaries of engineers, technicians and related overhead expenses, the cost of materials utilized in research, and additional engineering or consulting services. R&D costs are expensed as incurred.

Business Acquisition and Related Charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, business valuation consultants and accelerated stock option expenses related to business combinations. Related charges include costs incurred related to our efforts to consolidate operations of recently acquired and legacy businesses.

Other Income (Expense)

Other income (expense) consists of interest income on cash and cash equivalents and marketable securities, interest expense on term loans, notes payable, operating loans and capital leases, amortization of note discounts from debt extinguishments, gains or losses on disposal of property and equipment, and gains or losses on foreign currency transactions. Other income also includes gains related to the sales of fixed assets held for sale and acquisition-related gains when net assets acquired exceed the purchase price of the business acquisition.

Backlog

Management uses a number of indicators to measure the growth of the business. One measure is sales backlog. Our sales backlog at August 31, 2011 was approximately $146,565,000 compared to $69,591,000 at May 31, 2011. The increase primarily relates to the acquisition of Spectrum, which represents approximately $73,357,000 of our backlog.

 

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Table of Contents

Our backlog figures represent confirmed customer purchase orders that we had not shipped at the time the figures were calculated and that have a delivery date within a 12-month period. We have very little insight on the timing of new contract releases and, as such, the backlog can increase or decrease significantly based on timing of customer purchase orders.

Results of Operations for the Three Months Ended August 31, 2011 and 2010

The following discussion of results of operations is a comparison of our three months ended August 31, 2011 and 2010.

Operating Revenue

 

     Three months ended August 31,  
     2011      2010      %
Change
 

Revenues by segments:

        

Systems & Subsystems from continuing operations

   $ 63,164,620       $ 24,934,434         153.3

Secure Systems & Information Assurance from continuing operations

     6,066,602         4,189,111         44.8
  

 

 

    

 

 

    

 

 

 
   $ 69,231,222       $ 29,123,545         137.7
  

 

 

    

 

 

    

 

 

 

We recorded a 137.7% increase in overall revenues for the three months ended August 31, 2011 over the same period in 2010. The increase is mainly attributed to the acquisition of Spectrum on June 1, 2011, which represented approximately $40 million of revenue for the Systems & Subsystems segment. During the three months ended August 31, 2011, our Systems & Subsystems revenues were negatively impacted by continued lower throughput while manufacturing operations from one of our New York facilities were physically moved into our Pennsylvania location as part of our restructuring initiatives. The Secure Systems & Information Assurance results include additional revenue generated by our subsidiary in the United Kingdom from two new customers.

Operating Expenses

Cost of Revenue and Gross Margin

 

     Three months ended August 31,  
     2011     2010  

Gross margin by segments:

    

Systems & Subsystems from continuing operations

     23.0     23.2

Secure Systems & Information Assurance from continuing operations

     34.1     27.1

Overall

     24.0     23.8

Our combined gross margin for the three months ended August 31, 2011 increased by approximately 0.2 percentage points compared to the three months ended August 31, 2010. Gross profit margin varies from period to period and can be affected by a number of factors, including product mix, new product introduction, production efficiency and restructuring activities. Overall cost of revenue from continuing operations as a percentage of sales decreased in the three months ended August 31, 2011 from 76.2% to 76.0% compared to the same period last year. The Systems & Subsystems segment cost of sales increased 0.2% compared to the same period in 2010, mainly as a result of product mix from the acquisition of SenDEC, partially offset by lower cost of sales from the impact of the acquisition of Spectrum. The Secure Systems & Information Assurance segment realized a decrease in cost of sales mainly as a result of additional higher margin revenue from two new customers of our subsidiary in the United Kingdom and the Company realizing benefits achieved through the consolidation efforts and cost cutting measures.

General and Administrative Expenses

General and administrative expenses increased to approximately $7,499,000 for the three months ended August 31, 2011 from $3,460,000 for the three months ended August 31, 2010. The increase is primarily a result of the addition of Spectrum in June 2011 and SenDEC in January 2011, which increased general and administrative expenses by approximately $3,074,000 and $1,002,000, respectively, for the three months ended August 31, 2011, partially offset by cost reductions following restructuring initiatives. As a percentage of sales, general and administrative expenses were 10.8% for the three months ended August 31, 2011, compared to 11.9% for the three months ended August 31, 2010.

 

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The major components of general and administrative expenses are as follows:

 

     Three months ended August 31,  
     2011      % of
sales
    2010      % of
sales
 

Depreciation and Amortization

   $ 2,348,136         3.4   $ 126,112         0.4

Accounting and Administration

   $ 1,967,243         2.8   $ 1,152,563         4.0

Professional Services

   $ 570,689         0.8   $ 567,361         1.9

Selling Expenses

Selling expenses from continuing operations increased to approximately $4,450,000 for the three months ended August 31, 2011 from $1,113,000 for the three months ended August 31, 2010. The increase was largely due to the inclusion of selling expenses related to the acquisition of Spectrum and SenDEC on June 1, 2011 and January 21, 2011, respectively. As a percentage of sales, selling expenses were 6.4% for the three months ended August 31, 2011, compared to 3.8% for the three months ended August 31, 2010.

The major components of selling expenses are as follows:

 

     Three months ended August 31,  
     2011      % of
sales
    2010      % of
sales
 

Payroll Expense – Sales

   $ 2,067,243         3.0   $ 833,687         2.9

Commissions

   $ 1,340,411         1.9   $ 18,440         0.1

Advertising

   $ 323,319         0.5   $ 73,979         0.3

Research and Development Expenses

Research and development costs from continuing operations increased to approximately $2,406,000 for the three months ended August 31, 2011 compared to $531,000 for the three months ended August 31, 2010. The increase was largely due to the inclusion of research and development expenses related to the acquisition of Spectrum and SenDEC on June 1, 2011 and January 21, 2011, respectively. As a percentage of sales, research and development expenses were 3.5% for the three months ended August 31, 2011, compared to 1.8% for the three months ended August 31, 2010.

Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, business valuation consultants and accelerated stock option expenses related to business combinations. For the three months ended August 31, 2011, there were no business acquisition and related charges compared to approximately $94,000 for the three months ended August 31, 2010 associated with the completion of the asset acquisitions of Cryptek and the KGC Companies.

Operating Income

We posted operating income from continuing operations for the three months ended August 31, 2011 of approximately $1,582,000 compared to operating income of approximately $1,128,000 for the three months ended August 31, 2010. The increase in operating income of approximately $454,000 is attributed to the improved overall results in our Systems & Subsystems segment as a result of the Spectrum acquisition.

Other (Income) and Expense

Total other expense for the three months ended August 31, 2011 amounted to approximately $4,208,000, compared to other expense of $497,000 for the three months ended August 31, 2010.

The increase in other expense is largely attributable to an increase in interest expense of approximately $2,990,000 from higher debt levels throughout the three month period ended August 31, 2011, compared to the prior year. The increase in net other expense was also attributable to reduced other income. The three months ended August 31, 2010 included approximately $870,000 of gains on the sale of the Company’s buildings in Hauppauge and Endicott, N.Y. and other fixed assets.

Income Taxes

Income taxes amounted to a net recovery of approximately $12,998,000 for the three months ended August 31, 2011, compared to income tax expense of approximately $3,000 for the three months ended August 31, 2010. As a result of acquiring Spectrum, we determined it was more likely than not to recognize a portion of the deferred tax assets; therefore we released approximately $13,514,000 valuation allowance as of August 31, 2011.

 

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Income (Loss) From Discontinued Operations

We had no activity in discontinued operations for the three months ended August 31, 2011, compared to a gain of approximately $130,000 in the same period of fiscal 2010. The gain was attributable to the sale of the assets of our nanotechnology operations in June 2010.

Net Income

We recorded net income for the three months ended August 31, 2011 of approximately $10,372,000, compared to net income of approximately $757,000 for the three months ended August 31, 2010. The increase in net income is largely due to the net income tax recovery of approximately $12,998,000 and the additional operating income from the acquisition of Spectrum on June 1, 2011, partially offset by higher interest and amortization expenses and lower gains on the sales of fixed assets.

Liquidity and Capital Resources

Our sources of capital include cash flows from operations, available credit facilities and the issuance of equity securities.

At August 31, 2011, we held cash and cash equivalents of approximately $16,155,000 compared to $108,417,000 at May 31, 2011. On June 1, 2011, we used approximately $91,000,000 as part of the purchase price of the Spectrum acquisition.

Cash used by continuing operating activities of approximately $11,505,000 for the three months ended August 31, 2011, was higher than cash used by continuing operations of approximately $570,000 for the three months ended August 31, 2010. During the three months ended August 31, 2011 compared to the same period in 2010, the increase in cash used by continuing operating activities resulted primarily from higher interest payments and an increase in cash used by changes in operating assets and liabilities as a result of inventory purchases for future sales and increased accounts receivable balances from sales in the month of August 31, 2011.

Cash used by investing activities for the three months ended August 31, 2011 consisted of $266,123,000 for the Spectrum business acquisition net of cash acquired and the acquisition of capital assets of approximately $668,000. Cash generated in investing activities for the three months ended August 31, 2010 consisted mainly of proceeds from sale of two manufacturing buildings totaling approximately $1,569,000, partially offset by the acquisition of capital assets of approximately $701,000.

Cash flow generated by financing activities for the three months ended August 31, 2011 totaled approximately $186,059,000, and resulted mainly from the net proceeds of approximately $158,643,000 from term loans issued to Morgan Stanley and approximately $31,795,000 from the issuance of common stock as a result of a private placement on June 27, 2011 and stock options exercised during the quarter, partially offset by the repayment of approximately $4,372,000 on a line of credit. That line of credit was subsequently terminated and replaced by a $15 million secured revolving credit facility with Morgan Stanley, that is undrawn at August 31, 2011. During the three months ended August 31, 2010 cash flow used by financing of approximately $1,040,000 consisted mainly of the repayment of certain capital lease obligations.

On June 27, 2011, the Company entered into an Amended and Restated Credit Agreement with Morgan Stanley and the other lenders parties thereto. As of August 31, 2011, the Company had $15,000,000 available under its revolving credit facility with Morgan Stanley to meet its cash requirements. Accrued interest on the revolving loans and term loans is due and payable in arrears at the end of each of our fiscal quarters, provided that revolving loans and term loans accruing interest based upon the LIBOR rate are due and payable at the end of each applicable interest period (or at each three month interval in the case of loans with interest periods greater than three months).

The credit facility with Morgan Stanley contains two financial covenants: a consolidated total leverage ratio and a consolidated interest expense coverage ratio. At August 31, 2011, the Company was in compliance with these covenants. The consolidated total leverage ratio, which is defined as the ratio of total consolidated indebtedness to trailing four quarter consolidated EBITDA, as defined in the Amended and Restated Credit Agreement, must be less than the ratio set forth opposite such period below:

 

Fiscal Quarter Ending

   Ratio  

August 31, 2011

   4.50:1.00   

November 30, 2011

   4.00:1.00   

February 29, 2012

   3.50:1.00   

May 31, 2012

   3.25:1.00   

August 31, 2012

   3.00:1.00   

November 30, 2012

   2.75:1.00   

February 28, 2013

   2.50:1.00   

May 31, 2013

   2.50:1.00   

August 31, 2013

        2.25:1.00   

November 30, 2013

        2.25:1.00   

February 28, 2014 and each Fiscal Quarter ending thereafter

        2.00:1.00   

 

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The consolidated interest expense coverage ratio, which is defined as the ratio of consolidated EBITDA to Consolidated Cash Interest Expense, as defined in the Amended and Restated Credit Agreement, must be greater than the ratio set forth opposite such fiscal quarter below:

 

Fiscal Quarter Ending

   Ratio  

August 31, 2011

     3.00:1.00   

November 30, 2011

     3.25:1.00   

February 29, 2012

     3.50:1.00   

May 31, 2012 and each Fiscal Quarter ending thereafter

     4.00:1.00   

The Amended and Restated Credit Agreement also includes customary events of default that include, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, non-compliance with ERISA laws and regulations, defaults under the security documents or guaranties, material judgment defaults, and a change of control default. Under certain circumstances, the occurrence of an event of default could result in an increased interest rate equal to 2.0% above the applicable interest rate for loans, the acceleration of the Company’s obligations pursuant to the Amended and Restated Credit Agreement and an obligation of the subsidiary guarantors to repay the full amount of the Company’s borrowings under the credit facility. If the Company were unable to obtain a waiver for a breach of covenant and the bank accelerated the payment of any outstanding amounts, such acceleration may cause the Company’s cash position to deteriorate or, if cash on hand were insufficient to satisfy the payment due, may require the Company to obtain alternate financing to satisfy the accelerated payment.

We believe that i) our available cash and cash equivalents, ii) funds available under our credit facilities with Morgan Stanley, and iii) future cash flows from operations, will be sufficient to satisfy our anticipated cash requirements for the next twelve months, including scheduled debt repayment, lease commitments, planned capital expenditures, and research and development expenses. There can be no assurance, however, that unplanned capital replacement or other future events will not require us to seek additional debt or equity financing and, if so required, that it will be available on terms acceptable to us, if at all. In addition, any raising of additional funds could dilute our current shareholders’ ownership interests.

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note 2 to the unaudited consolidated financial statements in Item 1 of this Report and the effects of recent accounting pronouncements in Note 3 to the unaudited consolidated financial statements in Item 1 of this Report. There were no significant changes in our accounting policies or critical accounting estimates since the end of the fiscal year ended May 31, 2011.

Off-Balance Sheet Arrangements

During fiscal 2011 and the three months ended August 31, 2011, the Company did not have any off-balance sheet arrangements.

FORWARD-LOOKING STATEMENTS

This document and the documents incorporated in this document by reference contain forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact contained in this document and the materials accompanying this document are forward-looking statements.

The forward-looking statements are based on the beliefs of management, as well as assumptions made by and information currently available to management. Frequently, but not always, forward-looking statements are identified by the use of the future tense and by words such as “believes,” “expects,” “anticipates,” “intends,” “will,” “may,” “could,” “would,” “projects,” “continues,” “estimates” or similar expressions. Forward-looking statements are not guarantees of future performance and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the Company or its industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements.

The forward-looking statements contained or incorporated by reference in this document are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (“Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (“Exchange Act”) and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding our plans, intentions, beliefs or current expectations.

 

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Management wishes to caution investors that any forward-looking statements made by or on behalf of the Company are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Among the important factors that could cause actual results to differ materially from those indicated by forward-looking statements are the risks and uncertainties described under “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended May 31, 2011, and in our other filings with the SEC. These uncertainties and other risk factors include, but are not limited to: changing economic and political conditions in the United States and in other countries, the ability to effectively integrate acquired companies, war, changes in governmental spending and budgetary policies, governmental laws and regulations surrounding various matters such as environmental remediation, contract pricing, and international trading restrictions, customer product acceptance, continued access to capital markets, and foreign currency risks.

Management wishes to caution investors that other factors might, in the future, prove to be important in affecting the Company’s results of operations. New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or a combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Forward-looking statements are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this document are made as of the date of this document and management does not undertake any obligation to update forward-looking statements to reflect new information, subsequent events or otherwise.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency

Certain of our European sales and related selling expenses are denominated in Euros, British Pounds Sterling, and other local currencies. In addition, certain of our operating expenses are denominated in Canadian dollars, Mexican Pesos and Chinese Yuan. As a result, fluctuations in currency exchange rates may affect our operating results and cash flows. For each of the periods presented herein, currency exchange rate gains and losses were not material.

Interest Rate Exposure

We have market risk exposure relating to possible fluctuations in interest rates. We may utilize interest rate swap agreements in the future to minimize the risks and costs associated with variable rate debt, however, we have not done so to date. We do not enter into derivative financial instruments for trading or speculative purposes.

 

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ITEM 4. CONTROLS AND PROCEDURES

Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures.

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of August 31, 2011. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of August 31, 2011.

 

(b) Changes in Internal Control over Financial Reporting

During the quarter ended August 31, 2011, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

Information with respect to legal proceedings can be found in Note 15 “Commitments” to the Condensed Consolidated Financial Statements contained in Part I, Item 1 of this report.

 

ITEM 1A. RISK FACTORS

There are no material changes from the risk factors set forth under Part I, Item 1A–”Risk Factors” in our Annual Report on Form 10-K for the year ended May 31, 2011.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) No further disclosure required.

(b) Not applicable.

(c) None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. REMOVED AND RESERVED

 

ITEM 5. OTHER INFORMATION

None.

 

ITEM 6. EXHIBITS

 

10.1    Credit Agreement among the Company, the lenders party thereto and Morgan Stanley Senior Funding, Inc., as Administrative Agent, dated as of June 1, 2011 (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.2    U.S. Guaranty and Collateral Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.3    Canadian Guarantee and Collateral Agreement (incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.4*    Letter Agreement between the Company and John P. Freeman, effective as of June 1, 2011 (incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.5*    Amended and Restated API Technologies Corp. 2006 Equity Incentive Plan (incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.6*    Form of Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.7*    Form of Indemnification Agreement (incorporated by reference to Exhibit 10.7 of the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011).
10.8    Amended and Restated Credit Agreement dated as of June 27, 2011 by and among API Technologies Corp., the lenders party thereto and Morgan Stanley Senior Funding, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the SEC on July 1, 2011).
10.9    Common Stock Purchase Agreement dated as of June 27, 2011 by and among the Company and the Purchasers listed on Exhibit A (incorporated by reference to Exhibit 10.30 to the Company’s Form 10-K filed with the SEC on August 26, 2011).
10.10    Registration Rights Agreement dated as of June 27, 2011 by and among the Company, the persons and entities listed on Exhibit A, and, with respect to Section 8(1) only, Vintage Albany Acquisition, LLC (incorporated by reference to Exhibit 10.31 to the Company’s Form 10-K filed with the SEC on August 26, 2011).

 

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31.1    Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer (filed herewith).
31.2    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
32.1    Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (filed herewith).
32.2    Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (filed herewith).
101    The following financial information from API Technologies Corp.’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statement of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to the Consolidated Financial Statements (filed herewith).

 

* Management contracts, compensation plans or arrangements.

 

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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.

 

    API TECHNOLOGIES CORP.

Date: October 17, 2011

    By:   /s/ JOHN P. FREEMAN
        John P. Freeman
        Chief Financial Officer
        (Duly Authorized Officer)

 

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