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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 February 29, 2016

 

¨ 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)

(855) 294-3800

(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:

55,855,800 shares of common stock with a par value of $0.001 per share at April 1, 2016.

 

 

 


Table of Contents

API TECHNOLOGIES CORP. AND SUBSIDIARIES

Report on Form 10-Q

Quarter Ended February 29, 2016

Table of Contents

 

     Page  

PART I—FINANCIAL INFORMATION

     3   

Item 1. Financial Statements (unaudited)

     3   

Consolidated Balance Sheets at February 29, 2016 and November  30, 2015

     3   

Consolidated Statements of Operations and Comprehensive Loss for the three months ended February 29, 2016 and February 28, 2015

     4   

Consolidated Statement of Changes in Shareholders’ Equity for the three months ended February 29, 2016

     5   

Consolidated Statements of Cash Flows for the three months ended February 29, 2016 and February 28, 2015

     6   

Notes to Consolidated Financial Statements

     7   

Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     21   

Forward-Looking Statements

     28   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     29   

Item 4. Controls and Procedures

     29   

PART II—OTHER INFORMATION

     30   

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. Mine Safety Disclosures

     30   

Item 5. Other Information

     30   

Item 6. Exhibits

     31   

Signatures

     32   

 

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Table of Contents

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

API TECHNOLOGIES CORP.

Consolidated Balance Sheets

(unaudited) (Dollar Amounts in Thousands)

 

     February 29,
2016
    November 30,
2015
 

Assets

    

Current

    

Cash and cash equivalents

   $ 4,519      $ 7,207   

Accounts receivable, less allowance for doubtful accounts of $739 and $756 at February 29, 2016 and November 30, 2015, respectively

     40,428        41,684   

Inventories, net (note 5)

     63,985        65,243   

Prepaid expenses and other current assets

     2,247        1,980   
  

 

 

   

 

 

 
     111,179        116,114   

Fixed assets, net

     29,324        30,246   

Goodwill

     149,239        149,239   

Intangible assets, net

     43,968        46,928   

Other non-current assets

     1,102        2,498   
  

 

 

   

 

 

 

Total assets

   $ 334,812      $ 345,025   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Current

    

Accounts payable and accrued expenses

   $ 37,744      $ 41,795   

Deferred revenue

     4,323        3,694   

Current portion of long-term debt (note 8)

     27,200        21,816   
  

 

 

   

 

 

 
     69,267        67,305   

Deferred income taxes

     4,683        4,373   

Other long-term liabilities

     1,640        1,601   

Long-term debt, net of current portion and discount of $2,161 and $2,480 at February 29, 2016 and November 30, 2015, respectively (note 8)

     170,554        175,730   

Deferred gain (note 8c)

     7,044        7,193   
  

 

 

   

 

 

 
     253,188        256,202   
  

 

 

   

 

 

 

Commitments and contingencies (note 13)

    

Shareholders’ Equity

    

Common shares ($0.001 par value, 250,000,000 authorized shares, 55,850,736 and 55,850,736 shares issued and outstanding at February 29, 2016 and November 30, 2015, respectively)

     56        56   

Special voting stock ($0.01 par value, 1 share authorized, issued and outstanding at February 28, 2016 and November 30, 2015, respectively)

     —         —    

Additional paid-in capital

     331,492        331,144   

Accumulated deficit

     (248,827     (242,401

Accumulated other comprehensive income (loss)

     (1,097     24   
  

 

 

   

 

 

 
     81,624        88,823   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 334,812      $ 345,025   
  

 

 

   

 

 

 

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

 

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API TECHNOLOGIES CORP.

Consolidated Statements of Operations and Comprehensive Loss

(unaudited) (Dollar Amounts in Thousands, Except Per Share Data)

 

     For the Three
Months
Ended
Feb. 29, 2016
    For the Three
Months
Ended
Feb. 28, 2015
 

Revenue, net

   $ 54,427      $ 50,850   

Cost of revenues

    

Cost of revenues

     40,063        37,859   

Restructuring charges

     527        42   
  

 

 

   

 

 

 

Total cost of revenues

     40,590        37,901   
  

 

 

   

 

 

 

Gross profit

     13,837        12,949   
  

 

 

   

 

 

 

Operating expenses

    

General and administrative

     8,430        5,279   

Selling expenses

     3,896        3,655   

Research and development

     871        2,000   

Business acquisition and related charges

     183        62   

Restructuring charges

     69        830   
  

 

 

   

 

 

 

Total operating expenses

     13,449        11,826   
  

 

 

   

 

 

 

Operating income

     388        1,123   

Other expense (income), net

    

Interest expense, net

     5,326        3,127   

Amortization of note discounts and deferred financing costs

     343        23   

Other expense (income), net

     456        (120
  

 

 

   

 

 

 
     6,125        3,030   
  

 

 

   

 

 

 

Loss before income taxes

     (5,737     (1,907

Expense for income taxes

     689        272   
  

 

 

   

 

 

 

Net loss

   $ (6,426   $ (2,179
  

 

 

   

 

 

 

Net loss per share—Basic and diluted

   $ (0.11   $ (0.04
  

 

 

   

 

 

 

Weighted average shares outstanding

    

Basic

     55,914,633        55,461,217   

Diluted

     55,914,633        55,461,217   

Comprehensive loss

    

Unrealized foreign currency translation adjustment

     (1,121     (428
  

 

 

   

 

 

 

Other comprehensive loss

     (1,121     (428
  

 

 

   

 

 

 

Comprehensive loss

   $ (7,547   $ (2,607
  

 

 

   

 

 

 

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

 

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Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited)

(In thousands of dollars, except share data)

 

     Common
stock-
number of
shares
     Common
stock
amount
     Additional
paid- in
capital
     Accumulated
deficit
    Accumulated
other
comprehensive
income (loss)
    Total
shareholders’
equity
 

Balance at November 30, 2015

     55,850,736       $ 56       $ 331,144       $ (242,401   $ 24      $ 88,823   

Stock-based compensation expense

     —          —          348         —         —         348   

Net loss for the period

     —          —          —          (6,426     —         (6,426

Other comprehensive loss

     —          —          —          —         (1,121     (1,121
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at February 29, 2016

     55,850,736       $ 56       $ 331,492       $ (248,827   $ (1,097   $ 81,624   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

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

 

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Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statements of Cash Flows

(Unaudited) (Dollar Amounts in Thousands)

 

     Three
Months
Ended
February 29,
2016
    Three
Months
Ended
February 28,
2015
 

Cash flows from operating activities

    

Net loss

   $ (6,426   $ (2,179

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     4,322        3,459   

Amortization of note discounts and deferred financing costs

     343        23   

Stock based compensation

     348        79   

Gain on sale of fixed assets

     (149     (149

Deferred income taxes

     311        98   

Changes in operating asset and liabilities, net of business acquisitions

    

Accounts receivable

     674        2,410   

Inventories

     438        (3,830

Prepaid expenses and other current assets

     (309     39   

Accounts payable and accrued expenses

     (2,379     560   

Deferred revenue

     857        153   
  

 

 

   

 

 

 

Net cash (used for) provided by operating activities

     (1,970     663   

Cash flows from investing activities

    

Purchase of fixed assets

     (271     (159

Purchase of intangible assets

     (61     (107
  

 

 

   

 

 

 

Net cash used by investing activities

     (332     (266

Cash flows from financing activities

    

Repayments of long-term debt (note 8)

     (41     (2,500
  

 

 

   

 

 

 

Net cash used by financing activities

     (41     (2,500

Effect of exchange rate on cash and cash equivalents

     (345     44   
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (2,688     (2,059

Cash and cash equivalents, beginning of period

     7,207        8,258   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 4,519      $ 6,199   
  

 

 

   

 

 

 

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

 

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Table of Contents

API Technologies Corp.

Notes to Consolidated Financial Statements

(Unaudited) (Dollar Amounts in Thousands, Except Per Share Data)

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 systems, subsystems, modules, and components for RF microwave, millimeterwave, electromagnetic, power, and security applications, as well as provides electronics manufacturing for technically demanding, high-reliability applications.

On February 28, 2016, API entered into an Agreement and Plan of Merger (the “Merger Agreement”) with RF1 Holding Company (“Parent”) and RF Acquisition Sub, Inc., a wholly owned subsidiary of Parent (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with API surviving the Merger as a wholly owned subsidiary of Parent (see Note17).

On June 8, 2015 API completed the acquisition of Aeroflex / Inmet, Inc. (“Inmet”) and Aeroflex / Weinschel, Inc. (“Weinschel”) from Cobham plc for a total purchase price of approximately $80,000. Inmet and Weinschel have each been in business for more than 40 years, and each manufactures and sells RF and microwave products for defense, space, avionics, wireless, and test and measurement applications. The acquisitions of Inmet and Weinschel add breadth to API’s RF, microwave, and microelectronics product portfolio, extend the Company’s subsystems offering, and further API’s reach in key end markets, including defense, space, commercial aviation, and wireless. API financed the acquisition with an $85,000 add-on to its existing term loan with Guggenheim Corporate Funding LLC (see Note 4 and Note 8a).

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 Article 8 of 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. 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 February 29, 2016 and the results of its operations and cash flows for the three month period ended February 29, 2016. 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 year ended November 30, 2015 included in the Company’s Form 10-K filed with the SEC on March 2, 2016.

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. On a quarterly basis, the Company evaluates inventories for potential write-down for identifiable obsolescence and slow moving items. The evaluation includes analysis of future demand, product mix and possible alternative uses. The Company records a provision that includes excess and obsolete inventory when write-downs or write-offs are identified. Any write-down of inventory at the close of a fiscal period creates a new cost basis that subsequently would not be marked up based on changes in underlying facts and circumstances. The Company periodically reviews and analyzes its inventory management systems, and conducts inventory impairment testing on a quarterly basis.

 

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Table of Contents

Fixed Assets

Fixed assets are recorded at cost less accumulated depreciation and are depreciated using the straight-line method over the following periods:

 

Straight line basis

 

Buildings and leasehold improvements

     5-40 years   

Computer equipment

     3-5 years   

Furniture and fixtures

     5-8 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.

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. The Company completes an annual (or more often if impairment indicators arise under the applicable accounting guidance) impairment assessment of its goodwill on a reporting unit level. The Company’s annual impairment test for goodwill is September 1st.

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 reduce deferred tax assets to the amounts that we estimate are probable to be realized. In determining the adequacy of the valuation allowance, the Company applied the authoritative guidance, and considered such factors as (i) the reversal of existing temporary differences; (ii) future taxable income exclusive of reversing temporary differences and carryforwards; (iii) taxable income in prior carryback years where carryback is permitted; and (iv) prudent and feasible tax planning strategies.

 

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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. Open tax years include the tax years ended January 21, 2011 through November 30, 2015.

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 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 production-type contracts, which represents less than one per cent of total revenue, 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.

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 on a straight-line basis over the requisite service period for each separately vesting portion of the award. 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 U.S. dollars and the consolidated financial statements are stated in U.S. dollars, “the reporting currency.” Integrated operations have been translated from various foreign currencies (British Pounds Sterling, Canadian dollars, Chinese Yuan, Euros, and Mexican Pesos) into U.S. 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.

 

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Financial Instruments

The fair values of financial instruments including cash and cash equivalents, 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. 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 (British Pounds Sterling, Canadian Dollars, 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 loss. Currently, the Company does not maintain a foreign currency hedging program.

Debt Issuance Costs and Long-term Debt Discounts

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 net against long-term debt in the consolidated balance sheets.

The Company may record debt and equity discounts in connection with raising funds through the issuance of convertible notes or equity instruments. These discounts may arise from (i) the receipt of proceeds less than the face value of convertible notes or equity instruments, (ii) beneficial conversion features and/or (iii) recording derivative liabilities related to embedded features. These costs are amortized over the life of the debt to interest expense utilizing the effective interest method. If a conversion of the underlying debt occurs, a proportionate share of the unamortized discount is immediately expensed.

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 U.S., U.K. and Canadian Governments’ Departments of Defense (directly and through subcontractors) accounts for approximately 41%, 12% and 3% of the Company’s revenues for the three months ended February 29, 2016 (41%, 11% and 1% for the three months ended February 28, 2015), respectively. A loss of a significant customer could adversely impact the future operations of the Company.

Earnings (Loss) per Share of Common Stock

Basic earnings per share of common stock is computed by dividing income (loss) 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 12).

Comprehensive Income (Loss)

Comprehensive income (loss), which includes foreign currency translation adjustments, is shown in the Consolidated Statement of Operations and Comprehensive Income (Loss).

3. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued guidance which affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). The new guidance will supersede the existing revenue recognition requirements, and most industry-specific guidance. Following the announcement of a one year deferral in July 2015, for a public entity, the amendments in this guidance are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early application is not permitted. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented or apply the requirements in the year of adoption, through a cumulative adjustment. The Company has not yet selected a transition method nor has it determined the impact of adoption on its consolidated financial statements.

 

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In February 2016, the FASB issued guidance, which replaces the existing guidance for leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and requires retrospective application. The Company will adopt in fiscal 2020 and is currently evaluating the impact of the guidance on its consolidated financial statements.

In July 2015, the FASB issued guidance that requires an entity to measure inventory at the lower of cost and net realizable value when the FIFO or average cost method is used. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, and should be applied prospectively. Earlier adoption is permitted. The Company is currently assessing the impact the adoption of the amended guidance will have on its consolidated financial statements but the adoption is not expected to have a significant impact on the Company’s consolidated financial statements.

4. ACQUISITIONS

Inmet and Weinschel

On June 8, 2015 API completed the acquisition of Inmet and Weinschel for a total purchase price of $79,392, which included a payment of $80,000 partially offset by a working capital adjustment of $608. Inmet and Weinschel have each been in business for more than 40 years, and each manufactures and sells RF and microwave products for defense, space, avionics, wireless, and test and measurement applications. The acquisitions of Inmet and Weinschel add breadth to API’s RF, microwave, and microelectronics product portfolio, extend the Company’s subsystems offering, and further API’s reach in key end markets, including defense, space, commercial aviation, and wireless. API financed the acquisition with an $85,000 add-on to its existing term loan with Guggenheim Corporate Funding LLC (see Note 8). The acquisition expands the Company’s RF and Microwave capabilities and the Company believes that additional revenue opportunities will be generated through cross selling. These factors contributed to a purchase price resulting in the recognition of goodwill.

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 $1,129 as of November 30, 2015. These expenses have been accounted for as operating expenses. The results of operations of Inmet and Weinschel have been included in the Company’s results of operations beginning on June 8, 2015 in the Systems, Subsystems & Components (SSC) segment.

Accounting guidance requires that identifiable assets acquired and liabilities assumed be reported at fair value as of the acquisition date of a business combination. The purchase consideration was preliminarily allocated to assets acquired and liabilities assumed as follows:

 

     (in thousands)  

Accounts receivable and other current assets

   $ 6,854   

Inventory

     12,655   

Fixed assets

     5,365   

Customer, marketing and technology related intangible assets

     28,179   

Goodwill

     32,469   

Current liabilities

     (6,130
  

 

 

 

Total purchase consideration

   $ 79,392   
  

 

 

 

The purchase consideration for Inmet and Weinschel exceeded the underlying fair value of the net assets acquired, giving rise to the goodwill. The resulting goodwill will be deductible for tax purposes. Customer, marketing and technology related intangibles are amortized based on the pattern in which the economic benefits are expected to be realized, over estimated lives of four to twelve years. The purchase accounting is preliminary subject to the completion of the fair value assessment of the accounting for income taxes. Material adjustments, if any, to provisional amounts in subsequent periods, will be reflected as required.

Revenues and net loss of Inmet and Weinschel combined, for the three month period ended February 29, 2016 were approximately $10,583 and $632, respectively.

 

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Fixed assets acquired in this transaction consist of the following:

 

     (in thousands)  

Land

   $ 385   

Buildings and leasehold improvements

     3,397   

Computer equipment

     15   

Furniture and fixtures

     207   

Machinery and equipment

     1,361   
  

 

 

 

Total fixed assets acquired

   $ 5,365   
  

 

 

 

The following unaudited pro forma summary presents the combined results of operations as if the Inmet and Weinschel acquisitions described above had occurred at the beginning of the three month period ended February 28, 2015.

 

     Three months ended
February 28,
 
     2015  

Revenues

   $ 62,045   

Net loss

   $ 130   

Net loss per share—basic and diluted

   $ 0.00   

5. INVENTORIES

Inventories consisted of the following:

 

     (in thousands)  
     February 29,
2016
     November 30,
2015
 

Raw materials

   $ 34,624       $ 34,222   

Work in progress

     19,257         19,355   

Finished goods

     10,104         11,666   
  

 

 

    

 

 

 

Total

   $ 63,985       $ 65,243   
  

 

 

    

 

 

 

At February 29, 2016 and November 30, 2015, inventories are presented net of inventory reserves of $8,169 and $9,343, respectively.

6. SHORT-TERM DEBT

The Company has a credit facility in place for certain of its U.K. subsidiaries for approximately $347 (250 GBP), which renews in July 2016. 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 February 29, 2016 and November 30, 2015.

7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consisted of the following:

 

     (in thousands)  
     February 29,
2016
     November 30,
2015
 

Trade accounts payable

   $ 19,843       $ 22,493   

Accrued expenses

     13,204         12,551   

Wage and vacation accrual

     4,697         6,751   
  

 

 

    

 

 

 

Total

   $ 37,744       $ 41,795   
  

 

 

    

 

 

 

 

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8. LONG-TERM DEBT

The Company had the following long-term debt obligations:

 

     (in thousands)  
     February 29,
2016
     November 30,
2015
 

Term loans, due February 6, 2018, base rate plus 7.50% interest or LIBOR plus 8.50%, (a)

   $ 193,690       $ 193,690   

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

     864         956   

Capital leases payable (c)

     5,361         5,380   
  

 

 

    

 

 

 
   $ 199,915       $ 200,026   

Less: Current portion of long-term debt

     (27,200      (21,816

Discount and deferred financing charges on term loans

     (2,161      (2,480
  

 

 

    

 

 

 

Long-term portion

   $ 170,554       $ 175,730   
  

 

 

    

 

 

 

 

a) On February 6, 2013, the Company refinanced its credit facilities and entered into (i) a credit agreement (the “Term Loan Agreement”) with various lenders and Guggenheim Corporate Funding, LLC, as agent (the “Agent”) that provided for a $165,000 term loan facility and (ii) a credit agreement with various lenders and Wells Fargo Bank, National Association (the “Revolving Loan Agreement”) that provided for a $50,000 asset-based revolving borrowing base credit facility, with a $10,000 subfacility (or the Sterling equivalent) for certain of our United Kingdom subsidiaries, a $10,000 subfacility for letters of credit and a $5,000 subfacility for swingline loans.

On March 21, 2014, the Company entered into Amendment No. 2 to the Term Loan Agreement (the “Amendment No. 2”), to provide for an incremental term loan facility in an aggregate principal amount equal to $55,000 (the “Incremental Term Loan Facility”), which Incremental Term Loan Facility is subject to substantially the same terms and conditions, including the applicable interest rate and the maturity date of February 6, 2018, as the $165,000 term loan facility provided upon the initial closing of the Term Loan Agreement. In addition, Amendment No. 2 amended the Term Loan Agreement to reduce the minimum interest coverage ratio and increase the maximum leverage ratio, among other things.

The proceeds of the Incremental Term Loan Facility were used (i) to pay in full and terminate the Company’s Revolving Loan Agreement; (ii) to redeem all 26,000 shares of the Company’s Series A Preferred Stock that were outstanding; (iii) to pay fees, costs and expenses associated with the Incremental Term Loan Facility and related transactions; and (iv) for general corporate purposes. This resulted in the write-off of approximately $10,212 of deferred financing costs and note discounts in the quarter ended May 31, 2014.

On June 8, 2015, the Company entered into Amendment No. 3 to the Term Loan Agreement (the “Amendment No. 3”), to provide for an incremental term loan facility in an aggregate principal amount equal to $85,000 (the “Second Incremental Term Loan Facility”), increased the margins applicable to the outstanding term loans to 7.50% in the case of base rate loans and 8.50% in the case of LIBOR loans, beginning December 2015, amended the prepayment premiums that the Company is required to pay upon voluntary prepayments or certain mandatory prepayments of the term loans, permitted certain additional adjustments to the Company’s consolidated EBITDA for cost savings in connection with the acquisition Inmet and Weinschel and reduced the minimum interest coverage ratio and increased the maximum leverage ratio for certain compliance periods. The proceeds of the Second Incremental Term Loan Facility were primarily used to fund the purchase price for the Inmet and Weinschel acquisition.

On February 28, 2016, the Company entered into Amendment No. 4 to the Term Loan Agreement ( “Amendment No. 4”), by and among the Company, the lenders party thereto and the Agent.

Term Loan Agreement

The term loans incurred pursuant to the Term Loan Agreement, as amended through Amendment No. 2, bore interest, at the Company’s option, at the base rate plus 6.50% or an adjusted LIBOR rate (based on one, two or three-month interest periods) plus 7.50% for the first year and at the base rate plus 7.50% or an adjusted LIBOR rate (based on one, two or three-month interest periods) plus 10.75% thereafter, with a LIBOR floor of 1.50%. Amendment No. 3 increased the margins applicable to the outstanding term loans to 7.50% in the case of base rate loans and 8.50% in the case of LIBOR loans, beginning December 2015. For purposes of the Term Loan Agreement, the “base rate” means the highest of Wells Fargo Bank, National Association’s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 3-month interest period plus a margin equal to 1.00%.

Interest is due and payable in arrears monthly for term loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of term loans with interest periods greater than three months) in the case of term loans bearing interest at the adjusted LIBOR rate. Principal payments of the term loans are paid at the end of each of the Company’s fiscal quarters, with the balance of any outstanding term loans due and payable in full on February 6, 2018. The quarterly principal payments amortized at 1.25% for the fiscal quarters through the end of the Company’s 2014 fiscal year, at 1.875% for the fiscal quarters through the end of the Company’s 2015 fiscal year and will amortize at 2.50% for each of the fiscal quarters thereafter.

 

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Under certain circumstances, the Company is required to prepay the term loans upon the receipt of cash proceeds of certain asset sales, cash proceeds of certain extraordinary receipts and cash proceeds of certain debt or equity financings, and based on a calculation of annual excess cash flow. Mandatory prepayments resulting from assets sales or certain debt financings may require the payment of certain prepayment premiums.

The term loans are secured by a first priority security interest in accounts receivable, inventory, machinery, equipment and certain other personal property relating to the foregoing, and any proceeds from any of the foregoing, subject to certain exceptions and liens, and a first priority security position on substantially all other real and personal property, in each case that are owned by the Company and the subsidiary guarantors.

The Term Loan Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries’ ability to, among other things, incur indebtedness, grant liens, dispose of assets and pay dividends or make distributions to stockholders. The Term Loan Agreement has the financial covenants of a minimum interest coverage ratio and maximum leverage ratio. On February 28, 2016, in connection with transactions contemplated by the Merger Agreement (see Note 17), the Company entered into Amendment No. 4. Amendment No. 4 amends the Term Loan Agreement to add additional mandatory prepayment events upon the occurrence of a change of control (as defined in the Term Loan Agreement) and/or receipt of any termination fees under the Merger Agreement and decreases the prepayment premiums that the Company is required to pay upon a voluntary or mandatory prepayment of any of the outstanding term loans. Upon consummation of the transactions contemplated by the Merger Agreement, the Company will be required to pay a prepayment premium in an amount equal to 1% of the amount of the term loans prepaid. Amendment No. 4 also amends the amortization schedule applicable to future term loan payments made by the Company by removing the Company’s obligation to make an amortization payment for the fiscal quarters ending February 29, 2016 and May 31, 2016 and requiring the Company to make an amortization payment in an amount equal to 5.0% of the original aggregate term loan amount on the earlier of (a) May 27, 2016 and (b) the date of termination of the Merger Agreement.

Amendment No. 4 reduces the minimum interest coverage ratio and increases the maximum leverage ratio for the November 30, 2015 compliance period and the fiscal 2016 compliance periods, and adds additional events of default upon either (a) the termination of the Merger Agreement or (b) the Company’s failure to consummate the transactions contemplated by the Merger Agreement on or prior to May 27, 2016. At February 29, 2016, the Company was in compliance with these amended financial covenants.

Pursuant to the Term Loan Agreement, the Company is also required to limit its annual capital expenditures to $4,000 per fiscal year (subject to carry-over rights).

Revolving Loan Agreement

On March 21, 2014, approximately $25,136 of the proceeds of the Incremental Term Loan Facility was used to pay in full and terminate the Company’s Revolving Loan Agreement.

 

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 November 30, 2015. The mortgage is secured by the subsidiary’s assets.

 

c) On December 31, 2013, the Company completed the sale and leaseback (the “Sale/Leaseback”) of the Company’s facility located in State College, Pennsylvania. The Company sold the facility to an unaffiliated third party for a gross purchase price of approximately $15,500 and will lease the property from the buyer for approximately $1,279 per year, subject to annual adjustments. As a result of this transaction the Company initially recorded a capital lease obligation of $5,225. The gain on the sale has been deferred and is being recognized over the 15 year lease term.

9. SHAREHOLDERS’ EQUITY

On January 20, 2010 the Company agreed to issue 800,000 shares of API common stock payable as part of the compensation to Kuchera Defense Systems, Inc. (“KDS”), KII, Inc. (“KII”) and Kuchera Industries, LLC (“KI Industries” and collectively with KDS and KII, the “KGC Companies”) or their designees. 250,000 shares were issued and delivered at closing, an additional 250,000 shares were to be issued and delivered on the first anniversary of the closing and 300,000 shares were to be issued and delivered on the second anniversary of the closing. The Company issued 126,250 shares in escrow from the originally deferred 550,000 shares. The unissued shares were initially accounted for as common shares subscribed but not issued. Following the Kuchera settlement in October 2015, the Company issued the remaining 423,750 shares. In addition, on January 20, 2010 and January 22, 2010, we issued warrants to purchase an aggregate of 892,862 shares of common stock with an exercise price of $5.60 per share, which expired on January 20, 2015 and January 22, 2015.

 

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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 February 29, 2016, API is obligated to issue a remaining approximately 63,886 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 22,617 exchangeable shares outstanding (excluding exchangeable shares held by the Company) as of February 29, 2016. Exchangeable shares are substantially equivalent to our common shares.

On November 6, 2006, API amended its certificate of incorporation to allow it to issue one special voting share. This special voting share was issued to a trustee in connection with a Plan of Arrangement and allows the trustee to have at meetings of stockholders of API the number of votes equal to the number of exchangeable shares not held by API or subsidiaries of API. (The trustee is charged with obtaining the direction of the holders of exchangeable shares on how to vote at meetings of API stockholders.) The API Nanotronics Sub, Inc. exchangeable shares are convertible into shares of API common stock at any time at the option of the holder. API may force the conversion of API Nanotronics Sub., Inc. exchangeable shares into shares of API common stock on the tenth anniversary of the date of the Plan of Arrangement or sooner upon the happening of certain events.

The Company issued 661,250 options and 217,500 RSUs during the three months ended February 29, 2016 (no options or RSUs during three months ended February 28, 2015) (Note 10). The Company values its option grants using the Black-Scholes option-pricing model.

10. STOCK-BASED COMPENSATION

Of the 5,875,000 shares authorized under the Equity Incentive Plan, 2,341,534 shares are available for issuance pursuant to options, RSUs, or stock as of February 29, 2016. 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 February 29, 2016 there was $641 of total unrecognized compensation related to non-vested stock options, which are not contingent upon attainment of certain milestones. The cost is expected to be recognized over the remaining periods of the options, which are expected to vest from 2015 to 2019.

During the three months ended February 29, 2016 and February 28, 2015, $348 and $79, respectively, has been recognized as stock-based compensation expense in general and administrative expense.

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:

 

     Year ended
February 29, 2016
 

Expected volatility

     70.8

Expected dividends

     0

Expected term

     9.3 years   

Risk-free rate

     1.7

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

 

     Options      Weighted
Average
Exercise
Price
 

Stock Options outstanding—November 30, 2014

     1,328,310       $ 4.52   

Less forfeited

     (33,183    $ 4.60   

Issued

     707,500       $ 1.98   
  

 

 

    

Stock Options outstanding—November 30, 2015

     2,002,627       $ 3.62   

Less forfeited

     (414,925    $ 3.21   

Issued

     661,250       $ 1.15   
  

 

 

    

Stock Options outstanding—February 29, 2016

     2,248,952       $ 2.97   
  

 

 

    

Stock Options exercisable—February 29, 2016

     850,202       $ 5.24   
  

 

 

    

 

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Restricted stock unit activity under the 2006 Equity Compensation Plan is presented below:

 

     Units      Weighted
Average
Grant
Date Fair
Value
 

RSUs outstanding—November 30, 2014

     48,334       $ 3.30   

Issued

     273,381       $ 1.96   

Vested—Stock issued

     (43,334    $ 3.72   
  

 

 

    

RSUs outstanding—November 30, 2015

     278,381       $ 1.96   

Issued

     217,500       $ 1.15   
  

 

 

    

RSUs outstanding—February 29, 2016

     495,881       $ 1.61   
  

 

 

    

RSUs vested—February 29, 2016

     5,000       $ 2.37   

 

     RSUs and Options Outstanding      RSUs Vested and Options Exercisable  

Range of

Exercise Price

   Number of
Outstanding
at Feb. 29,
2016
     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Life
(Years)
     Aggregate
Intrinsic
Value
(in thousands)
     Number
Vested or
Exercisable
at Feb. 29,
2016
     Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
(in thousands)
 

$0.00 – $3.55

     2,149,631       $ 1.45         7.92       $ 1,530         260,000       $ 3.41       $ 10   

$3.56 – $4.99

     17,084       $ 3.56         4.65       $ —          17,084       $ 3.56       $ —    

$5.00 – $6.99

     572,284       $ 5.98         4.73       $ —          572,284       $ 5.98       $ —    

$7.00 – $20.00

     5,834       $ 14.07         1.24       $ —          5,834       $ 14.07       $ —    
  

 

 

          

 

 

    

 

 

       

 

 

 
     2,744,833            7.22       $ 1,530         855,202          $ 10   
  

 

 

          

 

 

    

 

 

       

 

 

 

The price of the RSUs for purposes of Weighted Average Exercise Price is zero. The intrinsic value is calculated as the excess of the market value as of February 29, 2016 over the exercise price of the options and over an amount of zero with respect to the RSUs. The market value as of February 29, 2016 was $1.95 as reported by the NASDAQ Stock Market.

11. SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information:

 

    

(in thousands)

Three months ended

 
     February 29,
2016
     February 28,
2015
 

Supplemental Cash Flow Information

     

Cash paid for income taxes

   $ 636       $ 220   

Cash paid for interest

   $ 4,627       $ 2,792   

12. 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
February 29 and February 28
 
     2016      2015  

Weighted average shares-basic

     55,914,633         55,461,217   

Effect of dilutive securities

     *         *   
  

 

 

    

 

 

 

Weighted average shares—diluted

     55,914,633         55,461,217   
  

 

 

    

 

 

 

Basic EPS and diluted EPS for the three months ended February 29, 2016 and February 28, 2015 have been computed by dividing the net income (loss) 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.

 

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* Outstanding options and RSUs aggregating 2,744,833 – February 29, 2016 (1,363,961 – February 28, 2015) incremental shares have been excluded from the February 29, 2016 and February 28, 2015 computation of diluted EPS as they are anti-dilutive due to the losses generated in each respective period.

13. COMMITMENTS AND CONTINGENCIES

On September 15, 2011, Currency, Inc., KII Inc., Kuchera Industries, LLC, William Kuchera and Ronald Kuchera (the “Plaintiffs”) filed a lawsuit against API and three API subsidiaries (the “API Pennsylvania Subsidiaries”) in the Court of Chancery of the State of Delaware in relation to the Asset Purchase Agreement by and among API, the API Pennsylvania Subsidiaries, the KGC Companies, William Kuchera, and Ronald Kuchera dated January 20, 2010. Plaintiffs’ complaint alleges claims for breach of contract and unjust enrichment based on their contention that API and the API Pennsylvania Subsidiaries violated the Agreement by failing to issue certain shares of stock to Plaintiffs and by failing to cooperate with Plaintiffs in the filing of a final general and administrative overhead rate with the Defense Contracting Audit Agency. API and the API Pennsylvania Subsidiaries filed an answer to the complaint denying all liability and a counterclaim for breach of contract against Plaintiffs. Of the 550,000 shares that had not been delivered under the Asset Purchase Agreement, 126,250 were placed in escrow and the remaining 423,750 shares were previously accounted for as common shares subscribed but not issued with a value of $2,373.

In October 2015, the Company settled the Kuchera litigation described above for a $2,500 note payable to the plaintiffs and the delivery of the remaining 550,000 shares under the Asset Purchase Agreement to the plaintiffs. If the net proceeds resulting from the sale of the 550,000 shares do not, in the aggregate, yield at least $1,000, API will issue additional shares of common stock until the net proceeds of all such shares is $1,000. To the extent net proceeds from the sale of the 550,000 shares exceed $1,000, such excess will be credited against amounts due under the note. As of February 29, 2016 the shares have been issued and delivered, but have not been sold. The closing price of the Company’s stock as of February 29, 2016 was $1.95 per share, as reported by the NASDAQ Stock Market. The note (recorded in Accounts payable and accrued expenses) will bear interest at the rate of 12% until April 1, 2016 and 18% thereafter. Monthly payments of interest only are required until April 1, 2016, and thereafter equal monthly payments of interest and principal will be amortized and payable over a 48 month period. All amounts due under the note will accelerate and become due and payable if the Term Loan Agreement is refinanced. There is no prepayment penalty.

In connection with the Merger, three purported class action complaints have been filed on behalf of the stockholders against the Company, members of the board of directors, J.F. Lehman & Company, Parent and Merger Sub in the Circuit Court for the Ninth Judicial Circuit in and for Orange County, Florida. The three complaints are captioned as follows: Smith v. API Technologies Corp. et. al., 2016-CA-001988-O (Cir. Ct. Fl.); Marcus v. API Technologies Corp. et. al., 2016-CA-002257-O (Cir. Ct. Fl.); Strougo v. API Technologies Corp. et. al., 2016-CA-002629-O (Cir. Ct. Fl.) (actions filed March 2, 2016, March 14, 2016, and March 24, 2016, respectively). The complaints generally allege, among other things, that the board of directors of the Company breached its fiduciary duties to the stockholders by failing to ensure that Company stockholders received adequate and fair value for their shares. The complaints also generally assert that the Company, J.F. Lehman & Company and Parent aided and abetted the board of directors’ breach of its fiduciary duties. The lawsuits seek, among other things, to enjoin the consummation of the Merger, rescission of the Merger Agreement (to the extent the Merger has already been consummated), damages, and attorneys’ fees and costs. The parties have engaged in discovery and litigation activities in advance of the finalization of the Merger. All three actions are currently pending, a motion to consolidate the three actions is also pending, and the Merger has not yet been finalized.

The Company is also a party to lawsuits in the normal course of its 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.

In accordance with required guidance, the Company accrues for litigation matters when losses become probable and reasonably estimable. The Company has no recorded accrual relating to its outstanding legal matters as of February 29, 2016 (November 30, 2015—$0). As of the end of each applicable reporting period, or more frequently, as necessary, the Company reviews each outstanding matter and, where it is probable that a liability has been incurred, it accrues for all probable and reasonably estimable losses. Where the Company is able to reasonably estimate a range of losses with respect to such a matter, it records an accrual for the amount within the range that constitutes its best estimate. If the Company can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, it will use the amount that is the low end of such range. Because of the uncertainty, the complexity and the many variables involved in litigation, the actual costs to the Company with respect to its legal matters may differ from our estimates, could result in a significant difference and could have a material adverse effect on the Company’s financial position, liquidity, or results of operations. If we determine that an additional loss in excess of our accrual is probable but not estimable, the Company will provide disclosure to that effect. The Company expenses legal costs as they are incurred.

Upon closing the contemplated Merger as referenced in Note 17, the Company is liable to pay fees and expenses to its investment banking firm in the amount of approximately $4,300. Other Merger related costs yet to be incurred, such as additional legal, accounting and certain investment banking fees, must be paid even if the Merger is not completed. Under certain circumstances specified in the Merger Agreement, the Company may be required to pay Parent a termination fee of approximately $3,500.

14. INCOME TAXES

For the three month periods ended February 29, 2016 and February 28, 2015, the Company’s effective income tax rates were (12.0)% and (14.3)% for continuing operations, respectively compared to an applicable U.S. federal statutory income tax rate of 34%. The difference between the effective tax rate and U.S. statutory tax as of February 29, 2016 and February 28, 2015 is primarily due to the existence of a valuation allowance recorded against deferred tax assets including net operating losses, as well as, the income of foreign subsidiaries being taxed at rates lower than the U.S. statutory rate. For the three months ended February 29, 2016, the Company recorded valuation allowances on deferred tax assets relating to current year losses. The Company also recorded non-cash deferred tax expense in connection with the tax amortization of indefinite-lived intangible assets, which cannot be used as a source of future taxable income in calculating the current year valuation allowance.

 

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As of February 29, 2016, the Company had no significant unrecognized tax benefits.

The Company records interest and penalties related to tax matters within general and administrative expenses on the accompanying Consolidated Statement of Operations. These amounts are not material to the consolidated financial statements for the periods presented. The Company’s U.S. tax returns are subject to examination by federal and state taxing authorities. Generally, tax years 2011-2015 remain open to examination by the Internal Revenue Service or other tax jurisdictions to which the Company is subject. The Company’s Canadian tax returns are subject to examination by federal and provincial taxing authorities in Canada. Generally, tax years 2011-2015 remain open to examination by Canada Revenue Agency or other tax jurisdictions to which the Company is subject.

15. 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 February 29, 2016 and February 28, 2015 the Company has reflected within the consolidated statement of operations restructuring charges of $596 and $872, respectively. These restructuring charges included lease impairment and legal charges, workforce reductions and other expenses related to consolidating certain operations, and costs related to the change in the Company’s Chief Executive Officer. The actions taken as part of these restructuring activities are intended to realize synergies from our combined SSC operations, contain costs and streamline our operations. Management continues to evaluate whether other related assets have been impaired, and has concluded that there should be no additional impairment charges as of February 29, 2016.

As of February 29, 2016, the Company has also recorded a lease impairment accrual of approximately $1,516 related to one of the facilities of its EMS business and $241 related to one of the facilities of its SSC business.

16. 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, geographic areas and major customers.

The Company’s operations are conducted in three principal business segments: Systems, Subsystems & Components (SSC), Secure Systems & Information Assurance (SSIA) and Electronic Manufacturing Services (EMS). Inter-segment sales are presented at their market value for disclosure purposes. Corporate includes general and administrative functions and unallocated costs of our shared service operations/management, administrative and other shared corporate services functions such as information technology, legal, finance, human resources, and marketing. These administrative and other shared services costs have been allocated in the adjusted EBITDA measure based on a percent of revenue for each respective operating segment.

The Company’s chief operating decision maker evaluates segment performance based primarily on revenues and Adjusted EBITDA. The accounting policies of each of the operating segments are the same as those described in the summary of significant accounting policies in Note 2. Adjusted EBITDA represents income from continuing operations excluding depreciation and amortization, stock-based compensation expense and other items as described below. Management views adjusted EBITDA as an important measure of segment performance because it removes from operating results the impact of items that management believes do not reflect the Company’s core operating performance. Adjusted EBITDA is a measure which is also used in calculating financial ratios in material debt covenants in the Company’s credit facilities.

Management does not evaluate the performance of its operating segments using asset measures. The identifiable assets by segment disclosed in this note are those assets specifically identifiable within each segment and include cash, accounts receivable, inventory, goodwill and intangible assets.

 

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Three months ended February 29, 2016

(in thousands)

   SSC      SSIA      EMS     Corporate      Inter
Segment
Eliminations
     Total  

Revenue from external customers

   $ 42,701       $ 5,261       $ 6,465      $ —        $ —        $ 54,427   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Adjusted EBITDA:

     5,142         1,528         (475     —          —          6,195   

Acquisition related charges

                   183   

Restructuring

                   596   

Depreciation and amortization

                   4,322   

Interest expense, net

                   5,326   

Amortization of note discounts and deferred financing costs

                   343   

Other adjustments *

                   1,162   
                

 

 

 

Loss before income taxes

                 $ (5,737
                

 

 

 

Segment assets—as at February 29, 2016

   $ 296,168       $ 12,017       $ 20,793      $ 5,834       $ —        $ 334,812   

Goodwill included in assets—as at Feb. 29, 2016

   $ 146,770       $ —        $ 2,469      $ —        $ —        $ 149,239   

Purchase of fixed assets, to February 29, 2016

   $ 255       $ 1       $ 15      $ —        $ —        $ 271   

Three months ended February 28, 2015

(in thousands)

   SSC      SSIA      EMS     Corporate      Inter
Segment
Eliminations
     Total  

Revenue from external customers

   $ 38,386       $ 4,258       $ 8,206      $ —        $ —        $ 50,850   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Adjusted EBITDA:

     5,242         755         50        —          —          6,047   

Acquisition related charges

                   62   

Restructuring

                   872   

Depreciation and amortization

                   3,459   

Interest expense, net

                   3,127   

Amortization of note discounts and deferred financing costs

                   23   

Other adjustments *

                   411   
                

 

 

 

Loss before income taxes

                 $ (1,907
                

 

 

 

Segment assets—as at November 30, 2015

   $ 305,267       $ 11,089       $ 21,024      $ 7,645       $ —        $ 345,025   

Goodwill included in assets—as at Nov. 30, 2015

   $ 146,770       $ —        $ 2,469      $ —        $ —        $ 149,239   

Purchase of fixed assets, to February 28, 2015

   $ 144       $ 12       $ 3      $ —        $ —        $ 159   

 

* Other adjustments primarily include non-cash inventory provisions, stock based compensation, franchise taxes, financing and other adjustments, lease payments for the State College, Pennsylvania facility, and foreign exchange losses.

17. AGREEMENT AND PLAN OF MERGER

On February 28, 2016, API entered into the Merger Agreement with Parent and Merger Sub, providing for the merger of Merger Sub with and into API, with API surviving the Merger as a wholly owned subsidiary of Parent.

At the effective time of the Merger, each share of common stock, par value $0.001 per share, of API (the “API Common Stock”) issued and outstanding as of immediately prior to the effective time, other than certain excluded shares, will be cancelled and automatically converted into the right to receive $2.00 cash, without interest (the “Per Share Price”). API RSUs and API options will be cancelled and converted into the right to receive the Per Share Price, less, with respect to API options, the exercise price per share underlying such API options, if any.

Consummation of the Merger is subject to certain conditions, including, without limitation, (i) the receipt of the necessary approval of the Merger from API’s stockholders, which was obtained by written consent on February 29, 2016; (ii) the absence of any law or order restraining, enjoining or otherwise prohibiting the Merger; and (iii) the expiration or termination of any waiting periods applicable to the consummation of the Merger under applicable antitrust and competition laws.

API has made customary representations and warranties in the Merger Agreement and has agreed to customary covenants regarding the operation of the business of API prior to the consummation of the Merger.

 

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The Merger Agreement contains certain termination rights for API and Parent. Upon termination of the Merger Agreement under specified circumstances (principally in connection with terminating the Merger Agreement to accept a superior proposal, as defined in the Merger Agreement), API will be required to pay Parent a termination fee of $3,500.

Upon termination of the Merger Agreement under specified circumstances, Parent will be required to pay API a termination fee of $5,000. This reverse termination fee is payable if the Merger Agreement is terminated by API if Parent and Merger Sub fail to consummate the Merger under certain circumstances or if Parent or Merger Sub have willfully breached their respective representations, warranties, covenants or other agreements in the Merger Agreement in certain circumstances and have failed to cure such breach within a certain period. A private equity fund affiliated with J.F. Lehman & Company has provided API with a limited guaranty guaranteeing the payment of the reverse termination fee and certain other monetary obligations that may be owed by Parent pursuant to the Merger Agreement. The Merger Agreement also provides that either party may, under certain circumstances, specifically enforce the other party’s obligations under the Merger Agreement.

In addition to the foregoing termination rights, and subject to certain limitations, API or Parent may terminate the Merger Agreement if the Merger is not consummated by May 27, 2016.

On February 29, 2016, Vintage Albany Acquisition, LLC (“Vintage”), the record and beneficial owner of 22,000,000 shares of API Common Stock, and Steel Excel Inc. (“Steel”), the record and beneficial owner of 11,377,192 shares of API Common Stock, approved the Merger and adopted the Merger Agreement by written consent. Together, Vintage and Steel hold over a majority of the outstanding shares of API Common Stock. The approval by Vintage and Steel constitutes the required approval of the Merger and adoption of the Merger Agreement by API’s stockholders under Delaware General Corporation Law and the charter.

 

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

Introduction

This section is provided as a supplement to, and should be read in conjunction with, our unaudited Consolidated Financial Statements and accompanying Notes thereto included in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year ended November 30, 2015 to help provide an understanding of our financial condition, changes in financial condition and results of our operations.

Business Overview of API Technologies Corp.

General

We design, develop and manufacture high reliability RF microwave, millimeterwave, microelectronics, power, and security products and solutions to the defense, aerospace, industrial, satellite, and commercial end markets. In addition, we provide electronics manufacturing services to such markets. We own and operate several state-of-the-art manufacturing facilities in the U.S., the U.K., Canada, China and Mexico.

Operating through our three segments: Systems, Subsystems & Components (SSC), Electronic Manufacturing Services (EMS) and Secure Systems & Information Assurance (SSIA), we are positioned as a differentiated solution provider to U.S. and U.S. friendly governments, military, defense, aerospace and homeland security contractors, and leading industrial and commercial firms. With a focus on high-reliability products and solutions, our product portfolio spans RF/microwave and microelectronics, electromagnetics, power products, and security products. We also offer a wide range of electronic manufacturing services from prototyping to high volume production.

Merger Agreement

On February 28, 2016, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with RF1 Holding Company (“Parent”) and RF Acquisition Sub, Inc., a wholly owned subsidiary of Parent (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with API surviving the Merger as a wholly owned subsidiary of Parent.

At the effective time of the Merger, each share of common stock, par value $0.001 per share, of API (the “API Common Stock”) issued and outstanding as of immediately prior to the effective time, other than certain excluded shares, will be cancelled and automatically converted into the right to receive $2.00 cash, without interest (the “Per Share Price”). API RSUs and API options will be cancelled and converted into the right to receive the Per Share Price, less, with respect to API options, the exercise price per share underlying such API options, if any.

The Merger Agreement contains certain termination rights for API and Parent. Upon termination of the Merger Agreement under specified circumstances (principally in connection with terminating the Merger Agreement to accept a superior proposal, as defined in the Merger Agreement), API will be required to pay Parent a termination fee of $3.5 million.

Upon termination of the Merger Agreement under specified circumstances, Parent will be required to pay API a termination fee of $5 million. This reverse termination fee is payable if the Merger Agreement is terminated by API if Parent and Merger Sub fail to consummate the Merger under certain circumstances or if Parent or Merger Sub have willfully breached their respective representations, warranties, covenants or other agreements in the Merger Agreement in certain circumstances and have failed to cure such breach within a certain period. A private equity fund affiliated with J.F. Lehman & Company has provided API with a limited guaranty guaranteeing the payment of the reverse termination fee and certain other monetary obligations that may be owed by Parent pursuant to the Merger Agreement. The Merger Agreement also provides that either party may, under certain circumstances, specifically enforce the other party’s obligations under the Merger Agreement.

In addition to the foregoing termination rights, and subject to certain limitations, API or Parent may terminate the Merger Agreement if the Merger is not consummated by May 27, 2016.

On February 29, 2016, Vintage Albany Acquisition, LLC (“Vintage”), the record and beneficial owner of 22,000,000 shares of API Common Stock, and Steel Excel Inc. (“Steel”), the record and beneficial owner of 11,377,192 shares of API Common Stock, approved the Merger and adopted the Merger Agreement by written consent. Together, Vintage and Steel hold over a majority of the outstanding shares of API Common Stock. The approval by Vintage and Steel constitutes the required approval of the Merger and adoption of the Merger Agreement by API’s stockholders under Delaware General Corporation Law and the charter.

 

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The foregoing summary of the Merger Agreement does not purport to be complete and is qualified in its entirety by the full text of the Merger Agreement attached as Exhibit 2.1 to the Current Report on Form 8-K filed with the SEC on March 1, 2016.

Inmet and Weinschel

On June 8, 2015 we completed the acquisition of Aeroflex / Inmet, Inc. (“Inmet”) and Aeroflex / Weinschel, Inc. (“Weinschel”) from Cobham plc for a total purchase price of approximately $80.0 million. Inmet and Weinschel have each been in business for more than 40 years, and each manufactures and sells RF and microwave products for defense, space, avionics, wireless, and test and measurement applications. The acquisitions of Inmet and Weinschel add breadth to our RF, microwave, and microelectronics product portfolio, extend our subsystems offering, and further our reach in key end markets, including defense, space, commercial aviation, and wireless. We financed the acquisition with an $85.0 million add-on to our existing term loan with the Agent through an Amendment No. 3 to Credit Agreement (the “Amendment No. 3”), by and among the Company, as borrower, the lenders party thereto and the Agent, as administrative agent. Amendment No. 3 permits the acquisitions of Inmet and Weinschel and amends the Credit Agreement, dated as of February 6, 2013, by and among the Company, as borrower, the lenders party thereto and Agent (as amended, supplemented or modified from time to time, the “Term Loan Agreement”) to provide for an incremental term loan facility in an aggregate principal amount equal to $85.0 million (the “Second Incremental Term Loan Facility”). The proceeds of the Second Incremental Term Loan Facility were used to fund the purchase price for the acquisition of Inmet and Weinschel and related fees and expenses, with the remainder available for general corporate purposes. We paid customary arrangement and commitment fees, as well as an amendment fee, in connection with the Second Incremental Term Loan Facility.

Operating Revenues

We derive operating revenues from our three principal business segments: Systems, Subsystems & Components (SSC); Electronic Manufacturing Services (EMS); and Secure Systems & Information Assurance (SSIA). We sell our products to customers throughout the world, with a concentration in North America, western Europe, and the Asia-Pacific region.

Systems, Subsystems & Components (SSC) Revenue includes high-performance RF/microwave, microelectronics, millimeter wave, electromagnetic, power, and microelectronics solutions used in high-reliability defense, space, industrial and commercial applications, including missile systems, radar systems, electronic warfare systems (e.g. counter-IED RF jamming devices), unmanned air, ground and robotic systems, satellites, as well as industrial, medical, energy and telecommunications products. The main demand today for our SSC products come from U.S. friendly governments, including militaries, defense organizations, commercial aerospace, space, homeland security, prime defense contractors and manufacturers of industrial products.

Electronic Manufacturing Services (EMS) Revenue includes high speed surface mount circuit card assemblies using both surface mount and thru-hole processes, electromechanical assemblies, system and integrated level solutions used in high-reliability defense, industrial, and commercial applications. The main demand today for our EMS products come from various defense organizations, aerospace, prime defense contractors and manufacturers of industrial, medical and commercial products.

Secure Systems & Information Assurance (SSIA) Revenue includes revenues derived from the manufacturing of TEMPEST and Emanation control products, ruggedized computers and peripherals, secure mobile devices, secure access and information assurance products. The principal market for these products are the defense industries of the U.K., the U.S., and Canada and other U.S. friendly governments, Fortune 500 companies and telecommunication service providers.

Cost of Revenue

We conduct all of our design and manufacturing efforts in the U.S., U.K., Canada, Mexico and China. Cost of goods sold primarily consists of costs that were incurred to manufacture, test and ship the products and some design costs for customer funded research and development (“R&D”). These costs include raw materials, including freight, direct labor, subcontractor services, 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.

 

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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

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, and business valuation consultants related to business combinations or divestitures. Related charges include costs incurred related to our efforts to consolidate operations of recently acquired and legacy businesses and expenses associated with divestitures.

Other Expenses (Income)

Other expenses (income) consists of interest expense on term loans, notes payable, operating loans and capital leases, interest income on cash and cash equivalents and marketable securities, amortization of note discounts and deferred financing costs, gains or losses on disposal of property and equipment, and gains or losses on foreign currency transactions.

Backlog

Our sales backlog at February 29, 2016 was approximately $128.0 million compared to approximately $118.6 million at November 30, 2015. Our backlog figures represent confirmed customer purchase orders that we had not shipped at the time the figures were calculated. We anticipate that approximately $99.6 million of our backlog orders will be filled by February 28, 2017. We lack control over the timing of new purchase orders, as such, the backlog can increase or decrease significantly based on timing of customer purchase orders.

 

     (dollar amounts in thousands)  
     February 29,
2016
     November 30,
2015
     %
Change
 

Backlog by segments:

        

SSC

   $ 101,940       $ 97,308         4.8

EMS

     25,314         15,577         62.5

SSIA

     6,046         5,759         5.0
  

 

 

    

 

 

    

 

 

 
   $ 133,300       $ 118,644         12.4
  

 

 

    

 

 

    

 

 

 

The increase at February 29, 2016 compared to November 30, 2015 was primarily related to higher bookings in all segments due to program timing in the quarter ended February 29, 2016, partially offset by a reduction in the UK foreign exchange rate, which affected the SSC and SSIA segments.

Results of Operations for the Three Months Ended February 29, 2016 and February 28, 2015

The following discussion of results of operations is a comparison of our three months ended February 29, 2016 and February 28, 2015.

Segment Operating Revenue and Adjusted EBITDA

Financial information for each of our segments is set forth in Note 16 “Segment Information” to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q. In deciding how to allocate resources and assess performance, our chief operating decision maker regularly evaluates the performance of our reportable segments on the basis of revenue and adjusted EBITDA. Segment adjusted EBITDA assists us in comparing our segment performance over various reporting periods because it removes from our operating results the impact of items that our management believes do not reflect our core operating performance. Our reportable segment measure of adjusted EBITDA is not a recognized measure under GAAP and should not be considered an alternative to, or more meaningful than, net income (loss) or other measures of financial performance derived in accordance with GAAP. Our segment adjusted EBITDA may not be comparable to similarly titled measures of other companies because other entities may not calculate segment adjusted EBITDA in the same manner.

 

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Our segment Adjusted EBITDA is defined as income from continuing operations before income taxes, interest, depreciation and amortization, and excluding other items. Such items include stock-based compensation expense, non-cash inventory provisions, franchise taxes, acquisition related charges, restructuring charges, financing and other adjustments, foreign exchange losses and lease payments related to the Sale/Leaseback.

 

     (dollar amounts in thousands)
Three months ended
 
     February 29,
2016
     February 28,
2015
     %
Change
 

Revenues by segments:

        

SSC

   $ 42,701       $ 38,386         11.2

EMS

     6,465         8,206         (21.2 )% 

SSIA

     5,261         4,258         23.6
  

 

 

    

 

 

    

 

 

 
   $ 54,427       $ 50,850         7.0
  

 

 

    

 

 

    

 

 

 

We recorded a 7.0% increase in overall revenues for the three months ended February 29, 2016 over the same period in 2015. The increase was due to higher revenues in our SSC and SSIA segments, compared to the three months ended February 28, 2015. During the three months ended February 29, 2016, the increase in our SSC segment revenues was primarily due to $10.6 million from the acquisition of Inmet and Weinschel, partially offset by the timing of certain programs and approximately $0.4 million due to the devaluation of the Pound Sterling to the US dollar during the quarter ended February 29, 2016, compared to the same period in the prior year. Revenues for the EMS segment were negatively impacted by the timing of certain programs and the fact that its opening backlog, as at November 30, 2015, was much lower than the prior year. The increase in the SSIA segment revenue was primarily due to higher revenues in Canada, following the completion of elections and in the U.K., partially offset by approximately $0.2 million, each due to the devaluation of the Canadian dollar and Pound Sterling compared to the US dollar during the quarter ended February 29, 2016, compared to the same period in the prior year.

 

     (dollar amounts in thousands)
Three months ended
 
     February 29,
2016
     February 28,
2015
     %
Change
 

Segment Adjusted EBITDA:

        

SSC

   $ 5,142       $ 5,242         (1.9 )% 

EMS

     (475      50         (1058.6 )% 

SSIA

     1,528         755         102.5

The SSC segment adjusted EBITDA for the three months ended February 29, 2016 was lower than the comparable period in 2015 primarily due to a change in product mix, as we shipped products on certain programs with higher costs of revenues. During the three months ended February 29, 2016, the decrease in our EMS segment adjusted EBITDA was primarily due to the impact of lower revenues. The SSIA segment adjusted EBITDA for the three months ended February 29, 2016 was higher than the comparable period in 2015, primarily due to higher revenues and an improved product mix.

Operating Expenses

Cost of Revenue and Gross Margin

 

     Three months ended  
     February 29,
2016
    February 28,
2015
 

Gross margin by segments:

    

SSC

     27.1     29.1

EMS

     3.3     6.5

SSIA

     38.9     29.6

Overall

     25.4     25.5

 

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Our combined gross margin for the three months ended February 29, 2016 decreased by approximately 0.1 percentage points compared to the three months ended February 28, 2015. Gross margin varies from period to period and can be affected by a number of factors, including product mix, production efficiency, and restructuring activities. Overall cost of revenues from continuing operations as a percentage of sales increased in the three months ended February 29, 2016 from 74.5% to 74.6% compared to the same period last year. The SSC segment cost of revenues percentage for the three months ended February 29, 2016 increased by 2.0 percentage points compared to the same period in 2015, primarily due to a change in product mix in the quarter ended February 29, 2016 compared to the same period last year, as we shipped products on certain programs with higher costs of revenues. The EMS segment cost of revenues percentage for the three months ended February 29, 2016 increased by 3.2 percentage points compared to the same period in 2015, primarily due to the impact of lower revenues and therefore lower coverage of our fixed costs. The SSIA segment realized a decrease in cost of revenues of 9.3 percentage points primarily due to the impact of higher revenues and therefore higher coverage of our fixed costs. Combined restructuring costs recorded in the three months ended February 29, 2016 were approximately $0.5 million compared to approximately $0.1 million in the comparable period of 2015.

General and Administrative Expenses

General and administrative expenses increased to approximately $8.4 million for the three months ended February 29, 2016 from $5.3 million for the three months ended February 28, 2015. The increase is primarily a result of the Inmet and Weinschel acquisition and an increase in stock based compensation, partially offset by lower depreciation and amortization as other intangible assets became fully amortized. As a percentage of sales, general and administrative expenses were 15.5% for the three months ended February 29, 2016, compared to 10.4% for the three months ended February 28, 2015.

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

 

     (dollar amounts in thousands)
Three months ended
 
     Feb. 29,
2016
     % of
sales
    Feb. 28,
2015
     % of
sales
 

Depreciation and Amortization

   $ 3,106         5.7   $ 2,026         4.0

Accounting and Administration

   $ 3,285         6.0   $ 1,989         3.9

Stock based compensation

   $ 348         0.6   $ 79         0.2

Professional Services

   $ 416         0.8   $ 402         0.8

Selling Expenses

Selling expenses increased to approximately $3.9 million for the three months ended February 29, 2016 compared to approximately $3.7 million for the three months ended February 28, 2015. As a percentage of sales, selling expenses were 7.2% for the three months ended February 29, 2016, compared to 7.2% for the three months ended February 28, 2015.

The major components of selling expenses are as follows:

 

 

     (dollar amounts in thousands)
Three months ended February 28,
 
     Feb. 29,
2016
     % of
sales
    Feb. 28,
2015
     % of
sales
 

Payroll Expense – Sales

   $ 2,073         3.8   $ 2,000         3.9

Commissions

   $ 1,275         2.3   $ 1,101         2.2

Advertising

   $ 214         0.4   $ 300         0.6

Research and Development Expenses

Research and development costs decreased to approximately $0.9 million for the three months ended February 29, 2016 compared to approximately $2.0 million for the three months ended February 28, 2015. The decrease is primarily a result of cost reduction initiatives and a shift during the three months ended February 29, 2016, as more engineering time was spent on continuous improvement of manufacturing processes, compared to research and development initiatives in the comparable period of last year. As a percentage of sales, research and development expenses were 1.6% for the three months ended February 29, 2016, compared to 3.9% for the three months ended February 28, 2015.

 

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Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, and business valuation consultants related to business combinations or divestitures. For the three months ended February 29, 2016, business acquisition charges of approximately $0.2 million of costs primarily related to the Merger Agreement compared to approximately $0.1 million for the three months ended February 28, 2015.

Operating Income

We posted operating income for the three months ended February 29, 2016 of approximately $0.4 million compared to operating income of approximately $1.1 million for the three months ended February 28, 2015. The decrease in operating income of approximately $0.7 million is primarily attributed to higher operating costs primarily associated with costs related to the acquisition of Inmet and Weinschel, partially offset by higher revenues in the quarter.

Other Expenses (Income)

Total other expense for the three months ended February 29, 2016 is approximately $6.1 million, compared to other expense of $3.0 million for the three months ended February 28, 2015.

The increase in other expense in the three month period ended February 29, 2016, compared to the comparable period in 2015 is largely attributable to higher interest expense, approximately $0.8 million of finance related costs related to Amendment No. 4 to the Credit Agreement and higher amortization of note discounts and deferred financing costs as a result of the refinancing and extinguishment of our previous term loans in June 2015.

Income Taxes

Income taxes from continuing operations amounted to a net expense of approximately $0.7 million for the three months ended February 29, 2016 compared to a net expense of $0.3 million in the three months ended February 28, 2015. The expense during the three months ended February 29, 2016, is primarily due to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period. The current provision is less than the statutory tax rate due to valuation allowances placed upon the deferred tax assets. The prior year expense related to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period.

Net loss

We recorded a net loss for the three months ended February 29, 2016 of approximately $6.4 million, compared to the net loss of approximately $2.2 million for the three months ended February 28, 2015. The net loss in the three month period ended February 29, 2016 is higher than the comparable period in 2015, primarily attributed to higher interest expense and finance related costs, higher income taxes, and higher operating costs primarily associated with costs related to the acquisition of Inmet and Weinschel, partially offset by higher revenues in the quarter.

Liquidity and Capital Resources

Overview and Summary

Our principal sources of liquidity include cash flows from operations, funds from borrowings and existing cash on hand.

At February 29, 2016, we held cash and cash equivalents of approximately $4.5 million compared to $7.2 million at November 30, 2015. We believe that our available cash and cash equivalents and 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 replacements 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. Any issuance of additional equity could dilute our current stockholders’ ownership interests. In addition, see below regarding a discussion of the consequences if there is an event of default under the Term Loan Agreement.

On June 8, 2015, we entered into Amendment No. 3, which amends the Term Loan Agreement to provide for an incremental term loan facility in an aggregate principal amount equal to $85.0 million (the “Second Incremental Term Loan Facility”), increases the margins applicable to the outstanding term loans to 7.50% in the case of base rate loans and 8.50% in the case of LIBOR loans, beginning December 2015, amends the prepayment premiums that we are required to pay upon voluntary prepayments or certain mandatory prepayments of the term loans, permits certain additional adjustments to our consolidated EBITDA for cost savings in connection with the acquisition Inmet and Weinschel, and reduces the minimum interest coverage ratio and increases the maximum leverage ratio for certain compliance periods. The proceeds of the Second Incremental Term Loan Facility were primarily used to fund the purchase price for the Inmet and Weinschel acquisition.

 

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Amendment No. 4, among other items, adds additional mandatory prepayment events upon the occurrence of a change of control (as defined in the Term Loan Agreement) and/or receipt of any termination fees under the Merger Agreement and decreases the prepayment premiums that we are required to pay upon a voluntary or mandatory prepayment of any of the outstanding term loans. Upon consummation of the transactions contemplated by the Merger Agreement, we will be required to pay a prepayment premium in an amount equal to 1% of the amount of the term loans prepaid. Amendment No. 4 also amends the amortization schedule applicable to future term loan payments made by the Company by removing our obligation to make an amortization payment for the fiscal quarters ending February 29, 2016 and May 31, 2016 and requiring us to make an amortization payment in an amount equal to 5.0% of the original aggregate term loan amount on the earlier of (a) May 27, 2016 and (b) the date of termination of the Merger Agreement. Amendment No. 4 reduces the minimum interest coverage ratio for certain compliance periods, increases the maximum leverage ratio for certain compliance periods, and adds additional events of default upon either (a) the termination of the Merger Agreement or (b) our failure to consummate the transactions contemplated by the Merger Agreement on or prior to May 27, 2016. As of February 29, 2016, we had borrowed $193.7 million under the Term Loan Agreement.

Term Loan Agreement

The outstanding term loans, including the term loans incurred pursuant to the Second Incremental Term Loan Facility (collectively, the “Term Loans”), bear interest, at our option, at the base rate plus 6.50% or an adjusted LIBOR rate (based on one, two or three-month interest periods) plus 7.50% during the first six months after Amendment No. 3’s closing date, and a base rate plus 7.50% or the adjusted LIBOR rate plus 8.50% thereafter. The base rate continues to mean the highest of Wells Fargo Bank, National Association’s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 3-month interest period plus a margin equal to 1.00%. The adjusted LIBOR rate remains subject to a floor of 1.25%.

Interest is due and payable in arrears monthly for Term Loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of Term Loans with interest periods greater than three months) in the case of Term Loans bearing interest at the adjusted LIBOR rate. Principal payments of the Term Loans are paid at the end of each of our fiscal quarters, with the balance of any outstanding Term Loans due and payable in full on February 6, 2018. The quarterly principal payments will amortize at 1.875% for the fiscal quarters through the end of our 2015 fiscal year, 0% for the quarters ending February 29, 2016 and May 31, 2016 and 2.50% for each of the fiscal quarters thereafter.

Under certain circumstances, we are required to prepay the Term Loans upon the receipt of cash proceeds from certain asset sales, cash proceeds of certain extraordinary receipts and cash proceeds of certain debt or equity financings, and based on a calculation of annual excess cash flow. Mandatory prepayments resulting from assets sales or certain debt financings may require the payment of certain prepayment premiums. Amendment No. 3 increases the prepayment premiums that we are required to pay upon voluntary prepayments or certain mandatory prepayments of any of the outstanding term loans and requires additional prepayment premiums for any prepayment of the Second Incremental Term Loan Facility made on or prior to December 8, 2015, as calculated in accordance with the Term Loan Agreement. Amendment No. 4 adds additional mandatory prepayments as described above.

The Term Loans are secured by a security interest in substantially all of the assets owned by the Company and the subsidiary guarantors.

The Term Loan Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries’ ability to, among other things, incur indebtedness, grant liens, dispose of assets and pay dividends or make distributions to stockholders, in each case subject to customary exceptions for a term loan of this size and type.

Pursuant to the Term Loan Agreement, we are required to maintain compliance with an interest coverage ratio and a leverage ratio and to limit our annual capital expenditures to $4.0 million per fiscal year (subject to carry-over rights). The interest coverage ratio is defined as the ratio of Consolidated EBITDA to cash Interest Expense (as each term as defined in the Term Loan Agreement), as at the end of each fiscal quarter. Amendment No. 3 and Amendment No. 4 reduce the minimum interest coverage ratio and increase the maximum leverage ratio for the November 30, 2015 compliance period and the fiscal 2016 compliance periods. For the first fiscal quarter during the fiscal year ending November 30, 2015, the interest coverage ratio must not have been less than the ratio of 2.20:1.00, for the second and third fiscal quarters ending November 30, 2015, it must not have been less than the ratio of 1.90:1.00, and for the fourth fiscal quarter not less than 1.55:1.00. For the fiscal 2016 periods, the interest coverage ratio must not be less than the ratio of 1.56:1.00 for the first quarter, 1.66:1.00 for the second quarter, 1.63:1.00 for the third quarter, and 1.82:1.00 for the fourth quarter. The leverage ratio is defined as the ratio of Funded Debt to Consolidated EBITDA (as each term as defined in the Term Loan Agreement), as at the end of each fiscal quarter. For each of the fiscal quarters during the fiscal year ending November 30, 2015, the leverage ratio must not have been greater than 5.25:1.00, except for the second fiscal quarter during the fiscal year ending November 30, 2015 for which the leverage ratio must not have been greater than 5.50:1.00 and for the fourth fiscal quarter not greater than 6.50:100. For the fiscal 2016 periods, the leverage ratio must not be greater than 6.64:1.00 for the first quarter, 6.13:1.00 for the second quarter, 6.03:1.00 for the third quarter, and 5.18:1.00 for the fourth quarter. Amendment No. 3 also permits certain adjustments to the Company’s consolidated EBITDA, which is used in calculating the financial covenants, to reflect cost savings in connection with the acquisition of Inmet and Weinschel.

 

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As at February 29, 2016, we were in compliance with our financial covenants under the Term Loan Agreement.

The Term Loan Agreement includes customary events of default including, 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, in each case subject to certain exceptions for a term loan of this type. In addition, it is an event of default upon either (a) the termination of the Merger Agreement or (b) the Company’s failure to consummate the transactions contemplated by the Merger Agreement on or prior to May 27, 2016. 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 our obligations pursuant to the Term Loan Agreement and an obligation of the subsidiary guarantors to repay the full amount of our borrowings under the Term Loan Agreement. If we were unable to obtain a waiver for a breach of covenant and the lenders accelerated the payment of any outstanding amounts, such acceleration may cause our cash position to deteriorate or, if cash on hand were insufficient to satisfy the payment due, may require us to obtain alternate financing to satisfy the accelerated payment. If our cash is utilized to repay any outstanding debt, we could experience an immediate and significant reduction in working capital available to operate our business.

Quarter Ended February 29, 2016 Compared to February 28, 2015

Cash used by operating activities of approximately $2.0 million for the three months ended February 29, 2016 (“Q1 FY2016”) was lower than cash provided by operating activities of approximately $0.7 million for the three months ended February 28, 2015 (“Q1 FY2015”). The increase in cash used by operating activities resulted primarily from higher interest payments and changes in operating assets and liabilities in Q1 FY2016 compared to Q1 FY2015.

Cash used in investing activities for the three months ended February 29, 2016 was approximately $0.3 million, which consisted of the acquisition of fixed and intangible assets. Cash used in investing activities for the three months ended February 28, 2015 was approximately $0.3 million, which consisted of the acquisition of fixed and intangible assets.

Cash used by financing activities for the three months ended February 29, 2016 totaled approximately $0.1 million, and resulted from the repayment of long-term debt, mainly related to the UK mortgage and capital lease obligations. During the three months ended February 28, 2015 cash used by financing totaled approximately $2.5 million, and resulted from the repayment of long-term debt, mainly related to the term loans under the Term Loan Agreement.

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 any recently adopted 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 that are discussed in our Annual Report on Form 10-K for the year ended November 30, 2015.

Off-Balance Sheet Arrangements

During the year ended November 30, 2015 and the three months ended February 29, 2016, 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.

 

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The forward-looking statements are based on the beliefs of our management, as well as assumptions made by and information currently available to our 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 our or our 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.

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 year ended November 30, 2015 and in our other filings with the SEC. These uncertainties and other risk factors include, but are not limited to: general economic and business conditions, including without limitation, reductions in government defense spending; governmental laws and regulations surrounding various matters such as environmental remediation, contract pricing and international trading restrictions; our ability to integrate and consolidate our operations; our ability to expand our operations in both new and existing markets; the ability of our review of strategic alternatives to maximize stockholder value; the effect of growth on our infrastructure; our ability to maintain compliance with our financial covenants; and continued access to capital markets.

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 we do 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

A smaller reporting company is not required to provide the information in this Item.

 

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. 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 February 29, 2016. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of February 29, 2016.

 

(b) Changes in Internal Control over Financial Reporting

During the quarter ended February 29, 2016, 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 13 “Commitments and Contingencies” to the 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 November 30, 2015.

 

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

(a) None.

(b) Not applicable.

(c) None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

ITEM 5. OTHER INFORMATION

None.

 

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ITEM 6. EXHIBITS

 

    2.1    Agreement and Plan of Merger, dated as of February 28, 2016, by and among API Technologies Corp, RF1 Holding Company, and RF Acquisition Sub, Inc. (incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K filed with the SEC on March 1, 2016)
    3.1    Amended and Restated Bylaws of API Technologies Corp. (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed with the SEC on March 1, 2016)
  10.1    Amendment No. 4 to Credit Agreement, dated as of February 28, 2016, by and among API Technologies Corp., the lenders party thereto and Guggenheim Corporate Funding, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the SEC on March 1, 2016)
  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.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

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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: April 13, 2016     By:   /S/ ERIC F. SEETON
      Eric F. Seeton
     

Chief Financial Officer

(Duly Authorized Officer)

 

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