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ATNY > SEC Filings for ATNY > Form 10-Q on 9-Jul-2014All Recent SEC Filings

Show all filings for API TECHNOLOGIES CORP.

Form 10-Q for API TECHNOLOGIES CORP.


9-Jul-2014

Quarterly Report


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, 2013 to help provide an understanding of our financial condition, changes in financial condition and results of our operations.

As discussed below, we sold Data Bus and Sensors. The results of Data Bus and Sensors are presented as discontinued operations for all periods presented.

Business Overview of API Technologies Corp.

General

We design, develop and manufacture high reliability RF/Microwave, Power, and Security solutions to the defense, aerospace, industrial, satellite, and commercial end markets. We own and operate several state-of-the-art manufacturing facilities in the United States, the United Kingdom, Canada, China and Mexico. Our customers, which include defense and commercial, outsource some of their electronic components, subsystems, and solutions requirements to us as a result of our technical expertise, capabilities, and our extensive product and solutions offerings.

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 for critical applications, our solutions 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 and secure communication products, including ruggedized computers and peripherals, network security appliances, and TEMPEST Emanation prevention products.

On March 21, 2014, we entered into Amendment No. 2 to Credit Agreement (the "Amendment No. 2"), by and among the Company, as borrower, the lenders party thereto and Guggenheim Corporate Funding, LLC, as administrative agent (the "Agent"). Amendment No. 2 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 $55 million (the "Incremental Term Loan Facility"). The 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 million term loan facility provided upon the initial closing of the Term Loan Agreement. In addition, Amendment No. 2 amends 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 the amounts due under a Credit Agreement (the "Revolving Loan Agreement"), by and among the Company and certain of its U.S. subsidiaries, as borrowers, the lenders from time to time party thereto and Wells Fargo Bank, National Association, as administrative agent and U.K. security trustee, which Revolving Loan Agreement was then terminated; (ii) to redeem all 26,000 shares of the Company's Series A Mandatorily Redeemable Preferred Stock that were outstanding (as described below); (iii) to pay fees, costs and expenses associated with the Incremental Term Loan Facility and related transactions; and (iv) for general corporate purposes.

As of March 21, 2014, we redeemed all 26,000 shares of our Series A Mandatorily Redeemable Preferred Stock that were outstanding. We paid the holder of the Series A Mandatorily Redeemable Preferred Stock an aggregate of $27.6 million to effect the redemption. Following redemption, all shares of Series A Mandatorily Redeemable Preferred Stock were cancelled and such shares were returned to authorized but undesignated shares of preferred stock.

On December 31, 2013, we completed the sale and leaseback (the "Sale/Leaseback") of the Company's facility located in State College, Pennsylvania. We 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. We used $14,200 of the proceeds of the Sale/Leaseback to prepay a portion of our outstanding indebtedness under the Term Loan Agreement.

On July 5, 2013, we entered into an agreement (the "APA") with ILC Industries, LLC ("Parent") and Data Device Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (the "Purchaser") pursuant to which we sold to the Purchaser certain assets comprising the Company's data bus business ("Data Bus") in the U.S. and the U.K., including substantially all of the assets of the Company's wholly owned subsidiary, National Hybrid, Inc., a New York corporation (the "Asset Sale"). The Purchaser paid us approximately $32.15 million in cash for the assets, after certain adjustments based on closing inventory values as set forth in the APA and customary indemnification provisions. Substantially all of the proceeds from the Asset Sale were used to repay certain of our outstanding debt.


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On April 17, 2013 we sold all of the issued and outstanding shares of capital stock or other equity interests of Spectrum Sensors and Controls, Inc., a Pennsylvania corporation ("Sub 1"), Spectrum Sensors and Controls, LLC, a California limited liability company ("Sub 2"), and Spectrum Sensors and Controls, Inc., an Ohio corporation ("Sub 3" and together with Sub 1 and Sub 2, "Sensors"), for gross cash proceeds of approximately $51.35 million. Of this amount, $1.5 million was placed into an escrow account for 12 months to secure any indemnification claims made by the purchaser against the sellers, API and Spectrum Control, Inc. ("Spectrum"), a wholly owned subsidiary of API.

On February 6, 2013, we refinanced substantially all of our indebtedness. We entered into (i) the "Term Loan Agreement; and (ii) the Revolving Loan Agreement, which provided for a $50.0 million revolving borrowing base credit facility, with a $10.0 million subfacility (or the Sterling equivalent) for a revolving borrowing base credit facility that was available to certain of our United Kingdom subsidiaries, a $10.0 million sub-facility for letters of credit and a $5.0 million sub-facility for swingline loans. The proceeds of both loan facilities were used to refinance and pay in full our existing credit facility under a Credit Agreement by and among the lenders from time to time party thereto and Morgan Stanley Senior Funding, Inc., as administrative agent, lead arranger and sole book-runner, to payoff the term loan facility with Lockman Electronics Holdings Limited, and to pay fees, costs and expenses associated with the refinancing. As discussed above, the Revolving Loan Agreement was repaid and terminated in March 2014.

Commencing in 2010, we began various cost reduction initiatives to rationalize the number of our facilities and personnel, which has resulted in us consolidating certain parts of our manufacturing operations. During the year ended November 30, 2013, we also began the consolidation of certain parts of our Ottawa, Canada operations to State College, Pennsylvania. The collective impact of these changes has resulted in a net reduction of costs of approximately $43.0 million on an annualized basis.

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). Our customers are located primarily in the United States, Canada and the United Kingdom, but we also sell products to customers located throughout the world, including NATO and European Union countries.

Systems, Subsystems & Components (SSC) Revenue includes high-performance RF/microwave, electromagnetic, power, and microelectronics solutions used in high-reliability defense, space, industrial and commercial applications, including missile defense 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 various world 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, 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 products, ruggedized computers and peripherals, secure access and information assurance products. The principal market for these products are the defense industries of the United States, Canada and the United Kingdom and other U.S. friendly governments, Fortune 500 companies and telecommunication service providers.


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Cost of Revenues

We conduct all of our design and manufacturing efforts in the United States, Canada, United Kingdom, Mexico and China. Cost of goods sold primarily consists of costs that were incurred to manufacturer, 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.

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, business valuation consultants and accelerated stock option expenses 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. Other income also includes gains related to the sales of fixed assets held for sale and acquisition-related gains when net assets acquired exceed the purchase price of the business acquisition.

Backlog

Our sales backlog at May 31, 2014 was approximately $123.7 million compared to approximately $131.0 million at November 30, 2013. Our backlog figures represent confirmed customer purchase orders that we had not shipped at the time the figures were calculated. We anticipate that approximately $89.5 million of our backlog orders will be filled by May 31, 2015. 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)
                                    May 31,         November 30,         %
                                     2014               2013          Change
           Backlog by segments:
           SSC                    $   102,304      $       96,493         6.0 %
           EMS                         16,187              25,028       (35.3 )%
           SSIA                         5,202               9,489       (45.2 )%

                                  $   123,693      $      131,010        (5.6 )%

The decrease at May 31, 2014 compared to November 30, 2013 was related to our EMS and SSIA segments as a result of lower EMS and SSIA bookings due to program timing in the six months ended May 31, 2014, partially offset by increased SSC bookings in the six months ended May 31, 2014.


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Results of Operations for the Three Months Ended May 31, 2014 and 2013

The following discussion of results of operations is a comparison of our three months ended May 31, 2014 and 2013.

Segment Operating Revenue and Adjusted EBITDA

Financial information for each of our segments is set forth in Part I- Item 1, Financial Statements (unaudited), Note 18 "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.

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, corporate franchise taxes, financing related costs, foreign exchange losses, reversal of contingency accruals and lease payments related to the Sale/Leaseback.

                                         (dollar amounts in thousands)
                                               Three months ended
                                                    May 31,
                                                                       %
                                        2014             2013       Change
             Revenues by segments:
             SSC                     $    39,272       $ 42,865        (8.4 )%
             EMS                           8,835         16,229       (45.6 )%
             SSIA                          5,062          5,135        (1.4 )%

                                     $    53,169       $ 64,229       (17.2 )%

We recorded a 17.2% decrease in overall revenues for the three months ended May 31, 2014 over the same period in 2013. The decrease was primarily due to lower revenues in our EMS segment compared to the three months ended May 31, 2013. During the three months ended May 31, 2014, the decrease in our EMS segment revenues was due to timing of certain key defense programs and our customer's new product execution. The SSC revenues decreased primarily due to timing of certain programs as a result of funding delays, while the SSIA revenues were fairly consistent compared to the prior period.

                                          (dollar amounts in thousands)
                                                Three months ended
                                                     May 31,
                                                                       %
                                         2014            2013        Change
           Segment Adjusted EBITDA:
           SSC                        $    4,534        $ 5,626        (19.4 )%
           EMS                              (791 )          637       (224.2 )%
           SSIA                              540          1,048        (48.5 )%

The SSC segment adjusted EBITDA for the three months ended May 31, 2014 was lower than the comparable period in 2013 primarily due to impact of lower revenues in the quarter ended May 31, 2014 compared to the same period last year. During the three months ended May 31, 2014, the decrease in our EMS segment adjusted EBITDA was primarily due to lower revenues in the quarter ended May 31, 2014 compared to the same period last year. The SSIA results include lower adjusted EBITDA as a result of the impact of a change in product mix in the quarter ended May 31, 2014, compared to the same period last year, as we shipped products on a contract with lower margin that is expected to be completed by August 31, 2014.


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Operating Expenses

Cost of Revenues and Gross Margin



                                               Three months ended
                                                     May 31,
                                               2014            2013
                 Gross margin by segments:
                 SSC                              24.9 %        26.3 %
                 EMS                              (5.1 )%        9.6 %
                 SSIA                             21.6 %        34.7 %
                 Overall                          19.6 %        22.8 %

Our combined gross margin for the three months ended May 31, 2014 decreased by approximately 3.2 percentage points compared to the three months ended May 31, 2013. 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 May 31, 2014 from 77.2% to 80.4% compared to the same period last year. The SSC segment cost of revenues percentage for the three months ended May 31, 2014 increased by 1.4 percentage points compared to the comparable period in 2013. The EMS segment cost of revenues increased by 14.7 percentage points compared to the same period in 2013, primarily due lower revenues in the quarter ended May 31, 2014 compared to the same period last year. The SSIA segment realized an increase in cost of revenues of 13.1 percentage points primarily due to unfavorable product mix in the quarter ended May 31, 2014, as we shipped products on a contract with lower margin. Combined restructuring costs recorded in the three months ended May 31, 2014 were approximately $0.3 million compared to approximately $0.1 million in the comparable period of 2013.

General and Administrative Expenses

General and administrative expenses decreased to approximately $5.8 million for the three months ended May 31, 2014 from $6.2 million for the three months ended May 31, 2013. The decrease is primarily a result of lower depreciation and amortization, lower stock based compensation due to forfeitures, lower professional fees and cost reductions following restructuring initiatives. As a percentage of sales, general and administrative expenses were 10.9% for the three months ended May 31, 2014, compared to 9.6% for the three months ended May 31, 2013.

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

                                               (dollar amounts in thousands)
                                                     Three months ended
                                                          May 31,
                                                      % of                     % of
                                         2014        sales         2013       sales
        Depreciation and Amortization   $ 2,431         4.6 %     $ 2,651        4.1 %
        Accounting and Administration   $ 1,824         3.4 %     $ 2,056        3.2 %
        Stock based compensation        $   (21 )      (0.0 )%    $   210        0.3 %
        Professional Services           $   445         0.8 %     $   523        0.8 %

Selling Expenses

Selling expenses decreased to approximately $3.5 million for the three months ended May 31, 2014 compared to approximately $4.1 million for the three months ended May 31, 2013. The decrease is primarily a result of lower commissions as a result of lower revenues. As a percentage of sales, selling expenses were 6.7% for the three months ended May 31, 2014, compared to 6.3% for the three months ended May 31, 2013.


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The major components of selling expenses are as follows:

                                            (dollar amounts in thousands)
                                                  Three months ended
                                                       May 31,
                                                    % of                    % of
                                       2014        sales        2013       sales
           Payroll Expense - Sales   $   2,078        3.9 %    $ 2,074        3.2 %
           Commissions               $     896        1.7 %    $ 1,302        2.0 %
           Advertising               $     250        0.5 %    $   329        0.5 %

Research and Development Expenses

Research and development costs decreased to approximately $2.2 million for the three months ended May 31, 2014 compared to approximately $2.3 million for the three months ended May 31, 2013. As a percentage of sales, research and development expenses were 4.1% for the three months ended May 31, 2014, compared to 3.6% for the three months ended May 31, 2013.

Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, business valuation consultants and accelerated stock option expenses related to business combinations or divestitures. For the three months ended May 31, 2014, business acquisition charges of approximately $0.1 million compared to approximately $0.6 million primarily related to the sale of the Sensors operations during the three months ended May 31, 2013.

Operating Income (loss)

We recorded an operating loss from continuing operations for the three months ended May 31, 2014 of approximately $1.9 million compared to operating income of approximately $1.1 million for the three months ended May 31, 2013. The increase in operating loss of approximately $3.0 million is primarily attributed to lower revenues and a change in product mix in the quarter, partially offset by a decrease in operating expenses.

Other Expenses (Income)

Total other expense for the three months ended May 31, 2014 amounted to approximately $12.9 million, compared to other expense of $5.4 million for the three months ended May 31, 2013.

The increase in other expense in the three month period ended May 31, 2014, compared to the comparable period in 2013 is largely attributable to the write-down of approximately $10.2 million of note discounts and deferred financing costs as a result of the refinancing of our term loans and termination of our previous revolving loans in March 2014, partially offset by lower interest expense in the quarter ended May 31, 2014, compared to the comparable period in 2013, which had lower average borrowings and lower interest rates on term loans.

Income Taxes

Income taxes from continuing operations amounted to a net expense of approximately $0.2 million for the three months ended May 31, 2014 compared to a net benefit of $0.4 million in the three months ended May 31, 2013. The expense during the three months ended May 31, 2014, 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 recorded for the deferred tax assets arising from current year losses. The prior year benefit related to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period.

Income From Discontinued Operations

We had no activity in discontinued operations for the three months ended May 31, 2014, compared to net income from discontinued operations of approximately $11.4 million in the same period of fiscal 2013, which is primarily attributable to a $11.9 million gain on the sale of Sensors and operating results for Sensors and Data Bus, during the three months ended May 31, 2013.


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Net loss

We recorded a net loss for the three months ended May 31, 2014 of approximately $15.0 million, compared to net income of approximately $7.5 million for the three months ended May 31, 2013. The increase in net loss is largely due to the write-down of approximately $10.2 million of note discounts and deferred financing costs as a result of the refinancing of our term loans and termination of our previous revolving loans in the quarter ended May 31, 2014, and lower operating income, partially offset by lower interest expense from lower debt levels in the three month period ended May 31, 2014, compared to the comparable period in 2013.

Results of Operations for the Six Months Ended May 31, 2014 and 2013

The following discussion of results of operations is a comparison of our six . . .

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