Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, DC 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 July 1, 2016
or
¨
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: 333-173372-07
CPI INTERNATIONAL HOLDING CORP.
(Exact Name of Registrant as Specified in Its Charter) 
Delaware
(State or Other Jurisdiction of Incorporation or Organization)
 
90-0649687
(I.R.S. Employer Identification No.)
 811 Hansen Way, Palo Alto, California 94303
(Address of Principal Executive Offices and Zip Code) 
(650) 846-2900
(Registrant’s telephone number, including area code) 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 ¨ No ý
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 ý 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. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨ No ý
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding for each of the registrant’s classes of Common Stock, as of the latest practicable date: As of August 9, 2016, 1,110 shares of Common Stock, $0.01 par value, all of which are owned by CPI International Holding LLC, the registrant’s parent holding company, are outstanding and are not publicly traded.
 



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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

10-Q REPORT
 
INDEX
 

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




 



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Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

Cautionary Statements Regarding Forward-Looking Statements
 
 
This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that relate to future events or our future financial performance. In some cases, readers can identify forward-looking statements by terminology, such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. Forward-looking statements are subject to known and unknown risks and uncertainties, which could cause actual results to differ materially from the results projected, expected or implied by the forward-looking statements. These risk factors include, without limitation, competition in our end markets; our significant amount of debt; changes or reductions in the United States defense budget; currency fluctuations; goodwill impairment considerations; customer cancellations of sales contracts; U.S. Government contracts; export restrictions and other laws and regulations; international laws; changes in technology; the impact of unexpected costs; the impact of a general slowdown in the global economy; the impact of environmental and zoning laws and regulations; and inability to obtain raw materials and components. All written and oral forward-looking statements made in connection with this document that are attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing risk factors and other cautionary statements included herein and in our filings with the Securities and Exchange Commission (“SEC”). We are under no duty to update any of the forward-looking statements after the date of this document to conform such statements to actual results or to changes in our expectations.

The information in this report is not a complete description of our business or the risks and uncertainties associated with an investment in our securities. Prospective investors should carefully consider the various risks and uncertainties that impact our business and the other information in this report and in our filings with the SEC before deciding to invest in our securities or to maintain or increase such investment.





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Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

Part I:  FINANCIAL INFORMATION
 
Item 1.    Unaudited Condensed Consolidated Financial Statements
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data – unaudited) 
 
July 1,
2016
 
October 2,
2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
39,168

 
$
37,514

Restricted cash
1,811

 
1,681

Accounts receivable, net
58,830

 
61,750

Inventories
115,926

 
103,276

Prepaid and other current assets
6,677

 
6,200

Total current assets
222,412

 
210,421

Property, plant, and equipment, net
74,439

 
78,592

Intangible assets, net
250,891

 
263,273

Goodwill
216,505

 
215,434

Other long-term assets
3,906

 
3,424

Total assets
$
768,153

 
$
771,144

 
 
 
 
Liabilities and stockholders’ equity
 

 
 

Current liabilities:
 

 
 

Current portion of long-term debt
$
3,100

 
$
3,100

Accounts payable
30,971

 
30,349

Accrued expenses
29,973

 
44,106

Product warranty
6,082

 
5,304

Income taxes payable
2,563

 
1,154

Advance payments from customers
15,390

 
13,037

Total current liabilities
88,079

 
97,050

Deferred tax liabilities
88,863

 
91,227

Long-term debt:
 
 
 
Principal, less current portion
542,925

 
545,250

Less unamortized original issue discount
(3,056
)
 
(4,400
)
Less unamortized debt issuance costs
(8,969
)
 
(11,084
)
Long term debt, net of discount and debt issuance costs
530,900

 
529,766

Other long-term liabilities
6,168

 
6,384

Total liabilities
714,010

 
724,427

Commitments and contingencies


 


Stockholders’ equity:
 

 
 

Common stock ($0.01 par value, 2 shares authorized: 1 share issued and outstanding)

 

Additional paid-in capital
27,137

 
26,565

Accumulated other comprehensive income (loss)
1,082

 
(1,995
)
Retained earnings
25,924

 
22,147

Total stockholders’ equity
54,143

 
46,717

Total liabilities and stockholders’ equity
$
768,153

 
$
771,144


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



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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

CONDENSED CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
(In thousands – unaudited)


 
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Sales
$
129,612

 
$
109,645

 
$
360,579

 
$
328,283

Cost of sales, including $0, $0, $906 and $0 of utilization of net increase in cost basis of inventory due to purchase accounting, respectively
89,820

 
79,831

 
259,411

 
236,978

Gross profit
39,792

 
29,814

 
101,168

 
91,305

Operating costs and expenses:
 

 
 

 
 
 
 
Research and development
4,001

 
3,813

 
12,236

 
11,370

Selling and marketing
6,368

 
5,518

 
19,426

 
17,018

General and administrative
7,650

 
7,572

 
23,132

 
23,234

Amortization of acquisition-related intangible assets
3,299

 
2,546

 
10,414

 
7,637

Total operating costs and expenses
21,318

 
19,449

 
65,208

 
59,259

Operating income
18,474

 
10,365

 
35,960

 
32,046

Interest expense, net
9,800

 
9,119

 
29,308

 
27,312

Income before income taxes
8,674

 
1,246

 
6,652

 
4,734

Income tax expense
4,161

 
27

 
2,875

 
1,402

Net income
4,513

 
1,219

 
3,777

 
3,332

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 

 
 

 
 
 
 
Unrealized income (loss) on cash flow hedges, net of tax
818

 
876

 
3,077

 
(688
)
Total other comprehensive income (loss), net of tax
818

 
876

 
3,077

 
(688
)
Comprehensive income
$
5,331

 
$
2,095

 
$
6,854

 
$
2,644

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



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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands – unaudited)
 
 
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
Cash flows from operating activities
 
 
 
Net cash provided by operating activities
$
13,579

 
$
17,687

 
 
 
 
Cash flows from investing activities
 

 
 

Capital expenditures
(4,873
)
 
(4,695
)
Acquisition, net of cash acquired
(363
)
 

Net cash used in investing activities
(5,236
)
 
(4,695
)
 
 
 
 
Cash flows from financing activities
 

 
 

Payment of contingent consideration
(4,300
)
 

Payment of debt issue costs
(64
)
 

Repayment of borrowings under First Lien Term Loan
(2,325
)
 
(2,325
)
Net cash used in financing activities
(6,689
)
 
(2,325
)
 
 
 
 
Net increase in cash and cash equivalents
1,654

 
10,667

Cash and cash equivalents at beginning of period
37,514

 
50,617

Cash and cash equivalents at end of period
$
39,168

 
$
61,284

 
 
 
 
Supplemental cash flow disclosures
 

 
 

Cash paid for interest
$
21,249

 
$
19,531

Cash paid for income taxes, net of refunds
$
3,071

 
$
4,311

Decrease in accrued capital expenditures
$
464

 
$
9

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



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Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(All tabular dollar amounts in thousands)
 
 
1.
The Company and a Summary of its Significant Accounting Policies
 
The Company

Unless the context requires otherwise, (i) “Holding LLC” refers to CPI International Holding LLC, (ii) “CPI International” or “Parent” refers to the issuer, CPI International Holding Corp., and (iii) “CPII” means CPI International, Inc. Holding LLC owns all of the outstanding common stock of CPI International, which in turn owns all of the outstanding common stock of CPII, which in turn owns all of the outstanding equity interests of Communications & Power Industries LLC (“CPI”) and Communications & Power Industries Canada Inc. (“CPI Canada”), CPI International’s main operating subsidiaries. The term “the Company” refers to CPI International and its direct and indirect subsidiaries on a consolidated basis. The Veritas Capital Fund IV, L.P. and its affiliates and certain members of CPII’s management beneficially own shares of CPI International’s common stock indirectly through their holdings in Holding LLC. Holding LLC, CPI International and CPII are holding companies with no material assets or operations other than their respective direct or indirect equity interests in CPI and CPI Canada and activities related thereto.
The accompanying unaudited condensed consolidated financial statements represent the consolidated results and financial position of the Company. The Company develops, manufactures and globally distributes components and subsystems used in the generation, amplification, transmission and reception of microwave signals for a wide variety of systems including radar, electronic warfare and communications (satellite and point-to-point) systems for military and commercial applications, specialty products for medical diagnostic imaging and the treatment of cancer, as well as microwave and radio frequency (“RF”) energy generating products for various industrial and scientific pursuits. The Company has two reportable segments: RF products and satcom equipment.
        
Basis of Presentation and Consolidation

The Company’s fiscal year is the 52- or 53-week period that ends on the Friday nearest September 30. Fiscal years 2016 and 2015 comprise the 52-week periods ending September 30, 2016 and October 2, 2015, respectively. Each of the three months ended July 1, 2016 and July 3, 2015 included 13 weeks, and each of the nine months ended July 1, 2016 and July 3, 2015 included 39 weeks. All other period references are to the Company’s fiscal periods unless otherwise indicated.

The accompanying condensed consolidated financial statements of the Company as of July 1, 2016 and for the three and nine months ended July 1, 2016 and July 3, 2015 are unaudited and reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of such financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 2, 2015 filed with the Securities and Exchange Commission on December 10, 2015. The condensed consolidated balance sheet as of October 2, 2015 has been derived from the audited financial statements at that date. The results of operations and cash flows for the interim period ended July 1, 2016 are not necessarily indicative of results to be expected for the full year.

Certain prior year amounts within the condensed consolidated balance sheets have been reclassified to conform to the current year presentation. Specifically, debt issuance costs and current deferred tax assets and current deferred tax liabilities have been reclassified due to recent accounting standard updates. See Note 2, “Recently Issued Accounting Standards” for additional information on these updates.
 
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances, transactions and stockholdings have been eliminated in consolidation.




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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



Use of Estimates and Assumptions

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and costs and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition; inventory valuation; recoverability and valuation of recorded amounts of long-lived assets and identifiable intangible assets, including goodwill; recognition and measurement of current and deferred income tax assets and liabilities; and business combinations. The Company bases its estimates on various factors and information, which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third-party professionals that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 
2.Recently Issued Accounting Standards
 
In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update that provides a single model for revenue arising from contracts with customers. This accounting standard update, which will supersede current revenue recognition guidance, requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of goods or services. In July 2015, the FASB approved a one-year deferral of the effective date of this accounting standard update. This accounting standard update is now effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal year 2019. 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 is currently evaluating the impact the adoption will have on its consolidated results of operations, financial position or cash flows and related disclosures. The Company has not yet selected a transition method, nor has it determined the effect of the standard on its ongoing financial reporting.

In April 2015, the FASB issued an accounting standard update that requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This accounting standard update requires retrospective adoption and is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Early adoption is permitted. The Company early adopted this accounting standard update beginning in the first quarter of fiscal year 2016. The new accounting standard update reduced other long-term assets and long-term debt on the Company’s consolidated balance sheet as of October 2, 2015 by $11.1 million, representing the unamortized balance of deferred debt issuance costs at that date. The new accounting standard update had no impact on the Company’s consolidated results of operations or cash flows.

In September 2015, the FASB issued an accounting standard update that replaces the requirement that an acquirer in a business combination account for measurement period adjustments retrospectively with a requirement that an acquirer recognize such adjustments in the reporting period in which the adjustment amounts are determined. This accounting standard update requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. For public business entities, this accounting standard update is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The guidance is to be applied prospectively to adjustments to provisional amounts that occur after the effective date of the guidance, with earlier application permitted for financial statements that have not been issued. The Company early adopted this accounting standard update in the first quarter of fiscal year 2016. See Note 3, Business Combination, for details on the measurement period adjustments made during the nine months ended July 1, 2016 related to the Company's acquisition of ASC Signal Holdings Corporation and their corresponding impact on the Company’s financial statements.




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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



In November 2015, the FASB issued an accounting standard update that requires deferred tax liabilities and assets be classified as noncurrent in the balance sheet. The existing requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this accounting standard update. The Company early adopted this accounting standard update retrospectively in the first quarter of fiscal year 2016. The new accounting standard update reduced current assets by $8.5 million, increased other long-term assets and reduced current liabilities by $0.1 million each, and reduced noncurrent deferred tax liabilities by $8.3 million on the Company’s consolidated balance sheet as of October 2, 2015. The new accounting standard update had no impact on the Company’s consolidated results of operations or cash flows.

In February 2016, the FASB issued an accounting standard update which requires lessees to record most leases on their balance sheets. Lessees initially recognize a lease liability (measured at the present value of the lease payments over the lease term) and a right-of-use (“ROU”) asset (measured at the lease liability amount, adjusted for lease prepayments, lease incentives received and the lessee’s initial direct costs). Lessees can make an accounting policy election to not recognize ROU assets and lease liabilities for leases with a lease term of 12 months or less as long as the leases do not include options to purchase the underlying assets that the lessee is reasonably certain to exercise. This accounting standard update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted with the recognition and measurement of leases at the beginning of the earliest period presented in the financial statements using a modified retrospective approach. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal year 2020. The Company is currently evaluating the impact the adoption may have on its consolidated results of operations, financial position or cash flows and related disclosures.


3.           Business Combination
 
On September 17, 2015, the Company acquired all of the issued and outstanding equity securities of ASC Signal Holdings Corporation (“ASC Signal”), a Delaware corporation, for a payment of approximately $50.7 million in cash consideration, net of $2.2 million cash acquired, including a post-closing adjustment based on a determination of ASC Signal’s closing net working capital of $0.4 million paid in the three months ended January 1, 2016. ASC Signal designs and builds advanced satellite communications, radar and high-frequency antennas and controllers used in commercial and government satellite communications, terrestrial communications, imagery and data transmission, and radar and intelligence applications. The results of ASC Signal’s operations were included in the Company’s satcom equipment segment and the Company’s consolidated results of operations beginning on the date of the acquisition.

The purchase of the outstanding equity securities of ASC Signal was accounted for under the acquisition method of accounting, in which CPI is deemed to be the accounting acquirer. All assets acquired and liabilities assumed were recorded at their respective fair values at the acquisition date and the excess of the purchase price over the fair value of all assets acquired and liabilities assumed was recognized as goodwill.
    



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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The following table sets forth a preliminary allocation of the total purchase price, including the measurement period adjustments, as of July 1, 2016 to the assets acquired and the liabilities assumed and the resulting goodwill based on the preliminary estimates of fair value.
 
Preliminary
 
Measurement Period Adjustments
 
As Adjusted
Purchase price                                                                                                              
$
52,918

 
$

 
$
52,918

Less: Fair value of assets acquired:
 

 
 
 
 
Net current assets                                                                                                           
(12,558
)
 
1,816

 
(10,742
)
Property, plant and equipment                                                                                                           
(7,465
)
 
(347
)
 
(7,812
)
Identifiable intangible assets                                                                                                           
(25,750
)
 
1,300

 
(24,450
)
Other long-term asset
(2,817
)
 

 
(2,817
)
 
(48,590
)
 
2,769

 
(45,821
)
Add: Fair value of liabilities assumed:
 

 
 
 
 
Long-term deferred tax liabilities
9,408

 
(1,698
)
 
7,710

Other long-term liabilities
2,817

 

 
2,817

 
12,225

 
(1,698
)
 
10,527

 
 
 
 
 
 
Goodwill                                                                                                              
$
16,553

 
$
1,071

 
$
17,624


The other long-term asset and other long-term liability represent an environmental indemnification receivable and an environmental loss reserve, respectively, for environmental remediation efforts at ASC Signal’s Whitby, Ontario, Canada manufacturing facility. See Note 8, Contingencies, for more information.

The measurement period adjustments shown in the table above reflect (i) an increase of $0.5 million to the fair value of assumed product warranty, (ii) a reduction of $0.1 million in sales tax benefit, (iii) an increase of $0.3 million to the fair value of property, plant and equipment, (iv) a decrease of $1.1 million to the fair value of customer relationship, (v) a decrease of $0.2 million to the fair value of backlog, and (vi) a decrease of $0.5 million to long-term deferred tax liabilities, along with their effect on goodwill. In addition, deferred tax assets of $1.2 million were netted against deferred tax liabilities. These measurement period adjustments were among those expected to be made to the preliminary purchase price allocation based on awaited information obtained in the measurement period and are properly reflected in the Company’s condensed consolidated balance sheet as of July 1, 2016.

As mentioned in Note 2, Recently Issued Accounting Standards, the Company has recently adopted an accounting standard update that requires the acquirer in a business combination to record the effect on earnings of measurement period adjustments in the same period the adjustments are identified. As a result, the Company recorded cumulative catch-up pre-tax adjustments of an additional $0.1 million to the depreciation of property, plant and equipment and a reduction of $0.2 million in the amortization of acquisition-related intangible assets in the Company’s condensed consolidated statements of comprehensive income for the three months ended July 1, 2016.

The Company is in the process of finalizing the purchase price allocation and may make additional adjustments to the allocation during the remaining measurement period. The areas of the purchase price allocation that are not yet finalized and are subject to change relate to the contingent environmental indemnification receivable and loss reserve, certain accrued liabilities, income and non-income tax-related items and the resulting goodwill adjustment. The Company expects to continue to obtain information to finalize these preliminary valuations during the measurement period, which ends during the Company’s fiscal quarter ending September 30, 2016.
    



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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The fair value assigned to identifiable intangible assets acquired is determined using variations of the income approach. Under these methods, fair value is estimated based upon the present value of cash flows that the applicable asset is expected to generate. The valuation of tradenames and completed technology is based on the relief-from-royalty method, and backlog and customer relationship is valued using the excess earnings method. The royalty rates used in the relief-from-royalty method are based on both a return-on-asset method and market comparable rates. The excess earnings method requires for the Company to forecast future expected earnings of ASC Signal based on management’s best estimates derived from historical results and future projected demand of their offerings. The Company believes that these identifiable intangible assets will have no residual value after their estimated economic useful lives. The fair value of the identifiable intangible assets and their weighted-average useful lives are as follows:
 
Estimated Fair Value
 
Estimated Useful Life
(years)
Tradenames
$
3,050

 
15
Completed technology
11,150

 
15
Backlog
2,200

 
1
Customer relationship
8,050

 
14
Total identifiable intangible assets
$
24,450

 
 

All of the above identifiable intangible assets are definite-lived and are amortized over their estimated useful lives.

Goodwill resulting from the ASC Signal acquisition is largely attributable to future growth opportunities within the Company’s communications and radar markets and is not deductible for income tax purposes.

In connection with the ASC Signal acquisition, the Company incurred various direct costs totaling $0.2 million and $1.0 million for the three and nine months ended July 1, 2016, respectively, and $0.3 million for each of the three and nine months ended July 3, 2015 included in general and administrative in the condensed consolidated statements of comprehensive income. These costs, which the Company expensed as incurred, consist primarily of professional fees payable to financial and legal advisors and an accrual for retention bonuses for ASC Signal's senior management.

The following unaudited pro forma results of operations are presented as though the ASC Signal acquisition had occurred as of the beginning of the fiscal year 2014 or September 28, 2013, after giving effect to purchase accounting adjustments relating to depreciation and amortization of the revalued assets and debt incurred by the Company to partially fund the acquisition. The pro forma results of operations exclude the impact of certain charges that have resulted from or were in connection with the acquisition, including (i) the utilization of the net increase in the cost basis of inventory of $0.9 million for the nine months ended July 1, 2016, and (ii) amortization of backlog of $0.4 million and $1.6 million for the three and nine months ended July 1, 2016, respectively. All other pro forma adjustments reflected in the supplemental pro forma results of operations are individually immaterial to each period presented. The pro forma results of operations are not necessarily indicative of the combined results that would have occurred had the acquisition been consummated as of the earliest period presented, nor are they necessarily indicative of future operating results. 
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Sales
$
129,711

 
$
123,662

 
$
360,876

 
$
360,535

Net income
$
5,049

 
$
2,158

 
$
6,179

 
$
3,819






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CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



4.
Supplemental Financial Information
  
Accounts Receivable: Accounts receivable are stated net of allowances for doubtful accounts as follows: 
 
July 1,
2016
 
October 2,
2015
Accounts receivable
$
59,480

 
$
62,379

Less: Allowance for doubtful accounts
(650
)
 
(629
)
Accounts receivable, net
$
58,830

 
$
61,750


Inventories: The following table provides details of inventories: 
 
July 1,
2016
 
October 2,
2015
Raw materials and parts
$
59,765

 
$
54,499

Work in process
35,880

 
33,991

Finished goods
20,281

 
14,786

Total inventories
$
115,926

 
$
103,276

 
Reserve for loss contracts: The following table summarizes the activity related to reserves for loss contracts during the periods presented: 
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Balance at beginning of period
$
2,095

 
$
5,347

 
$
1,638

 
$
5,008

Provision for loss contracts, charged to cost of sales
216

 
336

 
1,251

 
908

Credit to cost of sales upon revenue recognition
(1,297
)
 
(4,400
)
 
(1,875
)
 
(4,633
)
Balance at end of period
$
1,014

 
$
1,283

 
$
1,014

 
$
1,283

 
The reduction in reserve for loss contracts was primarily due to completion of certain contractual obligations.

At the end of each period presented above, reserve for loss contracts was reported in the condensed consolidated balance sheet in the following accounts: 
 
July 1,
2016
 
July 3,
2015
Inventories
$
941

 
$
1,283

Accrued expenses
73

 

Total reserves for loss contracts
$
1,014

 
$
1,283

 



- 12 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



Accrued Expenses:    The following table provides details of accrued expenses:
 
 
July 1,
2016
 
October 2,
2015
Payroll and employee benefits
$
14,621

 
$
14,980

Accrued interest
7,288

 
2,721

Foreign exchange forward derivatives
308

 
1,821

Deferred income
948

 
3,329

Contingent consideration liability

 
9,700

Other accruals
6,808

 
11,555

Total accrued expenses
$
29,973

 
$
44,106


Product Warranty: The following table summarizes the activity related to product warranty: 
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Beginning accrued warranty
$
6,232

 
$
4,553

 
$
5,304

 
$
4,863

Actual costs of warranty claims
(1,129
)
 
(1,342
)
 
(3,965
)
 
(3,751
)
Assumed from acquisition

 

 
555

 

Estimates for product warranty, charged to cost of sales
979

 
1,658

 
4,188

 
3,757

Ending accrued warranty
$
6,082

 
$
4,869

 
$
6,082

 
$
4,869


Assumed from acquisition represents measurement period adjustment related to ASC Signal acquisition.




- 13 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



5.
Financial Instruments
 
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, available-for-sale securities, derivative instruments and contingent consideration. The following tables set forth financial instruments carried at fair value by level of fair value hierarchy: 
 
 
 
 
 
Fair Value Measurements at July 1, 2016 Using
 
 
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market and overnight U.S. Government securities1
$
19,692

 
$
19,692

 
$

 
$

Mutual funds2
298

 
298

 

 

Foreign exchange forward derivatives3
1,670

 

 
1,670

 

Total assets at fair value
$
21,660

 
$
19,990

 
$
1,670

 
$

 
 
 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Foreign exchange forward derivatives4
$
322

 
$

 
$
322

 
$

Total liabilities at fair value
$
322

 
$

 
$
322

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1 
The money market and overnight U.S. Government securities are classified as part of cash and cash equivalents in the condensed consolidated balance sheet.
2 
The mutual funds are classified as part of other long-term assets in the condensed consolidated balance sheet.
3 
The asset position of foreign currency derivatives is classified as part of prepaid and other current assets and other long-term assets in the condensed consolidated balance sheet.
4 
The liability position of foreign currency derivatives is classified as part of accrued expenses and other long-term liabilities in the condensed consolidated balance sheet.




- 14 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



 
 
 
 
 
Fair Value Measurements at October 2, 2015 Using
 
 
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market, fixed deposit and overnight U.S. Government securities1
$
22,390

 
$
22,390

 
$

 
$

Mutual funds2
282

 
282

 

 

Total assets at fair value
$
22,672

 
$
22,672

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Foreign exchange forward derivatives3
$
1,821

 
$

 
$
1,821

 
$

Contingent consideration liability4
9,700

 

 

 
9,700

Total liabilities at fair value
$
11,521

 
$

 
$
1,821

 
$
9,700

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1 
The money market, fixed deposit and overnight U.S. Government securities are classified as part of cash and cash equivalents in the condensed consolidated balance sheet.
2 
The mutual funds are classified as part of other long-term assets in the condensed consolidated balance sheet.
3 
The liability position of foreign currency derivatives is classified as part of accrued expenses in the condensed consolidated balance sheet.
4 
The contingent consideration liability is classified as part of accrued expenses in the condensed consolidated balance sheet.

See Note 7, Derivative Instruments and Hedging Activities, for information regarding the Company’s derivative instruments.

Contingent Consideration
 
In connection with, and as part of the Company’s acquisition of Radant Technologies, Inc. (“Radant”), the Company was obligated to pay a maximum of $10.0 million in contingent consideration if certain financial targets were achieved by Radant over the two years following the acquisition. The fair value of the contingent consideration was based on a probability-weighted calculation whereby the Company assigned estimated probabilities to achieving the earn-out targets and then discounted the total contingent consideration to net present value using Level 3 inputs. Key assumptions included a discount rate of 14%, which the Company believed to reflect market participant assumptions, and a probability-adjusted level of Radant’s earnings before net interest expense, provision for income taxes and depreciation and amortization (“EBITDA”) in aggregate for the two years following the acquisition. Radant achieved the set financial targets, which gave rise to the earn-out payment of $10.0 million in December 2015.

The following table summarizes the activity related to contingent consideration during the periods presented: 
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Balance at beginning of period
$

 
$
8,700

 
$
9,700

 
$
7,600

Change in fair value included in earnings

 
700

 
300

 
1,800

Payment of contingent consideration

 

 
(10,000
)
 

Balance at end of period
$

 
$
9,400

 
$

 
$
9,400




- 15 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



        
The change in fair value of the contingent consideration since the date of the Radant acquisition was primarily due to the passage of time and subsequent adjustments in the probability assumptions regarding Radant’s EBITDA. Other assumptions used for determining the estimated fair value of the contingent consideration did not change significantly from those used at the acquisition date.

Other Financial Instruments

The Company’s other financial instruments include cash, restricted cash, accounts receivable, accounts payable, accrued expenses and long-term debt. Except for long-term debt, the carrying value of these financial instruments approximates fair values because of their relatively short maturity.

The estimated carrying and fair values of the Company’s long-term debt are as follows:
 
 
 
 
July 1, 2016
 
October 2, 2015
 
 
Fair Value Measurement
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
First Lien Term Loan
Level 2
 
$
296,970

 
$
289,394

 
$
298,432

 
$
293,088

Second Lien Term Loan
Level 3
 
26,449

 
26,449

 
26,333

 
26,333

8.75% Senior Notes due 2018
Level 2
 
211,105

 
211,105

 
208,768

 
209,843

 
 
 
 
$
534,524

 
$
526,948

 
$
533,533

 
$
529,264

 
 
 
 
 
 
 
 
 
 
 
Note: Amounts are net of associated issue discounts and debt issuance costs. Not reflected in the above table are debt issuance costs related to the Company's revolving credit facility of $524 and $667 as of July 1, 2016 and October 2, 2015, respectively. Prior year amounts have been adjusted to conform to the current year presentation.

The fair value of the Second Lien Term Loan, into which the Company entered in September 2015, was estimated using inputs that are not observable (Level 3) as there are no quoted prices in active markets for this term loan. The fair value of the Second Lien Term Loan approximates its carrying value at July 1, 2016 as interest payments on this term loan are based on LIBOR rates that are reset monthly, and the Company believes that its credit risk has not changed materially since the date the term loan was executed.





- 16 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



6.
Long-term Debt
 
The Company’s long-term debt comprises the following as of the dates presented:
 
 
 
July 1,
2016
 
October 2,
2015
Senior Secured Credit Facilities:
 
 
 
First Lien Credit Agreement:
 
 
 
Revolver
$

 
$

First Lien Term Loan
303,025

 
305,350

Less unamortized original issue discount
(547
)
 
(625
)
Less unamortized debt issuance costsa
(6,032
)
 
(6,960
)
 
 
296,446

 
297,765

Second Lien Credit Agreement:
 
 
 
Second Lien Term Loan
28,000

 
28,000

Less unamortized original issue discount
(498
)
 
(557
)
Less unamortized debt issuance costs
(1,053
)
 
(1,110
)
 
26,449

 
26,333

 
 
 
 
Senior Notes
215,000

 
215,000

Less unamortized original issue discount
(2,011
)
 
(3,218
)
Less unamortized debt issuance costs
(1,884
)
 
(3,014
)
 
211,105

 
208,768

 
 
 
 
Long term debt, net of discount and debt issuance costs
534,000

 
532,866

Less current portion
(3,100
)
 
(3,100
)
Long-term portion
$
530,900

 
$
529,766

 
 
 
 
Standby letters of credit secured by Revolver
$
5,267

 
$
5,998

 
 
 
 
 
 
a 
Amounts comprised debt issuance costs associated with both Revolver and First Lien Term Loan.

Senior Secured Credit Facilities

On April 7, 2014, CPII entered into a First Lien Credit Agreement, which provides for (a) a term loan in an aggregate principal amount of $310.0 million (“First Lien Term Loan”) and (b) a $30.0 million revolving credit facility (“Revolver”), with sub-limits for letters of credit and swingline loans. On the closing date of the First Lien Credit Agreement, CPII borrowed the entire $310.0 million available under the First Lien Term Loan. No borrowings have been made to date under the Revolver (other than for approximately $5.3 million of outstanding letters of credit as of July 1, 2016).
    
On September 17, 2015, CPII entered into a Second Lien Credit Agreement, which provides for term loan borrowings in an aggregate principal amount of $28.0 million (“Second Lien Term Loan”). On the closing date of the Second Lien Term Loan, CPII borrowed the entire $28.0 million available under the Second Lien Term Loan. Proceeds of $27.4 million, after netting $0.6 million of issue discount, were principally used to fund a portion of the Company’s acquisition of ASC Signal.




- 17 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



Except as noted below, the First Lien Term Loan and the Second Lien Term Loan (collectively, “Term Loans”) will mature on November 17, 2017 and the Revolver will mature on August 19, 2017. However, if (a) in the case of the Term Loans, on or before November 17, 2017, and, in the case of the Revolver, on or before August 19, 2017, CPII has repaid or refinanced no less than 65% of the Senior Notes due 2018 (“Senior Notes”) outstanding as of the closing date of the First Lien Term Loan, or (b) the first lien leverage ratio as of August 19, 2017 is 2.50:1 or less on a pro forma basis (“Maturity Extension Condition”), then the Term Loans will mature on April 7, 2021 and the Revolver will mature on April 7, 2019.

Borrowings under the First Lien Credit Agreement bear interest at a rate equal to, at CPII’s option, the LIBOR or the base rate (“ABR”) plus the applicable margin. LIBOR and ABR borrowings under the First Lien Term Loan are subject to a 1.00% and 2.00% “floor,” respectively. The ABR under the First Lien Credit Agreement is the greatest of (a) the base rate established by the administrative agent, (b) the federal funds rate plus 0.50% and (c) adjusted LIBOR for a one-month interest period plus 1.00%. For the First Lien Term Loan, the applicable margin will be 3.25% per annum for LIBOR borrowings and 2.25% per annum for ABR borrowings. The applicable margins under the Revolver vary depending on CPII’s total leverage ratio, as defined in the First Lien Credit Agreement and range from 3.25% to 3.00% for LIBOR borrowings and from 2.25% to 2.00% for ABR borrowings.

Borrowings under the Second Lien Credit Agreement bear interest at a rate equal to, at CPII’s option, the LIBOR or the ABR plus the applicable margin. LIBOR and ABR borrowings under the Second Lien Term Loan are subject to a 1.00% and 2.00% “floor,” respectively. The ABR under the Second Lien Credit Agreement is the greatest of (a) a rate equal to the rate last quoted by The Wall Street Journal as the “Prime Rate” in the United States or, if The Wall Street Journal ceases to quote such rate, the highest per annum interest rate published by the Federal Reserve Board as the “bank prime loan” rate or, if such rate is no longer quoted therein, any similar rate quoted therein (as determined by the administrative agent) or any similar release by the Federal Reserve Board (as determined by administrative agent), (b) the federal funds rate plus 0.50% and (c) adjusted LIBOR for a one-month interest period plus 1.00%. For the Second Lien Term Loan, the applicable margin will be 7.00% per annum for LIBOR borrowings and 6.00% per annum for ABR borrowings. However, upon satisfaction of the Maturity Extension Condition, the applicable margin shall be increased by an amount equal to 150% of the difference in the coupon rate of the Senior Notes after the exchange and the coupon rate of the Senior Notes prior to the exchange, to the extent such difference is positive.

Senior Notes due 2018

In February 2011, CPII issued an aggregate of $215 million of Senior Notes due 2018 (“Senior Notes”) originally bearing interest at the rate of 8.0% per year. The outstanding notes are CPII’s senior unsecured obligations. Parent and each of CPII’s existing and future restricted subsidiaries (as defined in the indenture governing the Senior Notes) guarantee the Senior Notes on a senior unsecured basis. The interest rate on the Senior Notes increased from 8.00% to 8.75% per annum in April 2014. Interest is payable in cash on a bi-annual basis. The indenture governing the Senior Notes limits, subject to certain exceptions, CPII and its restricted subsidiaries’ ability to incur additional indebtedness or issue certain preferred stock; pay dividends and make other restricted payments; make certain investments; sell assets; create liens; consolidate, merge or sell all or substantially all of CPII’s assets; enter into transactions with affiliates and designate subsidiaries as unrestricted subsidiaries.

At any time, or from time to time, on or after February 15, 2016, CPII, at its option, may redeem the Senior Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount) set forth below, together with accrued and unpaid interest thereon, if any, to the redemption date, if redeemed during the 12-month period beginning February 15 of the years indicated:
 
Year
 
Optional Redemption Price
2016
 
104%
2017 and thereafter
 
101%





- 18 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



Upon a change of control, CPII may be required to purchase all or any part of the Senior Notes for a cash price equal to 101% of the principal amount, plus accrued and unpaid interest thereon, if any, to the date of purchase.

Debt Maturities:    As of July 1, 2016, maturities on long-term debt were as follows: 
Fiscal Year
 
First Lien Term Loan
 
Second Lien Term Loan
 
8.75% Senior Notes
 
Total
2016 (remaining three months)
 
$
775

 
$

 
$

 
$
775

2017
 
3,100

 

 

 
3,100

2018
 
299,150

 
28,000

 
215,000

 
542,150

2019
 

 

 

 

2020
 

 

 

 

Thereafter
 

 

 

 

 
 
$
303,025

 
$
28,000

 
$
215,000

 
$
546,025

 
The above table assumes (i) that the respective debt instruments will be outstanding until their scheduled maturity dates, and (ii) a debt level based on mandatory repayments according to the contractual amortization schedule of the Company’s senior credit facilities. The above table excludes any optional and excess cash flow prepayments on the Term Loans. The table also excludes the effect of the Company’s contractual right to repay or refinance the Senior Notes by November 17, 2017, which would extend the maturity date for the Term Loan from November 2017 to April 2021.
Covenants

As of July 1, 2016, the Company was in compliance with the covenants under the agreements governing CPII’s First Lien Credit Agreement, Second Lien Credit Agreement and the indentures governing the Senior Notes.


7.
Derivative Instruments and Hedging Activities
 
Foreign Exchange Forward Contracts: Although the majority of the Company’s revenue and expense activities are transacted in U.S. dollars, the Company does transact business in foreign countries. The Company’s primary foreign currency cash flows are in Canada and several European countries. In an effort to reduce its foreign currency exposure to Canadian dollar-denominated expenses, the Company enters into Canadian dollar forward contracts to hedge the Canadian dollar-denominated costs for its manufacturing operations in Canada. The Company does not engage in currency speculation.

The Company’s Canadian dollar forward contracts in effect as of July 1, 2016 have durations of five to 20 months. These contracts are designated as a cash flow hedge and are considered highly effective. Unrealized gains and losses from foreign exchange forward contracts are included in accumulated other comprehensive income (loss) in the condensed consolidated balance sheets. At July 1, 2016, the unrealized gain, net of tax of $0.4 million, was $1.1 million. At October 2, 2015, the unrealized loss, net of tax of $0.7 million, was $2.0 million. The Company anticipates recognizing the entire unrealized gain or loss in operating earnings within the next six fiscal quarters. Changes in the fair value of foreign currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and are immediately recognized in general and administrative expenses in the condensed consolidated statements of comprehensive income. The time value was not material for all periods presented. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, then the Company immediately recognizes the gain or loss on the associated financial instrument in general and administrative expenses in the condensed consolidated statements of comprehensive income. No ineffective amounts were recognized due to hedge ineffectiveness in each of the three and nine months ended July 1, 2016 and July 3, 2015.




- 19 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



As of July 1, 2016, the Company had entered into Canadian dollar forward contracts for nominal values of approximately $75.0 million (Canadian dollars), or approximately 76% of estimated Canadian dollar denominated expenses for July 2016 through September 2017, at an average rate of approximately 0.75 U.S. dollars to one Canadian dollar.

The following table summarizes the aggregate fair value of all derivative instruments designated as cash flow hedges at July 1, 2016 and October 2, 2015
 
 
Asset Derivatives
 
Liability Derivatives
 
 
 
 
Fair Value
 
 
 
Fair Value
 
 
Balance Sheet Location
 
July 1,
2016
 
October 2,
2015
 
Balance Sheet Location
 
July 1,
2016
 
October 2,
2015
Derivative designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Forward contracts
 
Prepaid and other current assets
 
$
1,266

 
$

 
Accrued expenses
 
$
308

 
$
1,821

Forward contracts
 
Other long-term assets
 
404

 

 
Other long-term liabilities
 
14

 

 
 
 
 
$
1,670

 
$

 
 
 
$
322

 
$
1,821

 
As of July 1, 2016 and October 2, 2015, the Company had no derivative instruments that were classified as non-hedging instruments. The Company’s derivatives are reported on a gross basis. The Company has no master netting arrangements with its derivative counterparties that would allow for net settlement.




- 20 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The following table summarizes the effect of derivative instruments on the condensed consolidated statements of comprehensive income for the periods of fiscal years 2016 and 2015 presented:
Derivatives in Cash Flow Hedging Relationships
 
 Amount of Gain Recognized in
OCI on Derivative
(Effective Portion)
 
Gain (Loss) Reclassified from
Accumulated OCI into Income
(Effective Portion)
 
Loss Recognized in
Income on Derivative
(Ineffective and Excluded Portion)
 
 
Location
 
Amount
 
Location
 
Amount
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
July 1,
2016
 
July 3,
2015
 
 
 
July 1,
2016
 
July 3,
2015
 
 
 
July 1,
2016
 
July 3,
2015
Forward contracts
 
$
483

 
$
71

 
Cost of sales
 
$
(569
)
 
$
(928
)
 
General and administrative(a)
 
$
(45
)
 
$
(4
)
 
 
 
 
 
 
Research and development
 
(33
)
 
(86
)
 
 
 
 
 
 
 
 
 
 
 
 
Selling and marketing
 
(20
)
 
(37
)
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative
 
13

 
(44
)
 
 
 
 
 
 
Total
 
$
483

 
$
71

 
 
 
$
(609
)
 
$
(1,095
)
 
 
 
$
(45
)
 
$
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(a)The amount recognized in income for each period presented represents a loss related to the amount excluded from the assessment of hedge effectiveness.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in Cash Flow Hedging Relationships
 
 Amount of Gain (Loss)
Recognized in
OCI on Derivative
(Effective Portion)
 
Loss Reclassified from
Accumulated OCI into Income
(Effective Portion)
 
Gain (Loss) Recognized in
Income on Derivative
(Ineffective and Excluded Portion)
 
 
Location
 
Amount
 
Location
 
Amount
 
 
Nine Months Ended
 
 
 
Nine Months Ended
 
 
 
Nine Months Ended
 
 
July 1,
2016
 
July 3,
2015
 
 
 
July 1,
2016
 
July 3,
2015
 
 
 
July 1,
2016
 
July 3,
2015
Forward contracts
 
$
1,643

 
$
(2,752
)
 
Cost of sales
 
$
(2,099
)
 
$
(1,455
)
 
General and administrative(b)
 
$
(72
)
 
$
83

 
 
 
 
 
 
Research and development
 
(177
)
 
(194
)
 
 
 
 
 
 
 
 
 
 
 
 
Selling and marketing
 
(83
)
 
(85
)
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative
 
(101
)
 
(100
)
 
 
 
 
 
 
Total
 
$
1,643

 
$
(2,752
)
 
 
 
$
(2,460
)
 
$
(1,834
)
 
 
 
$
(72
)
 
$
83

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(b)The amount recognized in income for each period presented represents a gain (loss) related to the amount excluded from the assessment of hedge effectiveness.


8.
Contingencies
 
From time to time, the Company may be subject to claims that arise in the ordinary course of business. In the opinion of management, all such matters involve amounts that would not have a material adverse effect on the Company’s consolidated results of operations, financial position or cash flows if unfavorably resolved.

In 2010, the Company’s new subsidiary, ASC Signal, became aware of volatile organic compounds (“VOC”) and other contamination in the soil and groundwater at the Whitby, Ontario, Canada industrial site. The Company believes that the contamination originated from the neighboring property, which reportedly is used for crystal manufacturing, and secondarily from the operational practices of the prior operators of ASC Signal. The Company intends to address these conditions through the implementation of a remediation plan. ASC Signal holds a pair of pollution insurance policies, and the insurer has advised that it will indemnify ASC Signal for the remediation costs. The Company expects that the remediation costs will be less than the insurance policy limits. In addition, ASC Signal has filed a civil action against the neighbor and certain other parties to recover consequential damages resulting from the contamination. The Company has been informed that one of the defendants in this lawsuit has filed for bankruptcy. 




- 21 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The Company believes that the cost of remediating the contamination at the Whitby site will be approximately Canadian $3.7 million (or U.S. $2.9 million based on an exchange rate of 0.77 U.S. dollars to one Canadian dollar as of July 1, 2016), the amount of environmental loss reserve acquired by the Company through the ASC Signal acquisition. The reserve was provided for environmental liabilities that are considered probable and for which a reasonable estimate of the obligation can be made. As mentioned above, ASC Signal has environmental liability insurance policies that are expected to provide complete indemnification from any costs incurred for the remediation efforts. The expected indemnification gave effect to an environmental indemnification asset also acquired by the Company with the ASC Signal acquisition for the same amount as the estimated cost of remediation. The accompanying condensed consolidated balance sheet as of July 1, 2016 reflect the environmental loss reserve of $2.9 million and the environmental indemnification asset of $2.9 million in other long-term liabilities and other long-term assets, respectively. The calculation of environmental loss reserves is based on the evaluation of currently available information. Actual costs to be incurred in future periods may vary from the amount of reserve given the uncertainties regarding the status of laws, regulations, enforcement policies, and the impact of potentially responsible parties, technology and information related to the affected site.
 

9.
Related-party Transactions

A former major stockholder of the predecessor of the Radant Division now serves as the Director of Business Development of that division (the “Radant Director of Business Development”). In connection with, and as part of the consideration for, the Radant acquisition, the Company was obligated to make $10.0 million in additional payments to the former stockholders of Radant including the Radant Director of Business Development and certain of his relatives for Radant’s having achieved certain agreed-upon financial targets over the two years following the acquisition. The Company, as a result, made the earn-out payment in full in December 2015. Also in connection with the acquisition, the Company entered into a lease agreement for a property in Stow, Massachusetts, that contains a manufacturing plant and office facilities owned by a company controlled by the Radant Director of Business Development. The Company records rent expense for the Stow lease on an arm’s length basis. The Company paid and recorded a rent expense for such lease of $0.1 million for each of the three months ended July 1, 2016 and July 3, 2015 and $0.3 million for each of the nine months ended July 1, 2016 and July 3, 2015.

One of the vendors of the of the Company's ASC Signal Division is owned by the father of ASC Signal's Vice President of Products. The vendor is also a customer of ASC Signal. Purchases from this vendor were $0.6 million and $1.7 million for the three and nine months ended July 1, 2016, respectively. Sales to this vendor were not material for the same periods. The Company had $0.1 million and $0.2 million outstanding payables to this vendor as of July 1, 2016 and October 2, 2015, respectively.

    
10.
Income Taxes
 
The condensed consolidated statements of comprehensive income reflect the following income tax expense:
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Income before income taxes
$
8,674

 
$
1,246

 
$
6,652

 
$
4,734

Income tax expense
$
4,161

 
$
27

 
$
2,875

 
$
1,402

Effective income tax rate
48.0
%
 
2.2
%
 
43.2
%
 
29.6
%




- 22 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The Company’s 48.0% effective income tax rate for the three months ended July 1, 2016 differs from the federal statutory rate of 35.0% primarily due to foreign tax credit limitations, partially offset by the domestic manufacturing deduction, tax benefits from a change in state income apportionment and expiration of the statute of limitations for uncertain tax positions. The Company’s 2.2% effective tax rate for the three months ended July 3, 2015 differs from the federal statutory rate of 35.0% primarily due to tax benefits from a change in state income apportionment, the expiration of the statute of limitations for uncertain tax positions and the domestic manufacturing deduction, partially offset by foreign tax credit limitations.

The Company’s 43.2% effective income tax rate for the nine months ended July 1, 2016 differs from the federal statutory rate of 35.0% primarily due to foreign tax credit limitations, partially offset by the domestic manufacturing deduction, tax benefits from a change in state income apportionment and favorable resolution of and the expiration of the statute of limitations for uncertain tax positions. The Company’s 29.6% effective income tax rate for the nine months ended July 3, 2015 differs from the federal statutory rate of 35.0% primarily due to tax benefits from a change in state income apportionment and a California income tax refund for prior year amended tax returns, partially offset by foreign tax credit limitations and income tax expense for an uncertain tax position as a result of an intercompany sale of assets.

The Company files a U.S. federal income tax return and state income tax returns in California, Massachusetts and several other U.S. states. The Company also files income tax returns in Canada and other foreign jurisdictions. With the exception of Canada and California, the Company is no longer subject to examination by the various taxing authorities for fiscal years prior to 2011. The Company is no longer subject to examination by taxing authorities in Canada and California for fiscal years prior to 2008. The Company has income tax audits in progress in several jurisdictions in which it operates, including an audit by the Canada Revenue Agency (“CRA”) for fiscal year 2010 and for the periods from October 2, 2010 to February 10, 2011 and February 11, 2011 to September 30, 2011. The Company’s policy is to classify interest, foreign exchange rate changes and penalties, if any, on unrecognized tax benefits as components of income tax expense.

The total liability for gross unrecognized tax benefits was $3.6 million and $3.0 million at July 1, 2016 and July 3, 2015, respectively. For the three and nine months ended July 1, 2016, there was no significant change in the total liability for gross unrecognized tax benefits. All of the unrecognized tax benefit balances, if recognized, would reduce the effective tax rate on income from continuing operations. The Company believes that the amount of unrecognized tax benefits that is reasonably possible of changing in the next 12 months is approximately $0.1 million.


11.
Accumulated Other Comprehensive Income (Loss)

The following table provides the components of accumulated other comprehensive income (loss) in the condensed consolidated balance sheets: 
 
July 1,
2016
 
October 2,
2015
Unrealized income (loss) on cash flow hedges, net of tax of $353 and $(673), respectively
$
1,056

 
$
(2,021
)
Unrealized actuarial gain and prior service credit for pension liability, net of tax of $8 and $8, respectively
26

 
26

Accumulated other comprehensive income (loss)
$
1,082

 
$
(1,995
)



- 23 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The following tables provide changes in accumulated other comprehensive income (loss), net of tax, reported in the Company’s condensed consolidated balance sheets for the three and nine months ended July 1, 2016 and July 3, 2015 (amounts in parentheses indicate debits):
 
Three Months Ended
 
July 1, 2016
 
July 3, 2015
 
Gains and Losses on Cash Flow Hedges
 
Defined Benefit Pension Items
 
Total
 
Gains and Losses on Cash Flow Hedges
 
Defined Benefit Pension Items
 
Total
Balance at beginning of period
$
238

 
$
26

 
$
264

 
$
(2,317
)
 
$
100

 
$
(2,217
)
Other comprehensive income before reclassifications
361

 

 
361

 
54

 

 
54

Amounts reclassified from accumulated other comprehensive loss
457

 

 
457

 
822

 

 
822

Net current-period other comprehensive income
818

 

 
818

 
876

 

 
876

Balance at end of period
$
1,056

 
$
26

 
$
1,082

 
$
(1,441
)
 
$
100

 
$
(1,341
)
 
 
Nine Months Ended
 
July 1, 2016
 
July 3, 2015
 
Gains and Losses on Cash Flow Hedges
 
Defined Benefit Pension Items
 
Total
 
Gains and Losses on Cash Flow Hedges
 
Defined Benefit Pension Items
 
Total
Balance at beginning of period
$
(2,021
)
 
$
26

 
$
(1,995
)
 
$
(753
)
 
$
100

 
$
(653
)
Other comprehensive income (loss) before reclassifications
1,232

 

 
1,232

 
(2,064
)
 

 
(2,064
)
Amounts reclassified from accumulated other comprehensive loss
1,845

 

 
1,845

 
1,376

 

 
1,376

Net current-period other comprehensive income (loss)
3,077

 

 
3,077

 
(688
)
 

 
(688
)
Balance at end of period
$
1,056

 
$
26

 
$
1,082

 
$
(1,441
)
 
$
100

 
$
(1,341
)

The following table provides the gross amount reclassified from accumulated other comprehensive income (loss) and the corresponding amount of tax relating to losses on cash flow hedges for the three and nine months ended July 1, 2016 and July 3, 2015 (amounts in parentheses indicate debits):
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Amounts reclassified from accumulated other comprehensive loss
$
609

 
$
1,095

 
$
2,460

 
$
1,834

Less: tax
(152
)
 
(273
)
 
(615
)
 
(458
)
Amounts reclassified from accumulated other comprehensive loss, net of tax
$
457

 
$
822

 
$
1,845

 
$
1,376


See Note 7, Derivatives Instruments and Hedging Activities, for additional disclosures about reclassifications out of accumulated other comprehensive income (loss) and their corresponding effects on the respective line items in the condensed consolidated statements of comprehensive income.





- 24 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



12.
Segments, Geographic and Customer Information
 
The Company’s reportable segments are RF (“radio frequency”) products and satcom equipment. Made up of five divisions, the RF products segment develops, manufactures and distributes high-power/high-frequency microwave and RF signal components and structures. These products are used in the communications, radar, electronic warfare, industrial, medical and scientific markets depending on the specific power and frequency requirements of the end-user and the physical operating conditions of the environment in which the RF products will be located. The satcom equipment segment, which consists of two divisions, including the Company’s newly acquired ASC Signal Division, manufactures and supplies high-power amplifiers primarily for communication with satellites, and satellite communications, radar and high-frequency antennas and controllers. These products are used for satellite communication uplinks, terrestrial communications, imagery and data transmission, and radar and intelligence applications. Segment information reported below is consistent with the manner in which it is reviewed and evaluated by the Company’s chief operating decision maker (“CODM”), its chief executive officer, and is based on the nature of the Company’s operations and products offered to customers.

Amounts not reported as RF products or satcom equipment are reported as “other.” Other includes the activities of the Company’s Malibu Division and unallocated corporate expenses, such as business combination-related expenses, share-based compensation expense and certain other charges and credits that the Company’s management has determined are non-operational, non-cash items or not directly attributable to the Company’s operating divisions. The Malibu Division is a designer, manufacturer and integrator of advanced antenna systems for radar, radar simulators and telemetry systems, as well as for data links used in ground, airborne, unmanned aerial vehicles (“UAVs”) and shipboard systems.

Summarized financial information concerning the Company’s reportable segments is shown in the following tables: 
 
 
Three Months Ended
 
Nine Months Ended
 
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Sales from external customers
 
 
 
 
 
 
 
RF products
 
$
86,677

 
$
82,867

 
$
247,163

 
$
251,101

Satcom equipment
 
36,307

 
20,475

 
101,087

 
59,762

Other
 
6,628

 
6,303

 
12,329

 
17,420

 
 
$
129,612

 
$
109,645

 
$
360,579

 
$
328,283

Intersegment product transfers
 
 
 
 
 

 
 

RF products
 
$
5,038

 
$
3,652

 
$
14,464

 
$
14,958

Satcom equipment
 
1

 
6

 
57

 
24

 
 
$
5,039

 
$
3,658

 
$
14,521

 
$
14,982

Capital expendituresa
 
 
 
 
 
 

 
 

RF products
 
$
553

 
$
974

 
$
2,728

 
$
3,703

Satcom equipment
 
127

 
57

 
673

 
188

Other
 
480

 
537

 
1,008

 
795

 
 
$
1,160

 
$
1,568

 
$
4,409

 
$
4,686

EBITDA
 
 
 
 
 
 

 
 

RF products
 
$
20,300

 
$
17,351

 
$
49,938

 
$
53,376

Satcom equipment
 
6,069

 
2,211

 
15,273

 
6,293

Other
 
(1,334
)
 
(3,385
)
 
(9,321
)
 
(10,083
)
 
 
$
25,035

 
$
16,177

 
$
55,890

 
$
49,586

 
 
 
 
 
 
 
 
 
a Capital expenditures incurred on an accrual basis.
 
 
 
 
 



- 25 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



 
July 1,
2016
 
October 2,
2015
Total assets
 
 
 
RF products
$
517,025

 
$
515,966

Satcom equipment
183,784

 
183,711

Other
67,344

 
71,467

 
$
768,153

 
$
771,144


EBITDA represents earnings before net interest expense, provision for income taxes and depreciation and amortization. The Company believes that EBITDA is useful to assess its ability to generate cash from operations sufficient to pay taxes, to service debt and to undertake capital expenditures.

For the reasons listed below, the Company believes that U.S. GAAP-based financial information for leveraged businesses like its own should be supplemented by EBITDA so that investors better understand its financial performance in connection with their analysis of the Company’s business:

EBITDA is a component of the measures used by the Company’s board of directors and management team to evaluate the Company’s operating performance;
the Company’s first lien senior credit facility contains covenants that require the Company to maintain a total leverage ratio in certain circumstances that contains EBITDA as a component, and the Company’s management team uses EBITDA to monitor compliance with these covenants;
EBITDA is a component of the measures used by the Company’s management team to make day-to-day operating decisions;
EBITDA facilitates comparisons between the Company’s operating results and those of competitors with different capital structures and, therefore, is a component of the measures used by the management to facilitate internal comparisons to competitors’ results and the Company’s industry in general; and
the payment of management bonuses is contingent upon, among other things, the satisfaction by the Company of certain targets that contain EBITDA as a component.

EBITDA is not a presentation made in accordance with U.S. GAAP and has important limitations as an analytical tool. EBITDA should not be considered as an alternative to comprehensive income, net income, operating income or any other performance measures derived in accordance with U.S. GAAP as a measure of operating performance or operating cash flows as a measure of liquidity. The Company’s use of the term EBITDA varies from others in the Company’s industry. The Company’s presentation of EBITDA should not be construed to imply that the Company’s future results will be unaffected by the items added back or excluded in the calculation of EBITDA. Operating income by the Company’s reportable segments was as follows:
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Operating income
 
 
 
 
 
 
 
RF products
$
18,369

 
$
15,064

 
$
44,009

 
$
46,425

Satcom equipment
5,444

 
1,951

 
13,790

 
5,504

Other
(5,339
)
 
(6,650
)
 
(21,839
)
 
(19,883
)
 
$
18,474

 
$
10,365

 
$
35,960

 
$
32,046

 



- 26 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)



The following table reconciles net income to EBITDA:
 
Three Months Ended
 
Nine Months Ended
 
July 1,
2016
 
July 3,
2015
 
July 1,
2016
 
July 3,
2015
Net income
$
4,513

 
$
1,219

 
$
3,777

 
$
3,332

Depreciation and amortization
6,561

 
5,812

 
19,930

 
17,540

Interest expense, net
9,800

 
9,119

 
29,308

 
27,312

Income tax expense
4,161

 
27

 
2,875

 
1,402

EBITDA
$
25,035

 
$
16,177

 
$
55,890

 
$
49,586



13.     Supplemental Guarantors Condensed Consolidating Financial Information
 
The tables that follow reflect the supplemental guarantor financial information associated with CPII’s Senior Notes issued on February 11, 2011. The Senior Notes are guaranteed by Parent and, subject to certain exceptions, each of Parent’s existing and future domestic restricted subsidiaries (other than CPII) on a senior unsecured basis. Separate financial statements of the guarantors are not presented because (i) the guarantors are wholly owned and have fully and unconditionally guaranteed the Senior Notes on a joint and several basis and (ii) CPII’s management has determined that such separate financial statements are not material to investors. Instead, presented below are the consolidating financial statements of: (i) the guarantor subsidiaries, (ii) the non-guarantor subsidiaries, (iii) the consolidating elimination entries, and (iv) the consolidated totals. The accompanying consolidating financial information should be read in connection with the condensed consolidated financial statements of the Company.

Investments in subsidiaries are accounted for based on the equity method. The principal elimination entries eliminate investments in subsidiaries, intercompany balances and intercompany transactions.
     



- 27 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands)




CONDENSED CONSOLIDATING BALANCE SHEET
As of July 1, 2016
 
 
Parent
 
Issuer
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Eliminations
 
Consolidated
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$

 
$

 
$
17,724

 
$
21,444

 
$

 
$
39,168

Restricted cash

 

 
1,744

 
67

 

 
1,811

Accounts receivable, net

 

 
40,238

 
18,592

 

 
58,830

Inventories

 

 
74,420

 
42,078

 
(572
)
 
115,926

Intercompany receivable

 

 
120,030

 
4,100

 
(124,130
)
 

Prepaid and other current assets
1

 
82

 
3,280

 
3,097

 
217

 
6,677

Total current assets
1

 
82

 
257,436

 
89,378

 
(124,485
)
 
222,412

Property, plant and equipment, net