Quarterly Report


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 January 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  February 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) 
 
January 1,
2016
 
October 2,
2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
34,234

 
$
37,514

Restricted cash
1,724

 
1,681

Accounts receivable, net
50,064

 
61,750

Inventories
107,773

 
103,276

Prepaid and other current assets
7,200

 
6,200

Total current assets
200,995

 
210,421

Property, plant, and equipment, net
77,159

 
78,592

Intangible assets, net
259,492

 
263,273

Goodwill
215,434

 
215,434

Other long-term assets
3,328

 
3,424

Total assets
$
756,408

 
$
771,144

 
 
 
 
Liabilities and stockholders’ equity
 

 
 

Current liabilities:
 

 
 

Current portion of long-term debt
$
3,100

 
$
3,100

Accounts payable
26,498

 
30,349

Accrued expenses
31,450

 
44,106

Product warranty
5,460

 
5,304

Income taxes payable
988

 
1,154

Advance payments from customers
16,955

 
13,037

Total current liabilities
84,451

 
97,050

Deferred tax liabilities
90,217

 
91,227

Long-term debt:
 
 
 
Principal, less current portion
544,475

 
545,250

Less unamortized original issue discount
(3,963
)
 
(4,400
)
Less unamortized debt issuance costs
(10,435
)
 
(11,084
)
Long term debt, net of discount and debt issuance costs
530,077

 
529,766

Other long-term liabilities
6,290

 
6,384

Total liabilities
711,035

 
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
26,810

 
26,565

Accumulated other comprehensive loss
(2,374
)
 
(1,995
)
Retained earnings
20,937

 
22,147

Total stockholders’ equity
45,373

 
46,717

Total liabilities and stockholders’ equity
$
756,408

 
$
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 (LOSS)
(In thousands – unaudited)


 
 
Three Months Ended
 
January 1,
2016
 
January 2,
2015
Sales
$
110,682

 
$
110,674

Cost of sales, including $906 and $0 of utilization of net increase in cost basis of inventory due to purchase accounting, respectively
81,784

 
78,051

Gross profit
28,898

 
32,623

Operating costs and expenses:
 

 
 

Research and development
3,893

 
3,595

Selling and marketing
6,529

 
5,667

General and administrative
8,118

 
8,189

Amortization of acquisition-related intangible assets
3,558

 
2,547

Total operating costs and expenses
22,098

 
19,998

Operating income
6,800

 
12,625

Interest expense, net
9,723

 
9,039

(Loss) income before income taxes
(2,923
)
 
3,586

Income tax (benefit) expense
(1,713
)
 
603

Net (loss) income
(1,210
)
 
2,983

 
 
 
 
Other comprehensive loss, net of tax
 

 
 

Unrealized loss on cash flow hedges, net of tax
(379
)
 
(676
)
Total other comprehensive loss, net of tax
(379
)
 
(676
)
Comprehensive (loss) income
$
(1,589
)
 
$
2,307

 
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

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands – unaudited)
 
 
 
Three Months Ended
 
January 1,
2016
 
January 2,
2015
Cash flows from operating activities
 
 
 
Net cash provided by operating activities
$
4,146

 
$
9,920

 
 
 
 
Cash flows from investing activities
 

 
 

Capital expenditures
(1,925
)
 
(1,651
)
Acquisition, net of cash acquired
(363
)
 

Net cash used in investing activities
(2,288
)
 
(1,651
)
 
 
 
 
Cash flows from financing activities
 

 
 

Payment of contingent consideration
(4,300
)
 

Payment of debt issue costs
(63
)
 

Repayment of borrowings under First Lien Term Loan
(775
)
 
(775
)
Net cash used in financing activities
(5,138
)
 
(775
)
 
 
 
 
Net (decrease) increase in cash and cash equivalents
(3,280
)
 
7,494

Cash and cash equivalents at beginning of period
37,514

 
50,617

Cash and cash equivalents at end of period
$
34,234

 
$
58,111

 
 
 
 
Supplemental cash flow disclosures
 

 
 

Cash paid for interest
$
3,991

 
$
3,416

Cash paid (received) for income taxes, net
$
1,061

 
$
(669
)
Decrease in accrued capital expenditures
$
400

 
$
143

 
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 January 1, 2016 and January 2, 2015 included 13 weeks. All other period references are to the Company’s fiscal periods unless otherwise indicated.

The accompanying unaudited condensed consolidated financial statements of the Company as of January 1, 2016 and for the three months ended January 1, 2016 and January 2, 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 January 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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Table of Contents

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. The new accounting standard update had no impact because there were no measurement period adjustments related to any prior business combinations in the quarter.




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Table of Contents

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 current 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.
        

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.
    
The following table sets forth a preliminary allocation of the total purchase price as of January 1, 2016 to the assets acquired and the liabilities assumed and the resulting goodwill based on the preliminary estimates of fair value.
Purchase price                                                                                                              
$
52,918

Less: Fair value of assets acquired:
 

Net current assets                                                                                                           
(12,558
)
Property, plant and equipment                                                                                                           
(7,465
)
Identifiable intangible assets                                                                                                           
(25,750
)
Other long-term asset
(2,817
)
 
(48,590
)
Add: Fair value of liabilities assumed:
 

Long-term deferred tax liabilities
9,408

Other long-term liabilities
2,817

 
12,225

 
 
Goodwill                                                                                                              
$
16,553


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 manufacturing facility. See Note 8, Contingencies, for more information.
    



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Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

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



The areas of the purchase price allocation that are not yet finalized and are subject to change within the measurement period relate to personal property, deferred revenue, income and non-income tax-related items and the resulting goodwill adjustment. Measurement period adjustments are expected to be made to the preliminary purchase price allocation based on new information obtained in the period subsequent to the acquisition and for the period ending the earlier of one year from the acquisition date or when the valuation process is complete. No such adjustments were recorded in the three months ended January 1, 2016 .

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
2,450

 
1
Customer relationship
9,100

 
14
Total identifiable intangible assets
$
25,750

 
 

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 $0.6 million included in general and administrative in the condensed consolidated statement of comprehensive loss for the three months ended January 1, 2016 . 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.




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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 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 , and (ii) amortization of backlog of $0.6 million for the three months ended January 1, 2016 . 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
 
January 1,
2016
 
January 2,
2015
Sales
$
110,682

 
$
117,099

Net income
$
104

 
$
2,253



4.
Supplemental Financial Information
  
Accounts Receivable: Accounts receivable are stated net of allowances for doubtful accounts as follows: 
 
January 1,
2016
 
October 2,
2015
Accounts receivable
$
50,678

 
$
62,379

Less: Allowance for doubtful accounts
(614
)
 
(629
)
Accounts receivable, net
$
50,064

 
$
61,750


Inventories: The following table provides details of inventories: 
 
January 1,
2016
 
October 2,
2015
Raw materials and parts
$
57,588

 
$
54,499

Work in process
35,484

 
33,991

Finished goods
14,701

 
14,786

Total inventories
$
107,773

 
$
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
 
January 1,
2016
 
January 2,
2015
Balance at beginning of period
$
1,638

 
$
5,008

Provision for loss contracts, charged to cost of sales
571

 
135

Credit to cost of sales upon revenue recognition
(304
)
 
(165
)
Balance at end of period
$
1,905

 
$
4,978

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




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Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

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



At the end of each period presented above, reserve for loss contracts was reported in the condensed consolidated balance sheet in the following accounts: 
 
January 1,
2016
 
January 2,
2015
Inventories
$
1,905

 
$
4,968

Accrued expenses

 
10

Total reserves for loss contracts
$
1,905

 
$
4,978

 
Accrued Expenses:     The following table provides details of accrued expenses:
 
 
January 1,
2016
 
January 2,
2015
Payroll and employee benefits
$
12,763

 
$
14,980

Accrued interest
7,309

 
2,721

Foreign exchange forward derivatives
2,949

 
1,821

Deferred income
1,192

 
3,329

Contingent consideration liability

 
9,700

Other accruals
7,237

 
11,555

Total accrued expenses
$
31,450

 
$
44,106


Product Warranty: The following table summarizes the activity related to product warranty: 
 
Three Months Ended
 
January 1,
2016
 
January 2,
2015
Beginning accrued warranty
$
5,304

 
$
4,863

Actual costs of warranty claims
(1,350
)
 
(1,179
)
Estimates for product warranty, charged to cost of sales
1,506

 
965

Ending accrued warranty
$
5,460

 
$
4,649

 




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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 January 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 securities 1
$
18,813

 
$
18,813

 
$

 
$

Mutual funds 2
297

 
297

 

 

Total assets at fair value
$
19,110

 
$
19,110

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Foreign exchange forward derivatives 3
$
2,949

 
$

 
$
2,949

 
$

Total liabilities at fair value
$
2,949

 
$

 
$
2,949

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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.




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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 and overnight U.S. Government securities 1
$
22,390

 
$
22,390

 
$

 
$

Mutual funds 2
282

 
282

 

 

Total assets at fair value
$
22,672

 
$
22,672

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Foreign exchange forward derivatives 3
$
1,821

 
$

 
$
1,821

 
$

Contingent consideration liability 4
9,700

 

 

 
9,700

Total liabilities at fair value
$
11,521

 
$

 
$
1,821

 
$
9,700

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 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 consideration for the Company’s acquisition of Radant Technologies, Inc. (“Radant”), the Company was obligated to make a maximum of $10.0 million in potential additional payments if certain financial targets were achieved by Radant over the two years following the acquisition. These potential earn-out payments were considered contingent consideration. 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 include 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
 
January 1,
2016
 
January 2,
2015
Balance at beginning of period
$
9,700

 
$
7,600

Change in fair value included in earnings
300

 
500

Payment of contingent consideration
(10,000
)
 

Balance at end of period
$

 
$
8,100




- 14 -

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:
 
 
 
 
January 1, 2016
 
October 2, 2015
 
 
Fair Value Measurement
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
First Lien Term Loan
Level 2
 
$
297,942

 
$
298,717

 
$
298,432

 
$
293,088

Second Lien Term Loan
Level 3
 
26,326

 
26,326

 
26,333

 
26,333

8.75% Senior Notes due 2018
Level 2
 
209,527

 
208,452

 
208,768

 
209,843

 
 
 
 
$
533,795

 
$
533,495

 
$
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 $618 and $667 as of January 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 on September 17, 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  January 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.





- 15 -


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:
 
 
 
January 1,
2016
 
October 2,
2015
Senior Secured Credit Facilities:
 
 
 
First Lien Credit Agreement:
 
 
 
Revolver
$

 
$

First Lien Term Loan
304,575

 
305,350

Less unamortized original issue discount
(599
)
 
(625
)
Less unamortized debt issuance costs a
(6,652
)
 
(6,960
)
 
 
297,324

 
297,765

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

 
28,000

Less unamortized original issue discount
(538
)
 
(557
)
Less unamortized debt issuance costs
(1,136
)
 
(1,110
)
 
26,326

 
26,333

 
 
 
 
Senior Notes
215,000

 
215,000

Less unamortized original issue discount
(2,826
)
 
(3,218
)
Less unamortized debt issuance costs
(2,647
)
 
(3,014
)
 
209,527

 
208,768

 
 
 
 
Long term debt, net of discount and debt issuance costs
533,177

 
532,866

Less current portion
(3,100
)
 
(3,100
)
Long-term portion
$
530,077

 
$
529,766

 
 
 
 
Standby letters of credit secured by Revolver
$
5,860

 
$
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 $5.9 million of outstanding letters of credit as of January 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.




- 16 -

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. 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%





- 17 -

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 January 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 nine months)
 
$
2,325

 
$

 
$

 
$
2,325

2017
 
3,100

 

 

 
3,100

2018
 
299,150

 
28,000

 
215,000

 
542,150

2019
 

 

 

 

2020
 

 

 

 

Thereafter
 

 

 

 

 
 
$
304,575

 
$
28,000

 
$
215,000

 
$
547,575

 
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 January 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 operation in Canada. The Company does not engage in currency speculation.

The Company’s Canadian dollar forward contracts in effect as of January 1, 2016 have durations of two to 19 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 loss in the condensed consolidated balance sheets. At January 1, 2016 , the unrealized loss , net of tax of $0.8 million , was $2.4 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 four 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 (loss) . 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 (loss) . No ineffective amounts were recognized due to hedge ineffectiveness in the three months ended January 1, 2016 and January 2, 2015 .

As of January 1, 2016 , the Company had entered into Canadian dollar forward contracts for nominal values of approximately $44.9 million (Canadian dollars), or approximately 78% of estimated Canadian dollar denominated expenses for January 2016 through September 2016 , at an average rate of approximately 0.79 U.S. dollars to one Canadian dollar.



- 18 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

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




The aggregate fair value of all derivative instruments designated as cash flow hedges were in a liability position on January 1, 2016 and October 2, 2015 as shown in the following table: 
 
 
 
Liability Derivatives
 
 
 
 
 
Fair Value
 
 
 
Balance Sheet Location
 
January 1,
2016
 
October 2,
2015
Derivative designated as hedging instruments
 
 
 
 
 
 
Forward contracts
 
 
Accrued expenses
 
$
2,949

 
$
1,821

 
As of January 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.

The following table summarizes the effect of derivative instruments on the condensed consolidated statements of comprehensive income (loss) for the periods of fiscal years 2016 and 2015 presented:
Derivatives in Cash Flow Hedging Relationships
 
 Amount of Loss
Recognized in
OCI on Derivative
(Effective Portion)
 
Loss Reclassified from
Accumulated OCI into Income
(Effective Portion)
 
Gain Recognized in
Income on Derivative
(Ineffective and Excluded Portion)
 
 
Location
 
Amount
 
Location
 
Amount
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
January 1,
2016
 
January 2,
2015
 
 
 
January 1,
2016
 
January 2,
2015
 
 
 
January 1,
2016
 
January 2,
2015
Forward contracts
 
$
(1,643
)
 
$
(1,154
)
 
Cost of sales
 
$
(1,038
)
 
$
(236
)
 
General and administrative (a)
 
$
45

 
$
75

 
 
 
 
 
 
Research and development
 
(48
)
 
(8
)
 
 
 
 
 
 
 
 
 
 
 
 
Selling and marketing
 
(21
)
 
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative
 
(29
)
 
(4
)
 
 
 
 
 
 
Total
 
$
(1,643
)
 
$
(1,154
)
 
 
 
$
(1,136
)
 
$
(252
)
 
 
 
$
45

 
$
75

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(a) The amount recognized in income for each period presented represents a gain 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 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. 




- 19 -

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. $2.7 million based on an exchange rate of 0.72 U.S. dollars to one Canadian dollar as of January 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 which 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 January 1, 2016 reflect the environmental loss reserve of $2.7 million and the environmental indemnification asset of $2.7 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 of $0.1 million for such lease for each of the three months ended January 1, 2016 and January 2, 2015 .
    
    
10.
Income Taxes
 
The condensed consolidated statements of comprehensive income (loss) reflect the following income tax expense:
 
Three Months Ended
 
January 1,
2016
 
January 2,
2015
(Loss) income before income taxes
$
(2,923
)
 
$
3,586

Income tax (benefit) expense
$
(1,713
)
 
$
603

Effective income tax rate
58.6
%
 
16.8
%

The Company’s 58.6% effective income tax rate for the three months ended January 1, 2016 differs from the federal statutory rate of 35.0% primarily due to foreign tax credit limitations partially offset by tax benefits from a change in uncertain tax positions upon completion of a Canada Revenue Agency (“CRA”) tax audit and U.S. research and development tax credits from passage of the Protecting Americans from Tax Hike Act of 2015. The Company’s 16.8% effective income tax rate for the three months ended January 2, 2015 differs from the federal statutory rate of 35.0% primarily due to tax benefits from a California income tax refund.




- 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 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 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 $4.0 million and $2.6 million at January 1, 2016 and January 2, 2015 , respectively. For the three months ended January 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 the amount of unrecognized tax benefits that is reasonably possible of being resolved in the next 12 months is not significant.


11.
Accumulated Other Comprehensive Loss

The following table provides the components of accumulated other comprehensive loss in the condensed consolidated balance sheets: 
 
January 1,
2016
 
October 2,
2015
Unrealized loss on cash flow hedges, net of tax of $(800) and $(673), respectively
$
(2,400
)
 
$
(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 loss
$
(2,374
)
 
$
(1,995
)
The following tables provide changes in accumulated other comprehensive loss , net of tax, reported in the Company’s condensed consolidated balance sheets for the three months ended January 1, 2016 and January 2, 2015 (amounts in parentheses indicate debits):
 
Three Months Ended
 
January 1, 2016
 
January 2, 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 loss before reclassifications
(1,231
)
 

 
(1,231
)
 
(865
)
 

 
(865
)
Amounts reclassified from accumulated other comprehensive loss
852

 

 
852

 
189

 

 
189

Net current-period other comprehensive loss
(379
)
 

 
(379
)
 
(676
)
 

 
(676
)
Balance at end of period
$
(2,400
)
 
$
26

 
$
(2,374
)
 
$
(1,429
)
 
$
100

 
$
(1,329
)




- 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 following table provides the gross amount reclassified from accumulated other comprehensive loss and the corresponding amount of tax relating to losses on cash flow hedges for the three months ended January 1, 2016 and January 2, 2015 (amounts in parentheses indicate debits):
 
Three Months Ended
 
January 1,
2016
 
January 2,
2015
Amounts reclassified from accumulated other comprehensive loss
$
1,136

 
$
252

Less: tax
(284
)
 
(63
)
Amounts reclassified from accumulated other comprehensive loss, net of tax
$
852

 
$
189


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


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.




- 22 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

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



Summarized financial information concerning the Company’s reportable segments is shown in the following tables: 
 
 
Three Months Ended
 
 
January 1,
2016
 
January 2,
2015
Sales from external customers
 
 
 
RF products
 
$
75,287

 
$
86,073

Satcom equipment
 
33,453

 
18,598

Other
 
1,942

 
6,003

 
 
$
110,682

 
$
110,674

Intersegment product transfers
 
 
 
RF products
 
$
4,822

 
$
5,193

Satcom equipment
 
20

 
18

 
 
$
4,842

 
$
5,211

Capital expenditures a
 
 
 
 
RF products
 
$
1,118

 
$
1,333

Satcom equipment
 
211

 
21

Other
 
196

 
154

 
 
$
1,525

 
$
1,508

EBITDA
 
 
 
 
RF products
 
$
13,461

 
$
19,826

Satcom equipment
 
5,490

 
1,867

Other
 
(5,433
)
 
(3,166
)
 
 
$
13,518

 
$
18,527

 
 
 
 
 
a Capital expenditures incurred on an accrual basis.
 
 
January 1,
2016
 
October 2,
2015
Total assets
 
 
 
RF products
$
505,840

 
$
515,966

Satcom equipment
184,495

 
183,711

Other
66,073

 
71,467

 
$
756,408

 
$
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;



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Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

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



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
 
January 1,
2016
 
January 2,
2015
Operating income
 
 
 
RF products
$
11,426

 
$
17,456

Satcom equipment
5,071

 
1,603

Other
(9,697
)
 
(6,434
)
 
$
6,800

 
$
12,625

 
The following table reconciles net income to EBITDA:
 
Three Months Ended
 
January 1,
2016
 
January 2,
2015
Net (loss) income
$
(1,210
)
 
$
2,983

Depreciation and amortization
6,718

 
5,902

Interest expense, net
9,723

 
9,039

Income tax (benefit) expense
(1,713
)
 
603

EBITDA
$
13,518

 
$
18,527






- 24 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.
and Subsidiaries

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



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.
     



- 25 -

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 January 1, 2016
 
 
Parent
 
Issuer
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Eliminations
 
Consolidated
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$

 
$

 
$
20,934

 
$
13,300

 
$

 
$
34,234

Restricted cash

 

 
1,651

 
73

 

 
1,724

Accounts receivable, net

 

 
35,454

 
14,610

 

 
50,064

Inventories

 

 
72,308

 
35,946

 
(481
)
 
107,773

Intercompany receivable

 

 
100,165

 
14,810

 
(114,975
)
 

Prepaid and other current assets
1

 
30

 
5,491

 
1,518

 
160

 
7,200

Total current assets
1

 
30

 
236,003

 
80,257

 
(115,296
)
 
200,995

Property, plant and equipment, net

 

 
56,935

 
20,224

 

 
77,159

Intangible assets, net

 

 
184,916

 
74,576

 

 
259,492

Goodwill

 

 
127,281

 
88,153

 

 
215,434

Other long-term assets

 

 
504

 
2,824

 

 
3,328

Investment in subsidiaries
45,861

 
788,215

 
34,620

 

 
(868,696
)
 

Total assets
$
45,862

 
$
788,245

 
$
640,259

 
$
266,034

 
$
(983,992
)
 
$
756,408

Liabilities and stockholders’ equity
 

 
 

 
 

 
 

 
 

 
 

Current portion of long-term debt
$

 
$
3,100

 
$

 
$

 
$

 
$
3,100

Accounts payable

 

 
14,243

 
12,255

 

 
26,498

Accrued expenses
489

 
7,335

 
15,903

 
7,790

 
(67
)
 
31,450

Product warranty

 

 
3,068

 
2,392

 

 
5,460

Income taxes payable

 

 
86

 
902

 

 
988

Advance payments from customers

 

 
13,657

 
3,298

 

 
16,955

Intercompany payable

 
5,353

 

 

 
(5,353
)
 

Total current liabilities
489

 
15,788

 
46,957

 
26,637

 
(5,420
)
 
84,451

Deferred tax liabilities

 

 
69,531

 
20,686

 

 
90,217

Long term debt, net of discount and debt issuance costs

 
530,077

 

 

 

 
530,077

Other long-term liabilities

 

 
2,867

 
3,423

 

 
6,290

Total liabilities
489

 
545,865

 
119,355

 
50,746

 
(5,420
)
 
711,035

Common stock

 

 

 

 

 

Parent investment

 
211,100

 
404,882

 
184,218

 
(800,200
)
 

Equity investment in subsidiary
(2,374
)
 
(2,374
)
 
9,377

 

 
(4,629
)
 

Additional paid-in capital
26,810

 

 

 

 

 
26,810

Accumulated other comprehensive loss

 

 

 
(2,374
)
 

 
(2,374
)
Retained earnings
20,937

 
33,654

 
106,645

 
33,444

 
(173,743
)
 
20,937

Total stockholders’ equity
45,373

 
242,380

 
520,904

 
215,288

 
(978,572
)
 
45,373

Total liabilities and stockholders’ equity
$
45,862

 
$
788,245

 
$
640,259

 
$
266,034

 
$
(983,992
)
 
$
756,408

 



- 26 -

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 October 2, 2015

 
Parent
 
Issuer
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Eliminations
 
Consolidated
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$

 
$

 
$
25,444

 
$
12,070

 
$

 
$
37,514

Restricted cash

 

 
1,605

 
76

 

 
1,681

Accounts receivable, net

 

 
40,738

 
21,012

 

 
61,750

Inventories

 

 
69,787

 
33,999

 
(510
)
 
103,276

Intercompany receivable

 

 
101,600

 
7,350

 
(108,950
)
 

Prepaid and other current assets
2

 
57

 
4,655

 
1,315

 
171

 
6,200

Total current assets
2

 
57

 
243,829

 
75,822

 
(109,289
)
 
210,421

Property, plant and equipment, net

 

 
58,101

 
20,491

 

 
78,592

Intangible assets, net

 

 
187,678

 
75,595

 

 
263,273

Goodwill

 

 
127,281

 
88,153

 

 
215,434

Other long-term assets

 

 
502

 
2,922

 

 
3,424

Investment in subsidiaries
48,076

 
785,267

 
36,978

 

 
(870,321
)
 

Total assets
$
48,078

 
$
785,324

 
$
654,369

 
$
262,983

 
$
(979,610
)
 
$
771,144

Liabilities and stockholders’ equity
 

 
 

 
 

 
 

 
 

 
 

Current portion of long-term debt
$

 
$
3,100

 
$

 
$

 
$

 
$
3,100

Accounts payable

 

 
17,015

 
13,334

 

 
30,349

Accrued expenses
1,361

 
3,410

 
33,239

 
6,165

 
(69
)