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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended November 30, 2010

 

¨ 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 000-29429

 

 

API TECHNOLOGIES CORP.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   98-0200798

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

c/o One North Wacker Drive, Suite 4400

Chicago, IL 60606

(Address of Principal Executive Offices)

(312) 214-4864

(Registrant’s Telephone Number, Including Area Code)

 

 

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

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

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

 

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

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

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

8,201,003 shares of common stock with a par value of $0.001 per share at January 7, 2011.

 

 

 


Table of Contents

API TECHNOLOGIES CORP. AND SUBSIDIARIES

Report on Form 10-Q

Quarter Ended November 30, 2010

Table of Contents

 

          Page  

PART I—FINANCIAL INFORMATION

  
Item 1.    Financial Statements   
  

Consolidated Balance Sheets at November 30, 2010 (unaudited) and May 31, 2010

     3   
  

Consolidated Statements of Operations (unaudited) for the six and three months ended November  30, 2010 and November 30, 2009

     4   
  

Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the six months ended November 30, 2010

     5   
  

Consolidated Statements of Cash Flows (unaudited) for the six months ended November  30, 2010 and November 30, 2009

     6   
  

Notes to Consolidated Financial Statements (unaudited)

     7   
Item 2.   

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

     23   
  

Forward Looking Statements

     31   
Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     31   

Item 4.

  

Controls and Procedures

     32   
PART II—OTHER INFORMATION   
Item 1.   

Legal Proceedings

     33   
Item 1A.   

Risk Factors

     33   
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     33   
Item 3.   

Defaults Upon Senior Securities

     33   
Item 4.   

Removed and Reserved

     33   
Item 5.   

Other Information

     34   
Item 6.   

Exhibits

     34   
Signatures      35   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

API TECHNOLOGIES CORP.

Consolidated Balance Sheets

 

     Nov. 30,  2010
(Unaudited)
    May 31,
2010
 

Assets

    

Current

    

Cash and cash equivalents

   $ 5,508,865      $ 4,496,025   

Marketable securities, at fair value

     241,793        200,474   

Accounts receivable, less allowance for doubtful accounts of $91,566 and $101,911 at November 30, 2010 and May 31, 2010, respectively

     12,871,720        15,115,117   

Inventories, net (note 6)

     21,179,316        29,761,594   

Deferred income taxes

     257,923        1,277,452   

Prepaid expenses and other current assets

     1,064,805        1,370,407   

Current assets of discontinued operations (note 5)

     —          44,172   
                
     41,124,422        52,265,241   

Fixed assets, net

     11,308,820        11,493,384   

Fixed assets held for sale (note 2)

     150,000        931,075   

Deferred income taxes

     —          257,290   

Goodwill

     8,461,889        8,461,889   

Intangible assets, net

     2,966,831        3,160,422   

Long-lived assets of discontinued operations (note 5)

     —          2,041,155   
                
   $ 64,011,962      $ 78,610,456   
                

Liabilities and Shareholders’ Equity

    

Current

    

Bank indebtedness

   $ 705,157      $ 697,654   

Accounts payable and accrued expenses

     11,154,530        16,215,900   

Deferred revenue

     587,077        7,776,622   

Deferred income taxes

     —          1,301,364   

Sellers’ note payable (note 9)

     10,000,000        10,000,000   

Current portion of long-term debt (note 10)

     143,857        289,638   

Current liabilities of discontinued operations (note 5)

     141,311        439,633   
                
     22,731,932        36,720,811   

Deferred income taxes

     257,899        233,354   

Long-term debt, net of current portion and discount of $2,775,918 and $3,286,872 at November 30, 2010 and May 31, 2010, respectively (note 10)

     22,397,023        22,718,609   
                
     45,386,854        59,672,774   
                

Commitments and contingencies (note 16)

    

Shareholders’ equity

    

Common stock, ($0.001 par value, 100,000,000 authorized shares, 8,200,936 and 8,211,319 shares issued and outstanding at November 30, 2010 and May 31, 2010, respectively)

     32,803        32,845   

Special voting stock ($0.01 par value, 1 share authorized, issued and outstanding at November 30, 2010 and May 31, 2010, respectively)

     —          —     

Additional paid-in capital

     42,269,069        41,544,341   

Common stock subscribed but not issued

     2,373,000        2,373,000   

Accumulated deficit

     (26,481,402     (25,477,455

Accumulated other comprehensive income:

    

Currency translation adjustment

     235,704        302,874   

Unrealized gain on marketable securities, net of tax

     195,934        162,077   
                

Total accumulated other comprehensive income

     431,638        464,951   
                
     18,625,108        18,937,682   
                
   $ 64,011,962      $ 78,610,456   
                

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

 

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Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statements of Operations

 

     For the Six
Months Ended
Nov 30,
2010
(Unaudited)
    For the Six
Months Ended
Nov 30,
2009
(Unaudited)
    For the Three
Months Ended
Nov 30,
2010
(Unaudited)
    For the Three
Months Ended
Nov 30,
2009
(Unaudited)
 

Revenue, net

   $ 55,022,237      $ 20,953,890      $ 25,898,692      $ 11,885,312   

Cost of revenues

        

Cost of revenues

     40,895,215        15,955,603        19,002,238        9,076,826   

Restructuring charges (note 18)

     757,988        —          458,337        —     
                                

Total cost of revenues

     41,653,203        15,955,603        19,460,575        9,076,826   
                                

Gross profit

     13,369,034        4,998,287        6,438,117        2,808,486   
                                

Operating expenses

        

General and administrative

     7,656,148        4,071,856        4,195,897        2,323,969   

Selling expenses

     2,243,923        1,665,687        1,131,305        927,850   

Research and development

     1,254,549        780,874        723,055        443,683   

Business acquisition and related charges

     —          1,141,797        —          578,025   

Restructuring charges

     1,641,857        —          943,203        —     
                                
     12,796,477        7,660,214        6,993,460        4,273,527   
                                

Operating income (loss)

     572,557        (2,661,927     (555,343     (1,465,041

Other (income) expenses, net

        

Interest expense, net

     2,531,856        211,921        1,262,982        183,339   

Other (income) expense, net

     (779,873     (1,927,204     264        (468,488

Gain on foreign currency transactions, net

     (56,487     (42,765     (65,111     (24,092
                                
     1,695,496        (1,758,048     1,198,135        (309,241
                                

Loss from continuing operations before income taxes

     (1,122,939     (903,879     (1,753,478     (1,155,800

Provision for income taxes

     13,287        25,047        10,175        6,206   
                                

Loss from continuing operations

     (1,136,226     (928,926     (1,763,653     (1,162,006

Income (loss) from discontinued operations, net of income taxes

     132,279        (1,787,592     2,612        (771,789
                                

Net loss

   $ (1,003,947   $ (2,716,518   $ (1,761,041   $ (1,933,795
                                

Loss per share from continuing operations—Basic and diluted

   $ (0.12   $ (0.11   $ (0.20   $ (0.14

Income (loss) per share from discontinued operations—Basic and diluted

   $ 0.01      $ (0.21   $ (0.00   $ (0.09
                                

Net loss per share—Basic and diluted

   $ (0.11   $ (0.32   $ (0.20   $ (0.23
                                

Weighted average shares outstanding

        

Basic

     8,874,263        8,563,135        8,839,982        8,563,128   

Diluted

     9,274,197        8,563,135        9,153,183        8,563,128   

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

 

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API TECHNOLOGIES CORP.

Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited)

 

     Common
stock-
number
of shares
    Common
stock
amount
    Additional
paid-in capital
    Common
stock
subscribed
but not issued
     Accumulated
Deficit
    Accumulated
other
comprehensive
income
    Total
stockholders’
equity
 

Balance at May 31, 2010

     8,211,319      $ 32,845      $ 41,544,341      $ 2,373,000       $ (25,477,455   $ 464,951      $ 18,937,682   

Stock-based compensation expense

     —          —          776,570        —           —          —          776,570   

Stock repurchase

     (10,383     (42     (51,842     —           —          —          (51,884

Net loss for the period

     —          —          —          —           (1,003,947     —          (1,003,947

Foreign currency translation adjustment

     —          —          —          —           —          (67,170     (67,170

Unrealized gain on marketable securities – net of taxes

     —          —          —          —           —          33,857        33,857   
                           

Total comprehensive loss

                  (1,037,260
                                                         

Balance at November 30, 2010

     8,200,936      $ 32,803      $ 42,269,069      $ 2,373,000       $ (26,481,402   $ 431,638      $ 18,625,108   
                                                         

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

 

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Table of Contents

API TECHNOLOGIES CORP.

Consolidated Statements of Cash Flows

 

     Six Months Ended
November 30,
 
     2010     2009  

Cash flows from operating activities

    

Net income (loss)

   $ (1,003,947   $ (2,716,518

Less: (Income) loss from discontinued operations

     (132,279     1,787,592   

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

    

Depreciation and amortization

     854,519        407,693   

Amortization of note discounts

     510,953        —     

Write down of fixed assets held for sale

     451,745        —     

Stock based compensation

     776,570        612,609   

Gain on business asset acquisition

     —          (993,192

Gain on sale of fixed assets

     (761,354     (961,412

Deferred income taxes

     10,395        250,461   

Changes in operating asset and liabilities, net of business acquisitions

    

Accounts receivable

     2,262,475        (1,432,977

Inventories

     8,625,352        1,440,335   

Prepaid expenses and other current assets

     308,974        (10,562

Accounts payable and accrued expenses

     (5,017,836     (276,811

Deferred revenue

     (7,189,542     (6,119
                

Net cash used by continuing activities

     (303,975     (1,898,901

Net cash provided (used) by discontinued operations

     2,189,026        (1,434,361
                

Net cash provided (used) by operating activities

     1,885,051        (3,333,262

Cash flows from investing activities

    

Purchase of fixed assets

     (1,003,330     (121,579

Proceeds from disposal of fixed assets

     1,569,208        2,827,012   

Business acquisitions net of cash acquired of $2,071,270 (note 4)

     —          (2,928,730

Discontinued operations (note 5)

     —          (64,544
                

Net cash provided (used) by investing activities

     565,878        (287,841

Cash flows from financing activities

    

Repurchase and retirement of common shares

     (51,884     (2,400

Short-term borrowings advances (repayments), net

     7,503        —     

Repayment of long-term debt

     (1,104,035     (136,301

Net proceeds—long-term debt (note 10)

     —          3,650,000   
                

Net cash (used) provided by financing activities

     (1,148,416     3,511,299   

Effect of exchange rate on cash and cash equivalents

     (305,266     (293,200
                

Net change in cash and cash equivalents

     997,247        (403,004

Cash and cash equivalents, beginning of period—continuing operations

     4,496,025        2,423,835   

Cash and cash equivalents, beginning of period—discontinued operations

     15,593        6,093   
                

Cash and cash equivalents, beginning of period

     4,511,618        2,429,928   

Cash and cash equivalents, end of period

   $ 5,508,865      $ 2,026,924   

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

     —          37,209   
                

Cash and cash equivalents of continuing operations, end of period

   $ 5,508,865      $ 1,989,715   
                

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

 

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Table of Contents

API Technologies Corp.

Notes to Consolidated Financial Statements

(Unaudited)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Nature of Business

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

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

The consummation of the Merger is subject to the closing of the merger pursuant to the Agreement and Plan of Merger (the “First Merger Agreement”) among Parent, SenDEC, and South Albany Acquisition Corp, pursuant to which Parent will acquire SenDEC (the “First Merger”), which transaction is intended to close immediately prior to the Merger. The closing of the First Merger is subject to customary conditions, including without limitation the approval by the holders of at least two-thirds of a majority of the outstanding shares of SenDEC’s common stock entitled to vote on the First Merger. The consummation of the Merger also is subject to customary closing conditions, including the absence of any law, order or injunction prohibiting the Merger. The Merger is not subject to approval of API’s stockholders.

API will succeed to the rights, and assume the obligations, of Parent under the First Merger Agreement, including without limitation, the obligation to pay up to $14 million in earn-out payments, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC. In addition, certain SenDEC employees will be eligible for a bonus under a management bonus plan of up to $11 million, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC.

API has made customary representations, warranties and covenants in the Merger Agreement, including, among others, covenants to conduct its business in the ordinary course during the interim period between the execution of the Merger Agreement and the consummation of the Merger.

Either API or Parent may terminate the Merger Agreement if the Merger is not completed by January 21, 2011. API may terminate the Merger Agreement if the Board of Directors of API authorizes API to enter into an agreement constituting a Superior Proposal (as defined in the Merger Agreement). In connection with a termination due to a Superior Proposal, API must pay Parent a termination fee of $2.5 million.

On January 20, 2010, API and three newly formed subsidiaries, API Systems, Inc. (“API Systems”), API Defense, Inc. (“API Defense”) and API Defense USA, Inc. (“API Defense USA” and collectively with API Systems and API Defense, the “API Pennsylvania Subsidiaries”) entered into an asset purchase agreement with Kuchera Defense Systems, Inc. (“KDS”), KII, Inc. (“KII”) and Kuchera Industries, LLC (“K Industries” and collectively with KDS and KII, the “KGC Companies”) dated January 20, 2010 pursuant to which the API Pennsylvania Subsidiaries purchased substantially all of the assets of the KGC Companies (see Note 4). The KGC Companies included defense subcontractors specializing in highly engineered systems and robotics for various world governments, as well as military, defense, aerospace and homeland security prime contractors.

API, through the July 7, 2009 acquisition of Cryptek Technologies Inc. (see Note 4), expanded its manufacturing and design of products to include secured communication products, including ruggedized computer products, network security appliances, and TEMPEST Emanation prevention products. API continues to position itself as a total engineered solution provider to various world governments, as well as military, defense, aerospace and homeland security contractors.

The unaudited consolidated financial statements include the accounts of API and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. There are no other entities controlled by the Company, either directly or indirectly. The financial statements have been prepared in accordance with the requirements of Form 10-Q and Article 8 of Regulation S-X of the Securities and Exchange Commission (the “SEC”).

 

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Accordingly, certain information and footnote disclosures required in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for the fair presentation of the Company’s consolidated financial position as of November 30, 2010 and the results of its operations and cash flows for the three and six month periods ended November 30, 2010. Results for the interim period are not necessarily indicative of results that may be expected for the entire year or for any other interim periods. The unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements of the Company and the notes thereto as of and for the fiscal year ended May 31, 2010 included in the Company’s Form 10-K filed with the SEC on August 10, 2010.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

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

Inventories

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

The Company will continue to periodically review and analyze our inventory management systems, and conduct inventory impairment testing on an annual basis.

Fixed Assets

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

 

Straight line basis

    

Buildings and leasehold improvements

   5-40 years

Computer equipment

   3 years

Furniture and fixtures

   5 years

Machinery and equipment

   5 to 10 years

Vehicles

   3 years

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

Fixed Assets Held for Sale

Fixed assets held for sale have been classified as held for sale in the consolidated balance sheets. The Company estimated the fair value of the net assets to be sold at approximately $150,000 at November 30, 2010 compared to $930,000 at May 31, 2010. The decrease is attributed to the sale of land and buildings at two manufacturing sites in the United States for proceeds of approximately $1,569,000.

 

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Discontinued Operations

Components of the Company that have been or will be disposed of are reported as discontinued operations. The assets and liabilities relating to API Nanofabrication and Research Corporation (“NanoOpto”) have been reclassified as discontinued operations in the consolidated balance sheets for fiscal 2011 and 2010 and the results of operations of NanoOpto for the current and prior periods are reported as discontinued operations (Note 5) and not included in the continuing operations figures.

Goodwill and Intangible Assets

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

The Company has two reporting units: (i) Engineered Systems and Components and (ii) Secure Communications. The goodwill on our consolidated financial statements relates to the acquisition of the Filtran Group, which was completed in 2002 and the acquisition of the assets of the KGC Companies in 2010. All of our goodwill relates to our Engineered Systems and Components reporting unit. Goodwill represents the excess of the purchase price of acquired companies over the estimated fair value assigned to the individual assets acquired and liabilities assumed. The Company does not amortize goodwill but instead tests goodwill for impairment annually (on May 31) or more frequently if impairment indicators arise under the applicable accounting guidance.

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

Following the required accounting guidance, the Company performed the first step of the two-step test method based on discounted future cash flows on May 31. The respective reporting units’ future cash flows significantly exceeded the carrying value of the underlying assets and therefore goodwill was not impaired and no further testing was required.

At May 31, 2010 we had no reporting units at risk of failing step one of the impairment model based on a comparison of the fair values of the individual reporting units to their respective carrying amounts.

The Company considered and has determined that no interim impairment testing was required since impairment indicators did not exist for either of its reporting units during the six months ended November 30, 2010.

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

 

Non-compete agreements    Straight line over 5 years
Computer software    3-5 years
Customer related intangibles    10-15 years

Long-Lived Assets

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

Income Taxes

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

 

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The Company’s valuation allowance was taken on the deferred tax assets to provide for a reasonable provision, which in the Company’s estimation is more likely than not that all or some portions of such tax assets will not be realized. In determining the adequacy of the valuation allowance, the Company applied the authoritative guidance, and considered such factors as (i) which subsidiaries were producing income and which subsidiaries were producing losses and (ii) temporary differences occurring from depreciation and amortization which the Company expects to increase the taxable income over future periods. In view of the prior years’ losses and the uncertainty relating to future profitability the Company has provided for 100% valuation allowance resulting in no deferred tax assets on net basis. The position the Company takes on its deferred tax assets in the future may change, as it may be affected by the success or failure of its short-term or long-term strategies and overall global economic conditions. In addition, the consummation of the Merger (see Note 20 – Subsequent Events) may limit the amounts of net operating losses which may be utilized in future periods.

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

Based on the Company’s evaluation, management has concluded that there are no significant uncertain tax positions requiring recognition in the consolidated financial statements or adjustments to deferred tax assets and related valuation allowance. Open tax years include the tax years ended May 31, 2006 through 2010.

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

Revenue Recognition

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

Deferred Revenue

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

Research and Development

Research and development expenses are recorded when incurred.

Stock-Based Compensation

The Company follows the authoritative guidance for accounting for stock-based compensation. The guidance requires that new, modified and unvested share-based payment transactions with employees, such as grants of stock options and restricted stock, be recognized in the financial statements based on their fair value at the grant date and recognized as compensation expense over their vesting periods. The fair value of each option granted is estimated on the grant date using the Black-Scholes option pricing model which takes into account as of the grant date the exercise price and expected life of the option, the current price of the underlying stock and its expected volatility, expected dividends on the stock and the risk-free interest rate for the term of the option. The Company also follows the guidance for equity instruments issued to consultants.

Foreign Currency Translation and Transactions

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

 

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Financial Instruments

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

The Company carries out a portion of transactions in foreign currencies included in the Company’s cash, marketable securities, accounts receivable, accounts payable and bank indebtedness with balances denominated in Canadian dollars or Pound Sterling as well as a mortgage loan denominated in Pound Sterling. The translation adjustments related to these accounts have been reflected as a component of comprehensive income.

Long-term Debt Discount

In accordance with accounting standards the Company recognized the value of detachable warrants issued in conjunction with the issuance of the secured promissory notes and the modification of the convertible promissory notes. The Company valued the warrants using the Black-Scholes pricing model. The Company recorded the warrant relative fair value as an increase to additional paid-in capital and a discount against the related debt. The discount attributed to the value of the warrants is amortized over the term of the underlying debt using the effective interest method.

Concentration of Credit Risk

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

The US, Canadian and United Kingdom Governments’ Departments of Defense (directly and through subcontractors) accounts for approximately 71%, 6% and 4% of the Company’s revenues for the six months ended November 30, 2010 (46%, 11% and 16% for the six months ended November 30, 2009), respectively. One of these customers, a tier one Defense subcontractor, represented approximately 35% of revenues for the six months ended November 30, 2010 and represented 9% of accounts receivable as of November 30, 2010 and 20% of our accounts receivable at May 31, 2010. A separate customer represented 15% of accounts receivable as of November 30, 2010. A loss of a significant customer could adversely impact the future operations of the Company.

Earnings (Loss) per Share of Common Stock

Basic earnings (loss) per share of common stock is computed by dividing income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) per share of common stock gives effect to all dilutive potential shares of common stock outstanding during the period. The computation of diluted earnings (loss) per share does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on earnings (loss) per share (Note 15).

Comprehensive Income (Loss)

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

Comparative Reclassifications

Certain amounts from 2010 have been reclassified to conform to the November 30, 2010 financial statement presentation. The reclassifications had no effect on previously reported net loss or the balance sheet.

3. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS

Recently Issued Accounting Pronouncements

In October 2009, the FASB issued guidance related to revenue recognition for arrangements with multiple deliverables. This guidance eliminates the residual method of allocation and requires the relative selling price method when allocating deliverables of a multiple-deliverable revenue arrangement. The determination of the selling price for each deliverable requires the use of a hierarchy designed to maximize the use of available objective evidence including, vendor specific objective evidence, third party evidence of selling price, or estimated selling price. The guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and must be adopted in the same period using the same transition method. If adoption is elected in a period other than the beginning of a fiscal year, the amendments in these standards must be applied retrospectively to the beginning of the fiscal year. Full retrospective application of these amendments to prior fiscal years is optional. Early adoption of these standards may be elected. We are currently evaluating the impact of these new accounting standards on our consolidated financial statements.

 

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4. ASSET ACQUISITIONS

a) Cryptek Technologies Inc.

On July 7, 2009, API Cryptek Inc. (“API Cryptek”), a wholly-owned subsidiary of the Company, incorporated on June 23, 2009, acquired substantially all of the assets of Cryptek Technologies Inc. (“Cryptek”), including its wholly-owned subsidiaries, Emcon Emanation Control Ltd., located in Canada and Secure Systems & Technologies, Ltd., located in the United Kingdom and its Ion Networks division (DBA Ion) located in the United States, through the foreclosure on API Cryptek’s security interest and liens in the Cryptek assets, and subsequent sale under the Uniform Commercial Code. API Cryptek was the successful bidder of the Cryptek assets at the sale, by bidding the total amount owed by Cryptek to API Cryptek under loan documents previously purchased by API Cryptek for $5,000,000.

Cryptek developed and delivered secure communication solutions to various industries and government agencies. Cryptek also was a provider of emanation security products and solutions.

The Cryptek acquisition was completed with proceeds from corporate funds and the private placement of secured, convertible promissory notes completed June 23, 2009. (Note 10a)

The Company has accounted for the acquisition using the purchase method of accounting in accordance with the guidance on business combinations. The Company also incurred legal costs, reorganization charges and professional fees in connection with the acquisition of approximately $790,000. The expenses have been accounted for as operating expenses. The results of operations of API Cryptek have been included in the Company’s results of operations beginning on July 7, 2009.

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

 

Cash

   $ 2,071,270   

Accounts receivable and prepaids

     2,409,736   

Inventory

     2,990,046   

Fixed assets

     3,434,836   

Customer related intangibles

     508,000   

Assumed current liabilities

     (3,519,194

Assumed mortgage payable

     (1,901,502
        

Fair value of net assets acquired

   $ 5,993,192   
        

The fair value of the net assets acquired in this transaction exceeded the fair value of the purchase price. As a result, in accordance with the guidance, the Company recognized a gain on acquisition of approximately $993,000 in the consolidated statement of operations for the year ended May 31, 2010. This gain was included in other income (expense), net.

Revenues and net loss for the six months ended November 30, 2010 were approximately $8,921,000 and $(1,371,000), respectively. Revenues and net loss from the acquisition date, July 7, 2009, to November 30, 2009 were approximately $9,795,000 and $(1,153,000), respectively.

Fixed assets acquired in this transaction consist of the following:

 

Buildings and leasehold improvements

   $ 2,820,576   

Machinery and equipment

     530,747   

Furniture and fixtures

     36,857   

Vehicles

     46,656   
        

Total fixed assets acquired

   $ 3,434,836   
        

b) KGC Companies

On January 20, 2010, API and three newly formed subsidiaries, the API Pennsylvania Subsidiaries, entered into an asset purchase agreement with the KGC Companies dated January 20, 2010 pursuant to which the API Pennsylvania Subsidiaries purchased substantially all of the assets of the KGC Companies.

 

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The KGC Companies included defense subcontractors specializing in highly engineered systems and robotics for the defense and aerospace industries. The API Pennsylvania Subsidiaries purchased the assets of the KGC Companies for total consideration of $28,480,000, comprised of (i) $24,000,000, including $14,000,000 of cash paid at closing and a $10,000,000 short-term note (the “Sellers’ Note”) dated January 20, 2010 issued to the KGC Companies and (ii) 800,000 shares of API common stock (the “Shares”) payable as follows: 250,000 Shares were issued and delivered at closing, 250,000 Shares are to be issued and delivered on the first anniversary of the closing and 300,000 Shares are to be issued and delivered on the second anniversary of the closing. The principal amount of the Sellers’ Note is subject to downward adjustment in the event the value of the assets purchased is less than contemplated by the parties. During December 2010, there has been a $900,000 downward adjustment to the principal amount and an extension of the due date, see Note 20 Subsequent Events. The Company issued 126,250 shares in escrow from the 550,000 shares remaining to be delivered, which have been accounted for as common stock subscribed but not issued with a value of $2,373,000. The API Pennsylvania Subsidiaries may claim the escrowed shares in the event amounts become due to them under the indemnification provisions of the asset purchase agreement. The unissued shares have been accounted for as common stock subscribed but not issued. The stock issued and to be issued was valued at $5.60 per share, the fair value of the common stock at the transaction date.

The Company has accounted for the acquisition using the purchase method of accounting in accordance with the guidance on business combinations. The Company also incurred legal costs, reorganization charges and professional fees in connection with the acquisition of approximately $1,216,000. The expenses have been accounted for as operating expenses. The results of operations of the API Pennsylvania Subsidiaries have been included in the Company’s results of operations beginning on January 20, 2010.

Accounting guidance requires that identifiable assets acquired and liabilities assumed be reported at fair value as of the acquisition date of a business combination. The fair values of the assets acquired and the liabilities assumed have been determined provisionally and are subject to adjustment as additional information is obtained by the Company. Assets and liabilities acquired were as follows:

 

Accounts receivable and prepaids

   $ 8,554,386   

Inventory

     20,271,816   

Fixed assets

     5,490,129   

Technology and Customer related intangibles

     2,585,000   

Goodwill

     7,330,983   

Assumed current liabilities

     (3,006,135

Assumed deferred revenue

     (11,628,411

Assumed capital leases payable

     (1,117,768
        

Fair value of net assets acquired

   $ 28,480,000   
        

The fair value of the KGC Companies exceeded the underlying fair value of all other assets acquired, thereby giving rise to the goodwill. Technology and customer related intangibles are amortized on a straight line basis over 15 years.

The fair value of the consideration, assets acquired and liabilities assumed remain subject to potential adjustments. Material adjustments, if any, to provisional amounts in subsequent periods, will be reflected retrospectively as required.

Revenues and net income of API Pennsylvania Subsidiaries, for the six months ended November 30, 2010, were approximately $35,329,000 and $2,660,000, respectively (2009 – nil, nil).

Fixed assets acquired in this transaction consist of the following:

 

Buildings and leasehold improvements

   $  1,958,390   

Machinery and equipment

     3,337,661   

Furniture and fixtures

     120,667   

Vehicles

     73,411   
        

Total fixed assets acquired

   $ 5,490,129   
        

The following unaudited pro forma summary presents the combined results of operations as if the KGC Companies and Cryptek acquisitions described above had occurred at the beginning of the comparative six month period ended November 30, 2009.

 

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     Six months
ended
November 30,
2009
(Pro forma)
    Three months
Ended
November 30,
2009
(Pro forma)
 

Revenues

   $ 56,754,534      $ 26,112,634   

Net loss from continuing operations

   $ (600,597   $ (2,647,596

Net loss

   $ (2,388,189   $ (3,419,385

Net loss from continuing operations per share – basic and diluted

   $ (0.06   $ (0.28

Net loss per share – basic and diluted

   $ (0.26   $ (0.37

5. DISCONTINUED OPERATIONS

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

The operating results of NanoOpto are summarized as follows:

 

     Six months ended November 30,     Three months ended November 30,  
     2010     2009     2010     2009  

Revenue, net

   $ —        $ 442,308      $ —        $ 299,697   

Cost of revenues

     —          101,706        —          84,496   
                                

Gross Profit

     —          340,602        —          215,201   

General and administrative

     103,543        351,529        36,673        94,317   

Research and development

     31,332        1,737,017        (9,082     881,744   

Selling expenses

     —          38,608        —          9,889   

Provision for income taxes

     —          1,040        —          1,040   

Other income

     (267,154     —          (30,203     —     
                                

Income (loss) from discontinued operations, net of tax

   $ 132,279      $ (1,787,592   $ 2,612      $ (771,789
                                

The assets and liabilities relating to NanoOpto consisted of the following:

 

     November 30,
2010
     May 31,
2010
 

Cash

   $ —         $ 15,593   

Prepaid expenses

     —           28,579   
                 

Current assets of discontinued operations

   $ —         $ 44,172   
                 

Fixed assets, net

   $ —         $ 636,757   

Intangible assets, net

     —           1,404,398   
                 

Long-lived assets of discontinued operations

   $ —         $ 2,041,155   
                 

Accounts payable and accrued expenses

   $ 141,311       $ 439,633   
                 

Current liabilities of discontinued operations

   $ 141,311       $ 439,633   
                 

6. Inventories

Inventories consisted of the following:

 

     November 30,
2010
     May 31,
2010
 

Raw materials

   $ 9,814,882       $ 9,159,594   

Work in progress

     9,246,060         18,397,270   

Finished goods

     2,118,374         2,204,730   
                 

Total

   $ 21,179,316       $ 29,761,594   
                 

Inventories are presented net of valuation allowances.

 

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7. Bank Indebtedness

On December 21, 2009, the Company secured a line of credit facility, which renews annually at its Emcon Emanation Control subsidiary in Canada in the amount of approximately $980,000 ($1,000,000 CAD). Interest on the line of credit facility is charged at a margin of 1.8% over the Royal Bank Prime Rate for Canadian borrowings or Royal Bank US Prime Base Rate for USD borrowings, which were 2.25% and 3.75%, respectively at November 30, 2010. The facility is secured by the subsidiaries’ assets. As of November 30, 2010 the Company had drawn $705,157 under this facility.

The Company also has a credit facility in place for its U.K. subsidiary for approximately $390,000 (250,000 GBP), which renews in October 2011. This line of credit is tied to the prime rate in the United Kingdom and is secured by the subsidiaries’ assets. This facility was undrawn as of November 30, 2010.

8. Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consisted of the following:

 

     November 30,
2010
     May 31,
2010
 

Accounts payable and accrued expenses

   $ 9,802,884       $ 13,892,876   

Wage and vacation accrual

     1,351,646         2,323,024   
                 

Total

   $ 11,154,530       $ 16,215,900   
                 

9. Sellers’ Note Payable

The Company was obligated under the following debt instrument:

 

     November 30,
2010
     May 31,
2010
 

Sellers’ Note payable, due December 31, 2010, 5% interest

   $ 10,000,000       $ 10,000,000   
                 

On January 20, 2010, the API Pennsylvania Subsidiaries issued a $10,000,000 short-term note in connection with the purchase of the assets of the KGC Companies (see Note 4b). The principal amount of the Sellers’ Note is subject to downward adjustment in the event the value of the assets purchased is less than contemplated by the parties. During December 2010, there has been a $900,000 downward adjustment to the principal amount and an extension of the due date, see Note 20 Subsequent Events. The Sellers’ Note bears interest at an annual rate of five percent (5%) and matures on December 31, 2010. The Sellers’ Note provides for certain monthly interest payments. Accrued interest as of November 30, 2010 was $42,466 and is included in accounts payable and accrued expenses. The entire principal balance and accrued interest is due and payable at maturity. The Sellers’ Note is secured by certain assets of the KGC Companies purchased by the API Pennsylvania Subsidiaries, excluding government contracts.

 

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10. Long-Term Debt

The Company was obligated under the following debt instruments:

 

     November 30,
2010
    May 31,
2010
 

Convertible promissory notes, net of discount of $141,052 and $185,092 at November 30, 2010 and May 31, 2010, respectively, due June 23, 2012, 12% interest (a)

   $ 3,508,948      $ 3,464,908   

Secured promissory notes, net of discount of $2,634,866 and $3,101,780 at November 30, 2010 and May 31, 2010, respectively, due January 20, 2013, 15% interest (b)

     17,365,134        16,898,220   

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

     1,634,460        1,572,227   

Capital leases payable (d)

     32,338        1,072,892   
                
   $ 22,540,880      $ 23,008,247   

Less: Current portion of long-term debt

     (143,857     (289,638
                

Long-term portion

   $ 22,397,023      $ 22,718,609   
                

 

a) On June 23, 2009, the Company issued secured, convertible promissory notes (“Convertible Notes”) to a group of investors in the aggregate principal amount of $3,650,000 (see Note 14). Interest on the convertible notes is payable at the annual rate of 12% at the end of each calendar quarter. The Convertible Notes are secured by the personal property of the Company and its subsidiaries. The Convertible Notes are due on June 23, 2012.

The outstanding principal amount of the Convertible Notes and/or accrued and unpaid interest or any portion thereof are convertible at the holder’s option into shares of common stock of the Company, at a price per share equal to $3.00 per share. The Company used the proceeds of the Convertible Notes to purchase all of the rights, title and interest of Wachovia Bank, National Association (“Wachovia Bank”) and Wachovia Capital Finance Corporation (Canada) (collectively with Wachovia Bank, “Wachovia”) in and to certain loans and financing documents (the “Cryptek Loan”). The loans and financing documents included the loan to Cryptek by Wachovia and security agreements covering substantially all of the assets of Cryptek.

On December 21, 2009, the Note and Security Agreement between the Company and the holders of the Convertible Notes was amended (the “First Amendment”). The holders of the Convertible Notes agreed that the Company may incur senior secured debt in connection with any line of credit or other working capital facility, or in connection with any stock or asset acquisition. In consideration of the holders of the Convertible Notes entering into the First Amendment, the Company agreed to issue warrants to purchase approximately 62,500 shares of the common stock of the Company (the “December Warrants”), pro rata among the Convertible Notes holders, at an exercise price of $5.08 per share. The December Warrants expire June 23, 2012.

The number of shares of common stock that can be purchased upon the exercise of the December Warrants and the exercise price of the December Warrants are subject to customary anti-dilution provisions. The Company evaluated the December Warrants for purposes of classification and determined they did not embody any of the conditions for liability classification, but rather meet the conditions for equity classification. In addition, the Company determined that the December Warrants should be treated as a modification and not an extinguishment of debt. As a result, the discount resulting from the value of the warrants will be amortized over the life of the Convertible Notes using the effective interest method.

Interest expense for the period ended November 30, 2010, includes non-cash interest expense of $44,040 for the amortization of the convertible note discount using the interest method.

 

b) On January 20, 2010 and January 22, 2010, API received total cash proceeds of $20,000,000 in conjunction with the sale of Secured Promissory Notes (“Notes”) with a principal amount of $20,000,000 and warrants to purchase approximately 892,900 shares of common stock (“Warrants”) of API to various investors including certain Directors and Officers of the Company (Note 14c). Neither the KGC Companies nor their owners were issued any Notes or Warrants.

The Notes are due three years from issuance. Interest accrues at an annual rate of 15% per annum and is payable in arrears each calendar quarter. The entire principal balance and all accrued and unpaid interest on the Notes is payable upon maturity. The Company can elect to prepay all or a portion of the Notes anytime. If the Company elects to prepay in the first year, it must pay the investor interest that would have accrued on such prepaid amount from and after the prepayment date to January 20, 2011. Otherwise, the Company must pay the investor an additional 2% of the prepaid amount. The Notes are secured by the assets of API and its subsidiaries pursuant to security agreements, excluding real estate. The following are permitted senior debt and liens under the Notes: (1) working capital loans and (2) security interests granted in connection with any acquisition by API of other companies, lines of businesses or assets, or the financing thereof.

 

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The warrants have an exercise price of $5.60 per share and expire in five years. The number of shares of common stock that can be purchased upon the exercise of the Warrants and the exercise price of the Warrants are subject to customary anti-dilution provisions. The Company evaluated the Warrants for purposes of classification and determined that they did not embody any of the conditions for liability classification, but rather meet the conditions for equity classification. The discount resulting from the value of the warrants will be amortized over the life of the Notes using the effective interest method.

Interest expense for the period ended November 30, 2010, includes non-cash interest expense of $466,914 for the amortization of the note discount using the interest method.

 

c) A subsidiary of the Company in the United Kingdom entered into a 20 year term mortgage agreement in 2007, under which interest is charged at a margin of 1.35% over Barclays Fixed Base Rate of 0.5% at November 30, 2010. The mortgage is secured by the subsidiaries’ land and building.

 

d) On August 5, 2010, the Company purchased certain equipment that was under capital lease by paying the outstanding capital lease obligation amount of approximately $1,003,000 related to those assets.

11. Shareholders’ Equity

As discussed in Note 20 – Subsequent Events, on December 28, 2010, the Company filed a Certificate of Amendment of Amended and Restated Certificate of Incorporation, which effected a one-for-four reverse stock split of the Company’s outstanding common shares and exchangeable shares. All the references to number of shares, options and warrants presented in these financial statements have been adjusted to reflect the post split number of shares.

On January 20, 2010 the Company agreed to issue 800,000 shares of API common stock payable as part of the compensation to the KGC Companies (Note 4b) or their designees. 250,000 shares were issued and delivered at closing, 250,000 shares are to be issued and delivered on the first anniversary of the closing and 300,000 shares are to be issued and delivered on the second anniversary of the closing. The Company has issued 126,250 shares in escrow from the 550,000 shares remaining to be delivered. The API Pennsylvania Subsidiaries may claim the escrowed shares in the event amounts become due to them under the indemnification provisions of the asset purchase agreement. The unissued shares have been accounted for as common stock subscribed but not issued.

In connection with the Plan of Arrangement that occurred on November 6, 2006, the Company was obligated to issue 2,354,505 shares of either API common stock or exchangeable shares of API Nanotronics Sub, Inc. in exchange for the API common shares previously outstanding. As of November 30, 2010, (i) API had issued 1,728,403 shares of its common stock for API common shares or upon the exchange of previously issued exchangeable shares, (ii) API Nanotronics Sub, Inc. had issued 584,630 shares of its exchangeable shares for API common shares (excluding exchangeable shares held by the Company and its affiliates and exchangeable shares subsequently exchanged for our common stock), which exchangeable shares are the substantially equivalent to our common stock, and (iii) API’s transfer agent was awaiting stockholder elections on approximately 41,300 shares of API common stock or exchangeable shares of API Nanotronics Sub, Inc. issueable with respect to the remaining API common shares. Consequently, API has not issued, but is obligated to issue, approximately 625,900 shares of its common stock under the Plan of Arrangement either directly for API common shares or in exchange for API Nanotronics Sub, Inc. exchangeable shares not held by API or its affiliates.

On March 9, 2010, the Company’s Board of Directors authorized a program to repurchase approximately 10% of its common stock (approximately 831,250 shares) over the next 12 months. As of November 30, 2010, the Company repurchased and retired 112,568 of its common stock under this program for net outlay of approximately $620,000.

The Company issued 193,333 options during the six months ended November 30, 2010. During the year ended May 31, 2010 the Company issued 688,277 options related to employment arrangements (Note 12). These option grants were valued using the Black-Scholes option-pricing model.

12. Stock-Based Compensation

On October 26, 2006, the Company adopted its 2006 Equity Incentive Plan (the “Equity Incentive Plan”), which was approved at the 2007 Annual Meeting of Stockholders of the Company. All the prior options issued by API were carried over to this plan under the provisions of the Plan of Arrangement. On October 22, 2009, the Company amended the 2006 Equity Compensation Plan to increase the number of shares of common stock under the plan from 1,250,000 to 2,125,000. Of the 2,125,000 shares authorized under the Equity Incentive Plan, 519,177 shares are available for issuance pursuant to options or as stock as of November 30, 2010. Under the Company’s Equity Incentive Plan, incentive options and non-statutory options may have a term of up to ten years from the date of grant. The stock option exercise prices are generally equal to at least 100 percent of the fair market value of the underlying shares on the date the options are granted.

 

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As of November 30, 2010, there was $2,305,340 of total unrecognized compensation related to non-vested stock options, which are not contingent upon attainment of certain milestones. For options with certain milestones necessary for vesting, the fair value is not calculated until the conditions become probable. The cost is expected to be recognized over the remaining periods of the options, which are expected to vest from 2011 to 2015. No stock options were issued to the KGC Companies or their owners in conjunction with the KGC Companies asset acquisition.

During the six months ended November 30, 2010 and 2009, $776,570 and $612,609, respectively, has been recognized as stock-based compensation expense in cost of revenues, selling expense and general and administrative expense.

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

 

     November 30, 2010     November 30, 2009  

Expected volatility

     99.8     104.3

Expected dividends

     0     0

Expected term

     3 – 5 years        3 – 5 years   

Risk-free rate

     1.43     2.37

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

 

     Shares     Weighted
Average
Exercise
Price
 

Stock Options outstanding—May 31, 2009

     885,462      $ 5.972   

Less forfeited

     (94,583   $ 7.088   

Exercised

     —        $ —     

Issued

     688,277      $ 5.520   
          

Stock Options outstanding—May 31, 2010

     1,479,156      $ 5.708   

Less forfeited

     (66,666   $ 6.616   

Exercised

     —        $ —     

Issued

     193,333      $ 4.428   
          

Stock Options outstanding—November 30, 2010

     1,605,823      $ 5.508   
          

Stock Options exercisable— November 30, 2010

     721,281      $ 5.704   
          

The weighted average grant price of stock options granted during the six months ended November 30, 2010 and November 30, 2009 was $4.44 and $5.72, respectively.

 

Options Outstanding      Options Exercisable  

Range of

Exercise Price

    Number of
Outstanding
at November 30,
2010
    Weighted
Average
Exercise
Price
    Weighted
Average
Remaining
Life
(Years)
    Aggregate
Intrinsic
Value
     Number
Exercisable
at November 30,
2010
     Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
 
  $3.56 – $12.00        1,593,740      $ 5.424        7.635      $ 202,273        713,755       $ 5.596       $ —     
  $12.01 – $24.00        12,083      $ 16.140        6.245      $ —           7,526       $ 16.140       $ —     
                                        
    1,605,823          7.624      $ 202,273        721,281          $ —     
                                        

The intrinsic value is calculated at the difference between the market value as of November 30, 2010 and the exercise price of the shares. The market value as of November 30, 2010 was $4.04 as reported by the OTC Bulletin Board.

 

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13. Supplemental Cash Flow Information

Supplemental cash flow information for the six months ended November 30:

 

     2010      2009  

(a) Supplemental Cash Flow Information

     

Cash paid for income taxes

   $ 2,892       $ 23,321   

Cash paid for interest

   $ 2,137,430       $ 139,256   

(b) Non cash transactions (note 4a)

     

Assets acquired and liabilities assumed in business acquisitions, net

   $ —         $ 3,928,219   

14. Related Party Transactions

 

  (a) Included in general and administrative expenses for the six months ended November 30, 2010 are consulting fees of $47,788 (2009 – $44,618) paid to an individual who is a director and officer of the Company and rent, management fees, and office administration fees of $90,576 (2009 – $93,428) paid to a corporation of which two of the directors are also directors of the Company. Pursuant to an oral agreement, the individual provides strategic planning services, including the identification and evaluation of financing options, capital structure, and potential acquisitions.

 

  (b) On June 23, 2009, API issued $3,650,000 of Convertible Notes to a group of investors. Three of the investors are, or are affiliates of, directors or officers of the Company. In addition, on December 20, 2009 the Company agreed to issue warrants to purchase approximately 62,500 shares of the common stock of the Company, pro rata among the convertible notes holders, at an exercise price of $5.08 per share (Note 10a).

Included in interest expenses for the six months ended November 30, 2010 are interest charges of $87,238 (2009 - $76,751) related to the Convertible Notes paid to certain directors of the Company.

 

  (c) On January 20, 2010, API issued $20,000,000 of Notes and Warrants to purchase approximately 892,900 shares of common stock of API to a group of investors (Note 10b). Seven of the investors are, or are affiliates of, directors or officers of the Company. Neither the KGC Companies nor their owners were issued such Notes or Warrants.

Included in interest expenses for the six months ended November 30, 2010 are interest charges of $387,308 related to the Notes paid to certain directors and officers of the Company.

15. Earnings (Loss) Per Share of Common Stock

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

 

     Six months ended November 30,      Three months ended November 30,  
     2010      2009      2010      2009  

Weighted average shares-basic

     8,874,263         8,563,135         8,839,982         8,563,128   

Effect of dilutive securities

     399,934         *         313,201         *   
                                   

Weighted average shares—diluted

     9,274,197         8,563,135         9,153,183         8,563,128   
                                   

Basic EPS and diluted EPS for the six months ended November 30, 2010 and 2009 have been computed by dividing the net income (loss) by the weighted average shares outstanding. The weighted average numbers of shares of common stock outstanding includes exchangeable shares and shares to be issued under the Plan of Arrangement.

 

* All outstanding options aggregating 1,605,823 incremental shares, 955,362 warrants and 1,216,667 shares underlying the convertible promissory notes, have been excluded from the November 30, 2010 (all outstanding options aggregating 1,321,239 incremental shares from the November 30, 2009) computation of diluted EPS from continuing operations as they are anti-dilutive due to the losses generated in 2010 and 2009.

16. Commitments

 

  (a) The Company has an oral agreement for management services with Icarus Investment Corp. Under the terms of the agreement, the Company is provided with office space, office equipment and supplies, telecommunications, personnel and management services, which renews annually. Included in general and administrative expenses for the six months ended November 30, 2010 and November 30, 2009 are $90,576 and $93,428, respectively.

 

  b) From time to time the Company may be a party to lawsuits in the normal course of our business. Litigation can be unforeseeable, expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on the Company’s business, operating results, or financial condition. Currently there are no known matters.

 

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17. Income Taxes

The Company has identified several tax jurisdictions because it has operations in United States, Canada, and the United Kingdom. Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s consolidated financial statements.

18. Restructuring Charges Related to Consolidation of Operations

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

During the six months ended November 30, 2010 restructuring expenses included charges of approximately $1,959,000 related to workforce reductions and other expenses related to consolidating certain parts of its operations from Ronkonkoma, N.Y. and Hauppauge, N.Y. to its new leased facility in Windber, P.A. and from consolidating its two wholly-owned subsidiaries in Ottawa, Canada. The Company also realized impairment charges of approximately $414,000 on leasehold improvements from Ronkonkoma, and Endicott N.Y. and incurred approximately $27,000 in lease charge commitments related to its effort to consolidate its two wholly-owned subsidiaries in Ottawa, Canada into one location. Management continues to evaluate whether other related assets have been impaired, and has concluded that there should be no additional impairment charges as of November 30, 2010.

As of November 30, 2010, the following table represents the details of restructuring charges:

 

     Workshare
Reduction Cost
 

Balance, May 31, 2010

   $ 524,595   

Restructuring charges

     1,985,826   

Write-offs of leasehold improvements

     414,019   
        

Total accumulated restructuring charges at November 30, 2010

     2,924,440   

Cash payments

     2,210,776   

Non-cash charges

     414,019   
        

Balance, November 30, 2010

   $ 299,645   
        

The remaining balance at November 30, 2010 is included in accounts payable and accrued liabilities.

19. Segment Information

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

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

 

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Six months ended November 30, 2010

   Engineered
Systems and
Components
    Secure
Communications
    Corporate     Inter Segment
Eliminations
     Total  

Sales to external customers

   $ 46,731,010      $ 8,291,227      $ —        $ —         $ 55,022,237   

Inter-segment sales

     —          —          —          —           —     
                                         

Total revenue

     46,731,010        8,291,227        —          —           55,022,237   
                                         

Operating income (loss) before expenses below:

     4,714,376        (1,012,609     —          —           3,701,767   

Corporate head office expenses

     —          —          2,274,691        —           2,274,691   

Depreciation and amortization

     567,989        204,766        81,764        —          854,519   

Other (income) expenses

     (576,203     4,124        2,267,575        —           1,695,496   

Income tax expense

     13,287        —          —          —           13,287   
                                         

Net income (loss) from continuing operations

     4,709,303        (1,221,499     (4,624,030   $ —           (1,136,226

Income from discontinued operations, net of tax

     132,279        —          —          —           132,279   
                                         

Net income (loss)

   $ 4,841,582      $ (1,221,499   $ (4,624,030   $ —         $ (1,003,947
                                         

Segment assets—as of November 30, 2010

   $ 53,761,438      $ 10,630,115      $ 1,199,431      $ —         $ 65,590,984   

Goodwill included in assets—as of November 30, 2010

   $ 8,461,889      $ —        $ —        $ —         $ 8,461,889   

Capital expenditures, to November 30, 2010

   $ 811,897      $ 119,653      $ 71,780      $ —         $ 1,003,330   

Six months ended November 30, 2009

   Engineered
Systems and
Components
    Secure
Communications
    Corporate     Inter Segment
Eliminations
     Total  

Sales to external customers

   $ 11,505,045      $ 9,448,845      $ —        $ —         $ 20,953,890   

Inter-segment sales

     —          —          —          —           —     
                                         

Total revenue

     11,505,045        9,448,845        —          —           20,953,890   
                                         

Operating income (loss) before expenses below:

     (37,208     (654,409     —          —           (691,617

Corporate head office expenses

     —          —          1,562,617        —           1,562,617   

Depreciation and amortization

     268,123        137,923        1,647        —           407,693   

Other (income) expenses

     (915,588     358,275        (1,200,735     —           (1,758,048

Income tax expense (benefit)

     23,612        1,435        —          —           25,047   
                                         

Net income (loss) from continuing operations

     586,645      $ (1,152,042     (363,529   $ —           (928,926

Loss from discontinued operations, net of tax

     (1,787,592     —          —          —           (1,787,592
                                         

Net income (loss)

   $ (1,200,947   $ (1,152,042   $ (363,529   $ —         $ (2,716,518
                                         

Segment assets—as of May 31, 2010

   $ 63,641,687      $ 12,350,457      $ 2,618,312      $ —         $ 78,610,456   

Goodwill included in assets—as of May 31, 2010

   $ 8,461,889      $ —        $ —        $ —         $ 8,461,889   

Capital expenditures, to November 30, 2009

   $ 81,982      $ 39,597      $ —        $ —         $ 121,579   

20. Subsequent Events

The Company has evaluated subsequent events through January 14, 2011, the date the financial statements were issued, and up to the time of filing of the financial statements with the Securities and Exchange Commission.

On December 14, 2010, API and three of its subsidiaries, the API Pennsylvania Subsidiaries (API and the API Pennsylvania Subsidiaries collectively, the “Buyers”) and the KGC Companies, William Kuchera (“William”) and Ronald Kuchera (“Ronald” and with William, collectively, the “Shareholders”) entered into an Amended and Restated Promissory Note (the “Amended Note”) and an Amendment No. 1 to the Asset Purchase Agreement (the “Amendment”). The Asset Purchase Agreement was entered into by the Buyers, the KGC Companies and the Shareholders on January 20, 2010 in connection with the purchase by the API Pennsylvania Subsidiaries of the assets of the KGC Companies.

The API Pennsylvania Subsidiaries entered into the Amended Note in favor of K Industries, which amends certain terms of the promissory note in the principal amount of $10,000,000 made by the API Pennsylvania Subsidiaries in favor of the KGC Companies dated January 20, 2010 (the “Note”). The Amended Note reduces the outstanding principal balance from $10,000,000 to $9,100,000 to account for the $900,000 Reduction (as defined below), and extends the maturity date of the Note from December 31, 2010 to March 31, 2011 (the “First Extension”) and thereafter to June 30, 2011 (the “Second Extension”). In exchange for the extension of the maturity date of the Note, the API Pennsylvania Subsidiaries have agreed to pay to K Industries for the period from January 1, 2011 through March 31, 2011, interest at the rate of eight percent (8%) per annum and from the period from April 1 through June 30, 2011 interest at the rate of ten percent (10%) per annum. The interest for the First Extension and the Second Extension must be prepaid prior to the commencement of the extension. If the Amended Note is repaid prior to the end of the applicable extension period, K Industries will repay to the API Pennsylvania Subsidiaries the amount of prepaid interest that did not accrue. The entire principal balance of the Amended Note is due at maturity.

 

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The Amended Note remains secured by the assets of the Sellers purchased by the API Pennsylvania Subsidiaries, after-acquired government and non-government contracts and purchase orders relating to the business of the KGC Companies and the proceeds thereof as set forth in the security agreement (the “Security Agreement”) executed in connection with the Note.

The Amendment concerns audits of various government contracts that were performed by KGC Companies prior to the acquisition of the KGC Companies assets by Buyers. Some of those contracts have been audited (the “Audit”) and additional contracts are expected to be audited in the future (“Future Audits” and with the Audit, collectively the “DCAA Audits”, by the Defense Contract Audit Agency (the “DCAA”) and provides that the KGC Companies and the Shareholders agree to assume and satisfy the $900,000 for the Audit (the “$900,000 Reduction”) and for future DCAA audit liabilities (excluding attorneys fees and costs and professional fees and costs). In addition, Buyers have assigned to KGC Companies the positive net amounts that are paid, if any, to Buyers by the United States as a result of the DCAA Audits.

On December 28, 2010, the Company filed a Certificate of Amendment of Amended and Restated Certificate of Incorporation, which effected a one-for-four reverse stock split of the Company’s outstanding common shares and exchangeable shares. The reverse stock split was approved by the Company’s shareholders on October 7, 2010.

On January 9, 2011, API entered into the Merger Agreement. In the Merger, API will acquire all of the equity of SenDEC, which will include SenDEC’s electronics manufacturing operations and approximately $30 million of cash, in exchange for the issuance of 22,000,000 API common shares to Parent.

The consummation of the Merger is subject to the closing of the merger pursuant to the First Merger Agreement pursuant to which Parent will acquire SenDEC, which transaction is intended to close immediately prior to the Merger. The closing of the First Merger is subject to customary conditions, including without limitation the approval by the holders of at least two-thirds of a majority of the outstanding shares of SenDEC’s common stock entitled to vote on the First Merger. The consummation of the Merger also is subject to customary closing conditions, including the absence of any law, order or injunction prohibiting the Merger. The Merger is not subject to approval of API’s stockholders.

API will succeed to the rights, and assume the obligations, of Parent under the First Merger Agreement, including without limitation, the obligation to pay up to $14 million in earn-out payments.

API has made customary representations, warranties and covenants in the Merger Agreement, including, among others, covenants to conduct its business in the ordinary course during the interim period between the execution of the Merger Agreement and the consummation of the Merger.

Either API or Parent may terminate the Merger Agreement if the Merger is not completed by January 21, 2011. API may terminate the Merger Agreement if the Board of Directors of API authorizes API to enter into an agreement constituting a Superior Proposal (as defined in the Merger Agreement). In connection with a termination due to a Superior Proposal, API must pay Parent a termination fee of $2.5 million.

The Merger Agreement requires that all current officers and directors of API resign their positions.

 

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

Business Overview of API Technologies Corp.

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

The consummation of the Merger is subject to the closing of the merger pursuant to the Agreement and Plan of Merger (the “First Merger Agreement”) among Parent, SenDEC, and South Albany Acquisition Corp, pursuant to which Parent will acquire SenDEC (the “First Merger”), which transaction is intended to close immediately prior to the Merger. The closing of the First Merger is subject to customary conditions, including without limitation the approval by the holders of at least two-thirds of a majority of the outstanding shares of SenDEC’s common stock entitled to vote on the First Merger. The consummation of the Merger also is subject to customary closing conditions, including the absence of any law, order or injunction prohibiting the Merger. The Merger is not subject to approval of API’s stockholders.

API will succeed to the rights, and assume the obligations, of Parent under the First Merger Agreement, including without limitation, the obligation to pay up to $14 million in earn-out payments, potentially payable in three installments through July 13, 2013, based on achievement of certain financial milestones of SenDEC. In addition, certain SenDEC employees will be eligible for a bonus under a management bonus plan of up to $11 million, potentially payable in three installments through July 31, 2013, based on achievement of certain financial milestones of SenDEC.

API has made customary representations, warranties and covenants in the Merger Agreement, including, among others, covenants to conduct its business in the ordinary course during the interim period between the execution of the Merger Agreement and the consummation of the Merger.

Either API or Parent may terminate the Merger Agreement if the Merger is not completed by January 21, 2011. API may terminate the Merger Agreement if the Board of Directors of API authorizes API to enter into an agreement constituting a Superior Proposal (as defined in the Merger Agreement). In connection with a termination due to a Superior Proposal, API must pay Parent a termination fee of $2.5 million.

The information in this Quarterly Report on Form 10-Q does not give effect to the Merger.

We design, develop and manufacture highly engineered solutions, systems, robotics, secure communications and electronic components for military and aerospace applications, including mission critical information systems and technologies. We own and operate several state-of-the-art manufacturing facilities in North America and the United Kingdom. Our customers, which include military prime contractors, and the contract manufacturers who work for them, in the United States, Canada, the United Kingdom and various other countries in the world, outsource many of their defense electronic components and systems to us as a result of the combination of our design, development and manufacturing expertise.

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

Prior to the acquisition of Cryptek, our operations were conducted in two reportable segments which were distinguished by geographic location in Canada and United States. Both geographical segments designed and manufactured electronic components.

 

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The July 2009 Cryptek acquisition expanded our manufacturing and design of products to include secured communication products, including ruggedized computer products, network security appliances, and TEMPEST Emanation prevention products.

The acquired product lines from the KGC Companies contributed approximately $35,329,000 to net sales for the six months ended November 30, 2010.

Following the acquisitions of the assets of Cryptek and the assets of the KGC Companies in July 2009 and January 2010, respectively, API had operating facilities in Ronkonkoma and Hauppauge, New York, Somerset, New Jersey, and Ottawa, Ontario, as well as Windber, Pennsylvania, Sterling, Virginia, South Plainfield, New Jersey, and Gloucester, United Kingdom. Commencing in May 2010, we began a cost cutting initiative to rationalize the number of facilities and personnel which will result in us consolidating our manufacturing operations from eight facilities into three facilities. As at November 30, 2010, we had closed and sold our Hauppauge, New York manufacturing facility and completed the consolidation of our two Canadian facilities into one manufacturing location. This process was completed in December 2010 and is expected to result in the reduction of approximately $4 million in annual costs.

On June 15, 2010, we closed the asset sale of our nanotechnology research and development subsidiary based in Somerset, New Jersey. This business had historically been unprofitable and the closure is expected to improve our operating results and allow us to deploy our capital and management resources on our expanding defense business.

Effective September 13, 2010, the Company, API Defense USA, Phillip DeZwirek and Jason DeZwirek entered into a Proxy Agreement with the DoD, which governs the operations of API Defense USA, a direct subsidiary of the Company, and its subsidiaries, which includes all the operating subsidiaries of the Company.

In September 2010, we reorganized our subsidiaries so that all of our operating subsidiaries are now direct or indirect subsidiaries of API Defense USA. API Defense USA is a direct subsidiary of the Company. Under the Proxy Agreement, companies that are not subject to the Proxy Agreement cannot consolidate operations with companies subject to the Proxy Agreement. This reorganization was done so that all of our operating subsidiaries may take advantage of the efficiencies gained through consolidated operations.

In connection with the execution of the Proxy Agreement, Stephen Pudles resigned as the Chief Executive Officer and a director of the Company as of September 13, 2010. Under the terms of the Proxy Agreement, Mr. Pudles cannot serve as an officer or director of the Company if he is an officer of any company operating under the Proxy Agreement, which includes API Defense USA and its subsidiaries. Mr. Pudles is Chief Executive Officer of API Defense USA. On September 13, 2010, the Company appointed Phillip DeZwirek, also our Chairman, as its Chief Executive Officer.

Operating Revenues

We derive operating revenues from the sales in two principal business segments: Engineered Systems and Components, and Secure Communications. The asset acquisition of Cryptek on July 7, 2009 resulted in the creation of our new Secure Communications product line, and the asset acquisition of the KGC Companies on January 20, 2010 significantly expanded our Engineered Systems and Components revenues. Our customers are located primarily in the United States, Canada and the United Kingdom, but we also sell products to customers located throughout the world, including NATO and European Union countries.

Engineered Systems and Components Revenue includes high speed surface mount circuit card assembly for military prime contractors and advanced weapon systems including missiles, unmanned air, ground and robotic systems. Other products include naval aircraft landing and launching systems, radar systems alteration, aircraft ground support equipment, Aircraft Radar Indication Systems using Liquid Crystal Display (LCD) technology and other mission critical systems and components.

The main demand today for our Engineered Systems and Components products come from various world governments, including militaries, defense organizations, aerospace, homeland security and prime defense contractors.

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

 

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Cost of Revenue

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

Operating Expenses

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

Selling, General and Administrative Expenses

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

Research and Development Expenses

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

Business Acquisition and Related Charges

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

Other Income (Expense)

Other income (expense) consists of interest income on cash and cash equivalents and marketable securities, interest expense on notes payable, operating loans and capital leases, gains or losses on disposal of property and equipment, and gains or losses on foreign currency transactions. Other income also includes acquisition-related gains when net assets acquired exceed the purchase price of the business acquisition.

Backlog

Management uses a number of indicators to measure the growth of the business. One measure is sales backlog. Our sales backlog at November 30, 2010 was approximately $53,600,000 compared to $17,280,000 at November 30, 2009, an increase of approximately $36,320,000. API Defense and API Systems represent approximately $32,000,000 of our backlog.

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

Results of Operations for the Six Months Ended November 30, 2010 and 2009

The following discussion of results of operations is a comparison of our six months ended November 30, 2010 and 2009.

 

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Operating Revenue

 

     Six months ended November 30,  
     2010      2009      %
Change
 

Revenues by segments:

        

Engineered Systems and Components from continuing operations

   $ 46,731,010       $ 11,505,045         306.2

Secure Communications from continuing operations

     8,291,227         9,448,845         (12.3)
                          
   $ 55,022,237       $ 20,953,890         162.6
                          

We recorded a 162.6% increase in revenues for the six months ended November 30, 2010 over the same period in 2009. The increase is mainly attributed to approximately $35,329,000 of revenue related to the acquisition of the assets of the KGC Companies completed on January 20, 2010. The Secure Communication results include six months results compared to less than five months for the six months ended November 30, 2009, after the July 7, 2009 acquisition of the Cryptek assets. During the six months ended November 30, 2010 there was a decrease in our Secure Communication revenues primarily as a result of delays in finalizing a service contract with a large U.S. customer.

Operating Expenses

Cost of Revenue and Gross Profit

 

     Six months ended November 30,  
     2010     2009  

Gross profit by segments:

    

Engineered Systems and Components from continuing operations

     23.7     29.0

Secure Communications from continuing operations

     27.7     17.6

Overall

     24.3     23.9

Our combined gross margin for the six months ended November 30, 2010 increased by approximately 0.4% compared to the six months ended November 30, 2009. Gross profit margin varies from period to period and can be affected by a number of factors, including product mix, new product introduction, production efficiency and restructuring activities. Overall cost of revenue from continuing operations as a percentage of sales decreased in the six months ended November 30, 2010 from 76.1% to 75.7% compared to the same period in 2009. The Engineered Systems and Components segment cost of sales increased 5.3% compared to the same period in 2009, mainly as a result of product mix during the six months ended November 30, 2010 compared to the same period in 2009. The Secure Communications segment realized a decrease in cost of sales mainly as a result of the Company realizing benefits achieved through the consolidation efforts and cost cutting measures. Overall cost of revenue from continuing operations for the six months ended November 30, 2010 included approximately $758,000 of restructuring costs.

General and Administrative Expenses

General and administrative expenses increased to $7,656,148 for the six months ended November 30, 2010 from $4,071,856 for the six months ended November 30, 2009. The increase is a result of the addition of the KGC Companies, which increased general and administrative expenses by approximately $3,533,000 for the six months ended November 30, 2010. As a percentage of sales, general and administrative expenses were 13.9% for the six months ended November 30, 2010, compared to 19.4% for the six months ended November 30, 2009.

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

 

     Six months ended November 30,  
     2010      % of
sales
    2009      % of
sales
 

Accounting and Administration

   $ 2,312,807         4.2   $ 1,182,003         5.6

Professional Services

   $ 843,887         1.6   $ 489,184         2.3

Selling Expenses

Selling expenses from continuing operations increased to $2,243,923 for the six months ended November 30, 2010 from $1,665,687 for the six months ended November 30, 2009. The increase was largely due to the inclusion of selling expenses related to the asset acquisitions of Cryptek and the KGC Companies on July 7, 2009 and January 20, 2010, respectively. As a percentage of sales, selling expenses were 4.1% for the six months ended November 30, 2010, compared to 8.0% for the six months ended November 30, 2009.

 

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The major components of selling expenses are as follows:

 

     Six months ended November 30,  
     2010      % of
sales
    2009      % of
sales
 

Payroll Expense – Sales

   $ 1,575,674         2.9   $ 846,921         4.0

Advertising

   $ 149,405         0.3   $ 122,004         0.6

Research and Development Expenses

Research and development costs from continuing operations increased to $1,254,549 for the six months ended November 30, 2010 from $780,874 for the six months ended November 30, 2009. The increase is due primarily to additional research and development costs associated with the asset acquisitions of Cryptek and the KGC Companies.

Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence and business valuation consultants related to business combinations. For the six months ended November 30, 2010, there were no business acquisition and related charges compared to approximately $1,142,000 for the six months ended November 30, 2009. The decrease is associated with the completion of the Cryptek acquisition in the six months ended November 30, 2009.

Operating Income (Loss)

We posted operating income from continuing operations for the six months ended November 30, 2010 of approximately $573,000 compared to a loss of approximately $2,662,000 for the six months ended November 30, 2009. The increase in operating income of approximately $3,234,000 is attributed to the acquisition of the KGC Companies on January 20, 2010 and improved overall results in our Engineered Systems and Components segment.

Other (Income) and Expense

Total other expense for the six months ended November 30, 2010 amounted to $1,695,496, compared to other income of $1,758,048 for the six months ended November 30, 2009.

The increase in other expense is largely attributable to interest expense of approximately $2,532,000, of which $511,000 was a non-cash expense related to the amortization of note discounts. The increase in net other expense was also attributable to reduced other income. The six months ended November 30, 2010 included approximately $850,000 of gains on the sale of the Company’s buildings in Hauppauge and Endicott, N.Y. while the six months ended November 30, 2009 included a gain of approximately $993,000 on the acquisition of the assets of Cryptek, a gain of approximately $80,000 on the sale of a parcel of land in Ronkonkoma, N.Y. and a gain of approximately $845,000 on the sale of a building the Company owned in Ottawa, Canada.

Income Taxes

Income taxes amounted to an expense of $13,287 for the six months ended November 30, 2010, compared to $25,047 for six months ended November 30, 2009. In view of the prior years’ losses and the uncertainty relating to our future profitability we have provided for 100% valuation allowance resulting in no deferred tax assets on a net basis. However, in future periods there is potential for the valuation allowance to be lowered based upon operating results.

Income (Loss) From Discontinued Operations

We generated a gain from discontinued operations of approximately $132,000 for the six months ended November 30, 2010, compared to a loss of approximately $1,787,000 in the same period of fiscal 2009. The gain is attributable to the sale of the assets of our nanotechnology operations in June 2010 compared to the on-going operations of the nanotechnology business for the six months ended November 30, 2009.

Net Loss

We recorded a net loss for the six months ended November 30, 2010 of approximately $1,004,000, compared to a net loss of approximately $2,717,000 for the six months ended November 30, 2009. The decrease in the net loss is largely due to the acquisition of the KGC Companies on January 20, 2010 and overall improved results from our Engineered Systems and Components segment.

 

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The decrease in the net loss from overall improved results was partially offset by other expenses of approximately $1,695,000 for the six months ended November 30, 2010 compared to other income of approximately $1,758,000 for the six months ended November 30, 2009.

Results of Operations for the Three Months Ended November 30, 2010 and 2009

The following discussion of results of operations is a comparison of our three months ended November 30, 2010 and 2009.

Operating Revenue

 

     Three months ended November 30,  
     2010      2009      %
Change
 

Revenues by segments:

        

Engineered Systems and Components from continuing operations

   $ 21,796,576       $ 5,875,478         271.0

Secure Communications from continuing operations

     4,102,116         6,009,834         (31.7)
                          
   $ 25,898,692       $ 11,885,312         117.9
                          

We recorded a 117.9% increase in revenues for the three months ended November 30, 2010 over the same period in 2009. The increase is mainly attributed to approximately $16,235,000 of revenue related to the acquisition of the assets of the KGC Companies completed on January 20, 2010. During the three months ended November 30, 2010 there was a decrease in our Secure Communication revenues primarily as a result of delays in finalizing a service contract with a large U.S. customer.

Operating Expenses

Cost of Revenue and Gross Profit

 

     Three months ended November 30,  
     2010     2009  

Gross profit by segments:

    

Engineered Systems and Components from continuing operations

     24.2     29.1

Secure Communications from continuing operations

     28.4     18.3

Overall

     24.9     23.6

Our combined gross margin for the three months ended November 30, 2010 increased by approximately 1.3% compared to the three months ended November 30, 2009. Gross profit margin varies from period to period and can be affected by a number of factors, including product mix, new product introduction, production efficiency and restructuring activities. Overall cost of revenue from continuing operations as a percentage of sales decreased in the three months ended November 30, 2010 from 76.4% to 75.1% compared to the same period in 2009. The Engineered Systems and Components segment cost of sales increased 4.9% compared to the same period in 2009, mainly as a result of product mix during the three months ended November 30, 2010 compared to the same period in 2009. The Secure Communications segment realized a decrease in cost of sales mainly as a result of the Company realizing benefits achieved through the consolidation efforts and cost cutting measures. Overall cost of revenue from continuing operations for the three months ended November 30, 2010 include approximately $458,000 of restructuring costs.

General and Administrative Expenses

General and administrative expenses increased to $4,195,897 for the three months ended November 30, 2010 from $2,323,969 for the three months ended November 30, 2009. The increase is a result of the addition of the KGC Companies, which increased general and administrative expenses by approximately $1,833,000 for the three months ended November 30, 2010. As a percentage of sales, general and administrative expenses were 16.2% for the three months ended November 30, 2010, compared to 19.6% for the three months ended November 30, 2009.

 

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

 

     Three months ended November 30,  
     2010      % of
sales
    2009      % of
sales
 

Accounting and Administration

   $ 1,160,244         4.5   $ 687,126         5.8

Professional Services

   $ 276,526         1.1   $ 180,561         1.5

Selling Expenses

Selling expenses from continuing operations increased to $1,131,305 for the three months ended November 30, 2010 from $927,850 for the three months ended November 30, 2009. The increase was largely due to the inclusion of selling expenses related to the asset acquisition of the KGC Companies on January 20, 2010. As a percentage of sales, selling expenses were 4.4% for the three months ended November 30, 2010, compared to 7.8% for the three months ended November 30, 2009.

The major component of selling expenses is as follows:

 

     Three months ended November 30,  
     2010      % of
sales
    2009      % of
sales
 

Payroll Expense – Sales

   $ 754,003         2.9   $ 522,431         4.4

Research and Development Expenses

Research and development costs from continuing operations increased to $723,055 for the three months ended November 30, 2010 from $443,683 for the three months ended November 30, 2009. The increase is due primarily to additional research and development costs associated with the asset acquisition of the KGC Companies.

Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence and business valuation consultants related to business combinations. For the three months ended November 30, 2010, there were no business acquisition and related charges compared to approximately $578,000 for the three months ended November 30, 2009. The decrease is associated with the costs related to the Cryptek acquisition in the three months ended November 30, 2009.

Operating Income (Loss)

We recorded an operating loss from continuing operations for the three months ended November 30, 2010 of approximately $555,000 compared to a loss of approximately $1,465,000 for the three months ended November 30, 2009. The decrease in operating loss of approximately $910,000 is attributed to the acquisition of the KGC Companies on January 20, 2010 and improved overall results in our Engineered Systems and Components segment.

Other (Income) and Expense

Total other expense for the three months ended November 30, 2010 amounted to $1,198,135 compared to other income of $309,241 for the three months ended November 30, 2009.

The increase in other expense is largely attributable to an increase in interest expense of approximately $1,080,000 for the three months ended November 30, 2010, of which $260,000 was a non-cash expense related to the amortization of note discounts. The increase in net other expense was also attributable to reduced other income. The three months ended November 30, 2009 included a gain of approximately $845,000 on the sale of a building the Company owned in Ottawa, Canada, partially offset by an adjustment, which lowered the gain on the acquisition of Cryptek.

Income Taxes

Income taxes amounted to an expense of $10,175 for the three months ended November 30, 2010, compared to $6,206 for three months ended November 30, 2009. In view of the prior years’ losses and the uncertainty relating to our future profitability we have provided for 100% valuation allowance resulting in no deferred tax assets on a net basis. However in future periods there is potential for the valuation allowance to be lowered based upon operating results.

 

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Income (Loss) From Discontinued Operations

We generated a gain from discontinued operations of approximately $3,000 for the three months ended November 30, 2010, compared to a loss of approximately $772,000 in the same period of fiscal 2009. The minor gain is attributable to the sale of the assets of our nanotechnology operations in June 2010 compared to the on-going operations of the nanotechnology business for the three months ended November 30, 2009.

Net Loss

We recorded a net loss for the three months ended November 30, 2010 of approximately $1,761,000, compared to a net loss of approximately $1,934,000 for the three months ended November 30, 2009. The decrease in the net loss is largely due to the acquisition of the KGC Companies on January 20, 2010 and overall improved results from our Engineered Systems and Components segment.

The decrease in the net loss from overall improved results was offset by other expenses of approximately $1,198,000 for the three months ended November 30, 2010 compared to other income of approximately $309,000 for the three months ended November 30, 2009.

Liquidity and Capital Resources

The Six Months Ended November 30, 2010 compared to the Year Ended May 31, 2010

At November 30, 2010, we held cash of $5,508,865 compared to $4,496,025 at May 31, 2010.

Cash used by continuing operating activities of approximately $304,000 for the six months ended November 30, 2010, was lower than cash used by continuing operations of approximately $1,899,000 for the six months ended November 30, 2009. During the six months ended November 30, 2010 compared to the same period in 2009, the reduction in cash used by continuing operating activities resulted primarily from a decrease in the net loss due to the impact of consolidation initiatives, partially offset by an increase in cash used in changes in operating assets and liabilities.

Cash flows from continuing operations for the six months ended November, 2010 were impacted by restructuring charges of approximately $2,398,000 (six months ended November, 2009 – acquisition related charges of approximately $1,141,000), while cash flows from continuing operations were approximately $2,701,000 in fiscal 2009.

Investing activities for the six months ended November 30, 2010 consisted of the acquisition of capital assets of approximately $1,003,000 compared to approximately $122,000 for the same period in 2009 and proceeds from the sale of two manufacturing buildings totaling approximately $1,569,000. Investing activities for the six months ended November 30, 2009 consisted mainly of the sale of a parcel of land the Company owned in Long Island, New York for proceeds of approximately $951,000, the sale of a building the Company owned in Ottawa, Canada for proceeds of approximately $1,871,000, and the acquisition of the assets of Cryptek for a net cash total of approximately $2,929,000.

Cash flow used by financing activities for the six months ended November 30, 2010 totaled approximately $1,148,000, resulting mainly from the repayment of certain capital lease obligations, compared to cash flow provided by financing of approximately $3,511,000 primarily related to the net proceeds of $3,650,000 from the issuance of convertible debt in connection with the acquisition of the assets of Cryptek during the six months ended November 30, 2009.

We believe that i) cash and cash equivalents of $5,509,000, ii) funds available under our credit facilities as described in Note 7 of our financial statements included in this Form 10-Q, iii) cash flows from potential financing transactions, including cash to be received in connection with the Merger and iv) cash flows from operations, will be sufficient to satisfy our anticipated cash requirements for the next twelve months. These cash flow requirements over the next twelve months include the $9.1 million short-term promissory note to the sellers of the KGC Companies. In the event that the Merger does not occur, we intend to either raise additional capital to pay off the note or refinance the note with a commercial bank through an operating line and term note.

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note 2 to the unaudited consolidated financial statements in Item 1 of this Report and the effects of recent accounting pronouncements in Note 3 to the unaudited consolidated financial statements in Item 1 of this Report. There were no significant changes in our accounting policies or critical accounting estimates since the end of the fiscal year ended May 31, 2010.

 

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Off-Balance Sheet Arrangements

During fiscal 2010 and the six months ended November 30, 2010, the Company did not use off-balance sheet arrangements.

FORWARD-LOOKING STATEMENTS

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

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

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

Management wishes to caution investors that any forward-looking statements made by or on behalf of the Company are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Among the important factors that could cause actual results to differ materially from those indicated by forward-looking statements are the risks and uncertainties described under “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended May 31, 2010, and below in Part II, Item 1A of this Report, and in our other filings with the SEC. These uncertainties and other risk factors include, but are not limited to: changing economic and political conditions in the United States and in other countries, war, changes in governmental spending and budgetary policies, governmental laws and regulations surrounding various matters such as environmental remediation, contract pricing, and international trading restrictions, customer product acceptance, continued access to capital markets, and foreign currency risks.

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

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

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for Smaller Reporting Companies.

 

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ITEM 4. CONTROLS AND PROCEDURES

Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures.

We maintain “disclosure controls and procedures,” as such term is defined under Securities Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934 (the “Exchange Act”) reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of our disclosure controls and procedures as of November 30, 2010. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of November 30, 2010.

 

(b) Changes in Internal Control over Financial Reporting

During the quarter ended November 30, 2010, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

We are not a party to any material legal proceedings nor is our property the subject of any material legal proceedings.

 

ITEM 1A. RISK FACTORS

Since the date of the filing of our Annual Report on Form 10-K for the year ended May 31, 2010, there have been no material changes to the risk factors described in Item 1A - “Risk Factors” of the Annual Report on Form 10-K for the year ended May 31, 2010, except we have added the following risk factors to address the Merger.

Risks Relating to the Pending Merger

Uncertainty about the Merger and diversions of management could harm us, whether or not the Merger is completed.

In response to the announcement of the Merger, existing or prospective customers of ours may delay or defer decisions concerning us or they may seek to change their existing business relationships with us. In addition, as a result of the Merger, current and prospective employees could experience uncertainty about their future with us. These uncertainties may impair our ability to retain, recruit or motivate key personnel. Completion of the Merger will also require a significant amount of time and attention from management. The diversion of management attention away from ongoing operations could adversely affect our business relationships. If the Merger is not completed as anticipated, the adverse effects of these uncertainties and the diversion of management could be exacerbated by the delay.

Failure to complete the Merger could adversely affect the price of our shares and our future business and financial results.

Completion of the Merger is subject to, among other things, the approval of the shareholders of SenDEC. There is no assurance that such approval will be received or that the other conditions necessary for completion of the Merger will be satisfied. In addition, the current market price of our common shares may reflect a market assumption that the Merger will occur, and a failure to complete the Merger could result in a negative perception by the market of us generally and a resulting decline in the market price of our common shares.

We have incurred and will continue to incur significant costs in connection with the Merger, whether or not we complete it.

We have incurred and expect to continue to incur significant costs related to the Merger. These expenses include financial advisory, legal and accounting fees and expenses, employee expenses, and other related charges. If we fail to complete the Merger, we will remain liable for these transaction costs. We may also incur additional unanticipated expenses in connection with the Merger.

 

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

(a) None.

(b) Not applicable.

(c) None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. REMOVED AND RESERVED

 

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ITEM 5. OTHER INFORMATION

(b) On November 17, 2010, the Company’s Board of Directors adopted a Stockholder Communication Policy to govern the process of stockholder recommendations for candidates for the Board of Directors. To be timely, a stockholder recommendation must be delivered to, or mailed and received by the Company’s Secretary, not less than 90 days prior to the first anniversary date of the previous year’s annual stockholder meeting, subject to certain exceptions. If no annual meeting of stockholders was held in the previous year or if the date the annual meeting is advanced by more than 30 days prior to, or delayed by more than 60 days after, such anniversary date, notice by the stockholder to be timely must be so delivered, or mailed and received, not later than the close of business on the 10th day following the day on which the date of such meeting has been first publicly disclosed.

At the time the stockholder submits the recommendation for a director candidate, the stockholder must provide the following:

 

   

Certification from the candidate that he or she meets the requirements to be (a) independent under the NASDAQ standards, and (b) an independent director under the Exchange Act.

 

   

Consent of the candidate to serve on the Board, if nominated and elected.

 

   

Agreement of the candidate to complete, upon request, questionnaire(s) customary for directors of the Company.

 

   

All information relating to such candidate that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to the Exchange Act.

 

   

As to the stockholder giving notice, (i) the name and address, as they appear on the Company’s stock ledger, of such stockholder, (ii) the class and number of shares of the Company which are beneficially owned by such stockholder, and (iii) if the stockholder intends, directly or indirectly, to solicit proxies in support of such stockholder’s nominee for election or reelection as a director, the stockholder’s notice shall set forth, as to the stockholder and any other participants in the solicitation of proxies, all information relating thereto that is required pursuant to Regulation 14A under the Exchange Act.

A stockholder must also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Stockholders Communication Policy, and with all other SEC laws, rules, and regulations.

No person nominated by a stockholder will be eligible to serve as a director of the Company unless nominated in accordance with the Stockholder Communication’s Policy. The Board of Directors determines whether to interview any candidate recommended by a stockholder.

 

ITEM 6. EXHIBITS

 

10.1    Proxy Agreement with Respect to Capital Stock of API Defense USA, Inc. (Incorporated by reference from Exhibit 10.1 of the Company’s Form 8-K/A Amendment No. 1 filed with the SEC on October 12, 2010)
10.2    Amended and Restated Executive Employment Agreement by and between Stephen Pudles and API Defense USA, Inc. (Incorporated by reference from Exhibit 10.8 of the Company’s Post-Effective Amendment No. 5 on Form S-1 to Form S-1 Registration Statement filed with the SEC on September 29, 2010)
10.3    First Amendment to Consulting Agreement dated December 16, 2010, effective September 4, 2010 (Incorporated by reference from Exhibit 10.2 of the Company’s Form 8-K filed with the SEC on December 16, 2010)
10.4    Summary term sheet of arrangement governing Jason DeZwirek’s consulting services (filed herewith).
31.1    Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer (filed herewith).
31.2    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
32.1    Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (filed herewith).
32.2    Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (filed herewith).

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    API TECHNOLOGIES CORP.
Date: January 14, 2011     By:  

/S/ CLAUDIO MANNARINO

      Claudio Mannarino
      Chief Financial Officer and Vice President of Finance
      (Duly Authorized Officer)

 

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