CPI International Holding Corp. - FORM 10-Q

Attached files

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EX-31.1 - EXHIBIT 31.1 - CPI International Holding Corp.	cpih-2015070310qxex311.htm
EX-32.1 - EXHIBIT 32.1 - CPI International Holding Corp.	cpih-2015070310qxxex321.htm
EX-32.2 - EXHIBIT 32.2 - CPI International Holding Corp.	cpih-2015070310qxxex322.htm
EX-31.2 - EXHIBIT 31.2 - CPI International Holding Corp.	cpih-2015070310qxex312.htm

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE

COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)



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

For the quarterly period ended July 3, 2015



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

For the transition period from ________ to ________

Commission file number: 333-173372-07

CPI INTERNATIONAL HOLDING CORP.

(Exact Name of Registrant as Specified in Its Charter)



Delaware (State or Other Jurisdiction of Incorporation or Organization)		90-0649687 (I.R.S. Employer Identification No.)
811 Hansen Way, Palo Alto, California 94303 (Address of Principal Executive Offices and Zip Code)
(650) 846-2900 (Registrant’s telephone number, including area code)
Not Applicable (Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes ¨ No ý

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	x (Do not check if a smaller reporting company)	Smaller reporting company	¨

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding for each of the registrant’s classes of Common Stock, as of the latest practicable date: As of August 11, 2015, 1,110 shares of Common Stock, $0.01 par value, all of which are owned by CPI International Holding LLC, the registrant’s parent holding company, are outstanding and are not publicly traded.

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

10-Q REPORT

INDEX



			Page

Part I:	FINANCIAL INFORMATION		4

	Item 1.	Unaudited Condensed Consolidated Financial Statements	4

		Condensed Consolidated Balance Sheets as of July 3, 2015 and October 3, 2014	4
		Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended July 3, 2015 and July 4, 2014	5
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 3, 2015 and July 4, 2014	6
		Notes to Unaudited Condensed Consolidated Financial Statements	7

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
	Item 4.	Controls and Procedures	44

Part II:	OTHER INFORMATION		45

	Item 1.	Legal Proceedings	45
	Item 1A.	Risk Factors	45
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
	Item 3.	Defaults Upon Senior Securities	45
	Item 4.	Mine Safety Disclosures	45
	Item 5.	Other Information	45
	Item 6.	Exhibits	46

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

Cautionary Statements Regarding Forward-Looking Statements

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

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

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

Part I: FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data – unaudited)



	July 3, 2015			October 3, 2014
Assets
Current assets:
Cash and cash equivalents	$	61,284		$	50,617
Restricted cash	1,663			1,798
Accounts receivable, net	44,972			43,920
Inventories	98,883			97,156
Deferred tax assets	8,390			8,070
Prepaid and other current assets	7,919			7,960
Total current assets	223,111			209,521
Property, plant, and equipment, net	71,981			76,659
Deferred debt issue costs, net	10,636			12,557
Intangible assets, net	240,467			248,838
Goodwill	198,881			197,681
Other long-term assets	537			1,072
Total assets	$	745,613		$	746,328

Liabilities and stockholders’ equity
Current liabilities:
Current portion of long-term debt	$	3,100		$	3,100
Accounts payable	23,857			25,565
Accrued expenses	41,649			31,328
Product warranty	4,869			4,863
Income taxes payable	412			1,048
Advance payments from customers	15,275			15,448
Total current liabilities	89,162			81,352
Deferred income taxes, non-current	92,652			94,835
Long-term debt, less current portion	513,774			514,938
Other long-term liabilities	4,500			13,059
Total liabilities	700,088			704,184
Commitments and contingencies
Stockholders’ equity:
Common stock ($0.01 par value, 2 shares authorized: 1 share issued and outstanding)	—			—
Additional paid-in capital	26,326			25,589
Accumulated other comprehensive loss	(1,341		)	(653		)
Retained earnings	20,540			17,208
Total stockholders’ equity	45,525			42,144
Total liabilities and stockholders’ equity	$	745,613		$	746,328

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

CONDENSED CONSOLIDATED

STATEMENTS OF COMPREHENSIVE INCOME

(In thousands – unaudited)



	Three Months Ended					Nine Months Ended
	July 3, 2015		July 4, 2014			July 3, 2015			July 4, 2014
Sales	$	109,645	$	119,413		$	328,283		$	364,451
Cost of sales, including $0, $0, $0 and $1,539 of utilization of net increase in cost basis of inventory due to purchase accounting, respectively	79,831		83,502			236,978			258,875
Gross profit	29,814		35,911			91,305			105,576
Operating costs and expenses:
Research and development	3,813		4,069			11,370			11,686
Selling and marketing	5,518		5,911			17,018			17,655
General and administrative	7,572		7,754			23,234			22,927
Amortization of acquisition-related intangible assets	2,546		2,420			7,637			7,898
Total operating costs and expenses	19,449		20,154			59,259			60,166
Operating income	10,365		15,757			32,046			45,410
Interest expense, net	9,119		9,018			27,312			23,140
Loss on debt restructuring	—		7,235			—			7,235
Income (loss) before income taxes	1,246		(496		)	4,734			15,035
Income tax expense (benefit)	27		(3,966		)	1,402			2,524
Net income	1,219		3,470			3,332			12,511

Other comprehensive income (loss), net of tax
Unrealized income (loss) on cash flow hedges, net of tax	876		1,046			(688		)	(42		)
Total other comprehensive income (loss), net of tax	876		1,046			(688		)	(42		)
Comprehensive income	$	2,095	$	4,516		$	2,644		$	12,469

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands – unaudited)



	Nine Months Ended
	July 3, 2015			July 4, 2014
Cash flows from operating activities
Net cash provided by operating activities	$	17,687		$	39,641

Cash flows from investing activities
Capital expenditures	(4,695		)	(4,596		)
Acquisition, net of cash acquired	—			(36,776		)
Net cash used in investing activities	(4,695		)	(41,372		)

Cash flows from financing activities
Borrowings under Term Loan	—			309,225
Payment of debt issue costs	—			(8,734		)
Payment of debt modification costs	—			(5,365		)
Repayment of borrowings under previous term loan facility	—			(144,175		)
Repayment of borrowings under Term Loan	(2,325		)	(775		)
Dividends paid	—			(175,000		)
Net cash used in financing activities	(2,325		)	(24,824		)

Net increase (decrease) in cash and cash equivalents	10,667			(26,555		)
Cash and cash equivalents at beginning of period	50,617			67,051
Cash and cash equivalents at end of period	$	61,284		$	40,496

Supplemental cash flow disclosures
Cash paid for interest	$	19,531		$	15,707
Cash paid for income taxes, net of refunds	$	4,311		$	6,827
Decrease in accrued capital expenditures	$	9		$	360

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

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(All tabular dollar amounts in thousands)


1.	The Company and a Summary of its Significant Accounting Policies

The Company

Unless the context requires otherwise, (i) “Holding LLC” refers to CPI International Holding LLC, (ii) “CPI International” or “Parent” refers to the issuer, CPI International Holding Corp., and (iii) “CPII” means CPI International, Inc. Holding LLC owns all of the outstanding common stock of CPI International, which in turn owns all of the outstanding common stock of CPII, which in turn owns all of the outstanding equity interests of Communications & Power Industries LLC (“CPI”) and Communications & Power Industries Canada Inc. (“CPI Canada”), CPI International’s main operating subsidiaries. The term “the Company” refers to CPI International and its direct and indirect subsidiaries on a consolidated basis. The Veritas Capital Fund IV, L.P. and its affiliates and certain members of CPII’s management beneficially own shares of CPI International’s common stock indirectly through their holdings in Holding LLC. Holding LLC, CPI International and CPII are holding companies with no material assets or operations other than their respective direct or indirect equity interests in CPI and CPI Canada and activities related thereto.

The accompanying unaudited condensed consolidated financial statements represent the consolidated results and financial position of the Company. The Company develops, manufactures and globally distributes components and subsystems used in the generation, amplification, transmission and reception of microwave signals for a wide variety of systems including radar, electronic warfare and communications (satellite and point-to-point) systems for military and commercial applications, specialty products for medical diagnostic imaging and the treatment of cancer, as well as microwave and radio frequency (“RF”) energy generating products for various industrial and scientific pursuits. The Company has two reportable segments: RF products and satcom equipment (see Note 11, Segments, Geographic and Customer Information).

Basis of Presentation and Consolidation

The Company’s fiscal year is the 52- or 53-week period that ends on the Friday nearest September 30. Fiscal years 2015 and 2014 comprise the 52- and 53-week periods ending October 2, 2015 and October 3, 2014, respectively. Each of the three months ended July 3, 2015 and July 4, 2014 included 13 weeks. The nine months ended July 3, 2015 and July 4, 2014 included 39 and 40 weeks, respectively. All other period references are to the Company’s fiscal periods unless otherwise indicated.

The accompanying unaudited condensed consolidated financial statements of the Company as of July 3, 2015 and for the three and nine months ended July 3, 2015 and July 4, 2014 are unaudited and reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of such financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 3, 2014 filed with the Securities and Exchange Commission on December 11, 2014. The condensed consolidated balance sheet as of October 3, 2014 has been derived from the audited financial statements at that date. The results of operations and cash flows for the interim period ended July 3, 2015 are not necessarily indicative of results to be expected for the full year.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances, transactions and stockholdings have been eliminated in consolidation.

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

Immaterial Correction of Previously Provided Financial Information

In the first quarter of fiscal year 2015, the Company identified three computational errors: (i) a $0.7 million overstatement of deferred tax assets associated with the Company’s acquisition of its Malibu Division (“Malibu”) in fiscal year 2008, (ii) a $0.9 million balance sheet misclassification between non-current deferred revenue and current advanced payments from customers in fiscal year 2014, and (iii) a $0.5 million understatement of deferred revenue associated with the Company’s acquisition of Radant Technologies, Inc. (“Radant”) in fiscal year 2014. The Company corrected the errors in the first quarter of fiscal year 2015 by (i) releasing the deferred tax asset, which is recorded as part of deferred income taxes, non-current, and recognizing additional goodwill associated with the Malibu acquisition of $0.7 million, (ii) appropriately reclassifying $0.9 million from non-current deferred revenue, which is recorded as part of other long-term liabilities, to current advance payment from customers, and (iii) increasing current deferred revenue, which is recorded as part of accrued liabilities, and goodwill associated with the Radant acquisition by $0.5 million. The correction of the misstatements is reflected within the condensed consolidated balance sheet as of July 3, 2015.

The original misstatements had no impact on the consolidated statement of comprehensive income or the consolidated statement of cash flows for any prior period, and the correction of the misstatements had no impact on the condensed consolidated statements of comprehensive income or the condensed consolidated statement of cash flows in the nine months ended July 3, 2015. In accordance with Staff Accounting Bulletin (“SAB”) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, the Company assessed the materiality of these errors for each of the prior quarterly and annual periods that were affected and determined that the errors were not material to any of the prior periods. Additionally, the Company concluded that the cumulative impact of the errors did not have a material impact on its financial results for the nine months ended July 3, 2015 or its projected results for fiscal year 2015.

Use of Estimates and Assumptions

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)


2.	Recently Issued Accounting Standards

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

In April 2015, the FASB issued an accounting standard update that requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This accounting standard update requires retrospective adoption and is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Early adoption is permitted. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal year 2017. The Company expects the new accounting standard update will reduce other long-term assets and long-term debt on its consolidated balance sheets by amounts classified as deferred debt issuance costs and will have no impact on its consolidated results of operations or cash flows.


3.	Supplemental Financial Information

Accounts Receivable: Accounts receivable are stated net of allowances for doubtful accounts as follows:



	July 3, 2015			October 3, 2014
Accounts receivable	$	45,579		$	43,942
Less: Allowance for doubtful accounts	(607		)	(22		)
Accounts receivable, net	$	44,972		$	43,920

The increase in the Company’s allowance for doubtful accounts was due to a collection issue with a customer in Europe.

Inventories: The following table provides details of inventories:



	July 3, 2015		October 3, 2014
Raw materials and parts	$	51,051	$	48,958
Work in process	33,997		33,649
Finished goods	13,835		14,549
Total inventories	$	98,883	$	97,156

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

Reserve for loss contracts: The following table summarizes the activity related to reserves for loss contracts during the periods presented:



	Three Months Ended						Nine Months Ended
	July 3, 2015			July 4, 2014			July 3, 2015			July 4, 2014
Balance at beginning of period	$	5,347		$	5,329		$	5,008		$	4,992
Provision for loss contracts, charged to cost of sales	336			329			908			1,206
Credit to cost of sales upon revenue recognition	(4,400		)	(41		)	(4,633		)	(581		)
Balance at end of period	$	1,283		$	5,617		$	1,283		$	5,617

The reduction in reserve for loss contracts in the three and nine months ended July 3, 2015 was primarily due to completion of certain contractual obligations.

At the end of each period presented above, reserve for loss contracts was reported in the condensed consolidated balance sheet in the following accounts:



	July 3, 2015		July 4, 2014
Inventories	$	1,283	$	5,535
Accrued expenses	—		82
Total reserves for loss contracts	$	1,283	$	5,617

Goodwill: The following table sets forth goodwill by reportable segment:



	July 3, 2015		October 3, 2014
RF products	$	147,008	$	146,505
Satcom equipment	39,715		39,715
Other	12,158		11,461
Total goodwill	$	198,881	$	197,681

The increase of $0.5 million and $0.7 million in goodwill for RF products and Other segments, respectively, resulted from correction of certain computational errors on previously provided financial information as described in Note 1, The Company and a Summary of its Significant Accounting Policies.

Product Warranty: The following table summarizes the activity related to product warranty:



	Three Months Ended						Nine Months Ended
	July 3, 2015			July 4, 2014			July 3, 2015			July 4, 2014
Beginning accrued warranty	$	4,553		$	4,790		$	4,863		$	4,706
Actual costs of warranty claims	(1,342		)	(1,193		)	(3,751		)	(3,516		)
Estimates for product warranty, charged to cost of sales	1,658			1,198			3,757			3,605
Ending accrued warranty	$	4,869		$	4,795		$	4,869		$	4,795

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)


4.	Financial Instruments

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, available-for-sale securities, derivative instruments and contingent consideration. The following tables set forth financial instruments carried at fair value by level of fair value hierarchy:



				Fair Value Measurements at July 3, 2015 Using
		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Money market and overnight U.S. Government securities¹		$	47,367	$	47,367	$	—	$	—
Mutual funds²		300		300		—		—
Total assets at fair value		$	47,667	$	47,667	$	—	$	—

Liabilities:
Foreign exchange forward derivatives³		$	1,385	$	—	$	1,385	$	—
Contingent consideration liability⁴		9,400		—		—		9,400
Total liabilities at fair value		$	10,785	$	—	$	1,385	$	9,400


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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)



				Fair Value Measurements at October 3, 2014 Using
		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Money market and overnight U.S. Government securities¹		$	39,952	$	39,952	$	—	$	—
Mutual funds²		279		279		—		—
Total assets at fair value		$	40,231	$	40,231	$	—	$	—

Liabilities:
Foreign exchange forward derivatives³		$	759	$	—	$	759	$	—
Contingent consideration liability⁴		7,600		—		—		7,600
Total liabilities at fair value		$	8,359	$	—	$	759	$	7,600


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

See Note 6, Derivative Instruments and Hedging Activities, for information regarding the Company’s derivative instruments.

Contingent Consideration

In connection with, and as part of the consideration for, the October 2013 purchase of all of the outstanding stock of Radant, the Company will be obligated to make a maximum of $10.0 million in potential additional payments if certain financial targets are achieved by Radant over the two years following the acquisition. These potential earn-out payments are considered contingent consideration. The fair value of the contingent consideration is based on a probability-weighted calculation whereby the Company assigned estimated probabilities to achieving the earn-out targets and then discounted the total contingent consideration to net present value using Level 3 inputs. Key assumptions include a discount rate of 14%, which the Company believes to reflect market participant assumptions, and a probability-adjusted level of Radant’s earnings before net interest expense, provision for income taxes and depreciation and amortization (“EBITDA”) in aggregate for the two years following the acquisition. As of July 3, 2015, the Company assessed that it was virtually certain that Radant will achieve the financial targets giving rise to the earn-out payment at end of December 2015. The fair value of contingent consideration was, therefore, calculated as $10.0 million discounted to present value.

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

The following table summarizes the activity related to contingent consideration during the periods presented:



	Three Months Ended				Nine Months Ended
	July 3, 2015		July 4, 2014		July 3, 2015		July 4, 2014
Balance at beginning of period	$	8,700	$	4,600	$	7,600	$	—
Contingent consideration from Radant acquisition	—		—		—		4,300
Change in fair value included in earnings	700		300		1,800		600
Balance at end of period	$	9,400	$	4,900	$	9,400	$	4,900

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

Other Financial Instruments

The Company’s other financial instruments include cash, restricted cash, accounts receivable, accounts payable, accrued expenses and long-term debt. Except for long-term debt, the carrying value of these financial instruments approximates fair values because of their relatively short maturity. The estimated fair value of the Company’s long-term debt as of July 3, 2015 and October 3, 2014 using Level 2 fair value inputs was $521.3 million as of each date compared to the carrying value of $516.9 million and $518.0 million, respectively.


5.	Long-term Debt

The Company’s long-term debt comprises the following as of the dates presented:



	July 3, 2015		October 3, 2014
Term Loan, net of issue discount of $652 and $726	$	305,473	$	307,724
Senior Notes, net of issue discount of $3,599 and $4,686	211,401		210,314
	516,874		518,038
Less: Current portion	3,100		3,100
Long-term portion	$	513,774	$	514,938

Standby letters of credit secured by Revolver	$	5,614	$	3,468

Senior Secured Credit Facilities

On April 7, 2014, CPII entered into new senior secured credit facilities (“Senior Credit Facilities”), which provide for (i) Term B Loans in an aggregate principal amount of $310.0 million (“Term Loan”), and (ii) a $30.0 million revolving credit facility (“Revolver”), with sub-limits for letters of credit and swingline loans. CPII immediately borrowed the entire $310.0 million available under the Term Loan. The revolving credit facility was undrawn at July 3, 2015 (other than for approximately $5.6 million of outstanding letters of credit).

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

Upon satisfaction of certain specified conditions, including pro forma compliance with a total leverage ratio, CPII may seek commitments for new term loans and revolving loans, not to exceed the sum of (i) $75.0 million, plus (ii) the aggregate amount of all prepayments of Term Loans and permanent commitment reductions of the Revolver made prior to or simultaneously with the incurrence of new incremental commitments, plus (iii) such additional amounts to the extent CPII maintains a first lien leverage ratio of 3.50:1 or less on a pro forma basis after giving effect to such incremental commitments (“Incremental Cap”). In addition, instead of incremental commitments of term loans or revolving loans under the Senior Credit Facilities, CPII may utilize the Incremental Cap at any time by issuing or incurring incremental equivalent debt, outside of the Senior Credit Facilities, which may be in the form of secured or unsecured debt securities or loans, in each case upon satisfaction of certain specified conditions, including maintaining certain leverage ratios.

Except as noted below, the Term Loan will mature on November 17, 2017 and the Revolver will mature on August 19, 2017. However, if (i) in the case of the Term Loan, on or before November 17, 2017, and, in the case of the Revolver, on or before August 19, 2017, CPII has repaid or refinanced 65% of its Senior Notes due 2018, or (ii) the first lien leverage ratio as of August 19, 2017 is 2.50:1 or less on a pro forma basis, then the Term Loan will mature on April 7, 2021 and the Revolver will mature on April 7, 2019.

Borrowings under the Senior Credit Facilities bear interest, at CPII’s option, at a rate equal to a margin over either (i) a LIBOR rate or (ii) a base rate. LIBOR and base rate borrowings under the Term Loan are subject to a 1.00% and 2.00% “floor,” respectively. As of July 3, 2015, the variable interest rate on the term loan was 4.25%. The Senior Secured Credit Facilities are subject to amortization and prepayment requirements and contain customary representations and warranties, covenants, events of default and other provisions.

Senior Notes due 2018

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

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



Year		Optional Redemption Price
2016		104%
2017 and thereafter		101%

In addition, at any time prior to February 15, 2016, CPII may redeem all or a part of the Senior Notes at a redemption price equal to 100% of the principal amount of the Senior Notes to be redeemed plus an applicable premium (as defined in the indenture governing the Senior Notes) plus accrued and unpaid interest, if any, to, the redemption date.

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

Debt Maturities: As of July 3, 2015, maturities on long-term debt were as follows:



Fiscal Year	Term Loan		Senior Notes		Total
2015 (remaining three months)	$	775	$	—	$	775
2016	3,100		—		3,100
2017	3,100		—		3,100
2018	299,150		215,000		514,150
2019	—		—		—
Thereafter	—		—		—
	$	306,125	$	215,000	$	521,125

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

Covenants

As of July 3, 2015, the Company was in compliance with the covenants under the agreements governing CPII’s new Senior Credit Facilities and the indentures governing the Senior Notes.

Deferred Debt Issuance Costs

CPII incurred debt issuance costs, excluding issue discount, of $8.7 million associated with its new Senior Credit Facilities and $8.0 million associated with the Senior Notes. As of July 3, 2015, the unamortized deferred debt issuance costs related to CPII’s debt were $10.6 million, net of $6.1 million accumulated amortization. As of October 3, 2014, the unamortized deferred debt issuance costs related to CPII’s prior senior credit facilities and the Senior Notes were $12.6 million, net of $4.2 million accumulated amortization.


6.	Derivative Instruments and Hedging Activities

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

The Company’s Canadian dollar forward contracts in effect as of July 3, 2015 have durations of three to 19 months. These contracts are designated as a cash flow hedge and are considered highly effective. Unrealized gains and losses from foreign exchange forward contracts are included in accumulated other comprehensive loss in the condensed consolidated balance sheets. At July 3, 2015, the unrealized loss, net of tax of $0.5 million, was $1.4 million. At October 3, 2014, the unrealized loss, net of tax of $0.3 million, was $0.8 million. The Company anticipates recognizing the entire unrealized gain or loss in operating earnings within the next six fiscal quarters. Changes in the fair value of foreign currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and are immediately recognized in general and administrative expenses in the condensed consolidated statements of comprehensive income. The time value was not material for all periods presented. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, then the Company immediately recognizes the gain or loss on the associated financial instrument in general and administrative expenses in the condensed consolidated statements of comprehensive income. No ineffective amounts were recognized due to hedge ineffectiveness in the three and nine months ended July 3, 2015 and July 4, 2014.

As of July 3, 2015, the Company had entered into Canadian dollar forward contracts for nominal values of approximately $50.1 million (Canadian dollars), or approximately 73% of estimated Canadian dollar denominated expenses for July 2015 through September 2016, at an average rate of approximately 0.82 U.S. dollars to one Canadian dollar.

The aggregate fair value of all derivative instruments designated as cash flow hedges were in a liability position on July 3, 2015 and October 3, 2014 as shown in the following table:



	Liability Derivatives
		Fair Value
	Balance Sheet Location	July 3, 2015		October 3, 2014
Derivative designated as hedging instruments
Forward contracts	Accrued expenses	$	1,321	$	759
Forward contracts	Other long-term liabilities	64		—
Total derivative designated as hedging instruments		$	1,385	$	759

As of July 3, 2015 and October 3, 2014, the Company had no derivative instruments that were classified as non-hedging instruments. The Company’s derivatives are reported on a gross basis. The Company has no master netting arrangements with its derivative counterparties that would allow for net settlement.

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

The following table summarizes the effect of derivative instruments on the condensed consolidated statements of comprehensive income for the periods of fiscal years 2015 and 2014 presented:



Derivatives in Cash Flow Hedging Relationships	Amount of Gain Recognized in OCI on Derivative (Effective Portion)						Loss Reclassified from Accumulated OCI into Income (Effective Portion)							(Loss) Gain Recognized in Income on Derivative (Ineffective and Excluded Portion)
Derivatives in Cash Flow Hedging Relationships							Location	Amount						Location	Amount
	Three Months Ended							Three Months Ended							Three Months Ended
	July 3, 2015			July 4, 2014				July 3, 2015			July 4, 2014				July 3, 2015			July 4, 2014
Forward contracts	$	71		$	898		Cost of sales	$	(928	)	$	(443	)	General and administrative^(a)	$	(4	)	$	61
							Research and development	(86		)	(27		)
							Selling and marketing	(37		)	(12		)
							General and administrative	(44		)	(14		)
Total	$	71		$	898			$	(1,095	)	$	(496	)		$	(4	)	$	61

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

Derivatives in Cash Flow Hedging Relationships	Amount of Loss Recognized in OCI on Derivative (Effective Portion)						Loss Reclassified from Accumulated OCI into Income (Effective Portion)							Gain Recognized in Income on Derivative (Ineffective and Excluded Portion)
Derivatives in Cash Flow Hedging Relationships							Location	Amount						Location	Amount
	Nine Months Ended							Nine Months Ended							Nine Months Ended
	July 3, 2015			July 4, 2014				July 3, 2015			July 4, 2014				July 3, 2015			July 4, 2014
Forward contracts	$	(2,752	)	$	(1,234	)	Cost of sales	$	(1,455	)	$	(963	)	General and administrative^(b)	$	83		$	180
							Research and development	(194		)	(109		)
							Selling and marketing	(85		)	(48		)
							General and administrative	(100		)	(57		)
Total	$	(2,752	)	$	(1,234	)		$	(1,834	)	$	(1,177	)		$	83		$	180

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


7.	Contingencies

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

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)


8.	Related-party Transactions

A former major stockholder of Radant, which was acquired in October 2013, was retained by the Company to serve as president of the division (the “Radant president”). In connection with, and as part of the consideration for, the Radant acquisition, the Company will be obligated to make a maximum of $10.0 million in potential additional payments to the former stockholders of Radant, including the Radant president and certain of his relatives, if certain financial targets are achieved by Radant over the two years following the acquisition. Also in connection with the Radant acquisition, the Company has entered into a lease agreement for a property in Stow, Massachusetts, that contains a manufacturing plant and office facilities owned by a company controlled by the Radant president. The Company records rent expense for the Stow lease on an arm’s length basis. The Company recorded a rent expense for such lease of $0.1 million for each of the three months ended July 3, 2015 and July 4, 2014 and $0.3 million for each of the nine months ended July 3, 2015 and July 4, 2014.


9.	Income Taxes

The condensed consolidated statements of comprehensive income reflect the following income tax expense:



	Three Months Ended						Nine Months Ended
	July 3, 2015			July 4, 2014			July 3, 2015			July 4, 2014
Income (loss) before income taxes	$	1,246		$	(496	)	$	4,734		$	15,035
Income tax expense (benefit)	$	27		$	(3,966	)	$	1,402		$	2,524
Effective income tax rate	2.2		%	799.6		%	29.6		%	16.8		%

The Company’s 2.2% effective tax rate for the three months ended July 3, 2015 differs from the federal statutory rate of 35.0% primarily due to tax benefits from a change in state income apportionment, partially offset by foreign tax credit limitations. The Company’s 799.6% effective tax rate for the three months ended July 4, 2014 differs from the federal statutory rate of 35.0% primarily due to income tax benefits from the expiration of the statute of limitations for an unrecognized tax benefit and the provision to tax return true-up resulting from filing the U.S. fiscal year 2013 income tax return.

The Company’s 29.6% effective tax rate for the nine months ended July 3, 2015 differs from the federal statutory rate of 35.0% primarily due to tax benefits from a change in state income apportionment and a California income tax refund for prior year amended income tax returns, partially offset by foreign tax credit limitations and income tax expense for an uncertain tax position as a result of an intercompany sale of assets. The Company’s 16.8% effective tax rate for the nine months ended July 4, 2014 differs from the federal statutory rate of 35.0% primarily due to income tax benefits from the expiration of the statute of limitations for an unrecognized tax benefit and the provision to tax return true-up resulting from filing the U.S. fiscal year 2013 income tax return.

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

The total liability for gross unrecognized tax benefits was $3.0 million at July 3, 2015 and $4.3 million at July 4, 2014. For the three months ended July 3, 2015, the total liability for gross unrecognized tax benefits decreased by $0.1 million primarily due to the expiration of the statute of limitations. For the nine months ended July 3, 2015, the total liability for gross unrecognized tax benefits decreased by $1.7 million primarily due to settlement of the Company’s California tax audit for fiscal years 2005 through 2007, partially offset by an uncertain tax position as a result of an intercompany sale of assets. The total liability for gross unrecognized tax benefits, if recognized, would reduce the effective tax rate on income from continuing operations. The Company believes that it is reasonably possible that, in the next 12 months, the total amount of unrecognized tax benefits related to the resolution of federal, state and foreign matters could be reduced by $0.1 million as statutes expire and tax payments are made.


10.	Accumulated Other Comprehensive Loss

The following table provides the components of accumulated other comprehensive loss in the condensed consolidated balance sheets:



	July 3, 2015			October 3, 2014
Unrealized loss on cash flow hedges, net of tax of $(481) and $(251), respectively	$	(1,441	)	$	(753	)
Unrealized actuarial gain and prior service credit for pension liability, net of tax of $33 and $33, respectively	100			100
Accumulated other comprehensive loss	$	(1,341	)	$	(653	)

The following tables provide changes in accumulated other comprehensive loss, net of tax, reported in the Company’s condensed consolidated balance sheets for the three and nine months ended July 3, 2015 and July 4, 2014 (amounts in parentheses indicate debits):



	Three Months Ended
	July 3, 2015								July 4, 2014
	Gains and Losses on Cash Flow Hedges			Defined Benefit Pension Items		Total			Gains and Losses on Cash Flow Hedges			Defined Benefit Pension Items		Total
Balance at beginning of period	$	(2,317	)	$	100	$	(2,217	)	$	(1,096	)	$	94	$	(1,002	)
Other comprehensive income before reclassifications	54			—		54			674			—		674
Amounts reclassified from accumulated other comprehensive loss or income	822			—		822			372			—		372
Net current-period other comprehensive income	876			—		876			1,046			—		1,046
Balance at end of period	$	(1,441	)	$	100	$	(1,341	)	$	(50	)	$	94	$	44

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)



	Nine Months Ended
	July 3, 2015								July 4, 2014
	Gains and Losses on Cash Flow Hedges			Defined Benefit Pension Items		Total			Gains and Losses on Cash Flow Hedges			Defined Benefit Pension Items		Total
Balance at beginning of period	$	(753	)	$	100	$	(653	)	$	(8	)	$	94	$	86
Other comprehensive loss before reclassifications	(2,064		)	—		(2,064		)	(925		)	—		(925		)
Amounts reclassified from accumulated other comprehensive loss or income	1,376			—		1,376			883			—		883
Net current-period other comprehensive loss	(688		)	—		(688		)	(42		)	—		(42		)
Balance at end of period	$	(1,441	)	$	100	$	(1,341	)	$	(50	)	$	94	$	44

The following table provides the gross amount reclassified from accumulated other comprehensive loss and the corresponding amount of tax relating to losses on cash flow hedges for the three and nine months ended July 3, 2015 and July 4, 2014 (amounts in parentheses indicate debits):



	Three Months Ended						Nine Months Ended
	July 3, 2015			July 4, 2014			July 3, 2015			July 4, 2014
Amounts reclassified from accumulated other comprehensive loss	$	1,095		$	496		$	1,834		$	1,177
Less: tax	(273		)	(124		)	(458		)	(294		)
Amounts reclassified from accumulated other comprehensive loss, net of tax	$	822		$	372		$	1,376		$	883

See Note 6, Derivatives Instruments and Hedging Activities, for additional disclosures about reclassifications out of accumulated other comprehensive loss and their corresponding effects on the respective line items in the condensed consolidated statements of comprehensive income.


11.	Segments, Geographic and Customer Information

The Company’s reportable segments are RF (“radio frequency”) products and satcom equipment. Made up of five divisions, the RF products segment develops, manufactures and distributes high-power/high-frequency microwave and RF signal components and structures. The satcom equipment segment, which consists of one division, manufactures and supplies high-power amplifiers and networks for satellite communication uplink, industrial and electronic warfare applications. Segment information reported below is consistent with the manner in which it is reviewed and evaluated by the Company’s chief operating decision maker (“CODM”), its chief executive officer, and is based on the nature of the Company’s operations and products offered to customers.

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

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

Summarized financial information concerning the Company’s reportable segments is shown in the following tables:



	Three Months Ended						Nine Months Ended
	July 3, 2015			July 4, 2014			July 3, 2015			July 4, 2014
Sales from external customers
RF products	$	82,867		$	90,995		$	251,101		$	269,459
Satcom equipment	20,475			21,254			59,762			69,997
Other	6,303			7,164			17,420			24,995
	$	109,645		$	119,413		$	328,283		$	364,451
Intersegment product transfers
RF products	$	3,652		$	5,098		$	14,958		$	17,309
Satcom equipment	6			20			24			30
	$	3,658		$	5,118		$	14,982		$	17,339
Capital expenditures^a
RF products	$	974		$	938		$	3,703		$	3,354
Satcom equipment	57			25			188			211
Other	537			387			795			671
	$	1,568		$	1,350		$	4,686		$	4,236
EBITDA
RF products	$	17,351		$	22,475		$	53,376		$	63,604
Satcom equipment	2,211			1,934			6,293			6,797
Other	(3,385		)	(10,066		)	(10,083		)	(14,170		)
	$	16,177		$	14,343		$	49,586		$	56,231

^aCapital expenditures incurred on an accrual basis.



	July 3, 2015		October 3, 2014
Total assets
RF products	$	513,155	$	517,108
Satcom equipment	110,189		110,691
Other	122,269		118,529
	$	745,613	$	746,328

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

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


•	EBITDA is a component of the measures used by the Company’s board of directors and management team to evaluate the Company’s operating performance;


•	the Company’s senior credit facilities contain covenants that require the Company to maintain a total leverage ratio in certain circumstances that contains EBITDA as a component, and the Company’s management team uses EBITDA to monitor compliance with these covenants;

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)


•	EBITDA is a component of the measures used by the Company’s management team to make day-to-day operating decisions;


•	EBITDA facilitates comparisons between the Company’s operating results and those of competitors with different capital structures and, therefore, is a component of the measures used by the management to facilitate internal comparisons to competitors’ results and the Company’s industry in general; and


•	the payment of management bonuses is contingent upon, among other things, the satisfaction by the Company of certain targets that contain EBITDA as a component.

EBITDA is not a presentation made in accordance with U.S. GAAP and has important limitations as an analytical tool. EBITDA should not be considered as an alternative to comprehensive income, net income, operating income or any other performance measures derived in accordance with U.S. GAAP as a measure of operating performance or operating cash flows as a measure of liquidity. The Company’s use of the term EBITDA varies from others in the Company’s industry. The Company’s presentation of EBITDA should not be construed to imply that the Company’s future results will be unaffected by items excluded from the computation of EBITDA. Operating income by the Company’s reportable segments was as follows:



	Three Months Ended						Nine Months Ended
	July 3, 2015			July 4, 2014			July 3, 2015			July 4, 2014
Operating income
RF products	$	15,064		$	20,094		$	46,425		$	56,809
Satcom equipment	1,951			1,666			5,504			5,930
Other	(6,650		)	(6,003		)	(19,883		)	(17,329		)
	$	10,365		$	15,757		$	32,046		$	45,410

The following table reconciles net income to EBITDA:



	Three Months Ended					Nine Months Ended
	July 3, 2015		July 4, 2014			July 3, 2015		July 4, 2014
Net income	$	1,219	$	3,470		$	3,332	$	12,511
Depreciation and amortization	5,812		5,821			17,540		18,056
Interest expense, net	9,119		9,018			27,312		23,140
Income tax expense (benefit)	27		(3,966		)	1,402		2,524
EBITDA	$	16,177	$	14,343		$	49,586	$	56,231

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

12. Supplemental Guarantors Condensed Consolidating Financial Information

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

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

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING BALANCE SHEET

As of July 3, 2015



	Parent			Issuer			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Consolidating Eliminations			Consolidated Total
Assets
Cash and cash equivalents	$	—		$	—		$	52,298	$	8,986		$	—		$	61,284
Restricted cash	—			—			1,585		78			—			1,663
Accounts receivable, net	—			—			29,180		15,792			—			44,972
Inventories	—			—			72,032		27,569			(718		)	98,883
Deferred tax assets	—			—			7,355		1,035			—			8,390
Intercompany receivable	—			—			88,995		9,904			(98,899		)	—
Prepaid and other current assets	—			81			5,716		1,872			250			7,919
Total current assets	—			81			257,161		65,236			(99,367		)	223,111
Property, plant and equipment, net	—			—			57,600		14,381			—			71,981
Deferred debt issue costs, net	—			10,636			—		—			—			10,636
Intangible assets, net	—			—			163,853		76,614			—			240,467
Goodwill	—			—			110,728		88,153			—			198,881
Other long-term assets	—			—			520		17			—			537
Investment in subsidiaries	46,222			761,567			25,996		—			(833,785		)	—
Total assets	$	46,222		$	772,284		$	615,858	$	244,401		$	(933,152	)	$	745,613
Liabilities and stockholders’ equity
Current portion of long-term debt	$	—		$	3,100		$	—	$	—		$	—		$	3,100
Accounts payable	—			—			16,211		7,646			—			23,857
Accrued expenses	697			7,709			25,745		7,555			(57		)	41,649
Product warranty	—			—			2,530		2,339			—			4,869
Income taxes payable	—			—			95		317			—			412
Advance payments from customers	—			—			12,314		2,961			—			15,275
Intercompany payable	—			5,353			—		—			(5,353		)	—
Total current liabilities	697			16,162			56,895		20,818			(5,410		)	89,162
Deferred income taxes, non-current	—			—			71,240		21,412			—			92,652
Long-term debt, less current portion	—			513,774			—		—			—			513,774
Other long-term liabilities	—			—			3,350		1,150			—			4,500
Total liabilities	697			529,936			131,485		43,380			(5,410		)	700,088
Common stock	—			—			—		—			—			—
Parent investment	—			211,100			377,055		174,286			(762,441		)	—
Equity investment in subsidiary	(1,341		)	(1,341		)	9,377		—			(6,695		)	—
Additional paid-in capital	26,326			—			—		—			—			26,326
Accumulated other comprehensive loss	—			—			—		(1,341		)	—			(1,341		)
Retained earnings	20,540			32,589			97,941		28,076			(158,606		)	20,540
Total stockholders’ equity	45,525			242,348			484,373		201,021			(927,742		)	45,525
Total liabilities and stockholders’ equity	$	46,222		$	772,284		$	615,858	$	244,401		$	(933,152	)	$	745,613

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING BALANCE SHEET

As of October 3, 2014



	Parent			Issuer			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Consolidating Eliminations			Consolidated Total
Assets
Cash and cash equivalents	$	—		$	—		$	42,290	$	8,327		$	—		$	50,617
Restricted cash	—			—			1,708		90			—			1,798
Accounts receivable, net	—			—			30,062		13,858			—			43,920
Inventories	—			—			71,153		26,483			(480		)	97,156
Deferred tax assets	—			—			7,265		805			—			8,070
Intercompany receivable	—			—			95,370		16,706			(112,076		)	—
Prepaid and other current assets	—			49			6,010		1,719			182			7,960
Total current assets	—			49			253,858		67,988			(112,374		)	209,521
Property, plant and equipment, net	—			—			61,779		14,880			—			76,659
Deferred debt issue costs, net	—			12,557			—		—			—			12,557
Intangible assets, net	—			—			169,229		79,609			—			248,838
Goodwill	—			—			109,528		88,153			—			197,681
Other long-term assets	—			—			1,055		17			—			1,072
Investment in subsidiaries	43,845			752,212			15,026		—			(811,083		)	—
Total assets	$	43,845		$	764,818		$	610,475	$	250,647		$	(923,457	)	$	746,328
Liabilities and stockholders’ equity
Current portion of long-term debt	$	—		$	3,100		$	—	$	—		$	—		$	3,100
Accounts payable	9			25			15,039		10,492			—			25,565
Accrued expenses	1,692			2,782			19,513		7,340			1			31,328
Product warranty	—			—			2,633		2,230			—			4,863
Income taxes payable	—			—			425		623			—			1,048
Advance payments from customers	—			—			12,018		3,430			—			15,448
Intercompany payable	—			5,353			8,731		—			(14,084		)	—
Total current liabilities	1,701			11,260			58,359		24,115			(14,083		)	81,352
Deferred income taxes, non-current	—			—			72,693		22,142			—			94,835
Long-term debt, less current portion	—			514,938			—		—			—			514,938
Other long-term liabilities	—			—			12,035		1,024			—			13,059
Total liabilities	1,701			526,198			143,087		47,281			(14,083		)	704,184
Common stock	—			—			—		—			—			—
Parent investment	—			211,100			376,459		182,945			(770,504		)	—
Equity investment in subsidiary	(653		)	(653		)	9,377		—			(8,071		)	—
Additional paid-in capital	25,589			—			—		—			—			25,589
Accumulated other comprehensive loss	—			—			—		(653		)	—			(653		)
Retained earnings	17,208			28,173			81,552		21,074			(130,799		)	17,208
Total stockholders’ equity	42,144			238,620			467,388		203,366			(909,374		)	42,144
Total liabilities and stockholders’ equity	$	43,845		$	764,818		$	610,475	$	250,647		$	(923,457	)	$	746,328

- 25 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME

For the Three Months Ended July 3, 2015



	Parent			Issuer			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Consolidating Eliminations			Consolidated Total
Sales	$	—		$	—		$	83,729	$	38,630		$	(12,714	)	$	109,645
Cost of sales	—			—			62,536		29,823			(12,528		)	79,831
Gross profit	—			—			21,193		8,807			(186		)	29,814
Operating costs and expenses:
Research and development	—			—			1,474		2,339			—			3,813
Selling and marketing	—			—			3,449		2,327			(258		)	5,518
General and administrative	586			351			5,465		1,167			3			7,572
Amortization of acquisition-related intangible assets	—			—			1,527		1,019			—			2,546
Total operating costs and expenses	586			351			11,915		6,852			(255		)	19,449
Operating (loss) income	(586		)	(351		)	9,278		1,955			69			10,365
Interest expense (income), net	—			9,122			2		(5		)	—			9,119
(Loss) income before income tax (benefit) expense and equity in income of subsidiaries	(586		)	(9,473		)	9,276		1,960			69			1,246
Income tax (benefit) expense	(209		)	(3,599		)	3,672		137			26			27
Equity in income of subsidiaries	1,596			7,470			473		—			(9,539		)	—
Net income	1,219			1,596			6,077		1,823			(9,496		)	1,219
Equity in other comprehensive income of subsidiaries, net of tax	876			876			—		—			(1,752		)	—
Other comprehensive income, net of tax
Unrealized gain on cash flow hedges, net of tax	—			—			—		876			—			876
Total other comprehensive income, net of tax	—			—			—		876			—			876
Comprehensive income	$	2,095		$	2,472		$	6,077	$	2,699		$	(11,248	)	$	2,095

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME

For the Three Months Ended July 4, 2014



	Parent			Issuer			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Consolidating Eliminations			Consolidated Total
Sales	$	—		$	—		$	95,912	$	40,823		$	(17,322	)	$	119,413
Cost of sales	—			—			68,643		31,557			(16,698		)	83,502
Gross profit	—			—			27,269		9,266			(624		)	35,911
Operating costs and expenses:
Research and development	—			—			1,960		2,109			—			4,069
Selling and marketing	—			—			3,624		2,803			(516		)	5,911
General and administrative	711			150			5,126		1,585			182			7,754
Amortization of acquisition-related intangible assets	—			—			1,401		1,019			—			2,420
Total operating costs and expenses	711			150			12,111		7,516			(334		)	20,154
Operating (loss) income	(711		)	(150		)	15,158		1,750			(290		)	15,757
Interest expense (income), net	—			9,018			2		(2		)	—			9,018
Loss on debt restructuring	—			7,235			—		—			—			7,235
(Loss) income before income tax (benefit) expense and equity in income of subsidiaries	(711		)	(16,403		)	15,156		1,752			(290		)	(496		)
Income tax (benefit) expense	(249		)	(6,231		)	1,784		840			(110		)	(3,966		)
Equity in income of subsidiaries	3,932			14,104			451		—			(18,487		)	—
Net income	3,470			3,932			13,823		912			(18,667		)	3,470
Equity in other comprehensive income of subsidiaries, net of tax	1,046			1,046			—		—			(2,092		)	—
Other comprehensive income, net of tax
Unrealized gain on cash flow hedges, net of tax	—			—			—		1,046			—			1,046
Total other comprehensive income, net of tax	—			—			—		1,046			—			1,046
Comprehensive income	$	4,516		$	4,978		$	13,823	$	1,958		$	(20,759	)	$	4,516

- 27 -

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CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME

For the Nine Months Ended July 3, 2015



	Parent			Issuer			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Consolidating Eliminations			Consolidated Total
Sales	$	—		$	—		$	253,531	$	122,284		$	(47,532	)	$	328,283
Cost of sales	—			—			188,915		94,447			(46,384		)	236,978
Gross profit	—			—			64,616		27,837			(1,148		)	91,305
Operating costs and expenses:
Research and development	—			—			5,178		6,192			—			11,370
Selling and marketing	—			—			10,294		7,697			(973		)	17,018
General and administrative	1,748			1,657			16,712		3,114			3			23,234
Amortization of acquisition-related intangible assets	—			—			4,586		3,051			—			7,637
Total operating costs and expenses	1,748			1,657			36,770		20,054			(970		)	59,259
Operating (loss) income	(1,748		)	(1,657		)	27,846		7,783			(178		)	32,046
Interest expense (income), net	—			27,311			6		(5		)	—			27,312
(Loss) income before income tax (benefit) expense and equity in income of subsidiaries	(1,748		)	(28,968		)	27,840		7,788			(178		)	4,734
Income tax (benefit) expense	(664		)	(11,009		)	12,357		786			(68		)	1,402
Equity in income of subsidiaries	4,416			22,375			906		—			(27,697		)	—
Net income	3,332			4,416			16,389		7,002			(27,807		)	3,332
Equity in other comprehensive loss of subsidiaries	(688		)	(688		)	—		—			1,376			—
Other comprehensive loss, net of tax
Unrealized loss on cash flow hedges, net of tax	—			—			—		(688		)	—			(688		)
Total other comprehensive loss, net of tax	—			—			—		(688		)	—			(688		)
Comprehensive income	$	2,644		$	3,728		$	16,389	$	6,314		$	(26,431	)	$	2,644

- 28 -

Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME

For the Nine Months Ended July 4, 2014



	Parent			Issuer			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Consolidating Eliminations			Consolidated Total
Sales	$	—		$	—		$	281,196	$	135,149		$	(51,894	)	$	364,451
Cost of sales	—			—			205,711		103,775			(50,611		)	258,875
Gross profit	—			—			75,485		31,374			(1,283		)	105,576
Operating costs and expenses:
Research and development	—			—			4,808		6,878			—			11,686
Selling and marketing	—			—			10,398		8,531			(1,274		)	17,655
General and administrative	2,299			567			15,927		3,948			186			22,927
Amortization of acquisition-related intangible assets	—			—			4,842		3,056			—			7,898
Total operating costs and expenses	2,299			567			35,975		22,413			(1,088		)	60,166
Operating (loss) income	(2,299		)	(567		)	39,510		8,961			(195		)	45,410
Interest expense (income), net	—			23,139			6		(5		)	—			23,140
Loss on debt restructuring	—			7,235			—		—			—			7,235
(Loss) income before income tax (benefit) expense and equity in income of subsidiaries	(2,299		)	(30,941		)	39,504		8,966			(195		)	15,035
Income tax (benefit) expense	(853		)	(11,757		)	13,231		1,977			(74		)	2,524
Equity in income of subsidiaries	13,957			33,141			829		—			(47,927		)	—
Net income	12,511			13,957			27,102		6,989			(48,048		)	12,511
Equity in other comprehensive loss of subsidiaries	(42		)	(42		)	—		—			84			—
Other comprehensive loss, net of tax
Unrealized loss on cash flow hedges, net of tax	—			—			—		(42		)	—			(42		)
Total other comprehensive loss, net of tax	—			—			—		(42		)	—			(42		)
Comprehensive income	$	12,469		$	13,915		$	27,102	$	6,947		$	(47,964	)	$	12,469

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Table of Contents

CPI INTERNATIONAL HOLDING CORP.

and Subsidiaries

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular dollar amounts in thousands)

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

For the Nine Months Ended July 3, 2015



	Parent		Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated Total
Cash flows from operating activities
Net cash provided by operating activities	$	—	$	2,325		$	13,979		$	1,383		$	17,687
Cash flows from investing activities
Capital expenditures	—		—			(3,971		)	(724		)	(4,695		)
Net cash used in investing activities	—		—			(3,971		)	(724		)	(4,695		)
Cash flows from financing activities
Return of intercompany capital	—		8,800			—			(8,800		)	—
Intercompany funding	—		(8,800		)	—			8,800			—
Repayment of borrowings under Term Loan	—		(2,325		)	—			—			(2,325		)
Net cash used in financing activities	—		(2,325		)	—			—			(2,325		)
Net increase in cash and cash equivalents	—		—			10,008			659			10,667
Cash and cash equivalents at beginning of period	—		—			42,290			8,327			50,617
Cash and cash equivalents at end of period	$	—	$	—		$	52,298		$	8,986		$	61,284

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

For the Nine Months Ended July 4, 2014



	Parent			Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated Total
Cash flows from operating activities
Net cash provided by operating activities	$	—		$	—		$	36,600		$	3,041		$	39,641
Cash flows from investing activities
Capital expenditures	—			—			(4,171		)	(425		)	(4,596		)
Acquisition, net of cash acquired	—			—			(36,776		)	—			(36,776		)
Net cash used in investing activities	—			—			(40,947		)	(425		)	(41,372		)
Cash flows from financing activities
Return of intercompany capital	—			9,000			—			(9,000		)	—
Intercompany funding	—			15,824			(24,824		)	9,000			—
Intercompany dividend	175,000			(175,000		)	—			—			—
Borrowings under Term Loan	—			309,225			—			—			309,225
Payment of debt issue costs	—			(8,734		)	—			—			(8,734		)
Payment of debt modification costs	—			(5,365		)	—			—			(5,365		)
Repayment of borrowings under previous term loan facility	—			(144,175		)	—			—			(144,175		)
Repayment of borrowings under Term Loan	—			(775		)	—			—			(775		)
Dividends paid	(175,000		)	—			—			—			(175,000		)
Net cash used in financing activities	—			—			(24,824		)	—			(24,824		)
Net (decrease) increase in cash and cash equivalents	—			—			(29,171		)	2,616			(26,555		)
Cash and cash equivalents at beginning of period	—			—			61,387			5,664			67,051
Cash and cash equivalents at end of period	$	—		$	—		$	32,216		$	8,280		$	40,496

- 30 -

Table of Contents

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

Our fiscal years are the 52- or 53-week periods that end on the Friday nearest September 30. Fiscal years 2015 and 2014 comprise the 52- and 53-week periods ending October 2, 2015 and October 3, 2014, respectively. Each of the three months ended July 3, 2015 and July 4, 2014 included 13 weeks. The nine months ended July 3, 2015 and July 4, 2014 included 39 and 40 weeks, respectively. The following discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements, and the notes thereto, of CPI International Holding Corp.

Overview

CPI International Holding Corp. (“Parent”), headquartered in Palo Alto, California, is the parent company of CPI International, Inc. (“CPII”), which in turn is a parent company of Communications & Power Industries LLC (“CPI”) and Communications & Power Industries Canada Inc. (“CPI Canada”). CPI and CPI Canada, CPII’s main operating subsidiaries, together develop, manufacture and globally distribute components and subsystems used in the generation, amplification, transmission and reception of microwave signals for a wide variety of systems including radar, electronic warfare and communications (satellite and point-to-point) systems for military and commercial applications, specialty products for medical diagnostic imaging and the treatment of cancer, as well as microwave and radio frequency (“RF”) energy generating products for various industrial and scientific pursuits.

Inclusion of an additional week in the nine months ended July 4, 2014 increased our orders, sales and certain operating expenses for that period. The reduction in sales and certain operating expenses for the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014 was partially due to the absence of an additional week in the period ended July 3, 2015.

Orders

We sell our products into five end markets: defense (radar and electronic warfare), medical, communications, industrial and scientific.

Our customer sales contracts are recorded as orders when we accept written customer purchase orders or contracts. Customer purchase orders with an undefined delivery schedule, or blanket purchase orders, are not reported as orders until the delivery date is determined. Our government sales contracts are not reported as orders until we have been notified that the contract has been funded. Total orders for a fiscal period represent the total dollar amount of customer orders recorded by us during the fiscal period, reduced by the dollar amount of any order cancellations or terminations during the fiscal period.

Our orders by market for the nine months ended July 3, 2015, which included 39 weeks, and July 4, 2014, which included 40 weeks, are summarized as follows (dollars in millions):



	Nine Months Ended
	July 3, 2015				July 4, 2014				(Decrease) Increase
	Amount		% of Orders		Amount		% of Orders		Amount			Percent
Radar and Electronic Warfare	$	134.5	40	%	$	136.9	41	%	$	(2.4	)	(2	)%
Medical	56.7		17		56.9		17		(0.2		)	—
Communications	123.5		37		104.5		31		19.0			18
Industrial	16.9		5		21.9		7		(5.0		)	(23	)
Scientific	4.5		1		13.3		4		(8.8		)	(66	)
Total	$	336.1	100	%	$	333.5	100	%	$	2.6		1	%

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Table of Contents

Orders of $336.1 million for the nine months ended July 3, 2015 were $2.6 million, or approximately 1%, higher than orders of $333.5 million for the nine months ended July 4, 2014. Explanations for the order increase or decrease by market for the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014 are as follows:

•

Radar and Electronic Warfare: The majority of our products in the radar and electronic warfare markets are for domestic and international defense and government end uses. Orders in these markets are typically characterized by many smaller orders of less than $3.0 million, and the timing of these orders may vary from year to year. Orders for the radar and electronic warfare markets decreased 2%, primarily due to a decrease in orders to support Aegis radar systems, a one-time shipboard radar program and a foreign airborne electronic countermeasures program. Although orders to support Aegis radar systems decreased, order levels for this program are currently significantly higher than the long-term historical averages for this program. This decrease was partially offset by an increase in orders of radomes for an electronic warfare program and an increase in orders to support foreign naval radar systems.

•

Medical: Orders for our medical products consist of orders for medical imaging applications, such as x-ray imaging, MRI and other applications, and for radiation therapy applications for the treatment of cancer. Medical orders were essentially unchanged. A decrease in orders for products to support x-ray imaging, including x-ray imaging products used in radiation therapy applications, was offset by an increase in orders for MRI applications.

•

Communications: Orders for our communications products consist of orders for commercial and military communications applications. The 18% increase in communications orders was due to higher orders for products to support military communications applications, including advanced tactical common data link ("TCDL") antenna products and satellite communications amplifier products. This increase was partially offset by a decrease in radome orders for naval communications applications and a decrease in amplifier orders for direct-to-home broadcast applications due to the timing of large programs for those applications.

•

Industrial: Orders for our industrial market consist of products to support a wide range of systems used for applications including material processing, instrumentation and testing. Orders in this market are cyclical and generally follow the state of the economy. The $5.0 million decrease in industrial orders was largely due to lower orders for products to support electromagnetic vulnerability testing and material analysis applications.

•

Scientific: Orders in the scientific market consist of equipment used in accelerators for the study of high-energy particle physics and in reactor fusion programs. Orders in this market are historically one-time projects and can fluctuate significantly from period to period. The $8.8 million decrease in scientific orders was primarily due to the absence of orders for a foreign linear accelerator program, a foreign fusion program and a domestic linear accelerator program that were not expected to, and did not, repeat in the nine months ended July 3, 2015.

Incoming order levels can fluctuate significantly on a quarterly or annual basis, and a particular quarter’s or year’s order rate may not be indicative of future order levels. In addition, our sales are highly dependent upon manufacturing scheduling and performance and, accordingly, it is not possible to accurately predict when orders will be recognized as sales.

Backlog

Backlog represents the cumulative balance, at a given point in time, of recorded customer sales orders that have not yet been shipped or recognized as sales. Backlog is increased when an order is received, and backlog is decreased when we recognize sales. As of July 3, 2015, we had an order backlog of $316.5 million, compared to an order backlog of $331.2 million as of July 4, 2014. Because our orders for government end-use products generally have much longer delivery terms than our orders for commercial business (which require quicker turn-around), our backlog is primarily composed of government orders.

We believe that backlog and orders information is helpful to investors because this information may be indicative of future sales results. Although backlog consists of firm orders for which goods and services are yet to be provided, customers can, and sometimes do, terminate or modify these orders. However, historically the amount of modifications and terminations has not been material compared to total contract volume.

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Results of Operations

We generally recognize revenue upon shipment of product, following receipt of written purchase orders, when the price is fixed or determinable, title has transferred and collectability is reasonably assured. Revenue recognized under the percentage-of-completion method of accounting is determined on the basis of costs incurred and estimates of costs at completion, which require management estimates of future costs.

Cost of goods sold generally includes costs for raw materials, manufacturing costs, including allocation of overhead and other indirect costs, charges for reserves for excess and obsolete inventory, warranty claims, losses on fixed price contracts and, normally upon a business combination, utilization of the net increase in cost basis of acquired inventory. Operating expenses generally consist of research and development, selling and marketing, general and administrative expenses and amortization of acquisition-related intangibles.

The debt restructuring we completed in April 2014 resulted in, and will continue to result in, a substantial increase in interest expense and in amortization of debt issue costs and issue discount. The annual increase in cash interest expense due to the change in interest rate on our Senior Notes due 2018 (the “Senior Notes”) is approximately $1.6 million throughout their remaining term. The annual increase in cash interest expense due to increased borrowings under our new term loan facility is approximately $6.3 million throughout its remaining term. The annual increase in amortization of debt issue costs and issue discount on the Senior Notes and senior secured credit facilities averages $1.8 million throughout their respective remaining terms.

Three Months Ended July 3, 2015 Compared to Three Months Ended July 4, 2014

The following table sets forth our historical results of operations for each of the periods indicated (dollars in millions):



	Three Months Ended									(Decrease) Increase
	July 3, 2015				July 4, 2014
	Amount		% of Sales		Amount			% of Sales
Sales	$	109.6	100.0	%	$	119.4		100.0	%	$	(9.8	)
Cost of sales	79.8		72.8		83.5			69.9		(3.7		)
Gross profit	29.8		27.2		35.9			30.1		(6.1		)
Research and development	3.8		3.5		4.1			3.4		(0.3		)
Selling and marketing	5.5		5.0		5.9			4.9		(0.4		)
General and administrative	7.6		6.9		7.8			6.5		(0.2		)
Amortization of acquisition-related intangibles	2.5		2.3		2.4			2.0		0.1
Operating income	10.4		9.5		15.8			13.2		(5.4		)
Interest expense, net	9.1		8.3		9.0			7.5		0.1
Loss on debt restructuring	—		—		7.2			6.0		(7.2		)
Income (loss) before income taxes	1.2		1.1		(0.5		)	(0.4	)	1.7
Income tax expense (benefit)	—		—		(4.0		)	(3.4	)	4.0
Net income	$	1.2	1.1	%	$	3.5		2.9	%	$	(2.3	)
Other Data:
EBITDA ^(a)	$	16.2	14.8	%	$	14.3		12.0	%	$	1.9

Note: Totals may not equal the sum of the components due to independent rounding. Percentages are calculated based on rounded dollar amounts presented.

(a)

EBITDA represents earnings before net interest expense, provision for income taxes and depreciation and amortization. For the reasons listed below, we believe that U.S. generally accepted accounting principles (“GAAP”) based financial information for leveraged businesses, such as ours, should be supplemented by EBITDA so that investors better understand our financial performance in connection with their analysis of our business:


•	EBITDA is a component of the measures used by our board of directors and management team to evaluate our operating performance;


•	our senior credit facilities contain covenants that require us to maintain a total leverage ratio in certain circumstances that contains EBITDA as a component, and our management team uses EBITDA to monitor compliance with these covenants;


•	EBITDA is a component of the measures used by our management team to make day-to-day operating decisions;

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•	EBITDA facilitates comparisons between our operating results and those of competitors with different capital structures and, therefore, is a component of the measures used by the management to facilitate internal comparisons to competitors’ results and our industry in general; and


•	the payment of management bonuses is contingent upon, among other things, the satisfaction by us of certain targets that contain EBITDA as a component.

Other companies may define EBITDA differently and, as a result, our measure of EBITDA may not be directly comparable to EBITDA of other companies. Although we use EBITDA as a financial measure to assess the performance of our business, the use of EBITDA is limited because it does not include certain material costs, such as interest and taxes, necessary to operate our business. When analyzing our performance, EBITDA should be considered in addition to, and not as a substitute for or superior to, comprehensive income, net income, operating income, cash flows from operating activities or other statements of income or statements of cash flows data prepared in accordance with GAAP.

For a reconciliation of Net Income to EBITDA, see Note 11, Segments, Geographic and Customer Information, of the accompanying unaudited condensed consolidated financial statements.

Sales: Our sales by market for the three months ended July 3, 2015 and July 4, 2014 are summarized as follows (dollars in millions):



	Three Months Ended
	July 3, 2015				July 4, 2014				(Decrease) Increase
	Amount		% of Sales		Amount		% of Sales		Amount			Percent
Radar and Electronic Warfare	$	45.6	42	%	$	46.2	39	%	$	(0.6	)	(1	)%
Medical	15.5		14		18.0		15		(2.5		)	(14	)
Communications	40.8		37		44.2		37		(3.4		)	(8	)
Industrial	5.7		5		5.6		5		0.1			2
Scientific	2.0		2		5.4		4		(3.4		)	(63	)
Total	$	109.6	100	%	$	119.4	100	%	$	(9.8	)	(8	)%

Sales of $109.6 million for the three months ended July 3, 2015 were $9.8 million, or approximately 8%, lower than sales of $119.4 million for the three months ended July 4, 2014. Explanations for the sales increase or decrease by market for the three months ended July 3, 2015 compared to the three months ended July 4, 2014 are as follows:

•

Radar and Electronic Warfare: The majority of our products in the radar and electronic warfare markets are for domestic and international defense and government end uses. The timing of order receipts and subsequent shipments in these markets may vary from year to year. Sales for these two markets were essentially unchanged. An increase in sales to support a variety of radar applications, including several cloud-profiling radar programs, offset a decrease in sales of products for a radar program with fluctuating annual demand levels and an airborne electronic warfare program that has been completed.

•

Medical: Sales of our medical products consist of sales for medical imaging applications, such as x-ray imaging, MRI and other applications, and for radiation therapy applications for the treatment of cancer. The 14% decrease in sales in the medical market was due to a decrease in sales of products to support x-ray imaging, including x-ray imaging products used in radiation therapy applications, and was partially offset by an increase in sales of products to support MRI applications.

•

Communications: Sales of our communications products consist of sales for commercial and military communications applications. The 8% decrease in sales in the communications market was primarily due to lower sales of products to support military communications applications, including advanced TCDL antenna products and radomes for naval communications applications. The expected decrease in sales of advanced TCDL products was due to the completion of shipments for the large original order, however shipments are continuing for the smaller, follow-on orders subsequently received for these products. The decrease in sales of radomes are due to temporarily delayed shipments for an ongoing program.


•	Industrial: Sales for our industrial market consist of sales to support a wide range of systems used for applications including material processing, instrumentation and testing. Sales in this market are cyclical and generally follow the state of the economy. The $0.1 million increase in sales of industrial products was primarily the result of higher sales to support cargo screening applications.

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•

Scientific: Sales in the scientific market consist of sales of equipment used in accelerators for the study of high-energy particle physics and in reactor fusion programs. Sales in this market are historically one-time projects and can fluctuate significantly from period to period. The $3.4 million decrease in sales of scientific products was primarily the result of lower sales to support certain foreign accelerator programs.

Gross Profit. Gross profit was $29.8 million, or 27.2% of sales, for the three months ended July 3, 2015 compared to $35.9 million, or 30.1% of sales, for the three months ended July 4, 2014. The $6.1 million decrease in gross profit was primarily due to lower shipment volume and a less favorable mix of product shipments, partially offset by the favorable impact from currency translation of Canadian costs due to the strength of the U.S. dollar for the three months ended July 3, 2015.

Research and Development. Research and development expenses were $3.8 million, or 3.5% of sales, for the three months ended July 3, 2015 and $4.1 million, or 3.4% of sales, for the three months ended July 4, 2014. There was no significant change in research and development expenses for the three months ended July 3, 2015 compared to the three months ended July 4, 2014.

Total spending on research and development, including customer-sponsored research and development, was as follows (in millions):



	Three Months Ended
	July 3, 2015		July 4, 2014
Company sponsored	$	3.8	$	4.1
Customer sponsored	2.9		1.7
	$	6.7	$	5.8

Customer-sponsored research and development represents development costs incurred on customer sales contracts to develop new or improved products.

Selling and Marketing. Selling and marketing expenses were $5.5 million, or 5.0% of sales, for the three months ended July 3, 2015, and $5.9 million, or 4.9% of sales, for the three months ended July 4, 2014. The $0.4 million decrease in selling and marketing expenses was primarily due to lower accruals for sales incentives for the three months ended July 3, 2015 compared to the three months ended July 4, 2014.

General and Administrative. General and administrative expenses were $7.6 million, or 6.9% of sales, for the three months ended July 3, 2015, and $7.8 million, or 6.5% of sales, for the three months ended July 4, 2014. The $0.2 million decrease in general and administrative expenses was primarily due to $1.0 million lower accruals for management incentives, partially offset by a $0.6 million increase in allowance for doubtful accounts for the three months ended July 3, 2015 compared to the three months ended July 4, 2014.

Amortization of Acquisition-related Intangibles. Amortization of acquisition-related intangibles consists of purchase accounting charges for technology and other intangible assets. Amortization of acquisition-related intangibles was $2.5 million for the three months ended July 3, 2015 and $2.4 million for the three months ended July 4, 2014. There was no significant change in amortization of acquisition-related intangibles for the three months ended July 3, 2015 compared to the three months ended July 4, 2014.

Interest Expense, Net (“Interest Expense”). Interest expense was $9.1 million, or 8.3% of sales, for the three months ended July 3, 2015 and $9.0 million, or 7.5% of sales, for the three months ended July 4, 2014. There was no significant change in interest expense, net for the three months ended July 3, 2015 compared to the three months ended July 4, 2014.

Loss on Debt Restructuring. Loss on debt restructuring of $7.2 million for the three months ended July 4, 2014 was due to expenses incurred in connection with the April 7, 2014 debt restructuring. The loss on debt restructuring consisted of non-cash write-offs of deferred debt issue costs and original issue discount of $3.8 million for the termination of the previous senior secured credit facilities, as well as cash payments to third-party consultants of $3.4 million for services to modify the Senior Notes.

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Income Tax Expense (Benefit). We recorded income tax expense of $27,000 for the three months ended July 3, 2015 and an income tax benefit of $4.0 million for the three months ended July 4, 2014. The $27,000 income tax expense for the three months ended July 3, 2015 included current income tax provision of approximately $0.8 million, mostly offset by a $0.7 million income tax benefit from a change in state income apportionment. The income tax benefit of $4.0 million for the three months ended July 4, 2014 was primarily due to discrete income tax benefits of $3.4 million from the expiration of the statute of limitations for an unrecognized tax benefit and a $1.0 million provision to tax return true-up from filing the U.S. fiscal year 2013 income tax return.

Net Income. Net income was $1.2 million, or 1.1% of sales, for the three months ended July 3, 2015 compared to net income of $3.5 million, or 2.9% of sales, for the three months ended July 4, 2014. The $2.3 million decrease in net income was primarily due to lower gross profit from lower shipment volume and less favorable mix of product shipments, and higher income tax expense for the three months ended July 3, 2015, partially offset by lower operating expenses and by the absence of a loss on debt restructuring that was incurred for the three months ended July 4, 2014.

EBITDA. EBITDA was $16.2 million, or 14.8% of sales, for the three months ended July 3, 2015 compared to $14.3 million, or 12.0% of sales, for the three months ended July 4, 2014. The $1.9 million increase in EBITDA was primarily due to lower operating expenses and the absence of a loss on debt restructuring that was incurred for the three months ended July 4, 2014, partially offset by lower gross profit from lower shipment volume and a less favorable mix of product shipments, and an increase in allowance for doubtful accounts for the three months ended July 3, 2015.

Nine Months Ended July 3, 2015 Compared to Nine Months Ended July 4, 2014

The following table sets forth our historical results of operations for each of the periods indicated (dollars in millions):



	Nine Months Ended								(Decrease) Increase
	July 3, 2015				July 4, 2014
	Amount		% of Sales		Amount		% of Sales
Sales	$	328.3	100.0	%	$	364.5	100.0	%	$	(36.2	)
Cost of sales ^(a)	237.0		72.2		258.9		71.0		(21.9		)
Gross profit	91.3		27.8		105.6		29.0		(14.3		)
Research and development	11.4		3.5		11.7		3.2		(0.3		)
Selling and marketing	17.0		5.2		17.7		4.9		(0.7		)
General and administrative	23.2		7.1		22.9		6.3		0.3
Amortization of acquisition-related intangibles	7.6		2.3		7.9		2.2		(0.3		)
Operating income	32.0		9.7		45.4		12.5		(13.4		)
Interest expense, net	27.3		8.3		23.1		6.3		4.2
Loss on debt restructuring	—		—		7.2		2.0		(7.2		)
Income before income taxes	4.7		1.4		15.0		4.1		(10.3		)
Income tax expense	1.4		0.4		2.5		0.7		(1.1		)
Net income	$	3.3	1.0	%	$	12.5	3.4	%	$	(9.2	)
Other Data:
EBITDA ^(b)	$	49.6	15.1	%	$	56.2	15.4	%	$	(6.6	)

Note: Totals may not equal the sum of the components due to independent rounding. Percentages are calculated based on rounded dollar amounts presented.


(a)	Cost of sales for the nine months ended July 4, 2014 includes $1.5 million of utilization of the net increase in cost basis of inventory that resulted from purchase accounting in connection with an acquisition.


(b)	EBITDA represents earnings before net interest expense, provision for income taxes and depreciation and amortization. For the reasons listed below, we believe that U.S. GAAP-based financial information for leveraged businesses, such as ours, should be supplemented by EBITDA so that investors better understand our financial performance in connection with their analysis of our business:


•	EBITDA is a component of the measures used by our board of directors and management team to evaluate our operating performance;


•	our senior credit facilities contain covenants that require us to maintain a total leverage ratio in certain circumstances that contains EBITDA as a component, and our management team uses EBITDA to monitor compliance with these covenants;

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•	EBITDA is a component of the measures used by our management team to make day-to-day operating decisions;


•	EBITDA facilitates comparisons between our operating results and those of competitors with different capital structures and, therefore, is a component of the measures used by the management to facilitate internal comparisons to competitors’ results and our industry in general; and


•	the payment of management bonuses is contingent upon, among other things, the satisfaction by us of certain targets that contain EBITDA as a component.

For a reconciliation of Net Income to EBITDA, see Note 11, Segments, Geographic and Customer Information, of the accompanying unaudited condensed consolidated financial statements.

Sales: Our sales by market for the nine months ended July 3, 2015, which included 39 weeks, and July 4, 2014, which included 40 weeks, are summarized as follows (dollars in millions):



	Nine Months Ended
	July 3, 2015				July 4, 2014				Decrease
	Amount		% of Sales		Amount		% of Sales		Amount			Percent
Radar and Electronic Warfare	$	131.4	40	%	$	138.3	38	%	$	(6.9	)	(5	)%
Medical	51.7		16		55.7		15		(4.0		)	(7	)
Communications	119.8		37		140.0		39		(20.2		)	(14	)
Industrial	17.9		5		18.5		5		(0.6		)	(3	)
Scientific	7.5		2		12.0		3		(4.5		)	(38	)
Total	$	328.3	100	%	$	364.5	100	%	$	(36.2	)	(10	)%

Sales of $328.3 million for the nine months ended July 3, 2015 were $36.2 million, or approximately 10%, lower than sales of $364.5 million for the nine months ended July 4, 2014. Explanations for the sales decrease by market for the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014 are as follows:

•

Radar and Electronic Warfare: The majority of our products in the radar and electronic warfare markets are for domestic and international defense and government end uses. The timing of order receipts and subsequent shipments in these markets may vary from year to year. Sales for these two markets decreased 5%, primarily as the result of lower sales to support certain radar applications, including a program with fluctuating annual demand levels and a shipboard program for which the initial production contract has been substantially completed, as well as lower sales for an airborne electronic warfare program that has been completed.


•	Medical: Sales of our medical products consist of sales for medical imaging applications, such as x-ray imaging, MRI and other applications, and for radiation therapy applications for the treatment of cancer. The 7% decrease in sales in the medical market was primarily due to a decrease in sales of x-ray imaging products used in radiation therapy applications.

•

Communications: Sales of our communications products consist of sales for commercial and military communications applications. The 14% decrease in sales in the communications market was primarily due to lower sales of products to support military communications applications, including advanced TCDL antenna products and satellite communications amplifier products. The expected decrease in sales of advanced TCDL products was due to the completion of shipments for the large original order, however shipments are continuing for the smaller, follow-on orders subsequently received for these products. Sales to support commercial communications applications decreased, as well.

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•

Industrial: Sales for our industrial market consist of sales to support a wide range of systems used for applications including material processing, instrumentation and testing. Sales in this market are cyclical and generally follow the state of the economy. The $0.6 million decrease in sales of industrial products was primarily due to lower sales to support electromagnetic vulnerability testing applications and was partially offset by an increase in sales to support cargo screening applications.

•

Scientific: Sales in the scientific market consist of sales of equipment used in accelerators for the study of high-energy particle physics and in reactor fusion programs. Sales in this market are historically one-time projects and can fluctuate significantly from period to period. The $4.5 million decrease in scientific sales was the result of a decrease in sales for certain foreign and domestic accelerator programs.

Gross Profit. Gross profit was $91.3 million, or 27.8% of sales, for the nine months ended July 3, 2015 compared to $105.6 million, or 29.0% of sales, for the nine months ended July 4, 2014. The $14.3 million decrease in gross profit was primarily due to lower shipment volume and a less favorable mix of product shipments for the nine months ended July 3, 2015, partially offset by the favorable impact from currency translation of Canadian costs due to the strength of the U.S. dollar for the nine months ended July 3, 2015 and the absence of a $1.5 million charge for utilization of the net increase in cost basis of inventory acquired in the acquisition of Radant Technologies, Inc. (“Radant”) for the nine months ended July 4, 2014.

Research and Development. Research and development expenses were $11.4 million, or 3.5% of sales, for the nine months ended July 3, 2015 and $11.7 million, or 3.2% of sales, for the nine months ended July 4, 2014. There was no significant change in research and development expenses for the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014.

Total spending on research and development, including customer-sponsored research and development, was as follows (in millions):



	Nine Months Ended
	July 3, 2015		July 4, 2014
Company sponsored	11.4		11.7
Customer sponsored	7.2		6.4
	$	18.6	$	18.1

Customer-sponsored research and development represents non-recurring development costs incurred on customer sales contracts to develop new or improved products.

Selling and Marketing. Selling and marketing expenses were $17.0 million, or 5.2% of sales, for the nine months ended July 3, 2015, and $17.7 million, or 4.9% of sales, for the nine months ended July 4, 2014. The $0.7 million decrease in selling and marketing expenses was primarily due to the favorable impact of foreign currency denominated expenses due to the strength of the U.S. dollar for the nine months ended July 3, 2015 and the absence of the additional work week in the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014.

General and Administrative. General and administrative expenses were $23.2 million, or 7.1% of sales, for the nine months ended July 3, 2015, and $22.9 million, or 6.3% of sales, for the nine months ended July 4, 2014. The $0.3 million increase in general and administrative expenses was primarily due to a $1.2 million increase in the fair value of the Radant contingent consideration liability, a $1.1 million increase in acquisition-related expenses and a $0.6 million increase in allowance for doubtful accounts, mostly offset by lower accruals for management incentives and Veritas management fees of $1.7 million, as well as the absence of the additional work week in the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014.

Amortization of Acquisition-related Intangibles. Amortization of acquisition-related intangibles consists of purchase accounting charges for technology and other intangible assets. Amortization of acquisition-related intangibles was $7.6 million for the nine months ended July 3, 2015 and $7.9 million for the nine months ended July 4, 2014. The $0.3 million decrease in amortization of acquisition-related intangibles was primarily due to the absence of the additional work week in the nine months ended July 3, 2015.

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Interest Expense, Net (“Interest Expense”). Interest expense was $27.3 million, or 8.3% of sales, for the nine months ended July 3, 2015 and $23.1 million, or 6.3% of sales, for the nine months ended July 4, 2014. The $4.2 million increase in interest expense was primarily due to the approximately $170.0 million increase in borrowings under the new term loan facility in connection with the April 7, 2014 debt restructuring, partially offset by the absence of the additional work week in the nine months ended July 3, 2015.

Loss on Debt Restructuring. Loss on debt restructuring of $7.2 million for the nine months ended July 4, 2014 was due to expenses incurred in connection with the April 7, 2014 debt restructuring. The loss on debt restructuring consisted of non-cash write-offs of deferred debt issue costs and original issue discount of $3.8 million for the termination of the previous senior secured credit facilities, as well as cash payments to third-party consultants of $3.4 million for services to modify the Senior Notes.

Income Tax Expense. We recorded income tax expense of $1.4 million for the nine months ended July 3, 2015 and income tax expense of $2.5 million for the nine months ended July 4, 2014. The effective income tax rate for the nine months ended July 3, 2015 was 30% and the effective income tax rate for the nine months ended July 4, 2014 was 17%. The 30% tax rate for the nine months ended July 3, 2015 was lower than our estimated normalized effective tax rate for fiscal year 2015 of approximately 50% primarily due to a $0.7 million tax benefit from a change in state income apportionment and a $0.7 million tax benefit from a California income tax refund for prior year amended income tax returns, partially offset by a $0.7 million income tax expense for an uncertain tax position as a result of an intercompany sale of assets. The 17% income tax rate for the nine months ended July 4, 2014 was lower than our estimated normalized effective income tax rate of 38% for fiscal year 2014 primarily due to discrete income tax benefits of $3.4 million from the expiration of the statute of limitations for an unrecognized tax benefit and a $1.0 million provision to tax return true-up from filing U.S. fiscal year 2013 income tax returns. The increase in our estimated normalized tax rate of 38% for fiscal year 2014 to approximately 50% for fiscal year 2015 is primarily due to foreign tax credit limitations.

Net Income. Net income was $3.3 million, or 1.0% of sales, for the nine months ended July 3, 2015 compared to $12.5 million, or 3.4% of sales, for the nine months ended July 4, 2014. The $9.2 million decrease in net income was primarily due to lower gross profit from lower shipment volume and a less favorable mix of product shipments, higher interest expense due primarily to the April 7, 2014 debt restructuring, higher acquisition-related expenses and a higher increase in the fair value of the Radant contingent consideration liability, partially offset by the absence of a loss on debt extinguishment and a charge for utilization of the net increase in cost basis of inventory acquired in the Radant acquisition, lower management incentive accruals and the favorable effect of expenses denominated in foreign currencies due to the strength of the U.S. dollar for the nine months ended July 3, 2015 compared to the nine months ended July 4, 2014.

EBITDA. EBITDA was $49.6 million, or 15.1% of sales, for the nine months ended July 3, 2015 compared to $56.2 million, or 15.4% of sales, for the nine months ended July 4, 2014. The $6.6 million decrease in EBITDA was primarily due to lower gross profit from lower shipment volume and a less favorable mix of products, higher acquisition-related expenses and a higher increase in the fair value of the Radant contingent consideration liability, partially offset by the favorable effect of expenses denominated in foreign currencies due to the strength of the U.S. dollar for the nine months ended July 3, 2015 and the absence of a charge for utilization of the net increase in cost basis of inventory acquired in the Radant acquisition.

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Liquidity and Capital Resources

Overview

Our liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and others that are related to uncertainties in the markets in which we compete and other global economic factors. We have historically financed, and intend to continue to finance, our capital and working capital requirements, including debt service and internal growth, through a combination of cash flows from our operations and borrowings under our senior secured credit facilities. Our primary uses of cash are cost of sales, operating expenses, debt service and capital expenditures.

We believe that cash flows from operations and availability under our revolving credit facility included in our new senior secured credit facilities will be sufficient to fund our working capital needs, capital expenditures and other business requirements for at least the next 12 months. We may need to incur additional financings to make strategic acquisitions or investments or if our cash flows from operations are less than we expect. We cannot be certain that financing will be available to us on acceptable terms or that financing will be available at all.

Our ability to make payments to fund working capital, capital expenditures, debt service, strategic acquisitions, joint ventures and investments will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, regulatory and other factors that are beyond our control. Future indebtedness may impose various restrictions and covenants on us which could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities.

Cash and Working Capital

The following summarizes our cash and cash equivalents and working capital (in millions):



	July 3, 2015		October 3, 2014
Cash and cash equivalents	$	61.3	$	50.6
Working capital	$	133.9	$	128.2

We invest cash balances in excess of operating requirements in overnight U.S. Government securities and money market accounts. In addition to the above cash and cash equivalents, we have restricted cash of $1.7 million as of July 3, 2015, consisting primarily of bank guarantees from customer advance payments to our international subsidiaries and cash collateral for certain performance bonds. The bank guarantees will become unrestricted cash when performance under the sales contract is complete. The cash collateral for the performance bonds will become unrestricted cash when the performance bonds expire.

We are highly leveraged. As of July 3, 2015, excluding approximately $5.6 million of outstanding letters of credit, our total indebtedness was $521.1 million before the total unamortized debt discount of $4.3 million. We also had an additional $24.4 million available for borrowing under our revolving credit facility as of July 3, 2015. Our liquidity requirements are significant, primarily due to debt service requirements. For the three and nine months ended July 3, 2015, our interest expense exclusive of debt issue costs and discount amortization was $8.1 million and $24.2 million, respectively, and our cash interest paid was $3.4 million and $19.5 million, respectively. With the increase in the amount of our indebtedness and the increase in the interest rate on the Senior Notes resulting from our April 2014 debt refinancing transaction, we expect interest expense in fiscal year 2015 to increase compared to fiscal year 2014.

As of July 3, 2015, we were in compliance with the covenants under the agreements governing our senior credit facilities and the indentures governing the Senior Notes.

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Historical Operating, Investing and Financing Activities

In summary, our cash flows were as follows (in millions):



	Nine Months Ended
	July 3, 2015			July 4, 2014
Net cash provided by operating activities	$	17.7		$	39.6
Net cash used in investing activities	(4.7		)	(41.4		)
Net cash used in financing activities	(2.3		)	(24.8		)
Net increase (decrease) in cash and cash equivalents	$	10.7		$	(26.6	)

Operating Activities

During the periods presented above, we funded our operating activities through cash generated internally. Cash provided by operating activities is net income adjusted for certain non-cash items and changes to working capital items.

Net cash provided by operating activities of $17.7 million in the nine months ended July 3, 2015 was attributable to net income of $3.3 million and depreciation, amortization and other non-cash charges of $20.7 million, partially offset by net cash used in working capital of $6.3 million. The primary uses of cash for working capital during the nine months ended July 3, 2015 were an increase in inventories and accounts receivable and a decrease in accounts payable and advance payments from customers. Inventories increased in anticipation of fulfilling certain customer orders. Accounts receivable increased due to the timing factors associated with shipments and sales. Accounts payable decreased primarily as a result of a timing difference in the payment of various professional service fees. Advance payments from customers decreased due to timing differences in billing and receipt of contract advances.

Net cash provided by operating activities of $39.6 million in the nine months ended July 4, 2014 was attributable to net income of $12.5 million and depreciation, amortization and other non-cash charges of $27.7 million, partially offset by net cash used in working capital of $0.6 million. The primary uses of cash for working capital during the nine months ended July 4, 2014 were an increase in prepaid income taxes, a decrease in uncertain tax position reserves and a decrease in accounts payable. The timing of tax payments and tax liability estimates brought about the increase in prepaid income taxes. The decrease in reserves for uncertain tax positions was primarily due to the statute of limitation expiration. Accounts payable decreased primarily as a result of a timing difference in inventory purchases and the payment of various professional service fees. The aforementioned uses of working capital were significantly offset by the improved collection of accounts receivable and an increase in accrued interest resulting from the April 7, 2014 debt restructuring activities.

Investing Activities

Investing activities for the nine months ended July 3, 2015 comprised capital expenditures of $4.7 million. Investing activities for the nine months ended July 4, 2014 comprised a payment of $36.8 million made for the purchase of the outstanding stock of Radant and capital expenditures of $4.6 million.

Financing Activities

Financing activities for the nine months ended July 3, 2015 comprised repayment of borrowings under CPII’s new term loan facilities of $2.3 million.

Financing activities for the nine months ended July 4, 2014 comprised a dividend payment of $175.0 million, repayments of borrowings under CPII’s prior and new term loan facilities of $144.2 million and $0.8 million, respectively, and payments of various costs totaling $14.1 million associated with the April 7, 2014 debt restructuring activities. These financing uses of cash were significantly offset by $309.2 million in net proceeds from borrowings under the new term loan facility.

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Contractual Obligations

The following table summarizes our significant contractual obligations and the effect that such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):



			Fiscal Year
	Total		2015 (remaining three months)		2016-2017		2018-2019		Thereafter
Operating leases	$	9,110	$	699	$	4,162	$	1,894	$	2,355
Purchase commitments	45,615		27,345		18,270		—		—
Debt obligations	521,125		775		6,200		514,150		—
Interest on debt obligations	87,659		12,922		64,265		10,472		—
Uncertain tax positions, including interest	1,693		—		1,693		—		—
Contingent consideration	10,000		—		10,000		—		—
Total cash obligations	$	675,202	$	41,741	$	104,590	$	526,516	$	2,355
Standby letters of credit	$	5,614	$	5,614

The above table assumes (i) that the respective debt instruments will be outstanding until their scheduled maturity dates, (ii) a debt level based on mandatory repayments according to the contractual amortization schedule of our new senior credit facilities, and (iii) that interest rates in effect on July 3, 2015 remain constant for future periods. The above table excludes (i) any optional and excess cash flow prepayments on our new term loan facility, and (ii) the effect of our contractual right to repay or refinance the Senior Notes by November 17, 2017, which would extend the maturity date for the term loan facility from November 2017 to April 2021.

The contingent consideration in the above table relates to our purchase of all of the outstanding stock of Radant in October 2013. In connection with, and as part of the consideration for, the acquisition, we expect that we will be required to pay the previous owners of Radant additional consideration of $10.0 million at the end of December 2015 upon the achievement of certain financial targets by Radant over the two years following the date of acquisition. See Note 4, Financial Instruments, to the accompanying unaudited condensed consolidated financial statements for information regarding the contingent consideration.

The unrecognized tax benefits, including interest and penalties, shown in the above table, represent unrecognized tax benefits related to temporary differences. The years for which the temporary differences related to the unrecognized tax benefits will reverse have been estimated in scheduling the obligation within the table.

The expected timing of payment amounts of the obligations in the above table is estimated based on current information; the actual timing and amount of payments may be different.

As of July 3, 2015, there were no material changes to the contractual obligations not mentioned in the above table from what we disclosed in our Annual Report on Form 10-K for the fiscal year ended October 3, 2014 filed with Securities and Exchange Commission.

Capital Expenditures

Our continuing operations typically do not have large recurring capital expenditure requirements. Capital expenditures are generally made to replace existing assets, increase productivity, facilitate cost reductions or meet regulatory requirements. Total cash capital expenditures for the three and nine months ended July 3, 2015 were $1.6 million and $4.7 million, respectively. For fiscal year 2015, ongoing capital expenditures are expected to be approximately $6.5 million to $7.5 million and to be funded by cash flows from operating activities.

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Recent Accounting Pronouncements

See Note 2, Recently Issued Accounting Standards, to the accompanying unaudited condensed consolidated financial statements for information regarding the effect of new accounting pronouncements on our financial statements.

Critical Accounting Policies and Estimates

Our Critical Accounting Policies and Estimates have not changed from those reported in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended October 3, 2014.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We do not use market risk sensitive instruments for trading or speculative purposes.

Interest rate risk

Our exposure to market risk for changes in interest rates relates primarily to our long-term debt. As of July 3, 2015, we had (i) fixed-rate senior notes of $211.4 million (net of the unamortized original issue discount of $3.6 million) due in 2018, bearing interest at 8.75% per year, and (ii) under our senior secured credit facilities, a variable–rate term loan of $305.5 million (net of $0.7 million unamortized original issue discount). Our variable rate debt is subject to changes in the LIBOR rate. As of July 3, 2015, the variable interest rate on the term loan under our senior secured credit facilities was 4.25%.

We performed a sensitivity analysis to assess the potential loss in future earnings that a 10 basis points increase in the variable portion of interest rates over a one-year period would have on our term loan under our new senior secured credit facilities. The impact was determined based on the hypothetical change from the end of period market rates over a period of one year and would result in no change in future interest expense, as a 10 basis points increase in the current variable interest rate would not increase the rate above the “LIBOR floor” in the senior secured credit facilities. Based on the current provisions of our term loan, the LIBOR rate would have to increase to 1% before impacting our future interest expense.

Foreign currency exchange risk

Although the majority of our revenue and expense activities are transacted in U.S. dollars, we do transact business in foreign countries. Our primary foreign currency cash flows are in Canada and several European countries. In an effort to reduce our foreign currency exposure to Canadian dollar denominated expenses, we enter into Canadian dollar forward contracts to hedge the Canadian dollar denominated costs for our manufacturing operation in Canada. Our Canadian dollar forward contracts are designated as a cash flow hedge and are considered highly effective. At July 3, 2015, the fair value of foreign currency forward contracts comprised short- and long-term liabilities of $1.3 million (accrued expenses) and $0.1 million (other long-term liabilities), respectively. Unrealized gains and losses from foreign exchange forward contracts are included in accumulated other comprehensive loss in the condensed consolidated balance sheets. At July 3, 2015, the unrealized loss, net of tax of $0.5 million, was $1.4 million. We anticipate recognizing the entire unrealized gain or loss in operating earnings within the next six fiscal quarters. Changes in the fair value of foreign currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and are immediately recognized in general and administrative expenses in the condensed consolidated statements of comprehensive income. The time value was not material for all periods presented. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, then we promptly recognize the gain or loss on the associated financial instrument in general and administrative expenses in the condensed consolidated statements of comprehensive income. No ineffective amounts were recognized due to anticipated transactions failing to occur for the three and nine months ended July 3, 2015.

As of July 3, 2015, we had entered into Canadian dollar forward contracts for nominal values of approximately $50.1 million (Canadian dollars), or approximately 73% of estimated Canadian dollar denominated expenses for July 2015 through September 2016, at an average rate of approximately 0.82 U.S. dollars to one Canadian dollar. We estimate the impact of a one cent change in the U.S. dollar to Canadian dollar exchange rate (without giving effect to our Canadian dollar forward contracts) to be approximately $0.3 million annually to our net income.

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Item 4. Controls and Procedures

Our management, including our principal executive officer and principal financial officer, has evaluated, as of the end of the period covered by this report, the effectiveness of the design and operation of our disclosure controls and procedures with respect to the information generated for use in this report. Based upon, and as of the date of, that evaluation, the principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There have been no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter 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

None.

Item 1A. Risk Factors

For a discussion of risk factors, see “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended October 3, 2014. There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our 2014 Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits



No.		Description
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-15(e) and Rule 15d-15(e), promulgated under the Securities Exchange Act of 1934, as amended.
31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-15(e) and Rule 15d-15(e), promulgated under the Securities Exchange Act of 1934, as amended.
32.1*		Certifications of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certifications of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document

* 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.



		CPI INTERNATIONAL HOLDING CORP.



Dated:	August 11, 2015	/s/ JOEL A. LITTMAN
		Joel A. Littman
		Chief Financial Officer, Treasurer and Secretary
		(Duly Authorized Officer and Chief Financial Officer)

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CPI International Holding Corp. - FORM 10-Q - August 11, 2015

Attached files

CPI International Holding Corp. Reports